PREMIUMS. Gross (direct plus assumed) premiums written increased $24.5 million, or 25.1%, to $121.9 million in 1999 compared to $97.4 million in 1998. This increase in gross premiums written can be attributed partially to the acquisition of Southern which contributed $12.0 million of title insurance premiums. The remaining increase can be attributed to increases in direct premiums written for personal automobile (increased $7.3 million or 33.3%), commercial automobile (increased $1.4 million or 57.9%), commercial multi-peril (increased $1.8 million or 14.0%), and workers' compensation (increased $2.8 million or 42.9%). The significant increases in property and casualty premiums resulted from sales incentives with agents which were designed to increase writings in casualty lines and to cross-sell business to existing insureds. OGGI also benefited from book rollovers as agents attempted to concentrate their existing business with fewer insurance companies and to better position themselves with OGGI and our tiered agency compensation system. Under the tiered agency compensation system, agents are more richly compensated for volume of business and historical profitability.
LOSSES AND LOSS ADJUSTMENT EXPENSES. Net losses and loss adjustment expenses incurred increased by $22.4 million, or 46.3%, to $70.8 million in 1999 from $48.4 million in 1998. The increase in losses and loss adjustment expenses can be attributed to increases in net earned premium resulting from the changes in
UNDERWRITING EXPENSES. Underwriting expenses, which include amortization of deferred policy acquisition costs and operating expenses, increased $17.2 million, or 48.0%, in 1999 to $53.0 million from $35.8 million in 1998. Excluding title operations, operating expenses increased $3.0 million, or 8.3% compared to 1998. Included in 1999 operating expenses is a $1.1 million charge for guaranty fund assessments related to the insolvencies of PIC Insurance Group, Inc. (PIC) and P.I.E. Mutual Insurance Company (P.I.E.) as compared to the $2.0 million charge included in 1998 operating expenses. During 1998 when assessments for PIC and P.I.E. first became estimable, OGGI recorded its share of these insolvencies for 1997 and 1998. Absent this charge, the increase in 1999 operating expenses is primarily attributable to an increase in commission expense related to the changes made to the agent incentive program and the resulting increase in gross earned premiums. The expense ratio for P&C operations was 38.4% for 1999 versus 44.7% for 1998. The reduction in the expense ratio can be attributed to increases in net premiums earned without commensurate increases in expenses.
Ceded premiums written decreased $8.3 million to $13.5 million in 1998 compared to 1997. The decrease in premiums ceded was directly attributable to the elimination of the 15% quota share reinsurance agreement with our primary reinsurer, American Re. This agreement was cancelled on a run-off basis whereby new or renewal policies in 1998 are no longer covered. Ceded premiums written under this agreement amounted to nil and $9.4 million for 1998 and 1997, respectively.
Net premiums written increased $17.9 million, or 27.0%, in 1998 to $83.9 million from $66.1 million in 1997. For the same comparative periods, net premiums earned increased $12.9 million, or 20.7%, to $75.3 million from $62.4 million. The increases in net premiums written and net premiums earned were directly attributable to the effects of eliminating the quota share reinsurance agreement with American Re and the contribution of New Castle premiums to OGGI.
OGGI's property and casualty subsidiaries have in place an unsecured line of credit with a financial institution under which they may borrow up to an aggregate of $1.5 million to fund claims in the event of catastrophic losses not covered under reinsurance. As of December 31, 1999 and 1998, no amounts were borrowed against these lines of credit. Under a separate $400,000 unsecured operating line of credit, Southern has borrowed $352,368 to meet its operating cash requirements.
As a holding company, the principal source of liquidity for Old Guard Group, Inc. will be dividend payments and other fees received from its subsidiaries. The Company's insurance subsidiaries are restricted by the insurance laws of the state of domicile as to the amount of dividends or other distributions they may pay to the Company without the prior approval of the state regulatory authority. Generally, the maximum amount that may be paid by an insurance company during any twelve-month period after notice to, but without prior approval of, the insurance department cannot exceed the greater of 10% of the insurance company's statutory surplus as reported on the most recent annual statement filed, or the net income of the insurance company for the period covered by such annual statement.
As of March 22, 2000, OGGI was not aware of any Year 2000 problems with third parties with which OGGI has a direct and material relationship.
It is possible that OGGI's computerized systems could be affected in the future by the Year 2000 Issue. OGGI has numerous computerized interfaces with third parties that are possibly vulnerable to failure if those third parties have not adequately addressed their Year 2000 Issues. Systems failures resulting from these issues could cause significant disruptions to OGGI's operations. As of March 22, 2000, there do not appear to have been any such failures.
Certain statements contained in the Management's Discussion and Analysis and other statements made throughout this report constitute "forward-looking statements" (as such term is defined in the Private Securities Litigation Reform Act of 1995). Such forward-forwarding statements involve certain assumptions, risks and uncertainties that could cause actual results to differ materially from those included in or contemplated by the statements. These assumptions, risks and uncertainties include, but are not limited to those associated with factors affecting the property-casualty and title insurance industries generally, including price competition, size and frequency of claims, escalating damage awards, natural disasters, fluctuations in interest rates and general business conditions; OGGI's dependence on investment income; the geographic concentration of OGGI's business in the Northeast United States; the adequacy of OGGI's liability for losses and loss adjustment expenses; government regulation of the insurance industry and the other risks and uncertainties discussed or indicated in all documents filed by OGGI with the Securities and Exchange Commission. OGGI expressly disclaims any obligation to update any forward- looking statements as a result of developments occurring after the release of this report.
The consolidated financial statements include the accounts of Old Guard Group, Inc. and its wholly-owned subsidiaries (OGGI), Old Guard Insurance Company (Old Guard), Old Guard Fire Insurance Company (Old Guard Fire), First Patriot Insurance Company (First Patriot), New Castle Insurance Company of Delaware, Investors Southern Corporation (Southern), Old Guard Insurance Management Co. (OGIM), 2929 Service Corporation and OGGI's 80% owned subsidiary, First Delaware Insurance Company (First Delaware).
The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States. All significant intercompany transactions have been eliminated in consolidation. Certain amounts in the 1998 and 1997 financial statements have been reclassified to conform to the current year presentation.
OGGI classifies fixed income and marketable equity securities as trading or available for sale. In addition, fixed income securities may be classified as held to maturity. Each security's classification is evaluated at the time of purchase and periodically reevaluated. Held to maturity securities are carried at amortized cost. Available for sale securities are carried at fair value, with the unrealized gains and losses, net of deferred income tax, reported as a separate component of shareholders' equity. Currently, no securities are classified as trading.
The fair value of all investments is subject to various market fluctuations which include changes in equity markets, interest rate environment and general economic conditions. Interest on fixed maturities and short-term investments is credited to income as it accrues on the principal amounts outstanding, adjusted for amortization of premiums and accretion of discounts computed utilizing the effective interest rate method. Realized gains and losses on investments sold are calculated on the specific identification basis.
At December 31, 1999 and 1998, the statutory surplus of OGGI's insurance subsidiaries determined in accordance with practices prescribed or permitted by insurance regulatory authorities totaled $54,927,751 and $54,322,922, respectively. Statutory net income (loss) for 1999, 1998, and 1997 was $(3,231,557), $211,345 and $3,995,095, respectively.
3. INVESTMENTS: (CONTINUED) The cost and estimated fair value of investments at December 31, 1999 and 1998 were as follows:
(1) Original cost of equity securities; original cost of fixed income securities adjusted for amortization of premium and accretion of discount.
3. INVESTMENTS: (CONTINUED) The amortized cost and estimated fair value of fixed income securities at December 31, 1999 by contractual maturity are shown below:
Collateralized mortgage obligations consist of mortgage pass-through holdings and securities backed by credit card receivables, auto loans and home equity loans. These securities follow a structured principal repayment schedule and are predominately of high credit quality rated "AA" or better by Standard & Poor's. These securities are presented separately in the maturity schedule due to the inherent risk associated with prepayment on early authorization. The average duration of this collateralized mortgage obligation portfolio is 2.4 years.
OGGI's property and casualty insurance subsidiaries have geographic exposure to catastrophic losses in certain Mid Atlantic states. Catastrophes can be caused by various events including hurricanes, windstorms, earthquakes, hail, explosions, severe weather and fires. The incidence and severity of catastrophes are inherently unpredictable. The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected by the event and the severity of the event. Most catastrophes are restricted to small geographic areas; however, hurricanes and earthquakes may produce significant damage in large, heavily populated areas. OGGI's insurance subsidiaries generally seek to reduce their exposure to catastrophes through individual risk selection and the purchase of catastrophe reinsurance.
Property and equipment consisted of the following at December 31, 1999 and 1998:
Old Guard Fire's 25,000 square foot office facility near the main office at 147 West Airport Road in Lancaster was sold on July 30, 1999 for $1,394,011. A gain of $210,507 was realized on the sale.
Long-term debt is as follows at December 31, 1999 and 1998:
The fixed rate portions of the mortgage and acquisition line of credit were converted from variable rates through interest rate swaps. The fair values of the mortgage and line of credit swaps at December 31, 1999 were assets of $71,814 and $198,405, respectively. The fair value of the mortgage swap at December 31, 1998 was a liability of $101,682.
The property and casualty subsidiaries of OGGI jointly maintain a cash management program with a financial institution. The program provides for draws against lines of credit to fund claims in the event of
7. LONG-TERM DEBT: (CONTINUED) catastrophic losses not covered under reinsurance. The lines of credit are subject to a maximum of $1,500,000 bearing interest at prime. OGGI must maintain a consolidated tangible net worth, as defined in the agreement, of $68,000,000, liquid assets of $90,000,000 and an A.M. Best rating of A- under these agreements. No borrowings were outstanding under these lines at December 31, 1999 and 1998. Southern maintains a separate $400,000 operational line of credit that bears interest of LIBOR plus 1.50%. At December 31, 1999, Southern maintained a balance of $352,368 on this line of credit.
OGGI also maintains a $15,000,000 acquisition line of credit which is subject to certain approvals by the granting institution before funds can be drawn and bears interest at LIBOR plus 1.50%. This line of credit contains covenants similar to those outlined above for the catastrophic claims lines of credit. At December 31, 1999, OGGI maintained a balance of $9,250,000 on this line of credit of which $5,550,000 was used to fund the acquisition of Southern and $3,700,000 used to purchase treasury stock.
The tax effect of significant temporary differences that give rise to OGGI's net deferred tax asset as of December 31, is as follows:
The per share weighted-average fair value of options granted during 1999, 1998 and 1997 was $4.11, $5.05 and $10.75, respectively. The fair value of each option grant is estimated on the date of grant using an option-pricing model and the following weighted-average assumptions:
9. EMPLOYEE BENEFIT PLANS (CONTINUED) The following table summarizes information about OGGI's stock options outstanding at December 31, 1999, segregated into meaningful ranges:
On February 11, 1997, in connection with OGGI's subscription offering, 237,286 stock options were granted to directors and officers. These options have an exercise price of $10 per share and are exercisable by the grantee for a period of ten years. The granting of these options was approved by shareholders at OGGI's first Annual Meeting on August 19, 1997. At that time, the price of OGGI's stock was $18.50 per share. The difference between the price of the stock at the measurement date (August 19, 1997) and the exercise price of the options was charged to earnings in 1997. Since these options were granted as non-qualified incentive stock options, OGGI has recognized a deferred tax asset on the difference between the exercise price and the value of the options at the measurement date.
Awards under the MRP vest over a period of five years following the award date. OGGI is recognizing compensation cost over the vesting period equal to the value of the shares granted at the award date. In 1999, 1998 and 1997, $630,200, $491,083 and $196,878 of compensation cost was recognized under the MRP, respectively.
OGGI has a discretionary noncontributory profit sharing plan covering eligible employees. OGGI's contribution to the plan amounted to $0, $73,050 and $58,224 in 1999, 1998 and 1997, respectively.
Separately, OGGI maintains a voluntary defined contribution plan covering substantially all full-time employees of Southern. OGGI matches these employees' contributions 25% up to 6% of compensation. Contributions to this plan amounted to $26,139 in 1999.
Options totaling 27,360, 18,585 and 8,000 at December 31, 1999, 1998 and 1997, respectively, were not included in the computation of diluted earning per share because the options' exercise price was greater than the average market price of the common shares.
Because of the insolvencies of two large medical malpractice insurance companies, OGGI expects to be assessed the maximum allowable under Pennsylvania law (2% of subject premium writings) for the next two to three years. Based upon OGGI's current premium volume this amounts to approximately $1.2 million each year.
The carrying amounts of cash and cash equivalents, short-term investments and long- term debt approximate their fair value.
Fixed income securities, preferred stocks and common stocks are reported at fair value as established by quoted market prices on secondary markets as of the balance sheet dates.
13. RELATED PARTY TRANSACTIONS: (CONTINUED) Neffsville is provided management services by OGIM for a fee as determined under a management agreement. Management fees recognized under the aforementioned management agreement for 1999, 1998, and 1997 are $171,639, $462,061 and $110,220.
Neffsville maintains a quota share reinsurance agreement with Old Guard Fire whereby 90% of Neffsville's business is assumed by Old Guard Fire. The following summarizes the business ceded under the reinsurance agreement as of and for each of the years ended December 31:
Effective January 1, 1998 Old Guard reinsured 100% of New Castle's premiums, losses, and loss adjustment expenses in return for a commission of 35% of ceded premiums written. During 1997, Old Guard participated in a portion of New Castle's reinsurance program. The following summarizes the business assumed from New Castle for the nine months ended September 30, 1998, the date New Castle became a subsidiary of OGGI (See note 1), and for the year ended December 31, 1997.
15. LITIGATION (CONTINUED) approved by shareholders. The suit seeks such compensatory damages as may be allowed by law, a declaration that the Plan violates the Act and the United States and Pennsylvania Constitutions and the rights of the plaintiffs thereunder, and such other relief as the court deems appropriate. OGGI has filed an answer to the amended complaint denying all of the material allegations made against defendants and asserting certain affirmative defenses.
OGGI has filed a motion for summary judgment on all remaining claims. The issues relating to that motion have been fully briefed, but no hearing has yet been scheduled. Discovery is concluded, but no trial date has been set.
If the plaintiffs prevail in the above litigation, the remedy a court would grant or the amount of damages it might award is uncertain. A court has broad discretion to fashion a fair and equitable remedy in light of the nature of the violation, the relative harm to the parties, and the public interest. In some cases, relief is applied on a prospective basis only; in other cases, relief is applied on a retroactive basis. No prediction can be made concerning the remedy a court would fashion or the amount of damages it might award. However, two of the more far-reaching possibilities include:
15. LITIGATION (CONTINUED) distribution of common stock or other equity securities would materially dilute the interests of existing shareholders.
Our report on the consolidated financial statements of Old Guard Group, Inc. and Subsidiaries is included in Item 8 of this Form 10-K. In connection with our audits of such financial statements, we have also audited the related financial statement schedules included in Item 8 of this Form 10-K.
OLD GUARD INSURANCE GROUP SCHEDULE VI--SUPLEMENTAL INFORMATION CONCERNING PROPERTY & CASUALTY INSURANCE OPERATIONS AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997