The Company owns two buildings in Cedar Rapids, Iowa, which it occupies as its Home Office. One building is a five-story building which is occupied entirely by the Company except for certain tenants on the second floor. The other is an eight-story office building in which the first floor is leased to tenants. The Company occupies the fourth through eighth floors of this building and rents the third floor and an office on the second floor to its subsidiary, United Life Insurance Company. The two buildings are connected with a skywalk.
[A bar graph displaying net income per common share and dividends for the five years ended December 31, 1995.]
In accordance with Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities," ("SFAS No. 115"), the Company is required to classify its investments in debt and equity securities into one of three categories: 1) held-to-maturity 2) available-for-sale and 3) trading (the Company has no trading securities). In the fourth quarter of 1995, concurrent with its adoption of the implementation guide on SFAS No. 115, the Financial Accounting Standards Board allowed a one-time reassessment of the SFAS No. 115 classifications of all securities currently held. Any reclassifications would be accounted for at fair value in accordance with SFAS No. 115 and any reclassifications from the held-to-maturity portfolio that resulted from this one-time reassessment would not call into question the intent of the Company to hold other debt securities to maturity in the future. Though the Company primarily utilizes a buy and hold philosophy for all securities (we are long-term investors), we did use the opportunity under this one-time reassessment to reclassify $79,131,000 in securities from held-to-maturity to the available-for-sale category. In connection with this reclassification, gross unrealized gains of $5,145,000 and gross unrealized losses of $908,000 were recorded in available-for-sale securities and in stockholders' equity.
Approximately 31% of the fixed income portfolio is collateralized mortgage obligations ("CMOs"), compared to 28% at December 31, 1994. The Company's ongoing review of the fixed income market has shown that for asset and credit quality, CMOs still offer the best yield available. The Company minimizes its prepayment risk by buying most issues priced at a slight discount. While buying at a discount does not prevent prepayment, the yield is not penalized as is the case when a premium is paid. In addition, although the stated maturity is longer than the average life of the issues, the Company is concentrating on buying issues with expected maturity in the seven- to- twelve- year range. The Company also monitors the FLUX ratios of the CMOs it is purchasing, looking to add less volatile positions to its portfolio. FLUX measures cashflow variability about a predefined set of interest rate scenarios.
The Company also invests in readily marketable common and preferred stocks, all of which are classified as available-for-sale. Other long-term investments are primarily holdings in limited partnership funds investing in banks. Unrealized appreciation on available-for-sale fixed maturities, stocks and other long-term investments, net of applicable income taxes, increased between 1995 and 1994 by $15,273,000.
Most of the cash that the Company receives is generated from insurance premiums paid by policyholders. The premiums are invested in assets maturing at regular intervals in order to meet the Company's obligations to pay policy benefits, claims and claim adjusting expenses. Accounts receivable are balances due from property and casualty insurance agents and brokers for premiums written, net of commissions. In 1995, this asset grew by $4,756,000 or 14%. Increased premium writings and continued utilization by insureds of the Company's deferred billing plan contributed to this growth.
Reinsurance receivables are loss and expense payments and ceded reserves that are due the Company from reinsurers. The balance in this asset decreased by $8,226,000 or 34% in 1995, when compared to 1994. In 1994, the Company had reinsurance receivables related to the Northridge earthquake and $4,413,000 in the reinsurance receivables related to a claim issued against the Company, which was settled favorably in March, 1995. The Company does not anticipate collection problems with regard to any of its reinsurance receivables.
The increase in other underwriting expenses of $3,798,000 or 15.5% resulted primarily from an increase in commissions paid to our agents. In addition, prior to 1994, the Company purchased its health insurance from its subsidiary (United Life Insurance Company) and the applicable premium revenue and insurance expense was eliminated in the consolidation process. At December 31, 1993, $1,481,000 of other underwriting expenses were eliminated. In 1994, the Company began self-insuring its employee health insurance and no elimination was necessary.
The increase in the liability for future policy benefits and interest on policyholders' accounts grew in 1994 when compared to 1993 due to the addition of new premiums and growth in existing account balances.
Good progress continues to be made in upgrading our data processing systems for the twenty-first century. Early this year we introduced a new claims processing system that was developed in-house and is fully integrated into our other systems. Our commercial lines policy processing is now nearly completely automated and a contract has been let and work is progressing on completely revising our personal lines systems which are antiquated and lack flexibility. A pilot project in which selected agencies are "on-line" to our main-frame computer is under way. Ultimately, our goal is to have the capability to upload from and download to the agent's computer in his office and process most normal routine transactions paperlessly.
During the year the Lafayette had an opportunity to substantially expand its business in Mississippi and Arkansas transforming it into the regional insurer we had always envisioned. The business we are picking up is principally personal lines, seasoned and with good experience. With our commercial lines underwriting capabilities we believe it offers a good base for future growth. No, we are not going to insure the Madison Guaranty Savings & Loan and, yes, we realize that there may be an abundance of unemployed attorneys in Little Rock next year. Some of them may even decide to go straight and take up selling insurance.
Last year when we reported on the Lafayette's 125th anniversary we mentioned a fine old southern gentleman, George Wegmann. Mr. George died on January 26, 1996.
On December 1 our Lincoln regional office moved into newly remodeled quarters at 1314 "O" Street with all new furniture. Since acquiring the Protective Fire & Casualty Co. in 1981 our Lincoln offices have been in their old building which was a converted night club. Finally, old age and the ADA made a move a necessity. If you are in the vicinity we invite you to stop in and see our new quarters. We know "Spike" Hulit and his staff would be pleased to meet you and show off their new offices. Oh, incidentally, we sold the old building at a profit within a week after moving out.
Readers of previous reports will be aware of the importance we attach to the success of your Company in Iowa, our back yard. Last year business was good for your Company in Iowa with total statutory premiums, property, casualty, life, accident and health including annuities increasing 20% to $75,000,000.
$2,700,000 of the increase in stockholders' equity is an accounting trick. Two years ago the powers that be in the accounting world decreed an intellectual mish-mash called SFAS No. 115. It proclaimed that henceforth all debt securities, like Gaul, would be divided into three parts, held-to-maturity, available-for-sale and trading. Your Company, taking what we assumed was the most conservative approach at the time, classified nearly all of its bonds as held-to-maturity. Last fall Caesar came to the conclusion it wasn't working (it wasn't, it was a mess), called "olly, olly, oxen free!" and let everyone go back to square one and start all over again. That gave every one a chance to rearrange their hands, we did, reclassifying about $80,000,000 as available-for-sale, and hence the gain; it increased book value by $.25 per share.
One of our problems with the whole affair is that the underlying decision was a subjective one that most readers of financial statements are not aware of nor appreciate the importance. Another troubling aspect of many of these recent "Accounting Principles" is that their effect is the introduction of more and more "soft numbers" into the financial statements that can easily be manipulated if management is so inclined.
At its meeting on February 16, 1996, your Board of Directors appointed Jack Evans, President of the Hall Foundation of Cedar Rapids, Iowa. Prior to joining the Hall Foundation, Mr. Evans had been President of Securities Corporation of Iowa. One of my goals has been the transformation of your Board into an "outside board" and while we still have two retired officers of the Company on its Board, your chairman is now the only active company officer on the Board.
On December 8, 1995, your Board of Directors voted to pay a 50% stock dividend in the form of a three for two stock split for the second time in two years (please don't assume this will become an annual affair) and at the same time voted to increase the cash dividend 12.5 % to 15 cents on the new shares. Both were payable January 5, 1996. This is the eighth time since 1971 that your Company has split its shares and all but one of these was a three for two stock split.
We have audited the accompanying consolidated balance sheets of United Fire & Casualty Company (an Iowa corporation) and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1995. These consolidated financial statements and the schedules referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and schedules based on our audits.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of United Fire & Casualty Company and subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.
/s/ Arthur Andersen LLP Arthur Andersen LLP Chicago, Illinois February 22, 1996
Realized gains or losses on disposition of investments are included in the computation of net income. Cost of investments sold is determined by the specific identification method. Changes in unrealized appreciation and depreciation resulting from available-for-sale fixed maturities, equity securities and other long-term investments, are reported as direct increases or decreases in stockholders' equity, less applicable income taxes.
For purposes of reporting cash flows, cash and cash equivalents include cash and non-negotiable certificates of deposit with original maturities of three months or less. Income taxes paid during 1995, 1994 and 1993 were $8,801,000, $5,784,000, and $3,503,000, respectively. The Company paid $532,000 in interest on Federal income taxes in 1994. There were no other significant payments of interest other than interest credited on policyholders' accounts in 1995, 1994 or 1993.
Property and equipment is carried at cost less accumulated depreciation. Depreciation is computed primarily by the straight-line method over the estimated useful lives of the underlying assets.
The Company accounts for income taxes under Statement of financial Accounting Standard ("SFAS") No. 109. The Company files a consolidated Federal income tax return.
Effective January 1, 1994, the Company adopted SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities". SFAS No. 115 addresses the accounting and reporting for investments in equity securities that have readily determinable fair values and for all investments in debt securities. The statement requires that those investments be classified into the following three categories: 1) debt securities that the enterprise has the positive intent and ability to hold to maturity are classified as held-to-maturity securities and reported at amortized cost; 2) debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and reported at fair value, with unrealized gains and losses included in earnings; and 3) debt securities and marketable equity securities not classified as either held-to-maturity securities or trading securities are classified as available-for-sale securities and reported at fair value, with unrealized gains and losses excluded from earnings and reported in a separate component of stockholders' equity. Pursuant to the adoption of an implementation guide on SFAS No. 115, the Company has reclassed a portion of its held-to-maturity securities to the available-for-sale portfolio. Gross unrealized gains and losses were recorded in available-for-sale securities. See Note 2 for discussion of the reclassification.
Effective December 31, 1994, the Company adopted SFAS No. 119, "Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments". SFAS No. 119 expands disclosure requirements concerning derivative investments, including whether investments are held for trading or other purposes, such as hedging. The Company does not own any derivative investments as defined by SFAS No. 119, and therefore is not subject to the expanded disclosure requirements.
In the fourth quarter of 1995, concurrent with the adoption of its implementation guide on SFAS No. 115, the Financial Accounting Standards Board allowed a one-time reassessment of the SFAS No. 115 classifications of all securities currently held. Any reclassifications would be accounted for at fair value in accordance with SFAS No. 115 and any reclassifications from the held-to-maturity portfolio that resulted from this one-time reassessment would not call into question the intent of the Company to hold other debt securities to maturity in the future. The Company used the opportunity under this one-time reassessment to reclassify $79,131,000 in securities from held-to-maturity to the available-for-sale portfolio. In connection with this reclassification, gross unrealized gains of $5,145,000 and gross unrealized losses of $908,000 were recorded in available-for-sale securities and in stockholders' equity.
The amortized cost and fair value of held-to-maturity and available-for-sale fixed maturities at December 31, 1995, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Proceeds from sales of available-for-sale investments during 1995, 1994 and 1993 were $1,344,000, $246,000, and $78,000, respectively. Gross gains of $790,000, $10,000, and $4,000, respectively, were realized on those sales. No losses were realized on those sales.
A summary of realized investment gains (losses) resulting from sales, calls and maturities and net changes in unrealized investment appreciation (depreciation), less applicable income taxes, is as follows.
In most cases, quoted market prices were used in determining the fair value of fixed maturities, equity securities and short-term investments. Where quoted market prices were unavailable, the estimate was based on recent trading. Market values for collateralized mortgage obligations were provided by a custodian. Other long-term investments, consisting primarily of holdings in limited partnership funds, are valued by the Fund Manager based on quoted market prices for the underlying equity securities. In management's opinion, these values reflect fair value at December 31, 1995 and 1994.
The estimated fair value of mortgage loans was based on the estimated discounted future cash flows using 7.0% at December 31, 1995 and 7.5% at December 31, 1994.
The fair value of the liabilities for annuity products which are in a benefit payment phase, guaranteed investment contracts and structured settlements are based on a discount rate of 6.5% at December 31, 1995 and 7.5% at December 31, 1994. The fair value of annuities currently in an accumulation phase is based on the net cash surrender value.
The following is a summary of the Company's short-term borrowings that were payable to a bank for the years ended December 31, 1995, 1994 and 1993.
The following table provides an analysis of losses and loss adjustment expenses ("LAE"), including a reconciliation of beginning and ending liability balances for 1995 and 1994.
The Consolidated Financial Statements include the estimated liability for unpaid losses and LAE of the property and casualty lines of business. The liabilities for losses and LAE are determined using case-basis evaluations and represent estimates of the ultimate net cost of all unpaid losses and LAE incurred (both reported and not reported) through December 31 of each year. These estimates are continually reviewed and, as experience develops and new information becomes known, the liability is adjusted as necessary. Such adjustments, if any, are reflected in current operations.
The decrease of $19,877,000 in estimated losses and LAE for claims occurring in prior years resulted from both the Company's direct and assumed business. Favorable claims settlements on the Company's direct business contributed to the decrease for prior accident years in the workers' compensation, commercial liability and other liability lines. The Company establishes assumed loss reserves based on reporting by insurance intermediaries. In addition, the Company establishes reserves for those assumed losses that have occurred, but have not yet been reported. When assumed anticipated losses and settlement expenses are lower than anticipated, a redundancy results, as was the case in 1995.
Statutory stockholders' surplus and net income at December 31, 1995, 1994 and 1993 and for the years then ended are as follows.
The Company and its insurance subsidiaries prepare their statutory financial statements in conformity with practices prescribed or permitted by their state of domicile. Prescribed statutory accounting practices include a variety of publications of the National Association of Insurance Commissioners ("NAIC"), as well as state laws, regulations, and general administrative rules. Permitted statutory accounting practices are used when prescribed statutory practices do not address the accounting for transactions. The Company does not use permitted practices that individually or in the aggregate materially affect statutory surplus or risk-based capital.
The amount of dividends that may be paid to stockholders without prior approval by the State of Iowa Insurance Department is limited to the excess of statutory retained earnings over contributed surplus. Contributed surplus as of December 31, 1995, was $10,766,000. Based upon this restriction, the Company could make a maximum of $100,423,000 in dividend distributions to stockholders in 1996. Dividend payments by the insurance subsidiaries to the Company are subject to similar restrictions in the states in which they are domiciled. The Company received no dividends from its subsidiaries in 1995, and $500,000 in dividends in 1994.
A reconciliation of income tax expense computed at the applicable Federal tax rate of 35% in 1995 and 1994 and 34% in 1993 to the amount recorded in the Consolidated Financial Statements is as follows.
The significant components of the net deferred tax liability at December 31, 1995 and 1994 are as follows.
The valuation allowance for deferred tax assets in 1994 related to the purchased NOL's. The net change in the total valuation allowance for the years ended December 31, 1995 and 1994, was a decrease of $39,000 and $106,000, respectively due to the utilization and expiration of NOL carryforwards.
The weighted average discount rate used in determining the actuarial present value of projected benefit obligation was 7.0% at September 30, 1995, 8.25% at September 30, 1994, and 6.0% at September 30, 1993. The rate of increase in future compensation levels was 4.0% at September 30, 1995, 1994 and 1993. The expected long-term rate of return on plan assets was 7.5% at September 30, 1995 and 1994 and 6.0% at September 30, 1993.
The Company also has an Employee Stock Ownership Plan for the benefit of eligible employees and their beneficiaries. All employees are eligible to participate in the plan upon completion of one year of service and attaining age twenty-one. Contributions to this plan are made at the discretion of the Board of Directors. These contributions are based upon a percentage of total payroll and are allocated to participants on the basis of compensation. Contributions are made in cash which is used by the Trustee to acquire shares of the Company stock to allocate to participants' accounts. As of December 31, 1995, 1994 and 1993, the Trustee owned 86,712, 86,306 and 65,421 shares of Company stock, respectively. The Company's incurred contribution to the Plan was zero for the years ended December 31, 1995 and 1994 and $403,000 for the year ended December 31, 1993.
For measurement purposes, the following table displays the annual rate of increase in the per capita cost of covered medical and dental claims assumed.
The health care cost trend rate assumption has a significant effect on the amounts reported. To illustrate, increasing the assumed health care cost trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation as of December 31, 1995 by $1,089,000 and the aggregate of the service and interest cost components of net postretirement benefit expense for the year then ended by $122,000. The weighted-average discount rate used in determining the accumulated postretirement benefit obligation was 7.00% and 8.25% as of December 31, 1995 and 1994, respectively.
The Company declared a three for two stock split in the form of a 50% stock dividend to stockholders of record as of December 15, 1994 and again, as of December 18, 1995. Cash dividends per common share of $.55 and $.49 were declared in 1995 and 1994, respectively. Net income per common share, weighted average common shares outstanding and cash dividends declared per common share have been retroactively restated for all periods presented.