Effective January 1, 1996, the Registrant entered into a lease at 95 Route 17 South, Paramus, New Jersey. The Registrant's home office is now located at this facility. The lease expires on December 31, 2005. The Registrant has an option to terminate the lease after six years, and an option to extend the lease for an additional five years after the initial lease term expires.
Pursuant to the terms of the Release, the lease of the office building in Newark, New Jersey in which the Registrant and its subsidiaries formerly operated was terminated in exchange for $132,000. The lease was to run to December 31, 2011 at an annual rent of $324,000, plus expenses. The Release also enabled the Registrant to terminate the Joint Service Agreement ("JSA"). See Note Q to the Notes to Consolidated Financial Statements of Motor Club of America and Subsidiaries ("Notes") for further information.
The Registrant provides property and casualty insurance related services through the Insurance Companies. The Registrant also operated until December 1, 1996 a motor club through Enterprises. The Insurance Companies form the largest segment of operations, which accounted for 96% of 1996 revenues.
The Registrant anticipates continuing revenue growth in the State of New Jersey through small commercial and ancillary coverages written by Preserver as well as through new PPA writings by Motor Club.
The Registrant seeks to increase its identification as a provider of small commercial lines insurance. The Registrant also seeks to expand and diversify its insurance operations outside the State of New Jersey. The Registrant believes that both of these objectives can be attained through the acquisition of other insurance companies which present opportunities to write these product lines in different geographic areas. The Registrant expects to pursue these objectives during 1997 and beyond.
The Registrant also anticipates continued reductions in its operating expenses, namely through the implementation of operating efficiencies which should reduce other overhead expenditures.
The JSA entered into as part of the Settlement was retroactive to May 1, 1994 and provided for the rendering of certain services by the parties to the JSA and amounts due for these services, as well as the sharing of certain common expenses. Common expenses emanated from the parties' co-tenancy in the office building in which the parties' principal offices resided. The JSA was terminated effective March 31, 1996.
Motor Club received relief from the New Jersey Department of Banking and Insurance ("NJ DOBI") from certain provisions of the FAIRA. Such relief included the following: (1) exemption from its obligation to pay surtaxes and assessments on business written until December 31, 1992. These exemptions allowed Motor Club to reverse previously accrued surtaxes and assessments of $2,003,000 as a reduction of expense in 1994; (2) exemption (until January 1995) from the take-all-comers provisions of FAIRA, which requires the writing of new PPA insurance; (3) payment in 1994 of only $2,275,000 of the Market Transition Facility ("MTF") deficit (legislation retired the entire MTF deficit, enabling Motor Club to eliminate its remaining $1,653,445 MTF liability in 1994 as a reduction of expense); and (4) non-participation in the Personal Automobile Insurance ("Assigned Risk") Plan, through December 1996.
The New Jersey PPA market has historically been subject to regulatory and legislative volatility which has, at times, adversely affected the profitability of this line of business. The State of New Jersey also maintains an excess profits law which provides that PPA insurers whose profits exceed a statutorily computed maximum over a period of years will be required to pay such excess to its policyholders. It would appear that Motor Club does not have such excess profits.
The table below reconciles operating net income to reported net income for 1996, 1995 and 1994 with adjustments for certain unusual and non-recurring items:
(1) These non-recurring charges were incurred in connection with the termination of the lease of the office building in which the Registrant and its subsidiaries formerly operated.
(3) These non-recurring charges were incurred in connection with the settlement of a previously reported dispute with a reinsurer of Motor Club.
(5) The Registrant believes that it is more likely than not that it will generate future taxable income to realize the benefits of the net deferred tax asset, which consists primarily of net operating loss carryforwards. The Registrant has accordingly eliminated the valuation allowance on its net deferred tax asset in 1996, resulting in a benefit to net income. The ultimate amounts realized, however, could be reduced if actual amounts of future taxable income differ from projected future taxable income.
Operating net income was decreased by $529,000 or $.26 per share in 1996 as compared to 1995 and increased by $1,039,000 or $.51 per share in 1995 as compared to 1994, due to changes in the rate assessed for the New Jersey Unsatisfied Claim and Judgment Fund ("UCJF"), which pertains to New Jersey Personal Injury Protection claims in excess of Motor Club's statutory retention limit of $75,000. The premium rates assessed were approximately 4.5%, 1.4% and 6.4% in 1996, 1995 and 1994, respectively.
Insurance premiums increased $9,893,000 or 28% in 1996 as compared to 1995, primarily as a result of increases in new business written in 1996, particularly PPA.
The following table depicts increases in net earned premiums for 1996 as compared to 1995: Increase in Net Program Premium Percent
The following table depicts the composition of direct premiums written for the five years through 1996:
Net investment income increased $323,000 or 12% in 1996 as compared to 1995. Average invested assets were $46,296,000 in 1996 as compared to $41,806,000 in 1995. The growth in average invested assets and cash from operations is the result of the growth in revenues previously described. The investment portfolio, including short-term investments, yielded 6.25% in 1996 as compared to 6.23% in 1995. The Registrant's investment philosophy is to hold fixed maturity investments until maturity.
Net investment income increased $34,000 or 1% in 1995 as compared to 1994. Average invested assets were $41,806,000 in 1995 as compared to $42,272,000 in 1994. The investment portfolio, including short-term investments, yielded 6.23% in 1995 as compared to 6.21% in 1994. Although interest rate levels declined significantly during 1995, the increase in the Registrant's investment yield reflects investments made at higher interest rate levels in 1994.
Other revenues decreased $11,000 or 9% in 1996 as compared to 1995, and $72,000 or 37% in 1995 as compared to 1994. The decreases were due to reduced mortgage loan revenue and other miscellaneous income reductions.
The combined loss and loss expense ratios were 64.5% in 1996, 58.7% in 1995 and 54.8% in 1994.
Motor Club's loss and loss expense ratio was 61.4% for 1996 as compared to 57.3% for 1995, while the Preserver loss and loss expense ratio was 75.5% for 1996 as compared to 63.1% for 1995. Despite the higher loss and loss expense ratio on a comparative basis, no significant adverse trends were experienced or identified during 1996.
Excluding the loss and loss expense ratio on the new PPA business, the PPA loss and loss expense ratio was 52.2% in 1996, which compares with the loss and loss expense ratios of 55.1% in 1995 and 52.9% in 1994 on the same business. The Registrant believes that it has reserved for the new business conservatively, particularly as compared to its other PPA business.
The increase in Preserver's loss and loss expense ratio in 1996 as compared to 1995 is primarily attributable to: (1) winter storm losses of $635,000; and (2) poor liability experience caused by a limited number of large losses greater than $35,000. Frequency of losses has generally been at acceptable levels. This increase has been partially offset by the improved experience (excluding winter storm losses) in the homeowners line of business.
Acquisition costs incurred increased $2,856,000 or 25% in 1996 as compared to 1995 and increased $788,000 or 7% in 1995 as compared to 1994. The increase in acquisition related costs generally corresponds to the premium growth previously described.
The decrease in other operating expenses in 1996 as compared to 1995 resulted from lower operating expenses in general, including lower salaries and the savings realized from the aforementioned relocation.
The decrease in expenses has allowed for a decrease in the expense ratio (as adjusted for the non-recurring charges described above) to 36.8% for 1996 as compared to 43.9% for 1995. This decrease is the realization of the Registrant's previously stated strategy to increase its revenue while decreasing its overhead expenditures.
During 1995 these expenditures decreased $990,000 or 15% as compared to 1994. The cause of the decrease in 1995 as compared to 1994 was reduced salaries, benefits and professional services.
See the New Jersey Private Passenger Automobile section for an extended discussion of the New Jersey expenses mandated by FAIRA.
The Registrant is subject to certain assessments and required participations in mandated pools, associations and funds in the State of New Jersey. The most substantial assessments have been the FAIRA surtaxes and assessments. The surtaxes expired in 1992; the assessments are schedule to expire after 1997. FAIRA assessments totaled $962,000, $843,000 and $620,000 in 1996, 1995 and 1994, respectively.
The liability for unpaid losses and loss expenses are determined using case-basis evaluations and statistical projections and represent estimates of the ultimate net cost of all unpaid losses and loss expenses through December 31 of each year. These estimates are continually reviewed and refined as historical experience develops, new information becomes known and the effects of trends in future claim severity and frequency are considered.
The liabilities are adjusted accordingly with such adjustments being reflected in the current year operations. No trends that are considered abnormal have been identified as of the most recent evaluation date, December 31, 1996.
The following table presents a reconciliation of beginning and ending liability balances for 1996, 1995 and 1994 reported under generally accepted accounting principles ("GAAP"):
The difference between the reserves for unpaid losses and loss expenses reported in the Registrant's consolidated financial statements prepared in accordance with GAAP and those reported in the annual statements filed by the Insurance Companies with State insurance departments in accordance with Statutory Accounting Practices ("SAP") are reconciled as follows:
The table on Page 25 presents the development of the GAAP balance sheet liabilities for 1992 through 1996; data is presented for those years in which the Insurance Companies had operations.
The top line on the table shows the estimated liability for unpaid losses and loss expenses recorded at the balance sheet date for each of the indicated years. This liability represents the estimated amount of losses and loss expenses for claims arising in that and all prior years that are unpaid at the balance sheet date, including losses that had been incurred but not yet reported. The upper portion of the table shows the re-estimated amount of the previously recorded liability, based on experience as of the end of each succeeding year. The estimate is increased or decreased as more information becomes known about the frequency and severity of claims for development years. The "cumulative redundancy (deficiency)" represents the aggregate change in the estimates over all prior years. The lower section of the table shows the cumulative amount paid with respect to the previously recorded liability as of the end of each succeeding year.
In evaluating this information, it should be noted that each amount includes the effects of all changes in amounts for prior periods. For example, the amount of deficiency relating to losses settled in 1996, but incurred in 1993, will be included in the cumulative deficiency for the 1996 year.
The Registrant's book value increased to $6.89 per share at December 31, 1995 from $5.16 per share at December 31, 1994. The principal sources of the net increase are: (1) net income of $2,417,000 or $1.18 per share; plus (2) an increase of $2,661,000 or $1.30 per share in the fair value of the fixed maturity investments accounted for as available-for-sale securities under SFAS No. 115; offset by (3) a reduction in shareholders' equity of $1,545,000 or $.75 per share for recognition of additional minimum required pension liability. The additional minimum required liability was the result of a reduction in the discount rate used to compute pension plan liabilities to 7.25% at December 31, 1995 from 8.25% at December 31, 1994.
On July 1, 1996, the Insurance Companies obtained catastrophe reinsurance coverage in the increased amount of $29.5 million in excess of $500,000 with only a modest increase in premium.
Net cash utilized in investing activities was $6,015,000 in 1996 and $3,255,000 in 1995. Net cash provided by investing activities was $3,458,000 in 1994. The amounts used in both 1996 and 1995 reflect the investment of cash provided by operating activities; the amounts used in 1996 were offset by the $1,125,000 proceeds from the sale of Enterprises described previously. The amount provided in 1994 reflects the liquidation of investments required for the cash utilized by operating activities.
The Registrant's cash and cash equivalents at year end 1996 were enhanced by the proceeds of the sale of Enterprises. As part of its strategy to expand and diversify its insurance operations, the Registrant seeks to increase the level of cash and cash equivalents available to enable the execution of this strategy.
The payout ratio of losses has not fluctuated substantially over this period. Cash flow from operations is expected to continue to increase as the Registrant increases its revenue through additional premium writings, specifically commercial lines and PPA and continues to reduce its expenses and expense ratio. This will be offset somewhat by the development and payment of losses on the new PPA which Motor Club is writing.
Management has maintained, in its opinion, a conservative investing philosophy. At December 31, 1996 and 1995, the Registrant's investment portfolio was comprised of the following types of securities:
Tax exempt securities have not been acquired. Management believes that the current tax position of the Registrant, which includes substantial net operating loss carryforwards, dictates the exclusion of tax exempt securities from the portfolio, which historically provide substantially lower yields on a before tax basis than taxable securities.
December 31, 1996 December 31, 1995 Carrying Carrying Amount Percent Amount Percent United States Treasuries $27,758,603 57.9% $25,924,344 58.1% United States Government Agencies 6,637,485 13.9% 5,864,485 13.1% GNMA Mortgage-Backed Securities 8,363,964 17.4% 7,798,432 17.5% Corporate Bonds 5,167,041 10.8% 5,043,196 11.3% Total $47,927,093 100.0% $44,630,457 100.0%
The fixed maturity portfolio duration at December 31, 1996 and 1995 is 3.35 and 3.32 years, respectively.
The Registrant has not acquired, nor are there plans to acquire, below investment grade or "junk" bonds. Ninety-seven percent of the fixed maturity portfolio as of December 31, 1996 is graded Class 1 according to the National Association of Insurance Commissioners' valuation system. This classification is reserved for only the highest quality securities, generally rated A or better by two major rating services.
Including realized gains and losses, the investment portfolio yielded 6.26% in 1996 as compared to 6.36% in 1995.
The National Association of Insurance Commissioners ("NAIC") has adopted Risk-Based Capital ("RBC") requirements for property/casualty insurance companies, to evaluate the adequacy of statutory capital and surplus in relation to investment and insurance risks such as asset quality, credit risk, loss reserve adequacy, and other business factors. The RBC formula is used by State insurance regulators as an early warning tool to identify, for the purpose of initiating regulatory action, insurance companies that potentially are inadequately capitalized. Regulatory compliance is determined by a ratio of the insurer's regulatory total adjusted capital to its authorized control level RBC, as defined by the NAIC. Insurers below specific trigger points or ratios are classified within certain levels, each of which requires specific corrective action. The Insurance Companies' ratios are in excess of that required, therefore requiring no action.
In February 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No. 129 - Disclosure of Information About Capital Structure. This Statement becomes effective for financial statements for periods ending after December 15, 1997. This Statement establishes standards for disclosing information about an entity's capital structure. The Registrant does not believe that this Statement will materially change its disclosures regarding its capital structure.