The Company leases approximately 15,786 square feet of office space in Bedford Hills, New York, under a lease expiring in December 1996 at a monthly rental of $18,169, at which Med Pro conducts its medical malpractice insurance agency operations.
The Company leases approximately 4,472 square feet of office space in an office building in Great Neck, New York, under a lease expiring in March 1999 at a monthly rental of $8,788, at which claims settlement and adjusting services are performed.
The Company leases approximately 363 square feet of office space in an office building in Las Vegas, Nevada, under a lease expiring in April 1996 at a monthly rental of $1,200, at which SDIA conducts branch agency operations.
The Company leases approximately 720 square feet of office space in an office building in Reno, Nevada, under a lease expiring in December 1995 at a monthly rental of $800, at which SDIA conducts branch agency operations.
The Company leases approximately 1,429 square feet of office space in an office building in Houston, Texas, under a lease expiring in August 1998 at a monthly rental of $1,548, at which medical malpractice insurance agency operations are performed.
The increase in medical malpractice net premiums earned was primarily attributable to an increase in the number of physicians insured, principally those associated with mental health, home care, and other social service organizations, growth in the program for psychiatrists, greater penetration of the Ohio physician market, growth in the dental program endorsed by the Academy of General Dentistry, and rate increases in Florida and other geographic areas.
Net premiums earned for the workers' compensation line decreased primarily as a result of decreases in the specialty niche program for cotton gins caused by a weather-related reduction in the cotton crop, and decreases in other smaller programs due to the Company's decision not to renew accounts deemed unprofitable, and decreased required participation in the National Workers' Compensation Reinsurance Pools. These decreases were partially offset by increases in workers' compensation premiums written in the social services programs.
amortization of policy acquisition costs was attributable primarily to an increase in direct commission expense resulting from growth in programs with higher commission rates, a decrease in reinsurance contingent commissions, increased staffing and marketing expenses related to expansion, and salary increases, partially offset by a decrease in assumed commission expense resulting from the continued decrease in assumed written premiums. The 25.1% increase in underwriting, other expenses and interest expense was primarily the result of the interest expense associated with the borrowing under the line of credit facility, an increase in the additions to allowance for bad debts, increased staffing, increased facilities, equipment and materials expense necessitated by the Company's growth, a reduction in assessment recoveries from the Texas Workers' Compensation Insurance Facility, and salary increases, partially offset by a decrease in policyholder dividends. As the non-claim related component of the GAAP Combined Ratio increased at a greater rate than premiums earned, the non-claim component was 1.7 percentage points higher than in the comparable 1994 period. The total GAAP Combined Ratio decreased by 8.3 percentage points to 92.7% as a result of the above.
Growth in surety net premiums earned continued in 1994, primarily attributable to expanded writings of bonds for small contractors, bail bonds, miscellaneous bonds, and license and permit bonds. The increase in license and permit bonds was primarily attributable to the Company's acquisition in April 1994 of the license and permit bond business of a California insurance agency.
Net premiums earned for the general liability line increased primarily because of new programs, including cranes and excess employers' liability, and increases in various other programs, including social services, and alarms and guards. These increases were partially offset by decreases resulting from the continued decline in the number of risks covered under the liquor liability program, which the Company has discontinued.
Since the non-claim related expenses increased at a percentage rate more than that of net premiums earned, the non-claim related component of the GAAP Combined Ratio was 3.7 percentage points higher than in the prior year. The total GAAP Combined Ratio increased by 7.8 percentage points to 101% for the year.
The foregoing changes resulted in income before income taxes and cumulative effect of change in accounting for income taxes of $21,330,000 for 1994, a decrease of 29.6% from 1993. Net income for the year decreased by $6,891,000, or 28.9%, a lower percentage change than for pre-tax income as a result of a lower effective tax rate caused by an increase in the proportion of investment income which is tax preferenced.
At December 31, 1995 and 1994, the Company's fixed maturity securities include mortgage-backed bonds of $192.1 million and $57.3 million, respectively, which are subject to risks associated with variable prepayments of the underlying mortgage loans. Prepayments cause those securities to have different actual maturities than that expected at the time of purchase. Securities that have an amortized cost greater than par that are backed by mortgages that prepay faster than expected will incur a reduction in yield or loss, while securities that have an amortized cost less than par that are backed by mortgages that prepay faster than expected will generate an increase in yield or gain. The degree to which a security is susceptible to either gains or losses is influenced by the difference between its amortized cost and par, the relative sensitivity of the underlying mortgages backing the assets to prepayments in a changing interest rate environment and the repayment priority of the securities in the overall securitization structure.
The Company limits the extent of its credit risk by purchasing securities that are backed by stable collateral and by concentrating on securities with enhanced priority in the securitization structure. Such securities with reduced risk typically have a lower yield (but higher liquidity) than higher-risk mortgage-backed bonds (i.e., mortgage-backed bonds structured to share in residual cash flows or which cover only interest payments). At selected times, higher-risk securities may be purchased if they do not compromise the safety of the Company's general portfolio. There are negligible default risks in the Company's mortgage-backed bond portfolio as the vast majority of these bonds are either guaranteed by U.S. government-sponsored entities or are supported in the securitization structure by junior securities resulting in the bonds having high investment grade status.
At December 31, 1995, the following table provides a profile of the Company's fixed maturity investment portfolio by rating:
As of January 1, 1994, the Company adopted FASB Statement 115 and reclassified a portion of its fixed maturity securities portfolio as "available-for-sale," with the remainder being classified as "held-to-maturity." With that reclassification, the fixed maturity securities classified as "available-for-sale" are carried at fair value and changes in fair values, net of applicable income taxes, are charged or credited directly to shareholders' equity. "Held-to-maturity" securities are reported at amortized cost. The adoption of Statement 115 increased shareholders' equity by $3,651,000 at January 1, 1994.
The Company is a holding company, receiving cash principally through sales of equities, borrowings, and dividends from its subsidiaries, certain of which are subject to dividend restrictions described in Note I to the consolidated financial statements. The ability of insurance and reinsurance companies to underwrite insurance and reinsurance is based on maintaining liquidity and capital resources sufficient to pay claims and expenses as they become due. The primary sources of liquidity for the Company's subsidiaries are funds generated from insurance and reinsurance premiums, investment income, commission and fee income, capital contributions from the Company and proceeds from sales and maturities of portfolio investments. The principal expenditures are for payment of losses and LAE, underwriting and other operating expenses, commissions, and dividends to shareholders and policyholders.
Cash flow generated from operations for 1995, 1994, and 1993 was $105.0 million, $81.9 million, and $51.2 million, respectively, amounts adequate to meet all of the Company's obligations.
In January 1993, 1994, and 1995, investment funds were increased by $9.2 million, $9.0 million and $3.9 million, respectively, from the commutation of the 1989, 1990, and 1991 treaty years under the medical malpractice reinsurance treaties, resulting in the receipt of $5.4 million, $6.1 million, and $3.9 million, respectively, in cash and a concomitant increase in reserves for unpaid losses and LAE, with the balance received from the collection of contingent commissions earned by the Company for the 1994 and 1993 treaty years.
In May 1995, the Company and R. Spencer Douglas III ("Douglass") formed a California limited liability corporation, Douglass/Frontier, LLC ( Douglass/Frontier ), a bail bond insurance agency. The company made an initial cash investment of $2,400,000 and Douglass contributed the assets of his wholly-owned existing bail bond agency. The Company and Douglass share equally in the ownership of Douglass/Frontier.
As a result of a review by AM Best of Frontier Insurance Company's A- (Excellent) rating, the Company agreed with AM Best to make a $45 million capital infusion to Frontier Insurance Company by June 30, 1995 in order to fund its projected growth and retain its A- rating. At June 30, 1995 the Company had completed the $45 million capital infusion, utilizing a combination of funds previously held by the Company and loan proceeds from The Bank of New York loan.
In November 1995, the Company acquired the realtors, errors, and omissions book of business from Bankers Multiple Line Insurance Company ("BMLIC"). The purchase price was $400,000 with $200,000 remitted the date of closing, and an additional $200,000 due January 15, 1997, with downward adjustments possible if certain commitments are not kept. The personnel of BMLIC involved in placing and servicing the acquired business have become employees of the Company and will continue to operate from their location in Louisville, Kentucky.
the program may be suspended at any time at the Company's discretion. In 1995 and 1994, in conjunction with this repurchase program, the Company acquired 6,000 and 35,400 shares of Common Stock at a cost of $134,000 and $654,000, respectively.
In December 1990, the New York State Court of Claims rendered a decision in favor of the Company holding that a State University of New York ("SUNY") medical school faculty member engaged in the clinical practice of medicine at a SUNY medical facility, corollary to such physician's faculty activities, was within the scope of such physician's employment by SUNY and was protected against malpractice claims arising out of such activity by the State of New York and not under the Company's medical malpractice policy. The decision was affirmed on appeal by the New York State Appellate Division in November 1991 and not appealed by the State. In July 1992, the State of New York enacted legislation eliminating medical school faculty members of SUNY engaged in the clinical practice of medicine at a SUNY medical facility from indemnification by the State with respect to malpractice claims arising out of such activity, retroactive to July 1, 1991. In an opinion filed on September 3, 1993 the Court of Claims of the State of New York held, inter alia, that the July 1992 legislation by the State of New York eliminating SUNY medical school faculty members engaged in the clinical practice of medicine, as part of their employment by SUNY, from indemnification by the State with respect to malpractice claims arising out of such activity, was not to be applied retroactively. This decision was affirmed by the New York State Appellate Division in April 1994. Subsequently, in February 1995, the Appellate Division granted leave to Frontier and the State of New York to have the issues of Frontier's entitlement to recover its costs of defense and its costs of settlement ruled on by the State's highest Court, the New York Court of Appeals. In December 1995, the New York Court of Appeals ruled on this issue and concluded that Frontier was entitled to recoveries from the State for such medical malpractice claims. As a result of this decision, the Company believes the above-referenced decisions are controlling precedents and that it will benefit economically by not being ultimately responsible for certain claims against SUNY physicians for whom it presently carries reserves and be entitled to reimbursement of certain claims previously paid; accordingly, effective December 31, 1995, Frontier recorded a subrogation recoverable of approximately $19,000,000 representing the amount of claims already paid and the reserves currently held by Frontier on open cases that management believes are reimbursable by the State of New York. To the extent that the amount of the actual recovery varies, such difference will be reported in the period recognized. The Company is continuing to defend all SUNY faculty members against malpractice claims that have been asserted and is maintaining reserves therefor adjusted for the anticipated recoveries.
The ratios of Total Adjusted Capital to Authorized Control Level RBC for the Company's insurance subsidiaries were all in excess of 3:1 at both December 31, 1995 and 1994.
Similarly, the NAIC has proposed a new Model Investment Law that may affect the statutory carrying values of certain investments; however, the final outcome of this proposal is not certain, nor is it possible to predict what impact the proposal will have on the Company in the event it is adopted.
Although the Company believes that the classes of insurance which it underwrites have no material exposure to environmental pollution claims, there can be no such assurance in view of the expansion of liability for environmental claims in recent litigation.
actions also allege violations of the common law. The complaints relate to the Company's November 8, 1994 announcement of its third-quarter financial results and allege that the Company previously had omitted and/or misrepresented material facts with respect to its earnings and profits. The Company believes the suits are without merit and has retained special legal counsel to contest them vigorously.