The Company owns its Corporate offices which provide approximately 35,000 square feet of office space, and additionally provides parking. Future expansion will be possible by converting the parking area into office space.
The selected consolidated financial data presented below for, and as of the end of each of the years ended December 31, have been derived from the consolidated financial statements of the Company which have been audited by KPMG Peat Marwick LLP, independent certified public accountants. The consolidated balance sheets as of December 31, 1997 and 1996, and the consolidated statements of operations, shareholders' equity and cash flows for each of the years in the three-year period ended December 31, 1997, and the report thereon are included elsewhere in this document. The information presented below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations," consolidated financial statements and the notes thereto, and the other financial information included herein.
(4) Based on number of shares outstanding at the end of each year, retroactively adjusted for stock dividends and stock splits effected as stock dividends.
COMMERCIAL AUTO was down 9% in 1997 from 1996 and flat in 1996 from 1995. Kentucky contributed 4 points of decrease with Georgia, New Jersey, Pennsylvania and Virginia accounting for the remaining 5 points of decrease. A decision was made during the year to discontinue writing Kentucky coal truck risks and a New Jersey taxi cab program because of adverse claim results. In Pennsylvania several new carriers have entered the market and they are specifically targeting the Company's lines of business. In Georgia and Virginia competition has dramatically intensified with regard to pricing. In 1996, the flat premium growth was the result of decreases from Texas and Pennsylvania being offset with growth from Kentucky. The AUTO GARAGE product line resulted in a 13% decrease in 1997 after a 6% increase in 1996. The majority of the decrease came from Connecticut, Florida, Pennsylvania and Virginia. In Connecticut several new entrants to the market increased the competition by writing garage lines they had not previously written. Competition in Florida was in the form of price cutting from existing markets. In Pennsylvania the auto garage situation was similar to commercial auto, i.e., new carriers entered the market and targeted the Company's lines of
business. In 1996 the auto garage line recorded a 6% increase with Florida, Kentucky and Pennsylvania all producing significant increases. The GENERAL LIABILITY line decreased 10% in 1997 after an increase of 4% in 1996. California and Florida accounted for 6 points and 2 points of decrease, respectively. An underwriting decision was made in California to not renew large general contractors in light of the Montrose case. In Florida, increased competition from new and existing companies contributed to the decrease. In 1996, California and Florida were contributors to the increase while Texas was down. For 1997, gross premiums written percentages by significant state/product line are as follows: Texas commercial auto (22%), Kentucky commercial auto (6%), Pennsylvania commercial auto (6%), Texas general liability (6%), and Florida auto garage (5%) with no other individual state/product line comprising 5% or more. The persistency rate increased to 46% in 1997 from 45% in 1996. Premiums earned decreased 4% in 1997 to $102,255,979 and increased 10% in 1996 to $106,792,928 as a direct result of the level of premiums written.
Net investment income increased 6% in 1997 over 1996 and increased 12% in 1996 over 1995. These increases are the result of growth in the portfolio due to continued positive cash flows from operations. The return on average investments for 1997 is 4.7% versus 4.8% in 1996 and 1995. Inflation can cause interest rates to increase, which would cause the Company's interest income to increase. Because of the Company's profitability in the underwriting operations, the Company achieves the highest after tax net income by investing predominantly in tax-exempt securities as compared to taxable fixed income securities. At December 31, 1997, 83% of the Company's investments were in investment grade tax-exempt bonds with an average maturity of approximately 3.4 years. Since the majority of the Company's investments are tax-exempt, the yields appear lower than those of the industry; however, the industry as a whole has a significantly larger percentage of investments in taxable securities with substantially longer maturities. On a taxable equivalent basis the return on average investments was 6.5% in 1997 and 6.6% in 1996 and 1995. The Company has the ability to hold its fixed maturity securities until their maturity date. The Company does not actively trade its bonds, however, it does classify certain bond securities as available for sale. At December 31, 1997, approximately 16% of the Company's investments were in U.S. Treasury securities and 1% were in short-term money market funds. The Company has not and does not intend to invest in derivatives or high-yield ("junk") securities, nor equity securities in issuers of "junk" debt securities. The Company does not have any non-performing fixed maturity securities.
The Company recorded net realized capital gains of $326,905 in 1997 versus $471,956 in 1996 and $108,024 in 1995. All of these gains were generated from the bonds available for sale category of the fixed maturity portfolio.
Insurance services revenues increased $252,165 from 1996 to 1997 following an increase of $196,645 in 1996 from 1995. The table below presents the components.
Revenues from the premium finance operation are down 17% in 1997 from the 1996 level which was 23% above the 1995 level. The decrease is a result of the taxi cab programs that were discontinued, increased competition and the decision to offer interest free payment plans from the Company's insurance companies in order to increase premium writings. Amounts financed in 1997 were 32% below 1996 which had increased 5% over 1995. Premium finance notes receivable were approximately $1,400,000 at December 31, 1997 versus $1,991,000 at December 31, 1996 and the average return was 17% for 1997 and 1996 versus 19% in 1995.
The decrease in commissions from 1996 to 1997 is related to the decrease in gross premiums written. The increase in commissions from 1995 to 1996 is related to the increase in gross premiums written and to a decrease of approximately $1,669,000 in commission income from reinsurance treaties. The ratio of commissions to gross premiums written increased to 22% in 1997 and 1996 from the 20% level in 1995. The increase in 1996 is a result of a decrease in commission income. The ratio of commissions to premiums earned was 21% for 1997 as compared to 23% for 1996 and 1995. The decrease in 1997 was related to the decrease in the commission expense rate in 1997 attributable to lower contingent commissions resulting from higher C & CAE ratios.
Underwriting and operating expenses were up slightly in 1997 from 1996, and down slightly in 1996 from 1995. As a percent of operating revenues (premiums earned and insurance services revenues) the ratio remained relatively flat at 14.8% in 1997 while 1996 decreased to 14.2% from the 1995 level of 15.7%. The increase in the rate in 1997 is related to the 4% decrease in operating revenues for 1997. The decrease in 1996 was the result of savings from variable expenses in personnel costs and in the plan servicing operation. In March 1997, the Company began converting its computer systems to be year 2000 compliant. At December 31, 1997, approximately 70 percent of the Company's systems were compliant, with all systems expected to be compliant by the end of 1998. The total cost of the project is estimated to be $850,000 and is being funded through operating cash flows. The Company is expensing all costs associated with these system changes. As of December 31, 1997, the amount expensed was immaterial.
The effective tax rate of the Company was 19% in 1997, 24% in 1996, and 26% in 1995. The lower rates in 1997 and 1996 are largely the result of tax-exempt net investment income representing a larger portion of income than in 1995. 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 5 of Notes to Consolidated Financial Statements.
For 1998 the Company is targeting premiums written to be within a $105-115 million range with a GAAP combined ratio of 87.5-92.5% and a return on beginning equity of better than 11.5%. While the Company is optimistic these forward-looking goals can be attained, no assurances can be given they will occur.
With regard to long term liquidity, the average duration of the investment portfolio is approximately 3 years. The fair value of the fixed maturity portfolio at December 31, 1997 was $2,422,271 above amortized cost. With regard to the availability of funds to the holding company, see Note 6 of Notes to Consolidated Financial Statements for restrictions on the payment of dividends by the insurance companies. Various insurance departments of states in which the Company operates require the deposit of funds to protect policyholders within those states. At December 31, 1997 and 1996, the balance on deposit for the benefit of such policyholders totaled approximately $12,965,000 and $12,615,000, respectively.
The unrealized gains or losses on fixed maturities available for sale are presented, net of tax, as a separate component of shareholders' equity (see Note 2 of Notes to Consolidated Financial Statements). The net unrealized gain on the fixed maturities classified as held to maturity was $794,166 at December 31, 1997.
The Company purchased 243,932 shares of its common stock during 1997 at a cost of $2,113,560 or $8.66 per share which accounts for the increase in Treasury stock.