The headquarters building of the Company and Meridian Mutual is owned by Meridian Mutual and is located near downtown Indianapolis, Indiana. The building is a multi-level structure containing approximately 205,000 square feet of office space. During 1995, construction was completed on a 75,000-square-foot addition to the home office facility. This expansion allowed the Company and Meridian Mutual to enhance and enlarge its operational work areas and create a brighter, more open environment. The expansion also allowed Meridian to consolidate the two Indianapolis satellite offices, which were being leased, into the home office facility. Meridian Mutual also lease a district service office facility in Columbus Ohio and claim service centers in Lansing, Michigan and Louisville, Kentucky.
Year Ended December 31, 1997 1996 1995 1994 1993 (In thousands, except per share data and ratios) Operating data: Premiums earned $194,587 $167,304 $143,866 $135,002 $125,902 Net investment income 16,372 14,908 14,564 13,996 13,569 Realized investment gains 4,477 3,794 1,538 286 890 Other income (expense) 1,042 563 (146) 54 (115) Total revenues 216,478 186,569 159,822 149,338 140,246
Losses and loss adjustment expenses 149,219 130,101 99,124 93,971 86,622 General operating expenses 16,505 13,767 14,156 14,527 14,935 Interest expense 732 308 --- --- --- Amortization expenses 42,894 36,443 30,820 29,304 27,039 Total expenses 209,350 180,619 144,100 137,802 128,596
Dividends declared per share $ 0.32 $ 0.32 $ 0.28 $ 0.24 $ 0.24
Underwriting ratios (statutory basis): Loss and loss adjustment expense ratio 76.8% 78.0% 69.2% 69.8% 69.4% Expense ratio 30.3 30.0 31.0 32.0 32.4 Combined ratio 107.1% 108.0% 100.2% 101.8% 101.8%
During the 1990's, premium writings for non-standard automobile insurers generally enjoyed greater growth and profitability than the standard automobile marketplace. Effective January 1998, Meridian Mutual began offering a non-standard automobile product in the state of Indiana. Initial response from the Company's independent agency force was positive, as many of these agents have been writing non-
For the year ended December 31, 1997, the Company recorded net income of $6.9 million, or $1.04 basic earnings per common share ($1.03 diluted earnings per share). This compares to 1996 net income of $5.8 million, or $0.86 basic earnings per share ($0.85 diluted earnings per share). Included in the 1997 results was an entire year of operations from the 1996 acquisition of the Citizens Security companies, compared to five months of Citizens Security operations for the prior period. Earnings for both periods were negatively impacted by a large volume of property damage claims associated with severe weather that occurred throughout the Company's operating territory. Weather-related catastrophe losses were estimated to be approximately $7.2 million, or $0.72 per share, in 1997 and $10.6 million, or $1.03 per share, in 1996. The Company's 1997 statutory combined ratio was 107.1 percent versus 108.0 percent for 1996.
Net investment income for 1997 increased 9.8 percent to $16.4 million in comparison to $14.9 million for 1996. This was attributed to a larger asset base resulting primarily from the acquisition of Citizens Security Group. The Company's pre-tax net investment yield for 1997 improved slightly to 6.0 percent from 5.9 percent one year ago. The average yield of the Company's fixed maturity portfolio at December 31, 1997 was 6.7 percent compared to 6.8 percent at year end 1996. During 1997, the Company realized net gains on the sale of investments of $4.5 million, or approximately $0.44 per common share, versus $3.8 million, or $0.37 per share in 1996. Nearly all of the realized gains recognized over the last two years were generated from the sale of equity securities and have an insignificant effect on future investment yields.
operations of Citizens Security Group, versus approximately $9.1 million for the five months of operations in the 1996 total. The statutory loss and loss adjustment expense ratio of the Citizens Security companies for the 1997 period was 85.1 percent compared to 70.9 percent for the five months of operations in 1996. Deteriorations in the Citizens Security homeowners, private passenger automobile and commercial multi-peril lines of business were the primary factors in the loss and loss adjustment expense increase. Partially offsetting these increases were improved experience in the commercial automobile and workers' compensation lines. Exclusive of Citizens Security's operations, incurred losses and loss adjustment expenses for the Meridian book of business reflected a 4.6 percent reduction from approximately $121.0 million in 1996 to $115.4 million in 1997. The Meridian lines of business for 1997 produced a statutory loss and loss adjustment expense ratio of 74.7 percent, a 4.0 percentage point improvement from 78.7 percent for 1996. Meridian's farmowners, homeowners and commercial multi-peril lines of business were the major contributors to the reduced loss and loss adjustment expense ratio, due largely to a reduction in weather-related catastrophe losses. The impact of such catastrophes on the Company's loss ratio in 1997 and 1996 was estimated to be 3.7 and 6.4 percentage points, respectively.
General operating and amortization expenses of $59.4 million for the year ended December 31, 1997 increased 18.3 percent over the comparable 1996 total of $50.2 million. Substantially contributing to the increase was an additional seven months of operating expenses in 1997 related to the Citizens Security companies. Also contributing to the increased expenses were higher costs related to the Company's employee medical plan, and programming and other system costs associated with Year 2000 compliance. Relative to net earned premiums, the Company's expense ratio for 1997 was approximately 30.5 percent compared to 30.0 percent for 1996. The Company also incurred approximately $732,000 of interest expense in 1997 on the bank loan used to finance the Citizens Security Group acquisition.
defined tranches. These investments are designed to alleviate the risk of prepayment by providing predictable principal prepayment schedules within a designated range of prepayments. The Company has no exposure to high risk derivatives in its portfolio.
The Company's fixed income investment portfolio consists almost entirely of investment grade securities, the average quality of which is rated Aa / AA. The Company currently holds all of its fixed maturity investments in the "available-for-sale" category carried at market value. The Company at December 31, 1997 recorded unrealized gains in the bond portfolio of approximately $5.7 million, net of deferred income taxes. At year-end 1996, the Company recorded unrealized gains on the bond portfolio of approximately $2.7 million, net of deferred income taxes. The Company's equity security portfolio, which accounts for approximately 17.6 percent of invested assets, produced unrealized gains, net of deferred income taxes, of approximately $8.4 million in 1997, compared to approximately $4.5 million in 1996. Net unrealized appreciation of investments added $2.17 to the Company's $19.90 book value per share at December 31, 1997. Net unrealized appreciation added $1.05 per share to the $18.02 book value at December 31, 1996.
In July 1996, the Company completed the acquisition of Citizens Security Group Inc. of Red Wing, Minnesota. The Company purchased all of the outstanding shares of Citizens Security Group Inc. and its wholly-owned property and casualty insurance subsidiaries, Citizens Fund Insurance Company and Insurance Company of Ohio, for approximately $30.3 million in cash, including capitalized acquisition costs, and became affiliated with Citizens Security Mutual Insurance Company. Approximately 60 percent of the purchase price was generated from the sale of a portion of the Company's investment portfolio. The remaining $12 million was financed through bank debt and is being amortized over seven years with a variable interest rate of LIBOR plus 50 basis points. The acquisition was accounted for as a purchase with the assets acquired and liabilities assumed being recorded at their estimated fair value at the date of acquisition. The excess cost over the fair value of the net assets of approximately $14.5 million was recorded as goodwill, which is being amortized on a straight-line basis over a 25 year period.
Beginning in 1994, state insurance regulators required companies to calculate Risk Based Capital ("RBC"). RBC is the capital required to cover the varying degrees of risk inherent in a company's assets, loss reserves, underwriting, and reinsurance. The "company action level" RBC is the minimum amount of capital required in order to avoid regulatory action. In 1997, the adjusted capital of the Company's insurance subsidiaries was well above the required minimum.
We have audited the accompanying consolidated balance sheet of Meridian Insurance Group, Inc., and Subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
MERIDIAN INSURANCE GROUP, INC., AND SUBSIDIARIES CONSOLIDATED STATEMENT OF INCOME for the Years Ended December 31, 1997, 1996 and 1995
Income before taxes 7,128,123 5,950,093 15,722,039 Income taxes (benefit) Current 1,067,000 702,141 3,554,000 Deferred (860,000) (552,000) 551,000
Per share data: Basic earnings per share $ 1.04 $ 0.86 $ 1.72
MERIDIAN INSURANCE GROUP, INC., AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET as of December 31, 1997 and 1996
LIABILITIES AND SHAREHOLDERS' EQUITY Losses and loss adjustment expenses $169,801,326 $161,309,239 Unearned premiums 82,839,333 84,065,751 Other post-employment benefits 1,933,181 1,417,814 Bank loan payable 11,375,000 11,875,000 Reinsurance payables 9,078,076 8,664,358 Other liabilities 6,664,653 8,291,558 Total liabilities 281,691,569 275,623,720
Increase (decrease) in cash (1,939,731) 2,193,056 331,532 Cash at beginning of year 3,128,154 935,098 603,566 Cash at end of year $ 1,188,423 $ 3,128,154 $ 935,098
Earnings Per Share: The Company has adopted Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share", which requires changes in the computation, presentation, and disclosure of earnings per share. This Statement requires dual presentation of basic and diluted earnings per share on the face of the income statement for all companies with complex capital structures. SFAS No. 128 also replaces the presentation of primary earnings per share with a basic earnings per share computation and eliminates the modified treasury stock method and the three percent materiality provision as was required under the Accounting Principles Board Opinion No. 15. This Statement became effective for financial statements with fiscal years ending after December 15, 1997. All prior period information presented has been restated.
Impact of New Accounting Pronouncements: In June 1997 the Financial Accounting Standards Board issued SFAS No. 130, "Reporting Comprehensive Income" and SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information". The Statements are effective for fiscal years beginning after December 15, 1997. SFAS No. 130 establishes standards for reporting and displaying of comprehensive income and its components. All items that are required to be recognized under accounting standards as components of comprehensive income must be reported in a financial statement that is displayed with the same prominence as other financial statements. SFAS No. 131 establishes standards for the way that business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas and major customers. The Company did not elect early adoption of either pronouncement but will adopt both Statements as of January 1, 1998, as required. If the Company had adopted SFAS No. 130 as of December 31, 1997, other comprehensive income would have consisted of unrealized appreciation of investment securities, net of deferred income taxes of approximately $7,200,000. The effect of adopting SFAS No. 131 as not yet been determined in regards to the impact on the Company's consolidated financial statement disclosures.
1997 1996 1995 Realized gains (losses): Fixed maturities $ 14,108 $ (456,602) $ 87,370 Equity securities 5,052,295 4,559,380 1,458,589 Other invested assets --- --- (7,678) Total realized investment gains 5,066,403 4,102,778 1,538,281 Investment expenses 588,823 309,000 --- Net realized investment gains $ 4,477,580 $ 3,793,778 $ 1,538,281
Estimated Amortized Market Cost Value Available for sale: Due in one year or less $ 6,614,936 $ 6,659,349 Due after one year through five years 32,648,148 33,426,698 Due after five years through ten years 61,985,776 64,758,746 Due after ten years through fifteen years 29,646,907 31,089,477 Due after fifteen years through twenty years 8,094,972 8,464,107 Due after twenty years 58,192,167 60,653,455 Subtotal 197,182,906 205,051,832 Mortgage-backed securities 42,479,390 43,352,472 Total fixed maturity securities $239,662,296 $248,404,304
Proceeds from sales of investments in fixed maturity securities during 1997, 1996 and 1995, respectively, were $26,135,592, $38,131,207 and $17,111,272. During 1997, 1996 and 1995, respectively, gross gains of $338,920, $197,320 and $445,260 and gross losses of $324,812, $653,922 and $357,890 were realized on those sales.
Unrealized appreciation of equity securities at December 31, 1997 totaled $12,948,869 representing $14,400,487 of gains on certain securities and $1,451,618 of losses on other securities.
On July 31, 1996, the Company acquired Citizens Security Group Inc. and its property and casualty insurance subsidiaries, Citizens Fund Insurance Company and Insurance Company of Ohio, for a cash purchase price of $30,262,442, including capitalized acquisition costs. Approximately 60 percent of the purchase price was generated from the sale of a portion of the Company's investment portfolio and the remainder was financed through bank debt. The acquisition was accounted for as a purchase with the assets acquired and liabilities assumed being recorded at their estimated fair value at the date of acquisition. The excess cost over the fair value of the net assets resulted in goodwill of approximately $14,501,000, which is being amortized over a 25 year period on the straight-line basis.
The consolidated financial statements include the results of operations of the acquired entities from the date of acquisition. Unaudited pro-forma condensed consolidated results of operations presented below assumed the acquisition and financing of the transaction had occurred at the beginning of each period presented:
Premiums earned $185,808,000 $174,501,000 Total revenues $206,201,000 $192,416,000 Net income $ 4,138,000 $ 11,310,000 Basic and diluted earnings per share $ 0.61 $ 1.67
These unaudited pro-forma results are not necessarily indicative of the results of operations that would have occurred had the acquisition taken place at the beginning of each period, or of future operations of the combined companies.
Effective January 1, 1997, the Company became the employer of all employees that were formerly employed by Meridian Mutual and Citizens Security Mutual. This transfer of employees allowed for the integration of benefit plans, thus increasing management efficiencies and allowing for enhanced benefit options, such as the use of the Company's common stock as compensation.
Activity in the liability for losses and loss adjustment expenses is summarized as follows:
Incurred related to: Current year 165,576,734 137,817,367 104,584,909 Prior years (16,358,003) (7,716,175) (5,461,060) Total incurred 149,218,731 130,101,192 99,123,849 Paid related to: Current year 97,447,542 93,199,000 61,791,602 Prior years 50,332,258 30,470,408 36,898,679 Total paid 147,779,800 123,669,408 98,690,281
The companies that participate in the reinsurance pooling agreement reduce the maximum net loss that can arise from large risks or risks in concentrated areas of exposure by reinsuring their insurance business with unrelated third party insurers. In accordance with industry practice, the Company in its consolidated financial statements treats risks, to the extent reinsured, as though they were risks for which the Company is not liable. Reinsurance recoverables are estimated in a manner consistent with the claim liability associated with the reinsured policy. Insurance ceded by the Company's insurance subsidiaries does not relieve the subsidiaries' primary liability as the originating insurers.
The reinsurance purchased includes contracts under which certain types of policies are automatically reinsured up to the contract limits ("treaty reinsurance") and contracts which provide reinsurance on an individual risk basis which require a specific agreement of the reinsurer as to limits of coverage provided ("facultative reinsurance"). Meridian Mutual, Meridian Security, Citizens Security Mutual, Citizens Fund, and ICO were each named as insured parties under the treaty reinsurance contracts, and the coverage under those contracts applied to all risks written by each of the companies. Treaty coverage was purchased to cover property and liability exposures in excess of $200,000 and $250,000, respectively, up to the limits set forth in the individual treaty. (In 1996, the retention was $200,000 for both property and liability.) Facultative reinsurance was purchased to cover exposures on both property and liability coverages from losses over and above the limits provided by the treaty reinsurance.
1997 1996 1995 Premiums written: Direct $210,393,552 $181,680,624 $152,596,128 Assumed 718,004 3,730,504 7,269,782 Ceded (16,592,247) (16,216,479) (11,102,025) Net $194,519,309 $169,194,649 $148,763,885
On December 29, 1995, Meridian Mutual entered into an indemnity reinsurance agreement with Celina Mutual Insurance Company regarding commercial line business in the state of Pennsylvania. This transaction was recorded as assumed written premium, which was earned over the succeeding twelve months. Renewals of these policies are now being recorded as direct business on Meridian Mutual. Through the pooling agreement, Meridian Security assumed premiums written of approximately $2,100,000 and ceding commissions of approximately $409,000.
Effective January 1, 1997, the Company became the employer of all employees who were formerly employed by Meridian Mutual and Citizens Security Mutual. As a result of this transfer, all employee benefit plans that were previously under Meridian Mutual and Citizens Security Mutual were merged into the Company plans.
The Company also maintains a non-tax qualified supplemental retirement income plan for certain key employees who participate in the defined benefit pension plan. The plan provides additional benefits in excess of the limitations imposed by Section 401(a)(17) and Section 415 of the Internal Revenue Code on plans to which those sections apply. The benefit is in the form of a straight life annuity over the lifetime of the participant, and commences on the participant's normal retirement date.
The following table presents a reconciliation of the funded status for the Company's defined benefit pension plan and supplemental retirement income plan and the amounts recognized in the Company's consolidated balance sheet as of December 31, 1997:
Defined Supplemental Pension Retirement Actuarial present value of benefit obligations: Vested benefit obligation $17,360,209 $ 342,411 Non-vested benefit obligation 343,764 10,220 Accumulated benefit obligation 17,703,973 352,631 Additional amounts related to projected pay increases 5,728,743 407,471 Projected benefit obligation 23,432,716 760,102 Plan assets at fair value 31,582,957 --- Funded Status 8,150,241 (760,102) Unrecognized transition obligation (7,548,032) --- Unrecognized prior service costs --- 239,676 Unrecognized net (gain) loss (208,920) 74,012 Prepaid asset/(accrued liability) at December 31, 1997 $ 393,289 $ (446,414)
A 7.0 percent weighted average discount rate was assumed in determining the accumulated benefit obligation and a 5.0 percent average salary increase was used to project the additional pay increase on both plans. The expected return on assets for the defined pension plan was assumed to be 8.25 percent. Net periodic pension costs for the defined benefit pension plan and the supplemental retirement income plan for the year ended December 31, 1997 included the following components:
Prior to January 1, 1997, Meridian Security, Citizens Fund and ICO had no employees and were dependent on the business and operations of Meridian Mutual and Citizens Security Mutual. Meridian Mutual had a defined pension plan covering substantially all employees and a non-tax qualified retirement plan for certain key employees. Related pension costs allocated to the Company were immaterial to the results of operations for the periods ended December 31, 1996 and 1995. The Company also participated in the multi-employer plan for other post-retirement benefits offered by Meridian Mutual to employees, including medical benefits for early retirees (eligible upon attainment of age 55 and five years of service up to age 65) and group term life insurance that phases out over a five year period from the retirement date. Related costs allocated to the Company were approximately $53,000 and $98,000 for 1996 and 1995, respectively.
Tax at statutory rate $ 2,381,000 $ 2,023,000 $ 5,403,000 Tax-exempt interest (1,131,000) (1,134,000) (1,005,000) Dividends received deduction (613,000) (619,000) (598,000) Loss, LAE and salvage and subrogation fresh start (137,000) (17,000) (7,000) Nondeductible expenses 277,000 168,000 109,000 Other (570,000) (270,859) 203,000 Total income taxes $ 207,000 $ 150,141 $ 4,105,000
The Revenue Reconciliation Act of 1990 required insurance companies to accrue future recoveries of salvage and subrogation on a discounted basis. A fresh start of 87 percent of the beginning 1990 discounted balance was provided for by that act, which was to be amortized over the life of the reserves. The impact of this provision resulted in an aggregate tax benefit of approximately $923,000. During 1997, the remaining unamortized fresh start was fully recognized, resulting in a tax reduction of approximately $3,000. No amortization was recognized in 1996 and $7,000 was recognized in 1995.
1997 1996 1995 Deferred tax assets: Unearned premium reserves $ 5,528,000 $ 5,533,000 $ 4,336,000 Loss and loss adjustment expense reserves and salvage and subrogation 6,248,000 6,336,000 4,980,000 Other post-employment benefits 677,000 496,000 454,000 Other 1,431,000 875,000 --- Total deferred tax assets 13,884,000 13,240,000 9,770,000 Deferred tax liabilities: Deferred policy acquisition costs 6,178,000 5,842,000 4,674,000 Investments 144,000 327,000 178,000 Unrealized appreciation on investment securities 7,731,000 3,849,000 3,607,000 Other 56,000 425,000 34,000 Total deferred tax liabilities 14,109,000 10,443,000 8,493,000 Net deferred tax asset (liability) $ (225,000) $ 2,797,000 $ 1,277,000
The following table reflects the reconciliation of the numerators and denominators of the Company's basic earnings per share and diluted earnings per share computations reported on the Consolidated Statement of Income for the years ended December 31, 1997, 1996 and 1995.
Statutory capital and surplus $115,280,000 $105,506,000 $ 90,952,000 Statutory net investment income $ 15,212,000 $ 15,809,000 $ 14,733,000 Statutory net income $ 6,140,000 $ 3,307,000 $ 11,625,000
In 1987, the Company's Board of Directors and Shareholders approved an Incentive Stock Plan ("Plan") for the purpose of attracting and retaining key employees. The maximum number of common shares to be authorized for issuance was limited to 750,000 shares over a 10 year term. Awards under the Plan may include non- qualified and incentive stock options, stock appreciation rights, and restricted stock. Options to purchase common shares granted under the Plan are to have an exercise price of not less than the fair market value of the Company's common shares on the date of grant. Options are to be exercisable beginning one year from the date of grant and are to expire over various periods not to exceed ten years from the date of grant. Restricted stock awards may be granted subject to terms and conditions as prescribed by the committee which administers the Plan. Under the 1987 Plan, which expired on January 21, 1997, total options with respect to 477,144 shares were granted and 272,856 options had expired. In early 1996, the Board of Directors and Shareholders approved the 1996 Employee Incentive Stock Plan, which would eventually replace the 1987 Plan. Under the 1996 Plan, which became effective on May 8, 1996, the maximum number of shares authorized for issuance is 750,000 shares over the next ten years. During 1997, options with respect to 247,267 were granted under the 1996 Plan.
The Company also has a Director's Stock Plan that provides for an aggregate maximum of up to 150,000 common shares to be issued upon the exercise of stock options granted to outside directors, who are defined as non-employee directors of the Company or Meridian Mutual. Each outside director will automatically be granted an option to purchase 1,000 common shares on the date of each annual meeting of shareholders up until termination of the plan. The exercise price per share for each option will be equal to the fair market value of a common share on the date of grant. Each option will be exercisable commencing one year after the date of the grant and will expire no later than 10 years after the date of the grant. As of December 31, 1997, total options with respect to 64,000 shares have been granted.
Outstanding at January 1 $12.28 303,324 $11.69 313,781 $10.88 328,401 Granted 16.05 259,267 14.04 31,000 14.27 37,000 Exercised during the year --- --- 5.75 (4,042) 5.75 (30,521) Canceled during the year 14.08 (58,789) 9.51 (37,415) 12.20 (21,099) Outstanding at December 31 14.01 503,802 12.28 303,324 11.69 313,781
Portion thereof exercisable at December 31 $13.68 461,802 $12.30 272,324 $11.52 278,781
14. Unaudited Selected Quarterly Financial Data: (Amounts in thousands except per-share data)