(1) On May 24, 1996, the Company acquired 100% of the outstanding common stock of LDG and on June 17, 1997 the Company acquired 100% of the outstanding common stock and options of AVEMCO. These business combinations have been accounted for as poolings-of-interests and, accordingly, the consolidated financial data shown in this table has been restated to include the accounts and operations of LDG and AVEMCO for all periods presented.
(2) The 1996 and prior financial statements of AVEMCO, which was acquired in 1997, have been restated prior to their inclusion in the Company's historical consolidated financial statements to reflect certain prior period adjustments discovered in 1997. The selected financial data in this table has been restated to reflect these adjustments. The adjustments were for periods prior to HCC's ownership and relate to a restatement of the method of accounting for certain short-duration insurance contracts and to the correction of accounting errors. The adjusted consolidated financial statements of AVEMCO and its subsidiaries were utilized to restate the Company's financial statements for AVEMCO's acquisition in a pooling-of-interests transaction. (See Note 1 above and Note 1 of the Notes to Consolidated Financial Statements.)
THIS REPORT CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED, WHICH ARE INTENDED TO BE COVERED BY THE SAFE HARBORS CREATED THEREBY. INVESTORS ARE CAUTIONED THAT ALL FORWARD- LOOKING STATEMENTS NECESSARILY INVOLVE RISKS AND UNCERTAINTY, INCLUDING, WITHOUT LIMITATION, THE RISK OF A SIGNIFICANT NATURAL DISASTER, THE INABILITY OF THE COMPANY TO REINSURE CERTAIN RISKS, THE ADEQUACY OF ITS LOSS RESERVES, THE FINANCIAL VIABILITY OF REINSURERS, THE EXPANSION OR CONTRACTION IN ITS VARIOUS LINES OF BUSINESS, THE IMPACT OF INFLATION, CHANGING REGULATIONS IN FOREIGN COUNTRIES, THE ABILITY OF THE COMPANY TO INTEGRATE ITS RECENTLY ACQUIRED BUSINESSES, EFFECT OF PENDING OR FUTURE ACQUISITIONS AS WELL AS ACQUISITIONS WHICH HAVE RECENTLY BEEN CONSUMMATED, GENERAL MARKET CONDITIONS, COMPETITION, LICENSING AND PRICING. ALL STATEMENTS, OTHER THAN STATEMENTS OF HISTORICAL FACTS, INCLUDED OR INCORPORATED BY REFERENCE IN THIS REPORT THAT ADDRESS ACTIVITIES, EVENTS OR DEVELOPMENTS THAT THE COMPANY EXPECTS OR ANTICIPATES WILL OR MAY OCCUR IN THE FUTURE, INCLUDING, WITHOUT LIMITATION, SUCH THINGS AS FUTURE CAPITAL EXPENDITURES (INCLUDING THE AMOUNT AND NATURE THEREOF), BUSINESS STRATEGY AND MEASURES TO IMPLEMENT SUCH STRATEGY, COMPETITIVE STRENGTHS, GOALS, EXPANSION AND GROWTH OF THE COMPANY'S BUSINESSES AND OPERATIONS, PLANS, REFERENCES TO FUTURE SUCCESS, AS WELL AS OTHER STATEMENTS WHICH INCLUDES WORDS SUCH AS "ANTICIPATE", "BELIEVE", "PLAN", "ESTIMATE", "EXPECT", AND "INTEND" AND OTHER SIMILAR EXPRESSIONS, CONSTITUTE FORWARD-LOOKING STATEMENTS. ALTHOUGH THE COMPANY BELIEVES THAT THE ASSUMPTIONS UNDERLYING THE FORWARD-LOOKING STATEMENTS CONTAINED HEREIN ARE REASONABLE, ANY OF THE ASSUMPTIONS COULD OVER TIME PROVE TO BE INACCURATE AND THEREFORE, THERE CAN BE NO ASSURANCE THAT THE FORWARD-LOOKING STATEMENTS INCLUDED IN THIS REPORT WILL THEMSELVES PROVE TO BE ACCURATE. IN LIGHT OF THE SIGNIFICANT UNCERTAINTIES INHERENT IN THE FORWARD-LOOKING STATEMENTS INCLUDED HEREIN, THE INCLUSION OF SUCH INFORMATION SHOULD NOT BE REGARDED AS A REPRESENTATION BY THE COMPANY OR ANY OTHER PERSON THAT THE OBJECTIVES AND PLANS OF THE COMPANY WILL BE ACHIEVED.
The Company's primary sources of revenue are earned premium and investment income derived from its insurance company operations, and management fee and commission income generated from its insurance agency and services operations. The Company's core underwriting activities involve providing aviation, marine, offshore energy, property, accident and health, and lenders single interest insurance, which is underwritten on both a direct and a reinsurance basis, marketed directly by the Company and produced by independent agents. The Company concentrates on first party, physical damage coverages and lines of business which have relatively short lead times between the occurrence of an insured event and the reporting of claims to the Company.
During recent years, the Company has substantially increased its capital and surplus through the issuance of equity securities, incurrence of debt, and earnings, thereby enabling it to increase the underwriting capacity of its insurance company subsidiaries. The Company has utilized this additional capital by increasing underwriting activity across many of its core lines of business, emphasizing lines of business and individual opportunities with the most favorable underwriting characteristics at a particular point in time. In each line of business, the Company also cedes premium through the purchase of reinsurance in types and amounts appropriate to the line of business, market conditions and the Company's desired net risk retention profile.
The following table sets forth the relationships of certain income statement items as a percent of total revenue for the three years ended December 31, 1997:
Total revenue increased to $273.4 million in 1997 from $270.4 million in 1996. GWP increased to $346.4 million in 1997 from $337.3 million in 1996, due primarily to increased aviation and accident and health premiums offset by decreased property and marine premium. NWP for 1997 decreased to $143.4 million from $188.3 million in 1996, due to an increase in the amount of ceded reinsurance. Net earned premium decreased to $163.1 million in 1997 compared to $175.3 million in 1996 reflecting the
Management fee and commission income in 1997 increased 48% to $75.9 million from $51.4 million in 1996, reflecting internal growth and the acquisition of several agencies in 1997. The Company expects management fee and commission income to continue to increase due to the effect of recent and future acquisitions and internal growth. Net investment income increased 17% to $27.7 million in 1997 from $23.6 million in 1996 reflecting a higher level of investment assets.
Realized investment gains from sales of marketable equity securities were $8.3 million during 1996 compared to $1.3 million during 1995. Realized investment gains from dispositions of fixed income securities were $29,000 during 1996, compared to gains of $371,000 during 1995. During 1996, the Company liquidated most of its equity security portfolio and re-deployed those investment assets into fixed income securities. During 1996, AVEMCO consummated the sale of National Assurance Underwriters, Inc., which was a subsidiary of AVEMCO prior to the pooling-of-interests combination with the Company. This sale generated an after tax gain of $2.2 million or $0.05 per share.
Compensation expense decreased $6.0 million or 14% in 1996, to $37.1 million due primarily to changes in compensation to LDG's previous principal shareholders.
Merger expense represents non-recurring items incurred to consummate the acquisitions and mergers which are accounted for as poolings-of-interests. The amounts incurred during 1996 were due to the combination with LDG and included a compensatory stock grant of $24.0 million to certain key LDG employees immediately prior to the Company's May, 1996 merger with LDG.
The 1996 and prior financial statements of AVEMCO were restated prior to their combinations with those of the Company. See Note 1 to the Consolidated Financial Statements for the reasons for and the effects of this restatement.
Net earnings increased 22% to $38.5 million in 1996 from $31.7 million in 1995. Diluted earnings per share increased 14% to $0.87 in 1996 from $0.76 in 1995.
During 1997, HC renewed its existing credit facility (the "HC Facility") which provides for a $12.0 million bank line of credit for the issuance of letters of credit and for short-term borrowings at the prime rate of interest. The HC Facility is collateralized by securities with a market value equal to 125% of the total sum of the letters of credit issued and cash advances outstanding. The HC Facility matures on April 30, 1998. As of December 31, 1997, letters of credit in the amount of $10.3 million were issued on behalf of HC to collateralize certain reinsurance obligations.
At December 31, 1997, the Company had a net deferred tax asset of $6.6 million compared to $12.6 million at December 31, 1996. Due to the Company's history of consistent earnings, strong operating cash flows and expectations for the future, it is more likely than not that the Company will be able to realize the benefit of its deferred tax asset.
As of December 31, 1997, the domestic insurance company subsidiaries' total adjusted capital is significantly in excess of the NAIC authorized control level risk-based capital.
Industry and regulatory guidelines suggest that a property and casualty insurer's annual statutory GWP should not exceed 900% of its statutory policyholders' surplus and NWP should not exceed 300% of its statutory policyholders' surplus. The Company's insurance company subsidiaries maintain a premium to surplus ratio significantly lower than such guidelines, and for the year ended December 31, 1997, their annual statutory GWP was 104.3% of their statutory policyholders' surplus and their NWP was 43.1% of their statutory policyholders' surplus.
From time to time the Company enters into foreign currency forward contracts as a hedge against foreign currency fluctuations, primarily GBP. The Company's balances denominated in foreign currencies fluctuate as transactions are recorded and settled. During 1997, the average GBP liability, for subsidiaries whose functional currency was the United States dollar, was approximately L793,000 ($1.3 million at the December 31, 1997, rate of exchange) which was hedged by an average open forward contract balance of approximately L125,000 ($206,000 at the December 31, 1997, rate of exchange). There were no open foreign currency forward contracts as of December 31, 1997. The Company may continue to limit its exposure to currency fluctuations through the use of foreign currency forward contracts.
The Year 2000 issue is the result of computer programs being written using two digits rather than four digits to define the applicable year. If not corrected, computer applications could fail or create erroneous results by or at the Year 2000.
The Company, together with outside vendors engaged by the Company, has made assessments of the Company's potential Year 2000 exposure. The Company believes that with modifications to existing