Gross premiums written in 1996 increased 13.1% to $98.6 million from $87.2 million in 1995. Total premium writings in 1996 benefitted from a 19.2% increase in non-municipal reinsurance writings and a 22.8% increase in the Company's other insurance lines.
The volume of municipal bonds issued in 1996 increased by 15.0% over 1995 issuance to $184.4 billion. Bonds issued for new money purposes, increased to $126.7 billion in 1996 from the 1995 level of $112.5 billion. The insured portion of new issues rose to 46.2% in 1996 from 42.7% in 1995. Total municipal bond refundings in 1996 represented 23.9% of new-issue volume compared to 21.0% in 1995.
Net Premiums Written (in thousands) 1996 1995 - ----------------------------------- ---- ---- Municipal Reinsurance ...................... $41,147 $39,768 Non-Municipal Reinsurance .................. 17,379 13,497 Other Insurance Lines ...................... 37,136 29,723 ------- ------- $95,662 $82,988 ======= =======
The Company's other insurance lines include direct municipal bond insurance, credit reinsurance, financial responsibility, excess-SIPC/excess-ICS and other surety lines. Net premiums written from these businesses have grown from $8.6 million (15.6%) in 1991 to $37.1 million (38.8%) in 1996. The Company expects that these other insurance lines will continue to contribute a significant component of its premium revenues. In connection with certain of its other insurance lines, the Company underwrites with the anticipation of higher loss levels than those associated with its core municipal and non-municipal reinsurance business. The Company takes into account these higher loss levels in determining appropriate premium rates.
Net premiums earned grew 23.0% to $77.4 million in 1996 from $62.9 million in 1995. This growth in premiums earned was in large part attributable to increased earnings from the Company's other insurance lines as discussed in the preceding paragraph. The following table shows net premiums earned by line of business for the periods presented:
Net Premiums Earned (in thousands) 1996 1995 - ---------------------------------- ---- ---- Municipal Reinsurance ...................... $34,405 $29,489 Non-Municipal Reinsurance .................. 13,002 9,445 Other Insurance Lines ...................... 30,026 24,016 ------- ------- $77,433 $62,950 ======= =======
Net investment income increased 9.0% to $48.1 million in 1996 from $44.2 million for 1995 consistent with the growth in invested assets in the period. The average yields on the Company's investment portfolio, after deducting associated costs, were 6.4% for each of the years ended December 31, 1996 and 1995, respectively. In addition, the Company realized $4.0 million and $3.5 million of net capital gains in 1996 and 1995, respectively. Net investment income is presented after deduction of both external investment management fees and internal costs associated with managing the portfolio.
Incurred losses and loss adjustment expenses ("LAE") were $9.2 million in 1996 compared with $9.5 million in 1995. Of these amounts, $7.3 million and $6.1 million were incurred in connection with the Company's credit and surety businesses in 1996 and 1995, respectively. The Company believes that the reserves for losses and LAE, including case and non-specific reserve, are adequate to cover the ultimate net
cost of claims. However, the reserves are necessarily based on estimates, and there can be no assurance that the ultimate liability will not exceed such estimates.
The Company's operating expense ratio for 1996 was 52.6% compared to 54.2% in 1995. Policy acquisition costs, which vary with and are directly related to the generation of new and renewal premiums, totaled $26.7 million and $21.1 million in 1996 and 1995, respectively, representing 34.5% and 33.4% of premiums earned in those respective periods. Other operating expenses increased only marginally to $13.2 million in 1996 and $12.7 million in 1995.
The Company's specialty businesses include direct municipal bond insurance, credit reinsurance, financial responsibility, excess-SIPC/excess-ICS and other surety lines. Net premiums written from these businesses have grown from $8.6 million (15.6%) in 1991 to $29.7 million (35.8%) in 1995. The Company expects that these specialty businesses will continue to contribute a significant component to its revenues. The Company underwrites certain of its specialty businesses with the anticipation of higher loss levels than those associated with its core municipal and asset-backed reinsurance business. The Company takes these higher loss levels into account in determining appropriate premium rates.
Net premiums earned grew 1.9% to $62.9 million in 1995 from $61.8 million in 1994. Growth in premiums earned was achieved despite a $6.0 million decline in refundings, which accounted for only 9.0% of earned premiums in 1995 compared with 18.9% of premiums earned in 1994. A refunding eliminates the Company's reinsurance exposure to the refunded obligation, with the result that the Company recognizes in current earnings the remaining related deferred premium revenue. Excluding the impact of refundings, premiums earned were up 14.3% over the prior year. The growth in premiums earned also reflects the amortization of the deferred premium revenue balance, which has grown to $248.1 million at year-end 1995 from $227.9 million at year-end 1994.
Incurred losses and LAE were $9.5 million in 1995 compared with $22.8 million in 1994. Of these amounts, losses and LAE incurred in connection with the Company's discontinued commercial real estate-related portfolio aggregated $9.5 million in 1994 compared with $1.2 million in 1995. In addition, in 1995 and 1994, the Company incurred losses and LAE of $5.4 million and $5.7 million, respectively, in connection with its credit and surety businesses commensurate with the growth in premiums written from these businesses.
The Company's operating expense ratio was 54.2% in 1995 compared to 55.5% in 1994. Policy acquisition costs, which vary with and are directly related to the generation of new and renewal premium, totaled $21.1 million and $20.3 million in 1995 and 1994, respectively, representing 33.4% and 32.8% of premiums earned in those respective periods. Other operating expenses increased only marginally to $12.7 million in 1995 from $12.5 million in 1994.
Payment of dividends to Enhance Financial by the Insurance Subsidiaries are subject to restrictions relating to statutory capital and surplus and net investment income. Enhance Re declared and paid a total of $13.3 million in dividends in 1996. Asset Guaranty has not paid any dividends since its inception. As of December 31, 1996, under the Insurance Law, Enhance Financial had $21.2 million available from the Insurance Subsidiaries, compared with $20.8 million available as of December 31, 1995. Payments of dividends by Enhance Financial to its shareholders are further restricted by the terms of the Credit Agreement. At December 31, 1996, the maximum amount of dividends which may be paid by Enhance Financial to its shareholders in compliance with the terms of such agreement was $31.2 million.
As of December 31, 1996, the statutory policyholders' surplus of Enhance Re and Asset Guaranty were $225.3 million and $86.7 million, respectively, compared to the minimum $68.4 million required by each under the Insurance Law.
Consolidated Statements of Income for the Years Ended December 31, 1996, 1995, and 1994 35
Consolidated Statements of Shareholders' Equity for the Years Ended December 31, 1996, 1995, and 1994 36
We have audited the accompanying consolidated balance sheets of Enhance Financial Services Group Inc. and Subsidiaries (the "Company") as of December 31, 1996 and 1995 and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
Deloitte & Touche LLP March 3, 1997 New York, New York
ENHANCE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Notes to Consolidated Financial Statements Years Ended December 31, 1996, 1995 and 1994
The accompanying financial statements include the accounts of Enhance Financial, the Insurance Subsidiaries and Van-Am (collectively the "Company"). All significant intercompany accounts and transactions have been eliminated. Investments in non-material subsidiaries and in companies which represent from 20% to 50% of their ownership are accounted for in accordance with the equity method of accounting (see Note 5).
In accordance with Statement of Financial Accounting Standards ("SFAS") No. 115 "Accounting For Certain Investments in Debt and Equity Securities," management classifies all securities at the time of purchase as "held to maturity" or "available for sale." Fixed maturity securities held to maturity are those securities which the Company intends and has the ability to hold until maturity and are carried at amortized cost. All other fixed maturity securities are classified as available for sale and carried at market value. Unrealized gains and losses, net of taxes, on the available for sale portfolio are charged or credited to shareholders' equity.
In thousands Year Ended December 31, ---------------------------------- 1996 1995 1994 ---- ---- ----
Direct premiums written .......... $ 10,178 $ 12,313 $ 12,311 Assumed premiums written ......... 88,410 74,846 72,801 Reinsured ceded .................. (2,518) (2,995) (3,546) Return premiums/refundings ....... (408) (1,176) (881) --------- -------- -------- Net premiums written ............. $ 95,662 $ 82,998 $ 80,685 ========= ======== ========
Deferred policy acquisition costs comprise those expenses that vary with and are primarily related to the production of business, including: commissions paid on reinsurance assumed, salaries and related costs of underwriting and marketing personnel, rating agency fees, premium taxes and certain other underwriting expenses, offset by ceding commission income on premiums ceded to reinsurers. Acquisition costs are deferred and amortized over the period in which the related premiums are earned. Deferred policy acquisition costs are reviewed periodically to determine that they do not exceed recoverable amounts.
The Internal Revenue Code permits municipal bond insurance companies to deduct from taxable income, subject to certain limitations, the amounts added to the statutory mandatory contingency reserve during the year. The deduction taken is allowed only to the extent that U.S. Treasury non-interest-bearing tax and loss bonds are purchased at their par value prior to the original due date of the Company's consolidated federal tax return and held in an amount equal to the tax benefit attributable to such deductions. The amounts deducted must be included in taxable income when the contingency reserve is released, at which time the Company may redeem the tax and loss bonds to satisfy the additional tax liability. Purchases of tax and loss bonds are recorded as payments of federal income taxes and are not reflected in the Company's current tax provision.
The Company provides various post-retirement and post-employment benefits, including pension, health and other insurance benefits covering substantially all employees who meet certain age and service criteria. The Company accounts for these benefits under the accrual method of accounting. Amounts related to the defined benefit pension plan and postretirement benefits are charged based on actuarial determinations.
Primary and fully diluted earnings per share are computed using the treasury stock method to determine the weighted average number of shares of common stock and, where material, common stock equivalents outstanding during each year.
For primary earnings per share, the weighted average number of shares of common stock outstanding were 17,875,000, 17,316,000 and 17,875,000 for the years ended December 31, 1996, 1995 and 1994, respectively. The dilution from the exercise of stock options outstanding was not material.
The consolidated financial statements are prepared on the basis of generally accepted accounting principles ("GAAP") which, for the Insurance Subsidiaries, differ in certain material respects from accounting practices prescribed or permitted by insurance regulatory authorities. The significant differences result from the statutory accounting practices which treat premiums earned, policy acquisition costs, deferred income taxes, investments in fixed maturities and loss reserves differently.
The New York Financial Guarantee Insurance Law establishes single risk limits applicable to all obligations issued by a single entity and backed by a single revenue source. Under the limit applicable to municipal bonds, the insured average annual debt service for a single risk, net of reinsurance and collateral, may not exceed 10% of the sum of the insurer's policyholders' surplus and contingency reserves. In addition, insured principal of municipal bonds attributable to any single risk, net of reinsurance and collateral, is limited to 75% of the insurer's policyholders' surplus and contingency reserves. Additional single risk limits, which generally are more restrictive than the municipal bond single risk limit, are also specified for several other categories of insured obligations.
The following is a summary of the Company's investments in fixed maturities at December 31, 1996 and 1995:
In thousands Amortized Market Cost Value -------- -------- Fixed maturities, held to maturity Due in one year or less $ 25,112 $ 25,138 Due after one year through five years 77,272 79,743 Due after five years through ten years 76,979 81,782 Due after ten years 38,329 40,385 -------- -------- $217,692 $227,048 ======== ======== Fixed maturities, available for sale Due in one year or less $ 4,388 $ 4,386 Due after one year through five years 29,020 29,998 Due after five years through ten years 208,724 214,316 Due after ten years 284,841 291,184 -------- -------- $526,973 $539,884 ======== ========
Sources of the Company's consolidated net investment income are as follows:
In thousands Year Ended December 31, ----------------------------- 1996 1995 1994 ---- ---- ----
Under agreements with its cedants and in accordance with statutory requirements, the Insurance Subsidiaries maintain funds (bonds, common stocks, cash equivalents) in trust accounts principally for the benefit of reinsured companies and for the protection of policyholders in states in which the Insurance Subsidiaries are not licensed. The carrying amount of such restricted balances amounted to approximately $212 million and $162 million at December 31, 1996 and 1995 respectively.
In 1990, the Company acquired $5.3 million of face value 9% cumulative senior preferred shares (accounted for at cost) and $0.3 million of face value convertible preferred shares of Van-Am, an insurance holding company.
Year Ended December 31, -------------------------------------- In thousands 1996 1995 1994 ------- ------- ------ Tax provision at statutory rate $ 26,736 $ 22,344 $ 11,431 Tax exempt interest and dividends (6,492) (5,816) (6,095) Other, net 442 15 758 -------- -------- -------- Actual tax $ 20,686 $ 16,543 $ 6,094 ======== ======== ========
December 31, 1996 December 31, 1995 ----------------- ----------------- In thousands Assets Liabilities Assets Liabilities ------- ----------- ------- -----------
Contingency reserves $36,920 $31,364 Deferred policy acquisition costs 30,564 28,319 Deferred premium revenue 7,841 7,383 Unrealized capital gains 4,522 6,349 Tax and loss bonds $19,565 $17,896 Alternative minimum tax credit carryforward 4,900 6,400 Losses and LAE reserves 4,575 3,360 Deferred income 2,137 2,475 Other 5,472 3,204 5,817 1,731 ------- ------- ------- ------- $36,649 $83,051 $35,948 $75,146 ======= ======= ======= =======
December 31, --------------------------- 1996 1995 ------- ------- In thousands Debentures, due 2003 $75,000 $75,000 1991 Notes, due 1996 1,400 1991 Note, due 2001 2,000 ------- ------- Total $75,000 $78,400 ======= =======
Enhance Financial is a party to a credit agreement (the "Credit Agreement") with a major commercial bank allowing Enhance Financial to borrow up to $60 million (increased from $30 million in October 1996) to be used for general corporate purposes. The Credit Agreement provides for a revolving credit facility under which individual advances may be converted, at Enhance Financial's discretion, into four-year term loans. Interest on advances under the Credit Agreement is payable at the average of the then-current Eurodollar rate on dollar deposits adjusted to reflect regulatory reserve requirements, plus a margin equal to (i) .4% for advances under the revolving credit facility or (ii) .5% for amounts outstanding under any term loan. Borrowings under the Credit Agreement are conditioned on, among other things, the pledge by Enhance Financial of the common stock of Enhance Re. The Credit Agreement prohibits the Company from incurring additional indebtedness to the extent the resulting total would exceed 25% of the Company's total capitalization as defined and includes certain covenants, none of which significantly restrict the Company's operating activities or dividend-paying ability. Enhance Financial borrowed under the Credit Agreement $3 million in 1994, an additional $12 million in 1995 and a further $27.5 million net in 1996, all of which was outstanding at December 31, 1996.
In June 1996, Enhance Financial's charter was amended to authorize the issuance of up to 5,000 shares of preferred stock, the terms of which are determined by the board of directors upon issuance.
Long-term debt - The fair value is estimated based on the quoted market prices for the same or similar issue or on the current rates offered to the Company for debt of the same remaining maturities.
Short-term debt - The fair value of short-term debt, which bears interest at variable rates, is assumed to equal the carrying value of the debt.
The Company's potential liability in the event of nonperformance by the issuer of the insured obligation is represented by its proportionate share of the aggregate outstanding principal and interest payable ("insurance in force") on such insured obligation. At December 31, 1996, the Company's aggregate insurance in force was $56.6 billion. The Company's insured portfolio as of December 31, 1996 was broadly diversified by geographic and bond market sector with no single credit representing more than 1% of the Company's net insurance in force.
TYPE OF ISSUE In billions December 31, ------------------------ 1996 1995 --------- --------- General obligation and other tax backed $ 15.8 $ 15.6 Non-municipal 12.2 11.0 Utilities 9.2 8.9 Health care 6.2 6.3 Airport/Transportation 5.9 5.2 Housing 1.5 1.4 Other municipal 2.3 2.2 Other insurance businesses 3.5 2.8 --------- --------- Total $ 56.6 $ 53.4 ========= =========
The Company controls its exposure to credit risk through a structured underwriting process which includes detailed credit analysis, review of primaries' underwriting guidelines, surveillance policies and procedures, and the use of reinsurance.
The Company maintains a non-contributory defined benefit pension plan for the benefit of all eligible employees. Employer contributions are based upon a fixed percentage of employee salaries
determined at the discretion of the Company. Plan assets consist primarily of U.S. government and corporate debt securities.
The actuarially computed net pension cost for 1996, 1995, and 1994 using the projected unit credit actuarial method of attribution includes the following components:
Actuarial assumptions utilized to determine the projected benefit obligation and estimated unrecognized net (gain) loss were as follows:
The net post-retirement benefit cost for 1996, 1995 and 1994 was $118,000, $105,000, and $88,000, respectively, and includes service cost, interest cost and amortization of the transition obligation.
Outstanding at beginning of year 1,944,759 $14.50 - $20.25 Granted - Employees 490,350 $17.25 - $23.875 - Directors 30,000 $26.625 Exercised (24,575) $14.50 - $20.25 Expired or canceled (24,813) $16.00 - $20.25 --------- Outstanding at year-end 2,415,721 $14.50 - $26.625 --------- Exercisable at year-end - Employees 1,166,213 $14.50 - $20.25 - Directors 114,333 $17.125 - $19.875 ---------
Outstanding at beginning of year 1,502,100 $14.50 - $20.25 Granted - Employees 459,100 $16.00 - Directors 30,000 $17.125 Exercised (3,275) $14.50 Expired or canceled (43,166) $14.50 - $20.25 --------- Outstanding at year-end 1,944,759 $14.50 - $20.25 --------- Exercisable at year-end - Employees 250,026 $14.50 - $20.25 - Directors 83,333 $19.50 - $19.875 ---------
Rent expense was $1,139,000, $1,236,000 and $1,515,000 for the years ended December 31, 1996, 1995 and 1994, respectively, net of sublease income.
According to the terms of a number of the Company's treaty reinsurance contracts, the Company is required to pay the ceding companies a contingent commission based upon a percentage of the net underwriting profit, as defined, accruing to the Company under these treaties. Under the terms of most of these contracts, each individual underwriting year is required to be adjusted no earlier than five years after its inception, and adjustments are to be made annually thereafter until all written premiums are fully earned and all losses are settled.
Total revenues $ 1,312 $ 272 $ 253 Total expenses 12,343 11,321 8,459 -------- -------- -------- (11,031) (11,049) (8,206) Equity in net income of affiliates 61,727 55,873 30,117 -------- -------- -------- Income before income taxes 50,696 44,824 21,911 Income tax benefit 5,008 2,473 4,654 -------- -------- -------- Net income $ 55,704 $ 47,297 $ 26,565 ======== ======== ========
Activity in the liability for losses and loss adjustment expenses ("LAE") is summarized as follows:
In thousands Year Ended December 31, ---------------------------- 1996 1995 1994 ---- ---- ----
The liability for losses and LAE increased by $3.1 million, $6.0 million and $12.9 million in 1996, 1995, and 1994, respectively, principally as a result of changes in estimates of ultimate loss on certain real estate-backed transactions in the Company's discontinued commercial real estate portfolio. The terms "current year" and "prior years" in the foregoing table refer to the year in which case reserves were established.