The following is a summary of properties leased by the Company at December 31, 1996:
(1) The Company amended its lease in February 1997 to increase the area leased in its Headquarters space by 6,013 square feet to 41,918 square feet. This amendment extends to March 2000 only for the new space leased.
The consolidated statements of income data set forth below for each of the three years in the period ended December 31, 1996 and the consolidated balance sheet data at December 31, 1996 and 1995, are derived from, and are qualified by reference to, the audited consolidated financial statements included elsewhere in this Form 10-K. The consolidated statements of income data set forth below for each of the two years in the period ended December 31, 1993 and the consolidated balance sheet data at December 31, 1994, 1993 and 1992, are derived from audited consolidated financial statements not included herein. The information set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Company's consolidated financial statements and related notes included elsewhere in this Form 10-K.
- ------------------------------ (1) Adjusted to reflect a three-for-two stock split in May 1996 and a five-for- one stock split in 1995. For additional information relating to weighted average common and common share equivalents outstanding, see Note 1 of Notes to Consolidated Financial Statements.
RTW, Inc. ("RTW" or the "Company") was organized in 1983 to provide workers' compensation management products and services to employers. In 1989, the Company began offering its workers' compensation management services combined with workers' compensation insurance products provided by an unaffiliated insurance company. Under its arrangement with this insurance company, RTW was responsible for marketing and administering the insurance company's workers' compensation insurance policies and was compensated on a fee-for-service basis.
- - ACIC ceded, on a pro rata basis, a portion of its insurance business to Reliance Insurance Company ("Reliance"), an unaffiliated reinsurance company, under which Reliance assumed 25% of the 1994 and 66 2/3% of the 1993 and 1992 claim and claim settlement expenses in consideration for a proportionate share of eligible premiums. In addition, the Company received a fee from Reliance for claims administration, which the Company applied to reduce its claim and claim settlement expenses. The Company entered into this quota-share reinsurance agreement because it enabled the Company to provide management services and workers' compensation insurance products to a greater number of customers than its capital and surplus would have otherwise allowed. As a consequence of additions to ACIC's capital and surplus from the net proceeds of the Company's Senior Note offering in 1994 and its initial public offering in 1995, the Company determined that it no longer required quota-share reinsurance to expand its operations and terminated the agreement for 1995 and subsequent years. - - The Company also cedes a portion of its premiums for excess of loss reinsurance coverage that limits the Company's per incident exposure.
If Reliance or any of the Company's excess of loss reinsurers are unable to meet any of their obligations to the Company under their reinsurance policies, the Company would be responsible for the payment of all claim and claim settlement expenses covered by the workers' compensation policies that the Company had underwritten, including those expenses covered by reinsurance. The Company is not aware of any developments with respect to any of its reinsurers that would prevent them from honoring any of their obligations to the Company.
- - Claim and claim settlement expenses include payments and reserves for future payments for medical care and rehabilitation costs, indemnity costs for lost wages and third party claim settlement expenses such as independent medical examinations, surveillance costs and legal expenses, second injury fund charges based on claim outcomes, as well as staff and related expenses incurred to administer and settle claims. Because the Company has limited historical data for use in its estimates of unpaid claim and claim settlement expenses, the Company has used industry data to supplement its experience in determining the reserve for unpaid claim and claim settlement expenses. As a result of the use of industry data, the ultimate amount of unpaid claim and
The relationship of total revenues to each item in the statement of income varies from period to period due, in part, to the fact that the Company did not have a quota-share reinsurance agreement in effect in 1996 and 1995, whereas, the Company had a 25% quota-share reinsurance agreement in effect in 1994. The absence of a quota-share reinsurance agreement in 1996 and 1995 increased premiums earned as a percent of gross premiums earned.
Premiums in force at year-end Minnesota $ 52,400 $ 47,700 $ 39,900 Colorado 12,000 4,000 - Missouri 4,700 - - Michigan 400 - - --------- --------- --------- Total premiums in force $ 69,500 $ 51,700 $ 39,900 --------- --------- --------- --------- --------- ---------
PREMIUMS EARNED. Premiums earned increased to $63.1 million in 1996 from $45.4 million in 1995 due to the following:
gross premiums earned due to reduced rates charged for excess of loss reinsurance in Minnesota in 1997 and reduced rates negotiated for excess of loss reinsurance in non-Minnesota locations beginning January 1, 1997.
The following factors have resulted in premium reductions on renewal accounts and reduced premiums on new accounts.
The impact of legislative changes in estimated loss costs, increased competition in credit modifier customers and decreasing customer loss experience may continue to result in lower premiums generated on new and renewal policies for 1997.
Premiums earned increased to $45.4 million in 1995 from $26.6 million in 1994 as follows:
Investment income increased to $4.0 million in 1995 from $1.6 million in 1994, due to increased funds available for investment and increased yields on amounts invested. Funds available for investment increased to $68.5 million at December 31, 1995 from $33.1 million at December 31, 1994, due to the addition of approximately $27.0 million of net proceeds from a $29.9 million initial public offering in April 1995 and increased net cash provided by operating activities. The net proceeds from the initial public offering were received and invested during the second quarter of 1995. Investment yields increased to 6.1% in 1995 from 5.7% in 1994 due to higher interest rates on U.S. Treasury Securities purchased in 1995 from rates on U.S. Treasury Securities purchased in prior years. Investment income for 1995 also includes approximately $97,000 of other revenue amounts recognized during 1995.
CLAIM AND CLAIM SETTLEMENT EXPENSES. Claim and claim settlement expenses increased to $39.1 million in 1996 from $28.1 million in 1995. As a percentage of premiums earned, claim and claim settlement expenses increased to 62.0% in 1996 from 61.8% in 1995. These changes are due to the following:
- Premiums earned increased in 1996 from 1995 resulting in increased claim and claim settlement expenses. - Operating results for 1996 claim and claim settlement expenses in Colorado were higher than expected. The Company has made changes in Colorado designed to bring the operations there up to its expected level
Claim and claim settlement expenses increased to $28.1 million in 1995 from $16.6 million in 1994. As a percentage of premiums earned, claim and claim settlement expenses decreased to 61.8% in 1995 from 62.4% in 1994. These changes are due to the following:
- Premiums earned increased in 1995 from 1994 resulting in increased claim and claim settlement expenses. - The Company terminated its quota-share reinsurance agreement for 1995, which increased the amount of claim and claim settlement expenses retained by the Company. Under the quota-share reinsurance agreement, Reliance paid the Company a ceding commission for providing claims administrative services. Since the Company used these ceding commissions to reduce claim and claim settlement expenses, reducing the level of reinsurance had the effect of increasing claim and claim settlement expenses as a percentage of premiums earned. - During 1995, the Company reduced its estimate of the pre-1995 liability for unpaid claim and claim settlement expenses by $1.5 million as a result of favorable claims experience for those periods, which resulted in a $1.5 million reduction in 1995 claim and claim settlement expenses. - The decrease in claim and claim settlement expenses as a percentage of premiums earned in the 1995 period resulted from the Company's ability to achieve improved expense results in current periods. This decrease was partially offset by an increase in claim and claim settlement expenses resulting from the termination of the quota-share reinsurance agreement.
POLICY ACQUISITION COSTS. The following table summarizes policy acquisition costs for 1996, 1995 and 1994:
YEAR ENDED DECEMBER 31, 1996 1995 1994 -------- -------- -------- (IN THOUSANDS) Commission expense $ 4,670 $ 2,443 $ 1,631 Premium tax expense 1,312 955 762 Other policy acquisition costs 2,216 1,024 413 -------- -------- -------- Direct policy acquisition costs 8,198 4,422 2,806 Ceding commissions Provisional ceding commissions - - (2,018) Favorable claims experience adjustments from 1992 to 1994 (1,871) (1,733) (318) Re-negotiation adjustment - - (642) -------- -------- -------- Total ceding commissions (1,871) (1,733) (2,978) -------- -------- -------- Policy acquisition costs $ 6,327 $ 2,689 $ (172) -------- -------- -------- -------- -------- --------
The Company believes that the continued application of its claims management technology to 1992 through 1994 open claims will continue to provide future favorable ceding commission adjustments. These adjustments are expected to decrease significantly from the levels attained in 1996 and 1995 due to the reduced number of open claims remaining for those years.
The Company anticipates that general and administrative expenses will continue to increase in cost in 1997 as it continues to expand into new states and grows in its existing states.
The following tables present summarized quarterly operating results for the eight quarters ended December 31, 1996:
Claim and claim settlement expenses 6,649 7,515 7,139 6,759 Policy acquisition costs 893 1,071 803 (78) General and administrative expenses 1,242 1,473 1,467 1,931 -------- -------- -------- -------- Income from operations $ 2,084 $ 2,854 $ 3,407 $ 4,224 -------- -------- -------- -------- -------- -------- -------- -------- Net income $ 1,117 $ 1,592 $ 1,898 $ 2,451 -------- -------- -------- -------- -------- -------- -------- -------- Net income per common and common share equivalent $ 0.13 $ 0.14 $ 0.16 $ 0.20 -------- -------- -------- -------- -------- -------- -------- --------
FIRST SECOND THIRD FOURTH QUARTER QUARTER QUARTER QUARTER -------- -------- -------- -------- 1996 (IN THOUSANDS) Claim and claim settlement expenses, net $ 425 $ 650 $ 608 $ 6,392 Policy acquisition costs 225 50 142 1,454 -------- -------- -------- -------- Quarterly effect on income from operations $ 650 $ 700 $ 750 $ 7,846 -------- -------- -------- -------- -------- -------- -------- -------- Claim and claim settlement expenses, net $ - $ - $ 300 $ 1,174 Policy acquisition costs - - 100 1,633 -------- -------- -------- -------- Quarterly effect on income from operations $ - $ - $ 400 $ 2,807 -------- -------- -------- -------- -------- -------- -------- --------
As determined under Generally Accepted Accounting Principles ("GAAP"), the 1996 year-end reserves of $49.3 million for claim and claim settlement expenses were $6.2 million more than the reserves of $43.1 million recorded on the basis of statutory accounting principles for reports provided to state regulatory authorities. The difference is the reinsurance recoverable from third-party reinsurance carriers totaling $6.2 million that reduces reserves for statutory reporting and is recorded as an asset, reinsurance receivable, for GAAP reporting.
The following table is derived from the loss reserve development table and summarizes the effect of reserve re-estimates, net of reinsurance, on calendar year operations for the same five-year period ended December 31, 1996. The total of each column details the amount of reserve re-estimates made in the indicated calendar year and shows
the accident years to which the re-estimates are applicable. The amounts in the total accident year column represent the cumulative reserve re-estimates for the indicated accident year.
The Company's primary sources of cash are premiums and investment income, while its cash requirements consist primarily of payments for claim and claim settlement expenses, policy acquisition costs, general and administrative expenses, capital expenditures, income taxes, principal repayment and debt service on its outstanding Senior Notes. The Company generates positive net cash from operations due, in part, to the timing differences between the receipt of premiums and the payment of claim and claim settlement expenses. Cash is invested pending future payments for such expenses as indemnity, medical benefits and other operating expenses. The Company's investment portfolio currently consists of U.S. Treasury and Agency Securities. Cash and cash equivalents consist primarily of U. S. Treasury or Agency Securities acquired under repurchase agreements with maturities of 90 days or less, with the remaining balances in cash and a money market fund that invests in short-term government securities.
Cash provided by operating activities in 1996 was $23.1 million. This is primarily a result of the Company's net income of $9.0 million, an increase of $12.1 million in unpaid claim and claim settlement expenses which are non-cash accruals for future claims, and an increase of $2.1 million in unearned premiums, net of premiums receivable. Net cash used in investing activities was $23.8 million, primarily the result of purchases of $25.3 million of available- for-sale securities, $3.5 million of maturities of held-to-maturity securities and $2.0 million purchases of furniture and equipment. Net cash used in financing activities was $1.9 million, primarily due to payments totaling $2.4 million on outstanding Senior Notes and Series 1991A and 1991B Notes in December 1996.
On January 30, 1997, the Minnesota Workers' Compensation Reinsurance Association, of which ACIC is required to be a member, declared a refund of approximately $323 million to its insured members. The method of calculating the refund and the amount of the refund must be approved by the Minnesota Department of Commerce. The Company can not quantify, at this time, the amount of refund, if any, that it will receive.
Information included in this annual report which can be identified by the use of forward-looking terminology such as "may", "will", "expect", "anticipate", "estimate", or "continue" or the negative thereof or other variations thereon or comparable terminology constitutes forward-looking information. The following important factors, among others, in some cases have affected and in the future could affect the Company's actual results and could cause the Company's actual financial performance to differ materially from that expressed in any forward- looking statement: (i) the
Company's ability to expand into new states and attract customers in those states, (ii) the Company's ability to manage both its existing claims and its new claims in an effective manner, (iii) the Company's ability to further penetrate the market in its existing states, (iv) competition from traditional workers' compensation insurance carriers, (v) the Company's ability to retain its existing customers at favorable beneficial premium rates when their policies renew and (vi) changes in workers' compensation regulation by states, including changes in mandated benefits or insurance company regulation.
Independent Auditors' Report for Years Ended December 31, 1996, 1995 and 1994 24 Consolidated Balance Sheets - December 31, 1996 and 1995 25 Consolidated Statements of Income - Years Ended December 31, 1996, 1995 and 1994 26 Consolidated Statements of Shareholders' Equity - Years Ended December 31, 1996, 1995 and 1994 27 Consolidated Statements of Cash Flows - Years Ended December 31, 1996, 1995 and 1994 28 Notes to Consolidated Financial Statements - Years Ended December 31, 1996, 1995 and 1994 29
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company at December 31, 1996 and 1995, and the results of its operations and its cash flows for each of the years in the period ended December 31, 1996 in conformity with generally accepted accounting principles.
1996 1995 --------- --------- ASSETS Investments: Held-to-maturity, at amortized cost, fair value of $54,396 and $59,571 $ 53,977 $ 57,662 Available-for-sale, at fair value, amortized cost of $35,854 and $10,674 35,872 10,868 --------- --------- Total investments 89,849 68,530 Cash and cash equivalents 10,410 12,962 Accrued investment income 1,724 1,376 Premiums receivable, less allowance of $105 and $73 4,476 2,903 Reinsurance receivable 6,183 8,312 Reinsurance premiums receivable, net 2,555 1,569 Deferred policy acquisition costs 1,624 858 Furniture and equipment, net 3,423 1,957 Other assets 3,487 2,657 --------- ---------
RTW, INC. CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Interest expense 1,086 1,285 1,306 --------- --------- --------- Income before income taxes 13,722 11,284 6,573 Provision for income taxes 4,740 4,226 2,378 --------- --------- ---------
Net income $ 8,982 $ 7,058 $ 4,195 --------- --------- --------- --------- --------- ---------
RTW, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 (IN THOUSANDS)
In April 1995, the Company raised $27,039,000 (net of underwriting discounts and other offering expenses totaling $2,861,000) through an initial public offering of 3,450,000 shares of Common Stock at $8.67 per share. The Company contributed $18,000,000 of the net proceeds of the offering to ACIC to enable ACIC to expand its operations to Colorado, Missouri and other states, as well as to support the expansion of its business in Minnesota. The Company retained the remaining net proceeds for working capital and general corporate purposes, including, if appropriate, additional future contributions to ACIC.
PRINCIPLES OF CONSOLIDATION AND BASIS OF REPORTING - The consolidated financial statements include RTW, Inc. and ACIC. All significant intercompany accounts and transactions have been eliminated in the consolidation.
USE OF ESTIMATES IN PREPARING THE FINANCIAL STATEMENTS - Preparing financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Realized gains or losses on disposition of investments are included in the computation of net income. Cost of investments sold is determined by the specific identification method.
Included in investments at December 31, 1996 and 1995 are securities on deposit with various regulatory authorities as required by law with a carrying value of $2,073,000 and $1,493,000, respectively.
DEFERRED POLICY ACQUISITION COSTS - Certain costs of acquiring new business and renewing existing business, principally commissions and premium taxes, have been deferred. Such costs are amortized as premium revenue is recognized. The method followed in computing deferred policy acquisition costs limits the amount of such deferred costs to their estimated realizable value, which gives effect to the premium to be earned, claim and claim settlement expenses, and certain other costs expected to be incurred as the premium is earned.
UNPAID CLAIM AND CLAIM SETTLEMENT EXPENSES - The undiscounted reserve for unpaid claim and claim settlement expenses is based on estimates of reported and unreported claims and the related claim and claim settlement expenses. The Company has limited historical data for use in its estimate of the reserve for unpaid claim and claim settlement expenses. This is attributable to ACIC's commencement of operations in 1992, and accordingly, ACIC's reported experience does not reflect the full emergence or payment of losses due to the length of the settlement period associated with workers' compensation claims. Because of the Company's limited data with respect to the ultimate emergence of claims, management also utilizes external industry data sources, as adjusted to reflect anticipated differences between the Company and the industry, to supplement the Company's experience. While the Company considers its estimate of the reserve for unpaid claim and claim settlement expenses to be reasonable, the ultimate amount of claim and claim settlement expenses may differ from the amounts estimated as a result of the additional variability of such estimates associated with the need to utilize this industry data. These reserves and the related assumptions utilized in their development are continually reviewed and, as adjustments become necessary, are reflected in current operations.
REINSURANCE - In the normal course of business, the Company seeks to reduce the losses that may arise from catastrophes or other events that cause unfavorable underwriting results by reinsuring certain levels of risk in various areas of exposure with other insurance enterprises or reinsurers. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policy.
PREMIUMS - Premiums written are recorded on an installment basis to match the billing to the policyholder. Premiums are earned on a daily basis over the life of the insurance policy. Premiums earned include an estimate for earned but unbilled audit premiums. Unearned premium reserves are established for the portion of premiums billed applicable to the unexpired term of the premium.
INCOME TAXES - Provisions for federal and state income taxes include amounts currently payable and deferred income taxes resulting from the cumulative temporary differences in assets and liabilities determined on a tax return and financial statement basis. No valuation allowance was provided against the deferred tax assets recorded in 1996 or 1995, as the Company expects to generate sufficient taxable income in the future to offset reversing temporary differences.
STOCK BASED COMPENSATION - Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based Compensation," encourages, but does not require companies to record compensation cost for stock-based employee compensation plans at fair value. The Company has elected to continue to account for stock- based compensation plans using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related Interpretations. Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of the Company's stock at the date of the grant over the amount an employee must pay to acquire the stock. See Note 7 - Employee Benefits and Plans.
date have been considered outstanding for all periods after applying the treasury stock method for determining the dilutive effect of the stock options.
There were no sales of debt securities during 1996, 1995 or 1994.
Prior to 1995, ACIC ceded a portion of its insurance business to another insurance company on a pro rata basis. Under its reinsurance agreement, the reinsurer assumed one-quarter of the accident year 1994 claim and claim settlement expenses in consideration for a proportionate share of eligible premiums. In addition, Minnesota claims in excess of $1,040,000, $450,000 and $240,000 per occurrence during 1996, 1995 and 1994, respectively, are ceded to the Minnesota Workers' Compensation Reinsurance Association. In 1996 and 1995, Colorado, Missouri, Michigan and other state claims in excess of $500,000 were ceded to various reinsurers. Reinsurance contracts do not relieve ACIC from its obligations to policyholders. Failure of the reinsurers to honor their obligation could result in losses to ACIC. Management does not anticipate any such losses, and accordingly, no provision for amounts deemed uncollectible are included in these financial statements. ACIC evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar activities or economic characteristics of the reinsurers to minimize its exposure to significant losses from reinsurer insolvency. At December 31, reinsurance receivables are associated with reinsurers as follows (000's):
The effect of reinsurance on premiums written and earned are as follows (000's):
The effect of reinsurance on claim and claim settlement expenses for the years ended December 31 are as follows (000's): 1996 1995 1994 --------- -------- --------- Direct $ 38,389 $ 25,436 $ 25,838 Ceded 691 2,626 (9,235) --------- -------- --------- Net claim and claim settlement expenses $ 39,080 $ 28,062 $ 16,603 --------- -------- --------- --------- -------- ---------
Reinsurance premiums payable have been offset by amounts receivable from the reinsurer in accordance with the reinsurance agreement and consist of the following at December 31 (000's):
Activity in the liability for unpaid claim and claim settlement expenses is summarized as follows (000's):
As a result of changes in estimates of unpaid claim and claim settlement expenses for prior years, the provision for claim and claim settlement expenses (net of reinsurance expense of $691,000 and $2,626,000 in 1996 and 1995, respectively) decreased by $8,075,000 and $1,474,000 in 1996 and 1995, respectively. The favorable development in 1996 and 1995 reflects the ability of the Company to manage and close prior year claims more favorably than anticipated. Future favorable development, if any, will depend on the ability of the Company to continue managing and closing claims in such a manner.
1996 1995 ------- ------- Senior Notes payable to registered investors with principal maturities and monthly interest due as follows:
Series 1991A Notes payable, paid in full in December 1996 - 157 Series 1991A Notes payable to related parties, paid in full in December 1996 - 56 Series 1991B Notes payable, paid in full in December 1996 - 120 Series 1991B Notes payable to related parties, paid in full in December 1996 - 29 ------- ------- Notes payable - Principal 7,000 9,362 Less: Unamortized bond issuance cost (261) (471) ------- ------- Notes payable $ 6,739 $ 8,891 ------- ------- ------- -------
The Company may, at its option, redeem some or all of the Senior Notes payable on any interest date at the principal amount of the redeemed notes plus accrued interest and a premium ranging from 1%-3% depending on the redemption date.
Interest expense to related parties for the years ended December 31, 1996, 1995, and 1994 was $14,000, $28,000, and $45,000, respectively.
Based on borrowing rates currently available to the Company for loans with similar terms and average maturities (prime at December 31, 1996 and 1995 was 8.25%), the fair value of notes payable was approximately $7,254,000 and $9,805,000 at December 31, 1996 and 1995, respectively.
Income tax expense for the years ended December 31 consisted of the following (000's):
The differences between taxes computed at the federal statutory rate and recorded income tax expense are as follows (000's):
Deferred policy acquisition costs (611) (312) Other (266) (128) -------- -------- Deferred tax liabilities (877) (440) -------- --------
Net deferred tax asset $ 2,979 $ 2,212 -------- -------- -------- --------
Income taxes receivable (payable) at December 31, 1996 and 1995 were approximately $1,059,000 and ($281,000), respectively.
1995 EMPLOYEE STOCK PURCHASE PLAN - The RTW, Inc. 1995 Employee Stock Purchase Plan (the "ESPP") was adopted by the Board of Directors of the Company during 1995. The Company reserved 75,000 shares for distribution under the ESPP. The ESPP terminates in ten years and will be carried out in phases, each consisting of one year or a period of time approved by the Board. Any employee completing two weeks of service prior to the commencement of a phase of the plan may participate. The participant may elect to contribute from $10 to 10% of monthly salary to the plan through payroll withholdings. Contributors purchase shares of the Company's Common Stock at the option price set forth in the plan. The first one year ESPP phase began in April 1995 and expired in April 1996. Under the first phase, participants purchased 14,891 shares at $8.67 per share. The second one year ESPP phase began in April 1996 and expires in April 1997. Employee contributions withheld by the Company for the purchase of shares in April 1997 and April 1996 under the ESPP were approximately $154,000 and $98,000 at December 31, 1996 and 1995, respectively.
1994 STOCK PLAN - During 1994, the Company adopted a qualified stock option plan providing for Incentive Stock Options and Non-Qualified Stock Options. At December 31, 1996, the Company had 375,000 shares reserved for distribution under the plan. In January 1997, by action of the Board of Directors, the shares reserved for distribution under the plan were increased to 1,500,000. The option price, term, vesting provisions and other limits and restrictions are determined at the time of grant by the Board of Directors or, if established, by a separate committee.
The Company applies Opinion No. 25 and related interpretations in accounting for its plans. Accordingly, no compensation expense has been recognized for its stock-based compensation plans. Had compensation cost for the Company's 1996 and 1995 option grants under the 1994 Stock Plan and 1996 and 1995 stock purchases under the ESPP been determined consistent with Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation," the Company's net income and net income per common and common share equivalent for the years ended December 31 would approximate the pro forma amounts as follows (in 000's, except per share data):
1996 1995 ------- ------- Net income: As reported $ 8,982 $ 7,058 Pro forma $ 8,788 $ 6,924
NON-QUALIFIED COMMON STOCK OPTIONS - The non-qualified options granted, exercised and outstanding as of and for the years ended December 31, 1994, 1995 and 1996 are as follows:
WEIGHTED AVERAGE OPTION EXERCISE EXERCISE SHARES PRICE PRICE --------- ------------- -------- Balance, January 1, 1994 512,903 $ 0.22 - 2.00 $1.69 Exercised (99,000) 0.22 - 2.00 0.43 --------- ------------- -----
Balance, December 31, 1995 412,500 2.00 2.00 Exercised (49,000) 2.00 2.00 --------- ------------- -----
Balance, December 31, 1996 363,500 $2.00 $2.00 --------- ------------- ----- --------- ------------- -----
For the remaining outstanding non-qualified stock options, the Company is permitted a tax deduction equal to the difference between the option exercise price and the fair value on the option exercise date. Upon exercise, the proceeds and the amount of the deduction are recorded to Common Stock. In 1996, the Company recorded a reduction in income taxes payable and increased Common Stock by $510,000 to reflect exercises during the year. Future exercises of these non-qualified options would reduce future taxes payable based on the fair value of the options at the date of exercise.
EMPLOYEE CONTRACT - The Company entered into a five-year Employment and Salary Continuation Agreement (the "Agreement") with its President and Chief Executive Officer beginning November 1993. Under the Agreement, he receives a base salary of $357,500, which amount is to be increased each year by a cost of living adjustment or other such amount as determined by the Company's Board of Directors. This base salary is in addition to bonuses, reimbursements and fringe benefits including payment for the lease of and insurance for the use of an automobile. The Company also provides the President and CEO with health and dental insurance. Under this Agreement, the Company has agreed to indemnify the President and CEO with respect to his actions on behalf of the Company. In the event of his disability, the Company is obligated to continue to pay his then- current base salary and bonuses consistent with other officers for the remaining term of the Agreement.
EMPLOYEE BENEFIT PLANS - The Company sponsors a defined contribution retirement plan under Section 401(K) of the Internal Revenue Code for eligible employees. Employees become eligible for participation in the 401(K) as of the first day of the calendar quarter following completion of 3 months service and attainment of age 21. Company contributions to the plan are discretionary and are based on the contribution made by the employee to the plan. Expense recognized under the plan for the years ended December 31, 1996, 1995 and 1994, was $52,000, $35,000 and $22,000, respectively.
In addition to the defined contribution plan, the Company had bonus plans in 1996, 1995 and 1994 under which all employees, including officers, were paid a monthly bonus based on the prior month's results of the Company. These bonuses aggregated $498,000, $350,000, and $265,000 for the years ended December 31, 1996, 1995 and 1994, respectively.
DIVIDENDS AND RETAINED EARNINGS RESTRICTIONS - Dividends are paid as determined by the Board of Directors. No dividends have ever been paid by the parent company or received from ACIC.
Statutory policyholders' surplus as of December 31, 1996 and 1995, and statutory net income of ACIC for the years then ended are as follows (000's):
STATUTORY STATUTORY POLICYHOLDERS' NET SURPLUS INCOME -------------- --------- December 31, 1996 $ 39,543 $ 6,658 December 31, 1995 36,015 4,551 December 31, 1994 1,514
Rent expense, including contingent rentals, was $1,063,000, $803,000 and $488,000 for the years ended December 31, 1996, 1995 and 1994, respectively.