The selected Financial Data herein has been derived from the financial statements of the Company and its subsidiaries. The data should be read in conjunction with "The Chairman's Report," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Consolidated Financial Statements and related Notes.
[A bar graph displaying net income per common share and dividends declared for the five years ended December 31, 1996 appears here.]
Approximately 26% of the fixed maturities are collateralized mortgage obligations ("CMOs"), compared to 31% at December 31, 1995. 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 holds 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. Net unrealized appreciation on stocks and other long-term investments increased between 1996 and 1995 by $15,807,000, or 31%.
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.
The Company's short-term investments, comprised of money market accounts, overnight repurchase agreements and fixed maturities, are utilized to meet anticipated short-term cash requirements. In addition, the Company also maintains a $5 million line of credit with a local bank, which we did not utilize during 1996. Short-term investments increased from $21,530,000 to $29,330,000 in 1996.
The Company's deferred policy acquisition costs ("DAC") are expenses such as commissions, premium taxes and other costs associated with procuring and servicing insurance policies. The asset is established at the beginning of the policy periods and is then amortized over the lives of the respective policy terms to achieve a matching of expenses to revenue. The Company's premium growth has created a corresponding increase in deferred policy acquisition costs.
Reinsurance receivables are losses, expenses and reserves that are due the Company from reinsurers. The balance in this asset increased by $1,793,000 or 17% in 1996, when compared to 1995. The Company does not anticipate collection problems with regard to any of its reinsurance receivables.
The property and casualty segment's gross liability before reinsurance for losses and settlement expenses increased $22,804,000 between 1996 and 1995. Gross reserves remaining on the 1994 Northridge earthquake were $4,599,000 as of December 31, 1996, compared to $3,733,000 at December 31, 1995.
The liability for future policy benefits and interest on policyholders' accounts saw an increase of $37,979,000 for 1996 due to the addition of new premiums and growth in existing account balances.
Property and casualty premiums earned increased 16%, or $29,476,000 in 1996, when compared to 1995. Our direct business has provided a majority of the growth, with much of the increase concentrated in the midwestern states and Louisiana.
Loss and settlement expenses incurred by the property and casualty segment for 1996 increased 32% or $37,589,000 over 1995. While the last two years produced an unusually large number of hurricanes, the Company did not have much exposure related to these storms. Several other factors did contribute to underwriting results. The Company's consistent and long-term growth has inevitably led to a higher number of claims. During the first quarter of 1996, frigid weather causing frozen water pipes resulted in substantial water damage. Several large fire losses also occurred during the first few months of the year. Wind and hail storms occurring during the summer months in the midwestern states led to an increase in loss activity. In addition, a small number of large commercial auto liability losses were incurred throughout the year.
In 1996, the Company's largest catastrophe loss incurred year-to-date was the 1994 Northridge earthquake, with gross losses incurred of $3,149,000 in 1996 compared to $3,847,000 in 1995 and $10,342,000 in 1994. Ceded losses incurred related to this catastrophe were $2,882,000 in 1996, compared to $3,005,000 in 1995 and $4,319,000 in 1994. Gross incurred on other catastrophe losses for the years ending 1996, 1995 and 1994 were $10,200,000, $10,089,000 and $5,784,000, respectively. Ceded incurred on all other catastrophes for the years ending 1996, 1995 and 1994 were $(43,000), $114,000 and $(17,000), respectively.
Interest credited was flat in 1996 for two reasons. First, one block of universal life had withdrawals of $15,125,000 in December, 1995, and $15,561,000 in the first two months of 1996, which caused a reduction of approximately $2,025,000 in interest credited in 1996 compared to 1995. Second, deferred annuity policies with a five-year interest rate guaranteed between 7.1% and 8.0%, renewed in 1996 at a rate between 5.0% and 5.5% representing approximately a $500,000 decrease in interest credited. Also, all deferred annuity policies with guarantees of less than 6.5% earned up to 1.0% less in 1996.
The increase of $3,743,000 in premiums earned was comprised mainly of a $1,181,000 increase in collected traditional life premiums and a $1,479,000 increase in collected credit premiums. During 1995, we increased our anticipated future lapses and wrote off $1,300,000 of deferred acquisition costs due to the withdrawal of one block of universal life business totaling $15,559,000 in the first two months of 1996.
Investment income rose 15% in 1995, over 1994, which was largely attributable to a growing fixed income portfolio. The Company's investment yield was a consistent 7% for 1995, 1994 and 1993. Realized gains increased by $902,000, most of which was due to the sale of an available-for-sale preferred stock holding.
The Company is required by the NAIC and governing state insurance departments to calculate a risk-based capital formula. This calculation establishes minimum capital requirements based on an individual company's insurance risk. The results are used by the NAIC and state insurance departments to identify companies that merit regulatory attention or the initiation of regulatory action. At December 31, 1996 and 1995, the property and casualty segment and the life segment each had adjusted capital well in excess of the required capital levels.
The NAIC is currently working on a project to codify insurance statutory accounting practices. Currently, these practices are prescribed in a variety of publications, as well as state laws, regulations, and general administrative rules. The project, expected to be completed by January 1, 1998, would have some effect on the Company's statutory results. Due to the incomplete and complex proposed changes, it is impossible to estimate the impact at this time. The changes would not affect the accompanying financial statements, which are based on generally accepted accounting principles ("GAAP").
In July, the Company accepted the resignation of Randy Scheive, President of Addison Farmers' Insurance Company. He was replaced by E.A. (Spike) Hulit in September. Spike was the manager of our Lincoln Branch. Spike had turned the Lincoln Branch from a marginal operation into a profitable one with hard work and tough decisions.
We are always looking for new areas and products to offer our customers. Lafayette Insurance Company continues to increase its volume in Arkansas and Mississippi. Addison Farmers' Insurance Company plans to change its name to Addison Insurance Company to better reflect the diverse customer base it services.
With total assets, as of December 31, of $1,025,000,000, sometime during 1996 your Company passed a milestone when its assets exceeded one billion dollars for the first time in its history. Now, while we'll be the first to admit that a billion dollars isn't nearly what it used to be, still as Senator Dirkson once said, "A billion here and a billion there, and pretty soon your talking real money!"
Unfortunately, this milestone was not accompanied with record earnings. For the year, your Company earned $21,960,000 or $2.04 per share, 24% less than the previous year and not quite as much as it did in 1994. Stockholders' equity increased $19,106,000 to $227,859,000 and the book value of your shares is $21.24 per share.
After starting off the year with record earnings of $8,755,000 in the first quarter, property and casualty experience deteriorated for the next two quarters before recovering in the fourth, so that our statutory combined ratio (i.e. losses incurred to premiums earned, plus expenses incurred to premiums written) for the year ended up at a mediocre 104%. While this is still better than the industry as a whole which had an estimated combined ratio of 107%, we are not satisfied. Property and casualty premiums written increased 12% to $222,000,000, which is substantially more than the industry which grew only an estimated 4%.
Fortunately, except for a series of tornadoes that struck central Illinois and Missouri in April, and cost us approximately $2,000,000, we were able to escape most of 1996's storm activity.
Management consultants, those "experts" who know how to run everyone's business but their own and can solve all the world's problems but how to deliver what they promise, are forever inventing new buzz words to sell second-hand ideas. Two that have recently become popular in the lexicon are "niche player" and "core competence" . Unfortunately, the insurance business has not been immune from these fads as companies, large and small, have fallen all over each other trying to recast themselves as a niche player with a core competence whether it be health care, substandard automobile, reinsurance, or what have you, forgetting, apparently, what has been one of the basic justifications for multiple-line underwriting and a foundation of the insurance business - "spread of risk".
Even though it may be out of vogue, your Company is still committed to that principle and believes it is basic to managing a sound insurance enterprise. The virtue of "not putting all your eggs in one basket" has been demonstrated over and over again. Over the years, readers of these epistles have been treated to a litany of disasters that can befall an insurance company, be they tornadoes, hurricanes, insolvent contractors, politicians, inadequate rates, et al., but there usually has been enough profitable business in our portfolio to save the day. While 1996 was only a mediocre year for the property and casualty business, for your Company, the year was saved by our life insurance business which had an excellent year and our earnings, while down, did not go into the tank. In recent years, several property and casualty companies have disposed of their life insurance affiliates, but we believe life insurance is another example of how we spread our risks.
CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
Certain amounts included in the Consolidated Financial Statements for prior years have been reclassified to conform with the 1996 financial statement presentation.
Certain costs of underwriting new business, principally commissions, premium taxes and variable underwriting and policy issue expenses, have been deferred. Such costs are being amortized as premium revenue is recognized. The method followed in computing deferred policy acquisition costs limits the amount of such deferred costs to their estimated realizable value, which gives effect to the premium to be earned, losses and expenses, and certain other costs expected to be incurred as the premium is earned.
Unpaid losses and settlement expenses are based on estimates of reported and unreported claims and related settlement expenses. While management believes the reserve for claims and settlement expenses is adequate, the reserve is continually reviewed and as adjustments become necessary, they are reflected in current operations.
Investments in held-to-maturity fixed maturities are recorded at amortized cost. The Company has the ability and intent to hold these investments until maturity. If, however, a permanent impairment occurs in a security, the Company writes the security down to the new value. Available-for-sale fixed maturities, equity securities and other long-term investments are recorded at fair value. Mortgage loans are recorded at the unpaid balance amount. Policy loans and short-term investments are recorded at cost. Included in investments at December 31, 1996 and 1995, are securities on deposit with various regulatory authorities as required by law with carrying values of $481,703,000 and $434,605,000, respectively.
The Company files a consolidated federal income tax return. Deferred tax assets and liabilities are determined at the end of each period, based on differences between the financial statement bases of assets and liabilities and the tax bases of those same assets and liabilities, using the currently enacted statutory tax rates. Deferred income tax expense is measured by the change in the net deferred income tax asset or liability during the year.
Effective January 1, 1994, the Company adopted Statement of Financial Accounting Standards ("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.
The Financial Accounting Standards Board issued SFAS No. 123, "Accounting for Stock-Based Compensation" in October 1995, effective for fiscal years beginning after December 15, 1995. SFAS No. 123 establishes an alternative fair value-based method of accounting for stock options and other equity instruments. The standard also requires significantly expanded disclosure on stock and equity options. The Company does not issue equity instruments to employees or others in exchange for goods or services, and therefore this statement has no impact on the Company.
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.
Approximately 26% of the current fixed maturity portfolio is collateralized mortgage obligations ("CMOs"), compared to 31% at December 31, 1995. 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 amortized cost and fair value of held-to-maturity and available- for-sale fixed maturities at December 31, 1996, 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 1996, 1995 and 1994 were $35,251,000, $1,344,000, and $246,000, respectively. Gross gains of $3,499,000, $790,000 and $10,000, respectively, were realized on those sales. Gross losses of $342,000 were realized on those sales in 1996. No losses were realized on those sales in 1995 or 1994.
The net investment income for the years ended December 31, 1996, 1995 and 1994 is composed of the following.
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, 1996 and 1995.
A summary of the carrying value and estimated fair value of assets and liabilities meeting the definition of financial instruments at December 31, 1996 and 1995 is as follows.
The following is a summary of the Company's short-term borrowings that were payable to a bank for the years ended December 31, 1996, 1995 and 1994.
The property and casualty insurance companies also assume portions of their insurance business from other insurance companies. Assumed premiums earned for the years ended December 31, 1996, 1995 and 1994 were $38,545,000, $33,014,000 and $31,152,000, respectively.
United Life Insurance Company follows the policy of reinsuring that portion of the risk in excess of $200,000 on the life of any individual. Policy benefit reserves and claims are stated after deduction of reserves and claims applicable to reinsurance ceded to other companies; however, United Life Insurance Company is contingently liable for these amounts in the event such companies are unable to pay their portion of the claims. The Company is contingently liable for ceded insurance in force of $432,836,000 and $455,422,000 at December 31, 1996 and 1995, respectively. Approximately 70% of the Company's ceded life insurance in force has been ceded to two reinsurers. The Company believes all amounts are collectible with regard to reinsurance receivables.
The following table provides an analysis of losses and loss adjustment expenses ("LAE"), including a reconciliation of beginning and ending liability balances for 1996 and 1995.
A reconciliation of income tax expense computed at the applicable Federal tax rate of 35% in 1996, 1995 and 1994 to the amount recorded in the Consolidated Financial Statements is as follows.
The significant components of the net deferred tax liability at December 31, 1996 and 1995 are as follows.
The weighted average discount rate used in determining the actuarial present value of projected benefit obligation was 7.5% at September 30, 1996, 7.0% at September 30, 1995 and 8.25% at September 30, 1994. The rate of increase in future compensation levels was 4.5% at September 30, 1996 and 4.0% at September 30, 1995 and 1994. The expected long-term rate of return on plan assets was 8.0% at September 30, 1996, and 7.5% at September 30, 1995 and 1994.
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, 1996, 1995 and 1994, the Trustee owned 92,806, 86,712 and 86,306 shares of Company stock, respectively. The Company's incurred contribution to the Plan was $142,000 for the year ended December 31, 1996 and zero for the years ended December 31, 1995 and 1994.
Depreciation expense and property and equipment acquisitions for the years ended December 31, 1996, 1995 and 1994 are reflected in the property and casualty insurance segment.
We have audited the accompanying consolidated balance sheets of United Fire & Casualty Company (an Iowa corporation) and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1996. 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, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles.
VI -- Supplemental information concerning property and casualty insurance operations 40