GEICO, the principal subsidiary of the Corporation, owns its GEICO Plaza headquarters building in Chevy Chase, Maryland, its Regional Office buildings in Woodbury, New York, Macon, Georgia, Dallas, Texas, and Stafford County near Fredericksburg, Virginia, certain of its claims drive-in facilities and certain additional properties. GEICO also leases its Regional Offices in San Diego, California and office space and drive-in claims facilities in various cities in the United States. These facilities will accommodate foreseeable space requirements.
Ownership Plan was terminated. These transactions will be recorded immediately prior to the merger in 1996. As a result of the merger, the Corporation is entitled to omit certain information from this Form 10-K pursuant to General Instruction J to Form 10-K and provides the following discussion pursuant to paragraph (2)(a) thereof.
Premiums -- Consolidated premiums earned in 1995 were $2,787.0 million, up 12.5% from a year ago when premiums were $2,476.3 million. Premium growth reflects an increase of 3.1% in total policies in force in 1995 and modest average rate changes.
Voluntary auto policies-in-force increased 7.6% during 1995. Policy growth in the standard and nonstandard auto lines was 26.5% as efforts have been expanded to offer a rate quote to potential customers who do not meet GEICO preferred-risk underwriting guidelines. Voluntary auto new business sales in 1995 increased 16.5%. Preferred-risk voluntary automobile rates increased 5.3%. Renewal persistency in the preferred-risk auto lines exceeded 92%.
Residual market (involuntarily written assigned-risk business) policy counts decreased 21.5% during 1995. The business continues to remain unprofitable due to the inadequate rates dictated by the regulators. The premium rates for involuntarily written business in GEICO increased an average of 11.3% during 1995.
Realized Gains on Investments -- Pretax net realized gains were $21.6 million in 1995. Realized gains are primarily from the sale of equity securities. Such gains are a result of financial market conditions and can, therefore, fluctuate widely from period to period. The components of realized and unrealized gains and losses on investments are detailed in Note E to the financial statements.
Life benefits and interest on policyholders' funds were $9.8 million in 1995 compared to $8.6 million in 1994 reflecting growth in structured settlement annuity business.
Policy acquisition expenses increased 6.5% in 1995 to $213.1 million. The increase reflects the growth in business partially offset by the effect of reducing the general expense ratio to 13.6% from 14.3% in 1994.
The consolidated statutory underwriting ratio was 95.9% in 1995 compared to 96.4% in 1994 reflecting improved underwriting results.
Interest expense increased to $34.4 million in 1995 reflecting the issuance of $100 million of 7.5% Notes in April 1995. Interest expense also includes interest on deferred compensation which is linked to changes in the Corporation's stock price for those individuals who choose that option. Such interest expense was $4.2 million in 1995 and negative in 1994 when the stock price declined.
Federal income taxes were $60.7 million in 1995 compared to $42.4 million in 1994. The increase reflects a larger underwriting gain from insurance operations and higher investment income.
Net unrealized appreciation of investments, which is reflected in shareholders' equity but not in net income, increased $298.6 million, net of deferred taxes, in 1995 to $389.7 million at December 31, 1995. The unrealized appreciation on fixed maturities was $135.0 million during 1995 resulting in unrealized appreciation of $74.3 million as of December 31, 1995 due to a significant decrease in interest rates during the year. The unrealized appreciation on equity securities increased $163.6 million during 1995 to $315.4 million. In 1994 the unrealized appreciation on investments decreased $101.1 million due to $142.5 million of unrealized depreciation on fixed maturities due to a significant increase in interest rates partially offset by $41.4 million of unrealized appreciation on equity securities.
We have audited the accompanying consolidated balance sheets of GEICO Corporation and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1995. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits.
Approximately 6% of the Corporation's premium is from homeowners insurance. In 1995 the Corporation entered an agreement with Aetna Life and Casualty to phase out of the homeowners insurance business over the next three years. New homeowner customers are offered Aetna policies and most existing homeowner customers will be offered renewal policies in Aetna as their policies begin to expire after January 1, 1996. The Corporation's subsidiaries will act as the servicing agents for these policies.
Effective December 31, 1993, the Corporation adopted Statement of Financial Accounting Standards No. 115 "Accounting for Certain Investments in Debt and Equity Securities" which requires the classification of securities into one of three categories: held to maturity, available for sale, or trading. All fixed maturities (bonds, notes and redeemable preferred stocks) have been classified as available for sale and reported at market value since the Corporation may not hold those securities to maturity. All equity securities (common stocks and nonredeemable preferred stocks) have been classified as available for sale and reported at market value. Prior to December 31, 1993, all fixed maturities were reported at amortized cost and all equity securities were reported at market value. Short-term investments are carried at cost, which approximates the fair value of these instruments due to their short maturity. Short-term investments include repurchase agreements which are fully collateralized by U.S. Treasury securities or obligations of U.S. government corporations and agencies.
Costs that vary with and are directly related to the production of business and are recoverable have been deferred. Such costs include direct response advertising, certain underwriting and policy issuance costs, commissions, and premium taxes. The costs of acquiring insurance are being amortized to income as the related written premiums are earned.
The annual provisions for depreciation are computed by the straight-line method over 27 to 45 year useful lives for buildings and over 3 to 10 year useful lives for equipment.
Property and casualty premiums are earned prorata over the terms of the policies, and life and annuity premiums are recognized as revenue over the premium paying period. Premium revenue is reported net of reinsurance.
The Corporation files a consolidated federal income tax return which includes all subsidiaries except Criterion Life, which files a separate return.
Effective January 1, 1993, the Corporation adopted Statement of Financial Accounting Standards No. 109 "Accounting for Income Taxes" which required an adjustment of deferred taxes to the liability method and also established guidelines for recognizing deferred tax assets. The cumulative effect of adopting this statement was a charge of $8.8 million which is included in the consolidated statements of income as a change in accounting principle.
Effective January 1, 1994, the Corporation adopted Statement of Financial Accounting Standards No. 112 "Employers' Accounting for Postemployment Benefits" which required employers to accrue postemployment benefits, such as long-term disability benefits, over the period the employee works to earn the benefit rather than using a pay-as-you-go cash basis. The cumulative effect of adopting this statement was a charge of $1.1 million, net of tax, which is included in the consolidated statements of income as a change in accounting principle.
Property and casualty insurance is the Corporation's dominant business segment. The Corporation's property and casualty insurance subsidiaries include Government Employees Insurance Company (GEICO), GEICO General Insurance Company, GEICO Indemnity Company and GEICO Casualty Company. Summary financial data are as follows:
Merastar Insurance Company and Southern Heritage Insurance Company, former subsidiaries, were sold effective December 31, 1993 to a partnership, of which GEICO Corporation's former Chairman is the general partner, resulting in no material realized gain or loss after tax. Merastar and Southern Heritage had approximately $96.1 million of assets and $42.0 million of shareholder's equity at the date of sale and premiums of $40.6 million in 1993. The results of their operations are included in the property and casualty results until the date of sale in 1993.
Criterion Life Insurance Company, a subsidiary, writes structured settlement annuities for the Corporation's property and casualty affiliates. Summary financial data are as follows:
The Corporation's investments in Federal Home Loan Mortgage Corporation and Mattel, Inc. common stock with market values of $274.4 million and $230.6 million, respectively, exceeded 10% of the Corporation's shareholders' equity at December 31, 1995.
There were no investments in fixed maturities which were non-income producing for the year ended December 31, 1995.
Realized gains and losses from sales and maturities of fixed maturities consist of gross realized gains of $4.2 million, $1.4 million and $8.0 million and gross realized losses of $.2 million, $3.5 million and $.6 million for 1995, 1994 and 1993, respectively.
Reserves at December 31, 1995 include $111.5 million ($59.9 million net after reinsurance) for commercial umbrella liability business, which was issued by GEICO from 1981 to 1984. The ultimate development of losses related to the significant risks of this long-tail business, which includes environmental and product liability risks, is uncertain. Losses for GEICO's commercial umbrella business cannot be projected using traditional actuarial methods. The reserve for this business represents management's estimate of the ultimate liability which will emerge from a small number of potentially large claims. Management believes that the ultimate resolution of the commercial umbrella business will not have a material impact on the Corporation's financial position and results of operations.
Interest of $28.1 million, $27.3 million and $18.2 million was paid during 1995, 1994 and 1993, respectively.
The aggregate maturities of consolidated debt for the years 1996 through 2000 are $22.3 million; $10.2 million; $8.7 million; $15.4 million and $6.5 million, respectively.
Property with a cost of $17.5 million has been pledged as collateral for the 9.53% note of GEICO.
Federal income taxes of $73.3 million, $60.9 million and $71.7 million were paid during 1995, 1994 and 1993, respectively.
A reconciliation of the effective federal income tax rate in the consolidated statements of income to the prevailing federal income tax rate of 35% is as follows:
The Corporation has not established a valuation allowance because it believes it is more likely than not that all deferred tax assets will be fully realized based upon the Corporation's past history of profitability and anticipated future earnings.
Under the Corporation's 1985 Stock Option Plan, options and related stock appreciation rights (SARs) were granted to officers and key employees for the purchase of Common Stock at 100% or more of the fair market value at the date of grant. The options were exercisable in installments beginning one year from the date of grant and expired not more than ten years and one month thereafter. Exercisable options at December 31, 1995, 1994, 1993 and 1992 were 320,675; 374,125; 389,435 and 375,435, respectively. Under the plan, an individual could exercise any combination of stock options and SARs as long as the aggregate number did not exceed the number of stock options granted to that individual. No more options may be granted under this plan. In January 1993 the remaining outstanding SARs related to options under the 1985 Stock Option Plan were cancelled and, accordingly, no further charge was made against earnings for SARs.
Under the Corporation's 1992 Stock Option Plan, options to purchase 2,500,000 shares of Common Stock were granted to officers and key employees. The purchase price could not be less than 100% of the fair market value at date of grant, and the options were exercisable in installments beginning six months from the date of grant and expired not more than ten years thereafter. Exercisable options at December 31, 1995, 1994, 1993 and 1992 were 780,600, 761,830, 71,500 and 17,500, respectively.
On January 2, 1996, pursuant to the terms of the merger with Berkshire, each holder of a then outstanding option was entitled to receive cash from the Corporation, in settlement thereof, in the amount of the excess of $70 over the exercise per share price of each option held, with the right to defer such amount under the Corporation's deferred compensation plan. The Corporation's obligation to settle the options outstanding at the merger date was $32.9 million of which $6.2 million was paid in cash in January 1996 and the remainder was deferred. As a result, a charge of $21.5 million will be made immediately prior to the merger in 1996 for the excess of the $32.9 million obligation over $11.3 million previously accrued for SARs related to the options.
Under the Corporation's performance share plan, as approved by shareholders, awards of performance shares were made to key executives to be paid based on the attainment of certain goals. Charges of $3.0 million, $1.8 million and $3.1 million were made against 1995, 1994 and 1993 earnings, respectively, under the plan. As of December 31, 1995, 103,227 performance share awards were outstanding. Pursuant to the merger with Berkshire, any payment made after the merger will be made in cash on the basis of $70 per share and no Common Stock will be issued. Additionally, no future awards will be granted.
The Corporation and its subsidiaries have a noncontributory defined benefit pension plan covering most full-time employees. The plan provides for payment based on salary and years of service. Annual contributions to the plan are based on amounts determined by consulting actuaries. Plan assets at December 31, 1995 consist primarily of common stocks and U.S. Government obligations.
Effective January 1, 1994 the Corporation adopted Statement of Position No. 93-6 "Employers' Accounting for Employee Stock Ownership Plans" on a prospective basis for shares acquired after December 31, 1992 (new shares). Compensation cost was recognized on new shares based on the fair value of the shares as of the date the shares were committed-to- be-released to participants' accounts. Dividends on allocated new shares were charged to retained earnings. Dividends on unallocated new shares were charged to compensation cost and the shares were not considered outstanding for earnings per share computations until committed-to-be-released. Compensation cost for shares acquired on or before December 31, 1992 (old shares) was recognized based on the cost of the shares to the plan. Dividends on old shares were charged to retained earnings and such shares were considered outstanding for earnings per share computations.
In 1993 the Corporation adopted Statement of Financial Accounting Standards No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions." The cumulative effect of adopting this statement in 1993 was a charge of $3.9 million, net of tax, which is included in the consolidated statements of income as a change in accounting principle. Prior to 1993, the cost of providing these benefits was recognized on a pay-as-you-go basis.
Rental expense for all leases was $14.2 million in 1995, $14.7 million in 1994 and $13.7 million in 1993.
Statement of Financial Accounting Standards No. 107 "Disclosures about Fair Value of Financial Instruments" defines the fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties.
The carrying amounts and fair values of the Corporation's financial instruments are as follows:
The fair value of investments in fixed maturities are based on quoted market prices, where available, and obtained from independent pricing services for securities not actively traded. Equity securities are valued based on quoted market prices. The cost of short-term investments approximate fair value due to the short maturity of these instruments. The fair value of net loans receivable is based on their estimated net realizable value. The fair value of policyholders' funds on deposit is determined by discounting future cash flows. Debt is valued based on quoted market prices for GEICO Corporation's Debentures and on quoted market prices for similar issues of debt with similar remaining maturities for all other debt.