The corporate headquarters of the Company are located in office space in Southfield, Michigan, that is provided to the Company by CoverX pursuant to the General Agency Agreement between the Syndicate, CoverX and MM. All Nation owns the 18,000 square foot office building in which it is based, located at 155 Aurora Avenue, St. Paul, Minnesota 55103, and also owns five acres of land located in Inver Grove Heights, Minnesota. The Company believes that these existing facilities are adequate for its needs.
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The following table reflects net premiums earned of the Company for the years ended December 31, 1994, 1995 and 1996:
At December 31, 1996, approximately 24% of the Company's portfolio was deployed in conservatively structured collateralized mortgage obligations as compared with 34% at December 31, 1995. The securities represented by this sector are primarily planned amortization class ("PAC") securities with a small allocation to sequential pay securities. The Company does not own any Interest Only ("I.O.s"), Principal Only ("P.O.s") or other volatile, high risk structures. The Company has deployed funds, to varying degrees, in the mortgage-backed securities sector since 1988. Each mortgage-backed security is analyzed utilizing extremely conservative scenarios regarding prepayment estimates to gauge any particular bond's sensitivity to varying prepayment scenarios. The bonds that the Company owns within the mortgage-backed sector are conservative with considerably less volatility than other bonds available in the collateralized mortgage obligation market. The Company believes that cash flow variability is very modest and is more than offset by the incremental return offered by this sector.
AMORTIZATION OF DEFERRED ACQUISITION COSTS AND OTHER UNDERWRITING EXPENSES AND INTEREST EXPENSE
The Company incurred $1.2 million of interest expense related to the $10 million senior subordinated notes during 1995 and 1996, respectively.
Net premiums earned increased 2.9% in 1995 to $29.7 million from $28.8 million in 1994. Net premiums earned for private passenger non-standard automobile coverages increased 21.2% in 1995 to $16.9 million from $14.0 million for the year ended December 31, 1994. The increase resulted from several factors, including the introduction of a direct marketing non-standard automobile program late in 1994 that generated approximately $1.5 million in net premiums earned in 1995. In addition, the Company commuted a 17.5 percent quota share reinsurance agreement covering the non-standard automobile lines on September 30, 1995. The Company retained approximately $900,000 additional net premiums earned during the fourth quarter of 1995 because of the commutation. The quota share agreement was in force during all of 1994. The Company also recognized a modest increase in net premiums earned on its agency non-standard automobile programs. Net premiums earned for specialty commercial lines declined 14.3% to $12.7 million for the year ended December 31, 1995 as compared to $14.9 million for the year earlier. Within the specialty commercial lines, net premiums earned for security, fire and alarm coverages decreased 5.9% to $8.2 million primarily due to competitive pressures on rates. The Company actively targeted smaller insureds in 1995, and as a result, policy counts for security, fire and alarm coverages
For the year ended December 31, 1995, the Company realized a net loss on the sale of investments of $14,000 versus $67,000 for the same period in the prior year. The net loss on the sale of investments during 1995 primarily resulted from the Company's decision to reduce its investments in tax-exempt securities in the first quarter of 1995.
AMORTIZATION OF DEFERRED ACQUISITION COSTS AND OTHER UNDERWRITING EXPENSES, INTEREST EXPENSE AND MISCELLANEOUS INCOME (EXPENSE)
Additionally, the Company incurred $1.2 million of interest expense during 1995 related to the $10 million senior subordinated notes. The debt originated late in the fourth quarter of 1994, therefore, the Company had minimal interest expense in 1994.
The 1995 effective tax rate of 106.4% exceeded the 1994 effective tax rate of 19.4% due to a shift in the Company's investment portfolio from tax-exempt to taxable securities and the recording of a deferred tax liability for the post-acquisition tax benefits of National Family utilized to date by the Company. National Family was anticipating an order of liquidation with a finding of insolvency by a court of competent jurisdiction, with a subsequent cessation of operations. IRS regulations ultimately require repayment of tax benefits generated by National Family and used by the Company, therefore, the Company provided for this liability in 1995.
During 1995, the Financial Accounting Standards Board issued SFAS 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" ("SFAS 121"). SFAS 121 requires that long-lived assets and certain identifiable intangibles to be held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. SFAS 121 was implemented by the Company in 1996. The adoption of SFAS 121 did not have a material effect on the operating results or financial condition of the Company.
Mercury is a holding company whose principal assets are its investment in the capital stock of FMIC and All Nation. Mercury is dependent upon the receipt of dividends from FMIC and All Nation to fund any necessary cash requirements. FMIC and All Nation are restricted by regulation as to the amount of dividends they may pay without regulatory approval. After giving effect to those restrictions, during 1997, Mercury could receive up to $3.2 million in dividends from its subsidiaries without prior regulatory approval. Mercury received $1.9 million in dividends from its subsidiaries in 1996 (including $1.4 million in debt securities transferred from subsidiaries) which Mercury used for payment of interest expense and preferred stock dividends. Mercury also received $1.2 million during 1996 under its non-compete agreement with Deerbrook, with an additional $1.2 million to be paid during 1997. In addition, Mercury receives annual payments from its subsidiaries when appropriate pursuant to a tax allocation agreement between Mercury and its subsidiaries.
Pursuant to the terms of the Mercury preferred stock, holders of Mercury preferred stock generally have no voting rights or preemptive rights. Cumulative dividends are payable at the rate of 13.2% per annum on a periodic basis, as and when declared by the Board of Directors, before any dividends are declared or paid on the outstanding Mercury common stock. Mercury preferred stock is redeemable, at the option of Mercury, by resolution of its Board of Directors, at any time at a redemption price of $125 per share plus accrued and unpaid dividends, upon the giving of notice thereof to the holders of Mercury preferred stock.
As part of its investment strategy, and as required by debt covenants, the Company establishes a level of cash and highly liquid short- and intermediate-term securities which, combined with expected cash flow, is believed adequate to meet foreseeable payment obligations. As part of this strategy, the Company attempts to maintain an appropriate relationship between the average duration of the investment portfolio and the approximate duration of its liabilities.
The Syndicate's withdrawal agreement also required FMIC to establish a trust fund for the payment of claims under insurance policies issued and reinsurance agreements entered into by the Syndicate. Investments held in trust for the payment of Syndicate claims approximated $42.3 million at December 31, 1996.
As of March 28, 1997, the Company had no outstanding commitments for significant capital expenditures.
The National Association of Insurance Commissioners ("NAIC") has adopted certain risk-based capital standards for property and casualty insurance companies. Risk-based capital requirements attempt to measure minimum statutory capital needs based upon the risks in a company's mix of products and investment portfolio. Both FMIC's and All Nation's ratios of total adjusted capital to risk-based capital at December 31, 1996, substantially exceed the level which would prompt regulatory action.