Consolidated Statements of Income for the years ended December 31, 1996, 1995 and 1994 22
The accounts of Foremost Corporation of America and its subsidiaries have been included in the accompanying financial statements. Intercompany investments and all significant intercompany balances and transactions have been eliminated in consolidation. In order to more clearly reflect the operations of the segments of the consolidated group, certain intercompany charges, consisting principally of rent, interest and commissions, have been included in the operating income and expenses of the segments, but are eliminated from consolidated revenues and expenses.
Reinsurance contracts do not relieve the Company from its primary obligation to the policyholder; consequently, a contingent liability exists to the extent that losses recoverable under reinsurance treaties are not paid to the Company by reinsurers. The Company performs due diligence to ensure that reinsurers with whom the Company has reinsurance contracts are financially able to perform under the terms of the contract.
In accordance with the adoption of SFAS No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts" in 1994, the Company's reinsurance receivables and prepaid reinsurance premiums are reported as assets and no longer netted against unearned premiums and the liability for losses and loss adjustment expenses.
The fair values for all other assets and liabilities are reported at their carrying amounts which represents market value.
The Company expenses the costs of advertising as incurred. Advertising expense was $3,375,000 in 1996, $2,021,000 in 1995 and $1,617,000 in 1994.
Income taxes paid were $12,900,000, $21,557,000 and $7,650,000 for 1996, 1995, and 1994, respectively.
The Company performs ongoing risk and credit evaluations of its agents and insureds. Insurance is written throughout the United States with concentration in the southern and southwestern states.
Certain reclassifications have been made in the 1995 and 1994 financial statements to conform to those classifications used in 1996.
To conform with statutory requirements, bonds and certificates of deposit in principal amounts totaling $12,950,000 were on deposit with various regulatory agencies at December 31, 1996.
The mortgage loans and land contracts are primarily the result of financing sales associated with the development of an office park, an industrial park and a condominium development by the Company. At December 31, 1996, 99% of the mortgage loans and land contracts were categorized as commercial, and 1% as residential. Investment real estate consists primarily of vacant land for a future office park and real estate acquired through foreclosure on mortgage loans totaling $.5 million. The majority of mortgage loans, land contracts and investment real estate is concentrated in Michigan.
Depreciation expense on real estate and equipment utilized by the Company was $1,854,000 in 1996, $2,212,000 in 1995 and $2,493,000 in 1994.
The credit agreement and mortgage loan agreement subject the Company to certain restrictions and covenants related to, among others: the payment of dividends; minimum net worth levels; the sale, lease, transfer or other disposal of properties and assets other than in the ordinary course of business; new indebtedness; the assumption or creation of liens; and maintenance of certain ratios. The mortgage loan contains a covenant limiting the amount of stock repurchases. The Company has exceeded the limit and has requested a waiver of that covenant. The Company expects the waiver to be granted, however, should the waiver not be granted, the lender could declare the loan in default, at which time the Company would refinance the loan.
Borrowing rates on the term loan and revolving credit facility of the credit agreement are based on eurodollar and negotiated rates. During 1995, the Company entered into interest rate swap agreements with a financial institution. The notional principal amount of the swaps is $46 million and $12 million, with both maturing August 31, 2000. These agreements effectively fixed the interest rate on the entire $58 million outstanding under the credit agreement to 7.15%. The interest rate swaps are non-amortizing. The Company's exposure to credit risk is limited to interest movements and is considered to be negligible.
Maturities of long-term debt for each of the five years succeeding December 31, 1996 are as follows:
The Company also provides a Profit-Sharing Retirement and Savings Plan for all employees with one or more years of service. Under this plan the Company can make discretionary profit-sharing contributions as a percentage of eligible compensation. In 1996 and 1995, contributions equal to 5% of eligible compensation of all eligible employees were made by the Company. The savings feature of the plan is a 401(k) plan that allows for voluntary contributions by employees and provides a 50% Company-paid match of the employee's contribution, limited to 2% of the employee's eligible income.
The Company provides a Retirement Supplement Plan for certain key employees which provides monthly lifetime payments or lump sum payments upon retirement or disability, and lump sum payments to beneficiaries upon death. The retirement benefit is based on a percentage of the participant's final average earnings, less the participant's Money Purchase Pension Plan and Profit Sharing Plan benefits (excluding 401(k) plan benefits). The retirement benefits expected to be paid total $4,431,000 and are being amortized over the participants' anticipated employment with the Company, which range from 4 to 15 years. Life insurance contracts have been purchased to fund the retirement benefits. Key employees would receive their entire retirement benefit in the event of a change in control of the Company and their subsequent termination. The maximum contingent liability as of December 31, 1996 relating to the change in control provision is approximately $6,035,000.
The Company has a non-qualified stock option plan which authorizes the granting of options on 650,000 shares of the Company's common stock to certain key employees. During 1995, the Company's Board of Directors authorized, and the shareholders' approved, an additional 400,000 shares of the Company's common stock for future grants under the plan, making the total authorized under the plan 1,050,000. The options, granted at market value, vest at either 33.3% or 25% per year over a three or four year period, with a maximum term of 10 years.
The following table summarizes information about the Company's stock options outstanding at December 31, 1996:
The Company also has a restricted stock plan under which certain key employees were issued 64,814 shares of the Company's common stock in 1988, representing all of the shares available under the plan. The shares are registered in the name of the participant, who has all the rights of a shareholder, subject to restrictions as to transfer until they vest. Compensation expense is recorded over the periods in which they vest. The unamortized market value of the shares awarded is shown separately in shareholders' equity. As of December 31, 1996, 63,126 were vested, 72 shares were issued and non-vested and 1,616 shares remained unissued from forfeitures.
In 1995, the Company adopted and the shareholders' approved a restricted stock plan for the Company's Directors. Under the plan, the Company's Directors may elect to receive shares of the Company's common stock in lieu of their annual retainer fees. The shares are issued at market value and are registered in the name of the participant, who has all the rights of a shareholder, subject to restrictions as to transfer until they vest. Vesting occurs upon the completion of the Director's term. Up to 20,000 shares may be issued under the plan. In 1996 and 1995, 542 shares and 1,158 shares were issued, respectively.
The following is a schedule of future minimum lease payments under cancelable and noncancelable operating leases for each of the five years succeeding December 31, 1996 and thereafter, excluding renewal options:
The following is a schedule of future minimum lease payments under the Company's capitalized finance leases together with the present value of the net minimum lease payments as of December 31, 1996:
Rental expense charged to operations in 1996, 1995 and 1994 amounted to $5,109,000, $4,693,000 and $4,856,000, respectively, including amounts paid under short-term cancelable leases.
The Company has assigned its interest as tenant in a capital lease obligation. In the event of default by the assignee, a contingent liability exists of approximately $1.8 million at December 31, 1996.
In 1990 and 1989, the Company assumed credit life premium under various reinsurance treaties. Under the terms of these treaties, the Company is obligated to reimburse the ceding companies only if the overall incurred loss ratio exceeds a certain percentage. In the fourth quarter of 1990, the ceding companies were declared insolvent and placed into liquidation. The Company believes that its obligations under these treaties are such that it is not responsible to pay claims unless the prescribed loss ratios are exceeded. On June 11, 1996, with the sale of Foremost Life Insurance Company, the amount reserved to cover these reinsurance treaties was transferred to an escrow account. The Company believes that the amount in the escrow account is sufficient to cover all costs associated with these reinsurance treaties. Regarding any obligation the Company may have to indemnify the ceding companies for claims arising under the treaties should the ceding companies be unable to pay, it is the opinion of management and its outside legal counsel that the Company has the right to net any liabilities associated with these treaties against the premium owed to it, in which case there would be no material adverse impact to the Company. To date, no claims have been made against the Company for payment of claims.
The rights expire on December 14, 1999 and may be redeemed by the Company for $.01 per right at any time until the 10th day following the public announcement that a person or group, other than the existing stockholder group, has acquired 20% or more of the Company's common stock. The Company has reserved 200,000 shares of its common stock for issuance upon exercise of the rights.
The Company and its subsidiaries are routinely engaged in litigation in the normal course of business. The 1996 financial statements include an accrual of $4 million in connection with two contingent settlements in the Alabama Litigation. In the opinion of management, these proceedings, as well as the litigation described in Part I, Item 3. are not expected to have a material adverse effect on the Company's consolidated financial position, cash flows or operating results. Further liability, if any, of the Company and its subsidiaries for litigation is not determinable at December 31, 1996.
The Company's operations are principally in the property and casualty segment of the insurance industry. Its property and casualty insurance subsidiaries primarily furnish insurance to the mobile home and recreational vehicle markets. Insurance is written throughout the United States with concentrations in the southern and southwestern states. The nature of the Company's insurance operations expose it to risk in the case of numerous, severe catastrophic events. To minimize this risk, the Company performs ongoing evaluations of its insurance exposures, utilizes reinsurance when appropriate and performs credit and risk evaluations of its agents and insureds.
A director and major shareholder has investment advisory agreements with the Company and currently manages approximately 16% of the Company's investment portfolio. During 1996 and 1995, $745,000 and $424,000 of fees and commissions were earned under these agreements. This director has also been advised by another director in regards to the management of certain investments for the Company.
On June 11, 1996, the Company completed the sale of its life insurance subsidiary, Foremost Life Insurance Company, to Woodmen Accident and Life Company. The sale yield net after-tax proceeds of $17.4 million and the Company incurred an after-tax loss of $698,000 as a result of the sale. The loss was due primarily to the effects of taxes related to policyholders' surplus, discussed in Note 7. The majority of the net proceeds was used to purchase the Company's common stock under the approved stock buy-back program. The financial results of the life insurance segment and the sale are reflected in the financial statements as discontinued operations for all years presented.
Summarized results of operations and financial position for discontinued operations were as follows:
To the Shareholders and Board of Directors Foremost Corporation of America Grand Rapids, Michigan
We have audited the accompanying consolidated balance sheets of Foremost Corporation of America as of December 31, 1996 and 1995, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Foremost Corporation of America at December 31, 1996 and 1995, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles.
Our audits of the consolidated financial statements were performed for the purpose of forming an opinion on those financial statements taken as a whole. The supplemental statements on page 25 are presented for additional analysis and are not a required part of the consolidated financial statements. Such information has been subjected to the auditing procedures applied in the audits of the consolidated financial statements and, in our opinion, is fairly stated in all material respects in relation to the consolidated financial statements taken as a whole.