Fremont General Corporation, a nationwide property and casualty insurance and financial services holding company, operates through its wholly-owned subsidiaries in select businesses in niche markets. The three core operating lines of business are workers' compensation insurance, real estate lending and commercial finance lending. Additionally, on a smaller scale, the Company is involved in underwriting various other insurance products. The primary operating strategy of the Company is to build upon its core business units through acquisition opportunities and new business development. The Company's secondary strategy is to achieve income balance and geographic diversity among its business units in order to limit the exposure of the Company to industry, market and regional concentrations.
Since the date of acquisition, the Company has re-invested the short-term investments acquired into longer term investments. This accounts for the significant increase in the Company's fixed maturity and non-redeemable preferred stock portfolios for the year ended December 31, 1995. See Note B of Notes to Consolidated Financial Statements for additional information with respect to the acquisition of Casualty.
In July 1993, California enacted legislation to reform the workers' compensation insurance system and to, among other things, adopt an open rating system through the repeal of the minimum rate law effective January 1, 1995. The repeal of the minimum rate law has resulted in lower premiums and lower profitability on the Company's California workers' compensation insurance policies due to increased price competition. The Company expects that the premiums earned in California will continue to decrease, principally due to price competition. See "Results of Operations -- Property and Casualty Insurance Operations -- Premiums." The Company believes that its acquisition of Casualty, with policies written primarily outside of California, has lessened the impact of the repeal of the minimum rate law by providing geographic diversity, which mitigates the impact of economic and regulatory changes within a regional marketplace. In Illinois, where Casualty underwrites the majority of its workers' compensation insurance premiums, price competition will continue to impact workers' compensation companies due to an overall average decrease in advisory rates of 13.6% which became effective January 1, 1996. Although insurance companies are not required to adopt such advisory rates, companies in Illinois generally follow such rates. See "Results of Operations -- Property and Casualty Insurance Operations -- Workers' Compensation Regulation."
loan portfolio through origination of new loans and acquisition of loan portfolios that meet its underwriting guidelines applied to origination of new loans. Assets of the real estate lending operation grew from $278 million at the end of 1991 to $1.05 billion at the end of 1995, due primarily to increased loan originations and to the purchase of loan portfolios from other financial institutions. See "Item 1. Business -- Financial Services Operations -- Real Estate Lending." The ability of the Company to continue to originate loans, and of borrowers to repay outstanding loans, may be impaired by adverse changes in local or regional economic conditions which affect such areas or by adverse changes in the real estate market in those areas. Such events could also significantly impair the value of the underlying collateral. If the Company's collateral were to prove inadequate, the Company's results of operations could be adversely affected.
The Company's commercial finance subsidiary, Fremont Financial Corporation ("Fremont Financial"), provides working capital loans, primarily secured by accounts receivable and inventory, to small and middle market companies on a nationwide basis. Fremont Financial's total loan portfolio grew from $189 million at December 31, 1991 to $569 million at December 31, 1995. This growth has been achieved through development of Fremont Financial's customer base through loan originations and through participation in syndicated loan transactions. See "Item 1. Business -- Financial Service Operations -- Commercial Finance." The lending market has become increasingly competitive for small to middle market commercial borrowers. As a result, Fremont Financial has experienced decreasing yields on its commercial finance loans.
Adverse economic developments can negatively affect the Company's business and results of operations in a number of ways. Such developments can reduce the demand for loans, impair the ability of borrowers to pay loans and impair the value of the underlying collateral.
Between 1986 and 1991, the Company discontinued its domestic treaty reinsurance business, its other primary and excess property and casualty insurance operations and the underwriting of all remaining assumed reinsurance. In 1990, a single management group was put in charge of all discontinued operations, and it is the intention of the Company to complete the liquidation of these operations by the commutation of liabilities and as claims are paid. See "Item 1. Business -- Discontinued Operations" and Note M of Notes to Consolidated Financial Statements.
On December 4, 1995, the Company announced a three-for-two stock split of its Common Stock for stockholders of record at January 8, 1996. The stock split was distributed on February 7, 1996.
The Company generated revenues of $924 million for 1995, as compared to revenues of $653 million and $651 million for 1994 and 1993, respectively. Revenues were higher in 1995 as compared to 1994, due primarily to higher workers' compensation insurance premiums, net investment income and loan interest income. The higher workers' compensation insurance premiums and net investment income are due primarily to the acquisition of Casualty, partially offset by lower insurance premiums earned in California. See "Property and Casualty Insurance Operations -- Premiums." Revenues between 1994 and 1993 were flat due primarily to the combined effects of higher loan interest, substantially offset by lower workers' compensation insurance premiums. Realized investment gains (losses) were $1,000, $(315,000) and $2,165,000 in 1995, 1994 and 1993, respectively.
The Company had net income of $68.0 million or $2.61 per share for 1995, as compared to $55.8 million or $2.16 per share and $42.7 million or $1.85 per share for 1994 and 1993, respectively. Income before taxes for 1995 was $100.3 million as compared to $81.6 million and $64.3 million for 1994 and 1993, respectively.
Workers' compensation insurance operations posted income before taxes of $85.0 million for 1995, as compared to $62.2 million for 1994 and $49.8 million for 1993. The 37% increase in income before taxes in 1995 is due primarily to the acquisition of Casualty, offset partially by lower income on the Company's California business. The 25% increase in income before taxes in 1994 is due primarily to the continued decline in the frequency and severity of reported claims incurred on the 1992 through 1994 accident years and lower than expected operating costs, offset partially by lower premiums. The combined ratio for 1995 was 100.4% compared to 97.6% and 101.6% for 1994 and 1993, respectively.
Revenues from the property and casualty insurance operations consist primarily of workers'compensation insurance premiums earned and net investment income. Expenses consist primarily of loss and loss adjustment expenses, policy acquisition costs, other operating costs and expenses and, for the years ended December 1994 and 1993, dividends to policyholders.
The Company regularly reviews its reserving techniques, overall reserve position and reinsurance. In light of present facts and current legal interpretations, management believes that adequate provisions have been made for loss reserves. In making this determination, management has considered its claims experience to date, loss development history for prior accident years and estimates of future trends of claims frequency and severity. However, establishment of appropriate reserves is an inherently uncertain process, and there can be no certainty that currently established reserves will prove adequate in light of subsequent actual experience. Subsequent actual experience has resulted and could result in loss reserves being too high or too low. Future loss development could require reserves for prior periods to be increased, which would adversely impact earnings in future periods.
Workers' Compensation Regulation. Illinois began operating under an open rating system in 1982 and California began operating under such a system effective January 1, 1995. In an open rating system, workers' compensation companies are provided with advisory rates by job classification and each insurance company determines its own rates based in part upon its particular operating and loss costs. Although insurance companies are not required to adopt such advisory rates, companies in Illinois generally follow such rates. However, insurance companies in California have, since the adoption of an open rating system, generally set their premium rates below such advisory rates. Before January 1, 1995, California operated under a minimum rate law, whereby premium rates established by the California Department of Insurance were the minimum rates which could be charged by an insurance carrier.
In July 1993, California enacted legislation to reform the workers' compensation insurance system and to, among other things, (i) reduce workers' compensation manual premium rates by 7% effective July 16, 1993 and (ii) repeal the minimum rate law effective January 1, 1995. In addition to the July 1993 legislation, in December 1993, the California Insurance Commissioner reduced workers' compensation manual premium rates on new and renewal business an additional 12.7% effective January 1, 1994. In September 1994, California workers' compensation manual premium rates were further reduced by 16% effective October 1, 1994 on all business incepting on or after January 1, 1994.
Interest rate sensitivity data for the Company's thrift and loan and commercial finance subsidiaries as of December 31, 1995 is presented in the table below. The relationships shown are for one day only and significant changes can occur in the sensitivity relationships as a result of market forces and management decisions. The interest rate gaps reported in the table arise when assets are funded with liabilities having different repricing intervals and to this degree earnings will be sensitive to interest rate changes. The Company
attempts to match interest rate sensitive assets and liabilities to minimize the effect of fluctuations in interest rates.
The following table describes the asset classifications, loss experience and reserve reconciliation of the real estate lending and commercial finance operations as of or for the periods ended as shown below:
Included in the reserves established with portfolio acquisitions in 1994 is $3.2 million in reserves relating to a $225 million commercial real estate loan portfolio acquisition by Fremont Investment & Loan which was completed in August 1994.
The property and casualty insurance operations must have cash and liquid assets available to meet their obligations to policyholders in accordance with contractual obligations, in addition to having the funds available to meet ordinary operating costs. These operations have several sources of funds to meet their obligations, including cash flow from operations, recoveries from reinsurance contracts and investment securities. By statute, the majority of the cash from these operations is required to be invested in investment grade securities to provide protection for policyholders. The Company invests in fixed income and preferred equity securities with an objective of providing a reasonable return while limiting credit and liquidity risk. The Company's investment portfolio had an unrealized gain (loss) of $33.2 million and $(107.9) million at December 31, 1995 and 1994, respectively.
The Company's commercial finance operation funds its lending activities primarily through its asset securitization program, an unsecured revolving line of credit with a syndicated bank group and its capital. The asset securitization program was established to provide a stable and cost effective source of funds to facilitate the expansion of this business. The proceeds from the sale of the initial series of asset-backed certificates ("Series A") under this program in April 1993 were $200 million bearing interest at the rate of LIBOR plus 0.47%. In November 1993, an additional $100 million of these certificates ("Series B") were sold bearing interest at the rate of LIBOR plus 0.5%. The securities issued in this program have a scheduled maturity of three and four years, but could mature earlier depending on fluctuations in outstanding balances of loans in the portfolio and other factors. During April 1995, the Company issued $30 million in subordinated variable rate asset-backed certificates, which mature in 2000, via a private placement. As of December 31, 1995, up to $500 million in additional publicly offered asset-backed certificates may be issued pursuant to a shelf registration statement to fund future growth in the commercial finance loan portfolio. In February 1996, $135 million in asset-backed certificates ("Series C") were issued which mature in 2000. The proceeds were used, in conjunction with existing cash, to retire the $200 million in Series A certificates. The Series B
As a holding company, Fremont General pays its operating expenses, meets its other obligations and pays stockholders' dividends from its cash on hand, management fees paid by its subsidiaries and dividends paid by its subsidiaries. During 1995, stockholders' dividends totaling $12.6 million were paid. Stockholders' dividends declared aggregated $13.1 million, $11.5 million and $10.1 million during 1995, 1994 and 1993, respectively. Several of the Company's subsidiaries are subject to certain statutory and regulatory restrictions and various agreements, principally loan agreements, that restrict their ability to distribute dividends to the Company. The Company expects that during the next few years dividends from its subsidiaries will consist of dividends from its property and casualty subsidiaries and dividends on preferred stock of its thrift and loan holding company and commercial finance subsidiaries. The maximum amount available for payment of dividends by the property and casualty subsidiaries at December 31, 1995 without prior regulatory approval is approximately $30 million.
To facilitate general corporate operations, in August 1994 the Company obtained a revolving line of credit with a syndicated bank group that permitted borrowings of up to $150 million. In August 1995, the Company negotiated an increase of this line to $200 million, of which $85 million was outstanding as of December 31, 1995. In August 1997, this credit line converts to a term loan of up to $100 million, with scheduled semi-annual payments through August 2001. In addition, in July 1994 the Company replaced its internally financed loan to its Employee Stock Ownership Plan ("ESOP") with an external bank-financed loan totaling $11 million. The maximum principal amount of this loan was increased to $15 million in August 1995. The loan is due in seven equal annual installments commencing on April 1, 1996 and is secured by certain shares of the ESOP. The balance outstanding at December 31, 1995 was $6.6 million. The interest and principal payments are guaranteed by the Company. Interest is based on, at the Company's option, the bank's prime lending rate, LIBOR plus 1% or an applicable certificate deposit rate. The rate at December 31, 1995 was 6.69%.
On March 1, 1996, Fremont General Financing I, a statutory business trust (the "Trust") and consolidated wholly-owned subsidiary of the Company, sold $100 million of 9% Trust Originated Preferred SecuritiesSM ("the Preferred Securities") in a public offering. The Preferred Securities represent preferred undivided beneficial interests in the assets of the Trust. The proceeds from the sale of the Preferred Securities were invested in 9% Junior Subordinated Debentures of the Company ("the Junior Subordinated Debentures"). The $100 million Junior Subordinated Debentures are the sole asset of the Trust. The Preferred Securities will be redeemed upon maturity of the Junior Subordinated Debentures in 2026, subject to the election available to the Company to extend the maturity up to 2045, and they may be redeemed, in whole or in part, at any time on or after March 31, 2001 and under certain specified circumstances. The Junior Subordinated Debentures rank pari passu with the Company's $373,750,000 aggregate principal amount at maturity of Liquid Yield Option(TM) Notes due 2013, and subordinate and junior to all senior indebtedness of the Company. Payment of distributions out of cash held by the Trust, and payments on liquidation of the Trust or the redemption of the Preferred Securities are guaranteed by the Company. The Company will use the proceeds from the sale of the Junior Subordinated Debentures to reduce outstanding debt under the Company's revolving line of credit by approximately $50 million, with the remaining proceeds used for general corporate purposes.
Net cash provided by operating activities of continuing operations was $39.5 million, $68.0 million and $85.1 million for the years ended December 31, 1995, 1994 and 1993, respectively. Net cash provided by continuing operations decreased in 1995 over 1994 due primarily to the following items: (i) a smaller net decrease in agents' balances and reinsurance recoverables; (ii) an increase in accrued investment income; (iii) a greater decrease in claims and policy liabilities; (iv) and higher policy acquisition costs deferred, net of amortization. These conditions were partially offset by higher net income, a net increase in other liabilities, net of other assets and a significant increase in the provision for deferred income taxes. The decreases in agents' balances and claims and policy liabilities are primarily due to lower premium volume in the Company's California workers' compensation insurance business. Higher policy acquisition costs deferred are due primarily to increases in annuity contract receipts in the Company's life insurance operation (see Notes F and P of Notes to Consolidated Financial Statements). The net increase in other liabilities, net of other assets, is due primarily to increased accruals for other operating costs. Net cash provided by continuing operations decreased in 1994 compared to the prior year due primarily to a decrease in claims and policy liabilities, partially offset by an increase in net income and a net decrease in agents' balances and reinsurance recoverables.
Net cash used in investing activities was $514.0 million, $551.1 million and $448.1 million in 1995, 1994 and 1993, respectively. Net cash used in investing activities decreased in 1995 as compared to 1994, due primarily to a decrease in bulk loan purchases, net of loan repayments, in the real estate lending operation. This net decrease is due in part to $366 million in bulk commercial real estate loan purchases which the Company completed in 1994. The decrease in net loan purchases was offset partially by the acquisition of Casualty and an increase in investment purchases, net of sales, maturities, and calls. Net cash used in investing activities increased in 1994 as compared to 1993, due primarily to an increase in bulk loan purchases and loan originations, net of loan repayments, offset partially by a decrease in investment purchases, net of sales, maturities and calls.
Net cash provided by financing activities was $483.0 million, $485.6 million and $346.7 million for 1995, 1994 and 1993, respectively. Net cash provided by financing activities decreased modestly in 1995 as compared to 1994, due primarily to a lower increase in thrift deposits partially offset by a net increase in short-term and long-term debt and an increase in annuity contract receipts. Repayments of short-term debt increased and proceeds from long-term debt increased primarily due to a reclassification of the commercial finance operation's credit line from short-term debt to long-term debt as of December 31, 1995. This reclassification was made pursuant to the terms of the credit line, which was renegotiated in August 1995. Net cash provided by financing activities increased in 1994 as compared to 1993, due primarily to an increase in net thrift deposits, partially offset by a net decrease in short-term and long-term debt. The 1993 year is additionally impacted by $40.8 million in proceeds from a public offering of the Company's Common Stock in July 1993.
The Company's property and casualty premium to surplus ratio for the year ended December 31, 1995 was 2.3 to 1, which is within industry guidelines. The FDIC has established certain capital and liquidity
The Company's strategy is to expand its business to the extent possible without adversely impacting its loan portfolio and policyholder base. However, the Company's strategic model is not dependent on growth as a source of liquidity. While the level of revenues will obviously affect results of operations, the Company's liquidity is not dependent on future revenue growth.
Also, in 1995, the FASB issued Statement 123 ("FASB 123"), "Accounting for Stock-Based Compensation" that is effective for fiscal years beginning after December 15, 1995. FASB 123 establishes a method of accounting for stock-based compensation that is based on the fair value of stock options and similar instruments and encourages, but does not require, adoption of that method. The Company has elected to continue following Accounting Principles Board Opinion No. 25 for measuring compensation cost. Pursuant to FASB 123, the Company will disclose pro forma net income and earnings per share calculated as if the recognition and measurement provisions of the new standard had been adopted.