The Company owns its headquarters building in Sarasota, Florida, which contains approximately 112,000 square feet of space, as well as an adjacent parking facility. The Company leases an aggregate of approximately 57,000 square feet of office space at 7 other locations in six states, including Florida, under terms expiring through June 2001. The Company incurred rent expense of $1.7 million for the year ended December 31, 1997. Additionally, the Company has continuing commitments through October 2000 of approximately $0.4 million in the aggregate related to four locations in which offices were closed during 1997.
Prior to 1996, the Company's core at-risk operations were entirely focused in Florida; however, during 1996, the Company completed several acquisitions including an insurance company that was licensed in 19 states, and loss portfolio transfers and assumption reinsurance transactions with several self insurance funds outside the state of Florida, all of which allowed the Company to diversify its at-risk operations outside the state of Florida. The diversification of at-risk premiums outside the state of Florida continued during 1997. A comparison of the Company's direct premiums written by state (prior to reinsurance cessions or assumptions) is presented below:
(a) Includes RIC, RPC and RNIC for 1997 and 1996, and RIC and RPC for 1995.
The Company experienced increased pricing pressures during 1997 and expects that such pressures will continue into the foreseeable future. The Company intends to continue applying managed care techniques to differentiate itself from its competitors and to continue to reduce claims costs. During 1997, the Company made the strategic decision to discontinue writing business owners' protection, commercial multiple peril and auto and focus on its core workers' compensation business. Net written premiums on these lines of business were less than $1.0 million during 1997 and were less than $0.5 million in 1996. In addition, in June 1997, the Company implemented a strategic plan to consolidate several of its field offices and announced its intention to close all field offices, except Charlotte and Birmingham, by the end of 1997, and to cease writing new business in certain states including Oklahoma, Virginia, Missouri, Mississippi, Louisiana and Kansas. The estimated impact of the decision to discontinue writing business in these states was a reduction of approximately $16.0 million in direct premiums written.
The Company attempts to lower claims costs by applying managed care techniques and programs to workers' compensation claims, particularly by providing prompt medical intervention, integrating claims management and customer service, directing care of injured employees through a managed care provider network, and availing itself of potential recoveries under subrogation and other programs. See "Business - The Company's Operating Philosophy," for further discussion.
Part of the Company's claims management philosophy is to seek recoveries for claims which are reinsured or which can be subrogated or submitted for reimbursement under various states' recovery programs. As a result, the Company's losses and loss adjustment expenses are offset by estimated recoveries from reinsurers under specific excess of loss and quota share reinsurance agreements, subrogation from third parties and state "second disability" funds, including the SDTF.
Florida operates the SDTF that reimburses insurance carriers, self-insurance funds and self-insured employers for excess workers' compensation benefits paid to employees when an employee is injured on the job and the injury to the worker merges with, aggravates, or accelerates a preexisting impairment. The SDTF is managed by the State of Florida and is funded through assessments against insurers and self-insurers providing workers' compensation coverage in Florida. The SDTF's assessment formula has historically yielded sufficient revenues for annual reimbursement payments and for costs associated with administering the SDTF; however, the SDTF has not prefunded its claims liability and no reserves currently exist. As of September 30, 1996, the SDTF had an actuarially projected undiscounted liability of approximately $4.0 billion based on a study performed for the SDTF by independent actuarial consultants. In addition, the SDTF actuarial study indicated that, at the current assessment rates, the payment of the existing liability would take numerous years.
Direct earned premiums for the first six months of 1997 increased $31.1 million from the same period in 1996, while direct earned premiums for the last six months of 1997 decreased $29.8 million from the same period in 1996. The decrease in direct earned premiums for the last six months of 1997 of $29.8 million from the same period in 1996 was primarily due to the decrease in new and renewal premiums that the Company experienced in the second, third and fourth quarters of 1997 from the adverse publicity pertaining to the A.M. Best ratings of the Company's insurance subsidiaries (see "Business - A.M. Best Ratings of Insurance Subsidiaries"), the Company's inability to file its Form 10-K, 10-Q's and audited statutory financial statements in a timely manner and the delisting of the Company's stock by NASDAQ. In addition, the direct premiums earned for the first six months of 1997 were favorably impacted by the rapid growth that occurred in 1996 after the Company's initial public offering ("IPO") of stock in 1996. The $1.3 million net increase in the direct premiums earned for the year ended December 31, 1997 was primarily the result of the following factors:
Enhanced marketing initiatives implemented after the IPO to increase the number of policies and to write accounts with larger premiums.
These increases were almost entirely offset by a decrease in new and renewal premiums in the second, third and fourth quarters of 1997 due to the adverse publicity discussed above.
The net increase from 1995 to 1996 was primarily due to loss portfolio transfers and premium growth in states licensed through RNIC.
The increase in assumed premiums earned from 1996 to 1997 is primarily the result of the Company recording $11.4 million of earned premiums in the fourth quarter of 1997 from the National Council on Compensation Insurance, Inc. ("NCCI") pool participation. The remaining 1997 assumed premiums of $7.1 million are primarily the result of a fronting agreement entered into in September 1995 with another insurer which enabled the Company's insurance subsidiaries to begin expansion into states where they were not licensed. The assumed premiums from the fronting agreement were approximately $7.1 million for the year ended December 31, 1997 compared to $11.7 million for the year ended December 31, 1996. The assumed premiums earned for the third and fourth quarter of 1997 were approximately $1.1 million. The decrease in assumed premiums from the fronting agreement of approximately $3.0 million per quarter for the third and fourth quarters of 1997 was due to a reduction in the premium writings under this agreement.
Fee and other income for the years ended December 31, 1997, 1996 and 1995 was $20.4 million, $31.7 million and $22.4 million, respectively. The decrease of $11.3 million from 1996 to 1997 was primarily due to the loss of service fees from the conversion of the National Alliance for Risk Management ("NARM") self insurance funds of Virginia (which were previously managed by the Company) to at-risk business via a loss portfolio transfer and decreases in RISCORP West, Inc. ("RWI") service fees from the termination of RWI's Mississippi and Louisiana service contracts. The decrease in fee income was partially offset by new fees generated from CompSource, the fronting agreement discussed above, the new service agreement with Third Coast Insurance Company (a joint venture between the Company and another insurer) that began April 1, 1996 and growth in other existing fee products. The net increase of $9.3 million from 1995 to 1996 was primarily due to new fees generated from CompSource, the fronting agreement entered into in 1995, the new service agreement with Third Coast Insurance Company, growth in the Company's other existing fee products, offset by decreases in commissions on reinsurance premiums, loss of service fees when NARM and the Virginia funds (which were previously managed by the Company) were converted to at-risk business through loss portfolio transfers during 1996, and decreases in RWI service fees from the termination of RWI's Mississippi and Louisiana service contracts.
Net investment income for the years ended December 31, 1997, 1996 and 1995 was $16.4 million, $12.2 million and $6.7 million, respectively. The $4.2 million increase from 1996 to 1997 and the $5.5 million increase from 1995 to 1996 was primarily due to the increase in the investment portfolio balance during 1997 and 1996 due primarily to (i) to the investment of proceeds from the IPO by RISCORP into its insurance subsidiaries, which, in turn, invested the proceeds in their individual investment portfolios, (ii) the growth in premium volume during 1997 and 1996 which generated positive cash flow which was used to purchase investments, and (iii) the positive cash flow generated from the proceeds received from the 1996 loss portfolio transfers and assumption reinsurance transactions which were also used to purchase investments.
The loss ratio for the year ended December 31, 1997, 1996 and 1995 was 57.9 percent, 65.7 percent and 60.7 percent, respectively. Losses and loss adjustment expenses for the years ended December 31, 1997, 1996 and 1995 were $104.0 million, $114.1 million and $82.5 million, respectively. The decrease in the loss ratio from 1996 to 1997 was due primarily to favorable development in Florida (6.5 percent) and North Carolina (1.0 percent), and unfavorable development in Alabama (1.0 percent) relating to the Company's 1996 and earlier accident years' loss and loss adjustment reserves. The favorable development in the Florida business was due primarily to the reduction in the loss and loss adjustment expense reserves resulting from an actuarial analysis completed in the fourth quarter of 1997 and the favorable development for the 1996 accident year resulting primarily from favorable development of post 1993 Florida accident years due to enhanced savings from the legislative changes that became effective in 1994. The net increase in the loss ratio from 1995 to 1996 was primarily attributable to higher loss ratios on the business written in new states licensed through RNIC and higher loss ratios on the business acquired through assumption reinsurance transactions than the loss ratios on the Company's core Florida business.
The unallocated loss adjustment expense ratio for the years ended December 31, 1997, 1996 and 1995 was 10.7 percent, 7.4 percent and 7.5 percent, respectively. The net increase in unallocated loss adjustment expenses of $6.4 million from 1996 to 1997 was primarily due to the strengthening of these reserves in 1997 based on an actuarial analysis performed by the Company during 1997. The unallocated loss adjustment expense ratio for 1996 and 1995 were comparable. The net increase of $2.8 million from 1995 to 1996 in the unallocated loss adjustment expenses was attributable to the growth in premium volume.
Interest expense for the years ended December 31, 1997, 1996 and 1995 was $1.9 million, $2.8 million and $4.6 million, respectively. The decrease of $0.9 million from 1996 to 1997 and the decrease of $1.8 million from 1995 to 1996 was attributable primarily to the repayment of $28.6 million of bank borrowings in March 1996 with proceeds from the IPO.
Depreciation and amortization expenses for the years ended December 31, 1997, 1996 and 1995 were $7.4 million, $11.5 million and $1.7 million, respectively. The decrease from 1996 to 1997 of $4.1 million was primarily the result of the impairment losses recognized in 1996 offset by a full year's amortization of goodwill recognized on the 1996 acquisitions. There were no impairment losses recognized in 1997. The increase of $9.8 million from 1995 to 1996 was primarily due to the $3.2 million and $2.8 million write-off of goodwill associated with RWI and IAA, respectively.
The effective tax rates for the years ended December 31, 1997, 1996 and 1995 were 50.0 percent, 77.4 percent and 27.1 percent, respectively. The decrease in the effective tax rate from 1996 to 1997 was primarily the result of the decrease in the non-deductible amortization of goodwill and the reduction in state taxes in excess of the federal tax benefit. The increase in the effective tax rate from 1995 to 1996 was primarily the result of increases in the non-deductible amortization of goodwill resulting from the impairment losses recognized in 1996 and increases in state taxes in excess of the federal tax benefit.
On June 17, 1997, the Company entered into an agreement with Zenith to purchase substantially all of the operating assets of the Company and its affiliates at a purchase price equal to the greater of: (i) the book value of the acquired assets less the book value of the assumed liabilities, or (ii) $35 million cash and assumption of $15 million of debt. The transaction is subject to shareholder and regulatory approval. See "Business - Asset Purchase Agreement with Zenith."
Cash flow (used in) operations for the years ended December 31, 1997, 1996 and 1995 was ($22.9) million, $28.1 million and ($47.3) million, respectively. The decrease from 1996 to 1997 was due primarily to reductions in unearned premiums, and loss and loss adjustment expense reserves resulting from a decrease in direct premiums written of $76.2 million as well as increases in commissions, general and administrative expenses and unallocated loss adjustment expenses of $4.8 million and $6.4 million respectively. The increase from 1995 to 1996 was due primarily to the improved cash flows resulting from ceding of premiums under the AmRe Quota Share Reinsurance agreement and increases in reserves for losses and loss adjustment expenses.
In addition, the liquidity of the Company could be adversely affected by certain legal issues and its initial A.M. Best rating. See "Legal Proceedings" and "Business - A.M. Best Ratings of Insurance Subsidiaries."
As of December 31, 1997 and 1996, the Company's insurance subsidiaries had combined statutory capital and surplus of $96.3 million and $90.6 million, respectively. The individual statutory capital and surplus of each of the Company's insurance subsidiaries at December 31, 1997 and 1996 exceeded the minimum statutory capital and surplus required by their state of domicile.
The Company's consolidated financial statements, footnotes and supplementary schedules are set forth on pages to hereof.