On April 1, 1998, the Company sold its headquarters building in Sarasota, Florida to Zenith in accordance with the terms of the Asset Purchase Agreement. The building contained 112,000 square feet of space, as well as an adjacent parking facility. The Company currently leases an aggregate of 17,000 square feet of office space at four other locations in three states, including Florida, under terms expiring through January 2001. The Company incurred rent expense of $0.2 million for 1998. The Company has aggregate continuing lease commitments through October 2000 of $0.2 million related to two locations in which offices were closed during 1997.
(3) The 1997 and 1996 shares include 790,336 and 225,503 shares, respectively, of Class A Common Stock pursuant to the contingency clauses in the acquisition agreement with IAA. See Notes 4 and 20 to the Company's consolidated financial statements.
As discussed more fully in Note 1(b) of the accompanying consolidated financial statements, RISCORP and certain of its subsidiaries sold substantially all of their assets and transferred certain liabilities to Zenith on April 1, 1998. In connection with this sale, RISCORP ceased substantially all of its former business operations, including its insurance operations, effective April 1, 1998. Accordingly, after such date, the operations of the Company consisted primarily of the administration of the day-to-day activities of the surviving corporate entities, compliance with the provisions of the Asset Purchase Agreement, and the investment, protection, and maximization of the remaining assets of the Company.
The following comments pertain to the other balances on the December 31, 1998 balance sheet.
The $49.9 million receivable from Zenith represents the remaining purchase price to be received from Zenith in connection with the Asset Sale. A more in-depth discussion of the receivable amount can be found in Note 1(b) of the accompanying financial statements.
Deferred income taxes of $3.1 million consisted of federal and state income taxes that are anticipated to be recovered in future years. At this time, this asset is expected to be fully recoverable.
The $47.7 million loss on the sale to Zenith represents the adjustment to the purchase price as determined by the Independent Expert [see Note 1(b) of the accompanying consolidated financial statements].
In September 1998, the Company received a reimbursement of $1.2 million of legal fees incurred in 1997 and 1998 in connection with payments made on behalf of certain former officers and directors of the Company. This reimbursement was included as a reduction in commissions and underwriting and administrative expenses in the accompanying 1998 consolidated statement of operations.
Direct Premiums Written 1998 (a) 1997 1996 Florida $ 29.2 $ 180.8 $ 270.8 Alabama 4.1 39.1 21.7 North Carolina 4.4 32.2 41.4 Other 1.0 28.4 22.8 Total $ 38.7 $ 280.5 $ 356.7
The majority of the Company's premiums were written in Florida, a regulated pricing state where premiums for guaranteed cost products were based on state-approved rates. However, prior to the sale to Zenith, the Company also offered policies which were subject to premium reductions as high deductible plans, participating dividend plans, or other loss sensitive plans. Pricing for these plans tended to be more competitively based, and the Company experienced increased competition during 1997 and 1998 in pricing these plans. In addition, in October 1996, the Florida Insurance Commissioner ordered workers' compensation providers to reduce rates by an average of 11.2 percent for new and renewal policies written on or after January 1, 1997. Concurrently, with the premium reduction effective January 1, 1997, the 10 percent managed care credit was phased out. This credit had been offered since 1994 to employers who met certain criteria for participating in a qualified workers' compensation managed care arrangement. In October 1997, Florida further reduced premium rates by 1.7 percent for new and renewal policies written on or after January 1, 1998. North Carolina approved a 13.7 percent decrease in loss costs, effective April 1, 1997, that the Company adopted in October 1997, which resulted in an overall effective rate reduction of 8.4 percent.
The Company experienced increased pricing pressures during 1997. During 1997, the Company made the strategic decision to discontinue writing business owners' protection, commercial multiple peril, and auto, and to focus on its core workers' compensation business. Net written premiums on these lines of business were less than $1 million during 1997 and were less than $0.5 million in 1996.
The Company attempted to lower claims costs by applying managed care techniques and programs to workers' compensation claims, particularly by providing prompt medical intervention, integrating claims management and customer service, directing care of injured employees through a managed care provider network, and availing itself of potential recoveries under subrogation and other programs.
Part of the Company's claims management philosophy was to seek recoveries for claims which were reinsured or which could be subrogated or submitted for reimbursement under various state recovery programs. As a result, the Company's losses and loss adjustment expenses were offset by estimated recoveries from reinsurers under specific excess-of-loss and quota-share reinsurance agreements, subrogation from third parties, and state "second disability" funds, including the Florida Special Disability Trust Fund ("SDTF").
The following table shows direct, assumed, ceded, and net earned premiums for 1998, 1997, and 1996 (in millions):
The Company experienced a decrease in direct earned premiums in the last six months of 1997 and the first quarter of 1998 primarily due to the decrease in new and renewal premiums experienced by the Company in the second, third, and fourth quarters of 1997. These premium declines resulted from, among other things, the adverse publicity pertaining to the A.M. Best ratings of RISCORP's insurance subsidiaries, RISCORP's inability to file its 1996 Form 10-K, 1997 Form 10-Qs, and 1996 audited statutory financial statements in a timely manner, the delisting of RISCORP's stock by NASDAQ, and the failure by Zenith to provide a cut through endorsement for the non-Florida business, as requested by the Company.
For 1997 and 1996, the Company ceded 50 percent of its Florida premiums under a quota-share reinsurance agreement and 60 percent of the business written by RNIC under a separate quota-share agreement (65 percent during 1996) with Chartwell Reinsurance Company ("Chartwell"). The Company terminated the agreement with Chartwell at December 31, 1997; however, the reinsurer continues to receive premiums and to be responsible for its portion of all losses incurred on policies effective before the termination date. The decrease in ceded premiums to $22.7 million in 1998 from $167.3 million in 1997 was due primarily to the sale to Zenith and to the decrease in direct premiums earned discussed above.
Fee income for 1998 was $5.7 million compared to $20.4 million and $31.7 million for 1997 and 1996, respectively. The decrease in fee income was primarily due to sale of the insurance operations to Zenith. The decrease between 1996 and 1997 was primarily due to the loss of service fees from the conversion of the National Alliance for Risk Management ("NARM") self-insurance funds of North Carolina and Virginia (which funds were previously managed by the Company) to at-risk business via loss portfolio transfers and decreases in RISCORP West Incorporated ("RWI") service fee income from the termination of RWI's Mississippi and Louisiana service contracts. The decrease in fee income was partially offset by new fees generated from the CompSource acquisition, the fronting agreement, the new service agreement with Third Coast Insurance Company, and growth in other existing fee products.
The loss ratios for 1998, 1997, and 1996 were 93 percent, 58 percent, and 67 percent, respectively. The increase in the 1998 loss ratio of 35 percent was due primarily to adverse gross loss development during the first quarter of 1998 in the 1997 and prior accident years from certain business written in Florida of $10.3 million, gross favorable loss development in Alabama and North Carolina of $2.6 million, and gross adverse loss development of $0.3 million in business written by RNIC and RPC in several smaller states. The decrease in the loss ratio from 1996 to 1997 was due primarily to favorable development in Florida (7 percent) and North Carolina (1 percent) and unfavorable development in Alabama (1 percent) relating to the Company's 1996 and earlier accident years' loss and loss adjustment reserves. The favorable development in the Florida business was due primarily to the reduction in the loss and loss adjustment expense reserves resulting from an actuarial analysis completed in the fourth quarter of 1997 and the favorable development for the 1996 accident year resulting primarily from favorable development of post-1993 Florida accident years due to enhanced savings form the legislative changes that became effective in 1994.
Unallocated loss adjustment expenses for 1997 were $19.3 million compared to $12.9 million for 1996, a net increase of $6.4 million. This increase was primarily due to the increased premium volume, increased loss reserves during 1997, and unfavorable loss development. The unallocated loss adjustment expense ratio for 1998, 1997, and 1996 was 10 percent, 11 percent, and 7 percent, respectively. The 4 percent increase in the 1996 to 1997 ratio was primarily due to increased personnel and personnel related costs.
Interest expense for 1997 and 1996 was $1.9 million and $2.8 million, respectively. The decrease was due to the repayment of $28.6 million of debt in March 1996 using the proceeds from RISCORP's initial public offering.
Depreciation and amortization expense for 1997 and 1996 were $7.4 million and $11.5 million, respectively.
The Company historically met its cash requirements and financed its growth through cash flow generated from operations and borrowings. The Company's primary sources of cash flow from operations were premiums and investment income, and its cash requirements consisted primarily of payment of losses and loss adjustment expenses, support of its operating activities, including various reinsurance agreements and managed care programs and services, capital surplus needs for its insurance subsidiaries, and other general and administrative expenses. RISCORP and certain of its subsidiaries sold substantially all of their assets and transferred certain liabilities to Zenith on April 1, 1998. In connection with this sale to Zenith, the Company ceased substantially all of its former business operations and, accordingly, after April 1, 1998, the Company's primary source of cash flow has been generated from investment income. The Company's future cash requirements are expected to be satisfied through investment income and the liquidation of investments.
Cash flow from operations for 1998, 1997, and 1996 was $(37.6) million, $(22.9) million and $28.1 million, respectively. The decrease from 1997 to 1998 was due primarily to reductions in unearned premiums resulting from a decrease in direct premiums written and increases in losses and loss adjustment expenses, unallocated loss adjustment expenses, and commissions and underwriting and administration expenses in relation to premiums earned during the first quarter of 1998, and the expenses related to the sale to Zenith. These expenses included severance payments to certain employees, the payment of accrued employee benefits, and the payment of other expenses related to the sale. The decrease from 1996 to 1997 was due primarily to reductions in unearned premiums, and loss and loss adjustment expense reserves, resulting from a decrease in direct premiums written of $76.2 million, as well as increases in commissions and general and administrative expenses and unallocated loss adjustment expenses of $4.8 million and $6.4 million, respectively.
The Company has projected cash flows through December 1999 and believes it has sufficient liquidity and capital resources to support its operations. The liquidity of the Company could be materially adversely affected if Zenith should prevail in the dispute resolution process with respect to the determination of the final purchase price. Furthermore, the adverse resolution of certain legal issues or any material delay in the Company's receipt of the final payment of the ultimate purchase price determined to be payable by Zenith could have a material adverse effect on the Company's liquidity. See "Sale to Zenith," "Legal Proceedings," and "Recent Developments."
The term "Year 2000 issue" is a general term used to describe various problems that may result from the improper processing of date and date-sensitive calculations by computers and other machinery as the Year 2000 is approached and reached. These problems may arise from hardware and software unable to distinguish dates in the "2000's" from dates in the "1900's" and from other sources, such as the use of special codes and conventions that make use of a date field.