Set forth in Table #4 On Page 30 are five years of selected financial information. Financial information is presented for Associated Business & Commerce Workers Compensation Self-Insurance Fund (the "Fund") for the years ended December 31, 1992 through November, 1995 and for the Company for the period December, 1995 (inception of principal operations) through December 31, 1996. The GAAP information was derived from the audited financial statements and related notes of the Fund and the Company. The statutory data has been derived from statutory financial statements. Such
- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Upon acquisition of the Fund's assets and liabilities by the Company, the Company assumed claims liabilities and assessable provisions of existing insurance coverage of past members of the Fund who chose to be insured by the Company.
The Company is a wholly owned subsidiary of Associated Business & Commerce Holdings, Inc. ("Holdings"). Holdings was organized solely for the purpose of providing financing for the Company and performing certain management services for the Company under a Management Agreement between the Company and Holdings (the "Management Agreement"). Holdings does not carry on any other business activities. The employees of Holdings devote their full business time to the business and affairs of the Company pursuant to the terms of the Management Agreement.
For the year ended December 31, 1996, the Company is reporting an after-tax net loss of $923,000 determined under GAAP. Although the Company's net loss ratio decreased from 1995, the ratio of net underwriting expenses to earned premium increased significantly. Anticipated increases in premium volume over 1995 amounts did not materialize causing the relationship between increased underwriting costs and premium to deteriorate.
Gross earned premium for 1996 amounted to $27.7 million compared to $27.9 million for 1995 and $24.7 million for 1994. Net earned premium amounted to $8.2 million for 1996 compared to $20.9 million for 1995 and $22.5 million for 1994. Quota-share premium ceded (which was effective October 1, 1995) for 1996 amounted to approximately $17.7 as compared to approximately $4.5 million for 1995. Net losses and loss adjustment expenses decreased by $9.2 million over 1995 (primarily the result of quota-share ceding) and the loss ratio (losses over net earned premium) decreased from 71.1% in 1995 to 69.4% in 1996.
The underwriting expense ratio increased from 36.2% in 1995 to 55.3% in 1996 due primarily to personnel additions and related costs, increases in facilities costs, and increases in systems investments planned as a part of the Company's anticipated growth. With the additions to personnel combined with ongoing enhancements to data processing systems, management believes that the Company can increase its premium writings without a corresponding increase in the fixed component of underwriting expenses which would have the effect of decreasing the expense ratio in future periods. As discussed under liquidity and capital resources, the Company can double its net writings without an increase in capital.
Management believes the Company is appropriately staffed for this potential currently and, if realized, the Company's operating ratios should improve.
Over the four year period, the Fund (which commenced business only with its trustees as insureds) wrote more than $80 million of premium and realized GAAP after-tax profits of $835,000. Of the total 7,300 claims reported as of December 31, 1996, 6,300 have been settled and closed. In dollar terms, of the $52.8 million total of net losses and LAE incurred and reserved, $49 million have been paid as of December 31 with an ending reserve of $3.8 million (net of recoverables).
By agreement with the Department of Insurance, the Company will maintain separate financial records for the reserves of the Fund which were transferred to the Company as a part of the loss portfolio transfer. Such accounting will facilitate the Department's later review (projected to occur in 1999) of the Company's possible request to refund premium to certain former members of the Fund participating in the Fund's merit plan program. In making such a request, the Company will consider the financial position of the Company, the development of the Fund's loss reserves and the likelihood of collection of Fund recoverables still due.
The Company has entered into a management agreement with Holdings. The fees payable to Holdings under this arrangement include amounts necessary to service the debt related to Holdings term loan agreement with TIG, the proceeds of which were used by Holdings to refinance the Underwriters loan and to add additional capital to the Company. The portion of fees reserved for this debt service equates to approximately 2.3% of the Company's written premium.
The capitalization of the Company, through the sale of its Series A and B preferred stock increases the investment base of the Company, mitigating to some extent the cost of the management agreement described above and the loss of investment income of premium ceded through the quota-share agreements.
The financial plan of the company included as a part of its business plan gave effect to these differences and assumed that direct premium writings would increase by 50% (or approximately $15 million) during the Company's initial year of operations (1996) with increases thereafter approximating $10 million per year through December 31, 2000. The source of this anticipated growth was customers of assessable self-insurance funds, and, at the levels of writings projected, operating results and cash flows were sufficient to meet the Company's obligations, including the payment of dividends to holders of the Series A Preferred Stock.
The Florida workers' compensation insurance market has become increasingly competitive since the elimination of the Florida Workers' Compensation Assigned Risk Plan in 1994. These competitive pressures have required the Company to increase its insurance agent commissions and incentive programs and to hire additional marketing staff--there are now seven employees in this department--in order to better attract new business. These competitive pressures have also reduced the market standards for advance premiums on new accounts. In the past, the Company was able to obtain 20% advance premium. Now, many customers are able to find competitors willing to offer coverage for 10% advance premium or lower.
Loss reserves constitute 86% of the Company's liabilities as of December 31, 1996. The Company establishes reserves that reflect management's estimates of the total losses and loss adjustment expenses the Company will ultimately have to pay under insurance policies. These include losses that have been reported but not settled and losses that have been incurred but not yet reported to the Company (IBNR). Loss reserves are established on an undiscounted basis after reductions for deductibles, estimates of salvage and subrogation, and reinsurance recoverables. These reductions totaled $21.5 million, $14.5 million, and $6.8 million at the end of 1996, 1995, and 1994, respectively.
For reported losses, the Company establishes reserves on a "case" basis within the parameters of coverage provided in the related policy. For IBNR losses, the Company estimates reserves using established actuarial methods, which are reviewed and reported upon by the Company's independent actuaries. The case and IBNR loss reserve estimates reflect such variables as past loss experience, social trends in damage awards, changes in judicial interpretation of legal liability and policy provisions.
Table #6 on Page 31 presents a reconciliation of beginning and ending loss reserves for the last three years.
In 1994, the Fund recorded reductions in the loss provision for claims incurred in prior years. These reductions resulted primarily from reevaluation of claims reserves established during the two years following the Fund's inception where the lack of a reserving history and experience suggested reserving at industry norms. As claims were reported and settled, the Company's independent actuaries were able to develop a history for the Fund and the Company which led to significant reductions in reserved losses for 1992 and 1993.
In 1995, the Company recorded increases in the provisions for losses and LAE in prior years related primarily to reduced anticipated recoveries from the Special Disabilities Trust Fund (see below).
The Company retains the first $350,000 of liability on each claim. Reinsurance contracts attach thereafter, with SCOR RE providing coverage for up to $2,000,000 and CNA providing coverage for up to the maximum statutory benefits. For 1996 the Company entered into a reinsurance treaty with Allstate RE (now SCOR RE) for "aggregate" reinsurance for coverage of 70% of 15% excess 75% of Earned Standard Premium subject to a $4,500,000 maximum limit. The Company has assigned any recoveries on the aggregate reinsurance treaty to Underwriters which is reimbursing all of the cost of this reinsurance to the Company (see Proportional Quota-share Reinsurance below).
Commencing January 1, 1997, the Company has entered into a substantially similar aggregate reinsurance treaty with Scor Re (the successor company to Allstate Re). However, the Company has secured this cover for its own account and therefore no recoveries have been assigned and the cost will be borne by the Company.
such sums among insurers whose policyholders have employed individuals with previously determined workers' compensation-related disabilities, and such individuals have filed a claim. The Company has included, as recoverables against losses and LAE, amounts submitted and to be submitted to the Bureau. Table #7 on Page 32 summarizes the history of the Company's recordings of SDTF recoverables and Table #8 on Page 32 summarizes remaining recoverables due from reinsurers and the SDTF by loss year.
In September, 1996, the Company extended its contract with Humana for a 2 year period to provide a managed care arrangement under which Humana provides medical services to injured workers whose employers were participating in the managed care arrangement. The terms of the agreement with Humana provide for the payment of a capitated fee in exchange for which Humana covers all the medical cost associated with a claim for a period of three years after the date the claim is reported.
As of December 31, 1996, approximately 68% of the company's customers were covered by the Humana managed care program. Participation in a managed care program is mandatory under Florida law effective January 1, 1997. In January, 1996, the Company complimented its managed care alternatives by entering into an agreement with Vincam/HIP to provide case management services for covered medical claims for a fee under a preferred provider-type arrangement. These arrangements do not transfer risk to Vincam/HIP and the Company will continue to pay the costs of covered claims. However, the arrangement does qualify as a managed care arrangement under Florida law. The Vincam/HIP agreement is a three year contract terminable with 90 days notice.
The increase in effective yield for 1996 and 1995 is primarily due to higher yielding securities in the Company's investment portfolio, which included purchases of U.S. Government agency bonds and mortgage-backed securities in 1994, pursuant to a planned restructuring of the portfolio brought about by the changes in rules of the Department of Insurance governing allowed investments which became effective July 1, 1994.
Liquidity refers to the Company's ability to generate sufficient cash flows to meet the short- and long-term cash requirements of business operations. The short-term cash needs of underwriting primarily consist of funding insurance loss and loss adjustment expense payments and day-to-day operating expenses. Those needs are met through cash receipts from operations, which consist primarily of insurance premiums collected and investment income. The Company's investment portfolio is also a source of liquidity, in the form of readily marketable fixed maturities and short-term investments. Underwriting's net positive cash flows from operations are used to build the investment portfolio and thereby increase future investment income.
As security for an insured's contractual premium obligation, the Company previously required that each insured pay an advanced deposit premium, generally equal to 20% of the insureds estimated annual premium. During 1996, the competitive pressures of the market drove the average deposit below 10%
although the Company strives to maintain higher deposits whenever possible. The balance of premium is invoiced by the Company over a period of 12 months. Under these typical arrangements, the Company does not extend credit to any insured for premium which has been earned by the Company, and, in the event an insured is past due in installment payments, the underlying policy can be canceled for non-payment prior to the Company incurring bad debt losses on premium earned but not collected. The advanced deposit premiums provide an additional source of liquidity to operations and such funds are also used to build the Company's investment portfolio.
Because of the nature of an insurance company's underwriting operations, where premiums are generally collected and invested before related losses are paid, liquidity requirements are customarily funded by operational cash flows. Cash flows from operations for 1996 totaled a negative $6.2 million, compared to cash flows from the combined operations of the Fund and the Company for 1995 of a negative $1.5 million and the Fund's operating cash flows of $1.1 million in 1994. Operating cash flows for 1997 are expected to continue negative because of the Company's quota-share arrangements with Underwriters and TIG (see "Results of Operations" above). The payment of claims on reserves assumed by the Company from the Fund will require the liquidation of investments held for this purpose. It is anticipated that such liquidations (and maturities) will exceed investment purchases funded by cash flows from the Company's retained underwriting operations.
The Company's Series A preferred stock was sold to former member/insureds of the Fund and sales agents and vendors pursuant to a Form S-1 registration with the Securities and Exchange commission. The unregistered Series B preferred stock was sold to Holdings which also owns all of the Company's common stock. The Company's capital is regulated by the Department of Insurance with certain minimum levels of capital required depending upon net writings of the Company. For purposes of these calculations, capital (surplus as to policyholders) is calculated under statutory accounting practices ("SAP") which, generally, reduces capital to liquidation amounts.
As previously discussed, all of the Company's common stock and the Series B preferred stock is owned by Holdings. As discussed in Part 1 of this filing, Holdings has pledged all of its stock in the Company, among other things, as collateral for a loan from TIG. The Company entered into a management agreement with Holdings wherein Holdings shall be responsible for managing the day to day operations of the Company, including, but not limited to, marketing, loss control, safety engineering and continuing service, billing and premium collection, claims administration, maintenance of books and records, and underwriting. The fees payable by the Company to Holdings pursuant to the agreement are currently 14.1% of written premium. The note to TIG is otherwise due on December 4, 2003.
The Company expects to continue to offer for sale its Series A preferred stock in order to expand its premium writing capacity. The inability to pay a dividend, even though dividends accumulate, may nevertheless adversely affect these plans.
As a condition to the acquisition of the Fund's assets and approval of the TIG transaction, the Company has agreed to not pay a dividend on any class of stock without the written approval of the Department for a period of five years.
The Department's determination of the Company's capacity to pay a dividend may be biased in favor of policyholders, with a possible further adverse effect upon the Company's continuing sale of its preferred stock.
Even though the loan by TIG to Holdings may be paid, TIG and Underwriters may still exercise significant influence over operations of the Company in the future.
Holdings and the Company have agreed to use the proceeds of any sale of securities or financing (other than the sale of Series A preferred) to retire Holdings indebtedness to TIG.
Management of the Company and Holdings considers the relationship with TIG and Underwriters a mutually beneficial alliance. Through its loan to Holdings, TIG provided the financing necessary to complete a restructuring of debt and the addition of further capitalization to the Company; and, through the quota-share arrangements, TIG and Underwriters assist the Company in reducing the amount of required capital. Both TIG and Underwriters are major reinsurers with high AM Best Ratings. Management is of the opinion that its alignment with TIG is significant to the Company and its plans for the future.
The Company considers its relationship with the Department of Insurance to be good. In January of 1996, the Company was advised by the Department that the Department's audit of the Fund's financial statements covering the three year period ended December 31, 1994 resulted in no changes. The Department has worked with the Company's management since inception of the Company's business plan, providing interpretations of rules relating to capitalization and operations. Management understands that the Department has recognized the potential for adverse development of the Fund's loss reserves (assumed by the Company) and, therefore, has restricted the Company's payment of premium refunds (if any such refunds may be payable and approved) pending an ultimate accounting of the actual losses sustained by the Fund. Management considers these restrictions to be reasonable and in the best interests of policyholders.
See the Index included on Page and the Financial Statements which begin on Page.