The Company's executive offices are located at 12603 Southwest Freeway, Suite 315, Stafford, Texas, 77477. The Company leases approximately 7,000 square feet at this location with annual rental on a five-year lease expiring in September 2000 of approximately $70,000. The Company's legal and information systems departments are located at 475 Metro Place North, Dublin, Ohio. The Company leases approximately 16,000 square feet in Dublin, Ohio, under a five-year lease expiring in July 2001 at an annual rental of approximately $264,000. Offsetting the annual rental expense for the remaining lease term in Dublin is sublease rental income for approximately 10,000 square feet from Lyndon as a result of the sale of the Auto Aftermarket Group. See "Note M" in the Notes to Consolidated Financial Statements.
** Years 1994 and 1993 have not been restated for discontinued operations.
Effective January 1, 1998, ANIC ceded to Lyndon via quota share reinsurance 100% of its liability related to existing and future vehicle extended service business written on ANIC's policy forms. In connection with the sale, ANIC granted Lyndon the authority to write new vehicle extended service contracts insured by contractual liability policies issued in the name of ANIC for a maximum period of eighteen months which expires in July 1999. All new business written by Lyndon utilizing ANIC's policy forms will be automatically reinsured by Lyndon under the terms of the aforementioned reinsurance agreements.
The Company's income before income taxes, discontinued operations, and extraordinary item for 1996 was $1.4 million. This income is primarily the result of the recognition of $4.3 million of other income related to a legal settlement (see Liquidity and Capital Resources). In 1996, particularly in the first half, the Company continued to experience adverse loss development on discontinued lines of business in the property and casualty segment. Adverse development on the Farmowners and related discontinued lines amounted to $800,000.
Gross premium writings for 1997 were $40.9 million compared to $25.6 million and $12.4 million for 1996 and 1995, respectively. Premiums written increased from 1996 by $16.8 million for the new property and casualty programs and $1.4 million for the vehicle extended service contract program offset by a decrease of $2.9 million for discontinued product lines. The increase in premiums written in 1996 compared to 1995 is primarily the result of increases of $13.8 million for the new property and casualty programs and $.6 million for the vehicle extended service contract program offset by a decrease of $1.2 million for discontinued product lines. See Table II following the narrative in Management's Discussion and Analysis.
A positive impact on 1997 earnings was the level of service fees on the extended service contracts which increased to $3.1 million in 1997 from $2.5 million in 1996. The 1996 level also showed an increase from the 1995 level of $2.1 million. This increase is due to an overall increase in the fee levels as opposed to an increase in contract volume.
Ohio domiciled insurance companies are subject to Ohio law which regulates the ability of insurance companies to pay dividends. The regulation limits the annual dividend or distribution of an insurer to the greater of (1) net income of the previous year or (2) 10% of unassigned surplus as of the end of the previous year. In addition, all dividends must come from earned surplus to qualify as a non-extraordinary dividend. Amounts greater than this would be considered extraordinary dividends and could not be paid without permission of the Ohio Department. Based on this regulation, ANIC could pay a dividend of approximately $8.8 million without Ohio Department approval to ACCEL in 1998. During 1997, ACCEL received dividends totaling approximately $5 million from subsidiaries which were sold as part of the sale of the Auto Aftermarket Group.
Due to the nature of its operations, the Company is at all times subject to pending and threatened legal actions that arise in the normal course of its activities. For information regarding legal proceedings involving the Company including developments relating to the insolvency of Galaxy Insurance Company (a subsidiary of the Company) and a suit against ALIC by four long-term care policyholders, see "Note M" in the Notes to Consolidated Financial Statements. In management's opinion, based on the
The 1995 Private Securities Litigation Reform Act provides issuers the opportunity to make cautionary statements regarding forward-looking statements. Accordingly, any forward-looking statement contained herein or in any other oral or written statement by the Company or any of its officers, directors or employees is qualified by the fact that actual results of the Company may differ materially from such statement due to the following important factors, among other risks and uncertainties inherent in the Company's business: state insurance regulations, rate competition, adverse changes in interest rates, unforeseen losses with respect to loss and settlement expense reserves for unreported and reported claims, and catastrophic events.
We have audited the consolidated financial statements of ACCEL International Corporation and subsidiaries (the Company) as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedules as listed in the accompanying index. These consolidated financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits.
ACCEL INTERNATIONAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY Three Years Ended December 31, 1997 (Thousands of dollars)
BASIS OF PRESENTATION: The accompanying consolidated financial statements of ACCEL International Corporation ("ACCEL") and subsidiaries (collectively referred to herein as the "Company") have been prepared in accordance with generally accepted accounting principles ("GAAP") which, as to the insurance company subsidiaries, differ in some respects from statutory accounting practices prescribed or permitted by state insurance departments. The significant accounting policies followed by the Company that materially affect financial reporting are summarized below.
PRINCIPLES OF CONSOLIDATION: The accompanying consolidated financial statements include the accounts of ACCEL and its wholly-owned subsidiaries except for Randjill Group, Ltd ("RGL") (see Note M). As discussed more fully in Note B, Acceleration Life Insurance Company ("ALIC") and Dublin International Limited ("Dublin") are presented as discontinued operations. All significant intercompany accounts and transactions have been eliminated in the consolidated financial statements.
DESCRIPTION OF BUSINESS: ACCEL is an insurance holding company incorporated in Delaware. The Company is engaged in the underwriting and sale of property/casualty insurance products, concentrating on commercial lines of business. The Company offers various policies covering long-haul trucking, charter bus, limousine and paratransit vehicle fleets, as well as other specialized products tailored to other groups such as crane operators and gun dealers. The Company offers these products through general agents. The Company is subject to competition from other insurers throughout the states in which it writes business. The Company is also subject to regulation by the insurance departments of states in which it is licensed, and undergoes periodic examinations by those departments.
CREDIT RISK is the risk that issuers of securities owned by the Company will default or that other parties, including reinsurers, which owe the Company money, will not pay. The Company minimizes this risk by adhering to a conservative investment strategy, by maintaining reinsurance and credit and collection policies and by providing for any amounts deemed uncollectible.
INVESTMENTS: The Company classifies its fixed maturity and equity securities as available for sale, therefore these securities are carried at fair value and the unrealized appreciation or depreciation is reported as a separate component of common stockholders' equity after giving effect to applicable income taxes.
Short-term investments, which include U. S. Treasury securities, commercial paper and certificates of deposit are carried at fair value which approximates cost.
When an other than temporary decline in value is recognized, the specific investment is carried at estimated realizable value and its original book value is reduced to reflect such impairment of the investment. Such reductions in book value are reflected in realized investment losses for the period in which they were written down. For mortgage backed securities, when the present value of estimated future cash flows discounted at a risk-free rate of return is less than the cost basis of the investment, an impairment loss is recognized by writing the investment down to its fair value.
These techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Although fair value estimates are calculated using assumptions that management believes are appropriate, changes in assumptions could cause these estimates to vary materially. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in the immediate settlement of the instruments. The disclosure requirements related to financial instruments exclude certain assets and liabilities. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.
DEFERRED POLICY ACQUISITION COSTS: The costs (principally commissions and certain expenses of policy issuance) of acquiring or renewing insurance business, all of which vary with and are directly related to the production of business, have been deferred. These deferred policy acquisition costs are amortized in a manner related to the recognition of premiums earned. Anticipated investment income is considered in determining recoverability of deferred costs.
PREMIUM INCOME RECOGNITION AND UNEARNED PREMIUM RESERVES: Unearned premium reserves on property and casualty products are calculated on the pro rata method. Unearned premium reserves on the extended service contracts are based on the historical emergence pattern of claims. The Company's primary liability on new car contracts exists subsequent to the expiration of manufacturers' warranties. This method results in premium being recognized in direct proportion to the emergence of benefits on these contracts.
INSURANCE CLAIMS: The liabilities for insurance claims are determined using statistical analyses and represent estimates of the ultimate net cost of all reported and unreported claims that are unpaid at year end. Considerable variability is inherent in such estimates and actual results will likely differ from those estimates.
FEDERAL INCOME TAXES: ACCEL and its subsidiaries file a consolidated federal income tax return. The provision for income taxes is based on income for financial reporting purposes, after permanent differences. 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 bases and operating loss and tax credit carryforwards. 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. Under this method, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established when necessary to reduce the deferred tax assets to the amounts expected to be realized.
STOCK OPTION PLANS: Prior to January 1, 1996, the Company accounted for its stock option plans in accordance with the provisions of Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. As such, compensation expense would be recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. On January 1, 1996, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 123, Accounting for Stock-Based Compensation, which permits entities to recognize as expense over the vesting period the fair value of all stock-based awards on the date of grant. Alternatively, SFAS No. 123 also allows entities to continue to apply the provisions of APB Opinion No. 25 and provide pro forma net income and pro forma earnings per share disclosures for employee stock option grants made in 1995 and future years as if the fair- value-based method defined in SFAS No. 123 had been applied. The Company has elected to continue to apply the provisions of APB Opinion No. 25 and provide the pro forma disclosure provisions of SFAS No. 123 (see Note J).
RECLASSIFICATIONS: Certain amounts in the 1996 and 1995 consolidated financial statements have been reclassified to conform with the 1997 presentation.
The "Receivable from sale of discontinued and disposed of operations" of approximately $25 million as of December 31, 1997 in the Consolidated Balance Sheets represents the sales proceeds of $41 million less the note payable and accrued interest of $16 million transferred to ALIC by an unaffiliated company on December 31, 1997 (see Note E). The after-tax net gain on sale of the Auto Aftermarket Group was $3.2 million which was comprised of $10.3 million in continuing operations (included in "Other income" in the 1997 Consolidated Statement of Operations) and ($7.1 million) in discontinued operations (excluding the provision for operating loss of $495,000 during the phase-out period). The income tax expense of $2 million included in the loss on disposal of business segment in the 1997 consolidated statement of operations includes $1.5 million current tax expense for the distribution of the policyholders' surplus account as a result of the sale of ALIC (see Note H), current tax expense of $2.8 million for the gain on the sale of the subsidiaries included in discontinued operations, and $2.5 million deferred tax benefit and $.2 million current tax expense, respectively, related to the operations during the phase-out period of the subsidiaries included in discontinued operations.
Total assets consisting primarily of investments, cash, premiums receivable and amounts due from affiliates for the vehicle extended service contract business were $17.6 million as of December 31, 1997. Total liabilities consisting primarily of unearned premium reserves, loss reserves and commissions payable for the vehicle extended service contract business were $17.6 million as of December 31, 1997. Other summarized financial information for the vehicle extended service contract business for the three years ended December 31, 1997 is as follows:
The change in net unrealized gains (losses) on fixed maturity and equity securities is summarized as follows:
The amortized cost and estimated fair value of fixed maturity securities by category, all of which were available for sale, are as follows:
The amortized cost and estimated fair value of fixed maturity securities, all of which were available for sale, at December 31, 1997, by contractual maturity, are summarized as follows:
The expected maturities in the foregoing table will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalty. Mortgage-backed securities owned have an expected weighted average maturity of over 10 years.
Generally, the net assets of ANIC available for transfer to ACCEL are limited to the amounts that ANIC's net assets, as determined in accordance with statutory accounting practices, exceed minimum statutory capital and surplus requirements; however, payments of such amounts as dividends are currently subject to regulation by Ohio law. The regulation limits the annual dividend or distribution of an insurer to the greater of (1) net income of the previous year or (2) 10% of unassigned surplus as of the end of the previous year. In addition, all dividends must come from earned surplus to qualify as a non-extraordinary dividend. Amounts greater than this would be considered extraordinary dividends and could not be paid without permission of the Department of Insurance of the State of Ohio ("Ohio Department"). Based on this regulation, ANIC could pay a dividend of approximately $8.8 million to ACCEL during 1998 without prior approval.
The statutory basis capital and surplus and net income (loss) of ANIC, as reported to insurance regulatory authorities, are summarized as follows:
Commercial Auto has become a primary product line for the Company since its introduction as a new product in 1996. The program is marketed by a general agent located in Florida, Transportation Insurance Specialists ("TIS"), and its affiliate, Countrywide Insurance Agency, Inc. Gross written premium was $30.3 million and $13.8 million for 1997 and 1996, respectively. Gross earned premium was $23.6 million and $8.4 million, respectively, for 1997 and 1996 while premium receivable, net of commission, due from the general agents was $10.6 million and $5.2 million, respectively, as December 31, 1997 and 1996.
The Company files a consolidated federal income tax return with its subsidiaries. For tax purposes, certain amounts had been accumulated by ALIC in a memorandum tax account designated as "policyholders' surplus" that is taxed when distributed to shareholders. Policyholders' surplus on a tax basis was $4,489,000 at December 31, 1997 and was taxed as a result of the sale of ALIC effective December 31, 1997 (see Note B).
The tax effects of temporary differences that give rise to significant components of the deferred tax assets and liabilities at December 31, 1997 and 1996 are summarized as follows:
The table above reflects increases in the liability for insurance claims resulting from increased writings in the Company's Commercial Auto business. The increase in loss and loss adjustment expense incurred in 1995 for events of prior years relates to management's reevaluation of discontinued lines of business.
ACCEL's Board of Directors approved an Employee Stock Ownership Plan ("ESOP") during 1989. In 1990, the ESOP entered into an agreement with ALIC to borrow up to $1.0 million for the purchase of ACCEL's common stock. This loan was retired in 1997.
During November 1989, ACCEL's Board of Directors also approved a stock buy back program to repurchase up to 1,000,000 common shares in the open market. ACCEL has purchased 229,185 shares at a cost of $1.7 million under this program. The buy back program was funded from internally generated funds.
During 1987, ACCEL adopted the 1987 Incentive Stock Option Plan (the "87 Plan"). The 87 Plan provided for incentive stock options with respect to a maximum of 300,000 (347,287 after giving effect to all subsequent stock dividends) shares of common stock of ACCEL prior to the expiration of the 87 Plan in April 1997. During June of 1991, ACCEL's Board of Directors and shareholders approved the First Restatement of the 1987 Stock Incentive Plan (the "Restated Plan"). The Restated Plan replaced the 87 Plan except as to options granted and outstanding under the 87 Plan. The Restated Plan reserved an additional 450,000 shares for key employees and 50,000 shares for non-employee directors. Options could be granted prior to expiration of the Restated Plan covering shares subject to lapsed or terminated options. No additional shares may be granted under the 87 Plan or the Restated Plan.
During May 1995, two new Key Employees were granted stock options under ACCEL's Restated Plan. Under the terms of their arrangement with ACCEL, both were granted stock options for ACCEL's common stock in lieu of salary for their first year of service. Options for 150,000 shares were granted at an option price per share of $2.125, the fair value of ACCEL's common stock on the date of grant. The options vest immediately and become exercisable one year following the date of grant; however, they would become exercisable immediately upon either a) change of control of ACCEL, or b) involuntary termination. The options would be forfeited if employment with ACCEL was voluntarily terminated prior to May 23, 1996. The options will lapse five years from the effective date of grant.
* Includes 161,371 shares that were surrendered under the repricing offer to key employees.
The per share weighted-average fair value of stock options granted during 1997, 1996 and 1995 was $1.42, $1.20 and $.79, respectively, on the date of grant using the Black Scholes option-pricing model with the following weighted-average assumptions: 1997 - expected dividend yield 0%, risk-free interest rate of 6.00%, and expected lives of 5 to 10 years (based on the terms of the grant); 1996 - expected dividend yield 0%, risk-free interest rates ranging from 6.85% to 7.09% (based on the date of the grant), and expected lives of 5 to 10 years (based on the terms of the grant); 1995 - expected dividend yield 0%, risk-free interest rate of 7.00%, and expected lives of 5 to 10 years (based on the terms of the grant). The Company used a volatility factor of 25% in determining the fair value of options for pro forma purposes.
Pro forma net income reflects only options granted subsequent to 1994. Therefore, the full impact of calculating compensation cost for stock options under SFAS No. 123 is not reflected in the pro forma net income amounts presented above because compensation cost is reflected over the options' vesting periods from one to four years and compensation cost for options granted prior to January 1, 1995 is not considered.
Effective in 1998, the Company will adopt SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. This standard, which will not have an effect on net income, establishes standards for disclosing segment information.
The Acceleration Retirement Savings Plan became effective in 1985. During 1989, ACCEL's Board of Directors approved changes to this plan to include an ESOP and concurrently changed the plan name to the "Acceleration Retirement Savings and Stock Ownership Plan" ("Plan"). For the first six months of 1997, 1996 and 1995 the Board authorized contributions to the Plan at a level that would fund a 100% match of the first 6% of each participating employee's tax deferred contributions.
In July 1991, the Company acquired 100% of RGL. Galaxy Insurance Company ("Galaxy"), a wholly owned subsidiary of RGL, wrote commercial property insurance, property and casualty, and assumed treaty reinsurance. Galaxy became statutorily insolvent at June 30, 1994. Due to the insolvency of Galaxy, the Company wrote its investment in RGL to zero and deconsolidated RGL as of April 1, 1994.
In May 1996, the Liquidation Bureau, acting on behalf of the New York Property/Casualty Insurance Security Funds (the "Guaranty Fund"), informally advised the Company that on behalf of the Guaranty Fund it intended to seek indemnification or reimbursement from ANIC for claims paid by the Guaranty Fund to Galaxy insureds on policies which may have been covered by the Certificates. The Company has taken the position that the Guaranty Fund has no right to seek indemnification unless Galaxy insureds who hold properly issued Certificates have executed assignments and evidences of subrogation to ANIC. Even if any Galaxy insured properly made such a claim directly to ANIC, the Company has been advised by counsel that if ANIC paid any such claim, it would have the right, under assignment and subrogation agreements with its insureds, to assert all rights that the insureds could have asserted to recover the loss amounts from any other source, including the Guaranty Fund.
The allegations of fraud and misrepresentation at the time of sale of the long-term care policies are based on alleged statements that premiums "would not be raised too much" even though the policy on its face stated that the "Company reserves the right to increase premiums at anytime." Moreover, premiums were increased subsequent to the reinsurance of the business by ALIC and all increases appear to have been approved by the proper regulatory authority. The Company and Commonwealth are cooperating to vigorously defend the matter. Joint motions to dismiss and to strike the class action allegations were recently filed in the U.S. District Court, District of North Dakota, Southeastern Division. Both motions are currently pending before the Court. The Company believes there is little or no exposure of liability for ALIC and the matter will not have a material adverse effect on the financial condition or results of operations of the Company. In the event the plaintiffs prevail however, the Company believes that it has the right to seek indemnification from Commonwealth.
The Company currently leases office space under two operating leases which expire in 2000 and 2001. These leases are accounted for as operating leases. Minimum rental commitments in effect at December 31, 1997 are as follows:
The amount of rent charged to continuing operations was $80,000, $68,000 and $16,800 in 1997, 1996 and 1995, respectively. Total future rental payments have not been reduced by $364,000 of sublease rentals to be received in the future under non-cancelable subleases.
In 1993, the National Association of Insurance Commissioners ("NAIC") adopted Risk-Based Capital (RBC) formulas for insurance companies. These model acts require every insurer to calculate its total adjusted capital and RBC requirement, and provides for an insurance commissioner to intervene if the insurer experiences financial difficulty. These model acts became law in Ohio, ANIC's state of domicile, in 1996. The formula includes components for asset risk, liability risk, interest rate exposure, and other factors. ANIC exceeds all required RBC levels as of December 31, 1997.
Quarterly consolidated results of operations for 1997 and 1996 are summarized as follows:
* The previously reported total amounts for the first, second and third quarters of 1996 have been restated to be consistent with 1996's year-end presentation relating to certain reinsurance treaties of a discontinued subsidiary. The restatement of these quarterly amounts did not change net income or net income per common share as previously reported.
In 1996, ACCEL received a total of $4,291,085 in proceeds from a legal action brought by the Company against a non- affiliated marketing organization. With the approval of the Ohio Department the proceeds from the settlement were shared equally between ACCEL and ANIC. These proceeds have been categorized as "Other income" in the accompanying 1996 consolidated statement of operations.
During 1995, the Company redeemed most of its shares of AICL, which resulted in proceeds approximating the Company's original investment in AICL. The transaction was approved by the Department of Trade and Insurance (United Kingdom). On February 7, 1996, the Company received the final proceeds for redemption of its remaining shares, and AICL ceased to exist in December 1997.
Common stock options were not included in the computation of earnings per share assuming dilution because to do so would have been antidilutive for the periods presented.
Mr. Farmer joined the Company in February 1996 and was elected Senior Vice President Administration on March 12, 1996. Prior thereto he had been Senior Vice President-Corporate Development with Universal Underwriters Group, Overland Park, Kansas between June 1993 and November 1995. Prior thereto, he had been with Ranger Insurance Company, Houston, Texas for more than five years as Senior Vice President- Administration.
In accordance with General Instruction G(3), the information required by this Item 12 is incorporated by reference herein from the material under the headings "Security Ownership and Certain Beneficial Owners" contained in the Company's definitive proxy statement filed with the Commission relating to the Company's annual meeting of stockholders to be held on June 16, 1998.