The following analysis of the consolidated results of operations and financial condition of the Company should be read in conjunction with the Selected Financial Data and Consolidated Financial Statements and related footnotes included elsewhere herein.
ALLIED Group, Inc. (the Company) is a regional insurance holding company. As of December 31, 1995, The ALLIED Group Employee Stock Ownership Trust (ESOP Trust) owned 26.9% of the outstanding stock. ALLIED Mutual Insurance Company (ALLIED Mutual), an affiliated property-casualty insurance company, controlled 18% of the voting stock of the Company.
The operating results of the property-casualty insurance industry are subject to significant fluctuations from quarter to quarter and from year to year due to the effect of competition on pricing, the frequency and severity of losses incurred in connection with weather-related and catastrophic events, general economic conditions, and other factors such as changes in tax laws and the regulatory environment.
Consolidated revenues for 1995 were $552.8 million, up 8.9% over the $507.4 million reported for 1994. Excluding realized in gains, revenues grew 9.5% for 1995. The increase occurred primarily because of the 10.4% growth in earned premiums.
Income before income taxes was up 10.7% to $73.8 million from $66.7 million for 1994 primarily because of revenue growth and improved underwriting margins for the property-casualty segment. The property-casualty segment was the dominant contributor to operating income with an increase of $9.7 million.
Net income for the year ended December 31, 1995 was up 10% to $52.4 million, raising fully diluted earnings per share to $3.52 from $3.19. Fully diluted earnings per share before net realized investment gains were $3.50 for 1995 compared with $3.05. Book value per share increased to $24.23 from $19.68.
Revenues for the property-casualty segment increased to $472 million from $431.1 million for 1994. Direct earned premiums for the segment were $435.2 million for 1995 compared with $383.5 million one year earlier. Earned premiums increased 10.1% to $425.8 million from $386.7 million. The increase resulted primarily from growth in insurance exposure as well as a larger average premium per policy.
Pooled net written premiums (including ALLIED Mutual) totaled $692.6 million, a 9.4% increase over 1994 production. The average premium per policy for personal lines was up 3.4% to $586 while the policy count grew 6.5%. The average premium per policy for commercial lines increased 2% to $1,086, and policy count was up 5.3%. Earned premiums for the property-casualty segment were 65.7% personal lines and 34.3% commercial lines. The business mix for 1994 was 65.4% personal and 34.6% commercial lines.
Income before income taxes increased to $63.9 million from $54.2 million primarily as a result of lower underwriting expenses in 1995 and an increase in earned premiums. Investment income was $39.1 million compared with $35.3 million. The pretax yield on invested assets was 6.4%, down from 6.6% one year earlier. Realized investment gains were $236,000 compared with $3 million. Realized investment gains for 1994 included $2.6 million from the sale of the segment's 20% interest in a savings and loan holding company. Other income increased to $6.9 million from $6.1 million in 1994.
The statutory combined ratio (after policyholder dividends) improved to 95.7 from the 97.1 reported in 1994. Improvement was attributed primarily to a 1.3-point decrease in the underwriting expense ratio. The decrease was the result of the Company's continuing efforts to improve efficiency and productivity. Wind and hail losses for 1995 increased to $28.7 million from $24.4 million in 1994. The impact of wind and hail losses on the statutory combined ratio was 6.7 points for the year ended December 31, 1995 and 6.3 points for 1994. The underwriting gain (on a generally accepted accounting principles basis) was $17.7 million compared with $9.8 million for 1994. On a fully diluted basis, the impact of wind and hail losses on the results of operations was $1.35 per share versus $1.15 in 1994.
The personal auto statutory combined ratio improved to 96.5 for 1995 from 97.4 last year. The improvement was due to a 1.4-point decrease in the underwriting expense ratio that more than offset the increase in the loss and loss settlement expense ratio. The statutory combined ratio for the homeowners line was 99.2 compared with 107.4 for 1994. The impact of wind and hail losses on the homeowners combined ratio increased slightly to 21.7 points from 21.5 points. Results for the homeowners line were favorably affected by better pricing in 1995. Overall, the personal lines statutory combined ratio improved to 97.2 in 1995 from 99.8 in 1994. The statutory combined ratio for commercial lines increased to 92.7 from 92.0 for the previous year.
Income before income taxes for 1995 decreased 3.2% to $4.8 million from $5 million. The decrease was primarily due to poor loss development. Realized investment losses were $136,000 compared with losses of $24,000 for 1994. Investment income increased 11.2% to $5.8 million from $5.2 million. Investment income increased because a larger average balance of invested assets more than offset a 10 basis-point decline in the pretax yield from last year's 6.8%. Invested assets rose 21.2% from the previous year-end to $96.4 million at December 31, 1995.
Revenues for the data processing operations decreased 6% to $48.6 million from $51.8 million in 1994. The operations reported a pretax loss of $618,000 for 1995 and a pretax profit of $3.9 million the previous year. The 1995 decreases were primarily the result of a reduction in revenues generated from the affiliated property-casualty segment. Fees for processing and product maintenance services were lowered during the year to more closely approximate cost for providing such services to that segment's companies.
The investment policy for the Company's insurance segments requires that the fixed maturity portfolio be invested primarily in debt obligations rated investment grade (BBB) or higher by Standard & Poor's Corporation or a recognized equivalent at the time of acquisition. The policy also states that equity securities are to be of United States and Canadian corporations listed on
established exchanges or publicly traded in the over-the-counter market. Preferred stock is to be comprised primarily of issues rated at least A3/A- by Standard & Poor's Corporation or Moody's. At December 31, 1995 the Company's investment portfolio consisted almost exclusively of fixed income securities; 98.1% were rated investment securities or higher. The portfolios contained no real estate or mortgage loans.
At December 31, 1995, the Company held collateralized mortgage obligation (CMO) investments with a carrying and fair value of $77.7 million. The Company's investments in CMOs as of December 31, 1994 had a carrying value of $59.6 million (fair value of $57 million). Substantially all of the Company's CMO investments are in planned amortization class bonds or sequential pay bonds with anticipated durations of approximately five years at the time of acquisition. The Company has not invested in the more volatile types of CMO products such as companion or accrual (Z-bond) tranches. All of the Company's CMO investments have an active secondary market; accordingly, their effect on the Company's liquidity does not differ from that of other fixed income investments.
Income before income taxes was up 17.5% to $66.7 million from $56.8 million for 1993 primarily because of improved underwriting results for the property-casualty segment. The segment's operating income increased $13.3 million.
Net income for the year ended December 31, 1994 was up 19.3% to $47.6 million, raising fully diluted earnings per share to $3.19 from $2.61. Fully diluted earnings per share before net realized investment gains were $3.05 compared with $2.55. Book value per share increased to $19.68 from $17.98.
Revenues for the property-casualty segment increased to $431.1 million from $384.6 million for 1993. Direct earned premiums for the segment were $383.5 million for 1994 compared with $328.5 million one year earlier. Earned premiums increased 12.3% to $386.7 million from $344.3 million. The increase resulted primarily from growth in insurance exposure and a larger average premium per policy.
Pooled net written premiums (including ALLIED Mutual) totaled $632.8 million, an 11.3 % increase over 1993 production. The average premium per policy for personal lines was up 3.8% to $567 while the policy count grew 8%. The average premium per policy for commercial lines increased 4.5% to $1,065, and policy count was up 4.8%. Earned premiums for the property-casualty segment were 65.4% personal lines and 34.6% commercial lines. The business mix for 1993 was 65.5% personal and 34.5% commercial.
Income before income taxes for ALLIED Mortgage was up 16.5% to $4 million from $3.4 million for 1993. The increase was primarily the result of fewer servicing rights being written off due to the reduction in refinancing activities in 1994. During 1993, lower interest rates increased the amount of servicing rights being expensed as the underlying mortgages were repaid or refinanced.
Revenues increased 6.8% for the data processing operations to $51.8 million from $48.4 million in 1993. Income before income taxes decreased 16.8% to $3.9 million in 1994 from $4.6 million. The decrease occurred because the growth in operating expenses outpaced the increase in revenues. Higher operating expenses were the result of expensing direct development costs.
Consolidated investment income increased 5.2% to $41.1 million from $39 million for 1993. The Company's pretax rate of return on invested assets was down to 6.5% from the previous year's 7.1%. The aftertax yield for 1994 was 5.1% compared with 5.4%.
The Company's effective income tax rate was 28.6% compared with 29.7% for 1993. The increased tax-exempt income in 1994 was primarily responsible for the change in the effective tax rate. The income tax expense for 1994 rose to $19.1 million from $16.8 million due to higher operating income.
The NAIC's risk based capital (RBC) requirements were adopted by the NAIC in 1993 and call for property-casualty insurance companies to calculate and report information under the RBC formula. It is anticipated the Iowa legislature will enact the NAIC's proposal into law in 1996. The RBC formula uses the statutory financial statements to calculate the minimum indicated capital level to support asset (investment and credit) risk and underwriting (loss reserves, premiums, and unearned premiums) risk. The subsidiaries' statutory financial statements and counsel's interpretation of the RBC formula lead management to believe capital levels are sufficient to support the level of risk inherent in Company operations and are in excess of the minimums required.
The NAIC's model legislation to govern insurance company investments is in development. An exposure draft was released in December of 1995, and the model investment law may be adopted by the NAIC in 1996. The effect of the adoption by the Iowa legislature is not expected to be significant to the Company.
California has been the source of approximately 25% of the pool's direct written premiums for the past ten years. Proposition 103, approved by California voters in 1988, provides for a rollback of rates on premiums collected in calendar year 1989 to the extent that the insurer's return on equity for each Proposition 103 line exceeded 10%. Since it was passed, Proposition 103 has been the subject of a number of legal and regulatory proceedings for the purpose of clarifying the scope and extent of insurers' rollback obligations. Management of the Company continues to believe that the insurance subsidiaries will not be liable for any material rollback of premiums.
Substantial cash inflows are generated from premiums, pool administration fees, investment income, and proceeds from maturities of portfolio investments. The principal outflows of cash are payments of claims, commissions, premiums taxes, operating expenses, income taxes, and the purchase of fixed maturities and equity securities. In developing its strategy, the Company establishes a level
In 1995, operating activities generated cash flows of $97.9 million; in 1994, the total was $85.5 million; in 1993, the total was $91.6 million (including $25.8 million from the 1993 change in the pool participation percentage and pool administration). For each year, the primary source of funds was premium growth in the Company's property-casualty insurance operations. Proceeds from the sale of 1.6 million shares of common stock in the first quarter of 1993 accounted for the majority of the $38.1 million generated from financing activities during 1993.
Management anticipates that short-term and long-term capital expenditures, cash dividends, and operating cash needs will be met from existing capital and internally generated funds. In 1994, additional funds of $9.4 million were generated from the sale of the 20% interest in a savings and loan holding company. As of December 31, 1995, the Company and its subsidiaries had no material commitments for capital expenditures. Future debt and stock issuance will be considered as additional capital needs arise. The method of funding will depend upon financial market conditions.
Historically, the Company's insurance subsidiaries have generated sufficient funds from operations to pay their claims. While the property-casualty and excess & surplus lines insurance companies have maintained adequate investment liquidity, they have in the past required additional capital contributions to support premium growth. Industry and regulatory guidelines suggest that a property-casualty insurer's annual net written premiums should not exceed approximately 300% of statutory surplus. At December 31, 1995, the property-casualty and excess & surplus lines segments' net written premiums were 171% and 110% of their statutory surplus, respectively. On February 18, 1993, 1.6 million shares of common stock were sold to the public at $24.67 per share; the Company used the net proceeds to contribute $36.1 million to the property-casualty subsidiaries and improve overall liquidity.
During 1995, the Company received dividend payments of $12 million from the property-casualty subsidiaries and $974,000 from noninsurance subsidiaries. During 1994 and 1993, the property-casualty subsidiaries made dividend payments of $7.8 million and $7.7 million, respectively, to the Company; noninsurance subsidiaries paid dividends of $1.1 million and $440,000, respectively.
At its March 5, 1996 meeting, the Board of Directors approved a first-quarter 1996 common stock dividend of $0.22 per share for payment to holders of record on March 26. The dividend is $0.05 (29.4%) higher than the amount paid in the fourth quarter of 1995.
In 1990, the ESOP Trust issued notes totaling $35 million (ESOP obligations) to acquire ESOP Series preferred stock for the Company's Employee Stock Ownership Plan (ESOP). In March 1995, the ESOP Trust refinanced its notes with a Term Credit Agreement and Guaranty (Agreement) with two separate commercial banks. The Company guaranteed the ESOP Trust's obligations under the Agreement. See note 9 of Notes to Consolidated Financial Statements. At December 31, 1995, the balance of the obligations was $26.3 million. Company contributions plus dividends on the ESOP Series preferred stock are used by the ESOP Trust to service the ESOP obligations. Dividends and payments for the employee lease fees from its subsidiaries are used by the Company to fund the amounts paid to the ESOP Trust. The Company made contributions to the ESOP Trust of $733,000 in 1995, $35,000 in 1994, and $54,000 in 1993. The Company paid dividends of $2.8 million in 1995, 1994, and 1993, which were used for such debt service. In connection with its ESOP guarantee of ESOP obligations, the Company is required to maintain minimum stockholders' equity and to comply with certain other financial covenants. See notes 9 and 15 of Notes to Consolidated Financial Statements.
Insurance premiums are established before the amount of losses and loss settlement expenses, or the extent to which inflation may affect such expenses, is known. Consequently, the Company attempts to anticipate the impact of inflation in establishing premiums. Inflation is implicitly considered in the determination of reserves for losses and loss settlement expenses since portions of the reserves are expected to be paid over extended periods of time. The importance of continually reviewing reserves is even more pronounced in periods of extreme inflation.
Management maintains a system of internal control designed to provide reasonable assurance as to the integrity and reliability of the financial statements, the protection of assets from unauthorized use or disposition, the prevention and detection of fraudulent financial reporting, and the appropriate division of responsibility. In addition, the Company's internal audit department systematically reviews these controls, evaluates their adequacy and effectiveness, and reports thereon. Management has considered internal audit recommendations and those of KPMG Peat Marwick LLP and has in its opinion responded appropriately to those recommendations. Management believes that as of December 31,1995 the Company's system of internal control is adequate to accomplish the objectives discussed herein.
The Company's financial statements have been audited by KPMG Peat Marwick LLP, independent certified public accountants. The audit was conducted in accordance with generally accepted auditing standards, which included a consideration of the Company's system of internal control to the extent necessary to form an independent opinion on the financial statements prepared by management.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis. evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of ALLIED Group, Inc. and subsidiaries as of December 31, 1995 and 1994 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1995 in conformity with generally accepted accounting principles.
At year-end 1995 the ALLIED Group Employee Stock Ownership Trust (ESOP Trust) owned 26.9% of the outstanding voting stock of the Company. ALLIED Mutual Insurance Company (ALLIED Mutual), an affiliated property-casualty insurance company, controlled 18% of the voting stock of the Company.
held principally for the purpose of selling in the near term are segregated into an available for sale portfolio and are carried at fair value. Unrealized appreciation and depreciation of securities classified as available for sale are excluded from income and reported as a separate component of stockholders' equity net of deferred income taxes.
The carrying values of all investments in fixed maturities are reviewed on an ongoing basis. If this review indicates that a decline in fair value below cost is other than temporary, the Company's carrying value in the investment is reduced to its estimated realizable value and a specific write-down is taken. Such reductions in carrying value are recognized as realized losses and charged to income. Realized gains and losses on disposition of investments are based on specific identification of the investments sold.
Equity securities are carried at fair value with any unrealized appreciation and depreciation reported net of deferred income taxes as a separate component of stockholders' equity. All short-term investments are recorded at cost, which approximates fair value. Other investments are reported using the equity method. Other investments at December 31, 1995 and 1994 included a 20% ownership in Black Hawk Holding Company (Black Hawk), an abstract and title holding company.
Policy acquisition costs such as commissions, premium taxes, and certain other underwriting and agency expenses that vary with and are directly related to the production of business have been deferred. Such deferred policy acquisition costs are being amortized as premium revenue is recognized. The method followed in computing deferred policy acquisitions costs limits the amount of such deferred costs to their estimated realizable value, which gives effect to the premium to be earned, related investment income, losses and loss settlement expenses, and certain other costs expected to be incurred as the premium is earned.
contracts. Liabilities for loss settlement expenses are provided by estimating expenses expected to be incurred in settling the claims provided for in the loss reserve. Changes in estimates are reflected in current operating results (note 5).
Mortgage loans held for sale by ALLIED Mortage are reported at the lower of cost or fair value on an aggregate basis. The fair value calculation includes consideration of all open positions, outstanding commitments from investors, related fees paid, and unrealized gains and losses from open options and financial futures contracts. Loan origination fees and certain direct costs related to loan origination are deferred and recognized at the time the related loans are sold. In the normal course of business, ALLIED Mortgage protects its position in mortgages by taking positions in options, futures, and cash markets. Market risk exists in the event of fluctuations in market prices on the unhedged portions of mortgage loans held for sale and outstanding commitments.
For purposes of reporting cash flows, changes in notes payable issued by ALLIED Mortgage to purchase mortgage loans held for sale are included in cash flows from operating activities.
Short-term investments--Due to their short-term nature, their carrying amount approximates fair value.
Excess servicing rights--The fair value represents the present value of estimated future servicing revenues in excess of normal servicing revenues over the assumed life of the servicing portfolio.
Guarantee of ESOP obligations--Due to its floating interest rate, the guarantee approximates its fair value (note 9).
The following table presents the carrying value and estimated fair value of the financial instruments at December 31, 1995 and 1994.
Following is a schedule of amortized costs and estimated fair values of investments in fixed maturities and equity securities as of December 31, 1995 and 1994. The estimated fair values for fixed maturities and equity securities are based on quoted market prices for the same or similar issues or from independent pricing services.
A summary of net realized investment gains (losses) and net changes in unrealized appreciation (depreciation) of investments for the years ended December 31, 1995, 1994, and 1993 follows:
The reinsurance pooling agreement was amended January 1, 1993 to increase the property-casualty segment's participation to 64% from 60% in 1992. ALLIED Mutual transferred cash of $16,240 to the property-casualty segment to fund the additional net underwriting liabilities assumed. The pooling agreement was also amended January 1, 1993 to change the pool administrator from ALLIED Mutual to AMCO. As a result of becoming pool administrator, AMCO assumed $9,538 in certain underwriting liabilities and received a corresponding amount of cash from ALLIED Mutual. See note 6 for discussion of reinsurance transactions between the Company's property-casualty subsidiaries and ALLIED Mutual.
ALLIED Mutual participates with a nonaffiliated reinsurance company in a property catastrophe reinsurance agreement to cover the property-casualty segment's share of pooled losses. In 1995, 1994, and 1993, the coverage was $5,000 in excess of $5,000. ALLIED Mutual's and the reinsurance company's respective participation in such agreement was 90% and 10% in 1995, 1994, and 1993. Related premiums paid by the property-casualty segment to ALLIED Mutual were $2,330 in 1995, $1,866 in 1994, and $1,478 in 1993. There were recoveries of $2,586, $2,217, and $1,400 from ALLIED Mutual in 1995, 1994, and 1993, respectively.
All expenses incurred on the Company's behalf by its affiliates have been reflected in the accompanying financial statements. Management believes the costs incurred by its affiliates and allocated to the Company are reasonable and would not be materially different than if they had been incurred from a nonaffiliated third party. The aforementioned transactions result in intercompany balances that are created during the normal course of business and are settled on a monthly basis.
The Company and its affiliates deposit their excess cash into a short-term investment fund. The fund was established to concentrate short-term cash in a single account to maximize yield. AID Finance Services, Inc., a wholly owned subsidiary of ALLIED Mutual, is the administrator of the fund. At December 31, 1995 and 1994, the Company had $7,773 and $4,021, respectively, invested in the fund. The Company also had several unsecured notes payable to the fund at December 31, 1995 totaling $3,500. Interest rates ranged from 5.9% to 8.8%, and the notes mature in January of 1996. At December 31, 1994 the Company had two unsecured notes payable to the investment fund totaling $2,000.
In establishing reserves, management considers exposure the Company may have to environmental claims. Because reported claim activity levels are minimal and the emphasis of the Company's property-casualty business is primarily on personal lines and small commercial business, management believes exposure to material liability on such claims to be remote as of December 31, 1995. The Company continues to monitor legal developments as they relate to the Company's exposure to environmental claims.
The effect of reinsurance on premiums written and earned and losses and loss settlement expenses incurred for the years ended December 31, 1995, 1994, and 1993 was as follows:
On June 1, 1994, the Company completed the sale of its investment in MidAmerica Financial Corporation (MidAmerica) for $9,395. The 20% interest in MidAmerica was acquired for investment purposes and was reported in other investments. The pretax gain of $2,646 is included in realized investment gains for 1994 in the consolidated statements of income.
On October 29, 1993, the Company completed the sale of its investment banking and asset management subsidiary, Dougherty Dawkins, for $14,304. The results of operations through the closing date are reflected in the Company's consolidated income statements. The pretax loss on this transaction was $894 and is included in other expenses in the consolidated statements of income.
The Federal Home Loan Bank of Des Moines provides a $3,000 committed credit facility through a line of credit agreement with AMCO that expires March 6, 1996. Interest on any outstanding borrowings is payable at an annual rate equal to the federal funds unsecured rate for federal reserve member banks. The Company had no outstanding balance as of December 31, 1995. At December 31, 1994, there was an outstanding balance of $2,180.
On July 12, 1990, the ESOP Trust issued Remarketed Floating Rate Notes (FRN) totaling $35,000 with a final maturity of July 12, 2005. The proceeds from the FRN were used to acquire Series A ESOP Convertible Preferred Stock. Effective March 13, 1995, the ESOP Trust refinanced its $28,150 of FRN under the terms of a Term Credit Agreement and Guaranty (Credit Agreement) with two separate commercial banks. The loans mature July 12, 2005, and interest rates applicable to the borrowings are adjusted at the beginning of each interest period. The interest periods may be one, three, or six months at the discretion of the ESOP Trust.
The Company is authorized to issue 7,500,000 shares of preferred stock without par value. The preferred stock may be issued from time to time by the Board of Directors in one or more series with such dividend rights, conversion rights, voting rights, redemption provisions, liquidation preferences, and other rights and restrictions as the Board of Directors may determine.
The 6-3/4% Series preferred stock (6-3/4% Series), issued to ALLIED Mutual at a value of $28.50 per share, is perpetual, nonconvertible, voting, and cumulative with respect to dividends. The 6-3/4% Series has no preemptive rights and is not registered or traded. Upon any transfer by ALLIED Mutual, the 6-3/4% Series is callable under certain conditions and becomes nonvoting. It ranks on a parity with the ESOP Series. Each share of the 6-3/4% Series has 1-1/2 votes. The annual dividend rate is 6-3/4% of the liquidation preference of $28.50 ($1.92 per share) and is payable quarterly.
The Company entered into a Stock Rights Agreement with ALLIED Mutual to grant both parties certain rights in terms of registration, transfer, voting, board nominations, and other matters. Pursuant to the Stock Rights Agreement executed July 5, 1990, ALLIED Mutual is entitled to nominate for election to the Company's Board of Directors a number of director nominees that most closely approximates the same percentage of the total number of members of the Company's Board of Directors as is equal to ALLIED Mutual's percentage ownership of the total number of shares of Company voting stock.
The ESOP Series is redeemable at the option of the Company any time after three years from issuance and under specified circumstances prior thereto. The redemption price is $15 per share plus a premium in the first ten years after issuance that reduces in equal annual increments from 8% in the first year to 0% in the eleventh year. The Company, solely at its discretion, has the option to issue common stock, cash, or a combination thereof for any redemption price. Upon notice of redemption, the Trustee, acting in its fiduciary capacity, may elect to convert the ESOP Series to common stock prior to redemption.
The ESOP Series has no preemptive rights and is not registered or traded. Upon any transfer by the Trustee, the ESOP Series is automatically converted into shares of the Company's common stock. See note 20 for discussion of the conversion of ESOP Series to common stock subsequent to year-end 1995.
During 1995, 1994, and 1993, 174,960, 110,956, and 94,124 ESOP Series shares were converted to 262,440, 166,434, and 141,186 shares of common stock, respectively. The Company has reserved 5,950,524 shares of common stock for conversion of the ESOP Series.
The ALLIED Group, Inc. Restated and Amended Stock Option Plan (Option Plan) and the ALLIED Group, Inc. Nonqualified Stock Option Plan (Nonqualified Plan) had 675,000 and 225,000 shares of common stock, respectively, reserved for issuance to certain key employees of ALLIED Group, Inc. and subsidiaries. Both plans are nonqualified stock option plans as defined by the Internal Revenue Code. The period for granting options under these plans expired on August 5, 1995. During 1995, 30,000 and 40,000 options were granted under the Option Plan and the Nonqualified Plan, respectively, at an exercise price of $27.50 per share. The options expire ten years after the date of grant. During 1995, 33,135 shares were deregistered under the Nonqualified Plan.
The Company deregistered 103,955 shares under the ALLIED Group Executive Equity Incentive Plan (Equity Plan) during 1994. The Company had reserved 525,000 shares of common stock for issuance under the terms of the Equity Plan. The Equity Plan is a nonqualified stock option plan as defined by the Internal Revenue Code, with eligibility granted only to certain key employees of the Company and its affiliated companies. The optionees pay $0.67 of the per share option price upon exercise; the balance of the exercise price is paid by the company that leases the employee. At December 31, 1995, 14,460 options were outstanding and exercisable under the Equity Plan. There are no shares available to grant any additional options under the Equity Plan, and the options currently outstanding expire on December 31, 1997.
Under the Freedom Group Incentive Plan (Freedom Plan), the Company had reserved 270,000 shares of authorized but unissued common stock. The Freedom Plan is a nonqualified stock option plan as defined by the Internal Revenue Code. Three key employees were granted options to purchase up to 270,000 shares of the Company's common stock. The optionees pay $0.67 of the per share option price upon exercise; the balance of the exercise price is to be paid by Freedom Group. On April 30, 1993, the participants were vested in 54,000 stock options and the remaining 216,000 unvested shares were deregistered. At year-end 1995, 18,000 vested options remained unexercised.
During 1994, the Company reserved 600,000 shares of common stock for issuance to key employees of the Company and its affiliates under the ALLIED Group, Inc. Long-Term Management Incentive Plan (Incentive Plan). Under the Incentive Plan,
The following table includes selected information for the Company's insurance subsidiaries as determined in accordance with accounting practices prescribed or permitted by insurance regulatory authorities:
In the normal course of business, ALLIED Mortgage grants mortgage loan commitments to borrowers, subject to normal loan underwriting standards. As of December 31, 1995, ALLIED Mortgage had granted loan commitments of approximately $39,500, including floating rate commitments of $12,600. To hedge loan commitments, ALLIED Mortgage may enter into options, futures, or cash delivery
contracts. As of December 31, 1995, ALLIED Mortgage had commitments to sell mortgage securities totaling approximately $27,000 and no outstanding options. In connection with these commitments to buy and sell mortgages, ALLIED Mortgage is exposed to credit risk in the event the counterparty is unable to fulfill its contractual obligations.
Although loans serviced for others are not on the accompanying balance sheets, ALLIED Mortgage does have credit risk associated with the mortgage servicing portfolio. As the loan servicer, ALLIED Mortgage is required to process delinquent loans through the foreclosure process, thereby incurring certain direct expenses which generally are, but may not be, reimbursed. At December 31, 1995, ALLIED Mortgage had sold loans totaling approximately $20,500 while retaining recourse risk. ALLIED Mortgage established allowances for losses in connection with these various risks, which totaled $1,476 and $1,495 at December 31, 1995 and 1994, respectively. These allowances are included in other liabilities on the accompanying balance sheets.
The Company's ESOP expense was $2,682 in 1995, $1,780 in 1994, and $1,529 in 1993. Of those respective amounts, $65, $30, and $37 were included in the employee lease fee received from affiliates pursuant to the terms of the Intercompany Operating Agreement for the years ended December 31, 1995, 1994, and 1993, respectively.
During 1995, 1994, and 1993, the ESOP Trust received $2,782, $2,782, and $2,783, respectively, from dividends on the ESOP Series used to service debt on the ESOP obligations and to purchase stock for participants. ALLIED Group, Inc. made ESOP contributions of $733 in 1995, $35 in 1994, and $54 in 1993. Interest incurred on the ESOP debt, which is included as a component of ESOP expense, was $1,831, $1,225, and $918 in 1995, 1994, and 1993, respectively. The ESOP shares as of December 31, 1995 and 1994 were as follows:
In addition to the ESOP, the Company sponsors a health care plan that provides postretirement medical benefits to full-time employees who meet age and service requirements. The plan is contributory with retiree contributions adjusted annually, and it contains other cost-sharing features such as deductibles and coinsurance. The Company's policy is to fund the cost of medical benefits in amounts determined at the discretion of management.
The following table presents the plan's postretirement benefit obligations as of December 31, 1995 and 1994 reconciled with the plan's funded status and the amount recognized in the Company's consolidated balance sheets:
For measurement purposes, a 9% annual rate of increase in the per capita cost of covered benefits (i.e., health care cost trend rate) was assumed for 1996; the rate was assumed to decrease in equal annual increments to 5% by the year 2000 and to remain at that level thereafter. 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 by approximately $430 and the aggregate of the service and interest cost components of net periodic postretirement benefit cost by approximately $40.
The tax effects of temporary differences that gave rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1995 and 1994 relate to the following:
The actual income tax expense for the years ended December 31, 1995, 1994, and 1993 differed from the expected tax expense (computed by applying the federal corporate tax rate of 35% to income before income taxes). The difference was primarily a result of investment income exempt from federal income tax, which decreased tax expense by $4,504, $4,630, and $3,445 in 1995, 1994, and 1993, respectively.
Included in income tax expense is state income tax expense of $402, $456, and $956 for the years ended December 31, 1995, 1994, and 1993, respectively. The Company paid federal and state income taxes of $19,117, $16,702, and $14,525 in 1995, 1994, and 1993, respectively.
The IRS is currently examining the 1992 income tax return. Any proposed adjustments are not expected to have a material impact on the Company's financial condition or results of operations.
Eliminations and other--Eliminations between segments plus other noninsurance operations not reported as segments (including investment services, data processing, and employee lease fees from affiliates).