The Company leases approximately 49,500 square feet of office space, including its corporate headquarters located in New York, New York and underwriting offices located in Woodland Hills, California and Hoboken, New Jersey. The headquarters in New York, which consists of 3,900 square feet, is leased for a term ending in the year 1999. The Woodland Hills office space consists of 30,275 square feet and is leased for a term ending in the year 2008. The Hoboken office space consists of 13,525 square feet and is leased for a term ending in the year 2000. The Company also leases small regional offices in Grand Rapids, Michigan and Denver, Colorado.
The significant accounting policies followed by the Company are summarized below.
Direct, assumed and ceded property and liability insurance premiums written are recognized as earned on a pro rata basis over the terms of the policies. Unearned premiums are calculated principally by the application of pro rata fractions and represent the portion of premiums written that is applicable to unexpired terms of policies in force.
Recoverable policy acquisition costs that vary with and are directly related to the production of business, consisting of commissions, premium taxes and other underwriting expenses incurred, net of ceding allowances, are deferred and amortized to income as the related premiums are earned. The Company does not consider anticipated investment income when determining the recoverability of amounts deferred. Amortization of deferred policy acquisition costs amounted to $34.0 million, $30.1 million, and $26.7 million for the years ended December 31, 1997, 1996 and 1995, respectively.
To limit its risks, the Company acquires reinsurance coverage with retentions and limits that management believes are appropriate for the circumstances. Reinsurance arrangements effected under quota-share reinsurance contracts and excess-of- loss reinsurance contracts provide for greater diversification of business, allow management to control exposure to potential losses arising from large risks, and provide additional capacity for growth. The accompanying consolidated financial statements reflect premiums earned, losses and loss adjustment expenses ("LAE") and underwriting, acquisition and insurance expenses, net of reinsurance ceded. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policies.
The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.
The Company's securities are classified as available for sale and reported at fair value, with unrealized gains and losses, net of deferred income taxes, included in stockholders' equity.
Fair values are based on quoted market prices, when available, or estimates based on market prices for similar securities, when quotes are not available. Short-term investments are carried at cost, which approximates their fair value. Realized gains and losses from sales or liquidations of investments are determined on the basis of the specific identification method and are included in net income. Investment income is recognized when earned. The amortization of premium and accretion of discount for fixed maturity securities are computed utilizing the interest method.
The Company wrote policies with environmental impairment and asbestos-related exposures at high attachment levels and obtained reinsurance coverage reducing its net retention to $50,000 per occurrence. Among the complications of reserving for this type of business are a lack of sufficient historical data, long reporting delays, uncertainty as to the number and identity of insureds with potential exposure, and complex, unresolved legal issues regarding policy coverage and the extent and timing of any such contractual liability. Courts have reached different and sometimes inconsistent conclusions as to when a loss occurred and which policies provide coverage, which claims are covered, whether there is an insured obligation to defend, how policy limits are determined, how policy exclusions are applied and interpreted, and whether clean-up costs are includible as insured property damage. These legal issues are not likely to be resolved in the near future.
Transactions denominated in foreign currencies are translated at the rate of exchange at the transaction date. Revenues and expenses are translated at average exchange rates. Assets and liabilities are translated at the exchange rates in effect at the balance sheet date.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income", which requires enterprises to disclose comprehensive income and its components in a prominent position on the face of the financial statement. The Company will implement this statement in 1998. This statement relates to presentation of information and will have no impact on results of operations or financial condition.
The major categories of net investment income are summarized as follows:
At December 31, 1997, the amortized cost and estimated fair value of fixed maturities, by contractual maturity, are shown below. Expected maturities, which are best estimates, will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without prepayment penalties.
At December 31, 1997, investments in Federal National Mortgage Association securities aggregating $11.8 million represented the only investments in any entity in excess of 10.0% of stockholders' equity other than those investments issued or guaranteed by the U.S. government.
At December 31, 1997 and 1996, securities with a fair value of approximately $19.3 million and $18.6 million, respectively were on deposit with various state or governmental insurance departments in order to comply with statutory insurance laws.
At December 31, 1997, the reserve for unpaid asbestos- related losses and related LAE was $1.7 million, net of reinsurance recoverables deemed probable of collection by the Company of approximately $2.5 million. The range of gross reserves for unpaid asbestos-related losses and LAE is estimated to be $4.2 million to $9.4 million and the range of reserves, net of reinsurance recoverable, for unpaid asbestos-related losses and LAE is estimated to be approximately $1.7 million to $3.3 million.
There are significant uncertainties in estimating the amount of the Company's environmental impairment and asbestos- related liabilities resulting from a lack of historical data, long reporting delays, uncertainty as to the number and identity of insureds with potential exposure, and complex, unresolved legal issues regarding policy coverage and the extent and timing of any such contractual liability. Courts have reached different and sometimes inconsistent conclusions as to when a loss occurred and what policies provide coverage, what claims are covered, whether there is an insured obligation to defend, how policy limits are determined, how policy exclusions are applied and interpreted, and whether cleanup costs are includible as insured property damage. These issues are not likely to be resolved in the near future. As a result of these issues, the ultimate number and cost of these claims may generate losses that vary materially from the amounts currently recorded and could have a material adverse effect on the Company's results of operations and financial condition. While management believes the Company's reserves for these coverages are appropriately established, because of the uncertainty of circumstances surrounding many critical factors that affect environmental impairment and asbestos-related liabilities, there can be no assurance that the Company's reserves for and losses from these claims will not increase in the future.
Certain premiums and losses are assumed from and ceded to other insurance companies under various reinsurance agreements. The Company cedes a portion of its business through quota share treaties, excess of loss treaties and facultative placements, and generally retains net amounts of risk ranging from $100,000 to $500,000 per risk.
The following table sets forth the significant reinsurance receivables due from reinsurers as of December 31, 1997.
The amount and cost of reinsurance available to companies specializing in property and casualty insurance are subject, in large part, to prevailing market conditions beyond the control of the Company. The Company's ability to provide insurance at competitive premium rates and coverage limits on a continuing basis depends to a significant extent upon its ability to obtain adequate reinsurance in amounts and at rates that will not adversely affect its competitive position.
Effective October 1, 1996, the Company's reinsurance program was restructured to provide protection for loss events covering property and casualty classes of business, excluding DIC and certain other property business. The program provides for $24.5 million of coverage in excess of a new retention of $500,000 for each and every event. Certain business is covered by a quota share treaty that limits the Company's net retention per risk to a maximum of $250,000.
Reinsurance ceded contracts do not relieve the Company of its obligations to policyholders. The Company remains liable to its policyholders for the portion reinsured to the extent that any reinsurer does not meet its obligations for reinsurance ceded to it under the reinsurance agreements. Failure of reinsurers to honor their obligations could result in losses to the Company. In addition, as is often the case in the normal course of business, the Company is involved in disputes with reinsurers regarding certain loss recoverables. Although the Company believes that such issues will be resolved in the Company's favor, there can be no assurance that the Company will prevail; an unfavorable resolution could have a material effect on the Company's financial statements.
The Company follows SFAS No. 119, "Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments." SFAS No. 119 requires disclosure of an estimate of the fair value of financial instruments. The Statement defines the fair value of financial instruments as the amount at which the instruments could be exchanged in a current transaction between willing parties. The following table summarizes the carrying amount and estimated fair value of the Company's financial instruments at December 31, 1997 and 1996.
The Company and its subsidiaries lease certain office facilities and computer equipment. Minimum rental commitments for these leases, exclusive of escalations due to real estate taxes and operating expenses, are as follows:
Year ending December 31, (Dollars in thousands) 1998 $1,163 1999 1,130 2000 964 2001 755 2002 784 Thereafter 4,728 $9,524
Total rent expense for all leases was $1,469,000, $1,310,000 and $959,000 in 1997, 1996 and 1995, respectively.
Under state insurance laws of Pennsylvania, the maximum amount of dividends which can be paid by Pennsylvania-domiciled insurance companies without prior approval of the Insurance Commissioner is limited to the greater of 10% of surplus as regards policyholders as of the preceding year end or the insurance company's net income for the previous year. Under state insurance laws of California, Associated is permitted to pay as dividends to the Company, after advance notice to the California Insurance Department, an amount equal to the greater of 10% of Associated's policyholders surplus at the end of the preceding year or its statutory net income for the preceding year. Dividends in excess of these amounts require the prior approval of the California Insurance Department. Dividends may be paid only out of earned surplus. As such, at December 31, 1997, the maximum amount of dividends that Associated could pay in 1998 without California Insurance Department approval amounted to approximately $9.0 million and the maximum amount of dividends that Calvert could pay in 1998 without Pennsylvania Insurance Department approval amounted to approximately $2.0 million.
If a person or group acquires 20% or more of the Common Stock, the rights will entitle a holder (other than the acquiring person or group of acquiring persons) to buy shares of Common Stock having a market value of twice the exercise price of the right. If the Company is subsequently involved in a merger or other business combination with a holder of 20% or more of the stock of the Company, the rights will entitle a holder to buy shares of common stock of the acquiring corporation having a market value of twice the exercise price of the right.
Property and equipment, included in Other assets in the balance sheet, is comprised of the following:
The Company's restricted stock award plan provides for the granting of up to 100,000 shares of common stock to key employees, subject to restrictions as to continuous employment except in the case of death or normal retirement. Restrictions generally expire over a five-year period from date of grant. Compensation expense is recognized over the restriction period. As of December 31, 1997, 76,500 shares are available for issuance under the plan.
The pro forma net income and basic earnings per share determined consistent with SFAS No. 123 is as follows:
The weighted average fair value of options granted during 1997, 1996 and 1995 were $6.62, $7.64 and $6.29, respectively. The Black-Scholes option-pricing model was used with the following weighted average assumptions: volatility of 22.8%, and risk-free interest rate of 5.99% in 1997; volatility of 24.3%, and risk-free interest rate of 6.81% in 1996; volatility of 24.3%, and risk-free interest rate of 6.18% in 1995. For all periods, a seven-year life is assumed.
The Company maintains a defined contribution retirement 401(k) & Profit Sharing Plan. Participation in the plan is available to all employees upon their satisfaction of specified eligibility requirements. Under the 401(k) component of the plan, the Company matches, on a dollar-for-dollar basis, each employee's contribution up to 3% of eligible compensation. Under the profit sharing component of the plan, annual contributions may be authorized by the Board of Directors based upon the Company's performance for the relevant year. The Company's costs are charged to income and amounted to $0.5 million in 1997, $0.5 million in 1996 and $0.4 million in 1995.
Gross premiums written in the State of California amounted to approximately $59,696,000, $68,663,000 and $76,396,000 in 1997, 1996 and 1995, respectively. In the State of New York, the Company's gross premiums written were $11,190,000, $11,975,000 and $20,141,000 for the years ended December 31, 1997, 1996 and 1995, respectively. Gross premiums written in any other state do not exceed 10% of gross premiums written.
The Company's architects' and engineers' professional liability insurance business is produced by Risk Administration and Management Company ("RAMCO"), an unaffiliated managing general agent. For the years ended December 31, 1997, 1996 and 1995, direct premiums written by RAMCO for the Company amounted to approximately $17,704,000, $17,843,000 and $14,452,000, respectively.
Quarterly financial information (unaudited) for the year ended December 31, 1996 is presented below: