The Nobel U.S. Group purchased a 39,000 square foot building at 8001 LBJ Freeway, Dallas, Texas in 1995 of which 29,000 square feet is occupied by the corporate and commercial lines insurance operations. This property is subject to a lien in favor of Chase Bank of Texas National Association currently in the amount of approximately $954,000. Approximately 10,000 square feet of this building is leased to unrelated tenants.
The Nobel U.S. Group owns a 24,000 square foot building at 6923 North Trenholm Road, Columbia, South Carolina of which 22,300 square feet is occupied by the personal lines insurance operation. Approximately 1,700 square feet of the building is leased to unrelated tenants.
IAS, the claim adjusting operation, leases and occupies approximately 9,423 square feet of office space for their home office and Dallas-based service operation at 1485 Richardson Drive, Richardson, Texas. IAS leases office space for their branch offices located in various cities in the U.S..
(1) "Acquisition cost, net of amortization" is comprised of service fees and commissions, Reinsurance ceding commissions, and Deferred policy acquisition cost amortization.
NET PREMIUMS EARNED. Premiums are earned on a pro rata basis over the policy period, usually one year, and decreased $19,536,000 or 35% during 1997. Commercial casualty lines decreased by $21,409,000 due primarily to the earnings of $13,248,000 on the AmRe quota share premium, along with the reduction in direct written premiums. Specialty lines increased by $930,000 or 8% due to direct premium growth offset by the reinstatement premium. Personal lines increased $943,000 or 13% due to the direct premium growth.
For the "Financial Year" ended December 31, 1997, the Company experienced a net increase in reserves for prior accident years of $2,176,000. For a detailed explanation of reserve redundancies and deficiencies by year and line, see "Business--Reserves". When such deficiency of $2,176,000 is divided by earned premiums for 1997 of $35,865,000 it produces a 6% claims deficiency. This percentage is subtracted from the "Financial Year" current claims expense ratio of 69% ($24,605,000 divided by $35,865,000) to produce the 1997 "Accident Year" total claims expense ratio of 63% (($24,605,000 less $2,176,000) divided by $35,865,000).
On an aggregate basis, net claims and claims adjusting expenses decreased by $17,592,000 in 1997 as follows: (i) a decrease in earned premium of $12,169,000; (ii) a deficiency in reserves for prior years of $2,176,000 for 1997 versus a redundancy of $1,089,000 for 1996, and (iii) a decrease in the current year loss ratio of $2,158,000.
The decrease in net claims and claims adjusting expenses may also be analyzed by line. Commercial casualty decreased by $14,476,000 as follows: (i) a decrease in earned premium of $13,058,000; (ii) a deficiency in reserves for prior years of $652,000 for 1997 versus a deficiency of $4,193,000 for 1996; and (iii) a decrease in the current year loss ratio of $4,959,000. The timing and reporting of large commercial casualty losses impacts reserves when the IBNR reserve for these types of losses is found to be deficient. If there is an increase in the ultimate loss projection for the Accident Year and the Financial Year, the incurred loss ratios would also increase.
Specialty lines increased by $1,249,000 as follows: (i) an increase in earned premium $418,000; (ii) a deficiency in reserves for prior years of $2,639,000 for 1997 versus a redundancy of $498,000 for 1996; and (iii) an increase in the current year loss ratio $3,968,000. Personal lines decreased by $579,000 as follows: (i) an increase in earned premium of $471,000; (ii) a redundancy in reserves for prior years of $140,000 for 1997 versus a redundancy of $23,000 for 1996; and (iii) a decrease in the current year loss ratio $1,167,000. Runoff lines decreased by $3,786,000 as a result of a redundancy in reserves for prior years of $975,000 in 1997 versus a redundancy of $4,761,000 in 1996.
ACQUISITION COST, NET OF AMORTIZATION (UNDERWRITING OPERATIONS). Acquisition cost, net of amortization attributable to underwriting operations consisted of service fees and commissions (which decreased $5,778,000), reinsurance ceding commissions (which decreased $1,677,000) and deferred policy acquisition cost amortization (which decreased $1,655,000) for a net expense decrease of $5,756,000. Commercial casualty net expense decreased $3,733,000 due primarily to the earnings of ceding commissions of $3,836,000 associated with the AmRe 80% quota share premiums. Other changes associated with reduced premium writings, increased deferral rates and increased reinsurance purchased accounted for the balance. Specialty lines net expense decreased by $219,000. Increased commission expense associated with increased premium writings were offset by increased reinsurance ceding commissions. Personal lines net expense decreased by $1,804,000 due primarily to increases in contingent ceding commissions as a result of lower loss ratios.
FEDERAL INCOME TAXES. Federal income tax expense of $765,000 was recognized during 1997, primarily related to the income not taxed in the United States and tax exempt interest income. During 1996, the Company recognized a Federal income tax benefit of $2,069,000 in connection with the elimination of the deferred tax asset valuation allowance and the Nobel U.S. Group incurring a taxable loss.
REINSURANCE PURCHASED. The Company purchases reinsurance to limit maximum loss, diversify risk and to minimize exposure on large or hazardous risks. In 1996 the company realized an increase of $17,587,000, or 77%, as follows. Commercial casualty lines increased by $19,047,000, due primarily to the acquisition of 80% quota share coverage (AmRe 80% quota share reinsurance), effective December 31, 1996. This treaty covers the outstanding unearned premium reserve on subject premium in the auto and general liability lines of business, and amounted to $15,343,000. The remaining increase of $3,704,000 was a result of growth in gross premium written. Specialty lines increased by $1,589,000 as a result of the direct premium growth. Personal lines decreased by $3,049,000, primarily as a result of the restructuring of the quota share treaty from 75% to 50%.
NET PREMIUMS EARNED. Premiums are earned on a pro rata basis over the policy period, usually one year, and increased $12,203,000, or 28%, during 1996. The primary cause was the growth in net written premium in both 1995 and 1996.
NET CLAIMS AND CLAIMS EXPENSES. The claims ratio of 76% for 1996 compares to 73% for 1995 and is analyzed as follows:
For the "Financial Year" ended December 31, 1996, the Company experienced a net decrease in reserves for prior accident years of $1,089,000. For a detailed explanation of reserve redundancies and deficiencies by year and line, see "Business--Reserves". When the $1,089,000 redundancy is divided by the earned premiums for 1996 of $55,401,000 it produces 2% redundancy. When this percentage is added to the "Financial Year" current claims expense ratio of 76%, the sum is the "Accident Year" claims expense ratio of 78%.
For the "Financial Year" ended December 31, 1995, the Company experienced a net increase in reserves for prior accident years of $1,700,000. When such deficiency of $1,700,000 is divided by earned premiums for 1997 of $43,198,000 it produces 4% claims deficiency. This percentage is subtracted from the "Financial Year" current claims expense ratio of 73% ($31,702,000 divided by $43,198,000) to produce the 1995 "Accident Year" total claims expense ratio of 69% (($31,702,000 less 1,700,000) divided by $43,198,000).
ACQUISITION COST, NET OF AMORTIZATION (UNDERWRITING OPERATIONS). Acquisition cost, net of amortization attributable to underwriting operations consisted of service fees and commissions (which increased $4,703,000), reinsurance ceding commissions (which increased $3,549,000) and deferred policy acquisition cost amortization (which increased $4,555,000) for a net expense increase of $5,709,000. Commercial casualty net expense increased $503,000 consistent with increased levels of net earned premiums. Specialty lines net expense increased $2,530,000 primarily due to increased premiums. Personal lines net expense increased $2,676,000 due primarily to decreased contingent ceding commissions as a result of catastrophe claims in 1996.
NET INVESTMENT INCOME AND GAINS. Certain investments were sold during 1996 in order to finance, along with operating cash flow, the repurchase of $14,097,000 of treasury stock. This reduction in invested balances, along with reduced yield rates, contributed to a decrease in net investment income of $1,030,000. Net investment gains decreased by $650,000 due to gains on the sale of equity securities classified as available for sale, offset by unrealized losses in the trading portfolio.
FEDERAL INCOME TAXES. Federal income tax benefit decreased by $431,000. A benefit of $2,069,000 was recorded in 1996, due to the elimination of the valuation allowance related to the deferred tax asset, upon the return of the taxable group to profitable operations.
The credit agreement imposes certain financial covenants including consolidated net worth amount, capitalization ratio, earnings coverage ratio, capital expenditures amounts, statutory amount, operating leverage ratios, fixed change coverage ratios and risk based capital amount. As of December 31, 1997, the Company had not met the earnings coverage ratio. The Company has received from the lender a waiver of the event of default for the year ended December 31, 1997.
There can be no assurance that the systems of our customers, reinsurers or vendors will be timely converted and would not have an effect on the Company. The Company believes that the potential for a loss due to this exposure would be minimal, if any.