On June 30, 1995, Orion purchased all of the capital stock of McGee for $22,000,000 in cash. McGee specializes in underwriting ocean marine, inland marine and property insurance through an underwriting pool in the United States and one in Canada. The business is written by McGee on behalf of the insurance companies that comprise the pools. Orion's subsidiary, Security Insurance Company of Hartford, which has been a pool member for over 100 years, is a member of both the United States and Canadian pools. The Company's participation in the United States pool was 6%, 7% and 14.5% in 1993, 1994 and 1995, respectively. Participation in the Canadian pool was 10% in 1993 and 1994 and 15% in 1995. The Company has agreed to increase its rate of participation for 1996 to 37% in the United States and approximately 49% in Canada, and by an additional 10.5% to 16.5%, at the Company's option, for 1997 in both of the McGee pools.
The Company's insurance operations have experienced favorable trends for the past several years, as indicated by its combined ratio which has improved from 109.4% in 1991 to 105.4% in 1992, 103.2% in 1993, 101.2% in 1994 and 100.3% in 1995. Operating earnings (earnings after taxes, excluding the effects of the adoption of new accounting principles and after-tax realized investment gains) were $59,914,000, $52,818,000 and $51,100,000, or $4.22, $3.68 and $3.47 per share, in 1995, 1994 and 1993, respectively, based on weighted average shares outstanding of 14,187,000 in 1995, 14,348,000 in 1994 and 14,598,000 in 1993. Preferred stock dividends of $409,000 in 1993 were deducted from earnings to compute earnings per common share.
Net premiums written increased 6.4% ($45,381,000) to $757,436,000 in 1995 from $712,055,000 in 1994 and 12.0% ($76,469,000) in 1994 from $635,586,000 in 1993. The results by segment are as follows:
- Regional Operations' net premiums written increased 18.9% ($52,860,000) to $332,598,000 in 1995 from $279,738,000 in 1994 and 5.5% ($14,656,000) in 1994 from $265,082,000 in 1993. The premiums written increases were in new territories where the Company believes it will benefit from its service oriented approach. The increases were partially offset by the impact of legislative reforms in certain states which have led to lower premium rates and a reduction in losses and commission expenses, resulting in higher profit margins. The increases in this segment were also mitigated by a shift towards high-deductible workers compensation products, which also have lower premium rates.
protection program in Florida and a physical damage program in Texas, where the Company had unfavorable loss experience. The reduction in these programs was partially offset by the introduction of an additional marine program, increased participation in McGee's underwriting pools and an increase in premiums written in professional liability programs in 1995 and truck liability programs during 1994. The percentage of treaty and facultative reinsurance assumed to total net premiums written for Reinsurance/Special Programs amounted to 17.1%, 17.5% and 14.7% in 1995, 1994 and 1993, respectively.
Pre-tax net investment income amounted to $99,040,000, $84,915,000 and $91,803,000 in 1995, 1994 and 1993, respectively. The pre-tax yields on the average investment portfolio were 7.1% in 1995, 6.5% in 1994 and 7.4% in 1993, with after-tax yields of 5.5%, 5.0% and 5.5%, respectively. The year-to-year changes in net investment income reflect an increase in equity earnings from limited partnership investments of $8,510,000 from 1994 to 1995, and a decrease in limited partnership income of $8,648,000 from 1993 to 1994. Earnings from limited partnership investments can vary considerably from year- to-year, however, the Company's long-term experience with these investments has been quite favorable. The increase in net investment income for 1995 is also attributable to a higher average portfolio yield on a higher investment base. Net investment income was increased in both years by income generated from the deployment of operating cash flow of $148,017,000 in 1995 and $118,779,000 in 1994. The carrying value of the Company's investment portfolio amounted to $1,602,861,000 at December 31, 1995 and $1,319,040,000 at December 31, 1994.
Net realized investment gains amounted to $11,885,000 in 1995, $3,437,000 in 1994 and $9,478,000 in 1993. Sales of equity securities resulted in net gains of $16,531,000, $3,845,000 and $11,273,000 and sales of fixed maturities resulted in net gains (losses) of $(311,000), $723,000 and $6,662,000 in 1995, 1994 and 1993, respectively. Realized investment gains were reduced by provisions for losses on securities deemed to be other than temporarily impaired. These provisions amounted to $285,000 in 1995, $381,000 in 1994 and $6,310,000 in 1993 for equity securities and $4,050,000, $750,000 and $2,147,000 in 1995, 1994 and 1993, respectively, for fixed maturity investments. Such provisions, based on available information at the time, were made in consideration of the decline in the financial condition of the issuers of these securities.
Realized gains (losses) vary from period to period, depending on market conditions relative to the Company's investment holdings, the timing of investment sales generating gains and losses, the occurrence of events which give rise to other than temporary impairment of investments, and other
factors. At December 31, 1995 the Company held equity securities with unrealized appreciation of $47,507,000, as compared to unrealized appreciation of $13,505,000 for equity securities held at December 31, 1994. The market value of the fixed maturities portfolio at December 31, 1995 exceeded amortized cost by $45,974,000. This compares with an excess of amortized cost over market value of $43,958,000 for fixed maturities at December 31, 1994. Such amounts can vary significantly depending upon fluctuations in the financial markets. The rise in market values during 1995 is primarily attributable to the decline in interest rates during the year. The average maturity of the Company's fixed maturities has not varied significantly in recent years. The Company intends to shorten the maturity of a portion of its fixed maturity portfolio during 1996.
Year Ended December 31, -------------------------------- 1995 1994 1993 ---- ---- ---- (000s omitted) Net investment income ..................... $ 99,040 $ 84,915 $ 91,803 -------- -------- -------- Net realized gains (losses): Fixed maturities ........................ (4,361) (27) 4,515 Equity securities ....................... 16,246 3,464 4,963 -------- -------- -------- 11,885 3,437 9,478 -------- -------- -------- Net unrealized appreciation (depreciation): Fixed maturities ........................ 89,932 (92,325) 21,556 Equity securities ....................... 34,002 (18,827) 16,468 -------- -------- -------- 123,934 (111,152) 38,024 -------- -------- -------- $234,859 $(22,800) $139,305 ======== ======== ======== EXPENSES AND OTHER
The ratio of loss and loss adjustment expenses to premiums earned (the "loss ratio") was 68.4%, 72.1% and 74.4% in 1995, 1994 and 1993, respectively. The decreases in the 1995 and 1994 loss ratios were attributable to improvements in both the Regional Operations and Reinsurance/Special Programs segments.
Provisions for losses and loss adjustment expenses include development of loss and loss adjustment expense reserves relating to prior accident years, which increased the calendar year combined ratio by 1.6 percentage points in 1995, 2.5 percentage points in 1994 and 3.9 percentage points in 1993. The loss ratios were adversely affected by loss development in the pool and association (including assigned risk pools) and reinsurance businesses where loss reserves are established by the Company based on information provided from sources outside the Company, and where loss patterns were significantly different than in the past. Other contributing factors were higher than anticipated reported losses for commercial multiple peril business and reserve strengthening for certain other lines of business, including discontinued programs. In 1995 and 1994 adverse development was reduced by the continued improvement in workers compensation insurance from the application of risk management and loss control procedures.
Establishing reserve liabilities for environmental claims is subject to significant uncertainties that make reserve estimation difficult. Legal decisions have tended to expand insurance coverage beyond the intent of the policies. The disposition of such claims often requires lengthy and costly litigation. Uncertainties as to required clean-up remedies and difficulties in identifying the responsible parties add further to the complexity of reserve estimation for these claims. In recent years, the Company has intensified its efforts to settle and close environmental claims. To help minimize the cost of losses and claims, the Company maintains a dedicated environmental claims staff which administers and continually evaluates each claim and its defense and settlement possibilities. In 1995, 1994 and 1993, the Company paid $5,675,000, $7,233,000 and $5,557,000, respectively, for the costs of defending and settling such claims. Payments in 1995, 1994 and 1993 related to 213, 292 and 216 claims, respectively, for the Company's direct business. Claim counts have been aggregated by year of coverage for each occurrence for which policyholders are being defended, and often include numerous claimants.
As of December 31, 1995 and 1994, the Company has environmental claims- related loss and loss adjustment expense reserves, net of reinsurance recoverables, of $34,559,000 and $20,601,000, respectively, which include 474 and 467 claims, respectively, for direct business written by the Company. In estimating liabilities for environmental-related claims, the Company considers all pertinent information as it becomes available.
Management believes that the Company's reserves for loss and loss adjustment expenses make reasonable and sufficient provision for the ultimate cost of all losses on claims incurred. However, there can be no assurance that changes in loss trends will not result in additional development of prior years' reserves in the future. Variability in claim emergence and settlement patterns and other trends in loss experience can result in future development patterns different than expected. The Company believes that any such development will continue at the low levels experienced in recent years, considering actions taken to increase reserving levels, improve underwriting standards and emphasize loss control and prevention. The Company's loss ratios in recent years, including development of prior years' losses, have compared favorably with loss ratios experienced by the industry.
Interest expense was $15,943,000 in 1995, $13,597,000 in 1994 and $13,044,000 in 1993. The increase of 17.3% in 1995 is due to higher average debt outstanding after the issuance of $100,000,000 of Senior Notes by Orion on July 17, 1995. The 4.2% increase in interest expense in 1994 is primarily attributable to an increase in average interest rates.
Other expenses were $24,740,000, $7,862,000 and $6,527,000 in 1995, 1994 and 1993, respectively. The increases in both other income and other expenses for 1995 are primarily attributable to the inclusion of McGee's revenue and expenses after it was acquired by the Company on June 30, 1995.
Equity in earnings of affiliates includes the Company's portion of earnings from Guaranty National and Intercargo. Earnings (loss) of $1,038,000, $342,000 and ($122,000) were recorded from the Intercargo investment in 1995, 1994 and 1993, respectively. The Company's portion of Guaranty National's net earnings before the cumulative effect of adopting changes in accounting principles was $4,466,000 in 1995, $11,244,000 in 1994 and $9,509,000 in 1993 based on Guaranty National's earnings of $8,929,000, $22,551,000 and $19,285,000, respectively. Gross premiums written for Guaranty National increased to $451,513,000 in 1995 from $364,991,000 in 1994 and $322,613,000 in 1993. Guaranty National's combined ratios were 105.3% in 1995, 97.5% in 1994 and 99.6% in 1993. The increase in gross premiums written in 1995 included $61,766,000 from the acquisition of Viking Insurance Holdings, Inc. ("Viking") by Guaranty National in July 1995. The reduction in Guaranty National's earnings and the higher loss ratio for 1995 are due to Guaranty National strengthening its loss reserves in response to adverse claim trends in the first half of the year. Specific measures have been initiated by Guaranty National to improve results, including tightening underwriting standards and rate increases.
In June 1995 Guaranty National sold 1,550,000 shares of its common stock in an offering under Regulation S of the Securities Act of 1933, as amended at a net offering price of $15.76 per share. The Company converted $20,896,000 of Guaranty National subordinated notes it held into 1,326,128 shares of Guaranty National common stock at the net price received by Guaranty National from the offering. The sale of stock and conversion of the subordinated notes increased the stockholders' equity of Guaranty National and facilitated the procurement of bank financing for Guaranty National's acquisition of Viking.
Federal income taxes on pre-tax operating results and the related effective tax rates amounted to $20,413,000 (23.2%), $16,301,000 (22.8%) and $15,517,000 (21.4%) in 1995, 1994 and 1993, respectively. The Company files
Effective January 1, 1993 the Company recorded the cumulative effect of adopting SFAS No. 109 (discussed above) and SFAS No. 106 "Employers' Accounting for Postretirement Benefits Other than Pensions." SFAS No. 106 requires the accrual of the estimated cost of retiree benefit payments during the years employees provide services. Upon adoption of SFAS No. 106 the cumulative effect of the Company's accumulated obligation for providing medical benefits to retirees was $5,056,000, after a related tax benefit of $2,604,000. Included in the cumulative effects of adopting these accounting principles is the Company's portion of Guaranty National's benefit from changes in accounting principles in 1993 of $360,000, net of $185,000 of federal income taxes provided by the Company.
Primary earnings per common share amounted to $4.77 in 1995, $3.85 in 1994 and $4.69 ($3.88 before the effect of adopting new accounting principles) in 1993. Reflected in the calculation of 1993 earnings per common share are dividends of $409,000 on the Company's Adjustable Rate Preferred Stock (redeemed in 1993) and $2.125 Preferred Stock (converted into common stock or redeemed in 1993). The conversion and redemptions were effected pursuant to the terms of the preferred stocks. Fully diluted earnings per share is not presented as dilution is less than three percent for all periods.
Cash provided by operating activities increased $29,238,000 to $148,017,000 in 1995 from $118,779,000 in 1994 and decreased $4,375,000 in 1994 from $123,154,000 in 1993. Cash flow for 1995 included a disbursement of $7,800,000 under a retrospectively rated program written by DPIC. In 1994 operating cash flow included a $10,223,000 receipt from DPIC's discontinuation of a reinsurance contract. Cash flow for 1993 included a receipt of $17,096,000 under a retrospectively rated program written by DPIC, and the benefit of an income tax overpayment of approximately $4,000,000 from 1992. Excluding these one-time items, year-to-year operating cash flows increased $47,261,000 from 1994 to 1995 and $6,498,000 from 1993 to 1994. The increase in operating cash flow for 1995 was the result of an increase in premiums collected, net investment income received and lower paid losses, offset in part by higher payments for policy acquisition costs and federal income taxes. The increase in 1994 is primarily due to an increase in premiums collected offset by increases in paid losses, policy acquisition costs and federal income tax payments.
7.36% per annum. The net proceeds from the offering were approximately $98,113,000, of which $46,500,000 was used to repay all of Orion's debt under its bank loan agreement. The balance is available for general corporate purposes.
In March 1993 Orion entered into a bank loan arrangement that provided for initial borrowings of up to $60,000,000, consisting of a $50,000,000 term loan and a $10,000,000 line of credit. The proceeds from the term loan were used to redeem Orion's Adjustable Rate Preferred Stock and to repay a bridge loan facility with two banks which was used to redeem Orion's 12 1/2% Subordinated Debentures in December 1992. In November 1994 Orion increased its bank credit line to $30,000,000. In June 1995 Orion borrowed $12,000,000 under the credit line to finance part of the McGee acquisition. All of the Company's bank debt was repaid in July 1995 from the proceeds of the 7 1/4% Senior Notes.
The terms of Orion's indentures for its $100,000,000 of 7 1/4% Senior Notes due 2005 and its $110,000,000 of 9 1/8% Senior Notes due 2002 limit the amount of liens and guarantees by the Company, and the Company's ability to incur secured indebtedness without equally and ratably securing the senior notes. Management does not believe that these limitations unduly restrict the Company's operations or limit Orion's ability to pay dividends on its stock. At December 31, 1995 the Company was in compliance with the terms of its senior note indentures. Management believes that the Company continues to have substantial sources of capital and liquidity from the capital markets and bank borrowings.
The Company repurchased 173,181 shares, 442,327 shares and 177,658 shares of its common stock at an aggregate cost of $7,183,000, $13,745,000 and $5,473,000 in 1995, 1994 and 1993, respectively. The Company's remaining stock purchase authorization from its Board of Directors amounted to $5,446,000 at December 31, 1995. Between January 1 and February 21, 1996, Orion repurchased an additional 16,600 shares of its common stock for $720,000, reducing the remaining authorization to $4,726,000.
Orion and its subsidiaries are routinely engaged in litigation incidental to their businesses. Management believes that there are no significant legal proceedings pending against the Company which, net of reserves established therefor, are likely to result in judgments for amounts that are material to the financial condition, liquidity or results of operations of Orion and its consolidated subsidiaries, taken as a whole. (See also Note J to the consolidated financial statements).
Compliance with the system of internal controls is continuously maintained and monitored by management. The internal audit staff of the Company evaluates and reports on the adequacy of and adherence to these controls, policies and procedures. In addition, as part of its audit of the consolidated financial statements, Deloitte & Touche LLP, the independent auditors for the Company, perform an evaluation of the system of internal controls to the extent they consider necessary to express an opinion on the consolidated financial statements. Recommendations concerning the system of internal controls are provided by both the internal auditors and Deloitte & Touche LLP, and management takes actions which are believed to be appropriate responses to these recommendations.
Alan R. Gruber Daniel L. Barry Chairman & Chief Executive Officer Vice President & Controller
We have audited the accompanying consolidated balance sheets of Orion Capital Corporation and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of earnings, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1995. Our audits also included the financial statement schedules listed in the Index at Item 14(a)2. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedules based on our audits.
The carrying value of securities on deposit with state regulatory authorities in accordance with statutory requirements totalled $237,732,000 and $234,265,000 at December 31, 1995 and 1994, respectively. Excluding investments in Guaranty National and securities of the United States Government and its agencies, the Company did not have any investments in securities of any one issuer that exceeded $25,000,000. The Company had $1,441,000 and $1,344,000 of fixed maturity investments for which it was not accruing income for the years ended December 31, 1995 and 1994, respectively.
Reinsurance recoverables and prepaid reinsurance includes prepaid reinsurance of $68,525,000 at December 31, 1995 and $31,708,000 at December 31, 1994.
Minimum lease commitments at December 31, 1995, with the majority having initial lease periods from one to twenty-five years, are as follows:
On January 31, 1995, the Department of Insurance of the State of California (the "Department") advised the Company that it had a liability of approximately $4,000,000 plus interest under regulations issued with respect to an amendment to the California Insurance Code known as Proposition 103. On November 2, 1995, the terms of a Stipulation and Consent Order between the Department and the Company were adopted by the Commissioner of the Department. Pursuant to that order, the Company has no premium rollback liability under Proposition 103. Further, the Department acknowledged that premium rates charged by the Company in California since the passage of Proposition 103 have been in compliance with the requirements of the California Insurance Code.
Orion declared dividends on its common stock of $12,078,000, $10,828,000 and $9,860,000, or $.86, $.76 and $.68 per share in 1995, 1994 and 1993, respectively. Dividends were declared in 1993 in the amount of $407,000, or $1.10 per share, on Orion's Adjustable Rate Preferred Stock and $2,000, or $.12 per share, on the $2.125 Preferred Stock.
Orion has a Stockholder Rights Plan (the "Rights Plan") under which each outstanding share of common stock includes 64% of one preferred stock purchase right (the "Rights"). The Rights Plan is designed to assure stockholders that they will receive equitable treatment in the event of a proposed takeover.
Under the Rights Plan, each holder of a Right is entitled to buy one-hundredth of a share of Series A Participating Junior Preferred Stock. The Rights become exercisable if an acquiror gains a 20% or greater beneficial ownership interest in Orion's common stock, on other than fair and favorable terms to all stockholders. Each Right not owned by such acquiror will enable the holder to purchase, at an initial exercise price of $80, common stock having a value of twice the Right's exercise price. In addition, under certain circumstances if Orion is involved in a merger each Right will entitle its holder to purchase, at the Right's then current exercise price, common shares of such other company having a value of twice the Right's exercise price.
McGee maintains a Profit Sharing Plan (the "McGee Plan") which is also a 401(k) plan for eligible employees of McGee. Employee and employer contributions are limited by the McGee Plan and federal income tax law. Employer contributions vest over a seven-year period. McGee has noncontributory defined benefit retirement plans covering all eligible employees, and a nonqualified supplemental retirement plan for certain key employees. At December 31, 1995 the accumulated benefit obligation of the defined benefit plans was approximately $20,205,000, and plan assets for these plans were approximately $19,233,000.
The Company maintains a number of incentive plans for key employees. Under the Company's 1982 Long-Term Performance Incentive Plan (the "Incentive Plan"), shares of restricted stock as well as stock options may be granted by Orion. Orion granted 27,515, 70,015 and 5,688 shares of restricted stock to key employees during 1995, 1994 and 1993, respectively. Restricted stock is considered issued and outstanding when awarded. There are restrictions as to its transferability, which restrictions lapse proportionately from the second to the fifth anniversaries of grant date. As of December 31, 1995, the restrictions have not lapsed on 115,556 shares of restricted stock. All stock options are granted by Orion at fair market value at date of grant, and are intended to qualify as incentive stock options. Stock options become
The total expense for 1995, 1994 and 1993 for the above savings, retirement and pension benefit plans for employees and directors amounted to $6,588,000, $4,659,000 and $3,277,000, respectively.
The Company provides postretirement medical benefits to full-time employees who have attained age 55 and have 10 years of consecutive service immediately prior to retirement. McGee employees that attain age 55 while in service with McGee are eligible for postretirement medical benefits if they have 10 years of service, with an increasing level of benefits for additional years of service up to 35. The postretirement health care plans are not funded. The accumulated postretirement benefit obligation of these plans included in other liabilities in the consolidated balance sheet, including McGee's plan for 1995, is as follows:
The expected health care cost trend rate used as of December 31, 1995 was 9% for 1996 and 1997, decreasing linearly each year until it reaches 5% for 2005 and future years. At December 31, 1994 the expected health care cost trend rates used were 10.25% for 1995 and 9.5% for 1996, ratably reduced to 6% for 2003 and later years. A one-percentage-point increase in the assumed health care cost trend rate for each year would increase the aggregate service cost and interest cost for 1995, 1994 and 1993 by $245,000, $289,000 and $145,000, respectively, and increase the accumulated postretirement benefit obligation as of December 31, 1995 and 1994 by $1,304,000 and $953,000, respectively. A one-percentage-point decrease in the health care cost rate would decrease service and interest costs and the accumulated post retirement benefit obligation by similar amounts. The assumed discount rate used in determining the accumulated postretirement benefit obligation was 7.0% at December 31, 1995 and 8.5% at December 31, 1994.
The Company's insurance operations are organized and reported as three business segments: Regional Operations, Reinsurance/Special Programs and Guaranty National Companies. Regional Operations provides workers compensation insurance products through EBI Companies. Reinsurance/Special Programs includes DPIC Companies (which markets professional liability insurance), Connecticut Specialty (which writes specialty insurance programs), SecurityRe Companies (a reinsurer), McGee (an underwriting management company that specializes in ocean marine, inland marine and property insurance) and a 20% interest in Intercargo (which underwrites insurance coverages for international trade). The third segment consists of the Company's 49.1% interest in Guaranty National Corporation, which specializes in nonstandard commercial and personal automobile insurance. The Company includes its share of Guaranty National's earnings using the equity method of accounting. The miscellaneous income and expenses (primarily interest, general and administrative expenses and other consolidating elimination entries) of the parent company are reported as a fourth segment. Identifiable assets of the Regional Operations and Reinsurance/Special Programs segments are primarily allocated based on the cash flows of these segments.