- -------- (1) See Note 2 I of Notes to Consolidated Financial Statements for an explanation of the method used to determine the number of shares used to compute per share amounts. (2) Operating income--under generally accepted accounting principles ("GAAP") Operating income, which excludes realized capital (losses) gains--net of tax, is not separately presented. It is presented here as supplemental information. This should not be considered a better measure than net income calculated in accordance with GAAP. (3) Net of tax. (4) See Note 6 of Notes to Consolidated Financial Statements.
Set forth in Table I is an analysis of the components of the Company's revenues for each of the last three years. Revenue is not considered to be the best measure of the Company's performance since it includes Premiums earned which historically have been closely matched by Total insurance costs and should not have a significant impact on Net income. Excluding Premiums earned, revenues increased in 1997 by 29% over 1996 which increased 28% over 1995.
The growth of Fee income has been primarily due to the strong growth in Program Business which more than compensated for the decline in Corporate Risk Management business.
Overall, pre-tax profit margins on Fee income continue to remain steady at 41% in 1997 compared to 40% in 1996 and 43% in 1995.
The components of Fee income by business segment are illustrated in Table II.
Corporate Risk Management, the Company's original business segment, involves providing services to businesses and associations seeking to insure a portion of their risk in a loss sensitive Alternative Market structure. This segment, which accounted for 40% of total Fee income for 1997 compared to 61% in 1996 and 75% in 1995, has been the most affected by the extremely soft insurance market cycle for commercial risks. Corporate Risk Management fees decreased in 1997 for the first time due to these soft market conditions. The number of Corporate Risk Management accounts decreased in 1997 to 154 from 180 in 1996 which was in turn down from 194 in 1995. Profit margins remained consistent, despite the difficult market, at 44% in 1997 compared to 43% in 1996 and 45% in 1995.
Historically, workers' compensation has been the major line of business written by the Company in both its Corporate Risk and Program Business segments. Competition for workers' compensation business has increased in recent years, as a result of generally improved reported underwriting results and workers' compensation reform legislation. The resulting under-pricing of workers' compensation risks by traditional insurers reduces the incentive for insureds to enter "Alternative Market" vehicles such as those offered by the Company in its Corporate Risk Management segment. Despite these competitive forces, the Company was successful in increasing its business in most states as a result of the attractiveness of Program Business in this soft reinsurance market. In 1997 the Company added 25 new Program and Corporate Risk accounts in California compared to 8 in 1996 and 6 in 1995, while increasing the renewal rate to 85% from 77% in 1996 and 74% in 1995. There were 48 California based accounts at the end of 1997 compared to 27 in 1996 and 25 in 1995. The Company continued to strive to diversify its business to reduce its reliance on the workers' compensation market and was successful in doing so. As a percentage of Total Fee income, workers' compensation accounts decreased from over 80% at December 31, 1994 to 57% at December 31, 1997 as a result of the Company writing accounts which comprise other lines of coverage such as commercial auto liability, auto physical damage and other liability coverages as well as the expansion of the Company's Financial Services segment.
The Company's Specialty Brokerage business segment provides access to Alternative Risk Transfer insurers and reinsurers in Bermuda and Europe. Despite declines in premium on new and renewal policies, fees in this segment continued to grow. Renewal rates remained high at 85% for 1997 compared to 86% for 1996 and 87% for 1995. Profit margins decreased slightly to 35% from 37% in 1996 and 40% in 1995.
accounted for 8% of total Fee income for both 1997 and 1996 up from 7% in 1995. Fees from Financial Services increased primarily as a result of an increase in the number of mutual funds under management from 60 in 1995 and 85 in 1996, to 129 in 1997 as well as relatively high renewal rates of 98% in 1995, 80% in 1996 and 93% in 1997. Profit margins improved from 14% in 1995 and 20% in 1996 to 26% in 1997. Margins in the Financial Services segment are expected to decline slightly in 1998 due to start up costs being incurred in connection with the MRM mutual funds and MRM Life and on account of a revised Executive Incentive Plan being implemented at Hemisphere.
The Company has established provisions for losses as a result of these exposures for certain clients and reinsurers. These provisions, which totaled $5.6 million at December 31, 1997, $4.5 million in 1996 and $4.0 million in 1995, reduced the level of Fee income in each year by $1.1 million, $.5 million and $.2 million respectively. The increase in the number of accounts and their inherent growth in premium volume, the increase in the clients' aggregate retentions since 1991, the amounts recoverable from reinsurers which amounted to $787 million at December 31, 1997 and $424 million at December 31, 1996, in addition to competitive factors which have limited the amount of collateral that clients are willing to provide, have significantly increased the Company's exposure to such losses. The Company evaluates the financial condition of its clients, brokers and reinsurers to minimize its exposure to losses from insolvencies.
Included in Premiums earned are assigned risk premiums of $8.4 million in 1997 as compared to $7.8 million in 1996 and $11.9 million in 1995. The underwriting losses associated with these assigned risk premiums, together with other charges imposed by certain states on voluntary insurers such as Legion to support involuntary market losses ("residual market loads") are passed on by Legion to clients.
1996 and 1995 respectively. The Company incurred an underwriting loss of $1.5 million in 1997, $.2 million in 1996 and $1.0 million in 1995 as a result of the retained risk on its treaties and increases in acquisition expenses. The Company takes 100% of the risk within the first $1.25 million layer of the aggregate excess exposure on its main treaty up to a deductible amount equal to 1.5% of the Company's gross premiums (as defined) and 10% of the risk over a loss ratio of 120%, in the event that the loss ratio for the first layer exceeds 120% the Company takes no share of the risk in the layer $3.75 million excess of $1.25 million per account. The maximum retention for specific excess losses is 10% of $.75 million excess of $.25 million per occurrence. On other treaties the Company has decreased its exposure for excess losses.
The breakdown of expenses for each of 1997, 1996 and 1995 is set forth in Table III.
The increases in Total insurance costs were the direct result of the increases in Premiums earned during these periods. Losses incurred increased as a direct result of the decreased use of large deductible policies, and the increase in Program Business. The Company discounts its specific and aggregate workers' compensation reserves using a 4% rate recommended under Pennsylvania law where Legion Insurance is domiciled. The net effect of this discounting was to increase Net income after tax for the years ended December 31, 1997, 1996 and 1995 by $.1 million, $.2 million and $.3 million respectively. Discounting also reduced net loss reserves by $3.7 million, $3.5 million and $3.3 million at December 31, 1997, 1996 and 1995. The 48% increase in Acquisition costs from 1996 to 1997 is a direct result of the 49% increase in premiums earned. The 3% decrease from 1995 to 1996 is attributable to: (a) the fact that Acquisition costs in all years include significant expenses associated with the involuntary workers' compensation business the Company is required to assume and over which it has no control. Such expenses have no net financial impact on the Company as they are recharged to clients. These expenses decreased in 1996 and (b) Acquisition costs on large deductible policies are higher in relation to the
associated premium than under a traditional guaranteed cost policy. The volume of deductible programs written by the Company decreased in 1996.
At December 31, 1997 the market value of the Company's Total marketable investments was $474 million, as compared to $452 million at December 31, 1996. In accordance with SFAS 115, Investments available for sale are reported at fair market value with unrealized gains and losses included as a separate component of Shareholders' equity. These Investments generally consist of investment grade fixed-income securities which the Company believes are readily marketable and could be liquidated to meet cash requirements, if necessary.
The Company does not believe its operations have been materially affected by inflation. The potential adverse impacts of inflation include: (a) a decline in the market value of the Company's fixed maturity investment portfolio; (b) an increase in the ultimate cost of settling claims which remain unresolved for a significant period of time; and (c) an increase in the Company's Operating expenses. However, the Company generally holds its fixed maturity investments to maturity and currently believes that an acceptable amount is included in the yield to compensate the Company for the risk of inflation. In addition, any increase from inflation in the ultimate cost of settling unpaid claims will be borne by the Company's clients and offset by investment income earned for the benefit of the client during the period that the claim is outstanding. Finally, the increase in Operating expenses resulting from inflation should generally be matched by similar inflationary increases in the client's premium and therefore the Company's fee income which includes a fee based upon a percentage of the client's premium.
The Company is utilizing both internal and external resources to program or replace and test the software for Year 2000 modifications. The Company anticipates that this exercise will be completed during 1998 and will not be a material cost, due to the fact that most systems are relatively new and were Year 2000 compliant when purchased.
The Financial Accounting Standards Board has recently issued SFAS 130, "Reporting Comprehensive Income" and SFAS 131, "Disclosures about Segments of an Enterprise and Related Information". Both statements are effective for periods beginning after December 15, 1997. The Company is currently considering the effects of these statements on its financial statement presentation and disclosures.