The Company writes treaty reinsurance and primary insurance on selected personal and commercial lines risks. In both its reinsurance and primary insurance operations, the Company focuses principally on property coverages, for which ultimate losses generally can be more promptly determined than on casualty risks. The Company's revenues from operations are derived primarily from net premiums earned on risks written and reinsured by the Company, investment income and investment gains or losses, while expenses consist primarily of payments for claims losses and underwriting expenses, including agents' commissions and operating expenses.
Significant factors influencing results of operations include the supply and demand for property and casualty insurance and reinsurance, as well as the number and magnitude of catastrophic losses such as hurricanes, windstorms, fires and severely cold weather. Premium rate levels are affected by the availability of insurance coverage which is influenced by levels of surplus in the industry and other factors. Increases in surplus have generally been accompanied by increased price competition among property and casualty insurers. Pricing in this business has weakened slightly due to increased availability of reinsurance market capacity.
The Company seeks to manage its risk exposure by adjusting the mix and volume of business written in response to changes in price, balancing the geographic distribution of its risks, maintaining extensive reinsurance and retrocessional programs and applying the Company's knowledge of primary insurance markets to its reinsurance business. Management believes that this strategy accounts, in part, for combined ratios that are lower than the property and casualty industry average.
The Company has historically followed a practice of maintaining low retentions in its primary and reinsurance business to reduce the variability of its earnings. As a result of this practice and the Company's focus on short-tail property coverages, the Company's loss reserve levels historically have remained relatively stable from year to year despite changes in premium volume. The Company is continuing to cede portions of insurance risks while using its capital base to gradually increase, on a selective basis, its retention of certain property risks.
On December 31, 1996 the Company terminated the 75% pro rata reinsurance contract on its homeowners and dwelling lines of business (excluding HIG) produced through independent agents and also on its homeowners and dwelling lines of business in the financial services business. The cancellation enables the Company to increase its net writings in the personal lines of business.
In July of 1996, Vesta Fire entered into a pro-rata reinsurance facility covering substantially all primary and assumed business in order to provide capital flexibility to take advantage of growth opportunities in the future. This reinsurance facility had the effect of reducing net premiums written in the second half of 1996 by $98.0 million.
Gross Premiums Written; Net Premiums Written; Net Premiums Earned. Gross premiums written increased by $182.8 million, or 31.2%, to $769.6 million for the year ended December 31, 1996, from $586.8 million for the year ended December 31, 1995, as gross premiums written on reinsurance risks increased by $192.7 million and gross premiums written on primary insurance risks decreased by $9.9 million. Net premiums written increased by $81.4 million, or 17.7%, to $540.6 million for the year ended December 31, 1996, from $459.2 million for the year ended December 31, 1995.
Policy Acquisition and Other Underwriting Expenses. Policy acquisition and other underwriting expenses increased by $42.8 million, or 38.3%, to $154.6 million for the year ended December 31, 1996, from $111.8 million for the year ended December 31, 1995. The underwriting expense ratio for the year ended December 31, 1996, was 30.2%, as compared to 29.3% for the year ended December 31, 1995. The increase in the underwriting expenses was primarily due to the growth in premiums written.
Federal Income Taxes. Federal income taxes increased by $3.9 million, or 18.5%, to $25.0 million for the year ended December 31, 1996. The effective rate on pre-tax income increased only slightly from 33.1% to 33.2 % for the year ended December 31, 1996.
Gross Premiums Written; Net Premiums Written; Net Premiums Earned. Gross premiums written increased by $231.9 million, or 65.4%, to $586.8 million for the year ended December 31, 1995, from $354.8 million for the year ended December 31, 1994, as gross premiums written on reinsurance risks increased by $180.7 million and gross premiums written on primary insurance risks increased by $51.2 million. Net premiums written increased by $199.5 million, or 76.8%, to $459.2 million for the year ended December 31, 1995, from $259.7 million for the year ended December 31, 1994.
Net premiums earned increased by $121.8 million, or 46.9%, to $381.8 million for the year ended December 31, 1995, from $260.0 million for the year ended December 31, 1994. The increase in net premiums earned is primarily attributable to the increase in net written premiums for the year ended December 31, 1995.
Losses and Loss Adjustment Expenses Incurred. Losses and loss adjustment expenses ("LAE") increased by $78.8 million, or 56.2%, to $219.0 million for the year ended December 31, 1995, from $140.2 million for the year ended December 31, 1994. The loss and LAE ratio for the year ended December 31, 1995 was 57.4% as compared to 53.9% for the year ended December 31, 1994. This increased loss and LAE ratio for 1995 period was due principally to an increased frequency of losses and the effect of a greater percentage of pro- rata business in the mix of reinsurance written by the Company. Pro-rata business tends to carry lower, but more stable margins than excess reinsurance.
Policy Acquisition and Other Underwriting Expenses. Policy acquisition and other underwriting expenses increased by $23.5 million, or 26.6%, to $111.8 million for the year ended December 31, 1995, from $88.3 million for the year ended December 31, 1994. The underwriting expense ratio for the year ended December 31, 1995 was 29.3%, as compared to 34.0% for the year ended December 31, 1994. The decrease in the underwriting expense ratio resulted principally from the stability of fixed operating expenses relative to increases in net premiums earned and, to a lesser extent, from a decline in contingent commissions paid to agents and ceding reinsurers.
Federal Income Taxes. Federal income taxes increased by $8.3 million, or 64.8%, to $21.1 million for the year ended December 31, 1995. The effective rate on pre-tax income increased from 30.5% to 33.1% for the year ended December 31, 1995. This increase was due primarily to a smaller portion of income from tax free municipal bonds in the 1995 period versus the 1994 period.
Net Income. For the reasons discussed above, net income increased by $13.5 million, or 46.1%, to $42.7 million for the year ended December 31, 1995, from $29.2 million for the year ended December 31, 1994.
As a holding company with no other business operations, the Company relies primarily upon dividend payments from Vesta Fire to meet its cash requirements (including its debt service) and to pay dividends to its stockholders. Transactions between Vesta Fire and the Company, including the payment of dividends by Vesta Fire, are subject to certain limitations under the insurance laws of Alabama. Specifically, Alabama and Texas law permits the payment of dividends in any year which, together with other dividends or distributions made within the preceding 12 months, do not exceed the greater of 10% of statutory surplus as of the end of the preceding year or the net income for the preceding year, with larger dividends payable only after receipt of prior regulatory approval. Hawaii law limits dividends to the lesser of 10% of statutory surplus as of the end of the preceding year or the net income for the preceding year without prior approval. Based upon restrictions presently in effect, the maximum amount available for payment of dividends to the Company by its insurance subsidiaries in 1997 without prior approval of regulatory authorities is approximately $50.7 million.
The principal uses of funds at the holding company level are to pay operating expenses, interest on outstanding indebtedness and dividends to stockholders. During the last three years, the insurance subsidiaries of the Company have produced operating results sufficient to fund the needs of the Company. There can be no assurance as to the ability of the Company's insurance subsidiaries to continue to pay dividends at current levels. However, the Company is not aware of any demands or
commitments of the insurance subsidiaries that would prevent the payment of dividends to the Company sufficient to meet the anticipated needs (including debt service) of the Company over the next twelve months. See "Business-- Regulation."
On November 1, 1996, the Company instituted a stock repurchase program under which the Company may purchase up to two million shares of its common stock in the open market at prevailing prices or in privately negotiated transactions, depending on market conditions, stock price and other factors. As of December 31, 1996, the Company had purchased a total of 375,000 shares of its common stock under this program for an aggregate purchase price of $10.2 million (average cost of $27.31 per share). Purchases to date have been funded from available working capital and the repurchased shares are being held in treasury to be used for ongoing stock issuances such as issuances under the Company's incentive compensation and stock option programs.
On January 31, 1997, Vesta Capital Trust I, a Delaware business trust controlled by the Company, sold $100 million of its 8.525% Capital Securities. These securities have a 30 year maturity and are not redeemable except in certain limited circumstances. These securities were sold in a private
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Vesta Insurance Group, Inc. and subsidiaries at December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1996, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
Birmingham, Alabama January 30, 1997, except for Note Q which is as of January 31, 1997.
- -------- (1) Vesta acquired The Hawaiian Insurance & Guaranty Company, Limited on June 19, 1995.
VESTA INSURANCE GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLAR AMOUNTS IN THOUSANDS)
Losses and Loss Adjustment Expenses: The liability for losses and loss adjustment expenses includes an amount determined from loss reports and individual cases. It also includes an amount for losses incurred but not reported which is based on past experience. Such liabilities are necessarily based on estimates and, while management believes that the amount is adequate, the ultimate liability may be in excess of or less than the amounts provided. The methods for making such estimates and for establishing the resulting liabilities are continually reviewed, and any adjustments are reflected in earnings currently. These reserves are established on an undiscounted basis and are reduced for estimates of salvage and subrogation.
Reinsurance: Reinsurance enables an insurance company, by assuming or ceding reinsurance, to diversify its risk and limit its financial exposure to risk and catastrophic events. However, reinsurance does not ordinarily relieve the primary insurer from its obligations to the insured. In the ordinary course of business, Vesta assumes business from other insurance organizations and also reinsures certain risks with other insurance organizations. The Company accrues premiums not yet reported based on historical experience.
The excess, if any, of stockholders' equity of the insurance subsidiaries on a GAAP basis over that determined on a statutory basis is not available for distribution to its stockholders without regulatory approval.
A reconciliation of Vesta's insurance subsidiaries' statutory net income to Vesta's consolidated GAAP net income is as follows:
A reconciliation of Vesta's insurance subsidiaries' statutory stockholders' equity to Vesta's consolidated GAAP stockholders' equity is as follows:
A schedule of fixed maturities held for investment by contractual maturity at December 31, 1996 is shown below on an amortized cost basis and on a fair value basis. Actual maturities could differ from contractual maturities due to call or prepayment provisions.
Proceeds from sales of fixed maturities were $14 million in 1994, $8 million in 1995 and $40 million in 1996. Gross gains realized on those sales were $0 in 1994, $273 thousand in 1995, and $23 thousand in 1996. Gross losses on those sales were $695 thousand in 1994, $351 thousand in 1995, and $161 thousand in 1996.
Vesta leases office space from Torchmark Development Corporation, a wholly owned subsidiary of Torchmark. Rent expense of $439 thousand, $494 thousand and $566 thousand was charged to operations for the years ended December 31, 1994, 1995 and 1996, respectively, related to this lease agreement.
Leases: The Company leases office space for its home office and HIG under operating lease arrangements. These leases contain various renewal options and escalation clauses. Rental expense for operating leases was $439 thousand, $706 thousand, and $1,014 thousand, for the years ending December 31, 1994, 1995, and 1996, respectively. Future minimum rental commitments required under these leases are approximately $1.0 million per year.
At December 31, 1996, the Company has unsecured reinsurance recoverables from two reinsurers that are in excess of 2% of statutory surplus, the largest of which is $15 million.
Vesta engages in reinsurance ceded transactions as part of its overall underwriting and risk management strategy. Vesta's reinsurance ceded programs include coverages which limit the amount of individual claims to a fixed amount or percentage and which limit the amount of claims related to catastrophes.
The amounts deducted from reserves for unpaid losses and loss adjustment expenses and unearned premiums that Vesta would remain liable for should reinsuring companies be unable to meet their obligations are as follows:
Vesta has a defined contribution retirement and savings plan and a supplemental executive retirement plan. These plans are fully funded at year- end 1996. Vesta's total cost for benefits under these plans since the Offering date was $250,391 for 1994, $319,337 for 1995 and $348,125 for 1996.
a subsidiary of Torchmark and to increase the capital and surplus of its principal insurance subsidiary, Vesta Fire Insurance Corporation.
During 1995, the Financial Accounting Standards Board issued Financial Accounting Statement No. 123, Accounting for Stock-Based Compensation ("FAS 123"). The Statement defines a fair value based method of accounting for an employee stock option. It also allows an entity to continue using the intrinsic valued based accounting method prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. The Company has continued to use this method to account for its stock options. However, FAS 123 requires entities electing to remain with the intrinsic method of accounting to provide pro forma disclosures of net income and earnings per share as if the fair value based method of accounting had been applied as well as other disclosures about the Company's stock-based employee compensation plans. Information about the Company's stock option plans and the related required disclosures follow.
Prior to completion of the Company's initial public offering, the Company's stockholders approved the Vesta Insurance Group, Inc. Long Term Incentive Plan ("Plan"), which provided for grants to the Company's executive officers of restricted stock, stock options, stock appreciation rights, and deferred stock awards, and in certain instances grants of options to directors. The Company's stockholders approved certain amendments to the Plan effective May 16, 1995, including an amendment to increase the shares of the Company's common stock available for awards under the Plan from 1,091,400 shares to 2,221,998 shares and an amendment to delete the provision for the grant of options to non- employee directors. The Company's stockholders also approved the Vesta Insurance Group, Inc. Non-Employee Director Stock Plan ("Director Plan") effective May 16, 1995, which provides for grants to the Company's non- employee directors of stock options and restricted stock.
Of the 1,022,872 outstanding options at December 31, 1996, 549,087 were exercisable with the remaining having varying vesting periods. Exercise prices for options outstanding as of December 31, 1996 ranged from $15.00 to $35.375. Unexercised options with exercise prices of less than $25.00 for 810,358 shares had a weighted average contractual life of 7.8 years and a weighted average exercise price of $17.86 while unexercised options with exercise prices greater than $25.00 for 212,514 shares had a weighted average contractual life of 9.6 years and a weighted average exercise price of $30.01.
In 1993, the Company entered into restricted stock agreements under which Vesta granted 153,300 shares of common stock at $10.26 per share to officers of the Company in exchange for promissory notes. In 1994, an additional 60,000 shares of Common Stock at $18.92 per share were issued to an officer of the Company under a restricted stock agreement in exchange for a promissory note. The common stock is being held by the Company as security for repayment of the notes. A portion of the shares will be released to the officers annually as they repay the promissory notes. The Company intends to pay cash bonuses each year in amounts sufficient to reduce the notes by the amount of the purchase price for the shares which are earned in that year. During 1995 the company acquired 31,192 shares of its common stock with respect to previously granted awards of restricted stock in exchange for release of indebtedness of $320,036. The balance of the notes at December 31, 1995 was $1,962,150. During 1996 the Company acquired 19,564 shares of its common stock with respect to previously granted awards of restricted stock in exchange for release of indebtedness of $168,951. The balance of the notes at December 31, 1996 was $1,580,269. The promissory notes and the unearned compensation are shown as deductions from stockholders equity.