(1) Excludes premiums of $47,588,000 in 1998, $40,136,000 in 1997, $31,603,000 in 1996, $8,893,000 in 1995 and $5,056,000 in 1994 from the Company's fronting arrangements and the commercial automobile plans of Arkansas, California, Louisiana, Mississippi, and Pennsylvania under which the Company is a servicing carrier.
(3) All years retroactively adjusted for stock dividends and stock splits effected as stock dividends as follows: two 5% in 1995 and two 5% in 1994.
The Company recorded a net loss in 1998 of $11,662,564, or $.56 per share (basic), compared to net income for 1997 of $11,923,526, or $.56 per share (diluted), and net income of $16,019,567, or $.74 per share (diluted), for 1996. The Company recorded a GAAP combined ratio of 132.7% in 1998.
On October 23, 1998, the Company completed the acquisition of the Lalande Financial Group, Inc. ("Lalande Group"). The Lalande Group includes National Specialty Lines, Inc. ("NSL") and De La Torre Insurance Adjusters, Inc. ("DLT"). NSL is a managing general agency which markets nonstandard personal auto insurance through approximately 800 retail agencies in Florida. DLT is an automobile claims adjusting firm that provides claim services on NSL produced business and to outside parties. The purchase price was for $18 million in cash paid at closing plus up to an additional $22 million in cash to be paid over approximately five years contingent upon the operating performance of the Lalande Group.
On March 9, 1999, the Company announced the signing of an agreement for sale of the assets of Agents Processing Systems, Inc. ("APS"), its wholly-owed subsidiary engaged in marketing a computer software package related to general agency operations. The sale is expected to be completed in April 1999. The purchaser is to acquire all rights to the APS software products, assignment of the APS customer contracts and other miscellaneous assets for a nominal amount of cash, assumption of contract obligations, a fixed number of software use licenses and development work on an electronic data interchange project. The Company anticipates a small write-off as a result of this transaction.
Gross premiums written in 1998 of $91,162,086 were 9% below the $99,775,854 recorded in 1997, largely because of the run-off of discontinued classes and continued pricing pressure from competition. In 1997, gross premiums written decreased 9% from the 1996 level. In 1997, the run-off of the Kentucky coal truck program and a taxi program in New Jersey contributed 3 percentage points (points) of decrease while increased competition in the Florida, Georgia, Pennsylvania and Virginia markets contributed another 4 points of decrease in 1997. The following table compares the major product lines between the years for gross premiums written:
Insurance services revenues increased $296,268 from 1997 to 1998 following an increase of $252,165 in 1997 from 1996. The table below presents the components.
Fee income increased $124,219 in 1998 over 1997 and $265,021 in 1997 over 1996 as a result of continued growth from the fronting accounts.
Revenues from the premium finance operation are down 52% in 1998 from 1997 and down 17% in 1997 from the 1996 level. The Company decided in the second quarter of 1998 to exit the premium finance business for commercial lines but will continue to offer interest free payment plans for the Company's insurance operations.
Revenues in the Lalande Group are from automobile claim adjusting services and agency commissions on business from outside parties generated since the acquisition.
Claims and claim adjustment expenses ("C & CAE") increased $24,267,337 in 1998 over 1997 and $3,706,923 in 1997 over 1996. The C & CAE ratio was 93.7% in 1998, 60.7% in 1997 and 54.7% in 1996. For 1998 the increase in the C & CAE ratio of 33 percentage points is the result of unanticipated unfavorable development in C & CAE incurred from the 1997, 1996 and 1995 accident years for commercial auto liability. The Company reduced outstanding claim counts 30% in 1998 from the 1997 level. The increase in the C & CAE ratio of 6 percentage points in 1997 is the result of claim reserve increases recorded for commercial auto claims in Kentucky from the 1995 and 1996 accident years and adverse development in claim adjustment expense reserves for commercial auto in the 1994, 1995 and 1996 accident years. While the Company writes a material amount of business in areas where catastrophes have recently occurred, the gross and net claims incurred from these events were immaterial because the Company primarily writes liability coverages. With regard to environmental and product liability claims, the Company has an immaterial amount of exposure. The Company does not provide environmental impairment coverage and excludes pollution and asbestos related
coverages in its policies. The Company's premium writings for product liability coverages are immaterial. Inflation impacts the Company by causing higher claim settlements than may have originally been estimated. Inflation is implicitly reflected in the reserving process through analysis of cost trends and review of historical reserve results.
The change in deferred policy acquisition costs and deferred ceding commission income ("DAC") resulted in a net decrease to income of $297,994 and $1,015,802 for 1998 and 1997, respectively, and a net increase to income of $519,257 for 1996. The change in the amount of the increase or decrease in DAC between the comparable periods is directly related to the rate at which unearned premiums are growing or declining as a result of premium writings. Since DAC (asset) is a function of unearned premiums (liability), an increase in the growth rate of net unearned premiums would correspondingly result in an increase in the growth rate of DAC and vice versa.
For 1998 the Company generated a current tax benefit as a result of the loss from operations. The large increase in the deferred tax benefit is mainly the result of the large increase to C & CAE reserves. The effective tax benefit rate for 1998 of 45% is above the Federal statutory rate largely because of tax-exempt interest income. The effective tax rate of the Company was 19% in 1997 and 24% in 1996. The lower rate in 1997 is largely the result of tax-exempt net investment income representing a larger portion of income than in 1996. For the Company, the fresh start adjustment (tax benefit) was immaterial for all years presented. A reconciliation between income taxes computed at the Federal statutory rates and the provision for income taxes is included in Note 6 of Notes to Consolidated Financial Statements.
Unpaid claims and claim adjustment expenses increased largely as a result of unanticipated unfavorable claim and claim adjustment expense development from prior accident years, as well as material increases from plan servicing and fronting accounts. Unearned premiums decreased because of the decrease in premiums written, offset to some extent by an increase in fronting accounts. Accounts payable decreased because of the decrease in payables contingent upon profitability. Drafts payable decreased because a large amount of drafts were issued in the fourth quarter of 1997 this did not recur in the fourth quarter of 1998. The note payable resulted from the Lalande Group acquisition mentioned previously.
The Company purchased 17,200 shares of its common stock during 1998 at a cost of $142,191, or $8.27 per share, which accounts for the increase in Treasury stock.
Y2K Problem A "Year 2000 problem" exists worldwide because many existing computer programs use only the last 2 digits to refer to a year. Therefore, these computer programs do not properly recognize a year that begins with "20" instead of the familiar "19". If not corrected, many computer applications could fail or create erroneous results. In addition to the two-digit portion of the problem, other date issues can generate erroneous results. These include Year 2000 being a leap year and the use of Gregorian date of 9999 or the use of Julian date 9999 in a date field to alert the program to perform special handling, while Gregorian September 9, 1999 and Julian April 9, 1999 are actual dates.
The Company has completed the assessment phase, the strategy phase, the analysis phase and the planning phase for its hardware and software systems, non-information technology equipment and strategic business relationships. The Company believes that it has completed the remediation and testing phase of all mission critical systems and all hardware. The Company is either in the remediation or testing phase of its non-mission critical software. The Company anticipates that its non-mission critical software will be compliant by June 30,
During 1998 the Company contracted with a major consulting vendor to perform due diligence assessment and testing of its Year 2000 project. While assessing the Company's readiness, the vendor identified some programs that required additional remediation and re-testing. The Company believes that it has corrected all the identified non-conforming programs.
The Company has performed a written survey of all strategic business partners including producers, general agents, material vendors, reinsurers, reinsurance intermediaries, utilities, telecommunications services, web hosting providers, Internet service providers, hardware providers, software providers and financial institutions. The Company is monitoring the progress of the partners, which if impaired by a Year 2000 problem, would have a material impact on the Company. The Company is developing contingency plans in the event that a material business partner is not Year 2000 ready. However, there can be no assurance that all material business partners will be Year 2000 ready and such could have a material effect on the Company's financial position.
A comprehensive review was performed by the Company of the insurance policies written by it and its underwriting guides to determine Year 2000 exposure. The Company made a decision to exclude Year 2000 exposures from all insurance policies written by it and began adding exclusions in November 1997. The Company believes Year 2000 liabilities are not fortuitous in nature and would not be covered under its insurance policies. The Company believes that its coverage exposure with respect to Year 2000 losses will not be material. However, changes in social and legal trends may establish coverage unintended for Year 2000 exposures by re-interpreting insurance contracts and exclusions. Litigation with respect to Year 2000 claims and the attendant costs are to be expected. It is impossible to predict what exposure insurance companies may bear for the Year 2000 losses.
Lalande Readiness The Lalande Group has been addressing its Year 2000 readiness since 1997. As of December 31, 1998, Lalande's mission critical systems are believed to be Year 2000 compliant. The Company expects that Lalande's non-mission critical systems will be Year 2000 compliant by September 30, 1999.
Costs The Company estimates that its costs of addressing the Year 2000 problem will aggregate approximately $880,000, including modifying or replacing software and other systems, hiring Year 2000 solution providers and internal assessment, remediation and testing. Of this amount, approximately $435,000 was expensed prior to 1998, approximately $375,000 was expensed in the twelve months ended December 31, 1998 and approximately $70,000 remains to be expended. These costs are being funded by internally generated funds.
The following consolidated Financial Statements are on pages 36 through 63: