Republic Indemnity leases office space in Encino (72,000 square feet), San Francisco (57,000 square feet), San Diego (11,000 square feet) and Sacramento (9,000 square feet), California, and Phoenix, Arizona (3,000 square feet) under agreements expiring in 1996, 2001, 1998, 1996 and 2000, respectively.
105,000 acres of these properties remain leased at various royalty rates to coal mining companies under long-term arrangements, including fixed-term leases with renewal options and exhaustion leases.
The Company's real estate inventory at December 31, 1994 included approximately 13,000 acres of real estate (including approximately 50 acres with surplus facilities formerly used in divested operations) spread throughout 13 states.
(1) The Company's principal non-standard automobile insurance operations were acquired on December 31, 1990 in a business acquisition accounted for as a purchase. Results of operations of the acquired businesses are included from the effective date of the acquisition and the net assets of the acquired companies are included as of December 31, 1990. Year-to-year comparisons are also affected by business dispositions and by restructuring provisions and certain unusual charges. See Note 3 of Notes to Financial Statements and "Management's Discussion and Analysis - Results of Operations" for further information. (2) The 1993 results include a $132 million, or $2.74 per share, tax benefit attributable to an increase in the Company's net deferred tax asset. See Note 7 of Notes to Financial Statements and "Management's Discussion and Analysis - Results of Operations". (3) Statutory information is based on domestic insurance operations only. (4) For 1990, the writings to surplus ratio is based on statutory surplus of Republic Indemnity only, excluding the statutory surplus of the NSA Group which was acquired on December 31, 1990, and a reinsurance subsidiary which had insignificant written premiums. (5) Industry information was derived from Best Week Property/Casualty Supplement (January 11, 1995 edition).
NON-INSURANCE OPERATIONS These operations included the manufacture of a variety of industrial products and the providing of other industrial services as well as energy and real estate operations. In connection with the Company's previously announced divestiture effort, all of the industrial businesses have been sold. Two were sold during 1993, two in 1994 and one in February of 1995. Also during 1994, the Company sold its majority interest in operations which provided onshore oil and gas contract drilling and well workover services. These businesses did not comprise reportable industry segments of the Company and, accordingly, are not reportable as discontinued operations.
The $146.8 million increase during 1994 in the cash, short- term investments and marketable securities included in the preceding table was principally attributable to the sale for $176.7 million of the Company's General Cable Corporation ("General Cable") subordinated notes ("General Cable Notes") and General Cable common stock to Wassall PLC ("Wassall"). See Note 3 of Notes to Financial Statements for additional information on the General Cable transaction. The Company also received aggregate proceeds of $34.9 million from the divestiture of three of its non-insurance businesses. These increases in cash, short-term investments and marketable securities were partially offset by purchases of shares of Company Common Stock for $47.7 million and the Company's redemption of all of its outstanding 9 1/2 percent subordinated debentures for $16.2 million plus accrued interest. During the period subsequent to December 31, 1994 through February 13, 1995, the Company purchased 3.3 million shares of its Common Stock for $82.8 million. One of the strategic objectives of the Acquisition of AFC is to provide an opportunity to redeploy most of the Company's substantial Parent Company investment assets to produce a higher rate of return than has been available on the short-term fixed maturity instruments in which they have been invested. This objective is expected to be achieved through the utilization of up to approximately $625 million of the Parent Company investment portfolio to retire relatively expensive AFC and Company long-term debt. Any such assets used to retire AFC debt are expected to be provided for such purpose principally in the form of interest- bearing loans by the Company to AFC or New American Premier. 26PAGE
The Company's Federal income tax loss carryforward is available to offset taxable income and, as a result, the Company's requirement to currently pay Federal income tax is substantially eliminated. It is expected that the 1994 consolidated Federal income tax return will report a remaining net operating loss carryforward currently estimated at approximately $505 million, which will expire at the end of 1996 unless previously utilized. After the Acquisition, it is anticipated that the Company's federal income tax consolidated group will continue to exist, but will not include any companies not presently in the group, except for New American Premier. Accordingly, it is expected that the Company's Federal income tax loss carryforward will continue to offset taxable income of members of the continuing group through 1996, if not fully utilized prior thereto.
where applicable, was paid to the Parent Company through dividends and intercorporate tax allocation payments. The increase in the amount of operating cash flow retained by the insurance operations in 1994, as compared with 1993, is attributable to higher 1994 capital requirements to support net written premium growth in the NSA Group and variations in the timing of intercorporate tax allocation payments. The Company's insurance subsidiaries are restricted as to the amount of stockholder dividends they can pay to the Company without prior regulatory approval. Under these restrictions, the maximum amount of dividends which can be paid to the Company during 1995 by these subsidiaries is $83.8 million. Cash provided by operating activities in 1993 was $86.2 million higher than in 1992. This increase was primarily due to an increase in the insurance operations' operating cash flow at Republic Indemnity and, to a lesser extent, at the NSA Group. Proceeds from payment of the note relating to the prior sale of an offshore drilling rig and the previously mentioned litigation settlement relating to a former subsidiary which was included in the General Cable Spin-off, as well as lower interest payments due to the redemption of the Company's 11 percent subordinated debentures in July 1993, also contributed to the improved operating cash flow. These favorable variances were partially offset by a settlement payment resulting from the termination of a reinsurance contract, lower operating cash flow from the Company's industrial operations and lower interest receipts on the Parent Company investment portfolio.
During 1994, the Company's insurance operations made net purchases of investments of $275.4 million and net purchases of investments for the Parent Company investment portfolio totalled $129.1 million. The Company also used $47.7 million for purchases of shares of Company Common Stock, $40.6 million for the payment of Common Stock dividends, $22.1 million for capital expenditures, $16.2 million to redeem all of its outstanding 9 1/2 percent subordinated debentures and $13.9 million for the purchase of two small insurance companies. During this same period, the Company received $176.7 million from the sale of its General Cable Notes and stock to Wassall, $34.9 million from the sale of three of its non-insurance businesses and $19.1 million for shares of Company Common Stock issued pursuant to the exercise of employee stock options. At December 31, 1994, the Parent Company investment portfolio held unrated or less than investment grade corporate debt securities with carrying values of $27.2 million. At that date, the Company's insurance operations held $129.1 million of such unrated or less than investment grade debt securities and preferred stocks. As a group, unrated or less than investment grade investments may be expected to generate higher average yields than investment grade securities. However, the risk of loss from default by the borrower may be greater with respect to such securities because these issuers usually have higher levels of indebtedness and may be more sensitive to adverse economic conditions than are investment grade issuers. In addition, there is only a thinly traded secondary market for such securities and market quotations are available from a limited number of dealers. In order to manage its risk associated with these investments, the Company limits its investment in unrated or less than investment grade securities of any one issuer and regularly monitors the condition of the issuers and their industries. At December 31, 1994, the largest investment of the Company and its insurance operations in such securities of any one issuer totalled $37.5 million.
During 1993, sales of the Parent Company's shares of common stock of Tejas Gas Corporation ("Tejas")and limited partnership units of Buckeye Partners L.P. ("Buckeye Units"), sales of the Company's defense services operations and two of the Company's industrial businesses and payment by General Cable of its short- term note, issued in connection with the General Cable Spin-off, provided approximately $294 million in the aggregate. In addition, the Company received $24.0 million from the sale of shares of Company Common Stock pursuant to the exercise of employee stock options. During this same period, the Company used $133.3 million to redeem all of its outstanding 11 percent subordinated debentures, $52.8 million for the payment of the purchase price contingency relating to the acquisition of the NSA Group and $38.0 million to acquire Leader National Insurance Company ("Leader National"). The Company also used $38.2 million for the payment of Common Stock dividends, $17.5 million for capital expenditures and $4.5 million for the purchase of an investment in an insurance company located in the United Kingdom. The Company's insurance operations made net purchases of investments of $179.9 million during 1993 and the Company used approximately $165.5 million for net purchases of investments for the Parent Company investment portfolio. The Company's principal source of cash from investing and financing activities during 1992 was maturities of the Parent Company investment portfolio (net of purchases of investments) which provided $113.2 million. In addition to $25 million transferred to General Cable as part of the General Cable Spin-off, the Company used cash of $36.8 million for Common Stock dividends, $36.8 million for purchases of shares of Company Common Stock, $14.6 million for capital expenditures and $13.1 million for the repayment of debt. The Company's insurance operations made net purchases of investments totalling $164.3 million. During each of the three years in the period ended December 31, 1994, the Company's continuing operations did not have large capital spending requirements. The Company presently has no plans or commitments for material capital expenditures.
Earned premiums of the insurance operations increased to $1,273.6 million in 1993 as compared with $998.7 million for 1992 due to increases at both the NSA Group and Republic Indemnity. Investment income before realized gains and losses on sales of investments also increased due to higher average investment balances, partially offset by a decrease in the average yield on the insurance operations' investment portfolio. Operating income in 1993 increased to $167.4 million from $143.5 million in 1992, primarily due to improved underwriting results at Republic Indemnity and higher investment income, partially offset by lower net realized gains. Net realized gains from sales of investment securities in the insurance operations' portfolio totaled $17.5 million for 1993 compared with $23.6 million for 1992. Underwriting profitability of the insurance operations is measured by the combined ratio which, on a generally accepted accounting principles ("GAAP") basis, is calculated as the quotient of (a) the sum of insurance losses and loss adjustment expenses ("LAE"), policyholder dividends and commissions and other insurance expenses, excluding amortization of cost in excess of net assets acquired, divided by (b) premiums earned, as reflected in the accompanying financial statements. Underwriting results are considered profitable when the combined ratio is under 100 percent. The GAAP combined ratio was 97.0 percent in 1994, 96.2 percent in 1993 and 97.5 percent in 1992.
In general, automobile coverage written by the NSA Group is sold to drivers who have not been accepted for coverage by a writer of standard risks due to driving history, type of automobile, age of insured or other factors. Because it can be viewed as a residual market, the size of the non-standard private passenger automobile insurance market changes with the insurance environment. Management of the Company believes the non-standard market has experienced growth in recent years as standard insurers have become more restrictive in the types of risks they will write. During the past three years, the NSA Group continued to obtain new licenses to write business in additional jurisdictions. Total number of licenses held by the NSA Group has grown by approximately 69 percent during this time period. Entering additional states, increased market penetration in its existing states and the purchase of Leader National have been primarily responsible for the significant premium growth achieved by the NSA Group during the last three years. The NSA Group management believes it has achieved underwriting success over the past several years as compared to the automobile insurance industry as a whole due, in part, to the refinement of various risk profiles, thereby dividing the consumer market into more defined segments which can either be excluded from coverage or priced properly. The NSA Group also generally writes policies of short duration which allow more frequent rating evaluations of individual risks, providing management greater flexibility in the ongoing assessment of the business. In addition, the NSA Group has implemented cost control measures both in the underwriting and claims handling areas. 32PAGE
The following table presents certain information with respect to the NSA Group's insurance operations.
(2) Industry information was derived from Best Week Property/Casualty Supplement (January 11, 1995 edition). The comparison shown is to the private passenger automobile insurance industry. Although the Company believes that there is no reliable regularly published combined ratio data for the non-standard automobile insurance industry, the Company believes that such a combined ratio would present a less favorable comparison in that it would be lower than the private passenger automobile industry average shown above.
Despite increasing competitive pressures from other insurers during 1994, the NSA Group experienced growth in net written premiums of approximately 28 percent as compared to 1993, principally due to increased penetration within the NSA Group's existing markets. The net written premium growth rate during the latter half of 1994 was somewhat lower than that experienced during the first six months of the year. Underwriting conditions in the private passenger automobile insurance marketplace were affected by competitive conditions and the pricing policies of insurers. Also, improving economic conditions contributed to increased driving activity resulting in an increase in the frequency of accidents and severity of loss claims. These trends caused a deterioration in the NSA Group's underwriting profit margins during 1994. Also contributing to the decline in underwriting profit for 1994 were losses resulting from hailstorm damage in Texas. These factors were partially offset by underwriting profit from the Company's entry into certain foreign and domestic markets, as well as improved underwriting margins in several of the Company's markets where the book of business has matured and a greater portion of written premium is derived from renewal policies. The underwriting expense ratio 33PAGE
improved during 1994 as a result of cost containment measures and reductions in commission rates. In response to the declining underwriting margins, the NSA Group began to increase premium rates in certain states in mid-1994 and has continued this action into 1995. Although such new rate levels had little effect on earned premium and underwriting profit during 1994, the higher rate levels should have an impact during 1995 as the premiums written under the new rates are earned. However, the rate of written and earned premium growth during 1994 may not be sustained in the future as a result of such rate increases coupled with competitive pressures in the non-standard automobile insurance industry. The growth in net written premiums of approximately 37 percent during 1993 was principally due to the pursuit of business in new markets and the acquisition of Leader National. The increase in the combined ratio for 1993 was primarily caused by rate adjustments which more favorably affected 1992 underwriting results and an increase in losses in the 1993 first quarter resulting from a more severe winter than in the prior period. Partially offsetting these factors was a decrease in the underwriting expense ratio as growth in earned premiums outpaced associated expenses.
workers' compensation minimum rate law effective January 1, 1995. Management intends to maintain its stringent underwriting standards and pricing discipline, which are likely to have at least a temporary adverse effect on premium volume and profitability. Historically, Republic Indemnity's policyholder dividends have been among the highest in the industry. To meet future pricing competition, Republic Indemnity has the option of quoting business without indication of policyholder dividends. While this option may serve to partially mitigate the adverse effects of these developments, the Company is unable to predict their ultimate impact on its workers' compensation insurance operations. As a result of the Reform Legislation's provisions permitting employers to require injured workers to obtain medical services from "managed" health care organizations under prescribed circumstances, several health care organizations have become affiliated, contractually and otherwise, with certain workers' compensation insurers. During 1994, Republic Indemnity entered into a managed care arrangement with a health care organization. The Company continues to evaluate the implications of these provisions, as well as the resulting affiliations, but is unable to predict their ultimate impact on its workers' compensation insurance operations. While Republic Indemnity has operated on a profitable basis, no assurances can be given that it could continue to do so in the face of adverse conditions in the California workers' compensation market.
During 1994, Republic Indemnity experienced lower growth in earned and net written premiums largely due to the aforementioned mandatory premium rate reductions, and during the fourth quarter of 1994, Republic Indemnity experienced a decline in net written premiums of approximately 9.5 percent compared with the 1993 period. Nevertheless, the number of policies in force was approximately 11 percent higher at December 31, 1994 than at the end of 1993, reflecting Republic Indemnity's favorable competitive position in the industry in 1994. The decrease in Republic Indemnity's 1994 loss and LAE ratio as compared with 1993 was mainly attributable to favorable loss development relating to prior years' claims activity, partially offset by an increase in the frequency of claims and the impact of the 1994 rate reductions. The decrease in policyholder dividends during 1994 was due in part to a decrease in net premiums written by Republic Indemnity that were eligible for policyholder dividend consideration as well as increases in commission rates. The sizes of such rates are factors in the determination of potential policyholder dividend payments. During 1994, the underwriting expense ratio increased mainly due to higher commission expenses coupled with the decline in the earned premium growth rate. During 1993, the increase in both earned and net written premiums of approximately 17 percent was primarily due to improvement in the Company's relative competitive position in the industry resulting in part from the withdrawal of several workers' compensation carriers from the Los Angeles, California market. In addition, the California State Fund, the largest writer of workers' compensation insurance in California, reduced its policyholder dividends during 1992 making its program less attractive to the market. During this same period, Republic Indemnity's underwriting results benefited from a decrease in the frequency and severity of losses, in part due to a reduction in fraudulent claims, and a lower underwriting expense ratio as compared with the prior year.
Interest and dividend income of the Parent Company investments decreased $15.0 million in 1994, as compared with 1993, due primarily to the absence of interest income on the General Cable Notes in 1994 as a result of their sale. In 1993, the Company recognized approximately $25.4 million of interest income on the General Cable Notes. For further information, see Note 3 of Notes to Financial Statements. The decrease in interest income due to the sale of the General Cable Notes was partially offset by higher interest income on the Parent Company investment portfolio attributable to an increase in both average investment balances and average yields as compared with 1993. Interest and dividend income of the Parent Company investments increased $7.9 million in 1993, as compared with 1992, due primarily to an increase in interest income on the General Cable Notes largely attributable to the inclusion of a full year of interest in 1993 as compared with 1992. The increase in interest income due to the General Cable Notes was partially offset by lower interest income on the Parent Company investment portfolio attributable to a decrease in average yields as compared with 1992. 36PAGE
income used in determining the net deferred tax asset is not necessarily indicative of the Company's future results of operations. As is the case with any estimate of future results, there will be differences between assumed and actual economic and business conditions of future periods. Moreover, the estimate may also be affected by unpredictable future events, including but not necessarily limited to changes in the Company's capital structure and future acquisitions and dispositions. Therefore, the analysis of estimated future taxable income will be reviewed and updated periodically, and any required adjustments, which may increase or decrease the net deferred tax asset, will be made in the period in which the developments on which they are based become known. 38PAGE