During 1988, the Company purchased a 587 acre parcel of land in Caledonia Township (southeast of Grand Rapids, Michigan) and constructed a 260,000 square foot corporate headquarters building on part of this property. Approximately 50 acres of this parcel currently is used for the corporate headquarters and the balance of the parcel is held as investment property. During 1998, the Company completed construction of a 98,000 square foot office facility on part of its Caledonia Township property to house its direct response channel. The Company also leases several facilities in Cascade Township near Grand Rapids, Michigan for an additional 60,000
square feet of office, distribution, printing and warehouse space. The Company has other short-term leasehold interests in real property used for its claim service offices and captive agencies throughout the country.
The selected financial data shown on the prior page for the Company for each of the five years in the period ended December 31, 1998, has been derived from consolidated financial statements of the Company, which have been audited by the Company's independent auditors, BDO Seidman, LLP. The data should be read in conjunction with the consolidated financial statements and related notes thereto, Supplementary Financial Data and "Management's Discussion and Analysis of Financial Condition and Results of Operations" presented in Items 7 and 8 of this Form 10-K. All share and per share data have been restated in accordance with Financial Accounting Standards Board No. 128 and retroactively adjusted for the increased shares resulting from the three-for-one stock split distributed in January 1998.
The following section provides a narrative discussion about the Company's results of operations and financial condition. The following should be read in conjunction with the Company's Consolidated Financial Statements and related notes thereto.
Within the property and casualty insurance business, combined written premium for the Company's specialty line products of mobile home, motorhome and travel trailer increased 1% in 1998 to $409.4 million following a increase of 2% in 1997 ($405 million) and a decline of 1% ($397 million) in 1996. Over the past 3 years, the growth in these lines has been slowed by the Company's catastrophe exposure management programs. Mobile home written premium, which was flat the first six months of 1998, recovered in the second half to post an increase of 1.5% for the year, offsetting the effects of the Company's catastrophe management program. The Company's BASIC product, a dwelling fire and ACV homeowners insurance program distributed through independent agents, grew by 15% in 1998. This specialty product had $8.5 million written in 1998 and $7.4 million written in 1997. Management expects moderate growth in these specialty lines in the future as the Company continues to pursue profitable opportunities.
The Company's standard lines of automobile and homeowners insurance combined for total written premium of $20.3 million in 1998, an increase of
17% over the $17.3 million written in 1997, which was 27% more than the $13.6 million written in 1996. The Company's direct response automobile premium increased to $8.9 million in 1998 compared with $2.8 million in 1997. The Company believes that the direct automobile and homeowners insurance program provides favorable growth opportunities in the future.
On October 13, 1997, the Company signed an extension of the exclusive endorsement of the Company by AARP to offer mobile home insurance to its members through the year 2004. The positive results of this program, since its inception in 1989, encouraged both parties to extend their relationship five years beyond the original agreement's expiration date.
Management monitors its exposure to catastrophic risk and has taken aggressive action in coastal areas and earthquake prone areas to reduce the Company's risk to hurricane and earthquake losses. During 1997, the Company took action against another catastrophic risk by starting the process of eliminating flood from the Company's policy coverages. As of December 31, 1998, flood coverage was removed in 47 states. The policies in
these states account for approximately 50% of the Company's policies without flood coverage. This percentage is estimated to grow to approximately 70% by the end of 1999. The removal of coverage related to floods will significantly reduce the Company's exposure of loss due to flooding. The removal of flood coverage will be delayed by the guaranteed renewability of the AARP and some American Federation policies, which account for 15% of the total policies. Also, the bureau states of Texas and North Carolina refuse to modify the bureau forms to eliminate flood coverage, which account for 18% of the total policies. To manage this risk in 1999, management has secured aggregate catastrophe reinsurance to cover its exposure to flood losses in the states of North Carolina and Texas. In 1995, the Company started a coastal strategy which eliminated approximately 24,000 policies in the coastal counties from Maine to Texas. This program of coastal policy reduction was substantially completed by June 30, 1996. The Company has further reduced its exposure to hurricane loss by not writing a significant amount of new business in Florida since 1992. Management has pursued the reduction of the Company's earthquake exposure by non-renewing 21,000 policies in California with units greater than $50,000 in value since 1994. Attrition also has contributed to the reduction of earthquake exposure, pushing the total policy decline in California to approximately 50,000 since 1994. Since July 1, 1995, the Company's policies only provide earthquake coverage on an optional basis, which has reduced exposure to catastrophic loss due to earthquakes. Management will continue to take appropriate actions to reduce or eliminate certain exposures in the future where deemed necessary.
Management is committed to controlling expenses and has aggressively managed the Company's acquisition costs and general and administrative expenses. All expense categories are closely monitored and employees are constantly challenged to develop ideas and programs to continually improve results. These actions have helped reduce the Company's expense ratio from a high of 42.7 in 1988 to its current level of 35.1 in 1998. Expenses increased by 1.1 points in 1998 compared to last year because of the costs associated with the start up of the new direct automobile and homeowners program. As this standard business grows, these costs as a percentage of premiums earned will decline.
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 yielded 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 majority of the net proceeds were utilized to repurchase the Company's stock under the previously announced stock buy-back program approved by the Board of Directors. The financial results of the life insurance segment and the sale are reflected in the financial statements as discontinued operations.
In February 1994, the Company's Board of Directors approved a stock buy-back program of up to 3 million shares, which was raised to 6 million shares by subsequent Board approval of 1.5 million share increments in March and December of 1996. In December 1997, the Board of Directors raised the program to 9 million shares by authorizing the repurchase of an additional 3 million shares. Since the inception of this buy-back program, the Company has purchased 6,064,372 shares. During 1998, the Company purchased 777,658 of its shares. The total shares available under the authorization for the repurchase program is 2,935,628 shares. All of the
sensitive to adverse economic conditions, than are investment grade issuers. Management believes the unrealized loss in these securities will be temporary.
The Company and its subsidiaries are routinely engaged in litigation as plaintiff and defendant in the normal course of business. In the opinion of management, all litigation matters are not expected to have a material adverse effect on the Company's consolidated financial position,
operating results, or cash flows. The aggregate ultimate liability, if any, of the Company and its subsidiaries for the matters described in Part 1, Item 3 of this Form 10-K is not determinable at December 31, 1998. For further discussion of the Company's litigation matters, please refer to Part 1, Item 3 of this Form 10-K.
The Company is in the process of evaluating the Year 2000 readiness of third parties. Significant third parties with which the Company interfaces with regard to the Year 2000 problem include, among others, agents, technology vendors, financial institutions and service providers and companies that provide utility infrastructure (power, delivery services, telecommunications). Unreadiness by these third parties would expose the Company to the potential for loss and impairment of business processes and activities. The Company is assessing these risks through bilateral efforts and is considering the need for contingency plans intended to address perceived risks. The Company cannot predict what effect the failure of such a third party to address, in a timely manner, the Year 2000 problem would have on the Company.
As of December 31, 1998, the Company has completed approximately 75%- 80% of the Year 2000 modifications of its mainframe computer applications. The Company has identified the non-IT systems that have Year 2000 issues and has a plan to assess, remediate and test, if necessary, these systems. The Company will continue to assess the impact of the Year 2000 issue on the remainder of its systems and applications throughout 1999. The Company
has performed tests of its systems and applications during 1998 and will continue to do so in 1999. The Company's goal is to have systems and applications Year 2000 ready by the middle of 1999, allowing the remaining time to be used for further validation and testing.
Based on currently available information, management does not presently anticipate that the costs to address the Year 2000 issues will have a material adverse impact on the Company's financial conditions, results of operations or liquidity. However, the extent to which the computer operations and other systems of the Company's important third parties are adversely affected could, in turn, affect the Company's ability to communicate with such third parties and could materially affect the Company's results of operations in any period or periods.
This Year 2000 Readiness Disclosure is based upon and partially repeats information provided by the Company's outside consultants and others regarding the Year 2000 readiness of the Company and its customers, suppliers, financial institutions and other parties. Although the Company believes this information to be accurate, it has not independently verified such information.
the debt, the Company does not anticipate that the adoption of this statement will have a significant effect on its results of operations or financial position.
The American Institute of Certified Public Accountants (AICPA) Statement of Position 98-5, requires costs of start-up activities and organizational costs to be expensed as incurred. This statement is effective in 1999. Since the Company already expenses these costs as incurred, adoption of this statement will have no effect on its results of operations or financial positions. The (AICPA) Statement of Position 97-3, "Accounting by Insurance and Other Enterprises for Guaranty-Fund and Certain Other Insurance-Related Assessments", will be adopted in 1999 as required by the statement.
The investment portfolios of the Company are managed with the objective of maximizing after-tax investment income and total return, while minimizing credit and market risks in order to provide support for the insurance operations and overall results of the Company. When developing the investment strategies for the Company, management considers many factors including underwriting results, tax impacts, regulatory requirements, fluctuations in interest rates and other market risks. Investment decisions are managed by investment professionals based on guidelines established by management and approved by the board of directors.
Market risk represents the potential for loss due to changes in the fair value of financial instruments caused primarily by fluctuations in interest rates and equity prices. The Company mitigates these risks by managing the maturity of their financial instruments to provide adequate funding for the payout of their property and casualty reserves.
Duration is used by management to estimate the value change in the Company's fixed income securities. Price volatility and duration are directly related. Duration is the present value of all future cash flows to be received. The duration of the Company's fixed income portfolio at year end 1998 was four years and the market value was $356.8 million. Therefore, a 1% increase in interest rates would equate to a decrease in market value of approximately $14 million or 4%. Conversely, a 1% decline in interest rates would equate to an increase in market value of approximately $14 million. Other factors such as spread changes, call features, special redemption features and prepayment changes will all affect the duration of the portfolio. While duration is expressed in years, it is regarded as a percent change.
Equity price risk is the potential loss due to changes in the value of equity securities. Equities have more price variability than fixed securities. Historically, equities have provided higher returns over a long period of time. As of December 31, 1998, the Company's investment in
Financial Statements: Consolidated Balance Sheets at December 31, 1998 and 1997 24
Consolidated Statements of Income for the years ended December 31, 1998, 1997 and 1996 25
Consolidated Statements of Shareholders' Equity for the years ended December 31, 1998, 1997 and 1996 26
The Company is a holding company which, through its subsidiaries, provides property and casualty insurance to those who buy, sell or finance mobile homes and recreational vehicles. The Company also writes automobile and homeowners property and casualty insurance.
The accounts of the Company 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. 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.
The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the
Investment real estate consists primarily of land and buildings held for development and sale. Investment real estate is carried at cost less applicable accumulated depreciation. Depreciation expense on investment real estate was $284,000, $251,000 and $249,000 for 1998, 1997 and 1996, respectively.
The Company considers its catastrophe reinsurance costs to be an additional loss cost. Ceded reinsurance premiums, losses and commissions for these coverages are combined and presented in the insurance losses and loss expenses line. All non-catastrophe reinsurance amounts are reflected in their respective line items in the accompanying Consolidated Statements of Income. References to reinsurance ceded in the segment Statements of Income are for non-catastrophe reinsurance only.
The following methods and assumptions were used to estimate market or fair value:
Liabilities- Mortgage Note The present value of future cash flows and the prepayment penalty are used to determine estimated fair value. The rate used was based on quoted market prices for similar issues.
Income taxes paid were $12,719,000, $11,950,000 and $12,900,000 for 1998, 1997, and 1996, respectively.
The Company primarily utilizes the services of one banking institution for its cash depository accounts. The Company performs risk and credit evaluations of this institution on a routine basis.
In 1998, the Company changed its state of incorporation from Delaware to Michigan. Since the State of Michigan does not recognize treasury stock, a cumulative adjustment was made to reflect treasury stock purchases as a reduction of common stock, additional paid-in capital and retained earnings.
Certain reclassifications have been made in the 1997 and 1996 financial statements to conform to those classifications used in 1998.
The amortized cost and market values of fixed maturities are shown below by contractual maturity. Actual maturities will differ from contractual maturities because securities may be called or prepaid with or without prepayment penalties.
To conform with statutory requirements, bonds and certificates of deposit in principal amounts totaling $13,335,000 were on deposit with various regulatory agencies at December 31, 1998.
Depreciation expense on real estate and equipment utilized by the Company was $1,156,000 in 1998, $1,860,000 in 1997 and $1,854,000 in 1996.
Maturities of long-term debt for each of the five years succeeding December 31, 1998 are as follows:
The fair value of financial liabilities and off-balance-sheet financial instruments are as follows:
The Company files a consolidated tax return with its subsidiaries, including its life insurance subsidiary, until it was sold in 1996. For tax purposes, $10.5 million had been accumulated by the life insurance subsidiary in a memorandum policyholders' surplus account and became
A reconciliation of the federal statutory tax rate to the Company's effective tax rate is as follows:
The Company was party to both proportional and non-proportional reinsurance agreements in 1998.
The following amounts summarize the effect of reinsurance on the Company's financial statements:
The Company accounts for its stock option plans in accordance with APB Opinion 25, "Accounting for Stock Issued to Employees." Since the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation cost is recognized under APB Opinion 25. In accordance with SFAS No. 123, "Accounting for Stock-Based Compensation," the Company is required to provide pro forma information regarding net income and earnings per share as if compensation costs for the Company's stock option plan had been determined using a fair value based estimate. The Company uses the Black- Scholes option-pricing model to determine the fair value of each option at the grant date with the following weighted average assumptions:
The following table summarizes information about the Company's stock options outstanding at December 31, 1998:
The Company also has a restricted stock plan under which certain key employees were issued 194,442 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 participants, who has all the rights of a shareholder, subject to restrictions as to transfer until the shares vest. Compensation expense is recorded over the periods in which the shares vest. The unamortized market value of the shares awarded is shown separately in shareholders' equity. As of December 31, 1998, 189,798 were vested, 198 shares were issued and non-vested and 4,446 shares remained unissued from forfeitures.
The cost of the aforementioned benefit plans, excluding post- retirement benefits, for 1998, 1997 and 1996 was $3,733,000, $4,378,000 and $3,696,000, respectively.
retirement benefits accrue during the employees' working years rather than being expensed on a cash basis. The Company does not prefund its post- retirement benefit plan and has elected to amortize the transition obligation over a 20-year period.
The plan's funded status reconciled with the amounts included in other liabilities in the Company's Consolidated Balance Sheets, along with the change in accumulated post retirement benefit obligation an plan assets, is as follows:
The health care trend rate assumed was 7% for 1998, decreasing .25% per year to 6% in 2002 and thereafter. The dental trend rate was 6% per year. The rate of compensation increase regarding life insurance benefits was 5%. A 1% increase in the health care trend rate would increase the accumulated post-retirement benefit obligation as of December 31, 1998 by $240,165 and the net periodic benefit cost for the year then ended by $26,609. A 1% decrease in the health care trend rate would decrease the accumulated post-retirement benefit obligation as of December 31, 1998 by $223,290 and the net periodic benefit cost for the year then ended by $25,027.
The weighted average discount rate used in determining the accumulated post-retirement benefit obligation was 7.5%.
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, 1998:
As a holding company, the principal source of the Company's cash available for debt service and payment of dividends (other than through the use of borrowed funds or the employment of other assets) is dividends received from its principal property and casualty insurance subsidiary, Foremost Insurance. State regulatory requirements limit the amount of
Policyholders' surplus for the combined property and casualty insurance companies at December 31, 1998 and 1997 was $203.8 million and $220.5 million, respectively. Statutory net income for the combined property and casualty insurance companies for the years ended December 31, 1998, 1997 and 1996 was $45.0 million, $49.8 million and $34.1 million, respectively.
In 1989 the Company's Board of Directors declared a dividend of one common stock purchase right for each share of the Company's outstanding common stock. As a result of the three-for-one stock split distributed on January 20, 1998, each outstanding share of common stock presently represents one-third of a right which may become exercisable in certain circumstances to purchase three one-hundredths of a share of the Company's common stock at a purchase price of $36.67 per right. The rights are not currently exercisable.
Company performs ongoing evaluations of its insurance exposures, utilizes reinsurance when appropriate and performs credit and risk evaluations of its agents and insureds.
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 yielded 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. For tax purposes, $10.5 million had been accumulated by the life insurance subsidiary in a memorandum policyholders' account and became taxable upon its sale. The resulting $3.7 million of tax has been charged against the gain on the sale and included in net income from discontinued operations in 1996. The majority of the net proceeds was used to purchase the Company's common stock under the approved stock buy-back program.
In 1990 and 1989, the Company assumed credit life premium under various reinsurance treaties. Under the terms of these treaties, the Company was obligated to reimburse the ceding companies only if the overall incurred loss ratio exceeded a certain percentage. In the fourth quarter of 1990, the ceding companies were declared insolvent and placed into liquidation. 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. On July 31, 1997, the Company and the liquidator settled all outstanding reinsurance and legal issues regarding these treaties. The escrow account was closed with the Company recording an after-tax gain of $110,000 for 1997. The financial results of the life insurance segment and the sale are reflected in the financial statements as discontinued operations for all years presented.
The management of Foremost Corporation of America is responsible for the preparation and integrity of the consolidated financial statements and all other information contained in the Annual Report. The financial statements were prepared in accordance with generally accepted accounting principles and include amounts that are based on management's informed estimates and judgments.
The financial statements have been audited by the Company's independent public accountants, BDO Seidman, LLP, whose unqualified report is presented on the next page. The independent accountants provide an objective assessment of the degree to which management meets its responsibility for fairness of financial reporting. BDO Seidman, LLP regularly evaluates the internal control structure and performs such tests and other procedures as it deems necessary to reach and express an opinion on the fairness of the financial statements.
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, 1998 and 1997, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles.
BDO SEIDMAN, LLP - ---------------------- BDO SEIDMAN, LLP February 12, 1999 Grand Rapids, Michigan