The following table should be read in conjunction with, and is supplemented in its entirety by, the consolidated financial statements and the notes thereto. Financial data has been restated to take into effect the Transactions effective October 2, 1995. The financial data for the years 1993 through 1997 has been derived from the audited consolidated financial statements of the Company.
(6) Based upon statutory accounting practices and derived from the statutory financial statements of the Insurance Companies, which excludes the effects of CAC.
(7) As a result of a substantial amount of new business written with effective dates in the latter half of 1993, net underwriting gain for 1993 was significantly affected by the statutory accounting practices of charging commission expense to income immediately while premiums are earned over the term of the underlying policies.
The Company has foreign operations in Bermuda. For further discussion see Note 23 to the consolidated financial statements of the Company.
Other operating expenses decreased by $967,000 (7%) to $12,654,000 in 1997 compared with $13,621,000 in 1996. This decrease was mainly due to reduced account servicing expenses, the completion of amortization of organization costs in the latter part of 1996, expiration of certain management service contracts in 1996 and the third quarter of 1997, and reduced insurance cost.
Net investment income in 1997 increased by $231,000 (9%) to $2,692,000 from $2,461,000 in 1996 as a result of the increase in invested assets.
Losses and loss expenses increased in 1997 by $1,680,000 (24%) to $8,716,000 from $7,036,000 in 1996. The loss ratio for 1997 and 1996 was 38% and 36%, respectively. This increase was the result of growth in general liability coverage and reserve strengthening. The increase in absolute dollars was generally the result of increased net premiums earned.
Salaries and benefits decreased by $2,556,000 (12%) to $18,569,000 in 1996 compared to $21,125,000 in 1995. The decrease is a result of a reductions in work force, lower compensation earned under incentive contracts, termination of the Company's defined benefit pension plan, refunds received on group medical insurance, utilization of forfeitures in the 401K plan and the one time incentive payment in 1995 relating to the sale of Kaye Administrators.
Income before income taxes decreased in 1996 by $1,631,000 to $7,051,000 from $8,682,000 in 1995. This decrease was the result of reduced investment income and the increase in the combined ratio in 1996 to 79% from 70% in 1995 partially offset by an increase in net premiums earned, as discussed below.
Losses and loss expenses increased in 1996 by $2,186,000 to $7,036,000 from $4,850,000 in 1995. The loss ratio for 1996 was 36% compared to 29% in 1995. The increase in loss ratio is due to the change in the mix of business during 1996 from property and umbrella coverages to other general liability coverage, including exposure to lead paint, which experiences a higher loss ratio.
Acquisition costs and general and administrative expenses increased in 1996 by $1,290,000 to $8,218,000 from $6,928,000 in 1995. The expense ratio for 1996 and 1995 were 43% and 41%, respectively. The increase in expense ratio was mainly due to professional fees.
Net expenses before income taxes decreased in 1996 by $1,022,000 to $645,000 from $1,667,000 in 1995. The decrease in expenses was the result of nonrecurring reorganization costs incurred in 1995.
The pro forma presentation for 1995 includes the effect of a tax benefit from the Retail Brokerage Business which was not combined into the Company until October 2, 1995, resulting in an effective tax rate of 32% for 1995. The effective tax rate for 1997 and 1996 was 30% and 29%, respectively. The difference between the statutory tax rate and the effective tax rate in 1997 and 1996 was primarily related to tax exempt interest. The rate increase for 1997 was primarily due to additional state and local taxes while the decrease in 1996 was primarily due to a one time charge for reorganization costs in 1995 of $863,000 most of which are not deductible for income tax purposes.
Stockholders' equity increased by $10,184,000 (41%) to $35,168,000 at December 31, 1997 from $24,984,000 at December 31, 1996. The increase in equity, which resulted from net income of $4,357,000, the change in unrealized appreciation of investments (net of deferred taxes) of $338,000 and the effect of the merger (discussed below) resulting in the elimination of minority interest of $6,191,000, was partially offset by dividends paid of $702,000.
The Company's cash and cash equivalents increased by $3,348,000 for the year ended December 31, 1997. Operating activities provided cash of $15,845,000, primarily as a result of net income from operations and a net increase in accrued liabilities. Investing activities used cash of $2,204,000 for the purchase of new computer software and the enhancement of our California operations through the asset acquisition of Western. Financing activities used cash of $10,293,000 to pay dividends, notes payable on computer equipment, the early payment of the note to KILP and payments made under deposit reinsurance contracts, offset by proceeds received to finance the Company's new computer software.
The Company has calculated risk-based capital and the result is that the statutory net worth of Old Lyme Rhode Island is adequate in light of the current requirements.
The table below sets forth the composition of the Company's portfolio of fixed maturity investments by rating as of December 31, 1997 (in thousands):
Market Value as Percentage of Amortized Reflected on Total at Market Rating (a) Cost Balance Sheet Value ---------- ---- ------------- -----
AAA(b) $26,959 $27,297 66.1% AA 5,480 5,587 13.5% AA- 2,058 2,091 5.1% A+ 2,369 2,376 5.7% A 3,905 3,962 9.6% ------- ------- ----- $40,771 $41,313 100.0% ======= ======= =====
Investment results of the Company for each of the three years in the period ended December 31, 1997 are shown in the following table (in thousands):
At or for the years ended December 31, -------------------------------- 1997 1996 1995 -------- -------- --------
Net realized investment gains (losses) $ 21 $ 72 $ (47)
The Company's insurance subsidiaries require capital to support premium writing. The guidelines set forth by the NAIC suggest that a property and casualty insurer's ratio of annual statutory net premiums written to policyholders' surplus should not exceed 3 to 1. At December 31, 1997, the Insurance Companies, with a combined statutory surplus of $25,566,000, had a ratio of combined annual statutory net premiums written to their combined statutory surplus of approximately .87 to 1.
OLB is required to maintain a minimum statutory capital and surplus based upon the higher of $1,000,000 or an amount derived by applying a variable rate to its current premium volume or outstanding losses at December 31, 1997. At December 31, 1997, $904,000 was available for distribution from OLB and its subsidiary, Park Brokerage Ltd.
In October 1995, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 123, Accounting for Stock-Based Compensation. This statement establishes new financial accounting and reporting standards for stock-based employee compensation plans, including stock option and stock purchase plans. Compensation resulting from the award of stock-based compensation must be determined based on the fair value of consideration received or fair value of the equity instrument issued, whichever is more reliably measurable. Such compensation expense, net of income taxes, may be recognized in the statement of income over the service period of the employee (generally the vesting period). In lieu of recording such compensation expense, entities are permitted to disclose its pro forma impact net of income taxes, on reported net income and earnings per share. Entities choosing such disclosure will continue to measure compensation expense from stock-based compensation in the statement of income based on the intrinsic value method prescribed in Accounting Principles Board ("APB") No. 25, "Accounting for Stock Issued to Employees".
In February 1997, the FASB issued SFAS No. 128, Earnings Per Share. The statement establishes a new standard for computing and presenting earnings per share data. The statement is effective for financial statements issued for both interim and annual periods ending after December 15, 1997. This statement supersedes APB Opinion No. 15, Earnings Per Share, and requires dual presentation of basic and diluted earnings per share on the face of the income statement. Basic earnings per share exclude dilution and are computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share include the effect of all potentially dilutive securities. All prior period earnings per share presented were restated.
FRR No. 48 amends rules and forms for registrants and requires clarification and expansion of existing disclosures for derivative financial instruments, other financial instruments and derivative commodity instruments, as defined therein. The amendments require enhanced disclosure with respect to these derivative instruments in the notes to financial statements. As of December 31, 1997, the Company has no derivative financial instruments.
In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income. This statement establishes standards for the reporting and display of comprehensive income and its components in the consolidated financial statements. The purpose of reporting comprehensive income is to report the change in equity of a business enterprise for the period from transactions and other events and circumstances from non-owner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. These items include currency translation adjustments and unrealized appreciation of investments, which are currently reported as separate components of equity in the balance sheet. The statement is effective in 1998 and will change the presentation of information in the financial statements but will not have any effect on the financial position or results from operations of the Company.
Also in June 1997, the FASB issues SFAS No. 131, Disclosure about Segments of an Enterprise and Related Information. This statement requires that companies report certain information about their operating segments in the financial statements including, information about the products and services from which revenues are derived, the geographic areas of operations, and information about major customers. Operating segments are determined by the way management decides how to allocate resources and how it assesses performance. Descriptive information about the method used to identify the reportable operating segments must also be disclosed. The statement also requires a reconciliation of revenues, net income, and assets and other amounts disclosed for the segments to the corresponding amounts in the consolidated financial statements. The statement is effective for year end 1998 and is not expected to change the Company's current segmentation of its business. The financial position and operating results of the Company will not be affected by this statement.
The year 2000 issue is the result of computer programs being written using two digits rather than four to define the applicable year. Many computer programs have date-sensitive computer software that may not recognize the date with the year 2000. This could result in system failures or miscalculations causing disruptions of operations.
The Company has determined that it will be required to modify or replace significant portions of software it uses so that the affected software will properly recognize dates beyond December 31, 1999. The Company presently believes that with modifications to existing software and conversions to new software, the year 2000 issue will be mitigated. However, if such modifications and conversions are not made, or are
not completed in a timely manner, the year 2000 issue may have a material impact on the operations of the Company. The Company has assessed the problem, has an action plan in place with resources dedicated to resolution and the work is in progress.
While the cost for the new operational and accounting software is material, only a small portion of such cost is related to year 2000 programming. Other costs to the Company related to year 2000 compliance will not be material. Management has concluded that year 2000 procedures will be completed in a timely fashion. It is not anticipated that the year 2000 issue will have a material affect on future financial results.
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements. This SEC Form 10-K or any other written or oral statements made by or on behalf of the Company may include forward-looking statements which reflect the Company's current views with respect to future events and financial performance. These forward-looking statements are subject to certain uncertainties and other factors that could cause actual results to differ materially from such statements. These uncertainties and other factors (which are described in more detail elsewhere in documents filed by the Company with the Securities and Exchange Commission) include, but are not limited to, uncertainties relating to general economic conditions and cyclical industry conditions, uncertainties relating to government and regulatory policies, volatile and unpredictable developments (including storms and catastrophes), the legal environment, the uncertainties of the reserving process and the competitive environment in which the Company operates. The words "believe", "expect", "anticipate", "project", "plan", and similar expressions, identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their dates. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.