The Company leases all of its office space which, as of December 31, 1995, totaled approximately 135,000 square feet. The home office aggregates approximately 53,000 square feet. In addition, the Company leases and subleases approximately 18,000 square feet of office space in the same building as home office. Branch locations range from 270 to 4,600 square feet. See Note 12 of Notes to Consolidated Financial Statements.
On December 14,1995 the Supreme Court of the State of California affirmed the decision of the Second District Court of Appeal overturning Insurance Code Section 1861.135 which exempted the surety insurance industry from major provisions of proposition 103. Accordingly the Company will no longer be exempted from the rate rollback and prior approval provisions contained in Proposition 103.
The Company accrued $2,000,000 during the quarter ended December 31, 1995 representing the Company's best estimate of its rollback obligations pursuant to Proposition 103, the exact amount of which has not yet been determined. Such estimate was based on a variety of factors, including but not limited to, the profitability of the Company in California during 1989 (the rollback period), a review of the various regulations promulgated by the Department of Insurance, and a review of rollback obligations of other insurance companies, including a surety company. Pursuant to the provisions of Proposition 103, the rollback amount will ultimately be determined by complex California Department of Insurance formulas but is statutorily limited to a maximum of 20% of California written premiums during 1989, plus accrued interest thereon. In the event that the Company's rollback obligation were eventually determined to be the statutory maximum, it could approximate $7,500,000 which is $5,500,000 in excess of the Company's best estimate of its ultimate rollback liability. While the current accrual represents management's best estimate of the Company's Proposition 103 rollback obligations, no assurances can be given that a final settlement with the California Department of Insurance will not result in a rollback amount which could have a significant adverse impact on the Company's future earnings, although it is not anticipated that such result would materially adversely impact the Company's financial position. Until a final settlement is reached with the California Department of Insurance, no assurances can be given as to the ultimate amount of premiums to be refunded to policyholders.
Underwriting income (loss) decreased from income of $3,245,000 for the year ended December 31, 1994 to an underwriting loss of $1,896,000 for the year ended December 31, 1995. Excluding the Proposition 103 accrual, the Company would have had underwriting income of $104,000 for the year ended December 31,1995. The combined ratio increased from 94.8% in 1994 to 102.8% in 1995.
Interest expense increased 25.7% from $840,000 in 1994 to $1,056,000 in 1995 due to an increase in the interest rate on the bank indebtedness. The $12,500 000 in outstanding indebtedness has a variable rate which averaged 6.7% during 1994 but increased to an average rate of 8.5% during 1995 due to higher average short term interest rates in 1995 versus 1994. The interest rate on the Company's bank indebtedness at December 31, 1995 was 7.9375%. Collateral interest expense decreased 11.6% from $1,921,000 in 1994 to $1,698,000 in 1995. This decrease is attributed to an overall reduction in funds held as collateral during 1995. At December 31, 1994 and 1995, the collateral balances accrued interest daily at an average rate of 3.9% and 3.5% per annum, respectively.
Net investment income and realized investment gains (losses) increased 49.5% from $5,468,000 in 1994 to $8,172,000 in 1995. This increase is primarily due to an increase in realized gains (losses) on sales of investments from a loss of $320,000 in 1994 to a gain of $1,928,000 in 1995. This change of $2,248,000 was augmented by slightly higher yields on larger invested balances during 1995. Such higher yields were predominately attributable to investments made prior to the general decline in interest rates during 1995.
Premiums written increased 22% from $57,713,000 in 1993 to $70,486,000 in 1994. The increase in premiums written is attributable primarily to the court and contract performance product lines. Premium growth in the contract performance line is attributable to increased volume in all regions and the acquisition of the Bond Experts Insurance Agency in June 1993. The full impact of this acquisition was not realized until 1994.
Net premiums earned increased 23% from $50,090,000 in 1993 to $61,829,000 in 1994. Net premiums earned reflects the increased premium writings in 1994. The Company earns premiums ratably over the bond terms.
Policy acquisition costs increased from $24,749,000 in 1993 to $31,898,000 in 1994, an increase of 28.9%. The increase is attributable to a combination of increased expenses associated with the increase in premium writings, an increase in the average commission rates paid to agents in 1994 and a reduction in contingent commissions paid by the Company's reinsurers to the Company based on the experience of the excess of loss treaty. These factors caused policy acquisition costs to rise from 49.4% of net earned premium in 1993 to 51.6% in 1994. General operating costs increased 12% from $11,562,000 in 1993 to $12,582,000 in 1994. This increase is less than the increase in premiums written of 22%. General operating cost control continues to be one of management's primary objectives. The Company's ratio of general operating costs and expenses to net premiums earned decreased from 23.1% in 1993 to 20.3% in 1994.
Underwriting income increased from $1,767,000 in 1993 to $3,245,000 in 1994. The combined ratio decreased from 96.5% in 1993 to 94.8% in 1994.
Net investment income and realized investment gains (losses) decreased 19.0% from $6,749,000 in 1993 to $5,468,000 in 1994. This decrease is primarily due to an decrease in realized gains (losses) on sales of investments from a gain of $1,787,000 in 1993 to a loss $320,000 in 1994. This change of $2,107,000 was partially offset by higher yields on larger invested balances during 1994.
On November 30, 1995, an Agreement and Plan of Merger (the "Merger Agreement") was executed by and between the Company and Condor Services, Inc. ("Condor"), an unaffiliated insurance holding company which provides property and casualty insurance coverages and services in California and Arizona. Special meetings of the stockholders of Condor and Amwest were held on March 14,1996 at which the Merger Agreement was approved and adopted and the transaction was consummated later that day.
The Company's off balance sheet collateral which primarily consists of irrevocable letters of credit and certificates of deposit declined from $251,051,000 at December 31, 1994 to $228,428,000 at December 31, 1995. This decrease is primarily attributable to increased contract performance writings utilizing the Company's preferred rates which generally require less collateral due to the stronger financial position of the contractor as compared to generally higher collateral amounts for the Company's non-preferred business.
In addition, cash collateral declined from $46,926,000 at December 31, 1994 to $37,650,000 at December 31, 1995. The Company reflects in its consolidated financial statements only funds received as collateral on which net earnings inure to the benefit of the Company. The decline in this amount is primarily attributed to decreased writings in those lines of business for which cash collateral is generally accepted. These include contractor's license bonds, sales tax bonds and various court appeal bonds. The amount of cash collateral can also be impacted by the timing and payment of claims activity related to draws on irrevocable letters of credit and certificates of deposit.
On August 6, 1993, the Company entered into a revolving credit agreement with Union Bank for $12,500,000 which refinanced the 1988 Loan. This loan was amended on April 24,1995. The loan has a variable rate based upon fluctuations in the London Interbank Offered Rate (LIBOR) with amortizing principal payments beginning July 15, 1996 and maturing July 15, 2000. The interest rate at December 31, 1995 was 7.9375%. The credit agreement contains certain financial covenants with respect to capital expenditures, business acquisitions, liquidity ratio, leverage ratio, tangible net worth, net profit and dividend payments.
The Company believes that its cash flows from operations and other present sources of capital are sufficient to sustain its needs for the remainder of 1996.