(1) Occupied by Admiral's branch office. (2) Presently leased to a third party.
SELECTED FINANCIAL DATA FOR THE FIVE YEARS ENDED DECEMBER 31, 1995
(1) Investments and stockholders' equity reflect the adoption of SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," as of December 31, 1993. Included in the calculation of common stockholders' equity per share are unrealized investments gains (losses), net of federal income taxes, of $48,450,000, ($33,973,000) and $36,450,000 as of December 31, 1995, 1994 and 1993, respectively.
Operating Results for the Year Ended December 31, 1995 as Compared to the Year Ended December 31, 1994
Net income attributable to common shareholders ("Net Income") for 1995 was $50 million, or $2.86 per share, compared with 1994 earnings of $25 million, or $1.44 per share. The 1995 results include after-tax realized investment gains of $6 million or $.36 per share, compared with after-tax realized investment losses of $86,000 or $.01 per share recorded in 1994.
Management fees and commissions consists primarily of fees and commissions earned by the alternative markets operating units. These fees and commissions grew by 6% to $68 million in 1995 from $65 million earned in 1994. This increase was due mainly to the inclusion of a full year's results for Key Risk Services, Inc. which was acquired in May 1994 as well as fees earned by Berkley Care Network which the Company established in June 1995. These increases were partially offset by a restructuring of one alternative markets operating unit.
The combined ratio (on a statutory basis) of the Company's insurance operations decreased to 102.5% in 1995 from 105.0% (101.9% before the Northridge Earthquake) in 1994 due to an improvement in the consolidated loss ratio which was partially offset by a slight increase in the expense ratio. The consolidated loss ratio (losses and loss expenses incurred expressed as a percentage of premiums earned) decreased to 70.7% from 73.7% primarily due to the effect of the Northridge Earthquake, which significantly impacted 1994 results. This improvement was partially offset by an increase in the frequency and severity of losses incurred by our commercial transportation unit.
Operating Results for the Year Ended December 31, 1994 as Compared to the Year Ended December 31, 1993
Net premiums written in 1994 grew by 33.5% to $718 million from $538 million written during 1993, primarily due to growth in reinsurance premium volume as a result of the inclusion of Signet Star's results for the entire year. In addition, premiums written by the Company's regional insurance operations increased by $85 million. Approximately two thirds of this increase was due to the three new operations referred to above. The balance of this increase resulted primarily from the expansion into new markets by the remainder of the regional group. Premium volume for the alternative markets segment was $20 million in 1994, compared with $5 million in 1993. The increase is due primarily to the inclusion of the results of Signet Star's alternative markets division for the entire year.
The combined ratio (on a statutory basis) of the Company's insurance operations increased to 105.0% (101.9% before the Northridge Earthquake) in 1994 from 103.3% in 1993 due to an increase in the consolidated loss ratio. The consolidated loss ratio (losses and loss expenses incurred expressed as a percentage of premiums earned) increased to 73.7% from 71.1% in 1993. The increase in the loss ratio was due to a higher level of catastrophes including after-tax catastrophe losses of $7.5 million resulting from the Northridge Earthquake.
The Company's subsidiaries are highly liquid, receiving substantial cash from premiums, investment income, management fees and proceeds from sales and maturities of portfolio investments. The principal outflows of cash are payments of claims, taxes, interest and operating expenses. The net cash provided from operating activities (before trading account transactions) was $206.6 million in 1995 and $170.3 million in 1994. The increase in cash flow in 1995 was due primarily to additional cash flow generated by the Company's regional operations due to a significant increase in the premium volume.
As a holding company, the Company derives cash from its subsidiaries in the form of dividends, tax payments and management fees. The Company is obligated to service its debt, pay consolidated Federal income taxes and pay its expenses. Tax payments and management fees from the insurance subsidiaries are made under agreements which generally are subject to approval by state insurance departments. Maximum amounts of dividends that can be taken without regulatory approval are prescribed by statute; to date, cash dividends have not required regulatory approval (See Note 13 of "Notes to Consolidated Financial Statements").
In January 1994, the Company issued 6 million depositary shares each representing a one-sixth interest in a share of 7.375% Series A Cumulative Redeemable Preferred Stock and received net proceeds of approximately $145 million. A portion of the proceeds of this offering were contributed to the start up insurance subsidiaries to support their growth.
In March 1995, the Company purchased 117,000 shares of its Common Stock for approximately $4.1 million. Pursuant to an authorization of the Board of Directors, up to 334,000 additional shares may be purchased from time to time.
On December 31, 1995, in connection with the acquisition of the remaining 40% of Signet Star, the Company issued to General Reinsurance Corporation (General Re), 458,667 shares of Series B Cumulative Redeemable Preferred Stock having an aggregate liquidation preference of $68,800,000. The Series B Preferred Stock has a dividend rate increasing up to 6% during the first twelve months. The rate is subject to readjustment based on certain predetermined conditions. In addition, the Company guaranteed a senior subordinated promissory note of Signet Star in the principal amount of $35,793,085, which matures July 1, 2003 and bears interest at the rate of 6.5%. This note was issued to General Re in exchange for the convertible note previously held by General Re. In November 1993, Signet Star borrowed the maximum amount available under its revolving credit facility and used the proceeds to redeem senior notes issued in connection with the July 1, 1993 acquisition. The revolving credit facility was repaid on January 19, 1996 as discussed below.
In its investment strategy, the Company establishes a level of cash and highly liquid short-term and intermediate-term securities which, combined with expected cash flow, is believed adequate to meet foreseeable payment obligations. As part of this strategy, the Company attempts to maintain an appropriate relationship between the average duration of the investment portfolio and the approximate duration of its liabilities, i.e., policy claims and debt obligations.
Sales of fixed income securities in 1995 were the result of financial market conditions and the Company's strategy of maintaining an appropriate balance between the duration of its assets and liabilities.
The Company files a consolidated Federal income tax return with all its subsidiaries except Signet Star. Federal income tax expense in 1995 was $17.6 million (21% effective rate) as compared to a benefit of $1.6 million recorded in 1994. The 1995 effective tax rate is lower than the statutory tax rate of 35% because a substantial portion of investment income is tax-exempt. The 1994 tax benefit is due to the fact that tax-exempt investment income exceeded total pre-tax income. At December 1995, the Company had a deferred tax liability of $57.7 million, which results primarily from unrealized investment gains and intangible assets, and a deferred tax asset of $43.3 million, which results primarily from the discounting of loss reserves for Federal income tax purposes.
In 1995, Continental Western and the Habitational Division of Firemen's generally retained $475,000 on individual risks while the Company's other regional subsidiaries generally retained $400,000 on individual risks. The regional group also maintained catastrophe reinsurance protection for approximately 95% of weather-related losses above $3 million per occurrence up to a maximum of $35 million and carried additional catastrophe protection on an aggregate basis for storms resulting in loss events between $500,000 and $6 million ($8 million in 1996).
For the year ended December 31, 1995 as a result of retained earnings and the transactions discussed above under "Financing Activity", stockholders' equity increased by approximately $332.2 million and the total amount of capital employed in the business grew to $1,249.1 million. Accordingly, the percentage of the Company's capital attributable to debt decreased to 26% at December 31, 1995 from 36% at December 31, 1994. In January 1996 the Company issued $100 million of 6.25% ten-year notes. On a proforma basis, assuming the issuance of these notes occurred on December 31, 1995, the percentage of the Company's capital attributable to debt would have been 31%.
We have audited the consolidated balance sheets of W. R. Berkley Corporation and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1995. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of W. R. Berkley Corporation and subsidiaries at 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.
As discussed in note 1 to the consolidated financial statements, W. R. Berkley Corporation adopted the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" on December 31, 1993.
We have also previously audited, in accordance with generally accepted auditing standards, the consolidated balance sheets of W. R. Berkley Corporation and subsidiaries as of December 31, 1993, 1992 and 1991, and the related consolidated statements of operations, stockholders' equity and cash flows for the years ended December 31, 1992 and 1991 (none of which are presented herein); and we expressed unqualified opinions on those consolidated financial statements. In 1992, W. R. Berkley Corporation adopted the provisions of the Financial Accounting Standards Board's statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes."
Consolidated Statements of Operations Years ended December 31, 1995, 1994 and 1993 (Dollars in thousands, except per share data)
W. R. BERKLEY CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements For the Years Ended December 31, 1995, 1994 and 1993
The consolidated financial statements, which include the accounts of W. R. Berkley Corporation and its subsidiaries ("the Company"), have been prepared on the basis of generally accepted accounting principles ("GAAP"). The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the revenues and expenses reflected during the reporting period. Actual results could differ from those estimates. All significant intercompany transactions and balances have been eliminated. Reclassifications have been made in the 1993 and 1994 financial statements to conform them to the presentation of the 1995 financial statements.
A subsidiary of the Company, Midwest Employers Casualty Company ("Midwest") which was acquired in November 1995, discounts its liabilities for excess workers' compensation ("EWC") losses and loss expenses using a "risk-free" rate. Midwest discounts its EWC liabilities because of the long period of time over which it pays losses. The Company believes that utilizing a "risk-free" rate to discount these reserves more closely reflects the economics associated with the excess workers' compensation line of business (see Note 11 of notes to consolidated financial statements).
On September 11, 1995, the Company formed Berkley International, LLC ("Berkley International"), a limited liability company. The Company agreed to contribute up to $65 million to Berkley International in exchange for a 65% membership interest. During 1995, the Company purchased majority interests in two property and casualty companies in Argentina for consideration of approximately $9.2 million, which constituted a portion of the Company's initial contribution to Berkley International. The proforma effect of these transactions on the Company's results of operations is not significant.
On November 8, 1995, the Company acquired 100% of the stock of MECC, Inc., the Parent of Midwest Employer's Casualty Company, for $141,908,000. In connection with this acquisition, the Company also retired approximately $19,590,000 million of MECC, Inc.'s debt. The purchase was funded by the issuance of 3,450,000 shares of Common Stock issued at $43.75 per share. On December 31, 1995, the Company acquired General Re Corporation's ("General Re") 40% interest in Signet Star Holdings, Inc. ("Signet Star") by issuing to General Re 458,667 shares of Series B Cumulative Redeemable Preferred Stock of the Company having an aggregate liquidation preference of $68,800,000. The only significant effect on the Company's financial statements from this acquisition is an increase in preferred stock outstanding and the elimination of the related minority interest because Signet Star's results of operations were previously consolidated.
All of the acquisitions were accounted for as purchases and, accordingly, the results of operations of the acquired companies have been included from the dates of acquisition.
A reconciliation of the Federal income tax expense (benefit) and the amounts computed by applying the Federal income tax rate of 35% to pre-tax income is as follows (in thousands):
At December 31, 1995, 1994 and 1993, the tax effects of differences that give rise to significant portions of the deferred tax asset and deferred tax liability are as follows (dollars in thousands):
The difference between the face value of long-term debt and the carrying value is unamortized discount. All outstanding long-term debt is not redeemable until maturity and ranks on a parity with all other outstanding indebtedness of the Company.
The Company and several of its subsidiaries use office space and equipment under leases expiring at various dates through September 1, 2004. These leases are operating leases for financial reporting purposes. Some of these leases have options to extend the length of the leases and contain clauses for cost of living, operating expense and real estate tax adjustments. Rental expense was approximately; $9,437,000, $8,000,000 and $6,029,000 for 1995, 1994 and 1993 respectively. Future minimum lease payments (without provision for sublease income) are: $8,755,000 in 1996; $7,404,000 in 1997; $6,520,000 in 1998; $5,074,000 in 1999; $3,899,000 in 2000; and $9,474,000 thereafter.
Preferred stock consists of 1,000,000 shares of 7 3/8% Series A Cumulative Redeemable Preferred Stock and 458,667 shares of Variable Rate Series B Cumulative Redeemable Preferred Stock.
The Company has the option of redeeming the Series A preferred stock after January 23, 1999 at the liquidation value of $150 per share. The Series B preferred stock has a dividend rate increasing up to 6% during the first twelve months after issuance. The rate is thereafter subject to readjustment, based on certain predetermined conditions. The Series B preferred stock is reflected at its estimated fair value of $66,000,000, based upon the current estimate of the ultimate effective dividend rate, and will be accreted to its stated value of $68,800,000 over eighteen months.
The Company adopted the W. R. Berkley Corporation 1992 Stock Option Plan under which 1,750,000 shares of common stock were reserved for issuance. Pursuant to the Plan, options may be granted at prices determined by the Board of Directors but not less than 85% of the fair market value on the date of grant.
The Company and its subsidiaries have profit sharing retirement plans in which substantially all employees participate. The plans provide for minimum annual contributions of 5% of eligible compensation; contributions above the minimum are discretionary and vary with each participating subsidiary's profitability. Employees become eligible to participate in the Retirement Plans on the first day of the month following the first full three months in which they are employed. Profit sharing expense amounted to $6,344,000, $5,625,000 and $4,605,000 for 1995, 1994 and 1993, respectively.
At December 31, 1995 and 1994, there were no investments, other than investments in United States government securities, which exceeded 10% of stockholders' equity. At December 31, 1995 and 1994, investments were as follows:
(a) During 1995, 1994 and 1993, gross gains of $11,570,000, $5,601,000 and $22,893,000, respectively, and gross losses of $3,751,000, $8,177,000 and $1,879,000, respectively, were realized.
(b) The provision for decline in value of investments is $3,333,000, $7,172,000 and $11,869,000 as of December 31, 1995, 1994 and 1993, respectively. The reductions resulted from the sale of securities.
(a) The primary focus of the trading account activities is merger arbitrage. Merger arbitrage is the business of investing in the securities of publicly held companies which are the targets in announced tender offers and mergers. Merger arbitrage differs from other types of investments in its focus on transactions and events believed likely to bring about a change in value over a relatively short time period (usually four months or less). The Company believes that this makes merger arbitrage investments less vulnerable to changes in general financial market conditions. Potential changes in market conditions are also mitigated by the implementation of short sales. Short sales of $60,720,000 and $18,500,000 have been included in other liabilities as of December 31, 1995 and 1994, respectively. Investment income earned from trading account activity includes unrealized trading gains of $352,000 and $1,271,000 for 1995 and 1994, respectively.
The table below provides a reconciliation of the beginning and ending reserve balances, on a gross of reinsurance basis, (dollars in thousands):
The Company's net reserves for losses and loss adjustment expenses relating to pollution and environmental claims were $30.8 million and $22.8 million at December 31, 1995 and 1994, respectively. The Company's gross reserves for losses and loss adjustment expenses relating to pollution and environmental claims were $59.4 million and $50.6 million at December 31, 1995 and 1994, respectively. Net incurred losses and loss expenses for reported pollution and environmental claims were approximately $8.0 million, $5.6 million and $3.5 million in 1995, 1994 and 1993, respectively. Net paid losses and loss expenses has averaged approximately $3 million for each of the last three years. The estimation of these liabilities is subject to significantly greater than normal variation and uncertainty because it is difficult to make a reasonable actuarial estimate of these liabilities due to the absence of a generally accepted actuarial methodology for these exposures and the potential affect of significant unresolved legal matters, including coverage issues as well as the cost of litigating the legal issues. Additionally, the determination of ultimate damages and the final allocation of such damages to financially responsible parties is highly uncertain.
The Company's insurance subsidiaries are restricted by law as to the amount of dividends they may pay without the approval of regulatory authorities. During 1996, the maximum amount of dividends which can be paid without such approval is approximately $93,361,000.
Other operating costs and expenses consist of the following (dollars in thousands):
The Company's operations are presently conducted through four basic segments: regional property casualty insurance; reinsurance; specialty lines of insurance; and alternative markets operations. The Company established an international segment in 1995; the results of this segment have been included as part of the regional segment, due to immateriality. Summary financial information about the Company's operating segments is presented in the following table. Income before income taxes by segment consists of revenues less expenses related to the respective segment's operations. These amounts include realized gains (losses) where applicable. Intersegment revenues consist primarily of dividends, interest on intercompany debt and fees paid by subsidiaries for portfolio management and other services to the Company. Identifiable assets by segment are those assets used in the operation of each segment.
On January 19, 1996 the Company issued $100 million of 6.25% ten-year notes which are not redeemable until maturity and subsequently retired $28.4 million of outstanding bank debt