The selected financial data shown on the prior page for the Company for each of the five years in the period ended December 31, 1997, has been derived from consolidated financial statements of the Company, which have been audited by the Company's independent auditors, BDO Seidman, LLP. The data should be read in conjunction with the consolidated financial statements and related notes thereto, Supplementary Financial Data and "Management's Discussion and Analysis of Financial Condition and Results of Operations" presented in Items 7 and 8 of this Form 10-K. All share and per share data have been restated in accordance with Financial Accounting Standards Board No. 128 and retroactively adjusted for the increased shares resulting from the three-for-one stock split distributed in January 1998.
Written premium for the property and casualty segment was $435 million in 1997, which represents an increase of 3.3% over the $421 million written in 1996. The 1996 writings were 1.4% less than the $427 million written in 1995, while 1995's total was up 2.6% from the previous year.
Within the property and casualty segment, combined written premium for the Company's specialty line products of mobile home, motorhome and travel trailer increased 2% in 1997 to $405.1 million following a decline of 1% in 1996 and an increase of 3% in 1995 when written premium in these lines was $397 million and $401.4 million, respectively. Over the years, the growth in these lines has been slowed by the Company's catastrophe exposure management programs. The Company's BASIC product, a dwelling fire and ACV homeowners insurance program distributed through independent agents, experienced solid growth in 1997. This specialty product had $7.4 million written in 1997. The Company expects moderate growth in these specialty lines in the future as it continues to pursue profitable opportunities.
On October 13, 1997, the Company signed an extension of the exclusive endorsement of the Company by the American Association of Retired Persons (AARP), to offer mobile home insurance to its members through the year 2004. The results of this program, since its inception in 1989, encouraged both parties to extend their relationship five years beyond the original agreement's expiration date.
Management monitors its exposure to catastrophic risk and has taken aggressive action in coastal areas and earthquake prone areas to reduce the Company's risk to hurricane and earthquake losses. During 1997, the Company took action against another catastrophic risk by starting the process of eliminating flood from the majority of the Company's mobile home policies. By the end of 1998, the Company anticipates that approximately 80% of its policies will have flood coverage removed, which will dramatically reduce the Company's exposure to loss due to flooding. In 1995, the Company started a coastal strategy which eliminated approximately 24,000 policies in the coastal counties from Maine to Texas. This program of coastal policy reduction was substantially completed by June 30, 1996. The Company has further reduced its exposure to hurricane loss by not writing any significant amount of new business in Florida since 1992. Management has pursued the reduction of the Company's earthquake exposure by non-renewing 21,000 policies in California with units greater than $50,000 in value since 1994. Attrition also has contributed to the reduction of earthquake exposure, pushing the total policy decline in California to approximately 50,000 since 1994. Since July 1, 1995, the Company's policies only provide earthquake coverage on an optional basis, which has reduced exposure to catastrophic loss due to earthquakes. Management will continue to take appropriate actions in the future where deemed necessary.
The Year 2000 issue is the result of computer programs being written using two digits to define the applicable year instead of four. The problem exists when time sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. By nature, the insurance industry is highly dependent upon computer systems because of significant transaction volumes and a date dependency for many of its applications. The Company has done a comprehensive review of its computer programs to identify the systems that would be affected by the Year 2000 problem. The Company has a comprehensive, written plan, which regularly is updated and monitored by technical personnel. Plan status is regularly reviewed by management of the Company. The Company also has hired an outside consulting firm to assist in this conversion process and is half way through the modification of its computer programs to the four digit fields. Management also has reviewed its Year 2000 exposure to third party customers, distributors, suppliers and banking institutions. They have determined the exposure to be limited but are in the process of obtaining certification of compliance letters.
The Company will continue to assess the impact of the Year 2000 issue on the remainder of its computer-based systems and applications throughout 1998 and
1999. The Company's goal is to perform tests of its systems and applications during 1998 and 1999 and to have all systems and applications compliant with the century change by the middle of 1999, allowing the remaining time to be used for validation and testing.
The costs of the project and the date on which the Company believes it will complete the Year 2000 modifications are based on management's best estimates. There can be no guarantee that these estimates will be achieved and actual results could differ from those anticipated. Specific factors that might cause differences include, but are not limited to, the ability of other companies on which the Company's systems rely to modify or convert their systems to be Year 2000 compliant, the ability to locate and correct all relevant computer codes and similar uncertainties.
In conjunction with the new direct marketing of automobile and homeowners insurance, the Company has invested in a new policy processing system that is being developed and is expected to be operational in the fall of 1998. The $4.1 million cost incurred in connection with this system during 1997 was capitalized and will be expensed over the life of the system starting in 1998. The total cost of the project is currently estimated to be approximately $12 million.
The Company discontinued writing private credit insurance in 1985, and established a reserve to cover anticipated losses from the run-off of the product. The experience in the run off of this business has been positive, and accordingly, management reduced the reserve by $650,000 in both 1997 and 1996, and $1.9 million in 1995. These reductions are not reflected in the underwriting results of the insurance operations, but are a component of the parent company and other operational results. The majority of these policies will run off in 1999. Management believes that the aggregate reserves for this discontinued product are adequate at December 31, 1997, but will continue to review and adjust such reserves as needed.
On June 11, 1996, the Company completed the sale of its life insurance subsidiary, Foremost Life Insurance Company, to Woodmen Accident and Life
Company. The sale yielded net after-tax proceeds of $17.4 million and the Company incurred an after- tax loss of $698,000 as a result of the sale. The majority of the net proceeds were utilized to repurchase the Company's common stock under the stock buy-back program approved by the Board of Directors. The financial results of the life insurance segment and the sale are reflected in the financial statements as discontinued operations.
Significant cash requirements in the future include the Year 2000 and new policy processing system projects that were discussed previously, along with the construction of a new 98,000 sq. ft. building in the Company's Kraft Lake Office Park to be used in operations. This $10 million project is to be completed by the fall of 1998 and will be funded from operations. As of December 31, 1997, $1.5 million of construction in progress is included in real estate and equipment. The Company believes that its liquid assets plus cash flow from operations will be adequate to meet all foreseeable cash requirements.
The relatively strong stock market and the Company's investing strategy allowed unrealized capital gains to grow to $32 million at year end 1997 compared to $25 million at year end 1996 and $21 million at year end 1995. The Company was also able to realize after-tax gains of $7.9 million in 1997 compared to $2.0 million in 1996 and $312,000 in 1995.
and are more sensitive to adverse economic conditions than are investment grade issuers.
In accordance with FASB Statement No. 115, "Accounting for Certain Investments in Debt and Equity Securities," the Company has classified a portion of its fixed maturity investments and its equity securities into a category entitled "securities available for sale" which are adjusted to reflect market value. Due to the restrictive definition of assets qualifying to be categorized as held to maturity, most of the Company's fixed investment securities are considered to be available for sale, and are therefore adjusted to reflect market values. Unrealized investment gains and losses on securities available for sale are credited or charged directly to stockholders' equity net of applicable tax provisions or credits. The net unrealized gain on securities available for sale was an $20.9 million at December 31, 1997, and $16.4 million at December 31, 1996. Although the Company has the general intent and ability to hold most of its fixed maturities to maturity, sales may be made from this category due to changes in market conditions, relative yields available, tax planning and asset/liability management considerations. Since the Company does not purchase fixed maturity investments with a view to resale, the "available for sale" classification does not denote a trading account.
At December 31, 1997, the Company had $29.1 million of its consolidated assets in cash and other short-term investments.
Consolidated Statements of Stockholders' Equity for the years ended December 31, 1997, 1996 and 1995 26
Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1996 and 1995 27
Parent Company and Other Statements of Operations for the years ended December 31, 1997, 1996 and 1995 28
FOREMOST CORPORATION OF AMERICA AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
In accordance with Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity Securities," the Company has classified its investments in fixed maturities and equity securities into two categories, "fixed maturities held to maturity" and "securities available for sale." Fixed maturities held to maturity and mortgage loans and land contracts are reported at amortized cost. The Company expects that the investments in these categories will be held to maturity and, therefore, no unrealized gains or losses are recognized on such investments. Securities available for sale are reported at market value. The unrealized gains and losses of the investments in this category are credited or charged directly to stockholders' equity, net of applicable taxes. Although the Company has the general intent and ability to hold securities segregated as securities available for sale to maturity, sales from this category may be undertaken due to changes in market conditions, relative yields available, tax planning and asset/liability management considerations.
Investment real estate consists primarily of land and buildings held for development and sale. Investment real estate is carried at cost less applicable accumulated depreciation. Depreciation expense on investment real estate was $251,000, $249,000 and $232,000 for 1997, 1996 and 1995, respectively.
Short-Term Investments The recorded book value is presumed to be a reasonable estimate of market value.
Variable Rate Notes For financial instruments bearing variable interest rates, it is presumed that recorded book values are reasonable estimates of fair value.
The Company accounts for certain income and expenses in different periods for financial reporting and income tax purposes. Deferred income taxes are provided in the accompanying financial statements for the temporary differences between taxes currently payable and taxes based on financial income. The Company utilizes the liability method to account for deferred income taxes by applying statutory tax rates in effect at the balance sheet date to differences between the book cost and tax basis of assets and liabilities. The resulting deferred tax liabilities or assets are adjusted to reflect changes in tax laws or rates by means of charges or credits to income tax expense.
The Company expenses the costs of advertising as incurred. Advertising expense was $1,836,000 in 1997, $3,375,000 in 1996 and $2,021,000 in 1995.
Earnings per share amounts are computed based on the weighted average number of common shares outstanding during each year.
All outstanding common share amounts, additional paid-in capital and related earnings per share calculations have been retroactively adjusted to reflect the three-for-one stock split distributed in January 1998, except for treasury shares.
The amortized cost and estimated market values of investments in financial instruments held by the Company are as follows:
Proceeds from sales of investments in fixed maturities totaled $40,642,000 in 1997, $49,488,000 in 1996 and $66,544,000 in 1995. Gross gains of $617,000, $893,000 and $708,000 and gross losses of $240,000, $499,000 and $1,209,000 were realized on those sales in 1997, 1996 and 1995, respectively.
Depreciation expense on real estate and equipment utilized by the Company was $1,860,000 in 1997, $1,854,000 in 1996 and $2,212,000 in 1995.
Included in equipment and other in 1997 is $4.053 million of capitalized software.
Notes payable consist primarily of an unsecured credit agreement with a group of banks and a loan secured by a mortgage on the Company's corporate headquarters building. An unsecured credit agreement was entered into in April 1995 which provides for a revolving credit facility not to exceed $40 million and a term loan of $56 million, which reduced to $50 million on August 31, 1995. The credit agreement expires in April 2002. At December 31, 1997, the term loan had a balance of $50 million, the revolving credit facility had a balance of $8 million and the building mortgage had a balance of $31.7 million. In addition to the remaining $32 million available under the revolving credit facility, the Company has an uncommitted line of credit facility which may not exceed $20 million at any one time. This unsecured credit agreement expires on June 30, 1998.
The Company files a consolidated tax return with its subsidiaries, including its life insurance subsidiary, until it was sold in 1996. For tax purposes, $10.5 million had been accumulated by the life insurance subsidiary in a memorandum policyholders' surplus account and became taxable upon its sale. The resulting $3.7 million of tax has been charged against the gain on the sale and included in net income from discontinued operations in 1996.
The Company has a Long-Term Incentive Plan (LTIP) which provides awards to certain key employees based on the Company's return on stockholders' equity over three year periods. The LTIP was amended in December 1994 and approved by the stockholders for 70% of the awards to be paid in the Company's common stock. The awards are fully vested upon issuance; however, the stock is restricted for resale for three years from the date of the award. There were 21,846 shares and 25,239 shares issued under the plan for 1997 and 1996, respectively.
The following table summarizes information about the Company's stock options outstanding at December 31, 1997:
The Company maintains a defined benefit post-retirement plan for substantially all employees which provides certain health care, dental and life insurance benefits. Eligibility and benefits are based on age and years of service for the health care and dental benefits, which also require contributions from retirees under certain circumstances. The life insurance benefits are non-contributory and are calculated as a percentage of the employee's base annual compensation in the year of retirement. The benefit is reduced at age 70 to an ultimate benefit of $5,000. SFAS No. 106, "Employers' Accounting for Post-Retirement Benefits Other Than Pensions," requires companies to accrue post-retirement benefits during the employees' working years rather than expensing on a cash basis. The Company does not prefund its post-retirement benefit plan and has elected to amortize the transition obligation over a 20-year period.
The health care trend rate assumed was 7.25% for 1997, decreasing .25% per year to 6% in 2002 and thereafter. The dental trend rate was 6% per year. The rate of compensation increase regarding life insurance benefits was 5%. A 1% increase in the health care trend rate would increase the accumulated post-retirement benefit obligation as of December 31, 1997 by $170,413 and the net periodic benefit cost for the year then ended by $23,284.
The following is a schedule of future minimum lease payments under cancelable and noncancelable operating leases for each of the five years succeeding December 31, 1997 and thereafter, excluding renewal options:
At December 31, 1997, $74.9 million of consolidated stockholders' equity represents net assets of the Company's insurance subsidiary that cannot be transferred in the form of dividends, loans or advances to the Company.
A director and major stockholder has investment advisory agreements with the Company and currently manages approximately 16% of the Company's investment portfolio. During 1997 and 1996, $1,045,000 and $745,000 of fees and commissions were earned under these agreements. This director also has been advised by another director in regards to the management of certain investments for the Company.
On June 11, 1996, the Company completed the sale of its life insurance subsidiary, Foremost Life Insurance Company, to Woodmen Accident and Life Company. The sale yielded net after-tax proceeds of $17.4 million and the Company incurred and after-tax loss of $698,000 as a result of the sale. The loss was due primarily to the effects of taxes related to policyholders' surplus. For tax purposes, $10.5 million had been accumulated by the life insurance subsidiary in a memorandum policyholders' account and became taxable upon its sale. The resulting $3.7 million of tax has been charged against the gain on the sale and included in net income from discontinued operations in 1996. The majority of the net proceeds was used to purchase the Company's common stock under the approved stock buy-back program.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Foremost Corporation of America at December 31, 1997 and 1996, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles.
Our audits of the consolidated financial statements were performed for the purpose of forming an opinion on those financial statements taken as a whole. The supplemental statements on page 28 are presented for additional analysis and are not a required part of the consolidated financial statements. Such information has been subjected to the auditing procedures applied in the audits of the consolidated financial statements and, in our opinion, is fairly stated in all material respects in relation to the consolidated financial statements taken as a whole.
s/BDO SEIDMAN, LLP - ------------------ BDO SEIDMAN, LLP February 17, 1998 Grand Rapids, Michigan