The following selected financial data for each of the five years ended December 31, 1997 is derived from the audited consolidated financial statements of the Company. The selected data should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and accompanying notes included elsewhere herein.
The selected financial data and consolidated financial statements and related notes thereto should be read in conjunction with the following discussion as they contain important information for evaluation of the Company's financial condition and operating results. OVERVIEW
As one of the three servicing carriers, the Company earns commission and service income as a percentage of gross premiums written and also earns a fee on claims paid. Until October 1, 1994, the Company serviced the largest of three blocks of business for the SC Facility ("Block 1"). As the result of a competitive bid process in 1994, the Company, as the second lowest bidder, was awarded a five-year contract to service the second largest block of business ("Block 2") at lower rates than its old contract. However, the Company continued to process the remaining run-off claims from Block 1 for losses incurred prior to October 1, 1994, pursuant to the rates under its prior contract. Premium-based fees under the new contract are 21.0% of gross premiums written (compared with a rate of 28.0% under its prior contract). The Company is responsible for paying all costs of processing the policies, including a mandated 12.0% commission on gross premiums earned to the agent. The Company also receives income on the claims it pays for the SC Facility in the amount of 11.0% of the gross paid claims (compared with a 15.0% rate under its prior contract). The Company is responsible for paying all costs to process these claims, including adjusting expenses. However, the SC Facility does reimburse the Company in full for legal expenses associated with processing these claims.
In 1997, the Company expanded its participation in the South Carolina automobile business to include writing and retaining a portion of the risk on nonstandard automobile policies. These revenues were not significant during 1997. Also in the fourth quarter of 1997 the Company acquired Innovative and its subsidiary, Universal, a writer of nonstandard automobile insurance in North Carolina, West Virginia and Georgia. Only one month of activity from Universal is included in the current year results.
increase to 32.9% if the Company is able to increase its contracts in force, as defined by the NFIP, by 10%. The Company is responsible for paying all costs associated with processing the policies, including a commission to the independent agent. The Company also receives a fee on the claims that it pays on these policies in the amount of 3.3% of incurred claims. The Company is reimbursed for the allocated loss adjustment expenses associated with these claims according to a standard fee schedule.
Prior to February, 1998, the Company derived revenues from its role as a commercial lines Managing General Agent for an unaffiliated insurance company. While the Company performed all services and paid all costs (including the independent agents' commissions) related to administering and processing policies and claims, the policies were written on behalf of an unaffiliated insurance company. The Company's financial statements reflect commission income as a percentage of premiums written but do not reflect these premiums written or associated claims incurred. Beginning in February, 1998, as the commercial policies renew, the Company will retain the risk.
The Company continues to maintain reserves and pay significant claims with respect to its run-off operations. These run-off operations consist primarily of general liability policies that include contractors' liability and environmental coverages primarily in California and commercial (including worker's compensation) and personal lines policies in the Southeast. The run-off of claims on these policies created substantial losses to the Company during the past 10 years. The Company commissioned additional reviews of its run-off operations by independent actuaries resulting in a large increase in reserves during the year ended December 31, 1994.
Realized gains on investments totaled $529,000 for the year ended December 31, 1997, a $543,000 increase over the previous year. Of this total, $221,000 was realized on the sale of stock in an industry trade group ISO. In addition, the Company sold surplus real estate, which resulted in a gain of $311,000.
Property and casualty loss and loss adjustment expense for the year ending December 31, 1997 decreased $1.8 million , or 15.0% to $10 million from $11.8 million for the year ended December 31, 1996. The decrease is due to a reduction in losses and loss adjustment expenses related to the Company's run-off business.
Other operating costs and expense for the year ended December 31, 1997 increased $0.9 million, or 2.2% to $39.9 million from $39 million for the year ended December 31, 1996. This increase is mainly due to the Company hiring individuals in 1997 for its voluntary automobile program and associated start up costs for that program.
Commission and service income for the year ended December 31, 1996 decreased $3.2 million, or 6.4%, to $46.5 million from $49.6 million for the year ended December 31, 1995. This decrease is due primarily to a decline of $3.7 million in SC Facility claims-based fees resulting largely from the new contract effective in October, 1994. The effect of this new contract caused an immediate reduction in premium-based fees and a more gradual reduction over an approximate 18-month period in claims-based fees for the reasons explained in the above overview.
Net investment and other interest income for the year ended December 31, 1996 decreased $0.5 million, or 12%, to $3.8 million from $4.3 million for the year ended December 31, 1995. This decrease is primarily a result of a decrease of $7.7 million, or 15%, in the Company's overall cash and investment position from $50.6 million at December 31, 1995 to $42.9 million at December 31, 1996. This decrease is due to the Company's negative cash flow from operations in 1996 and is described in "Liquidity and Capital Resources." However, average yield on total cash and investments improved from 5.9% for the year ended December 31, 1995 to 6.3% for the year ended December 31, 1996.
Other operating costs and expenses for the years ended December 31, 1996 and 1995 were $39 million and $42.8 million, respectively. This decrease of $3.8 million, or 9%, is primarily a result of the Company's continuing efforts to maintain costs at a level appropriate to the associated revenue levels. A portion of this decrease is related to the cancellation of the Company's contract with Policy Management Systems Corporation ("PMSC") in September, 1996. While most of the services that PMSC had provided for the Company were discontinued in 1995 and 1994, the amount paid to PMSC during 1996 was reduced from $1.8 million for the year ended December 31, 1995 to $0.9 million for the year ended December 31, 1996.
The liability for losses on direct business is determined using case-basis evaluations and statistical projections. The liabilities determined under these procedures are reduced, for GAAP purposes, by estimated amount to be received through salvage and subrogation and second injury funds of $0.7 million in 1997. The resulting liabilities represent the Company's estimate of the net cost of all unpaid losses and LAE incurred through December 31 of each year. These estimates may be
The ceded reinsurance recoverable, classified as an asset, includes $ 67.1 million at the end of 1997 ($74.8 million at the end of 1996 and $76.1 million at the end of 1995) of balances recoverable from various facilities (such as the SC Facility, NC Facility and NFIP). See Note 13 of Notes to Financial Statements.
The difference between the year-end net liability for losses and LAE reported in the accompanying consolidated financial statements in accordance with GAAP and that in accordance with SAP was as follows for the years ended December 31 (in thousands):
The following table reflects the loss and LAE development for 1997 and 1996 on a GAAP basis (in thousands):
The following analysis reflects loss and LAE development on a SAP basis, net of ceded reinsurance recoverable, for a ten year period for retained business only for year ended December 31 (in millions):
The preceding table presents the development of balance sheet liabilities on a SAP basis for 1987 through 1997. The top line of the preceding table shows the initial estimated liability on a SAP basis. This liability represents the estimated amount of losses and LAE for claims arising in years that are unpaid at the balance sheet date, including losses that have been incurred but not yet reported. The next portion of the table reflects the cumulative payments made for each of the indicated years as they have developed through time. This table has been adjusted for a modification made to 1994 paid losses on a GAAP basis, not recorded for statutory net losses incurred. On a statutory basis, the modification is a reclassification only and has no effect on income.
A part of the Company's reserve for losses and LAE is set aside for environmental, pollution, and toxic tort claims. These claims relate to business written by the West Coast operation prior to 1986. On June 7,1994, the Company settled a dispute relative to approximately 400 of these claims. Any future liability on these claims is limited to 50% of the direct loss and LAE paid. The Company's obligation does not begin until the other company pays out subsequent to June 7,1994, a total of $ 20 million in losses and LAE paid, net of reinsurance. As of December 31, 1997, $7.5 million of claims payments have been made (before considering reinsurance recoveries) since June 7, 1994. A portion of the reinsurance on this business was placed with a reinsurer currently operating under the supervision of its state regulator. Estimates of any obligations of the Company take into account potential recoverable amounts.
The policies corresponding to these claims were written on a direct basis. The Company has excess of loss reinsurance with company retention through 1980 of $ 100,000 and $ 500,000 after that date. The claims are reserved as follows as of December 31, 1997 and 1996 (in thousands):
Net cash flow provided in 1997 by investing activities made up for the deficit in operating cash flow as total funds provided by investing activities equaled $2.3 million. Investments sold or matured totaled $4.3 million and proceeds were used to purchase new investments totaling $1.6 million.
Total cash and investments at December 31, 1997, 1996 and 1995 were $51.8 million, $42.9 million and $50.6 million, respectively. At December 31, 1997, $8.9 million, or 17.2%, of the portfolio was committed to cash and short term investments consisting primarily of repurchase agreements as compared to $2.7 million, or 6.2%, of the portfolio at December 31, 1996. Investments in US Treasury Securities, US Agency Securities, Overnight Repurchase Agreements and cash represents 96.2% of Cash and Investments.
All debt securities are considered available for sale and are carried at market value as of December 31, 1997 and 1996. The market values of the debt securities were $47,000 above book value at the end of 1997, which is included as an increase in shareholders' equity, compared with $0.5 million below book value at the end of 1996. The weighted average maturity of the fixed income investments as of December 31, 1997 was approximately 3.2 years. Average net investment yields on the Company's cash and investments were 5.9% in 1997 and 6.3% in 1996.
- - During the first quarter of 1996, the Company issued 408,750 shares of unregistered Company stock at a price of $8.00 per share to a group of investors. The proceeds of this stock sale were used to repay a $2 million loan from a shareholder which was due May 1, 1996. In addition, the Company has issued to this group stock options expiring on December 31, 2000 to acquire an additional 408,750 shares at the greater of $10.00 per share or the book value per share at the date of exercise.
The volume of premiums that the property and casualty insurance subsidiaries may prudently write is based in part on the amount of statutory net worth as determined in accordance with applicable insurance regulations. NAIC has adopted RBC requirements for property and casualty insurance companies to evaluate the adequacy of statutory capital and surplus in relation to investments and insurance risks such as asset quality, asset and liability matching, loss reserve adequacy, and other business factors. The RBC formula is used by state insurance regulators as an early warning tool to identify, for the purpose of initiating regulatory action, insurance companies that are potentially inadequately capitalized. Compliance is determined by the ratio of the companies' regulatory total adjusted capital to its authorized control level RBC (as defined by NAIC). All six of the property and casualty insurance subsidiaries of the Company have December 31, 1997 ratios of total adjusted capital to RBC that are in excess of the level which would prompt regulatory.
Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The Schedules I, II, III, IV, V and VI listed in Part IV, Item 14 are presented for purposes of complying with the Securities and Exchange Commissions rules and are not part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in the audit of the basic financial statements, and in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.
Columbia, South Carolina March 9, 1998 (except with respect to matters discussed in Note 16, as to which the date is March 16, 1998)
THE SEIBELS BRUCE GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS For the Year Ended December 31, (Dollars shown in thousands, except per share amounts)
The Seibels Bruce Group, Inc. ("SBIG", or the "Company") provides automobile, flood, and other property and casualty insurance services and products to customers located primarily in the southeastern United States. The Company's largest source of revenues derives from the Company's role as one of three servicing carriers for the South Carolina Reinsurance Facility (the "SC Facility"), a state-sponsored plan for insuring South Carolina drivers outside of the voluntary market. The Company also is a leading provider, and an original participant, in the National Flood Insurance Program (the "NFIP"), a flood insurance program administered by the federal government. As a servicing carrier for the Facility and the NFIP, the Company receives commissions and fees, but reinsures all of the underwriting risk. The Company provides other fee-based services, including services in its capacity as a managing general agent ("MGA") for commercial insurance policies underwritten by unaffiliated insurance companies, catastrophic claims services, excess and surplus lines brokerage services and liability run-off management services. Recently, the Company began marketing and underwriting nonstandard automobile insurance on a risk-bearing basis. In the fourth quarter of 1997, the company purchased The Innovative Company ("Innovative") and its subsidiaries Universal Insurance Company ("Universal") and Premium Budget Plan ("PBP"). Universal is a nonstandard automobile insurance company headquartered in North Carolina. PBP is a premium finance company also located in North Carolina. Only one month's operations of Innovative is included in the financial statements.
The fair values of debt securities and equity securities were determined in accordance with methods prescribed by the National Association of Insurance Commissioners which do not differ materially from nationally quoted market prices. The fair market value of certain municipal bonds is assumed to be equal to amortized cost where no market quotations exist.
Commission and service income is predominately derived from servicing carrier activities. The commission income related to producing and underwriting the business is recognized in the period in which the business is written. A portion of commission income is also derived from business produced by the Company as a Managing General Agent. The Company receives commissions for producing and underwriting the business as well as servicing such business. These revenues are recognized on an accrual basis as earned.
Allowance for uncollectable accounts for agents' balances and direct bill balances receivable, other receivables, and premium notes receivable were $1,095,000 and $823,000 at December 31, 1997 and December 31, 1996, respectively.
Goodwill is the excess of the amount paid to acquire a company over the fair value of its net assets, reduced by amortization and any subsequent valuation adjustments. The Company periodically evaluates whether later events and circumstances have occurred that indicate that the remaining balance of goodwill may not be recoverable or that the remaining useful life may warrant revision. When external factors indicate that goodwill should be evaluated for possible impairment, the Company uses an estimate of the related subsidiary's cash flows over the remaining life of the goodwill and compares it to the subsidiary's goodwill balance to determine whether the goodwill is recoverable, or if impairment exists, in which case an adjustment is made to the carrying value of the asset. The Company amortizes goodwill over a period of 40 years.
Other interest income includes interest received on reinsurance balances withheld, agents' balances receivable, and balances due from the SC Facility.
FASB Statement No. 130 "Reporting Comprehensive Income" has been issued and becomes effective in 1998. This statement establishes standards for reporting and display of comprehensive income and its components. Comprehensive income is a measure of all changes in equity of an entity and includes net income(loss) plus changes in certain assets and liabilities that are reported directly in equity. The Company has not elected early adoption of this statement and does not believe that adoption will result in a significant impact to the financial statements.
Investments in notes and other debt securities and common stocks are all considered available-for-sale securities and are carried at market at December 31, 1997 and 1996. Short-term investments are carried at cost, which approximates market value.
Net bond discount accretion and premium amortization charged to income for the years ended December 31, 1997, 1996 and 1995 was not material.
There were no debt securities which were non-income producing for the 12 months ended December 31, 1997. Debt securities with an amortized cost of $25 million and $22 million at December 31, 1997 and 1996, respectively, were on deposit with regulatory authorities.
Investment income as of December 31 consists of the following (in thousands):
A summary of property and equipment is as follows (in thousands):
Depreciation expense charged to operations was $0.8 million in 1997, $1 million in 1996 and $0.9 million in 1995.
Policy acquisition costs incurred and amortized to income on property and casualty business were as follows (in thousands):
Deferred policy acquisition costs attributable to the credit life operation were $15,000 and $96,000 at December 31, 1997 and 1996, respectively. These costs represent that portion of the cost of writing business which is deferred and charged against income, through other operating costs and expenses, as premiums are earned.
Notes payable at December 31, 1997 and 1996, are summarized as follows (in thousands):
Both of the BB&T notes payable are subject to restrictive financial covenants pertaining to minimum levels of net worth and ratios of debt to net worth and cash flow coverage. As of December 31, 1997, the Company was in compliance with all these restrictive covenants. Scheduled maturities of the notes payable are as follows (in thousands):
The Company has determined, based on its recent earnings history, that a valuation allowance of $12.6 million should be maintained against the deferred tax asset at December 31, 1997. The Company's valuation allowance decreased by $2.4 million during 1997 due to a utilization of net operating loss.
The policies corresponding to these claims were written on a direct basis. The Company has excess of loss reinsurance with company retentions through 1980 of $ 100,000 and $ 500,000 after that date. The claims are reserved as follows as of December 31, 1997 and 1996 (in thousands):
Losses incurred are reduced by recoveries made and to be made from reinsurers, which also includes substantial amounts related to business produced as a servicing carrier. Estimated reinsurance recoveries are as follows (in thousands):
Effective December 1, 1997, the Company acquired all of the issued and outstanding shares of common stock of Innovative, including its subsidiaries. Consideration in the transaction consisted of 220,000 shares of new Cumulative Convertible Redeemable Nonvoting Special Preferred Stock ("Preferred Stock") of the Seibels Bruce Group, Inc. The Company treated the transaction as a purchase and repaid $1.8 million of debt due the shareholders of Innovative out of cash and liquid investments. The excess purchase price over the fair value of the assets was $2.6 million and is being amortized using the straight-line method over 40 years. The Special Stock pays quarterly dividends at an annual rate of $0.62 per share. On or after August 15, 2000, but prior to August 15, 2002, the Company at its option only, may redeem in whole or in part the Special Stock at a price of $15.00 per share. On August 15, 2002, the Company must redeem any remaining shares at a rate of $10.00 per share. On or after August 15, 2000, but prior to August 15, 2002, holders of the shares have the right to convert each share of the Special Stock into 1.23 shares of Common Stock.
Pro-forma for the Company and Innovative Unaudited Results for the year ended December 31 (in thousands, except per share data)
A reconciliation between GAAP net income and statutory net income (loss) of the property and casualty insurance subsidiaries is as follows for the year ended December 31 (in thousands):
NOTE 11 BENEFIT PLANS, OPTIONS AND COMPUTATION OF EARNINGS PER SHARE
During the first quarter of 1996, the Company issued to a group of investors stock options expiring December 31, 2000 to acquire 408,750 shares of unregistered Company Common Stock at the greater of the price of $10.00 per share or book value at the date of exercise.
In the third quarter of 1996, the Company issued to a different group of investors stock options to acquire 781,250 shares of unregistered Company Common Stock at the greater of the price of $6.00 per share or the book value at the date of exercise, expiring December 31, 1998 and 781,250 shares at the greater of the price of $8.00 or the book value at date of exercise, expiring December 31, 2000.
During the fourth quarter of 1997, the Company issued 220,000 shares of Preferred Stock that are convertible into 270,000 shares of the Company's Common Stock. (see note 8)
Also included in the 1996 Plan are provisions for the granting of incentive stock and restricted stock. While there were no grants of incentive stock during 1997, 1996 or 1995, 28,279 shares of restricted stock were granted in 1996. Of that amount, 2,175 shares were issued in 1996 and 26,103 shares were issued in 1997 when the restrictions lapsed. In 1997, 55,298 shares of restricted stock were granted, 10,667 shares of which were issued during the year. Of the remaining 44,631 shares, 10,772 shares were forfeited during 1997 prior to the vesting date of January 1, 1998.
The weighted-average discount used in determining the accumulated post-retirement benefit obligation was 7.25% for 1997, 7.75% for 1996 and 7.25% for 1995.
Under the 401(k) element of the plan, employees may elect to have a portion of their salary withheld from pre-tax wages for investment in the plan, subject to limitations imposed by IRS regulations. The employee has several options as to how contributions will be invested. Effective July 1, 1997 the employer reinstated the 50% match of the employee's contribution up to the first 6%. The company match is split evenly with 25% invested in accordance with the investment options selected by the participant and the remaining 25% invested in the Seibels Bruce Stock Fund. The employer contribution for the plan on behalf of the participating employees was $72,159 in 1997 and $ -0- in 1996.
The Company performs servicing carrier activities for state and federal insurance facilities. Managing general agency services were also performed for a non-affiliated insurance company until February 1, 1998 (see Note 16). Insurance products are offered through independent agents, primarily in the southeastern United States. Effective in mid-1995, the Company voluntarily suspended underwriting new and renewal business for which the risks were not reinsured to an unaffiliated party. After both the Company and its regulators became satisfied that the capital level was adequate to undertake such risk, underwriting on a risk retention basis was resumed at very modest levels in mid-1996.
In 1997, depreciation and amortization charges for the various property and casualty insurance underwriting and commission and service segments, combined were $0.8 million ($1.0 and $0.9 million for 1996 and 1995 respectively). These amounts exclude policy acquisition costs of $1.3 million in 1997 ($1.6 and $3.2 million in 1996 and 1995 respectively).
Costs of additions to property and equipment for the property and casualty insurance underwriting and commission and service segments combined amounted to $1.1 million in 1997, $0.8 million in 1996 and $0.1 million in 1995. Additions in
1997 were primarily due to data processing software development to start the voluntary auto and commercial lines programs.
The amounts of premiums pertaining to catastrophe reinsurance that were ceded from earned premium during 1996 and 1995 were $0.2 million and $0.8 million respectively. The Company carried no catastrophe reinsurance in 1997.
With respect to credit concentrations, most of the Company's business activity is with agents and policyholders located within the five operating states. The primary reinsurance recoverables are from the state and federal servicing carrier
activities. There are otherwise no material credit concentrations related to premiums receivable, agents' balances, and premium notes receivable.
(e) The Company was served with a complaint dated November 19, 1997 by Norwest Financial Resources, Inc. ("Norwest") that claimed indemnification against the Company pursuant to the Asset Purchase Agreement dated as of July 2, 1993 by and among Premium Service Corporation of Columbia ("Premium"), the Company and Norwest. The indemnification claim relates to certain loans which were recorded on the books of Premium but which later were discovered to be incorrectly recorded as realizable assets. Management believes the Company has no liability in the case.
On March 16, 1998 the Company signed an agreement to acquire America's Flood Services, Inc. ("AFS") and a letter of intent to acquire Graward General Companies, Inc. ("Graward"). AFS manages flood zone determinations, flood insurance