The Company's relocated operations are principally located in a 150,000 square foot facility located in Englewood, Colorado, a 64,000 square foot building located in Madison, Wisconsin, a 23,000 square foot building in Salem, Oregon and a 35,000 square foot facility in Freeport, Illinois. All four of these facilities are owned by the Company, and are currently adequate for the Company's needs and are anticipated to remain adequate for future needs.
The following table summarizes information with respect to the operations of the Company for the five-year period ended December 31, 1996.
Premiums earned $481,648 $390,017 $321,638 $257,540 $220,033 Net investment income 39,439 30,976 23,576 22,551 22,701 Realized investment gains 8,455 3,291 3,007 5,996 2,342 Other income 2 69 424 -------- --------- -------- -------- ------- Total revenue 529,542 424,284 348,223 286,156 245,500 -------- --------- -------- -------- -------
Earnings before income taxes 36,881 7,332 29,587 24,626 27,332 Income taxes 9,375 (1,597) 7,036 5,341 7,061 -------- --------- -------- --------- ------ Earnings before accounting changes 27,506 8,929 22,551 19,285 20,271 Cumulative accounting changes 1,106 -------- ---------- -------- --------- ------ Net earnings $27,506 $ 8,929 $22,551 $20,391 $20,271 ========= ========== ======== ========= =======
Dividends: Dividends paid per common share $ 0.50 $ 0.50 $ 0.50 $ 0.50 $ 0.50
Balance Sheet Data: Total cash and investments $671,229 $625,872 $387,942 $386,250 $327,572 Total assets (b) 929,092 875,173 605,088 575,083 477,484 Unpaid losses and loss adjustment expenses (b) 368,408 354,634 241,221 220,965 191,508 Notes payable 101,688 103,000 52,896 38,896 32,896 Shareholders' equity 238,039 215,551 144,759 152,489 130,123 Statutory policyholders' surplus 253,815 220,621 133,229 122,452 105,931 Book value per share $15.90 $14.41 $12.02 $12.22 $10.44
(a) 1996 includes a nonrecurring tender offer charge of $2,163,000; 1994 includes a nonrecurring relocation charge of $838,000; 1993 includes a $1,750,000 nonrecurring charge for settlement of litigation. (b) 1995 net premiums written to policyholders surplus ratio was calculated using a full year of Viking net premiums written, rather than using Viking net premiums written from the acquisition closing date forward.
Guaranty National Corporation ("Guaranty") and its subsidiaries (collectively, the "Company") manage their property and casualty business in three operating units: commercial lines, personal lines and collateral protection insurance. Gross premiums written and GAAP combined ratios by operating unit for the three years ended December 31, 1996, 1995 and 1994, respectively, are summarized below: Year Ended December 31, ---------------------------------- 1996 1995 1994 ---- ---- ---- (Dollars in thousands) Personal lines: Gross premiums written $257,410 $197,147 $131,123 GAAP combined ratio 97.6% 104.9% 96.5% Commercial lines: Gross premiums written $201,537 $200,228 $195,028 GAAP combined ratio 105.5% 108.5% 98.6% Collateral protection: Gross premiums written $79,089 $54,138 $38,840 GAAP combined ratio 96.3% 95.7% 97.1% Total: Gross premiums written $538,036 $451,513 $364,991 GAAP combined ratio 100.1% 105.3% 97.5%
The Company's investment philosophy is aimed at achieving an attractive long-term rate of return while maintaining a high level of quality and liquidity in its portfolio. The Company maintains a diversified portfolio comprised of a broad spectrum of industries and types of securities. At December 31, 1996 and 1995, the Company's portfolio consisted primarily of investments in fixed maturities and short-term investments. Such investments represented 85% and 84%, respectively, of the Company's total invested assets. At December 31, 1996, the total equity securities portfolio at estimated fair value was comprised of $59,415,000 in common stocks and $28,687,000 in nonredeemable preferred stocks. The remaining investments at December 31, 1996, were primarily several investment limited partnerships. In addition, during 1995, Viking County Mutual ("VCM"), a county mutual organization
Year Ended December 31, 1996 Compared to the Year Ended December 31, 1995
Overall, gross premiums written increased 19% to $538,036,000 in 1996, from $451,513,000 in 1995. The majority of the growth was attributable to increases in the Company's personal lines and collateral protection operating units. Consolidated net premiums written for 1996 increased $93,333,000, or 23%, compared to 1995, due to a higher volume and change in mix of business. Premiums ceded to reinsurers, as a percentage of gross premiums written, decreased approximately three percent during 1996. The decline resulted primarily from a reduction in commercial lines premiums, as a percentage of total premiums. Commercial coverages are more heavily reinsured than the premiums from the personal lines and collateral protection units, which write business at lower limits than the commercial lines unit.
The commercial lines unit gross premiums written increased slightly, by $1,309,000, to $201,537,000 in 1996, compared to 1995. The increase is the net effect of both increases in the commercial standard division offset by decreases in certain nonstandard lines of business, primarily commercial automobile liability. In accordance with the Company's ongoing, planned, business mix change, which has been in progress over the past few years, commercial automobile liability gross premiums written were reduced to 36% of total commercial lines premiums for 1996 compared to 40% for 1995. While commercial automobile liability gross premiums written declined during 1996, the unit's 1996 property gross premiums written increased from 15% to 19% of total commercial lines gross premiums written, compared to the prior year. Also, in July 1995, this unit introduced an automobile physical damage program in California, which was 50% quota-share reinsured. This program accounted for $1,765,000 of the total increase in, and $10,454,000 of the 1996 commercial lines unit gross premiums written. However, due to poor loss experience in this program, the agent has been given notice of cancellation. As a result, the Company expects the gross premiums written for this program to be insignificant during 1997. The expected 1997 premium decline on this California physical damage program is expected to be offset by increased premium production in the commercial standard lines of business.
The commercial lines unit GAAP combined ratio decreased by 3.0 points to 105.5% in 1996, compared to 1995. The decrease resulted primarily from a 5.9 point improvement in the unit's loss ratio, which was partially offset by a 2.9 point deterioration in the unit's expense ratio. The lower loss ratio was attributable to lower overall commercial claims frequency and severity during 1996. Also, the 1995 loss ratio was unusually high because of the loss and loss adjustment expense reserve strengthening for prior year claims recorded in 1995. No significant reserve strengthening occurred during 1996. The higher expense ratio was due to more commercial business written in programs having higher commission rates, as well as increased contingent commissions.
The collateral protection unit GAAP combined ratio increased 0.6 points for 1996, compared to the prior year. The increase was due to an 8.1 point increase in the unit's loss ratio for 1996, compared to 1995. The higher loss ratio was a result of increased frequency in the Northeast blanket vendor single interest and Puerto Rico collateral protection programs. The unit has implemented underwriting and pricing adjustments and has canceled problematic accounts in an effort to correct the higher loss ratio. The unit's higher loss ratio was partially offset by its lower expense ratio. The expense ratio for 1996 was 36.0%, compared to 43.5% for 1995. The improvement in the expense ratio related to lower agency contingent commissions, which were proportionately reduced by the increased loss ratio.
During 1996, the Company's known exposure to environmental losses, such as asbestos and pollution contamination, did not materially change. Based on the minimal claim activity to date and the nature of the business written, the Company does not believe that it has a material exposure to environmental losses.
Pretax net investment income increased $8,463,000 in 1996, compared to 1995, and after-tax net investment income increased $5,592,000 for the same period. These increases were primarily due to an overall increase in average invested assets, which resulted primarily from the July 1995, addition of the Viking investment portfolio and positive operating cash flow. Additionally, the Company had stronger earnings from its limited partnership investments during 1996, when compared to 1995. Specifically, earnings from limited partnership investments increased $1,718,000 during 1996. The investment portfolio yield, on an after-tax basis, decreased slightly to 4.8% in 1996, compared to 5.0% in 1995.
On May 8, 1996, Orion Capital Corporation and certain of its subsidiaries ("Orion"), commenced a cash tender offer (the "Offer") to purchase up to 4,600,000 shares of the Company's common stock. As a result of the Offer, the Company incurred costs of approximately $1,778,000, net of tax, or $0.12 per share, for expenses related to the Offer. These costs were classified as nonrecurring in the Company's December 31, 1996 Consolidated Financial Statements. See Note 17 to the Consolidated Financial Statements for further discussion of these costs.
The income tax expense was 25.4% of pre-tax income in 1996 versus a 21.8% income tax benefit of pre-tax income in 1995. The 1996 income tax expense differed from the Federal statutory rate due to nontaxable interest income and the dividends received deduction on stock dividends. The 1995 income tax benefit resulted from a combination of underwriting losses and nontaxable interest income and dividends received deduction.
Year Ended December 31, 1995 Compared to the Year Ended December 31, 1994
During 1995, the commercial lines unit gross premiums written remained relatively constant, with only a three percent increase, when compared to 1994. This consistent level was a result of standard division new business generated outside the Rocky Mountain region, as well as the expansion of existing specialty programs and umbrella business, and the introduction of a new automobile physical damage program in California. These increases were offset by decreases in other commercial lines of business. In accordance with the Company's planned business mix change, commercial automobile liability gross premiums written were reduced to 40% of total commercial lines premiums for 1995 compared to 52% for 1994.
The commercial lines unit GAAP combined ratio increased by 9.9 points to 108.5% in 1995, due primarily to a higher loss ratio resulting from the reserve strengthening in commercial automobile liability recorded in the third quarter of 1995, and continued high severity in 1995. In addition, the commercial lines unit expense ratio increased slightly during 1995 compared to 1994.
The Company's loss ratio in 1995 was 75.3%, up from the 66.3% reported in 1994. The significant increase in the loss ratio was mainly due to the reserve strengthening, which was recorded in the third quarter of 1995, as discussed above. The commercial lines loss ratio increased 9.7 points to 78.0%, primarily as a result of the reserve strengthening and higher severity in 1995. In personal lines, the loss ratio increased to 78.6% from 69.4%, due to the reserve strengthening, as well as higher frequency of automobile physical damage claims, and catastrophe losses. The collateral protection unit loss ratio increased in 1995 to 52.2% compared to 48.6% in 1994.
Including the reserve strengthening charge, the Company's insurance operating units, in total, experienced $12,787,000 of adverse development in 1995 on 1994 and prior loss reserves, net of reinsurance. This compares to $1,047,000 of adverse development in 1994 on 1993 and prior loss reserves, net of reinsurance. The development equates to 7.1% and 0.6% of loss reserves carried at December 31, 1994 and 1993, respectively. The adverse development in 1995 was principally caused by commercial automobile and private passenger automobile liability outstanding claims and incurred but not reported losses developing higher than expected. The remainder was from general liability and other lines.
The Company's expense ratio in 1995 was 30.0% compared to 31.2% in 1994. The improvement in the expense ratio is due to higher personal lines business unit premiums coupled with improved operating efficiencies in this unit.
The Company's 1996 book value per share increased $1.49, to $15.90. This increase was primarily due to the significant increase in the Company's net earnings during 1996, compared to 1995, coupled with an increase in the unrealized investment gains caused by the strong stock markets during 1996.
The Company's level of short-term investments at December 31, 1996 and 1995 was 14.2% and 8.4%, respectively, of total investments. The increase resulted from management's decision to reduce the average duration of its investment portfolio and to shift its investment mix to securities with more liquidity. Company management believes that it maintains sufficient liquidity in its investment portfolio through its short-term investment holdings to meet anticipated claim payments and other insurance payment requirements.
Guaranty's projected use of cash consists of debt service, dividends to shareholders, income taxes, and administrative expenses. These required cash disbursements will be funded primarily from existing available cash and dividends from Guaranty National Insurance Company ("GNIC") and Viking Insurance Company of Wisconsin ("VICW"). GNIC paid no dividends to Guaranty during 1996. However, VICW paid dividends in the amount of $8,687,000 to Guaranty in 1996. Payment of dividends by GNIC and VICW must comply with insurance regulatory limitations. Under current regulations, permitted dividends exceed Guaranty's projected cash requirements. The Colorado dividend restriction law limits the annual dividend which can be paid by GNIC to the greater of 10% of the insurer's statutory surplus or statutory net income, excluding realized capital gains, as reported at the end of the preceding calendar year. The Wisconsin dividend restriction law limits the annual dividend that VICW may pay to Guaranty to the lesser of 10% of VICW's statutory surplus as of the end of the preceding calendar year or the greater of either the statutory net income of VICW for the preceding calendar year, less realized capital gains, or the aggregate of the net income of VICW for the three calendar years preceding the date of the dividend, less realized capital gains for those calendar years minus dividends paid or credited and distributions made within the first two of the preceding three calendar years. Under these laws, approximately $25,307,000, in total, is available to pay dividends to Guaranty in 1997. The Company believes both GNIC and VICW will be in position to pay comparable dividends to Guaranty in the future. Management believes that in addition to the $10,000,000 available under the Company's reducing, revolving credit facility, Guaranty has substantial sources of further liquidity, if necessary, from capital markets and bank borrowings.
the Company from 49% to 81%. See Note 17 to the Consolidated Financial Statements for further discussion related to these Orion transactions.
As a result of Orion's tender offer, the Company was served with three separate complaints alleging that the Orion tender offer price was unfair and inadequate. See Note 12 to the Consolidated Financial Statements for more discussion related to these complaints.
From 1991 through 1995, the Company was indebted to Orion under a $20,896,000 subordinated note agreement. However, subsequent to the date of the original agreement various refinancing arrangements and amendments were made. The last of these modifications took place on June 14, 1995, and added a common stock conversion feature. Thereafter, on June 22, 1995, the Company converted $8,667,000 of the Orion Notes into 550,000 shares of common stock. The remaining balance of these notes, $12,229,000, was converted into 776,128 shares of common stock on October 30, 1995. Of the total 1,326,128 common shares issued to Orion during 1995, as part of the note conversion, 415,000 of these shares were re-issued treasury shares. At December 31, 1994, the Company had a total of 438,200 shares of treasury stock, at a cost of $6,342,000, which had been repurchased during 1994 pursuant to its stock repurchase plan. However, in 1995 all of the treasury shares repurchased during 1994 were re-issued either to Orion or in connection with awards and the exercise of stock options under the Company's 1991 Long-Term Performance Incentive Plan.
On August 26, 1994, the Company acquired General Electric Mortgage Insurance Corporation of California ("GEMIC") for $6,363,000 in cash and received in exchange the common stock of GEMIC, which had net assets valued at $5,508,000. The Company renamed GEMIC as Guaranty National Insurance Company of California ("GNICOC"). The Company is utilizing GNICOC for its California commercial and collateral protection business, reducing the need for 100% reinsurance services from Orion. GNICOC retained no liabilities from its previously written business and other operations.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Guaranty National Corporation and subsidiaries at December 31, 1996 and 1995 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1996 in conformity with generally accepted accounting principles.
GUARANTY NATIONAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands, except share amounts)
Revenue: Premiums earned $481,648 $390,017 $321,638 Net investment income 39,439 30,976 23,576 Realized investment gains 8,455 3,291 3,007 Other income 2 -------- -------- -------- 529,542 424,284 348,223
Expenses: Losses incurred 279,108 248,771 180,865 Loss adjustment expenses 58,676 44,742 32,640 Policy acquisition costs 133,931 110,341 93,103 General and administrative 10,422 6,458 7,206 Interest 6,851 5,708 3,218 Nonrecurring charges 2,163 838 Other 1,510 932 766 -------- ------- -------- 492,661 416,952 318,636 -------- ------- -------- Earnings before income taxes (benefit) 36,881 7,332 29,587 Income taxes (benefit) 9,375 (1,597) 7,036 -------- -------- -------- Net earnings $27,506 $ 8,929 $22,551 ======== ======== ========
Financing Activities: Proceeds from issuance of notes payable 130,654 14,000 Repayment of notes payable (1,313) (60,000) Dividends paid to shareholders (7,485) (6,655) (6,049) Purchase of treasury stock (6,636) Proceeds from issuance of common stock 24,220 Proceeds from exercise of stock options 62 550 --------- -------- -------- Net cash (used in) provided by financing activities (8,736) 88,769 1,315 --------- -------- -------- Net (Decrease) Increase in Cash (2,806) (2,815) 5,622 Cash, Beginning of Year 6,794 9,609 3,987 --------- ------- -------- Cash, End Of Year $3,988 $6,794 $9,609 ========= ======= ======== Non-Cash Financing Transactions: Conversion of affiliate debt $ $ (20,896) $ Issuance of common stock in conversion of affiliate debt 14,881 Conversion of affiliate debt from treasury stock 6,015 Restricted stock forfeitures (126)
Year Ended December 31, --------------------------------------- 1996 1995 1994 ----- ---- ----
Nature of Operations - Guaranty National Corporation and its subsidiaries (the "Company") is a corporation based in Englewood, Colorado which principally underwrites and sells specialty property and casualty insurance coverages that are generally not available in traditional insurance markets. The Company manages its business under three operational areas based on function: commercial lines, personal lines and collateral protection.
The Company's insurance subsidiaries are authorized as multiple- line insurance carriers and may insure all types of property and liability risks. The insurance coverages provided by these insurance carriers are generally known as nonstandard risks due to the potential for poor claims experience because of increased risk exposure. The insurance subsidiaries market insurance coverage throughout the United States, and one or more of these subsidiaries are admitted in all states.
In 1995, the Company acquired control of, but not ownership of, Viking County Mutual Company ("VCM"). VCM is a Texas mutual organization which performs 100% reinsurance services in the state of Texas for its affiliated companies. VCM is not included in the consolidated financial statements.
Certain reclassifications have been made to the 1995 and 1994 consolidated financial statements to conform with the presentation used in 1996.
Principles of consolidation - The consolidated financial statements include the accounts of Guaranty National Corporation ("Guaranty") and its wholly-owned subsidiaries, Intercon General Agency, Inc. ("Intercon"), Auto Insurance Centers, Inc. ("AIC"), Guaranty National Warranty Services ("GNWS"), Guaranty National Insurance Company ("GNIC") and Viking. GNIC includes its wholly- owned subsidiaries, Landmark American Insurance Company ("LAIC"), Colorado Casualty Insurance Company ("CCIC"), Peak Property and Casualty Insurance Corporation ("PEAK"), and Guaranty National Insurance Company of California ("GNICOC"). All significant intercompany accounts and transactions have been eliminated in consolidation.
Significant accounting policies - This summary of significant accounting policies is presented to assist in understanding the Company's consolidated financial statements:
with stated maturities less than 10 years. All other fixed securities are classified as available for sale and may be sold in response to changes in interest rates, anticipated prepayments, liquidity needs or other economic factors. Select issues with maturities beyond 10 years may be classified as held to maturity due to certain factors, including expected early call provisions.
Estimated fair value for securities is generally based on last sales prices, listed bid prices, bid quotations received from security dealers or, when estimated fair values are not readily available through market sources, fair value estimates are based on quoted market prices of similar instruments. Mortgage loans are carried at their unpaid balance and are classified as other long- term investments. Estimated fair value for mortgage loans is calculated by discounting scheduled cash flows through maturity using estimated market discount rates. Other long-term investments, which are principally comprised of interests in several investment limited partnerships, are generally carried at equity value which approximates estimated fair value. Short-term investments, which include certificates of deposit, money market accounts, and commercial paper maturing within one year of the balance sheet date, are carried at cost which approximates estimated fair value.
Realized investment gains and losses are recognized on the specific identification method, and amortization of premiums and discounts is determined using the interest method.
f. Income taxes - Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.
h. Statement of cash flows - For purposes of the consolidated statements of cash flows, the Company considers only demand deposit accounts to be cash.
i. Earnings per share - Earnings per share for 1996, 1995 and 1994 has been computed by dividing net earnings by the number of weighted average shares and equivalent shares outstanding of 14,973,332, 13,324,200 and 12,135,505, respectively. The common stock equivalents are stock options which result in a dilutive effect from assumed exercise of the options.
j. Employee stock compensation plans - The Company follows Accounting Principles Board Opinion (APB) No. 25, "Accounting for Stock Issued to Employees." The exercise price of stock options issued to employees equals the market price of the stock on the measurement date, and therefore, the Company does not record compensation expense on stock options granted to employees. Restricted stock issued to employees is considered issued and outstanding when awarded, and is recorded as deferred compensation.
On July 18, 1995, the Company acquired Viking in a business combination accounted for as a purchase. Viking is a property and casualty insurance company writing nonstandard personal automobile insurance, primarily in the state of California. The results of operations of Viking are included in the accompanying consolidated financial statements since the date of acquisition.
Included in the cost of the acquisition was $3,250,000 paid to the Seller as additional purchase price, in anticipation of favorable development of Viking's recorded 1994 and prior accident year loss and LAE reserves. The Company has agreed to pay the Seller, as additional purchase price, two-thirds of any favorable loss development up to $15,000,000, and one-third of any favorable development between $15,000,000 and $20,000,000. The amounts payable will be reduced by 35% to compensate for the applicable tax rate. The Company and the Seller will initially settle any additional purchase price as of December 31, 1998, and will finalize the settlement as of December 31, 2001. If adverse development results, the Seller will repay to the Company an offsetting amount, after allowance for the tax adjustment, not to exceed the initial $3,250,000 paid to the Seller at the time of acquisition.
Management estimates that a payment in excess of the $3,250,000 already paid will ultimately be made to the Seller, and has included this estimated amount of approximately $4,333,000, as well as the corresponding
The above amounts reflect adjustments used in recording the purchase, such as adjustments for interest on notes payable issued as part of the purchase price, amortization of goodwill, and fees eliminated as a result of the acquisition.
December 31, ---------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------- ---------- ---------- --------- - ----
Fixed maturity securities held to maturity: U.S. Treasury and U.S. Government agencies $30,674 $ 170 $ 106 $30,738 State and municipal 47,605 1,202 146 48,661 Corporate 1,992 39 2,031 ------ ------ ------ ------ 80,271 1,411 252 81,430
December 31, -------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ---------- ---------- ----------- -------- - ----
Fixed maturity securities held to maturity: U.S. Treasury and U.S. Government agencies $ 17,943 $ 896 $ $ 18,839 State and municipal 53,907 1,564 400 55,071 Corporate 3,167 66 3,233 ------- ------ ------- ------- 75,017 2,526 400 77,143 Fixed maturity securities available for sale: U.S. Treasury and U.S. Government agencies 123,209 3,000 126,209 State and municipal 176,461 8,298 161 184,598 Corporate 83,465 2,884 1,958 84,391 ------- ------ ------ ------- 383,135 14,182 2,119 395,198 ======= ====== ====== ======= Total fixed maturity securities $458,152 $16,708 $ 2,519 $472,341 ======= ====== ====== ======= Equity securities: Common stocks $ 41,994 $12,767 $ 2,622 $ 52,139 Nonredeemable preferred stocks 31,277 3,654 1,985 32,946 ------- ------ ------ ------- Total equity securities $ 73,271 $16,421 $ 4,607 $ 85,085 ======= ====== ====== =======
For a summary of the amortized costs and estimated fair value of fixed investment maturities at December 31, 1996 and 1995, by contractual maturity, see Note 7.
To augment the average yield on its investment portfolio, the Company invests a portion of its fixed maturity assets in "high yield" bonds and preferred stocks, which are investments of a quality considered to be noninvestment grade (rated "BB" or below). Such securities are generally considered to have a higher potential of loss due to default because they are unsecured, subordinated to other debt and/or issued by highly leveraged companies. At December 31, 1996 and 1995, the Company had investments in "high yield" securities of $55,205,000 and $36,641,000 with estimated fair values of $56,477,000 and $36,356,000, respectively.
The Credit Agreement was amended and restated as of December 16, 1996, in order to obtain a more favorable commitment fee and London Interbank Offered Rate (LIBOR) margin, to adjust the repayment schedule and terms, and to modify certain of the debt covenants. Under the amended and restated Credit Agreement, principal payments are required beginning April 15, 1998, until the loan is retired in 2002. The Company made an early principal payment during 1995 in the amount of $2,000,000, and therefore, the next principal payment is due on April 15, 1999. Interest is payable quarterly, and interest rates are based on the floating LIBOR rate. As of December 31, 1996, the outstanding loan amount under this Agreement was $100,000,000, with an interest rate of 6.24% (see Note 11). Loan fees are being amortized over the seven year life of the loan.
On June 14, 1995, the Company amended the $20,896,000 subordinated notes ("Orion Notes") held by Orion, to include a common stock conversion feature. On June 22, 1995, the Company converted $8,667,000 of the Orion Notes into 550,000 shares of common stock. On October 30, 1995, the Shareholders of the Company approved the conversion of the remaining balance of the Orion Notes into 776,128 shares of common stock.
As of December 31, 1996, the Company had a remaining principal balance of $1,688,000 under its 6.5% term loan, which was entered into during 1994 in order to purchase furniture and fixtures for the new home office facility. This term loan is secured by the furniture and fixtures purchased. Quarterly principal and interest payments are due on this loan until April 1, 1999.
Maturities of notes payable are as follows: 1997-$562,500; 1998- $750,000; 1999- $22,375,000; 2000-$24,000,000; 2001-$26,000,000; 2002 and thereafter-$28,000,000.
The amortized cost and estimated fair value of fixed investment maturities at December 31, 1996 and 1995, by contractual maturity, are shown below (in thousands). Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
The carrying value and estimated fair value of other financial instruments at December 31, 1996 and 1995 are as follows (in thousands):
December 31, 1996 December 31, 1995 ------------------------- ----------------------- Carrying Estimated Carrying Estimated Value Fair Value Value Fair Value -------- ---------- -------- ---------- Assets: Equities $ 88,102 $ 88,102 $ 85,085 $ 85,085 Other long-term investments 13,585 13,600 11,521 11,572 Short-term investments 94,993 94,993 52,257 52,257 Liabilities: Notes payable 101,688 101,696 103,000 103,009
Estimated fair value of the term loan, included in notes payable above, was calculated by discounting contractual cash flows through maturity using quoted market rates for similar issues with similar maturities. Estimated fair value of the Credit Agreement, also included in notes payable above, approximates face value due to the credit terms during the revolving period. See Note 6 for further discussion of both the term loan and Credit Agreement.
the temporary differences and AMT carryforwards comprising the net deferred tax liability at December 31, 1996 and the net deferred tax asset at December 31 1995, which are included in other liabilities and other assets in the consolidated balance sheet, are as follows (in thousands):
Year Ended December 31, ------------------------- 1996 1995 ---- ---- Discounted loss reserves $10,406 $11,325 Unearned premiums 9,642 8,971 Deferred compensation arrangements 1,658 1,030 Realized investment losses 595 747 AMT credit carryforward 1,141 1,819 Accrued post retirement benefits other than pensions 643 504 Accrued exit activity costs 574 1,464 Other 891 1,039 ------ ------ Gross deferred tax assets 25,550 26,899 ------ ------
Deferred policy acquisition costs 15,560 13,173 Net unrealized investment gain 9,212 8,357 Amortization of fixed maturities 461 489 Other 1,120 664 ------ ------ Gross deferred tax liabilities 26,353 22,683 ------ ------ Net deferred tax (liability) asset $ (803) $ 4,216 ====== ======
Included in gross deferred tax assets at December 31, 1996 and 1995, is $1,141,000 and $1,819,000 of AMT credit carryforward, respectively. The credit is allowed for the amount of adjusted net minimum tax for all years reduced by the minimum tax credit for all prior tax years. This credit has no expiration date as a credit against the Company's future regular tax liability. Included in other deferred tax assets at December 31, 1996 and 1995, is the tax effect of a $573,000 and $639,000, respectively, net operating loss carryforward arising from the acquisition of CCIC, available to offset future taxable income of CCIC. This carryforward substantially expires in 1997, with final expiration in 2003. Also included in other deferred tax assets at December 31, 1995, is the tax effect of a $609,000 net operating loss carryforward, which was utilized to reduce the Company's 1996 regular tax liability. This carryforward expires in 2010. As of December 31, 1996, no valuation allowance on deferred tax assets was necessary.
The components of the provision (benefit) for income taxes on continuing operations are as follows (in thousands):
Year Ended December 31, -------------------------------------- 1996 1995 1994 ---- ---- ---- Current $5,211 $ 1,946 $7,012 Deferred 4,164 (3,543) 24 ----- ------ ----- $9,375 $(1,597) $7,036 ===== ====== =====
In the ordinary course of business, the Company reinsures certain risks, generally on an excess of loss basis with other insurance companies. Effective July 1, 1996, such reinsurance arrangements limit the Company's maximum loss per occurrence on casualty losses to $400,000, on property losses to $300,000 and for catastrophe losses to $600,000. For the first half of 1996, such reinsurance arrangements limited the Company's maximum loss per occurrence on individual risks to $400,000 and for catastrophes to $500,000. Amounts recoverable from reinsurers are recognized and estimated in a manner consistent with the claim liabilities arising from the reinsured policies and incurred but not reported losses.
Reinsurance contracts do not relieve the Company from its obligations to policyholders. To the extent that any reinsuring company is unable to meet its obligations, the Company would be liable for such defaulted amounts; consequently, allowances are established for amounts deemed uncollectible. The allowances established for uncollectible amounts were $200,000 at both December 31, 1996 and 1995. The Company generally does not require collateral to support reinsurance recoverables, but continually evaluates the financial condition of its reinsurers and monitors concentrations of credit risk to minimize exposure to significant losses from reinsurer insolvencies. At December 31, 1996 and 1995, reinsurance recoverables of $80,249,000 and $68,938,000, respectively, were associated with two reinsurers (both companies are rated A+ or above by A.M. Best) under the Company's excess of loss property and casualty treaties and certain facultative reinsurance contracts. The Company's reinsurance treaties generally provide that premiums are ceded on a written basis but are paid to the reinsurers on an earned basis; consequently, prepaid reinsurance premiums are primarily deposits required by contract terms and amounts paid related to facultative reinsurance contracts. Prepaid reinsurance premiums are amortized over the contract period in proportion to the amount of reinsurance protection provided.
Premiums, losses and LAE, including the effect of reinsurance, are comprised of (in thousands):
Year Ended December 31, ------------------------------------------------------------- 1996 1995 1994 ---------------- ---------------- ---------------- Written Earned Written Earned Written Earned ------- ------ ------- ------ ------- ------ Premiums: Direct $493,660 $492,077 $414,694 $393,886 $295,714 $284,918 Assumed 44,376 37,921 36,819 47,916 69,277 76,720 Ceded (46,804) (48,350) (53,614) (51,785) (42,066) (40,000) ------- ------- ------- ------- ------- ------- Net $491,232 $481,648 $397,899 $390,017 $322,925 $321,638 ======= ======= ======= ======= ======= =======
The Company has entered into reinsurance agreements with subsidiaries of Orion, whereby it assumes business written by the affiliates. Included in premiums assumed above, for the years ended December 31, 1996, 1995 and 1994, were $15,673,000, $9,495,000 and $30,921,000 of premiums written, respectively, which were assumed under these agreements. Assumed premiums and incurred losses have changed, compared to the prior years, as a result of the changes in the Company's business written in different states. The Company paid fees and expenses to affiliates for assumed business written as follows: 1996-$607,000; 1995-$338,000; 1994- $1,440,000.
Since the acquisition of Viking, the Company is party to 100% reinsurance agreements with VCM, whereby the Company assumes business written, in the state of Texas, by this affiliate. Included in 1996 and 1995 premiums assumed above were $29,623,000 and $5,525,000, respectively, of premiums written under these agreements. The policy issue fee charged by VCM is offset by the management fee charged by the Company to VCM. Therefore, the net amount of policy issue fees and management fees is immaterial.
As a result of changes in estimates of insured events in prior years, the provision for prior year losses and LAE decreased by $995,000 in 1996, a significant improvement compared to 1995. The favorable development in 1996 was the result of $4,038,000 redundant development in the personal lines business unit. The redundancy in this unit was due to estimated incurred but not reported losses at the beginning of the year developing lower than expected, as well as the successful implementation of claims operational changes, which resulted in better than expected development on 1995 personal lines acquired reserves. The favorable development within the personal lines business unit during 1996 was partially offset by adverse development within the commercial and collateral protection units. The total commercial lines adverse development in 1996 was $1,675,000, which represented a significant improvement over 1995, and resulted primarily from general liability losses and loss adjustment expenses on reported claims costing more to settle than expected. During 1996, the collateral protection unit experienced $1,368,000 adverse development primarily due to an under-estimation of unreported claims, as of December 31, 1995, for the Blanket Vendor Single Interest and Puerto Rico business.
Environmental claims reported to the Company to date, such as asbestos and pollution contamination, have primarily related to policies written during the period 1984 to 1978. In 1985, the Company added an absolute pollution exclusion clause to general liability policies to significantly reduce exposure to such claims. The Company's known exposure to environmental losses is not considered to be material as they have amounted to approximately three percent of cumulative payments on general liability claims for the accident years 1984 to 1978, and there are less than $600,000 in net outstanding claim reserves, and approximately $2,000,000 in total loss and loss adjustment expense reserves, at December 31, 1996. Based on the claim activity to date and the nature of the business written during this period and subsequent periods, the Company does not believe that a material exposure to such risks exists in the future.
The Company paid commissions to an Orion agency affiliate of $85,000, $72,000 and $90,000 in 1996, 1995 and 1994, respectively, for premiums written by the affiliate for the Company of $436,000, $411,000 and $516,000 in 1996, 1995 and 1994, respectively.
In 1990, GNIC entered into a loan participation agreement with a subsidiary of Orion, whereby they loaned money to another affiliate. The loan was secured by a leasehold deed of trust and matured in November 1995. GNIC's proportionate share of this loan was $3,700,000, or 41.1%. GNIC received quarterly interest payments at a rate of 11% of its proportionate share. Interest earned was $355,000 in 1995 and $407,000 in 1994. In 1995, during the assembly of the Viking acquisition financing, the Company received a commitment for a $21,000,000 Bridge Loan from Orion, for which the Company paid a $210,000 commitment fee. During 1995, the Company converted the $20,896,000 Orion Notes into 1,326,128 shares of common stock. See Note 6 for further discussion related to this conversion. In 1995 and 1994, the interest expense paid to Orion was $1,122,000 and $1,640,000, respectively.
Also, the Company has entered into certain reinsurance agreements with subsidiaries of Orion (see Note 9).
In the opinion of management, the terms of the Company's transactions with Orion are reasonable and representative of the terms that would have been applicable in transactions with unrelated parties.
A member of the Board of Directors of the Company is the owner of a general agency. Gross commissions paid by the Company to the agency, under a standard agency contract, for business produced were $731,000, $813,000 and $789,000 in 1996, 1995 and 1994, respectively.
As a result of the Viking acquisition and the subsequent change in control of VCM, VCM was required to increase its surplus to a minimum of $2,000,000 as required by the Texas Insurance Code. The increase was accomplished by the issuance of a surplus debenture to Viking in the amount of $1,300,000 in exchange for cash. The debenture pays interest annually at a rate of 8.5%. Interest earned in 1996 and 1995 was $129,000 and $33,000, respectively. Also, the Company provides management services to VCM. The fees paid by VCM are offset by policy issue fees paid to VCM by the Company under 100% reinsurance agreements (see Note 9).
All stock options under the Incentive Plan are granted at fair market value at date of grant, become exercisable proportionately from the first through the fourth anniversaries of the grant dates, and expire ten years after the date of grant. In October 1996, the Company's Board of Directors amended the Incentive Plan to be consistent with the terms of the Equity Incentive Plan.
As discussed in Note 1, the Company follows APB. No. 25 for stock options issued to employees, rather than following Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation." SFAS No. 123, among other things, requires estimating the fair value of stock options using an option pricing model that considers factors specified by this SFAS, and recording compensation cost based on the estimated fair value of the stock options. Had compensation cost for the stock options granted under the Company's Equity Incentive Plan and Incentive Plan been determined consistent with SFAS No. 123, the Company's net earnings and earnings per common share would have been reduced to the pro forma amounts indicated below:
Earnings Per Common Share: As Reported $ 1.84 $ 0.67 Pro Forma 1.81 (a) 0.65
The weighted-average remaining contractual lives for options outstanding at December 31, 1996 and 1995 were 7.5 and 7.4 years, respectively.
The Company has a defined contribution profit sharing plan, which qualifies under Section 401(k) of the Internal Revenue Code, for which substantially all employees are eligible after a specific waiting period. The plan is contributory and the Company matches employee contributions unless changed by the withBoard of Directors. Prior to 1996, Viking had its own separate Individual Retirement Plan which was pending qualification under Section 401(k) of the Internal Revenue Code. On April 1, 1996, the Company received a favorable determination letter from the Internal Revenue Service and rolled the Viking plan into its plan.
The Company has a non-qualified Supplemental Executive Retirement Plan ("SERP") for employees whose compensation meets a minimum requirement. This plan provides deferred benefits for those employees who received less than the full employer contribution of the Company's defined contribution profit sharing plan as a result of federal tax limitations on participation in the plan. Eligible employees are entitled to receive payment of funds upon retirement or termination unless terminated for good cause as defined in the SERP. Prior to 1996, Viking employees were not eligible to participate in this plan.
The Company, excluding Viking, has a defined benefit health care plan ("the Plan") that provides postretirement medical benefits to full-time employees who have worked for ten years and attained age 55 while in service with the Company. Benefits generally are provided under the Plan for retirees and their dependents until the retirees attain age 65. The Plan is contributory and contains other cost sharing features which may be adjusted annually for the expected general inflation rate. The Company's policy is to fund the cost of the Plan benefits in amounts determined at the discretion of management. To date, no funding of the Plan has been made.
Total expense for the Company's employee benefit plans, discussed above, is as follows: 1996-$2,692,000; 1995-$2,132,000; 1994- $1,602,000.
On November 20, 1991, the Board of Directors approved the adoption of a Shareholder Rights Agreement and in connection therewith declared a dividend distribution of one Right for each outstanding share of Common Stock until such time that separate Right certificates are distributed, or the Rights are redeemed or expire. When exercisable, each Right will entitle a holder to purchase from the Company a unit consisting of one one-hundredth of a share of a new series of the Company's Preferred Stock at a purchase price of $60 per share.
As a result of the Offer the Company incurred costs of approximately $2,163,000, in the second quarter of 1996, for legal fees, investment advisor fees, printing fees, director's fees, and compensation expense resulting from the acceleration of unvested restricted stock grants.
On July 2, 1996, Orion successfully completed the Offer and purchased the 4,600,000 shares of the Company's common stock at an amended price of $18.50 per share. According to the Depository for the Offer, 6,774,515 shares of the Company's shares were tendered and not withdrawn pursuant to the Offer. The proration factor used by Orion to purchase the tendered shares was .67901168. For further information related to the Orion Offer refer to the Company's report on Schedule 14D-9, filed with the Securities and Exchange Commission on May 22, 1996, and amendments thereto, filed on June 1, 1996, June 7, 1996 and June 19, 1996.
On July 17, 1996, Orion purchased an additional 120,000 shares of the Company's common stock in the open market. The purchase of these additional shares brought Orion's ownership level in the Company to 12,129,942 shares, or 81.0%.
1995: Total revenue $ 86,502 $ 88,306 $121,479 $127,997 Earnings (loss) before income taxes 7,535 6,575 (8,349) 1,571 Net earnings (loss) 5,768 4,851 (4,113) 2,423 Earnings (loss) per share $ 0.48 $ 0.40 $ (0.29) $ 0.16
During the third quarter of 1995, the Company completed the Viking acquisition (see Note 3), which significantly increased revenues in the third and fourth quarters of 1995. Also in the third quarter of 1995, the Company strengthened its loss reserves (losses and loss adjustment expenses) by $13,971,000, as a result of adverse development within the personal and commercial lines units (see Note 10).