SELECTED FINANCIAL DATA - ------------------------------- FOREMOST CORPORATION OF AMERICA AND SUBSIDIARIES FIVE YEAR SELECTED FINANCIAL DATA
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -----------------------------------------------------------------------
Written premium for the life segment in 1995 was $22 million, down slightly from 1994 when written premium totaled $22.2 million. The 1994 writings were up 1% from 1993 when they were $22 million. Since the Company's decision to exit the credit life and credit accident and health business at the end of 1992, the remaining product line is employee group benefit insurance for small employers.
Management continually monitors its exposure to catastrophic risk and has taken aggressive action in coastal areas and earthquake prone areas. In 1995, the Company started a coastal strategy that will eliminate approximately 21,000 policies in the coastal counties from Maine to Texas and will be completed by June 30, 1996. Management has also pursued the reduction of the Company's earthquake exposure by non-renewing 20,000 policies in California with units greater than $50,000 in value. Since July 1, 1995, the Company's California policies only provide earthquake coverage on an optional basis, which will continue to reduce exposure to catastrophic loss due to earthquakes. Management will continue to take actions in the future where necessary.
Expense reduction actions taken to control policy acquisition costs and general and administrative expenses have helped reduce the Company's expense ratio for the seventh consecutive year. The expense ratio has declined by 2.8 points from 1993 to 1995. Management is committed to controlling expenses by closely monitoring various expense categories and developing programs to continuously improve the results.
The life operations also produced strong results in 1995 with its third consecutive year of underwriting profits of $1.3 million. The consistent performance of the employee group benefits products written in West Michigan was the primary reason for the good results over the past three years. The employee group benefits business has produced combined ratios of 93.8%, 92.9% and 91.9% for the years 1995, 1994 and 1993, respectively.
The Company engages outside actuarial firms to attest to the adequacy of its carried life, and property and casualty reserves. These firms have rendered their opinions for the year ended December 31, 1995, and they attest to the adequacy of the Company-held reserves. The Company is committed to maintaining adequate loss reserves and places a high priority on balance sheet integrity.
In 1995, the Company negotiated and entered into a credit agreement under which its lenders committed to provide a seven year non-amortizing $50 million term loan and a five year $40 million revolving credit facility. At year-end 1995, $50 million remained outstanding on the term loan, $8 million was outstanding on the revolving credit facility, and $2 million was outstanding on an uncommitted line of credit.
The Company's insurance subsidiaries are subject to certain restrictions on their ability to transfer funds to the parent company in the form of cash dividends, loans or advances without regulatory approval. These restrictions are not expected to impair the ability of the Company to meet its cash obligations.
After-tax investment income increased 6% in 1995, after declines of 2% in 1994 and 10% in 1993. The increase in 1995 is the product of positive cash flow generated from the strong underwriting performance during the year. The declines in 1994 and 1993 are the result of the impact of lower interest rates on new investments made due to calls and maturities of higher-yielding securities. Average invested assets expanded by over 7% in 1995 after a slight decline in 1994 and an increase of 4% in 1993.
At December 31, 1995 the Company held securities in its investment portfolio which were either unrated or less than investment grade, high-yield corporate debt securities, including certain preferred stocks and limited partnerships. These securities had a cost basis of $26 million, with an aggregate market value of $26.3 million, and none of them individually exceeded $5.7 million. These securities have different risks than other investment grade securities. Risk of loss upon default by the borrower is greater with these investments than with other corporate or governmental debt securities because these securities are generally unsecured and are often subordinated to other creditors of the issuer. These issuers usually have high levels of indebtedness 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 is 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 shareholders' equity net of applicable tax provisions or credits. The net unrealized gain or loss on securities available for sale was an unrealized gain of $13.8 million at December 31, 1995, an unrealized loss of $3.4 million at December 31, 1994 and an unrealized gain of $10.1 million at December 31, 1993. 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.
The Company has been named as a defendant in a number of similar individual lawsuits and several related class actions filed in Alabama state and federal courts. In general, the cases allege fraud and misrepresentation in the sale of insurance. The Company denies all allegations and is vigorously defending each suit.
In November 1995, an Iowa jury returned a verdict of $688,000 in compensatory damages and $8 million in punitive damages against the Company for alleged fraud, breach of contract and misappropriation of trade secrets in the termination of an agent's contract. The Company believes the verdict was erroneous and is currently pursuing all post-trial remedies. The Company has not accounted for the damages in its financial statements because the amount of the loss cannot be reasonably estimated.
FOREMOST CORPORATION OF AMERICA AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
The Company's property and casualty insurance subsidiaries and life insurance subsidiary are included in the accompanying financial statements in accordance with generally accepted accounting principles for insurance companies. These principles are summarized as follows:
The most significant estimates in the Company's balance sheet are the determination of prepaid policy acquisition costs and the reserve for insurance losses and loss adjustment expenses. Management's best estimate of prepaid policy acquisition costs is based on historical studies and assumptions made regarding costs incurred. Management's best estimate of insurance losses and loss adjustment expenses is based on past loss experience and consideration of current claim trends as well as prevailing social, economic and legal conditions. Although management's estimates are not expected to change in the near term, the costs the Company will ultimately incur could differ from the amounts assumed will be incurred based on the assumptions made.
The Company's debt securities investment portfolio is predominantly comprised of investment grade securities. 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. Investment real estate acquired through foreclosure is carried at the lower of cost or market.
Realized investment gains and losses, based on specific identification of securities sold, are reported separately, on a pretax basis, as part of total income.
The Company expenses the costs of advertising as incurred. Advertising expense was $2,021,000 in 1995, $1,617,000 in 1994 and $1,820,000 in 1993.
The Company does not consider any of its assets cash equivalents for the purposes of the Consolidated Statements of Cash Flows.
Interest paid was $9,089,000 in 1995, $8,499,000 in 1994 and $8,799,000 in 1993.
Income taxes paid were $21,557,000, $7,650,000 and $9,095,000 for 1995, 1994, and 1993, respectively.
In 1994, the Company sold three buildings for $6.8 million for which the Company provided mortgage financing on approximately 56% of the purchase price, at an interest rate of 8%.
The incurred and paid activity in the liability for insurance losses and loss adjustment expenses is as follows:
Mortgage Note The present value of future cash flows and the prepayment penalty are used to determine estimated fair value. The rate used was based on quoted market prices for similar issues.
The Company files a consolidated tax return with its subsidiaries, including its life insurance subsidiary. For tax purposes, certain amounts have been accumulated by the life insurance subsidiary in a memorandum policyholders' surplus account and will be taxed only when distributed to shareholders, or when they exceed prescribed limits. In 1993, these limits were exceeded by the life subsidiary, resulting in $245,000 of income taxes being charged to operating income. Policyholders' surplus on a tax basis amounted to $10.5 million at December 31, 1995. In the event written premium is less than $21 million in 1996, a portion of the policyholders' surplus could become taxable again.
In addition to the Company's net deferred tax liability, the liability for income taxes includes a current tax liability (recovery) of $(429,000) and $2,063,000 at December 31, 1995 and 1994, respectively
The Company was party to both proportional and non-proportional reinsurance agreements in 1995, primarily to protect itself against catastrophic losses, but also to limit losses on individual claims for benefit payments and certain other risks.
Due from reinsurance companies balances are primarily premium amounts due from unconsolidated insurance subsidiaries for business assumed, and loss recoverables from a major U.S. reinsurance company.
The Company has a Long-Term Incentive Plan (LTIP) which provides awards to certain key employees based on the Company's return on shareholders' equity over three year periods. The LTIP was amended in December 1994 and approved by the shareholders 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 to resale for three years from the date of the award. In 1995, 9,804 shares were issued under the plan.
The following is a summary of the stock option transactions during 1995, 1994 and 1993:
In 1995, the Company adopted and the shareholders' approved a restricted stock plan for the Company's Directors. Under the plan, the Company's Directors may elect to receive shares of the Company's common stock in lieu of their annual retainer fees. The shares are issued at market value and are registered in the name of the participant, who has all the rights of a shareholder, subject to restrictions as to transfer until they vest. Vesting occurs upon the completion of the Director's term. Up to 20,000 shares may be issued under the plan, and in 1995, 1,158 shares were issued.
The cost of the aforementioned benefit plans, excluding post-retirement benefits, for 1995, 1994 and 1993 was $4,339,000, $4,307,000 and $2,982,000, respectively.
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. In 1993, the Company adopted SFAS No. 106, "Employers' Accounting for Post-Retirement Benefits Other Than Pensions," which 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 plan's funded status reconciled with the amounts included in other liabilities in the Company's Consolidated Balance Sheets is as follows:
Rental expense charged to operations in 1995, 1994 and 1993 amounted to $4,693,000, $4,856,000 and $4,485,000, respectively, including amounts paid under short-term cancelable leases.
As a holding company, the principal source of the parent company's cash available for debt service and payment of dividends (other than through the use of borrowed funds or the employment of other assets) is dividends received from its principal property and casualty insurance subsidiary, Foremost Insurance Company, and its life insurance subsidiary, Foremost Life Insurance Company. State regulatory requirements limit the amount of annual dividends these companies can pay to the holding company without obtaining prior insurance department approval. These restrictions are not expected to significantly affect the holding company's ability to meet its foreseeable cash requirements. The amount of dividends which the combined insurance operations can pay to the holding company in 1996 without obtaining prior insurance department approval under the current statute is $50.6 million. In 1995 these companies paid dividends in cash and other assets to the parent company totaling $37.2 million.
At December 31, 1995, $90.4 million of consolidated shareholders' equity represents net assets of the Company's insurance subsidiaries that cannot be transferred in the form of dividends, loans or advances to the parent company.
Policyholders' surplus for the combined property and casualty insurance companies at December 31, 1995 and 1994 was $200.5 million and $181.3 million, respectively. Policyholders' surplus for the life insurance company at December 31, 1995 and 1994 was $24 million and $24.5 million, respectively. Statutory net income for the combined property and casualty insurance companies for the years ended December 31, 1995, 1994 and 1993 was $49.3 million, $44.2 million and $33.6 million, respectively. Statutory net income for the life insurance company for the years ended December 31, 1995, 1994 and 1993 was $3.6 million, $4.7 million and $6.2 million, respectively.
The Company has assigned its interest as tenant in a capital lease obligation. In the event of default by the assignee, a contingent liability exists of approximately $1.9 million at December 31, 1995.
In 1989 the Company's Board of Directors declared a dividend of one common stock purchase right for each share of the Company's outstanding common stock. Each right may be exercised at any time to purchase one one-hundredth of a share of the Company's common stock at a purchase price of $110 per right.
The rights expire on December 14, 1999 and may be redeemed by the Company for $.01 per right at any time until the 10th day following the public announcement that a person or group, other than the existing shareholder group, has acquired 20% or more of the Company's common stock. The Company has reserved 200,000 shares of its common stock for issuance upon exercise of the rights.
The Company has been named as a defendant in a number of similar individual lawsuits and several related class actions filed in Alabama state and federal courts (the "Alabama Litigation"). The cases in the Alabama Litigation allege both compensatory and punitive damages. In general, the complaints allege that the Company or its Alabama agents failed to disclose information about insurance coverages and premium structure, misinformed policyholders about coverages or policy provisions, and in other ways misrepresented the nature and extent of insurance sold in Alabama. The Company denies all allegations and is vigorously defending each suit. The compensatory damages, if any, are likely to be nominal for each individual claimant. The primary risk exposure facing the Company involves the plaintiffs' claims for punitive damages.
In June 1995, a Bullock County, Alabama jury awarded $15 million in punitive damages against the Company, despite the fact that the amount of the compensatory damage award in the Alabama Litigation case was $12,500. The punitive damage element of the Bullock County jury award has been reduced by the trial court judge to $6.5 million and the compensatory damage element of the Bullock County jury award has been reduced to approximately $3,300. In February 1996, a Lowndes County, Alabama jury awarded two policyholders $26,000 in compensatory damages and $3.25 million in punitive damages. The Company believes that both Alabama Litigation awards, including the amount of the trial court's remittitur in the Bullock County case, are erroneous and is vigorously pursuing all post-trial remedies, including appeals of both judgments to the Alabama Supreme Court. Although the outcome of the appeals is uncertain, for each appeal the Company seeks to have a judgment entered in its favor notwithstanding the jury verdict, a new trial, or, at a minimum, a reduction of all or part of the punitive damages. The Company believes, due to its understanding of Alabama law and the facts and circumstances of each case, that both appeals will result, at a minimum, in a reduction in the punitive damage awards entered by the trial courts. The Company has not accounted for the damages in its financial statements because the amount of the loss cannot be reasonably estimated.
The Company is in the process of seeking a settlement of consolidated state class actions against the Company and other defendants that have been removed to and are now pending in the United States District Court for the Northern District of Alabama. The Company has proposed to contribute approximately $3.65 million into a settlement fund that will be used to fund payments to members of the settlement class, consisting of Foremost policyholders in Alabama from 1989 through 1995. The Company anticipates that the settlement of this class action, if approved by the federal court, will foreclose further claims against the Company except for claims by persons who affirmatively "opt out" of the settlement class. Although the Company has not established a specific reserve for this proposed settlement, sufficient reserves are available to cover the amount of the proposed settlement without affecting income or the adequacy of remaining held reserves.
In November 1995, an Iowa jury returned a verdict of $688,000 in compensatory damages and $8 million in punitive damages against the Company for alleged fraud, breach of contract and misappropriation of trade secrets in the termination of an agent's contract. The Company believes the verdict was erroneous and is currently pursuing post-judgment motions for judgment notwithstanding the jury verdict, a new trial and remittitur. The Company has not accounted for the damages in its financial statements because the amount of the loss cannot be reasonably estimated.
The Company's operations are principally in two segments of the insurance industry. Its property and casualty insurance subsidiaries primarily furnish insurance to the mobile home and recreational vehicle markets. Its life insurance subsidiary furnishes small employer group benefit insurance and credit life insurance; however, new credit life writings were discontinued as of December 31, 1992. Insurance is written throughout the United States with concentrations in the southern and southwestern states. The nature of the Company's insurance operations expose it to risk in the case of numerous, severe catastrophic events. To minimize this risk, the Company performs ongoing evaluations of its insurance exposures, utilizes reinsurance when appropriate and performs credit and risk evaluations of its agents and insureds.
Detailed operating information for the property and casualty, and life insurance segments is presented herein. There are no significant intercompany transactions among the segments.
The anticipated sale price would yield approximately $17 million in cash after taxes. Management projects that the Company will incur an after-tax loss on the sale of approximately $1.3 million primarily due to the effects of taxes related to policyholders' surplus, discussed in Note 7.
We have audited the accompanying consolidated balance sheets of Foremost Corporation of America as of December 31, 1995 and 1994, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
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, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.