North East leases its home office located in Scarborough, Maine. The lease expires on December 31, 2000 and North East pays annual rent of $145,000.
Management's Discussion and Analysis of Financial - - ---------------------------------------------------------- Condition and Results of Operations - - -----------------------------------
The Registrant has four subsidiaries which write property and casualty insurance. Motor Club writes PPA business in the State of New Jersey. Preserver writes small commercial, homeowners and ancillary coverages in that State.
On September 24, 1999, the Registrant acquired North East and its subsidiaries for $10,483,000, principally in cash. North East writes private passenger and commercial automobile as well as small commercial and ancillary coverages in the State of Maine. American Colonial, a wholly-owned subsidiary of North East, has not written any insurance coverage since March 1990.
On September 24, 1999 the Registrant acquired North East. Accordingly, the consolidated results of operations include, using the purchase method of accounting, the results of operation of North East for the three months ended December 31, 1999. The table below details the North East results from September 24 through December 31, 1999:
In addition, the Registrant incurred $800,000 in expenses related to the acquisition of North East. For purposes of this discussion, the North East results and non-recurring merger expenses are excluded in order to afford comparability.
Net investment income increased $530,000 or 12% resulting from an increase in invested assets. Average assets (at amortized cost) were $73,420,000 during 1999 compared to $68,374,000 during 1998. The average rate of return on invested assets increased to 6.6% in 1999 from 6.3% in 1998.
As noted, the increase in the Motor Club loss ratio was largely driven by significantly higher PIP (No Fault) first party medical claims occurring in 1999 ("Accident Year 1999"). The provision for Accident Year 1999 PPA claims was $1,723,000 higher in 1999 as compared to 1998, accounting for 75% of the consolidated increase. These losses did not increase until after the rate rollback and other provisions of AICRA were implemented. The Registrant believes that claimants filing more severe claims on an accelerated basis than historical patterns dictated caused this increase. The Registrant further believes that this acceleration was caused by the implementation of regulations tightening the fee schedule, allowing pre-certification methodologies and permitting a revised arbitration system, all of which should serve to ultimately reduce PIP claim costs.
In addition, elements of AICRA and other statutory amendments have yet to be implemented, and as such, may still have an impact on Motor Club's operations. The New Jersey PPA market continues to be subject to volatility, and consistent with the Registrant's long-stated goal to increase its identification as a provider of small commercial lines insurance and expand and diversify its operations outside the State of New Jersey, the Registrant is reviewing strategies to improve the profitability of its PPA business and to otherwise add more value to its shareholders.
The net loss ratio for Preserver in 1998 was historically low; therefore the increase in Preserver's net loss ratio in 1999 as compared to 1998 was partially caused by the net loss ratios returning to more representative experience. However, Preserver's direct loss ratio actually declined in 1999 as compared to 1998, as the table below shows:
With Preserver's reinsurance rates essentially unchanged during 1999 as compared to 1998, the remainder of the increase in the net loss ratio was attributable to an increased number of severe losses that did not have any reinsurance recoveries, as compared to 1998. Given the relatively small size of the Preserver book of business, a limited number of severe losses can adversely affect Preserver's net loss ratio results, depending on whether these losses were severe enough to generate a reinsurance recovery. There were no trends or indications in 1999 that Preserver's reinsurance programs were ineffective or that loss experience was adverse.
The increase in amortization of deferred policy acquisition costs relates to the amortization of expenses associated with the Policy Term Conversion which began in 1998 and was completed in 1999.
The 30% increase in other operating expenses is primarily due to the write off of uncollectible premium balances, which should be non-recurring. Expenses for 1999 also include $800,000 of general merger and acquisition expense and $448,000 of interest expense.
The principal sources of the net decrease were: (1) net income of $1,277,000 or $.60 per share described previously; (2) an increase of $1,420,500 or $.67 per share due to the decrease of the minimum required pension liability for the defined benefit pension plan sponsored by the Registrant as a result of asset gains and higher interest rates; offset by (3) a decrease of $2,894,600 or $1.36 per share due to the decrease (net of applicable deferred taxes) in the fair value of fixed maturity investments accounted for as available-for-sale securities under SFAS No. 115 ("Accounting for Certain Investments in Debt and Equity Securities").
Insurance premiums increased by $2,298,000 or 5% during the year, due primarily to commercial lines premiums written by Preserver and savings on reinsurance programs. The following table details the annual increases in the 1998 Insurance Premiums and underlying in force policy counts as compared to 1997:
More than half of the $1,787,000 or 12% decrease in acquisition costs was attributable to the 1998 elimination of the FAIR Act assessments previously paid, which totaled $971,000 in 1997. The remainder of the decrease was attributable to the temporary effects of the Policy Term Conversion, which has resulted in additional expenses being deferred to reflect the increase in unearned premiums through December 31, 1998. This circumstance was temporary as noted, and the amount of expense amortized in 1999 related to acquisition expenses was expected to rise in conjunction with the completion of the Policy Term Conversion.
This decrease in net expenses is the realization of the Registrant's previously stated strategy to increase its revenue while decreasing its overhead expenditures and resulted in a decrease in the expense ratio to 29.1% in 1998 as compared to 31.4% in 1997 (as adjusted for the FAIR Act assessments described above).
However, during 1999, the aforementioned completion of the Policy Term Conversion, in conjunction with the rate rollback required under the 1998 PPA reforms, increased the Registrant's expense ratio. Although the Registrant continues to anticipate that the net impact of these reforms will be a modest net negative, the impact of these reforms on premiums, losses, expenses or related financial ratios cannot be completely quantified.
The Registrant's book value increased to $13.15 per share at December 31, 1998 from $10.98 per share at December 31, 1997. The principal sources of the net increase were: (1) net income of $4,256,000 or $2.02 per share described previously; (2) $159,400 or $.08 decrease per share due to the increase of the minimum required pension liability for the defined benefit pension plan sponsored by the Registrant; and (3) $668,400 or $.32 per share increase due to the increase (net of applicable deferred taxes) in the fair value of the fixed maturity investments accounted for as available-for- sale securities under SFAS No. 115 ("Accounting for Certain Investments in Debt and Equity Securities").
The increase in the minimum pension liability was the result of a decrease in the discount rate used to compute Plan liabilities to 6.75% at December 31, 1998, from 7.25% at December 31, 1997, offset by the performance of the Plan assets in excess of the expected return on these assets. See Note L of the Notes for additional information regarding the Registrant's minimum pension liability.
Except as noted in Motor Club's PPA business, reserving assumptions and payment patterns of the Insurance Companies did not materially change from the prior year and there were no unusually large retained losses resulting from claim activity. Unpaid losses are not discounted.
Net cash provided by operating activities was $910,000, $10,547,000 and $10,389,000 in 1999, 1998 and 1997, respectively. The lower amount for 1999 is attributable to the reduction in insurance premiums in 1999 as a result of the New Jersey PPA rate rollback and increased payment of PIP losses for the 1999 Accident Year.
Net cash utilized in investing activities was $10,313,000, $11,054,000 and $13,886,000 in 1999, 1998 and 1997, respectively. The amounts used in 1999 reflect the investment of cash provided by operating and finance activities. The amounts used in 1998 and 1997 reflect the investment of cash provided by operating activities.
Aside from the changes in operating expenditures noted previously, particularly the expenditures associated with the acquisition of North East, no unusual or nonrecurring operating expenditures have been incurred over this period.
The payout ratio of losses, other than PIP, has not fluctuated substantially over this period. Cash flow from operations is expected to increase as the Registrant increases its revenue through additional premium writings, specifically commercial lines and PPA, and continues to reduce its expenses and expense ratio. This will be offset somewhat by the development and payment of losses on the new PPA which Motor Club is writing.
On December 27, 1999, the Registrant repaid the $3 million borrowed from Dresdner Bank, AG ("Dresdner") in September 1998. As of September 30, 1999, the Registrant had been in violation with one covenant and one term of its Loan Agreement with Dresdner. The Registrant had received a waiver of both conditions from Dresdner and the parties mutually agreed to have the loan repaid and the facility closed.