The Company acquired Western Surety in August 1992 and Universal Surety in September 1994 and disposed of United Capitol on May 22, 1996. The inclusion of the results of United Capitol through May 22, 1996, and of Western Surety and Universal Surety from their respective dates of acquisition affects the comparability of financial information. Such results are not necessarily indicative of future results. Effective January 1, 1994, the Company adopted SFAS No. 115. For a more detailed description of these transactions and their effects on the Company's financial data, see the audited Consolidated Financial Statements and related notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations appearing in this or previously filed Annual Reports on Form 10-K.
The Company, through its principal subsidiaries, Western Surety Company ("Western Surety"), acquired in August 1992, and Universal Surety of America ("Universal Surety"), acquired in September 1994, provides surety and fidelity bonds in all 50 states through a combined network of 120,000 independent agents.
Universal Surety specializes in the underwriting of small contract and miscellaneous surety bonds. Universal Surety is rated A (Excellent) by A.M. Best and is licensed in 37 states and the District of Columbia with most of its business generated in Texas (74% of 1996 gross written premiums). Contract bonds underwritten by Universal Surety, including those underwritten on behalf of Western Surety under the USA\Western program, are primarily contractor performance and payment bonds in amounts under $3.0 million for which underwriting expertise and distinctive service to agents are emphasized. Universal Surety underwrites primarily standard accounts and some specialty accounts for which it utilizes supplemental collateral arrangements and excess rates for contractors not qualified for standard surety rates. Universal Surety also reduces its exposure through participation in the Small Business Administration ("SBA") Surety Bond Guarantee Program. Under this program, the SBA will generally reimburse Universal Surety for between 80% and 90% of losses and loss adjustment expenses incurred on any SBA guaranteed bond in exchange for 20% of the premium. Contract bonds are more affected by prevailing market and general economic conditions than noncontract bonds.
agreement and approximately $94 million from available cash and marketable securities accumulated at the parent company level. In connection with the payment of the special distribution, the Board of Directors also authorized a corresponding repricing of all outstanding stock options. This resulted in a new measurement date for the stock options under applicable accounting pronouncements and required the Company to record in the third quarter of 1996 a non-recurring compensation charge of $4.1 million, after applicable income taxes, or 25 cents per share of which $3.6 million, or 22 cents per share, was non-cash.
On December 19, 1996, Capsure and certain direct and indirect subsidiaries of CNA Financial Corporation ("CNAF") entered into a definitive Reorganization Agreement pursuant to which Capsure will merge with a wholly-owned subsidiary of CNA Surety Corporation ("CNA Surety"). CNAF, through its subsidiaries, will be the majority stockholder of CNA Surety, owning 61.75 percent of the shares on a fully diluted basis. The remaining shares will be issued to the existing Capsure stockholders (a portion of these shares will be reserved for issuance to the existing holders of Capsure options who will receive CNA Surety options in the merger) in a tax-free exchange for their Capsure shares on a one-for-one basis. The CNA Surety shares are expected to be traded on the New York Stock Exchange. Equity Capsure Limited Partnership ("Equity Capsure"), Capsure's largest stockholder with a 25.6 percent ownership interest, and certain other directors of the Company have agreed to vote their shares in favor of the merger. The agreement and the transactions contemplated thereby are subject to several conditions, including ratification by the affirmative vote of Capsure stockholders and approval by governmental and insurance regulatory authorities.
The completion of the merger pursuant to the Reorganization Agreement will cause an ownership change under Section 382 of the Internal Revenue Code of 1986, as amended (the "Code") and significantly limit the future utilization of Capsure's net operating tax loss carryforwards ("NOLs"). If the Reorganization Agreement and transactions contemplated thereby are approved, Capsure shareholders will be asked to approve an amendment to its Certificate of Incorporation to delete a provision designed to facilitate the Company's ability to preserve and utilize its NOLs.
The components of income are summarized as follows (dollars in thousands):
Surety and fidelity represents the combined results of Western Surety and Universal Surety, since its September 1994 acquisition. Surety and fidelity are the principal lines of business of Western Surety and Universal Surety. Excess and surplus lines represents the results of United Capitol through May 22, 1996. United Capitol's principal lines of business were other liability, product liability and commercial property primarily written on an excess and surplus lines basis.
Net earned premiums increased $6.2 million for the year ended December 31, 1995, principally due to the inclusion of the full year results of Universal Surety in 1995. Universal Surety contributed net earned premiums of $14.7 million in 1995. Western Surety's net earned premiums increased 1.6% in 1995 compared to 1994. United Capitol's net earned premiums decreased 28.7%, or $5.5 million in 1995, reflecting decreases in both gross written premiums and net retentions. The lower net retentions were due primarily to the increased use of reinsurance for primary casualty risks in an effort to limit the potential loss volatility associated with a diminished premium base. United Capitol's net earned premiums for the years ended
The consolidated expense ratio increased to 68.3% in 1996, compared to 62.1% in 1995. The surety and fidelity expense ratio increased to 70.6% in 1996 from 68.5% in 1995, reflecting costs associated with ongoing re-engineering and automation efforts.
United Capitol's claims development through December 31, 1995, had been favorable relative to expectations based on industry experience. Due to the limited prior operating experience of United Capitol and the long-tail nature of its business, management previously relied principally upon industry development patterns and expected loss ratios in estimating incurred but not reported ("IBNR") losses. Given the availability of nine full years of experience and the growing evidence of favorable loss trends relative to industry indications, management concluded in the fourth quarter of 1995 that it was appropriate to place greater reliance on United Capitol's own development patterns and emerging loss ratios in estimating IBNR. United Capitol reduced loss and loss adjustment expenses by $23.2 million in 1995 for net favorable development related to prior years, substantially all of which pertains to this change in estimate. This loss reserve reduction increased Capsure's consolidated income before taxes by $23.2 million, and net income by $15.1 million, or $0.98 per share.
Capsure's insurance companies invest funds provided by operations predominantly in high-quality, short-duration, taxable fixed income securities. The preservation of capital and utilization of the Company's available NOLs are Capsure's principal investment objectives.
(losses) were $0.9 million, $(2.7) million and $(0.4) million, respectively, from the insurance operations. The net investment losses from the insurance operations in 1995 reflected the write-down of the carrying value for two asset-backed securities from the same issuer which experienced an other than temporary decline in fair value.
Amortization expense was $2.8 million for the year ended December 31, 1996, $16.9 million in 1995 and $3.4 million in 1994. Amortization expense in 1996, 1995 and 1994 included $1.1 million, $1.2 million and $1.3 million, respectively, of amortization of intangible assets and $1.7 million, $15.7 million and $2.1 million, respectively, of amortization of excess cost over net assets acquired related to the acquisitions of Western Surety, Universal Surety, United Capitol and Fischer. Amortization expense was not recorded in 1996 for the goodwill associated with the United Capitol operations. Amortization expense for 1995 included a $13.2 million write-down of goodwill associated with the 1990 United Capitol acquisition to reflect the estimated net realizable value on the sale of those operations. Excess cost over net assets acquired is amortized substantially over 40 years. Other intangible assets are amortized over periods ranging from three to 20 years.
Interest expense decreased by 58.2%, or $2.4 million, to $1.7 million for the year ended December 31, 1996, reflecting the effect of reduced average debt outstanding. The Company's average debt outstanding for the year ended December 31, 1996, was approximately $20.4 million compared to $49.6 million in 1995. The weighted average interest rates on outstanding balances were 6.3% and 6.9% for the years ended December 31, 1996 and 1995, respectively. In connection with the amendment of the Credit Facility (as herein defined) during the second quarter of 1996, the Company incurred a $0.7 million write-off of unamortized deferred loan fees in the year ended December 31, 1996. Interest expense decreased by 13.2%, or $0.6 million, to $4.1 million for the year ended December 31, 1995, reflecting the effect of reduced debt. The Company's average debt outstanding for the year ended December 31, 1995, was approximately $49.6 million compared to $70.5 million in 1994. The weighted average interest rate on outstanding balances was 5.7% for the year ended December 31, 1994. The Company incurred a $1.6 million write-off of unamortized deferred loan fees in the year ended December 31, 1994, associated with the early retirement of bank term loans.
In the fourth quarter of 1996, the Company incurred $1.1 million, after applicable income taxes, or 7 cents per share, in merger-related costs associated with the previously discussed pending business combination with CNAF.
The Company's insurance subsidiaries are highly liquid. The insurance operations derive liquidity from net premium collections, reinsurance recoveries and investment earnings and use these funds to pay claims and operating expenses. The operations of an insurance company generally result in cash being collected from customers in the form of premiums in advance of cash outlays for claims. Each insurance company invests its
On May 24, 1995, the Board of Directors of the Company approved a stock repurchase plan. The plan authorizes the Company to repurchase up to 500,000 shares of its common stock. These shares may be purchased from time to time in the public market or through privately negotiated transactions. As of December 31, 1996, no shares had been repurchased under this plan.
The following table sets forth the composition by ratings assigned by The Standard & Poors Corporation ("S&P") or Moody's Investor Services, Inc. ("Moody's") of the fixed income portfolio of the Company as of December 31, 1996 (dollars in thousands):
The following table presents selected loss and loss adjustment expense information and highlights the impact of revisions to the estimated liability established in prior years (dollars in thousands):
As a result of favorable claim settlements and changes in estimates of insured events in prior years, the provision for losses and loss adjustment expenses decreased by $10.6 million ($6.9 million, net of reinsurance) in 1996, $34.6 million ($29.1 million, net of reinsurance) in 1995 and $14.5 million ($8.3 million, net of reinsurance) in 1994. As described within Results of Operations -- Insurance Underwriting, United Capitol reduced loss and loss adjustment expenses by $23.2 million in 1995 for net favorable development related to prior years.
Capsure's insurance subsidiaries require capital to support premium writings. In accordance with industry and regulatory guidelines, the net written premiums to surplus ratio of a property and casualty insurer should not exceed 3 to 1 (the terms of the Credit Facility limit this ratio further to 2.75 to 1 for Western Surety and Universal Surety). On December 31, 1996, Western Surety's statutory surplus was $37.2 million and its net written premiums to surplus ratio was 1.9 to 1. On December 31, 1996, Universal Surety's statutory surplus was $11.7 million and its net written premiums to surplus ratio was 1.7 to 1. The Company believes that each insurance company's statutory surplus is sufficient to support its current and anticipated premium levels.
On July 31, 1986, the Company emerged from voluntary bankruptcy proceedings under Chapter 11 of the United States Bankruptcy Code. As a result of operating losses from oil and gas operations prior to the Company's bankruptcy, the Company emerged from bankruptcy with approximately $300 million in NOLs. Approximately $143 million of these NOLs were available at December 31, 1996 to reduce the Company's future federal taxable income.
The Company was engaged in oil and gas production, exploration and development until mid-1993. In connection with the sale of substantially all of the Company's oil and gas properties, the buyers assumed all material environmental liabilities.
In October 1995, the Financial Accounting Standards Board ("FASB") issued SFAS No. 123, "Accounting for Stock-Based Compensation." SFAS No. 123 is effective for fiscal years beginning after December 15, 1995. SFAS No. 123 introduces a preferable fair value-based method of accounting for stock-based compensation. SFAS No. 123 encourages, but does not require, companies to recognize compensation expense for grants of stock, stock options, and other equity instruments to employees based on the new fair value-based method of accounting. As permitted under SFAS No. 123, the Company has continued to apply the existing accounting rules contained in Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations, and has disclosed net income and earnings per share on a pro forma basis, based on the new fair value-based method of accounting in Note 13 to the Consolidated Financial Statements.