The Company owns a small parking lot adjacent to the eight-story building and a parking lot adjacent to the five-story building.
Lafayette Insurance Company owns one building in New Orleans, Louisiana which serves as its home office. The building consists of two floors of office space and a floor of parking, as well as a parking lot located adjacent to the building.
Earnings per common share and cash dividends declared per common share have been retroactively restated for additional shares issued as a result of a three-for-two stock split to stockholders of record as of December 18, 1995.
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 earnings per common share and dividends declared for the five years ended December 31, 1999 appears here.]
The information contained in the following Management's Discussion and Analysis contains forward-looking information as defined in the Private Securities Litigation Reform Act of 1995 and is therefore subject to certain risks and uncertainties. Actual results could differ materially from information within the forward-looking statements as a result of many factors, including, but not limited to, market conditions, competition and natural disasters.
American Indemnity, based in Galveston, Texas, is a holding company that is made up of the following regional property and casualty insurance companies: American Indemnity Company, American Fire and Indemnity Company, Texas General Indemnity Company, and American Indemnity Lloyds. The American Indemnity insurers offer personal and commercial lines of insurance through independent agents.
The transaction was accounted for using the purchase method of accounting. A schedule summarizing the assets acquired and the liabilities assumed as of August 10, 1999, as well as pro forma results of operations, can be found in Note 14 of the Notes to Consolidated Financial Statements.
The property and casualty segment reported an increase in net premiums earned of $26,504,000, or 12 percent in 1999, when compared to 1998. The purchase of American Indemnity contributed $19,413,000 of the growth. Net premiums earned in each line of business increased, with the exception of workers' compensation, which decreased slightly between years. With the purchase of American Indemnity, and the resulting expansion into southern and southeastern states, management anticipates property and casualty net premiums earned to continue to increase into 2000.
The Company had exposure to 23 catastrophes, in each of 1999 and 1998. The catastrophes negatively impacted net income (after tax) by $9,561,000, or $.95 per share in 1999, and $19,188,000, or $1.85 per share in 1998.
Experience in the Company's property and casualty segment is measured by the loss ratio (net losses incurred divided by net premiums earned). The lower the loss ratio, the more favorable the results. All but three lines of business showed improvement in the loss ratio (lower loss ratios) in 1999, compared to 1998. The three lines that deteriorated were other liability, reinsurance and all other. Catastrophe activity negatively impacted the Company's reinsurance line of business. The loss ratio for net assumed reinsurance, which constitutes business assumed from other insurance companies, deteriorated to 122.6 percent in 1999, from 95.9 percent in 1998 and 59.9 percent in 1997.
To measure total underwriting profitability, the property and casualty industry uses the statutory combined ratio, which is calculated by dividing net losses and net loss adjustment expenses incurred by net premiums earned, plus other underwriting expenses incurred divided by net premiums written. Generally, if the combined ratio is below 100 percent, the Company experiences an underwriting profit; if it is above 100 percent, an underwriting loss exists. In 1999, the segment's combined ratio was 109 percent, compared to 115 percent in 1998 and 98 percent in 1997. The catastrophes discussed above added 6 percent to the combined ratio in 1999 and 11 percent in 1998.
The Company reported net investment income of $75,317,000 in 1999, compared to $67,928,000 in 1998. More than 90 percent of the Company's investment income originates from interest on fixed income securities. The remaining investment revenue is derived from dividends on equity securities, interest on other long-term investments, interest on policy loans and rent earned from tenants in the Company's home office. The investment yield (investment income divided by average invested assets) was 6.5 percent in 1999 and 1998 and 6.6 percent in 1997.
The property and casualty segment's largest expenditures were for losses and loss adjustment expenses. According to the Insurance Services Office, a supplier of property and casualty statistical information, U.S. property and casualty insurers will have reported catastrophe losses (excluding expenses) of approximately $10 billion for events occurring in 1998, making 1998 the third-worst year for catastrophe losses in the last 10 years. The Company's exposure to 23 of these catastrophes negatively impacted net income by $19,188,000, or $1.85 per share, net of tax in 1998. This amount includes losses and expenses, net of ceded reinsurance.
his replacement was underway. The Company's fidelity and surety business continued to be very profitable, with a loss ratio of 9.9 percent, down from 12.3 percent in 1997 and 12.7 percent in 1996.
The Company's life insurance segment had record earnings in 1998. The segment reported net income after consolidating eliminations of $10,614,000, compared to $6,060,000 in 1997. Growth in net premiums earned of $6,064,000, or 32 percent, was a major factor in the favorable results. Much of the premium growth came from the segment's single premium credit life and accident and health products. Management anticipated smaller growth in the life insurance segment's premium income in 1999.
The life segment's largest expenditure is interest credited to annuities and universal life policies. As new premiums and existing account balances increase, the interest credited to policies will grow proportionately. Losses incurred, resulting primarily from death claims, is the second largest cost incurred by the life insurance segment. In 1998, there were a higher number of death claims and larger benefits were paid out on these claims, as compared with prior years. In addition, an increase in retention from $100,000 to $200,000 per insured, effective January 1, 1995, has increased both premium revenue and losses incurred.
The Company's other assets are composed primarily of accrued investment income, property and equipment (primarily land and buildings), and reinsurance receivables (amounts due from the Company's reinsurers for losses and expenses).
As part of the NAIC and state insurance department's solvency regulations, the Company is required to calculate a minimum capital requirement based on insurance risk factors. The risk-based capital results are used to identify companies that merit regulatory attention or the initiation of regulatory action. At December 31, 1999, the life segment and all but one of the property and casualty subsidiaries had capital well in excess of their required levels. American Indemnity Company's risk-based capital was beneath the minimum level prescribed by the NAIC. In response to the situation, the Company has made the decision to reinsure the underwriting business of American Indemnity Company in accordance with a 100 percent quota share reinsurance agreement effective January 1, 2000, for all American Indemnity Company policies new or renewed on or after January 1, 2000. This measure should bring American Indemnity Company's capital back to a point that is in excess of required NAIC levels. The Company is not aware of any other current recommendations by the NAIC or other regulatory authorities in the states in which the Company conducts business that, if or when implemented, would have a material effect on the Company's liquidity, capital resources or operations.
Accordingly, the Company will continue to monitor it's systems, and will maintain contact with its vendors concerning the status of their Year 2000 transition.
In February 2000, the Board of Directors authorized the repurchase of an additional 100,000 shares of the Company's stock. The total number of shares that are now authorized for repurchase is 114,075.
Recently, your Company has been doing very well, but you couldn't tell it from the performance of its stock. Most financial service stocks have not done well during the past year and, unfortunately, insurance stocks seem to have been particularly out of favor. In fact, they are so far out of favor that not even a dot.com in their name or a corner on the market for black tulip bulbs would help their price. Many, including your stock in United Fire, are selling below book value.
United Life Insurance Company continues to contribute significantly to our earnings. Earnings for the year were $9,322,000, down 12 percent from $10,614,000 for 1998. 1998's earnings benefited from reserve adjustments made in the last quarter of that year, which amounted to $1,615,000. Statutory premiums written, which include $146,000,000 of individual annuities, increased 12 percent to $173,000,000. In the past four years, premiums written have nearly doubled. The company that one of the rating agencies criticized for becoming an asset accumulator has now accumulated $825,293,000 in assets and an equity of $103,993,000. We may not know what we're doing, but we seem to be doing it very well. United Life's return on average invested assets was 7.5 percent, compared to 7.7 percent in 1998.
"I think I finally got it right!" At least I hope so! We're optimistic. One of our guiding principles has been to never bet the family farm on any one deal. An AOL/Time-Warner deal is not our style.
Last year, Congress finally enacted legislation revamping how financial institutions are to be regulated. Apparently the members of Congress and the lobbyists who have been living off this issue for years finally came to the conclusion they had milked it for all it was worth, so they might as well take some action. Among the bill's provisions is one which will permit banks, insurance companies and securities dealers to acquire each other. This is supposed to usher in the wonderful world of "one-stop" financial services. The only problem is that this may be the revolution nobody wants except the investment bankers who have visions of collecting fat fees for arranging such deals. Past attempts at bundling financial services together (the concept of "one-stop" financial services is not new) have not been roaring successes. The financial services customer knows what he or she wants and we believe that what he or she wants is suppliers that are good at what they do and not a pretty red umbrella. Anyway the internet may well make the whole question moot as customers learn to surf the "net" to find the best deal. This only lays credence to the proposition that by the time Congress finally addresses a problem, the problem has probably resolved itself.
No commentary on the last year of the millenium (although it really wasn't) would be complete without some mention of the bug that didn't bite, Y2K. I suppose we will never know how much this foolishness cost. The expenses incurred can be divided into two categories. The necessary expenses, those incurred to rewrite computer programs and test the systems (this work had largely been completed prior to 1999) and the ridiculous ones incurred to produce paper to fill other people's files. With the preparation of emergency plans, making of filings and conducting of audits, by year-end this part of the fiasco took on the appearance of a Chinese fire drill. Then "poof," nothing happened! Cassandra struck out again. Oh well, our Board Meetings should be a lot shorter now that we don't have Y2K to talk about.
Last year, I offered some investment advice about insurance stocks. It was bad advice and I hope no one took it. If you did, I'm sorry, but if it's any consolation, unfortunately so did I!
CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
(1) The change in net unrealized appreciation (depreciation) is net of reclassification adjustments and income taxes.
The Consolidated Financial Statements have been prepared on the basis of generally accepted accounting principles ("GAAP"), which differ in some respects from those followed in reports to insurance regulatory authorities.
The accompanying Consolidated Financial Statements include United Fire & Casualty Company and its wholly owned subsidiaries, United Life Insurance Company, Lafayette Insurance Company, Insurance Brokers & Managers, Inc., Addison Insurance Company, Addison Insurance Agency, UFC Premium Finance Company, American Indemnity Financial Corporation, American Indemnity Company, American Fire and Indemnity Company, Texas General Indemnity Company, American Computing Company, and the affiliate American Indemnity Lloyds, which is financially and operationally controlled by the Company. All material intercompany items have been eliminated in consolidation.
The costs of acquiring new life business, principally commissions and certain variable underwriting, agency and policy issue expenses, have been deferred and are being amortized to income over the premium paying period of the related traditional policies in proportion to the ratio of the expected annual premium revenue to the expected total premium revenue, and over the anticipated lives of nontraditional policies in proportion to the ratio of the expected annual gross margins to the expected total gross margins. The expected premium revenue and gross margins are based upon the same mortality and withdrawal assumptions used in determining future policy benefits. For nontraditional policies, changes in the amount or timing of expected gross margins will result in adjustment to the cumulative amortization of these costs.
estimated gross profits are revised. The effect on the deferred policy acquisition costs that would result from realization of unrealized gains (losses) is recognized with an offset to accumulated other comprehensive income in the Consolidated Statements of Stockholders' Equity as of the balance sheet date. As of December 31, 1999, an adjustment to increase deferred policy acquisition costs of $12,808,000 was made with a corresponding decrease to accumulated other comprehensive income. In 1998, the adjustment was to reduce deferred policy acquisition costs by $726,000.
Liabilities for future policy benefits are computed by the net level premium method using interest assumptions ranging from 4.5 percent to 8.0 percent and withdrawal, mortality and morbidity assumptions appropriate at the time the policies were issued. Health reserves are stated at amounts determined by estimates on individual cases and estimates of unreported claims based on past experience. Liabilities for universal-life-type and investment contracts are stated at policyholder account values before surrender charges. Liabilities for traditional immediate annuities are based primarily upon statutory reserves.
Investments in held-to-maturity fixed-income securities 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-income securities, 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, 1999 and 1998, are securities on deposit with various regulatory authorities as required by law with carrying values of $755,436,000 and $651,173,000, respectively.
For purposes of reporting cash flows, cash and cash equivalents include cash and non-negotiable certificates of deposit with original maturities three months or less. Negative cash balances are included in accrued expenses and other liabilities. Income taxes paid during 1999, 1998 and 1997 were $505,000, $11,201,000 and $5,789,000, respectively. There were no other significant payments of interest other than interest credited on policyholders' accounts in 1999, 1998 or 1997.
In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities." In June 1999, SFAS No. 133 was amended by SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB No. 133 - an amendment of FASB Statement No. 133". SFAS No. 133 is now effective for all fiscal quarters of fiscal years beginning after June 15, 2000. A
Effective January 1, 1999, the Company adopted Statement of Position ("SOP") 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments". The accounting guidance of this SOP focuses on the timing of recognition and measurement of liabilities for insurance-related assessments. Guidance is also provided on recording assets presenting future recoveries of assessments through premium tax offsets or policy surcharges. The SOP was issued to reduce diversity in practice and to improve comparability and disclosure. Under SOP 97-3, the Company estimates its liabilities for insurance-related assessments, as opposed to recording the liability and expense when notified by insurance regulators. This change in timing did not have a material effect on the Company's Consolidated Financial Statements.
The net investment income for the years ended December 31, 1999, 1998 and 1997 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 various data vendors. Other long-term investments, consisting primarily of holdings in limited partnership funds, are valued by the various fund managers. In management's opinion, these values reflect fair value at December 31, 1999 and 1998.
The property and casualty insurance companies cede portions of their insurance business to other insurance companies on both a pro rata and excess of loss basis. Insurance ceded by the property and casualty insurance companies does not relieve their primary liability as the originating insurers. Earned premiums ceded were $27,206,000, $22,349,000 and $25,716,000 for the years ended December 31, 1999, 1998 and 1997, respectively. The Company believes all amounts are collectible with regard to reinsurance receivables. There are no concentrations of credit risk associated with reinsurance.
Subsequent to the purchase of American Indemnity, the Company reviewed that company's loss and LAE case reserves and increased the liabilities to a level that was consistent with the reserving philosophies of the Company. A portion of the reserve increases were for losses that occurred in prior accident years. This would have negatively impacted the change in estimated losses and LAE for claims occurring in prior years. As a condition of the purchase of American Indemnity, an adverse development reinsurance agreement was negotiated that protects the Company against adverse development of the losses and LAE acquired.
- - - - - - -------------------------------------------------------------------------------- (Dollars in Thousands) - - - - - - -------------------------------------------------------------------------------- Statutory Stockholders' Statutory Surplus Net Income - - - - - - -------------------------------------------------------------------------------- PROPERTY AND CASUALTY $179,689 $ 191 LIFE, ACCIDENT AND HEALTH 53,912 2,605 - - - - - - -------------------------------------------------------------------------------- Property and casualty $202,342 $ 9,990 Life, accident and health 53,038 2,052 - - - - - - -------------------------------------------------------------------------------- Property and casualty $231,326 $23,627 Life, accident and health 53,095 2,331 ================================================================================
The Company and its insurance subsidiaries prepare their statutory financial statements in conformity with practices prescribed or permitted by their states 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. The NAIC is currently working on a project to codify insurance statutory accounting practices. The Company expects the State of Iowa to adopt codification by January 1, 2001, and the Company expects the new rules to have a financial effect upon application. The Company has not yet determined this impact. The changes would not affect the accompanying financial statements, which are based on GAAP. Prior to implementation of the codified 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 significant components of the net deferred tax liability at December 31, 1999 and 1998 are as follows.
The Company has tax net operating loss ("NOL") carryforwards totaling $42,912,023 as of December 31,1999. These NOL carryforwards were purchased by the Company when it acquired American Indemnity. These NOL carryforwards expire as follows: 2000: $4,927,522; 2001: $2,271,256; 2002: $621,205; 2003: $4,596,950; 2004: $1,246,728; 2005: $118,137; 2006: $43,352; 2007: $13,450; 2008: $13,410; 2009: $4,604,277; 2010: $989,347; 2011: $6,284,626; 2017: $6,882,190; 2018: $5,175,066; 2019: $5,124,507. The Company is required to establish a valuation allowance for any portion of the deferred tax asset that management believes will not be realized. The Company established a valuation allowance of $15,139,000 for deferred tax assets primarily relating to American Indemnity's NOLs, which can only be used to offset future income of that company. If the benefit of the American Indemnity NOLs is realized in the future, it will result in a reduction of goodwill and be amortized into income over its remaining life by reducing goodwill amortization expense.
Effective December 31, 1999, the pension plans of the Company and American Indemnity were merged. The merged defined benefit pension plan covers substantially all employees. Under the plan, retirement benefits are primarily a function of the number of years of service and the level of compensation. It is the Company's policy to fund the plan on a current basis to the extent deductible under existing tax regulations. For 1999, the Company used December 31 as the date for measuring plan assets and liabilities. As permitted by SFAS No. 87, "Employers' Accounting for Pensions," the Company used September 30 as the date for measuring plan assets and liabilities in 1998 in order to obtain information necessary for the preparation of the financial statements on a timely basis.
The Company has a defined benefit postretirement health care plan that covers substantially all benefit-eligible employees. The plan pays stated percentages of most necessary medical and dental expenses incurred by retirees, after subtracting payments by Medicare or other providers and after the stated deductible has been met. Participants become eligible for the benefits if they retire from the Company after reaching age 55 with 10 or more years of service in the plan. The plan is contributory, with retiree contributions adjusted annually.
The employees of American Indemnity are covered by a separate postretirement benefit plan, which provides health care and life insurance benefits to retired employees, after reaching age 55 with 25 years of service, age 60 with 20 years of service or age 65 with 15 years of service.
The following table provides a reconciliation of the changes in the plan's benefit obligations and fair value of plan assets and a statement of the funded status for 1999 and 1998. The table includes the obligations and fair values acquired in connection with the purchase of American Indemnity. The amounts related to the acquisition are based on valuations as of December 31, 1999, which approximates the valuation had it been measured as of the acquisition date.
The unrecognized prior service cost and the actuarial loss are being amortized on a straight-line basis over an average period of eight years. This period represents the average remaining employee service period until the date of full eligibility. The assumptions used in the measurement of the Company's benefit obligations are shown in the following table.
- - - - - - -------------------------------------------------------------------------------- Weighted-average assumptions as of Pension benefits Other benefits - - - - - - -------------------------------------------------------------------------------- December 31, 1999 1998 1999 1998 - - - - - - -------------------------------------------------------------------------------- Discount rate 7.50% 6.75% 7.50% 6.75% Expected return on plan assets 8.25 8.00 N/A N/A Rate of compensation increase 4.00 4.00 N/A N/A - - - - - - --------------------------------------------------------------------------------
Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A 1 percent change in assumed health care cost trend rates would have the following effects.
The Company has a profit-sharing plan in which employees who meet service requirements are eligible to participate. The amount of the Company's contribution is discretionary, and is determined annually but cannot exceed the amount deductible for Federal income tax purposes. The Company's contribution to the plan for the years ended December 31, 1999, 1998 and 1997, was $503,000, $883,000 and $936,000, respectively.
A total of 6,021 employee stock options were granted in February, 1999 and April 1999. All options are outstanding as of December 31, 1999. No options had been granted as of December 31, 1998. None of the options are exercisable as of December 31, 1999. The remaining life on the options granted in February 1999 is 9.8 years, and for those granted in April 1999, the remaining life is 9.7 years. The exercise price of the unexercisable options is $29.25 for the February 1999 options and $26.12 for the April 1999 options. The grant date fair value of the employee stock options, as prescribed by SFAS No. 123 has been determined to have an immaterial impact on net income and earnings per share.
United Life Insurance Company underwrites and markets ordinary life (primarily universal life), annuities (primarily single premium) and credit life products to individuals and groups through approximately 1,200 independent agencies in 24 states. Total revenue by segment includes sales to both outside customers and intersegment sales that are eliminated to arrive at the total revenues as reported in the Company's Consolidated Statements of Operations. Intersegment sales are accounted for on the same basis as sales to outside customers. The following tables set forth certain data for each of the Company's business segments.
Cash dividends per common share of $.68 and $.67 were declared in 1999 and 1998, respectively. In the calculation of earnings per share, stock options granted to employees were not included in the computation of diluted earnings per share because the options' exercise price was greater than the average market price of the common shares. The options were still outstanding as of December 31, 1999.
The following table sets forth the components of other comprehensive income (loss), and the related tax effects, for the years 1999, 1998 and 1997.
On August 10, 1999, the Company acquired American Indemnity as a wholly owned subsidiary for approximately $30,212,000 in cash in exchange for 1,962,410 shares of common stock. Common stockholders of American Indemnity received approximately $14.35 per share of common stock at the closing of the transaction and deferred consideration of up to $1.00 per share to be paid in two years, subject to adjustments relating to indemnities. An escrow account with a balance of $1,990,000 is included in the Company's consolidated balance sheets in other assets for payment of the deferred consideration.
The transaction was accounted for using the purchase method of accounting. American Indemnity's results for the period August 10, 1999 through December 31, 1999 are included in the consolidated statements of operations. The purchase price paid for American Indemnity has been allocated to the assets acquired and liabilities assumed based on their fair values and the excess purchase price has been recorded as goodwill. Goodwill of approximately $7,846,000 will be amortized on a straight-line basis for a period of ten years. The following schedule summarizes the assets acquired and the liabilities assumed as of August 10, 1999.
- - - - - - -------------------------------------------------------------------------------- Assets Acquired (Dollars in Thousands) - - - - - - -------------------------------------------------------------------------------- Fixed maturity securities $ 68,499 Equity securities 14,344 Other Assets 57,355 - - - - - - -------------------------------------------------------------------------------- Total assets acquired $140,198 - - - - - - -------------------------------------------------------------------------------- Liabilities assumed Policy reserves and unearned premiums $102,483 Other liabilities 17,340 - - - - - - -------------------------------------------------------------------------------- Total liabilities assumed $119,823 - - - - - - -------------------------------------------------------------------------------- Net assets acquired $ 20,375 - - - - - - -------------------------------------------------------------------------------- Excess of acquisition cost over net assets acquired 7,846 - - - - - - -------------------------------------------------------------------------------- Total purchase price $ 28,221 ================================================================================
The pro forma financial information is presented for informational purposes only and is not necessarily indicative of the operating results that would have occurred had the acquisitions been consummated as of the above dates, nor are such operating results necessarily indicative of future operating results.
TO THE STOCKHOLDERS AND BOARD OF DIRECTORS OF UNITED FIRE & CASUALTY COMPANY: