The Company maintains offices in leased premises at 4700 N.W. Boca Raton Boulevard, Boca Raton, FL 33431. In September of 1996, the Company added an additional 2,500 square feet of space to its existing facilities to accommodate growth. As of September, 1996, the lease covers 10,000 square feet of office
space for a monthly rental of $12,878. The Company may enter into a lease for larger space at competitive rates within the South Florida area as growth may require.
This discussion should be read in conjunction with the information contained in the Financial Statements and notes thereto included elsewhere in this filing.
Associated Business & Commerce Insurance Corporation (the "Company") commenced business as a stock insurance company in December 1995 upon receipt from the Florida Department of Insurance (the "Department of Insurance") of a Certificate of Authority. Concurrently with the commencement of business, the Company assumed substantially all of the assets and liabilities of the Associated Business and Commerce Workers' Compensation Self-Insurance Fund (the "Fund"). As of December 31, 1996, the Company had approximately 1,300 policyholders and $28 million in annual written premiums. The Company offers a full range of workers' compensation coverage, including a managed care plan. See "Business--Products" and "Business--Managed Care".
The Company's business is regulated by the Department of Insurance. The Company is subject to assessments by the Florida guarantee association for insurance carriers. Policies issued by the Company to its insureds, however, are non-assessable, in contrast to the assessable policies issued by self-insurance funds. A stock insurance company cannot assess its policyholders for losses of the company and is required to satisfy statutory capital and surplus requirements. Therefore, stock insurance companies afford their policyholders greater financial certainty and security.
It is the goal of the Company to provide superior service and minimize the cost of workers' compensation insurance for its insureds. This focus on a single line of business is expected to give the Company a unique opportunity to position itself as a focused company in a service-intensive line of insurance. The Company's primary marketing strategy is to preserve existing business relationships and establish new relationships with agents, thus creating a network of high-quality, high-volume producers for the Company.
Table #4 on Page 30 sets forth the operating results of the Fund since January 1, 1992 through November 30, 1995, the effective date of the loss portfolio transfer and assumption of the business by the Company and of the Company from December 1, 1995 through December 31, 1996. The data in this table has been adjusted to eliminate the loss portfolio transaction, and the operations of the Fund during 1995 have been combined with the Company's operations for the month of December, 1995 in order to allow comparison of 1995 operating results with that of the prior years and with 1996 results. The data for the Fund and the Company gives effect to the 70% proportional quota-share arrangements with Underwriters which became effective October 1, 1995, but which terminated at the 70% level December 31, 1996.
1996 underwriting expenses decreased by $3.1 million from 1995, net of expense reimbursements and ceding commissions of approximately $5.65 million. However, as discussed below, as a percentage of net earned premium, underwriting expenses increased by 19.1% over the prior year. The overall impact of these factors upon the Company's underwriting operations produced an underwriting loss of $2.0 million for 1996, compared to an underwriting loss for 1995 of $1.5 million, and an underwriting gain of $1.5 million in 1994. The GAAP combined ratio for 1996 was 124.7% compared to 107.3% for 1995 and 93.5% for 1994.
Investment incomes, including realized capital gains and losses, amounts to $832,000 for 1996 compared to $960,000 for 1995 and $605,981 for 1994. Depending on premium growth, management anticipates that investment income will be less for 1997 than 1996 and 1995 due to anticipated negative cash flows attributable to the quota-share treaty, as discussed under liquidity and capital resources.
The Fund concluded more than four years of operations in December, 1995 with annualized writings of $28 million. Of this amount, $23.5 million of insurance was renewed by the Company with the issuance of non-assessable policies during December of 1995 and January of 1996. (See "prospective Financial Information" below).
During the period of its existence, the Fund incurred extraordinary costs associated with its own start-up, legal fees in defense of its claims against a former service company (see "Legal Proceedings" under Part I), and fees and costs related to research and evaluation of methods proposed to limit the exposure of members to assessments including the use of retrospective loss portfolio transfer reinsurance, annualizing of claims liabilities, reorganization as a mutual assessable fund and, finally, a loss portfolio transfer transaction with an approved stock insurance carrier.
The historical operations of the Company cannot be used to predict the future results of operations of the Company. The factors affecting future operations and their probable favorable and unfavorable impacts upon the Company's operations in 1997 include the following:
The Company's quota-share arrangements with TIG and Underwriters will have the effect of ceding 70% of the Company's underwriting income to TIG & Underwriters and investment earnings will be reduced attributable to reserves held by TIG & Underwriters.
The Company failed to achieve its goal of $15 million of direct new premium in 1996; however, $10.8 million of direct new premium was added (which offset a similar amount of premium losses due to cancellations and other factors) which resulted in no net premium growth. The Company's inability to attain the projected level of new premium was due to increased competition generated by favorable legislative changes as well as rate adequacy during 1996. Management initially adjusted budgeted expenditures to account for the premium reduction and additionally has (effective December 4, 1996) refinanced its debt structure and generated an additional $1.9 million of capital through the TIG transactions. The financial and business plan of the Company has been adjusted accordingly and the additional capital shall be used for, among other things: expansion of marketing staff from three (3) to seven (7); increase in marketing budget to accommodate more agent incentive plans; increase in utilization of retrospective policy products; implementation of 24 hour coverage; expansion of underwriting staff; offset of Applied Systems computer implementation costs and general mobilization costs associated with staff increases necessary to accommodate an aggressive marketing and management philosophy. The Company's ability to achieve the planned increase of $10 million per year in premium writings subsequent to 1996 appears attainable (new premium written as of April 7, 1997 equals approximately $7.9 million) and the number of submissions received from the Company's agents continues to exceed those experienced by the Fund. However, the Company remains dedicated to accelerated growth in new premium writings consistent with adherence to the Company's long standing and conservative underwriting philosophy.
Despite the positive impact of system reforms, some system costs continue to increase. Significant expenses have been incurred by the Company to comply with SEC requirements for filing and reporting financial results and these costs are anticipated to continue. Furthermore, the Company has made a large investment in policy management system software. The staff time used for testing, training and implementing the improved system also affected the efficiency and cost of operating the company in 1996 and such costs are continuing during the first part of 1997.
During 1996 and 1997, the Company has responded to the increased competition in this line of business by improving the quality and quantity of the underwriting staff by attracting more experienced underwriters and a vice president of underwriting. These staff changes increased costs to the Company.
Finally, pressure on profits was exerted by increased fees from our managed care contract with Humana, Inc. These costs increased by 13.6% beginning in September, 1996. The estimated recoveries from the Florida Special Disability Trust Fund also decreased from previous years even though the assessment remained at 4.52% of premium.
The Company's statutory capital (policyholders' surplus) as of December 31, 1996, was $4.3 million or $300,000 above the statutory minimum of $4,000,000. However, the final funding of the TIG transaction did not occur until March 31, 1997 due to delays incurred in awaiting necessary approvals from the Florida Department of Insurance. Had the closing occurred as planned (December 4, 1996) then statutory capital would have been $5.8 million or $1.8 million in excess of the statutory minimum (see "Liquidity and Capital Resources"). The final closing and its impact on the Company's financial position will be reflected in the first quarter, 1997 unaudited financial reports (Form 10-Q). Although the Company may remain solvent under GAAP and Statutory accounting practices during the soft market, its continuation as a going concern will be dependent upon maintaining statutory surplus above the minimum level.
Due to the nature of workers' compensation insurance, which may involve claims that may not be settled for many years after they are incurred, subjective judgments as to the company's ultimate exposure to losses are an integral and necessary component of the loss reserving process. Management continually reviews the Company's reserves, using a variety of statistical and actuarial techniques to analyze current claim costs, frequency and severity data, and prevailing economic, social and legal factors. The Company adjusts reserves established in prior years as loss experience develops and new information becomes available. Adjustments to previously estimated reserves are reflected in the Company's financial results in the periods in which they are made.
For 1996, the Company has recorded a net decrease in the provisions for losses and LAE of $75,000.
For statutory purposes, the Company has reported its loss reserves at $7.8 million for the year ended December 31, 1996. The difference between this amount and the gross reserve of $31.9 million appearing in Table #6 is attributable to the reporting of recoveries due from reinsurance and the SDTF as reductions to gross reserves with $3.1 million of prepaid fees for managed care also classified as reductions to net reserves for statutory purposes. In addition, for statutory purposes, the Company is required to reserve for unallocated loss adjustment expenses (even though such costs have already been paid pursuant to the contract with CCI) which serves to increase statutory reserves by approximately $460,000.
The Company pays premiums to its excess of loss reinsurers on a quarterly basis and invoices reinsurers for recoveries as claim payments in excess of the Company's retention are paid. These amounts are classified as "paid recoverables" in the Company's financial statements and amounted to $0, $95,000, and $204,000 for 1996, 1995, and 1994, respectively.
For 1996, premium ceded amounted to approximately $17.7 million and expense reimbursements and commissions amounted to approximately $5.65 million.
The effect of these arrangements is a transfer of 70% of the net results of underwriting operations to Underwriters, which reduces the Company's net writings reported to the Department. This allows the Company to increase its direct writings through leveraging of its capital resources (see "Liquidity and Capital Resources" in this section). Premium ceded to Underwriters creates recoverables for Underwriters' share of unpaid losses and loss adjustment expenses. As claims are paid, the Company reduces amounts remitted to Underwriters proportional to Underwriters' liability. In addition, Underwriters' share of reimbursable expenses and amounts due the Company for the ceding commission are deducted from ceded premium amounts otherwise due Underwriters.
The Special Disabilities Trust Fund of the Bureau of Workers Compensation makes assessments upon all Florida workers compensation insurers at a current rate of 4.52% of premium collected and distributes
The Special Disability Trust Fund was created in 1955 to provide a financial incentive for employers to hire previously injured workers. If the worker was injured a second time and the employer (or insurance carrier) could prove that the two injuries were related, the Trust Fund will reinburse the insurer for claims paid regarding the second or subsequent injuries.
It has been reported that the Trust Fund is financially impaired with claims exceeding the Trust Fund's ability to pay. The Florida Legislature is considering legislation to deal with the issue but no definite laws have yet been adopted. Proposals range from increased assessments to carriers to terminating the Trust Fund at a date certain as a means of dealing with the problem.
The Company is unable to ascertain with any certainty what, if any, legislation will be adopted regarding the Trust Fund. If terminated at a date certain or if assessments are increased, such actions could adversely impact the Company.
The Company records amounts paid to Humana as a prepaid expense with adjustments recorded as medical services are rendered. The recorded prepaid expense at December 31, 1996 of $3.1 million equals the amount of covered medical losses recorded as unpaid and included in reserves.
Although the Company has no immediate plans for termination of this agreement, additional companies are now offering identical services as Vincam/HIP and are competitively pricing their services in light of the mandatory nature of managed care in Florida. The Company is exploring these alternatives with a view toward cost savings and may, at some point in 1997, avail itself of the more competitive nature of the PPO market.
The Company follows a conservative investment strategy that emphasizes maintaining a high-quality investment portfolio and maximizing after-tax current income. Investments since the inception of the Company have consisted solely of fixed maturity U.S. Treasury Notes, Treasury Strips, U.S. Government agency notes and mortgage-backed securities and certificates of deposit, all with ratings of AA or better.
As of December 31, 1996, total financial statement investments and cash under GAAP (pursuant to which certain assets are stated at amortized cost) decreased to $10.9 million, a decrease of 35% over the year ended December 31, 1995, total of $16.7 million. The 1996 amount includes $8.7 million of fixed maturity investments carried at amortized cost as held to maturity securities and $0 million carried at fair value as available for sale securities. The net decrease in financial statement investments and cash reflects the net proceeds (total proceeds less assigned security deposits) of the Company's continuing sale of its registered Series A preferred stock and the sale of its unregistered Series B preferred stock to Holdings, and underwriting results including net premium ceded to reinsurers.
Table #9 on Page 33 reflects investment results for the three year period ended December 31, 1996.
The average maturity of all investments is approximately 3.5 years. The Company continues to seek opportunities to enhance investment yield through a conservative, primarily fixed maturity investment strategy. Its current investment strategy does not contemplate material investments in non-investment grade securities, real estate, commercial mortgages, or equity securities.
More information concerning the Company's investments is contained in the notes to the Company's financial statements included in this filing.
The insurance code of Florida requires a stock insurance carrier to maintain capital of no less than $4 million. In addition, companies writing workers' compensation insurance cannot have annualized net writings in excess of 3.2 times their statutory surplus, calculated and reviewed on a quarterly basis. As of December 31, 1996, the Company's statutory surplus approximates $4.3 million or approximately $300,000 above the statutory minimum. The TIG transaction (see Business Developments 1996), was originally scheduled to close December 4, 1996. Due to delays suffered while awaiting Florida Department of Insurance approval only the TIG Loan portion of the transaction closed on December 4, 1996 (the first closing). The proceeds of the first closing were used to pay in full the Underwriters loan (approximately $3.6 million) and the balance was used by Holdings to purchase an additional 400,000 shares of the Company's Series B Preferred. The Securities Purchase Agreement closed March 31, 1997
(the second closing) and generated an additional approximate $2 million available to Holdings. The proceeds of this transaction were used by Holdings to purchase an additional 1.5 million shares of the Company's Series B Preferred Stock at $1.00 per share and $500,000 was advanced to the Company by Holdings as additional working capital. This additional capital (combined with the quota-share) has increased the Company's direct writing capacity to $65 million which is more than double the Company's current writings.
The Company's business plan (see "Prospective Financial Information") contemplates the continuing sale of Series A preferred stock to insureds, agents and vendors to provide a cushion to surplus and to facilitate further growth in writings. The Company intends to file additional registration statements and amendments thereto, as necessary, with the SEC to accomplish this objective.
In connection with the financing and securities purchase arrangements, the Company and Holdings have provided these and additional covenants and entered into other agreements with TIG, Underwriters and the Department of Insurance. The nature of these arrangements, their possible effects upon the Company, and management's opinion related thereto are summarized below.
Holdings has pledged all of the Company's common stock and Series B preferred stock as collateral for the TIG loan.
If Holdings defaults on the loan, and fails to cure the default, then TIG would own and control the operations of the Company.
Holdings and the Company have agreed not to declare or pay any dividends on any class of stock without the approval of TIG for so long as Holdings is indebted to TIG.
The Company has agreed to not pay any form of premium refund to the Fund's former insureds without the approval of the Department. DESCRIPTION: POSSIBLE EFFECTS UPON THE COMPANY:
The Company's continued retention of former Fund insureds as customers of the Company may be jeopardized if refunds are not paid.
The quota share arrangements serve to reduce the Company's required capital thus increasing the Company's writing capacity. However, underwriting and investment incomes related to ceded premium are eliminated.
Holdings has sold TIG 2,912,908 shares of its Series I Preferred Stock.
If Holdings fails to redeem this stock on or before December 4, 2003, TIG will be in a position to control the Company.
Opportunities for expansion in writing capacity or acquisitions of other business could be adversely affected in favor of this requirement.
Management considers the Company's indemnification of the former members of the Fund (who transferred coverage to the Company) against assessment for possible deficiencies in losses to be significant to the Fund's former members and that such indemnification will mitigate the consequences of the required delay in the payment of premium refunds, if any.
The Company's Series A preferred stock accumulates dividends at a rate of 6% of stated value. Any dividends not paid at each semi-annual payment date are accrued. The Company cannot pay a dividend on its common stock until all accrued dividends on the Series A preferred stock are paid in full. If the underwriting operations of the company continue profitable, excess earnings may accumulate sufficient to pay dividends, including a dividend on the common stock. Inasmuch as any dividends paid on the common stock must be used to retire any then remaining indebtedness by Holdings to TIG, management is of the opinion that TIG would approve such payments.