The selected financial data herein has been derived from the financial statements of the Company and its subsidiaries. The data should be read in conjunction with "The Chairman's Report," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Consolidated Financial Statements and related Notes.
The Company's fixed income portfolio grew by 14% in 1995, when compared to 1994. As it has in the past, the Company continues to invest primarily in investment grade securities, and it is the Company's intention to hold a majority of its fixed income securities to maturity. The portion of the portfolio that was investment grade (defined by the National Association of Insurance Commissioners - Securities Valuation Office and issued with NAIC code class 1 or class 2), as of December 31, 1995 and 1994, was 94% and 92%, respectively, for the property and casualty segment, and 92% in both years for the life segment.
The Company's short-term investments, comprised of money market accounts, overnight repurchase agreements and fixed maturities are utilized to meet anticipated short-term cash requirements. In addition, the Company also maintains a $5 million line of credit with a local bank. In 1995, short-term investments increased from $9,954,000 to $21,530,000, as the Company increased the liquidity of its life insurance subsidiary to meet an anticipated withdrawal of a block of single premium business.
Under generally accepted accounting principles ("GAAP"), the Company is allowed to establish an asset called deferred policy acquisition costs ("DAC") for expenses such as commissions, premium taxes and policy issue expenses associated with underwriting premiums. The asset is then amortized over the lives of the respective policy terms to attain a matching of expenses to revenue. As premium volume increases, the resulting deferrable expenses also increase, which was the case in 1995.
The increase in the liability for future policy benefits and interest on policyholders' accounts grew in 1995 when compared to 1994 due to the addition of new premiums and growth in existing account balances.
Loss and loss adjustment expenses increased 9% over 1994. An absence of significant exposure to 1995 catastrophes and a reduction in loss expenses have contributed to the Company's favorable results. Gross losses incurred related to the Northridge earthquake were $3,847,000 in 1995, compared to $10,342,000 in 1994. Ceded losses incurred related to this catastrophe were $3,005,000 in 1995, compared to $4,319,000 in 1994. Gross incurred on other catastrophe losses for the years ending 1995, 1994 and 1993 were $10,089,000, $5,784,000 and $13,876,000 respectively. Ceded incurred on all other catastrophes for the years ending 1995, 1994 and 1993 were $114,000, $(17,000) and $158,000, respectively.
The increase in the property and casualty segments' other underwriting expenses, (including amortization of deferred acquisition costs) of $4,904,000 or 9% resulted primarily from an increase in commissions paid to our agents, due to the increase in premium writings.
The Company's major losses in 1994 included three large fire losses, two large commercial auto liability losses, and losses related to the Los Angeles Northridge earthquake. Gross losses related to Hurricane Andrew tapered off to $369,000 from $6,643,000 in 1993 and $23,522,000 in 1992. Gross losses related to the Northridge earthquake were $10,342,000 in 1994. Gross incurred on other catastrophe losses for the years ending 1994, 1993 and 1992 were $5,042,000, $7,233,000, and $8,520,000, respectively. Ceded incurred on Hurricane Andrew losses for the years ending 1994, 1993 and 1992 were $(4,000), $(30,000) and $8,644,000, respectively. Ceded incurred on the Northridge earthquake losses were $4,319,000 in 1994. Ceded incurred on all other catastrophes for the years ending 1994, 1993 and 1992 were $(13,000), $188,000 and $124,000, respectively.
The Company is required by the National Association of Insurance Commissioners ("NAIC") and governing state insurance departments to calculate a risk-based capital formula. This calculation establishes minimum capital requirements based on an individual company's insurance risk. The results are used by the NAIC and state insurance departments to identify companies that merit regulatory attention or the initiation of regulatory action. At December 31, 1995 and 1994, the property and casualty segments and the life segment each had adjusted capital well in excess of the required capital levels.
The Company is not aware of any current recommendations by the NAIC or other regulatory authorities in the states in which the Company conducts business which, if or when implemented, would have a material effect on the Company's liquidity, capital resources or operations.
It has been said that good profits do not need much explanation, only losses and disappointing results require long-winded letters from the Chairman. By that criteria, this should be one of the shortest Chairman's Reports you receive this year, for your Company had a very good year earning a record $28,803,000 or $2.66 per share adjusted for the three for two stock split effective December 18, 1995. 1995 earnings exceeded 1994's, which was also a record year, by 28%. Stockholders' equity now exceeds two hundred million dollars and the book value of your shares as of December 31 was $19.28 per share.
In 1996, your Company will celebrate its fiftieth anniversary and while in this report we do not intend to dwell on nostalgia or ancient history (there may be some old photographs but no baby pictures), we would like to tell you a little about what your Company and its people have been doing to prepare the United Fire Group for its second half century.
Organizationally, wherever it is appropriate, work units have been arranged into teams to improve service to our customers, accountability of the individuals and create more interesting and challenging jobs. As a result, we have been able to cultivate a good team spirit and morale has never been higher. We believe the staff is as professional and competent as it has ever been.
1995's earnings were driven by the outstanding underwriting results of our property and casualty operations where our statutory combined ratio (i.e. losses incurred to premiums earned, plus expenses incurred to premiums written) improved nearly two points to 96% and premiums written increased 12% to $198,000,000 producing a return on equity of 18%. For the industry as a whole it is estimated that the combined ratio was 107% and written premiums increased only 4%. Even though there were a record number of named hurricanes in 1995 the insured losses were not substantial and your Company survived relatively unscathed. Loss experience improved for a number of lines with surety, workers' compensation, other liability and reinsurance producing outstanding results. The commercial property lines continue to be profitable. The development gain on prior year's loss reserves increased 16% to $20,000,000.
Life insurance earnings increased 26% to $7,332,000, producing a return on equity of 8%. Statutory premiums increased 22% to $80,000,000, of which $55,000,000 were annuities. Primarily because of the growth in its annuity business, United Life Insurance Company's assets increased $73,000,000 to $484,000,000. To maintain its leverage at an acceptable level United Fire & Casualty Company contributed an additional $10,000,000 to its surplus.
A substantial portion of our life insurance assets are invested in collateralized mortgage obligations ("CMOs") and other mortgage-backed securities. In purchasing these types of securities particular attention is paid to the characteristics of the underlying mortgages, their age, maturity, coupon, geographical location, etc. Generally speaking less can go wrong with a 15- year mortgage than a 30-year one and a 10-year mortgage is better still. As we have tracked the performance of these securities we have found they have performed about as we anticipated and provided a return sufficient for us to provide our policyholders a reasonable return on their money. Yet because of the controversy these securities have generated and pressure from some of the rating agencies, several life insurance companies have over the past year sold or substantially reduced their holdings of them even when it meant selling into a weak market. We have never understood this lemming-like approach to investing; selling on bad news rarely makes good sense.
With the Addison Farmers' hiring of a field underwriter located in Franklin, Indiana we are also expanding into that state. Indiana should be a good state for your Company and some of the domestic companies no longer seem as invincible as they once did.
Direct and assumed fidelity and surety premiums increased 8% to $17,000,000 solidifying your Company's position as a major writer of contract bonds in our territory. Mike Hansen and his staff continue to strive to give excellent service and the results speak for themselves.
For the third consecutive year, your Company was named one of the 50 outstanding property and casualty companies by Ward Financial Group, a firm of financial consultants specializing in the insurance business. One of the reasons we prize this recognition so highly is the other companies on the list. We are pleased to be able to count among our peers organizations like the Cincinnati and the St. Paul.
Your Company's policy has been to pay between one-fourth and one-third of our earnings to our stockholders in dividends which we feel is being very prudent, even though we have been criticized by one of the rating agencies for paying out too much in dividends. Over the past six years the actual payout has ranged between 21 and 31 percent of the preceding year's earnings except in 1993 when the preceding year's earnings had been devastated by Hurricane Andrew.
While we, of course, have no idea as to whether or not 1996 will be another record year for earnings it appears that your Company has achieved a new earnings plateau on which to build and that probably by the close of 1996 the assets of the Company my father mortgaged his home fifty years ago to help to finance will exceed one billion dollars. More importantly, you have one of the best teams working for you any insurance investor has.
Our audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The supplementary data (Schedule III - Supplementary insurance information, Schedule IV - Reinsurance, and VI - Supplemental information concerning property and casualty insurance operations) are presented for purposes of additional analysis and are not a required part of the basic financial statements. This information has been subjected to the auditing procedures applied in our audit of the basic financial statements and, in our opinion, is fairly stated in all material respects in relation to the basic financial statements taken as a whole.
United Life Insurance Company underwrites and markets ordinary life (primarily universal life), annuities (primarily single premium) and credit life products to individuals and groups through independent agencies.
Certain amounts included in the Consolidated Financial Statements for prior years have been reclassified to conform with the 1995 financial statement presentation.
The costs of acquiring new life business, principally commissions and certain variable underwriting, agency and policy issue expenses, have been deferred and are being amortized to income over the premium paying period of the related traditional policies in proportion to the ratio of the expected annual premium revenue to the expected total premium revenue and over the anticipated lives of nontraditional policies in proportion to the ratio of the expected annual gross margins to the expected total gross margins. The expected premium revenue and gross margins are based upon the same mortality and withdrawal assumptions used in determining future policy benefits.
Liabilities for future policy benefits are computed by the net level premium method using interest assumptions ranging from 4.5% to 8.0% and withdrawal, mortality and morbidity assumptions appropriate at the time the policies were issued. Health reserves are stated at amounts determined by estimates on individual cases and estimates of unreported claims based on past experience. Liabilities for universal life-type and investment contracts are stated at policyholder account values before surrender charges. Liabilities for traditional immediate annuities are based primarily upon statutory reserves.
The Company expects to realize a spread of approximately 1.5% between interest earned and interest credited on its Universal Life Plans and deferred annuities, for which the liability is equal to total policy account values plus deferred front-end loads.
Approximately 31% of the fixed maturity portfolio is collateralized mortgage obligations ("CMOs"), compared to 28% at December 31, 1994. The Company's ongoing review of the fixed income market has shown that for asset and credit quality, CMOs still offer the best yield available. The Company minimizes its prepayment risk by buying most issues priced at a slight discount. While buying at a discount does not prevent prepayment, the yield is not penalized as is the case when a premium is paid. In addition, although the stated maturity is longer than the average life of the issues, the Company is concentrating on buying issues with expected maturity in the seven- to- twelve- year range.
A reconciliation of the amortized cost to fair values of investments in held-to-maturity and available-for-sale fixed maturities, marketable equity securities and other long-term investments as of December 31, 1995 and 1994 is as follows.
The net investment income for the years ended December 31, 1995, 1994 and 1993 is composed of the following:
The book value of policy loans is considered to be fair value as the interest rate is fixed and in management's opinion the interest rates in the existing portfolio are comparable to current policy loan interest rates.
Accrued investment income is from a short-term financial instrument and considering credit risk, carrying value approximates fair value.
A summary of the carrying value and estimated fair value of assets and liabilities meeting the definition of financial instruments at December 31, 1995 and 1994 is as follows.
The Company maintains a $5 million line of credit with a local bank. Under the terms of the agreement, interest on outstanding notes would be payable at the lender's then prevailing prime rate.
The property and casualty insurance companies cede portions of their insurance business to other insurance companies on both a pro rata and excess of loss basis. Insurance ceded by the property and casualty insurance companies does not relieve their primary liability as the originating insurers. Earned premiums ceded were $26,053,000, $26,256,000 and $23,148,000 for the years ended December 31, 1995, 1994 and 1993, respectively. The Company believes all amounts are collectible with regard to reinsurance receivables. There are no concentrations of credit risk associated with reinsurance.
United Life Insurance Company follows the policy of reinsuring that portion of the risk in excess of $200,000 on the life of any individual. Policy benefit reserves and claims are stated after deduction of reserves and claims applicable to reinsurance ceded to other companies; however, United Life Insurance Company is contingently liable for these amounts in the event such companies are unable to pay their portion of the claims. The Company is contingently liable for ceded insurance in force of $455,422,000 and $531,558,000 at December 31, 1995 and 1994, respectively. The Company believes all amounts are collectible with regard to reinsurance receivables.
The Company is not aware of any significant contingent liabilities as far as environmental issues are concerned. Because of the type of business the Company writes, i.e. property coverage, there exists the potential for exposure for environmental pollution and asbestos claims. The Company's underwriters are aware of these exposures and use limited riders or endorsements to limit exposure. The one assumed reinsurance contract with a significant known environmental exposure was commuted with a complete release of further liability during 1994.
In addition, the insurance departments governing the Company and its subsidiaries have imposed risk-based capital ("RBC") requirements. The regulation is based on a model adopted by the NAIC. An RBC formula establishes capital requirements for insurance companies based on an individual company's major areas of risk, including assets, credit, underwriting and off-balance sheet risk. The results are used by the NAIC and state insurance departments to identify companies that merit regulatory attention or the initiation of regulatory action. At December 31, 1995 and 1994, the life and property and casualty segments had adjusted capital well in excess of the required capital levels.
The Company had tax net operating loss ("NOL") carryforwards totaling $115,000 as of December 31, 1994. These NOL carryforwards were purchased by the Company when it acquired Addison Farmers' Insurance Company in 1990. The Company also had alternative minimum tax credit ("AMT") carryforwards for Federal income tax purposes as of December 31, 1994. Such AMT credit carryforward were recorded as a deferred tax benefit for financial reporting purposes. The Company did not have any NOL or AMT carryforwards at December 31, 1995.
The Company has a profit sharing plan in which employees who meet age and service requirements are eligible to participate. The amount of the Company's contribution is discretionary and is determined annually but cannot exceed the amount deductible for Federal income tax purposes. The Company's contribution to the plan for the years ended December 31, 1995, 1994 and 1993 was $1,561,000, $649,000 and $626,000, respectively.
The following table reconciles the accrued postretirement benefit liability and amounts recognized in the Consolidated Financial Statements.
Net income per common share has been retroactively restated for additional shares issued as a result of a three for two stock split to stockholders of record as of December 18, 1995.
VI -- Supplemental information concerning property and casualty insurance operations. 39