The Columbia, South Carolina home office, containing approximately 148,000 square feet of occupied space, is owned by the Company and used primarily by its property and casualty insurance operations. Some additional premises are leased by the Company in locations in which they operate.
The new management team also engaged additional actuarial consultants at the conclusion of the year. Based upon this actuarial input, loss and adjusting expense reserves were increased significantly during the fourth quarter. Largely as a consequence of this reserve strengthening, the Company incurred a net loss of $19.1 million for the 1994 year. The portion of incurred losses and loss adjusting expenses that relates to claims occurring in prior years amounts to $17.0 million. Absent this development on prior year reserves and the realized capital losses of $6.3 million, the Company would have been profitable for the 1994 year.
The net loss for 1994 was $19.1 million ($1.72 per share). The principal factors influencing the loss were the increase in estimated losses and adjusting expenses for claims occurring in prior years of $20.3 million, the settlement of a long standing dispute at an additional cost of $2.8 million, realized losses on security sales of $6.3 million, and an offset in part by commuting outstanding liabilities with the National Council of Compensation Insurance in an amount that was $6.1 million less than the outstanding reserves. The operating loss for 1993 was $10.2 million ($1.37 per share). An extraordinary gain from the extinguishment of debt in the amount of $9.2 million ($1.23 per share) reduced the net loss for the year to $1.0 million ($.14 per share). The net loss for 1992 was $32.7 million ($4.36 per share) when operating results were dominated by losses from Hurricane Andrew. The total loss from Hurricane Andrew was $105.5 million before reinsurance and $35.4 million after reinsurance.
Service activities are predominantly related to acting as a servicing carrier for the South Carolina and North Carolina automobile reinsurance facilities, and for the WYO National Flood Insurance Program. The Company bears no underwriting risk for the business processed and administered as a servicing carrier.
The Company began in 1993 to produce business in its MGA capacity for an unaffiliated insurance carrier. The Company receives a commission for producing, underwriting, and servicing such business. In addition, the Company began in 1994 to act as a servicing carrier for the Kentucky Assigned Risk Plan.
The Company serviced $29.5 million of flood insurance premiums through the WYO program in 1994 ($32.7 million in 1993). It is among the ten largest companies acting in that capacity. The Independent Insurance Agents of America (the national association) sponsors the Company country-wide as a WYO company of preference to provide flood coverage to their members through special marketing programs of their associations. Approximately 51% of the Company's volume in this program comes from Florida. Since the Company left Florida's voluntary marketplace in 1993, the percentage of premium volume generated in that state 1994 has been reduced approximately 7% due to competition from other WYO companies.
The Company ceased to underwrite commercial lines in 1993 and has withdrawn from retaining any underwriting risk in all but five Southeastern states. The following table presents net premiums earned and loss ratios for the last three years:
The following is a breakdown of percentages of net premiums written in each of the Company's principal states for 1994, 1993, and 1992:
In 1993, the Company commuted its $43 million casualty aggregate excess of loss reinsurance agreement which it had entered into in 1989. The Company reduced its reinsurance recoverable on ceded losses and loss adjustment expenses by $43 million, and received $42.9 million in U.S. Treasury Strips. The commutation had no material effect on underwriting results, or on net income.
Through various types of reinsurance, the Company reduces its net liability on individual risks. A significant portion of the Company's covered risks are located in areas that are vulnerable to major windstorms. These risks are mitigated in part by using selective underwriting procedures and purchasing catastrophe property reinsurance protection to contain major losses. Although this protection was inadequate with regard to Hurricane Andrew, the substantial downsizing in premiums, risk areas, and lines of business should more adequately protect the Company in the event of a catastrophic event.
Loss reserves are estimates at a given point in time of the amount the insurer expects to pay claimants plus investigation and litigation costs, based on facts and circumstances then known. It can be expected that the ultimate liability in each case will differ
Reserve deficiencies are caused primarily by the difficulties inherent in estimating the liability for claims on the casualty lines of business, where the full extent of the damages can often be sizable, but not accurately determinable at the date of estimation. This situation is further complicated by the fact that the existence of a claim may not be reported to the Company for a number of years.
The next portion of the table shows the re-estimated amount of the liability based on experience as of the end of each succeeding year. The estimate is increased or decreased as more information becomes known about the claims for the year being reported.
1990, and in late 1992 made the decision to discontinue writing any new or renewal workers' compensation business. During 1994, liabilities associated with this Pool were commuted, eliminating exposure to further development for the Pool, and producing a $6.1 million reduction in the adverse development for 1994.
The majority of the adverse reserve development in 1989 was related to accident years 1982-1985 and the business produced by the former West Coast operation. The Company purchased that operation in 1981. The problem West Coast lines were primarily commercial automobile liability and other liability, including a substantial amount of contractors' and subcontractors' liability coverages. These claims turned out to have greater severity and much longer development periods than the Company had previously experienced. It was not until 1989 that the full extent of the problems started to become clear. The Company added $30 million to its reserves for that business in 1989, and until 1992 had no further adverse development. As of December 31, 1994, the Company has $21.5 million of reserves established for this business.
A part of the Company's reserve for losses and LAE is set aside for environmental, pollution and toxic tort claims. The majority of these claims relate to business written by the West Coast operation prior to 1986. At December 31, 1993, the reserves on these claims was $23.4 million. On June 7, 1994, the Company settled a dispute relative to approximately 400 of these claims. Any future liability on them is limited to 50% of the loss and reimbursement of the Company's 50% does not begin until the other company pays out subsequent to June 7, 1994 a total of $20 million in losses. The settlement also has policyholder surplus safeguards to the benefit of the Company built in to it. Future obligations, if any, are not likely to become payable for several years.
The above claims involve 11 Superfund sites, 5 asbestos or toxic tort claims, 11 underground storage tanks and 62 miscellaneous clean- up sites.
During 1994, the Company was forced to sell bonds to meet cash requirements while interest rates were rising. This action resulted in significant realized losses. A declining interest rate environment in 1993 and 1992 resulted in realized gains related to fixed maturity and equity investments. The 1993 and 1992 gains were taken primarily in the bond portfolio to shorten maturities, maximize liquidity, and increase surplus.
In December 1993, the Company entered into an Investment Management Client Agreement with Prudential Securities Incorporated. Prudential Securities serves as the Company's investment advisor on all portfolio investments.
Effective January 1, 1995, Forest Lake Travel Service, a subsidiary travel agency, was sold. FLT's 1994 pre-tax income was $95,000, $420,000 in 1993 and $443,000 in 1992. The sale generated an insignificant gain in the first quarter of 1995.
In 1993, the Company adopted FASB 109, "Accounting for Income Taxes", which requires the use of the liability method in accounting for income taxes. Deferred taxes are determined based on the estimated future tax effects of differences between the financial statement and tax bases of assets and liabilities given the provision of the enacted tax laws. The adoption had no material effect on the financial statements. Prior to the implementation of FASB 109, the Company accounted for income taxes using APB Opinion No. 11.
The 1994 provision for income taxes on operations of $28,820 resulted from certain life insurance taxable income and state income taxes that cannot be offset by tax operating losses. The provision also included a benefit from an overaccrual of expense in prior years.
In 1993, the Company recognized an income tax benefit from operations of $4.8 million and a $5.6 million income tax expense on the extraordinary gain from debt extinguishment. The net tax expense of $797,000 includes the tax effect of certain life insurance taxable income and state income tax expense that cannot be offset by tax loss carryovers. The 1992 provision for income taxes of $58,000 resulted from state taxes on subsidiary operations.
As the Company deliberately downsizes its exposure to underwriting risk, premium collections decline at a much faster pace than the decline in claim payments. Consequently, operations have used net cash in operating activities of $44.6 million in 1994, $43.6 million in 1993, and $22.3 million in 1992. During 1994, cash disbursements included $25.4 million for the non-recurring commutation of NCCI liabilities and a dispute settlement regarding American Star. The 1993 cash used in operating activities would have been $43 million greater than the actual cash drain had it not been for a non- recurring commutation of reinsurance ceded which produced a cash receipt in the amount of the reinsurance recoverable. The 1992 cash flow from operations would have been positive had it not been for $35.4 million in Hurricane Andrew losses.
The volume of premiums that the property and casualty insurance subsidiaries may prudently write is based in part on the amount of statutory net worth as determined in accordance with applicable insurance regulations. The National Association of Insurance Commissioners has adopted risk based capital requirements for property and casualty insurance companies to evaluate the adequacy of statutory capital and surplus in relation to investments and insurance risks such as asset quality, asset and liability matching, loss reserve adequacy, and other business factors. The RBC formula will be used by state insurance regulators as an early warning tool to identify, for the purpose of initiating regulatory action, insurance companies that are potentially inadequately capitalized. Compliance is determined by ratio of the companies' regulatory total adjusted capital to its authorized control level RBC (as defined by the NAIC). Three insurance subsidiaries of the Company have December 31, 1994 ratios of total adjusted capital to RBC that are comfortably in excess of the level which would prompt regulatory action.
To the Shareholders and Board of Directors of The Seibels Bruce Group, Inc.:
We have audited the accompanying consolidated balance sheets of The Seibels Bruce Group, Inc. (a South Carolina corporation) (the Parent Company) and its subsidiaries (collectively the Company ), as of December 31, 1994 and 1993, and the related consolidated statements of operations, changes in shareholders equity and cash flows for each of the three years in the period ended December 31, 1994. These financial statements and the schedules referred to below are the responsibility of the Company s management. Our responsibility is to report on these financial statements and schedules based on our audits.
Because of the significance of the matters discussed in the preceding paragraph, we are unable to express, and we do not express, an opinion on the 1994 financial statements referred to above. However, in our opinion, the 1993 and 1992 financial statements referred to above present fairly, in all material respects, the consolidated financial position of The Seibels Bruce Group, Inc. and subsidiaries, as of December 31, 1993 and the consolidated results of their operations and their cash flows for each of the two years in the period ended December 31, 1993 in conformity with generally accepted accounting principles.
As explained in Note 3 to the financial statements, effective January 1, 1994, the Company changed its method of accounting for investments in debt securities.
Effective April 13, 1995, the Company executed a note in favor of the new investors for $2 million, the proceeds of which were contributed as statutory surplus directly to SCICand its subsidiaries. See Note 13.
Although results of operations for the period subsequent to December 31, 1994 have not been quantified, management believes that SCIC currently meets the minimum statutory capital and surplus requirements of the DOI.
Certain classifications previously presented in the consolidated financial statements for prior periods have been changed to conform to current classifications.
The Company's insurance subsidiaries' assets, liabilities and results of operations have been reported on the basis of GAAP, which varies from statutory accounting practices ("SAP") prescribed or permitted by insurance regulatory authorities. The principal differences between SAP and GAAP, are that under SAP: (i) certain assets that are not admitted assets are eliminated from the balance sheet; (ii) acquisition costs for policies are expensed as incurred, while they are deferred and amortized over the estimated life of the policies under GAAP; (iii) no provision is made for deferred income taxes; (iv) the timing of establishing certain reserves is different than under GAAP; and (v) valuation allowances are established against investments. Each of the Company's insurance subsidiaries must file with applicable state insurance regulatory authorities an "Annual Statement" which reports, among other items, net income (loss) and shareholders' equity (called "surplus as regards policyholders" in property and casualty reporting).
A reconciliation between GAAP shareholders' equity and statutory capital and surplus is as follows:
Policy acquisition costs attributable to property and casualty operations represent that portion of the cost of writing business that varies with and is primarily related to the production of business. Such costs are deferred and charged against income as the premiums are earned. The deferral of policy acquisition costs is subject to the application of recoverability tests to each primary line or source of business based on past and anticipated underwriting results. The deferred policy acquisition costs that are not recoverable from future policy revenues are expensed. The Company has considered anticipated investment income in determining premium deficiency which would reduce the recoverable policy acquisition cost. Policy acquisition costs for property and casualty operations are as follows:
Deferred policy acquisition costs attributable to the credit life operation were $899,053 at December 31, 1994 and $2,542,104 at December 31, 1993. These costs represent that portion of the cost of writing business which is deferred and charged against income, through other operating costs and expenses, as premiums are earned.
The amounts of premiums pertaining to catastrophe reinsurance that were ceded from earned premiums during 1994, 1993 and 1992 were $1,693,752, $4,409,596, and $7,177,797 respectively.
(1) An accumulation of formula and case estimates for losses reported prior to the close of the accounting period. (2) Estimates of incurred-but-not-reported losses based upon past experience and current circumstances. (3) Estimates of loss adjustment expense liabilities by applying percentage factors to the unpaid loss reserves, with such factors determined on a by-line basis from past results of paid loss adjustment expenses to paid losses. (4) The deduction of estimated amounts recoverable from salvage and subrogation. (5) Estimated losses as reported by ceding reinsurers.
A part of the Company's reserve for losses and LAE is set aside for environmental, pollution and toxic tort claims. The majority of these claims relate to business written by the West Coast operation prior to 1986. At December 31, 1993 the reserves on these claims was $23.4 million. On June 7, 1994 the Company settled a dispute relative to approximately 400 of these claims, and any future liability on them is limited to 50% of the loss and reimbursement of the Company's 50% does not begin until the other company pays out a post June 7, 1994 total of $20 million. The settlement also has policyholder surplus safeguards inuring to the benefit of the Company built in to it. Future obligations, if any, are not likely to become payable for several years. (See Note 11)
Case reserves $ 2,160 IBNR reserves 9,950 LAE reserves 3,718 Total $15,828
Management, in conjunction with the Company's consulting actuaries, performs a complete review of the above components of the Company's loss reserves to determine the adequacy of such reserves. Management believes the reserves, which approximate the amount determined by independent actuarial reviews, are sufficient to prevent prior years' losses from adversely affecting future periods; however, establishing reserves is an estimation process and adverse developments in future years may occur and would be recorded in the year so determined.
Commission and service income is predominantly derived from servicing carrier activities. The commission income related to producing and underwriting the business is recognized in the period in which the business is written. Beginning in 1993, a significant portion of commission income is also derived from business produced by the Company as a Managing General Agent. The Company receives commissions for producing and underwriting the business as well as servicing such business. These revenues are recognized on an accrual basis as earned and are reduced by certain direct expenses related to acquiring and servicing the business.
Allowance for uncollectible accounts for agents' balances receivable, other receivables, and premium notes receivable were $69,992, $150,555, and $245,774 at December 31, 1994 and $186,770, $151,015, and $418,123 at December 31, 1993, respectively. There are no material credit concentrations related to premiums receivable, agents' balances, and premium notes receivable.
Other interest income for 1993 and 1992 includes $1.0 million and $1.9 million, respectively, on an excess of loss reinsurance agreement which was commuted in 1993. Other interest income also includes interest received on reinsurance balances withheld, agents' balances receivable, and balances due from the South Carolina Reinsurance Facility.
Other income for 1994 includes a $650,000 gain on the sale of a subsidiary, and other income for 1993 includes $687,031 from the sale of real estate.
In May 1993, FASB issued Statement No. 115, "Accounting for Certain Investments in Debt and Equity Securities". Statement No. 115 classifies securities into three categories: held-to-maturity, trading and available-for- sale. The Company's securities are classified as available- for-sale. Statement No. 115 requires available-for-sale securities be reported at fair value and the unrealized gains and losses be reported in a separate component of shareholders' equity. The Company adopted Statement No. 115 effective January 1, 1994. The market value of the fixed maturity investments was approximately $2,380,000 less than the amortized cost at the end of 1994.
Net amortization of bond discount and premium charged to income for the years ended December 31, 1994, 1993 and 1992 are $153,602, $53,021 and $355,394, respectively.
(d) The amortized cost and estimated market values of investments in fixed maturities and equity securities by categories of securities are as follows:
In December, 1993, the Company entered into an Investment Management Client Agreement with Prudential Securities Incorporated. Prudential Securities serves as the Company's investment advisor on all portfolio investments.
(a) The Seibels Bruce & Company Employees' Profit Sharing and Savings Plan contains both profit-sharing and 401(k) plan elements.
The profit-sharing element of the plan covers all full-time employees. There were no contributions to this element of the plan during the last three years. The profit-sharing account currently holds 214,587 shares of SBIG stock.
Under the 401(k) element of the plan, employees may elect to have a portion of their salary withheld on a pre-tax basis for investment in the plan, subject to limitations imposed by IRS regulations. Through December 31, 1992, the employer matched 50% of an employee's contributions, to the extent the match did not exceed a maximum 3% of the employee's eligible compensation. The
employer contribution was invested half in common stock of the Company and half in accordance with the investment option selected by the participant. From January 1, 1993 through June 30, 1994, the employer matched 25% of the employee contributions, limited to a maximum of 1.5% of the employee's eligible compensation. Effective July 1, 1994, the employer began matching 50% of the employee contributions, limited to a maximum of 3% of the employee's eligible compensation. The employer matched portion is invested in accordance with the investment options selected by the participant. The employer contribution to the plan on behalf of participating employees was $270,233 in 1994 ($81,850 in 1993 and $239,887 in 1992).
The range of option prices per share for options outstanding at the end of 1994 is $10.63-$11.25, such option prices being substantially greater than the current trading price. At December 31, 1994, 948,850 shares of the Company's common stock have been reserved for future grant.
(c) The Company and its subsidiaries currently provide certain health care and life insurance benefits for retired employees. Prior to 1993, the cost of these benefits was recognized as claims and premiums were paid.
In 1993, the Company adopted FASB Statement No. 106, which requires that the projected future cost of providing postretirement benefits, such as health care and life insurance, be recognized as an expense as employees render service instead of when the benefits are paid. The cumulative effect of the accounting change is being recorded as a charge against income on a prospective basis as part of the future annual benefit cost.
The following table presents the reconciliation of the funded status at December 31, 1994 and 1993:
The weighted average annual assumed rate of increase in the per capita cost of covered benefits (i.e., health care cost trend rate) was 12% for 1994 and 1993 and is assumed to decrease to a 7% ultimate trend with a duration to ultimate trend of 9 years. The health care cost trend rate assumption has a significant effect on the amounts reported. For example, increasing the assumed health care cost trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation as of December 31, 1994 by $44,882.
The weighted-average discount rate used in determining the accumulated postretirement benefit obligation was 7.5% at December 31, 1994 and 1993.
In 1993, the Company adopted FASB 109, "Accounting for Income Taxes", which requires the use of the liability method in accounting for income taxes. Deferred taxes are determined based on the estimated future tax effects of differences between the financial statement and tax bases of assets and liabilities given the provisions of the enacted tax laws. The adoption had no material effect on the financial statements. Prior to the implementation of FASB 109, the Company accounted for income taxes using Accounting Principles Board Opinion No. 11.
Deferred tax liabilities and assets at December 31, 1994 and 1993, are comprised of the following:
The Company has determined, based on its recent earnings history, that an asset valuation allowance of $46.0 million should be established against the deferred tax asset at December 31, 1994. The Company's asset valuation allowance changed by $6,695,000 during 1994, due primarily to the increase in net operating loss carryforwards.
As of December 31, 1994, the Company has unused tax net operating loss carryforwards and capital loss carryforwards of $94.3 million for income tax purposes. If not utilized against taxable income in future years, the tax carryforwards will expire as follows:
Subsequent to year-end, the Company completed a rights offering and there has been a stock purchase by investors (see Note 13). The possibility exists that a change in ownership, as defined by the Internal Revenue Code, may have occurred, although an actual determination with respect thereto has not been definitely made. If a change in ownership has occurred or does occur, the unused loss carryforwards will be subject to certain limitations.
The Act provides that, without prior approval of the South Carolina Insurance Commissioner, dividends within any twelve- month period may not exceed the greater of (i) 10% of SCIC's surplus as regards policyholders as of December 31 of the prior year or (ii) SCIC's statutory net income, not including realized gains, for the prior calendar year. Notwithstanding the foregoing, SCIC may not pay any dividend without the prior approval of the Chief Insurance Commissioner of the State of South Carolina.
The Company acts as a servicing carrier for certain state and federal insurance facilities on a commission basis. The Company is also engaged in the underwriting of property and casualty insurance through its subsidiary property and casualty insurance group.
Effective January 1, 1995, Forest Lake Travel Service, a subsidiary travel agency, was sold. FLT's 1994 pre-tax income was $95,000, $420,000 in 1993 and $443,000 in 1992.
Premium Service Corporation of Columbia ("PSC") provides insurance premium financing services through independent agents. Pretax income of Premium Service was $470,000 in 1993, and $262,000 in 1992. In February, 1994, substantially all of the assets of PSC were sold, and a new company, Policy Finance Company, ("PFC") was formed to handle the administration of the assets retained. The pre- tax income of PFC was $538,000 in 1994. The Company has no plans to continue its own premium financing activity.
In 1994, depreciation and amortization charges for the various property and casualty insurance underwriting and commission and service activities segments, combined, were $832,042 ($412,922 in 1993 and $920,623 in 1992). These amounts exclude policy acquisition costs of $5,538,067 in 1994, ($17,627,677 in 1993 and $35,709,144 in 1992).
(b) Reinsurance contracts do not relieve the Company of its obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company; consequently, allowances are established for amounts deemed uncollectible. The Company evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurers to minimize its exposure to significant losses from reinsurer insolvency. Reinsuring companies are obligated for the following amounts for unearned premiums, unpaid losses and LAE, and paid losses and LAE: (000's omitted)
(b) Due to the nature of their business, certain subsidiaries are parties to various other legal proceedings, which are considered routine litigation incidental to the insurance business.
(c) In connection with the 1990 sale of a subsidiary, the Company has committed to provide certain stated minimum dollar volumes of claims adjusting fees through December 31, 1996. Amounts provided in excess of the requirement, up to 10% of the requirement, can be carried forward to benefit future periods. Similarly, amounts provided below the requirement, up to 10%, can be added to the next year's commitment. The estimated commitment for 1995 is $6.3 million.
Certain members of the Board of Directors of the Company are also members of the Board of Directors of Policy Management Systems Corporation (PMSC), which provides data processing services to the Company. The term of this contract expires December 31, 1995. The Company paid data processing charges of $3,449,723 in 1994 ($6,128,624 in 1993 and $7,123,208 in 1992). The amount payable to PMSC at year-end was $203,210 at 1994 and $402,996 at 1993.
During the first quarter of 1995, the Company completed a Rights Offering. Each shareholder of record received one right for each five shares of common stock held at the close of business on December 9, 1994. The rights allowed the shareholders to purchase additional shares of common stock at a price of $2.40 per share. The Company received proceeds, net of expenses, of $5.1 million in exchange for 2,217,152 newly issued shares.
As a consequence of recording additional loss and loss adjusting expense liabilities after filing its statutory annual statement with regulators, SCIC has an adjusted negative statutory net worth as of December 31, 1994. To cure the deficiency, $7 million of capital was contributed directly to SCIC and its subsidiaries by the Company from the proceeds of the transactions described above. In addition, premium writings have been voluntarily curtailed until the Company and its regulators are satisfied that the financial condition of the Company has been stabilized. SUPPLEMENTARY DATA
QUARTERLY FINANCIAL INFORMATION (unaudited) (Dollars in thousands, except per share amounts)
The third quarter was affected by a $6.1 million reserve redundancy in connection with a commutation and $3.4 million in realized investment losses. The fourth quarter results include a reserve strengthening charge of $9.0 million in loss and loss adjustment expense reserves in addition to already recorded fourth quarter incurred losses and LAE of $10.4 million, a $2 million decrease, compared to prior quarters, in commission and service income and $4.1 million in realized investment losses.
The first quarter was affected by $4.2 million from the severe winter storm in March, 1993, as well as a $1 million rate rollback on North Carolina premiums. The second quarter was impacted by a $1.4 million reduction to revenue due to a refinement in the estimate of accrued servicing carrier loss adjusting fee income, and a $1.3 million loss from the Company's required participation in residual market pools and associations, primarily the National Workers' Compensation Pool. The third quarter was impacted by a $2.5 million expense due to an accrual for a litigation contingency. Fourth quarter underwriting results were affected by a $5.5 million addition to loss reserves.