The following selected financial data have been summarized from the Company's consolidated financial statements and are qualified in their entirety by reference to, and should be read in conjunction with, such consolidated financial statements and "Management's Discussion and Analysis of Financial Condition and Results of Operations," below.
(b) The Combined Ratio does not reflect the effect of investment income. For 1996 and 1995, a change in the statutory accounting treatment for retrospectively rated reinsurance agreements was the principal reason for the difference between the GAAP Combined Ratios and the SAP Combined Ratios. Additionally in 1997, 1996 and 1993, the difference relates to the accounting for certain costs which are treated differently under SAP and GAAP.
Management's Discussion and Analysis of Financial Condition and Results - ------- of Operations. -----------------------------------------------------------------------
The Parent maintains the principal borrowings for the Company and its non-banking subsidiaries and has provided working capital to certain of its subsidiaries. These borrowings have primarily been made from banks through various credit agreement facilities and term loans, and through public financings. In February 1997, the Company replaced its unsecured $150,000,000 bank credit agreement facilities and its $50,000,000 of outstanding unsecured bank term loans with a new unsecured bank credit facility of $200,000,000. In connection with the sale of the Colonial Penn P&C Group, the Company replaced the February 1997 bank credit facility with a new unsecured bank credit facility of $100,000,000 and provided the purchaser of the Colonial Penn P&C Group with a $100,000,000 non-cancelable letter of credit to secure certain indemnification obligations. This letter of credit was issued by one of the Company's credit facility banks and is collateralized by certain deposits of the Company aggregating approximately $105,000,000. The new $100,000,000 credit facility bears interest based on the prime rate or LIBOR and matures in November 2002. During the year ended December 31, 1997, the Company used a portion of its bank credit facility primarily to fund the redemption of its 5-1/4% Convertible Subordinated Debentures due 2003 (the "5-1/4% Debentures") and its 10-3/8% Senior Subordinated Notes due 2002 (the "10-3/8% Notes") and to provide bridge financing to PIB. At December 31, 1997, there were no amounts outstanding under the bank credit facility.
In March 1997, the Company called for redemption all of its outstanding 5-1/4% Debentures at a redemption price of 102.625% of the principal amount of the Debentures, plus accrued interest. Of the $100,000,000 principal amount of the 5-1/4% Debentures outstanding, $93,675,000 was converted into 3,258,145 Common Shares and $6,325,000 was redeemed.
In 1996, the Company formed PIB, a joint venture with PepsiCo, Inc., to be the exclusive bottler and distributor of PepsiCo beverages in a large portion of central and eastern Russia, Kyrgyzstan and Kazakstan. Although the Company's $79,500,000 aggregate equity investment in PIB ($28,500,000 of which was funded in January 1997 and $51,000,000 during 1996) resulted in an initial 75% economic interest in PIB, under the original terms of the joint venture agreement, the Company and PepsiCo equally shared voting rights over all significant aspects of PIB's operations. Consequently, since the Company did not control PIB despite its larger economic interest, the Company accounted for its share of PIB's operating results under the equity method of accounting. After reflecting its share of losses since inception, the book value of the Company's equity investment in PIB was $11,744,000 at December 31, 1997.
During 1997, the Company and PepsiCo provided bridge financing to PIB to cover operating costs and capital expenditures, of which $77,705,000 was funded by the Company. Although PIB continues to need additional funds while it is developing its business, since November 3, 1997, the Company has not provided any
While this has resulted in an increase in shareholders' equity, it had no effect on results of operations or cash flows.
The Company provides collateralized automobile loans to individuals with poor credit histories. In 1997, the Company continued to experience competition resulting in reduced volume. During 1996, the Company tightened its underwriting standards in an effort to improve its loan loss experience and increased the reserve maintained on this portfolio. The Company's investment in these loans was $77,607,000, $96,338,000 and $134,668,000 at December 31, 1997, 1996 and 1995, respectively.
Certain of the Company's subsidiaries have substantial loss carryforwards and other tax attributes. The amount and availability of tax loss carryforwards are subject to certain qualifications, limitations and uncertainties. As described in the Notes to the Consolidated Financial Statements, significant additional amounts of loss carryforwards may be available under certain circumstances. In order to reduce the possibility that certain changes in ownership could impose limitations on the use of these carryforwards, the Company's certificate of incorporation contains provisions which generally restrict the ability of a person or entity from accumulating at least five percent of the Common Shares and the ability of persons or entities now owning at least five percent of the Common Shares from acquiring additional Common Shares.
The Company's most significant operations are its insurance businesses, where it is a specialty markets provider of property and casualty and life insurance to its niche markets. For the year ended December 31, 1997, the Company's insurance segments contributed 59% of total revenues and, at December 31, 1997, constituted 68% of total assets, including the net proceeds from the sales of the Colonial Penn Life Group and Colonial Penn P&C Group.
enabling the Empire Group to concentrate its resources on its core non-service businesses and redeploy certain resources previously dedicated to the NYPAP. Accordingly, the Empire Group will not provide such services in 1998, except for the run-off of the remaining NYPAP claims, which will occur over approximately a two-year period. The Empire Group believes it has provided sufficient reserves for future claims servicing costs related to such run-off business.
Year Ended December 31, ----------------------- 1997 1996 1995 ---- ---- ----
The combined ratios of the Empire Group increased in 1997, primarily reflecting an increase in the 1997 accident year loss ratios, principally for the private passenger automobile and commercial assigned risk lines of business, based upon increased claim frequency and continued unfavorable development of prior accident year losses. This increase was partially offset by a decrease in expenses primarily due to a reduction in the reserve for prior years' servicing carrier expenses and reduced expenses reflecting reduced premium volume in 1997. Included in the Empire Group's results for 1997, 1996 and 1995 were approximately $27,000,000, $28,000,000 and $34,500,000, respectively, for reserve strengthening related to losses from prior accident years. In 1997 and 1996, the reserve strengthening primarily related to voluntary commercial automobile and commercial package lines of business, while in 1995 the reserve strengthening primarily related to automobile and workers' compensation lines of business.
The 1997 reserve strengthening included approximately $11,000,000 for commercial package lines of business and approximately $7,000,000 for voluntary commercial automobile lines of business. During 1997, the Empire Group reviewed the adequacy of the reserves carried for its open claims' files, as part of its normal ongoing practice, focusing on the commercial package, general liability and commercial automobile lines of business. As a result of this review and the continued unfavorable development of prior accident years losses, particularly the 1992 through 1994 accident years, the Empire Group has revised its assumptions regarding future increases in average claims severity and reserves were strengthened.
The 1995 reserve strengthening included approximately $23,000,000 for private passenger automobile lines of business and $10,000,000 for workers' compensation lines of business. In early 1994, the private passenger automobile business increased significantly as a result of the acquisition of a large block of assigned risk business. The acquisition of this block of business nearly doubled the volume previously written by the Empire Group. Early in 1995, losses began to develop in this line of business that indicated a higher ultimate loss ratio than the Empire Group had experienced on similar blocks of assigned risk business from earlier periods, which experience formed the basis of the Empire Group's original loss estimate. The Empire Group believes the increased losses in this line resulted primarily from its inability to effectively process a much larger volume of claims from its significantly increased customer base. Consequently, claims investigation and file documentation were not conducted timely which led to higher claim costs. With respect to workers' compensation lines, the Empire Group's policies provide insurance coverage to the employer if employees are able to successfully assert liability for employer negligence in providing a safe working environment. During 1995, a relatively small number of such claims with large dollar values emerged that had not been previously anticipated. The emergence of these claims, and the fact that the workers' compensation line of business is susceptible to the emergence of losses over an extended period, resulted in a revision of the Empire Group's estimate of ultimate losses and reserves were increased.
For the lines of business discussed above, as well as all other property and casualty lines of business, the Company employs a variety of standard actuarial loss projection techniques, statistical analyses and case-base evaluations to estimate its liability for unpaid losses. The actuarial projections include an extrapolation of both losses paid and incurred by business line and accident year and implicitly consider the impact of inflation and claims settlement patterns upon ultimate claim costs based upon historical patterns. These estimates are performed quarterly and consider any changes in trends and actual loss experience. Any resulting change in the estimate of the liability for unpaid losses, including those discussed above, is reflected in current year earnings during the quarter the change in estimate is identified.
for a premium of $25,000,000. The gain on this reinsurance will also be deferred and amortized into income in the same manner as described above.
Finance revenues and operating profits in 1997 and 1996 reflect the reduced level of consumer instalment loans, as discussed above. In addition, in 1997, although automobile loan losses declined, operating profit was adversely affected by a $3,500,000 reserve for estimated costs to settle litigation related to a lending program that is in liquidation. In 1996, the decline in operating profit was also caused by increased interest expense on customer banking deposits.
In 1997, investment and other income increased by $81,787,000 primarily due to increased gains from sales of real estate properties ($63,500,000) including the previously described sale of a New York City office building and increased interest income ($28,100,000) including earnings on the proceeds from the sales of the Colonial Penn Life Group and Colonial Penn P&C Group. Such increases were partially offset by reduced trading stamp and miscellaneous other revenues in 1997 and a litigation settlement gain recorded in 1996. Investment and other income decreased in 1996 primarily due to the gain on the return of the WMAC Companies in 1995. In 1995, control of the WMAC Companies was returned to the Company and such subsidiaries were consolidated, resulting in a gain of $41,030,000, representing the difference between the carrying amount of the Company's investment prior to consolidation and the net assets of such subsidiaries.
Equity in losses of associated companies increased in 1997 as compared to 1996 primarily due to start-up losses from the Company's equity investment in PIB of $50,481,000 in 1997 as compared to $17,104,000 in 1996. During 1997, PIB's increased efforts to build production, distribution capacity and market share, combined with sales that did not meet expectations, resulted in greater operating losses than in 1996. As mentioned above, as a result of the Company's recent agreement with PepsiCo, from February 1, 1998, the Company will no longer account for its investment in PIB under the equity method of accounting.
The reduction in interest expense in 1997 was primarily due to the decline in external borrowings as described above.
divisions and the charge for estimated costs to settle litigation relating to a lending program that is in liquidation.
The number of shares used to calculate basic earnings per share was 62,205,000, 60,301,000 and 57,465,000 for 1997, 1996 and 1995, respectively. The number of shares used to calculate diluted earnings per share was 62,205,000, 60,301,000 and 59,271,000 for 1997, 1996 and 1995, respectively. For diluted per share amounts, the 5-1/4% Debentures were not assumed to have been converted since the effect of such assumed conversion would have been to increase earnings per share.