The Company's loss before income taxes for 1998 was $10.7 million. A major factor affecting the loss was adverse development of insurance losses (excluding unallocated loss adjustment expense) of $4.2 million, of which $3.1 million related to commercial auto and $1.1 million related to lines of business in run-off. The adverse development for commercial auto of $3.1 million consisted primarily of a revision of the actuarial ultimate losses in 1998 for the 1996 and 1997 loss years. This adverse development was attributable to certain types of commercial auto insurance which the Company is no longer writing, including large fleets, paratransit vehicles and business in under-performing territories. The Company is focusing its ongoing efforts in commercial auto on insuring charter buses and small fleets which the Company defines as fleets of 1 to 25 vehicles. The Company's primary product line, commercial auto, produced a negative underwriting margin of $6.4 million in 1998 including the effects of the loss development.
As discussed further below, the after-tax net gain in 1997 on sale of the Auto Aftermarket Group was $3.2 million which was comprised of $10.3 million in continuing operations and ($7.1 million) in discontinued operations (excluding the provision for operating loss of $495,000 during the phase-out period). The gain was based upon the purchase price of approximately $41 million offset by the Company's equity in the sold subsidiaries of approximately $32.1 million, the write-off of goodwill related to ALIC of $.6 million, costs associated with the sale of $.8 million and federal income taxes related to the sale of $4.3 million.
Upon consummation of the aforementioned sale, the Company ceased to be engaged in the Auto Aftermarket Group business. The consolidated financial statements of the Company for 1997 and 1996 reflect the disposition of ALIC and Dublin which comprised the Life/Health business segment. Accordingly, the revenues, benefits and expenses, assets and liabilities, and cash flows of ALIC and Dublin have been excluded from the respective captions in the consolidated statements of operations, consolidated balance sheets and consolidated statements of cash flows. The net operating results of these entities have been reported, net of applicable
The effect of the Company's material lines of business that are in runoff was as follows for 1998: net incurred losses and loss adjustment expenses ("LAE") for the discontinued REO line of business were $245,000 in relation to zero earned premium. The total number of open claims at December 31, 1998 was 7 and the related reserves were $90,000. Net incurred losses and LAE for the discontinued agriculture lines of business at December 31, 1998 were $541,000. The net impact on the Company's loss ratio and net loss for these two discontinued lines of business in 1998 was approximately 4% and $.7 million loss, respectively.
The effect of the Company's material lines of business that are in runoff was as follows for 1997: net incurred losses and loss adjustment expenses ("LAE") for the discontinued REO line of business were ($355,000) in relation to zero earned premium. This result was due in large part to a re-evaluation of LAE reserves that lowered the reserve to the expected ultimate cost of settling the claims. The total number of open claims at December 31, 1997 was 10 and the related reserves were $351,000. Net incurred losses and LAE for the discontinued agriculture lines of business at December 31, 1997 were ($77,000). The net impact on the loss ratio and net income for these discontinued lines of business in 1997 was immaterial.
Commissions and selling expenses as a percent of gross premiums written decreased to 17.0% in 1998 from 22.2% in 1997 and 21.2% in 1996. This decrease in 1998 is due largely to commercial auto becoming the predominant product line for the Company. Commercial auto has significantly lower acquisition costs than the Company's extended service contract business which was fully ceded to Lyndon effective January 1, 1998.
The 1997 increase in general and administrative expenses is primarily attributed to the following expense categories: salaries and wages which increased due to an increase in the number of personnel related to the Property and Casualty product lines as well as normal salary increases; employee welfare which increased as a result of expenses associated with the Company's 401(K) plan and additional group insurance expenses; and rent which increased as a result of the sale of the Company's Dublin, Ohio office building in March 1996 and the subsequent rental of office space in Dublin, Ohio and Stafford, Texas. In addition, the Company wrote-off in 1997 approximately $150,000 in capitalized software costs related to software which was included in the sale of assets for the vehicle extended service contract business.
The Company's Board of Directors has engaged Advest, Inc., an investment banking firm, to assist the Company in finding a strategic partner or purchaser for itself or its insurance subsidiaries, with an eye to enhancing overall shareholder value.
The Company's "available for sale" fixed maturity securities at December 31, 1998 included $4.6 million of mortgage-backed securities, $2 million of collateralized mortgage obligation securities and $12.7 million of asset-backed collateralized securities. The mortgage and asset-backed securities are subject to risks associated with variable prepayments. As such, those securities may have a different actual maturity and yield than planned at the time of purchase. The degree to which a security is susceptible to either gains or losses is influenced by the difference between its amortized cost and par value, relative sensitivity of the underlying mortgages to prepayment risk in a changing interest rate environment and relative priority of the securities in the overall securitization.
The Company limits the extent of its risks on fixed maturity securities by generally avoiding securities whose cost significantly exceeds par, by purchasing securities which are backed by stable collateral, and by concentrating on securities that have either a planned amortization or sequential pay classes. The collateralized mortgage obligations and asset backed securities owned have primarily short to intermediate average lives. At December 31, 1998, the Company did not have a significant amount of higher risk mortgage or asset backed securities which had a significant risk of loss or principal. There are negligible default risks on the mortgage and asset backed security portfolios as a whole as the vast majority of the assets are either guaranteed by U. S. government-sponsored entities or are supported in the securitization structure by junior securities enabling the assets to achieve high investment grade status. The Company's collateralized mortgage obligations and asset backed securities are predominantly sequential pay with little or no exposure to interest only obligations ("IOs") or inverse IOs.
Ohio domiciled insurance companies are subject to Ohio law which regulates the ability of insurance companies to pay dividends. The regulation limits the annual dividend or distribution of an insurer to the greater of (1) net income of the previous year or (2) 10% of unassigned surplus as of the end of the previous year. In addition, all dividends must come from earned surplus to qualify as a non-extraordinary dividend. Amounts greater than this would be considered extraordinary dividends and could not be paid without permission of the Ohio Department. Based on this regulation, ANIC would require Ohio Department approval to pay any dividend to ACCEL during 1999. See "Note O" in the Notes to Consolidated Financial Statements for a discussion regarding Risk Based Capital.
Upon closing in January 1998 of the sale of the Auto Aftermarket Group, the Company used a portion of the proceeds to retire the outstanding balance of $15 million of senior notes held by ALIC, which had received them from an unaffiliated company, along with accrued interest of approximately $1.1 million, to make a capital contribution of $3.5 million to ANIC, to pay taxes on the sale of approximately $4.3 million, to transfer $8.8 million in cash to Lyndon in connection with the ceding of the existing vehicle extended service contract business on January 1, 1998 and utilized the remainder for general corporate purposes.
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133 is effective for all fiscal quarters of all fiscal years beginning after June 15, 1999. SFAS No. 133 requires that all derivative instruments be recorded on the balance sheet at their fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designed as part of a hedge transaction and, if it is, the type of hedge transaction. The Company does not expect the adoption of SFAS No. 133 to have a material impact on its consolidated financial statements because the Company does not currently hold any derivative instruments.
The National Association of Insurance Commissioners ("NAIC") has completed and adopted a project to codify statutory accounting principles with a provision for commissioner discretion in the determination of appropriate statutory accounting for insurers. Although the NAIC has indicated that January 1, 2001 is the expected date of implementation, the implementation is ultimately dependent upon the insurer's state of domicile. Implementation of the codified statutory principles may affect the surplus level of ANIC on a statutory basis. Management is unable at this time to determine what impact, if any this project will have on the statutory surplus of ANIC.
The Company is aware of the issues associated with the programming code in existing computer systems as the millennium (Year 2000) approaches. The Company's plan for assessment and renovation of these issues is grouped by hardware, system and operating software, application system software, end-user decision support software, telecommunications, office (non-information technology) systems, service provider relationships and business partner relationships. Within each grouping, components representing mission-critical operations to the Company have been prioritized. Hardware, operating software, application software, telecommunications, and key business partner relationships necessary to conduct the basic business of the Company have progressed beyond the renovation phase and are being validated or implemented. Additionally, the Company is performing final assessments of supportive components within each group to verify that normal life cycles and third party provider efforts have matured to compliance levels. The Company expects little renovation will be required from this phase other than completion of its general ledger system implementation which is scheduled to be completed by the end of the second quarter of 1999.
Since January 1996, the Company has incurred approximately $120,000 in costs associated with the Year 2000 project. The Company expects to incur approximately $60,000 in remaining costs prior to the project's anticipated completion by the end of the second quarter of 1999. Management is in constant appraisal of the project status and is supportive and committed to successful completion. Based on the Company's current state of readiness and project progress, management has determined that the effect on the Company's financial condition and earnings is not material. Should any of the Company's benchmarks be compromised from the planned completion timetables, the Company has contingency plans in the form of contractual resource relationships, which will be activated to accelerate the delinquent task.
The table above reflects increases in the liability for insurance claims in 1998 resulting from the Company's continued expansion into the Commercial Auto business. Maturity of claims for this line of business has resulted in recording in 1998 $3,667,000 in additional policy benefits incurred for prior policy years. Additionally, lines of business discontinued prior to 1995 were reevaluated resulting in the recording in 1998 of $859,000 in additional policy benefits incurred.