(4) Effective October 1, 1994, the Company acquired 100% of the stock of IMG and MEIB. Both acquisitions were accounted for using the purchase method. Therefore, the results of operations from both companies are included in the consolidated statements of earnings beginning October 1, 1994 and assets and liabilities of IMG and MEIB have been included in the consolidated balance sheets beginning October 1, 1994.
During recent years, the Company has substantially increased its capital and surplus through the issuance of equity securities, incurrence of debt, and earnings, thereby enabling it to increase its underwriting capacity. The Company has utilized this additional capital by increasing underwriting activity across many of its core lines of business, emphasizing lines of business and individual opportunities with the most favorable underwriting characteristics at a particular point in time. In each line of business, the Company also cedes premiums through the purchase of reinsurance in types and amounts appropriate to the line of business, market conditions and the Company's desired net risk retention profile. Accordingly, the Company has substantially increased both its GWP and NWP, although with different relative increases in each line of business. In addition, because the Company's operating expense and loss and LAE have not increased as quickly as its premium volume, the Company has been able to substantially expand its operating margins.
The following table sets forth certain premium revenue information for the periods indicated (dollars in thousands):
Fee and commission (non-risk bearing) income in 1996 increased 17% to $38.5 million from $32.9 million in 1995, reflecting increased agency activities. Net investment income increased 16% to $15.4 million in 1996 from $13.3 million in 1995 reflecting a higher level of investment assets.
year losses compared to a redundancy of $1.6 million in 1995. However, during 1996, the Company had gross loss and LAE deficiency of $45.8 million. The gross deficiency comes from two primary sources. The first source is the development of several large claims on individual policies which were substantially reinsured. These losses were either reported late or reserves were increased as subsequent information became available. However, because these policies were substantially reinsured, there is no material effect on a net basis. The second source is the run-off of the excess of loss "spiral" business which the Company ceased writing in 1991. This development is due to the delay in reporting of catastrophe losses by the London market, coupled with the unprecedented number of catastrophes and subsequent insurance company insolvencies. As the Company did not have enough representative years' underwriting experience upon which to base a more accurate estimate, significant gross development has been experienced. However, this business is substantially reinsured, thereby not having a material effect on the Company's current operations or shareholders' equity. The Company continues to believe it has materially provided for all net incurred losses.
Compensation expense decreased $6.4 million or 24% in 1996, to $20.4 million due primarily to changes in compensation to LDG's previous principal shareholders.
Realized investment gains from sales of marketable equity securities were $1.1 million during 1995 compared to $775,000 during 1994. Realized investment losses from sales of fixed income securities were $11,000 during 1995, compared to losses of $89,000 during 1994.
Loss and LAE increased $20.2 million in 1995, to $49.8 million, reflecting the overall increase in business written. During 1995, the Company had net loss and LAE redundancy of $1.6 million relating to prior year losses compared to a deficiency of $717,000 in 1994. However, during 1995, the Company had gross loss and LAE deficiency of $18.4 million. A substantial portion of this gross deficiency relates to the run-off of the excess of loss "spiral" business which the Company ceased writing in 1991. This development is due to the delay in reporting of catastrophe losses by the London market, coupled with the unprecedented number of catastrophes and subsequent insurance company insolvencies. As the Company did not have enough representative years' underwriting experience to base a more accurate estimate on, significant gross development has been experienced. However, this business is substantially reinsured, thereby not having a material effect on the Company's current operations or shareholders' equity. The Company continues to believe it has materially provided for all net incurred losses.
Earnings per share in 1995 increased 36% to $0.75 from $0.55 in 1994. This reflects the 59% increase in net earnings partially offset by the 17% increase in weighted average shares outstanding as a result of HCCH's 1994 acquisitions and 1995 public stock offering.
The Company receives substantial cash from premiums and reinsurance recoverables, and, to a lesser extent, investment income, proceeds from sales and redemptions of investment assets and fee and commission income. The principal cash outflows are for the payment of claims, payment of premiums to reinsurers, purchase of investments, debt service, LAE, policy acquisition costs, operating expense, income and other taxes and dividends.
During 1996, HCC renewed its existing credit facility which provides for a $12 million bank line of credit for the issuance of letters of credit and for short-term borrowings at the prime rate of interest. This line is collateralized by securities with a market value equal to 125% of the total sum of the letters of credit issued and cash advances outstanding. This facility matures on April 30, 1997. As of December 31, 1996, letters of credit in the amount of $4.6 million were issued on behalf of the HCC to collateralize certain reinsurance obligations, however no cash advances were outstanding under this line and, therefore, $7.4 million is available for short-term borrowings under this facility.
Property and casualty insurance companies domiciled in the State of Texas are limited in the payment of dividends to its shareholders in any 12 month period, without the prior written consent of the Commissioner of Insurance, to the greater of net investment income or 10% of statutory policyholders' surplus. HCC paid no dividends in 1996 to HCCH. During 1997, HCC's ordinary dividend capacity will be approximately $15.1 million.
At December 31, 1996, the Company had a net deferred tax asset of $11.5 million. Due to the Company's history of consistent earnings, strong operating cash flows, expectations for the future and the ability to hold investments to maturity, it is more likely than not that the Company will be able to realize the benefit of its deferred tax asset.
Industry and regulatory guidelines suggest that a property and casualty insurer's annual statutory GWP should not exceed 900% of its statutory policyholders' surplus and NWP should not exceed 300% of its statutory policyholders' surplus. The Company maintains a premium to surplus ratio significantly lower than such guidelines, and for the year ended December 31, 1996, its annual statutory GWP was 108.8% of its statutory policyholders' surplus and NWP was 45.6% of its statutory policyholders' surplus.
between the occurrence of an insured event, reporting of the claims to the Company and the final settlement of the claims, the effects of inflation are minimized.
The Company utilizes these foreign currency forward contracts strictly as a hedge against existing exposure to foreign currency fluctuations and it does not do so as any form of speculative or trading investment.