(3) Effective December 31, 1993, the Company adopted SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities."
On January 11, 1995, the Company entered into the Merger Agreement with ZRC and ZRC Merger-Sub.
Pursuant to the Option and Voting Agreement, between Deere Insurance and ZRC, Deere Insurance has (i) granted ZRC the Option to acquire under the circumstances described in the Option and Voting Agreement, at $18.50 per share, the Deere Insurance Shares, and (ii) agreed to vote the Deere Insurance Shares in favor of the approval of the Merger and any other related transactions or matters presented in connection with the Merger and against any other proposal which provides for any merger, sale of assets or other Third Party Business Combination, between the Company (or any subsidiary of the Company) and any person or entity, or which is otherwise inconsistent with the Merger or the Merger Agreement.
The Merger Agreement contains various agreements on the part of the Company that restrict its abilities to operate its business prior to the Effective Time. If the Merger is consummated as planned, the board of directors of the Company will consist of the directors of ZRC Merger-Sub immediately prior to the Effective Time.
Competition has been most severe in the areas of commercial property insurance and excess limits of casualty insurance for larger insureds. In addition, cedants have raised their retentions, resulting in a reduction in demand for reinsurance and concomitant overcapacity in the reinsurance industry.
The catastrophe losses in the property insurance market in 1992 and again in 1994 negatively affected the surplus of many property insurers and reinsurers, most of which also write casualty business. At the same time, cash flows are under continuing pressure from both large catastrophe loss payments and continued low rates of premium growth caused by the persistence of competitive market conditions. Additionally, the historically low interest rates that prevailed during 1993 have had a negative impact on the P&C Industry's investment income. Despite these factors, competitive market conditions prevail in the P&C industry.
The underwriting results of a property and casualty insurer or reinsurer typically are evaluated by reference to its loss ratio, expense ratio and combined ratio, determined on the basis of statutory accounting practices ("SAP"). Underwriting profit is only one element of overall profitability, which also includes investment results, interest expense and the effects of income taxation. Accordingly, the combined ratio alone should not be used to measure overall profitability.
Net premiums written and net premiums earned for the year ended December 31, 1994 of $132,421,000 and $129,398,000 increased 14.3% and 14.8%, respectively from $115,814,000 and $112,681,000 for the year ended December 31, 1993. The increase in net premiums written in 1994 resulted from a combination of new business and increased participations on existing treaties. The growth in premium volume was concentrated in the auto liability and auto physical damage lines of business. The 33.9% growth in the auto liability premiums was primarily attributable to an increase in the cessions from Re Cap's two largest cedants. Similarly, the increase of $4,883,000 or 57% in auto physical damage premiums relates almost entirely to an increase in Re Cap's share of premiums assumed from its second largest client. These increases were partially offset by a 71% decrease in mechanical breakdown premiums as a result of an adjustment to a retrocessional program.
In 1993, net premiums written of $115,814,000 and net premiums earned of $112,681,000 declined 4.5% and 4.9%, respectively, when compared to 1992. These decreases were almost entirely attributable to the cancellation or non-renewal in 1992 of a majority of the Company's commercial property per risk treaties. Due to the inadequate pricing which prevailed in this segment of the market, the Company reduced its pro rata commercial property writings by 71%, from $7,621,000 in 1992 to $2,235,000 in 1993. Conversely, the Company increased its writings of auto physical damage business during 1993 by approximately $4,600,000. This increase was principally attributable to market opportunities presented in the wake of Hurricane Andrew. Also, during 1993, auto liability premiums declined 12.6%, primarily as a result of the nonrenewal of two commercial trucking treaties. The following table summarizes the Company's net premiums written by line of business for the years 1992-1994.
Other operating expenses which include compensation, employee benefits and overhead, increased by $1,607,000 or 16.8% for the year ended December 31, 1994. Included within this increase is $1,134,000 of non-recurring expenses, principally legal and financial advisory costs, associated with the aforementioned pending acquisition by ZRC. The balance of the change relates to normal increases in salaries, pension and travel expenses as well as a full year's amortization of the costs incurred in 1993 in connection with the convertible debenture offering. The 2.4% decrease in other operating expenses from 1992 to 1993 was a result of a reduction in pension expense partially offset by increases in the Company's state and franchise taxes.
Effective December 31, 1993, the Company adopted the provisions of SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities." In connection therewith, the Company classified its entire portfolio of fixed income securities as available for sale. In accordance with the new standard, these securities are being carried at their market value. The unrealized depreciation on these bonds, net of tax, of $5,103,000 as of December 31, 1994 has been included as a component of shareholders' equity.
At December 31, 1994, the Company had investments and cash of $342,894,000, a decrease of $1,193,000 or .3% from 1993. This decrease was due principally to cash flow from operations of $26,824,000 net of unrealized depreciation in the fixed income portfolio of $23,583,000 and cash dividends paid to shareholders of $2,184,000.
As a holding company, the Company's principal sources of cash are cash dividends and tax payments from Re Cap, borrowings and the issuance of equity or debt securities. Generally, dividends that can be paid by Re Cap without the prior approval of the New Jersey Insurance Commissioner are limited for any twelve month period to the lesser of 10% of surplus or net investment income. At December 31, 1994, the surplus of Re Cap was $166,596,000 and net investment income for the year then ended was $21,514,000. Accordingly, dividends for 1994 not requiring prior approval of the New Jersey Insurance Commissioner are limited to approximately $16,660,000. To date, Re Cap has never paid a dividend to the Company. The Company and Re Cap are parties to a tax sharing agreement, which requires Re Cap to compute its hypothetical tax liability on a separate company basis. The amount of such liability, which has historically exceeded the amount of the Company's actual tax liability, is then remitted to the Company. For the years ended December 31, 1994 and 1993, the excess of such payments over actual payments by the Company was approximately $1,380,000 and $1,440,000, respectively.
In November 1992, the FASB issued SFAS No. 112, "Employers' Accounting for Post Employment Benefits." SFAS No. 112, which is effective for fiscal years beginning after December 15, 1993, establishes accounting standards for employers who provide benefits to former or inactive employees after employment but before retirement. The Company's adoption of SFAS No. 112, effective January 1, 1994, did not have a material impact on its financial statements.
In December 1993, the National Association of Insurance Commissioners (the "NAIC") adopted final minimum capitalization requirements for property-casualty reinsurance companies known as the Risk-Based Capital model. The NAIC's stated objective in developing these risk-based capital standards is to improve solvency monitoring. Formal implementation of these new minimum capitalization requirements will occur concurrent with the filing of the 1994 annual statement. Management believes that its capital and surplus are adequate to meet the risk-based capital requirements contained in the NAIC's model.