(1) 1996, 1995, 1994 and 1993 restated to reflect a two for one split of the Company's common stock distributed in November 1997.
The growth in gross written premiums primarily resulted from: the Company's recent new product offerings; strengthening of the proprietary field marketing organization to 100 professionals at year end 1997; and increasing product distribution through the preferred agent program.
The Company's investment objective is to realize relatively high levels of investment income while generating competitive after-tax total rates of return within a prudent level of risk and within the constraints of maintaining adequate securities in amount and duration to meet cash requirements of current operations and long-term liabilities, as well as maintaining and improving the Company's A.M. Best and Standard & Poor's ratings. The Company utilizes professional investment managers for its fixed maturity and equity investments. These investments consist of diversified issuers and issues, and as of December 31, 1997 approximately 76% of the total invested assets (total investments plus cash equivalents) consisted of investments in fixed maturity securities.
The Company increased its existing portfolio of fixed maturity securities by investing in investment grade corporate debt during 1997 due to more favorable after-tax yields. At the end of 1997 investment grade corporate debt represented 19.6% of total invested assets, compared to 6.0% as of the end of 1996. The Company has also continued to increase its investments in common stock of quality growth oriented mid- and large-cap companies seeking to achieve diversification and capital appreciation in its invested assets. At December 31, 1997, common stocks comprised 20.9% of invested assets, compared to 15.8% as of the end of 1996.
During 1997, the Company purchased certain collaterized mortgage and asset backed securities, totaling $18.6 million in market value at year end. These securities are short tranche securities possessing favorable prepayment risk profiles. The Company had no other derivative financial instruments in its total investments as of December 31, 1997.
Premiums: Gross written premiums grew $22.2 million (16.2%) to $159.1 million in 1997 from $136.9 million in 1996; gross earned premiums grew $28.3 million (23.2%) to $150.1 million in 1997 from $121.8 million in 1996; net written premiums increased $27.8 million (33.1%) to $111.8 million in 1997 from $84.0 million in 1996; and net earned premiums grew $28.5 million (39.5%) to $100.6 million in 1997 from $72.1 million in 1996. The overall growth in premiums and the varying growth rates for gross written premiums, gross earned premiums, net written premiums and net earned premiums are attributable to a number of factors including:
- - Net written and net earned premiums grew at higher rates than gross written and gross earned premiums primarily due to the renegotiation of the Company's reinsurance program effective January 1, 1997 whereby more favorable reinsurance rates were realized while substantially the same retentions and coverages were maintained.
Net Investment Income: Net investment income approximated $9.7 million in 1997 and $7.9 million in 1996. The increase of $1.8 million (22.8%) is due primarily to the increase in total investments as a result of cash flows provided from operating activities and the additional investment income as a result of the relative percentage increase in corporate taxable securities versus tax exempt municipal securities.
Net Loss and Loss Adjustment Expenses: Net loss and loss adjustment expenses increased $14.9 million (37.2%) to $55.0 million in 1997 from $40.1 million in 1996 and the loss ratio decreased to 54.7% in 1997 from 55.7% in 1996. The increase in net loss and loss adjustment expenses was due primarily to the 39.5% growth in net earned premiums. Additionally, since more earned premium was retained from the lower cost of reinsurance (see "Premiums", above), there was relatively higher net earned premium growth on products with low loss experience, the 37.2% increase in net loss and loss adjustment expenses was lower than the 39.5% net earned premium growth.
Income Tax Expense: The Company's effective tax rates for 1997 and 1996 were 24.0% and 20.3%, respectively. The effective rates differed from the 35% statutory rate principally due to investment income earned on tax-exempt securities. The increase in the effective tax rate is principally due to a greater investment in taxable securities relative to tax-exempt securities during 1997.
- The introduction of the Company's Preferred Agent Plan, wherein, business relationships were formed with brokers specializing in certain of the Company's business niches, thereby increasing the distribution of the Company's niche products.
- Overall premium growth has been offset in part by designed reductions in premiums from certain rental products due primarily to inadequate pricing levels which are currently being experienced as a result of market competition. However, the Company anticipates an improvement in these market conditions in the near future. Additionally, there have been recent consolidations in the car rental industry the effect of which on the rental car insurance market, if any, are not known at this time.
Acquisition Costs and Other Underwriting Expenses: Acquisition costs and other underwriting expenses increased $5.1 million (29.8%), to $22.2 million in 1996 from $17.1 million in 1995. The increase in acquisition costs and other underwriting expenses exceeds the 23.9% growth in net earned premiums, due primarily to increased commission expense as a result of the Company beginning to market its niche products through preferred brokers.
Other Operating Expenses: Other operating expenses decreased $1.2 million (46.2%), to $1.4 million in 1996 compared to $2.6 million in 1995 principally due to additional expenses related to the opening of new field offices in 1995.
Income Tax Expense: The Company's effective tax rates for 1996 and 1995 were 20.3% and 20.0%, respectively. The effective rates differed from the 34% statutory rate principally due to investment income earned on tax-exempt securities.
The attainment of profitable new business continues to be a primary focus of the Company. For 1998, the Company anticipates substantially growing its Preferred Agent program, thereby further increasing the distribution of the Company's niche products. In addition, the Company has grown its proprietary field organization during 1997 to 100 professionals, including production underwriters and customer service representatives and plans to further expand this organization in 1998, thereby further strengthening its resources to prospect the Company's existing niches for profitable new business. The Company also seeks acquisition opportunities to purchase programs or books of business which complement its niche markets or parallel its conservative underwriting and pricing discipline. The Company is also exploring financing opportunities in this regard; however, there is no assurance that an acquisition or financing will occur.
Overall, due to the abundance of capital in the insurance industry, the current business climate remains very competitive from a solicitation and pricing standpoint. In the context of the current environment, the Company will not sacrifice underwriting standards or pricing guidelines solely for premium volume and will "walk away", if necessary, from writing business that does not meet established underwriting standards and pricing guidelines as has occurred in the commercial auto niche over the past three years. Additionally, in response to the competitive market, the Company re-underwrote its errors and omissions product during 1997 by increasing deductible requirements and modifying underwriting guidelines in certain markets to reduce the size and risk profile of the product. Management believes, though, that the Company's mixed marketing strategy is a strength in this market environment, in that, it provides the flexibility to quickly deploy the marketing efforts of the Company's direct production underwriters from soft market segments to market segments with emerging opportunities. Additionally,
through the mixed marketing strategy, the Company's production underwriters have established relationships with approximately 4,000 brokers, thus facilitating a regular flow of submissions.
Philadelphia Insurance is a holding company whose principal assets currently consist of 100% of the capital stock of the Insurance Subsidiaries and Maguire Insurance Agency, Inc. Philadelphia Insurance's primary sources of funds are dividends from its subsidiaries and payments to it pursuant to tax allocation agreements with the Insurance Subsidiaries. For the year ended December 31, 1997, payments to Philadelphia Insurance pursuant to such tax allocation agreements totaled $7.3 million. The payment of dividends to Philadelphia Insurance from the Insurance Subsidiaries is subject to certain limitations imposed by the insurance laws of the Commonwealth of Pennsylvania. Statutory profits of the Insurance Subsidiaries from which dividends may be paid totaled $59.7 million at December 31, 1997. Of this amount, the Insurance Subsidiaries are entitled to pay a total of approximately $14.3 million of dividends in 1998 without obtaining prior approval from the Insurance Commissioner of the Commonwealth of Pennsylvania.
Under certain reinsurance agreements, the Company is required to maintain investments in trust accounts to secure its reinsurance obligations (primarily the payment of losses and loss adjustment expenses on business it does not write directly). At December 31, 1997, the investment and cash balances in such trust accounts totaled approximately $14.6 million. In addition, various insurance departments of states in which the Company operates require the deposit of funds to protect policyholders within those states. At December 31, 1997, the balance on deposit for the benefit of such policyholders totaled approximately $10.9 million.
The Company has reviewed all computer systems in operation within the Company and determined them to be Year 2000 compliant except for its mainframe policy administration computer system. The Company will begin the process of preparing this computer system and related applications for the Year 2000 in the second quarter 1998. The process involves modifying certain hardware and software. Management expects to have substantially all hardware and software upgraded as necessary, for compliance by year-end 1998. Management believes that its level of preparedness is appropriate. The Company estimates the cumulative costs of the process, which includes costs of modifying hardware and software, will not have a material effect on its business, operations or financial condition. The costs of the project and expected completion dates are based on management's best estimates.
The Insurance Subsidiaries, which operate under a pooling agreement, require policyholders' surplus to support premium writings. Guidelines of the National Association of Insurance Commissioners (the "NAIC") suggests that a property and casualty insurer's ratio of annual statutory net premium written to policyholders' surplus should not exceed 3 to 1. The ratio of combined annual statutory net premium written by the Insurance Subsidiaries to their combined policyholders' surplus was 1.0 to 1.0 for both 1997 and 1996. Management believes that the policyholders' surplus, which was $106.0 million at December 31, 1997 will be sufficient to support current and anticipated premium writings. Risk-based capital is designed to measure the acceptable amount of capital and surplus an insurer should have based on the inherent specific risks of each insurer. Insurers failing to meet this benchmark level may be subject to scrutiny by the insurer's domiciliary insurance department and ultimately rehabilitation or liquidation. Based on the standards currently contained in the applicable Pennsylvania Insurance Company statutes, the Company's capital and surplus is in excess of the prescribed risk-based capital requirements.
Property and casualty insurance premiums are established before the amount of losses and loss adjustment expenses, or the extent to which inflation may affect such amounts, is known. The Company attempts to anticipate the potential impact of inflation in establishing its premiums and reserves. Substantial future increases in inflation could result in future increases in interest rates which in turn is likely to result in a decline in the market value of the Company's investment portfolio and resulting unrealized losses and/or reductions in shareholders' equity.
In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings per Share", specifying the computation, presentation, and disclosure requirements for earnings per share for entities with publicly held common stock. Under SFAS No. 128, basic and diluted per share amounts shall be presented for net income on the face of the statement of operations. Basic earnings per share excludes dilution and is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. The Company adopted the provisions of SFAS No. 128 as of December 31, 1997.
In June 1997, the Financial Accounting Standards Board also issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information", which is effective for fiscal years beginning after December 15, 1997. This statement establishes standards for the disclosure of segment results. It requires that segments be determined using the "management approach", which means the way management organizes the segments within the enterprise for making operating decisions and assessing performance. The Company will adopt SFAS No. 131 in the fourth quarter of 1998, and is still evaluating its impact on the Company's segment disclosures.
TO THE SHAREHOLDERS AND BOARD OF DIRECTORS OF PHILADELPHIA CONSOLIDATED HOLDING CORP.:
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Philadelphia Consolidated Holding Corp. and Subsidiaries as of December 31, 1997 and 1996 and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1997 in conformity with generally accepted accounting principles.
PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(1) 1996 and 1995 share information restated to reflect a two for one split of the Company's common stock distributed in November 1997, see Note 11.
Philadelphia Consolidated Holding Corp. ("Philadelphia Insurance"), and its subsidiaries (collectively the "Company") doing business as Philadelphia Insurance Companies, include two Pennsylvania domiciled property and casualty insurance companies, Philadelphia Indemnity Insurance Company and Philadelphia Insurance Company ("Insurance Subsidiaries"), and an underwriting manager Maguire Insurance Agency, Inc. The Company designs, markets, and underwrites specialty commercial property and casualty insurance products for the rent a car industry, automobile leasing industry, non-profit organizations, the health, fitness and wellness industry, and selected classes of professional liability. All marketing, underwriting, claims management, investment, and general administration is provided by the underwriting manager.
Investments classified as Available for Sale are carried at market value with the change in unrealized appreciation (depreciation) credited or charged directly to shareholders' equity, net of applicable deferred income taxes. Income on fixed maturities is recognized on the accrual basis.
upon historical and current experience, as the premiums are earned. Amortization of policy acquisition costs in the accompanying consolidated statements of operations was $25,034,000, $17,739,000 and $13,662,000 for the years ended December 31, 1997, 1996 and 1995, respectively.
The Company files a consolidated federal income tax return. Deferred income taxes are recognized for the tax consequences of temporary differences by applying enacted statutory tax rates applicable to the differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. The effect on deferred taxes for a change in tax rates is recognized in income in the period that includes the enactment date (see Note 8).
Earnings per share and common stock equivalents outstanding have been retroactively restated to reflect the increased number of common shares resulting from a two for one stock split that was announced in October 1997 and distributed to shareholders on November 5, 1997. A total of 6,119,716 additional shares were issued as a result of the stock split. The par value of the Company's stock remained unchanged.
Under SAP, policy acquisition costs, such as commissions, premium taxes, fees, and other costs of underwriting policies are charged to current operations as incurred, while under GAAP, such costs are deferred and amortized on a pro rata basis over the period covered by the policy;
Under SAP, certain assets, designated as "Non-admitted Assets" (such as prepaid expenses) are charged against surplus;
Under SAP, federal income taxes are only provided on taxable income for which income taxes are currently payable, while under GAAP, deferred income taxes are provided with respect to temporary differences;
(1) Original cost of equity securities; original cost of fixed maturities adjusted for amortization of premiums and accretion of discounts.
The cost and estimated market value of fixed maturity securities at December 31, 1997, by remaining contractual maturity, are shown below (in thousands). Expected maturities may differ from contractual maturities because certain borrowers have the right to call or prepay obligations with or without call or prepayment penalties.
(1) Original cost adjusted for amortization of premiums and accretion of discounts.
The sources of net investment income for the years ended December 31, 1997, 1996 and 1995 are as follows (in thousands):
The Company also maintains investments in trust accounts under current reinsurance agreements with unrelated insurance companies. These investments collateralize the Company's obligations under the reinsurance agreements. The Company possesses sole responsibility for investment and reinvestment of the trust account assets. All dividends, interest, and other income resulting from investment of these assets are owned by the Company, and are distributed on a monthly basis. At December 31, 1997 and 1996 the carrying value of these trust fund investments were $12,205,000 and $23,223,000, respectively.
The following table summarizes property and equipment at December 31, 1997 and 1996 (dollars in thousands):
As of December 31, 1997, the Company has approximately $0.9 million in net operating loss carryforwards, which expire in 2000 and 2001, available to offset future taxable income. Utilization of the loss carryfowards is limited to an annual amount of $336,000. For financial reporting purposes, the tax benefit of any utilization of these operating loss carryfowards is applied to reduce goodwill ($114,000 in 1997) and does not reduce income tax expense.
Philadelphia Insurance has entered into tax sharing agreements with each of its subsidiaries. Under the terms of these agreements, the income tax provision is computed as if each subsidiary were filing a separate federal income tax return including adjustments for the income tax effects of net operating losses and other special tax attributes regardless of whether those attributes are utilized in the Company's consolidated federal income tax return.
The loss and loss adjustment expense reserves ceded under such arrangements were $13,502,000 and $10,919,000 at December 31, 1997 and 1996, respectively. The Company evaluates the financial condition of its reinsurers to minimize its exposure to losses from reinsurer insolvencies. The percentage of ceded reinsurance reserves that are with companies rated "A" (Excellent) or better by A.M. Best Company is 100% and 97% as of December 31, 1997 and 1996, respectively. Additionally, approximately 2%, 4%, and 11% of the Company's net written premiums for the years ended December 31, 1997, 1996 and 1995, respectively, were assumed from an unrelated reinsurance company.
The Company has established a non-qualified Employee Stock Purchase Plan (the "Stock Purchase Plan"). The aggregate maximum number of shares that may be issued pursuant to the Stock Purchase Plan is 500,000. Shares may be purchased under the Stock Purchase Plan by eligible employees during designated one-month offering periods established by the Compensation Committee of the Board of Directors at a purchase price of the lesser of 85% of the fair market value of the shares on the first business day of the offering period or the date the shares are purchased. The purchase price of shares may be paid by the employee over six years pursuant to the execution of a promissory note. The promissory note(s) are collateralized by such shares purchased under the Stock Purchase Plan and are interest free. Under the Stock Purchase Plan, the Company issued 78,569 and 52,144 shares in 1997 and 1996, respectively. The weighted average fair value of those purchase rights granted in 1997 and 1996 was $1.94 and $1.51, respectively.
(1) Per share information restated to reflect a two for one split of the Company's common stock distributed in November 1997, see Note 11.
On October 16, 1997, the Board of Directors approved a two for one split of the Company's common stock payable to shareholders of record on October 27, 1997 for distribution on November 5, 1997. Weighted average common shares outstanding, common stock equivalents, and earnings per share have been restated to reflect this stock split.
The Company has a defined contribution Profit Sharing Plan, which includes a 401K feature, covering substantially all employees. Under the plan, employees may contribute up to an annual maximum of the lesser of 15% of eligible compensation or the applicable Internal Revenue Code limit in a calendar year. The Company makes a matching contribution in an amount equal to 50% of the participant's pretax contribution, subject to a maximum of 6% of the participant's eligible compensation. The Company may also make annual discretionary profit sharing contributions at each plan year end. Participants are fully vested in the Company's contribution upon completion of 7 years of service. The Company's contributions to the plan were $474,300, $322,400, and $267,500 in 1997, 1996 and 1995, respectively.
At December 31, 1997, the future minimum rental payments required under operating leases that have initial or remaining non-cancelable lease terms in excess of one year as of December 31, 1997 were as follows: