On January 17, 1995, First Central Insurance purchased its home office building, located at 266 Merrick Road, Lynbrook, New York, (the "Building") for $4,000,000 in cash. The Building consists of approximately 30,000 square feet of office space and 2,000 square feet of retail space. The approval to acquire real estate required by the State of New York Insurance Department was obtained on December 27, 1994. The Company has assumed the leases of the tenants of the Building. Management believes that the Building is suitable for First Central's purposes for the foreseeable future.
Approximately 9,600 square feet of office and retail space is leased to eight unaffiliated tenants who paid $204,690 in rent during 1995.
The following table illustrates First Central Insurance's direct premiums written and net premiums earned on a category-by-category basis for 1995, 1994, and 1993.
Net premium written decreased 8.8% or approximately $4,900,000 in 1995 when compared to 1994. Ceded premiums increased 113.8% or approximately $11,600,000 in 1995 when compared to 1994 due to a change in the company's reinsurance treaty as of April 1, 1995. The endorsement to the reinsurance treaty changed the calculation of reinsurance premium from a percentage of earned premiums to a percentage of written premiums although reinsurance premiums will continue to be paid when earned. The effect of this endorsement is a change in the manner by which the Company
accounts for reinsurance ceded resulting in a decrease in net premiums written and a decrease in unearned premiums. The endorsement also produces a liability; Funds held for reinsurance treaty of $3,704,947 at December 31, 1995.
In 1994 net investment income increased 20.2% when compared to 1993. This increase was due to the 11.1% (approximately $8,000,000) increase in invested assets during 1994. During 1994, First Central recognized a net realized gain of $950,898 as compared to $2,114,412 in 1993. The 55.0% decrease in realized gains in 1994 was a result of a decrease in the market value of First Central's investment portfolio due to the decline of bond prices and weak stock market conditions evident in 1994. The 77.4% increase in realized gains for 1993 was due primarily to the sales of fixed maturity investments after a period of declining interest rates which had the effect of increasing the value of the First Central's portfolio.
During 1995, one security was deemed to have a decline in market value other than temporary. As a result of a recent public announcement stating that Discovery Zone Inc. filed for Chapter 11 bankruptcy protection, First Central Insurance wrote down the cost of the Discovery Zone Inc. subordinated Notes due 2000 held in First Central Insurance's investment portfolio. As of December 31, 1995, First Central Insurance held $3,000,000 par value of this security with a market value of $772,500. First Central Insurance realized a loss of $555,281 on this security lowering the amortized cost to the December 31, 1995 market value of $772,500.
Estimated salvage and subrogation recoveries are recorded after considering the effect of payments to reinsurers based on Management's estimate of the future recoveries applicable to claims incurred prior to December 31.
business decreased to 41.6% compared to 58.1% in 1993. This decrease was due to less losses incurred and an increase in premiums earned.
First Central Insurance's loss ratio on its automobile liability line of insurance increased to 80.7% in 1995 from 77.8% in 1994 and 87.9% in 1993, primarily due to the private passenger portion of the automobile liability line of business. Due to the historically increasing loss ratios on private passenger automobile liability insurance, First Central Insurance reviews this line and limits writings to the amount necessary to satisfy state insurance regulations. Additionally, First Central Insurance received permission from NYS Insurance Department to increase rates on private passenger automobile liability insurance which was implemented in December 1993.
In 1995 First Central's underwriting expenses decreased 0.9% when compared to 1994. This was a result of First Central Insurance's policy acquisition costs decreasing 1.0% and other operating expenses decreasing 0.7% when compared to the same period in 1994. The decrease in underwriting expenses was primarily due to an increase in ceded commissions and a decrease in rent offset by increases in commissions, premium taxes, real estate expenses, payroll and depreciation.
percentage of auditable policies issued during the 1995 year. The 1994 and 1993 increases in the provision for doubtful accounts is directly related to the increase in premium writing and the resulting increase in agents' balances.
Net income decreased 93.7% in 1995 when compared to 1994. This was a result of an increase in IBNR reserves and paid losses (see "Losses and Loss Adjustment Expense Reserves" above) as offset by increases in earned premiums, net investment income, realized gains, and claims adjusting revenue and a decrease in interest expense, underwriting expenses and doubtful accounts and income taxes.
Reinsurance First Central Insurance reinsures a portion of substantially all of the risks which it underwrites. First Central Insurance has entered into reinsurance treaties with Nat Re covering all risks underwritten by First Central Insurance. First Central Insurance also maintains an automatic facultative property loss reinsurance facility with Munich American and Swiss Re. See "Business -- Reinsurance Ceded" and Note 4 of the Notes to First Central's Consolidated Financial Statements for a discussion of those treaties.
In 1995, the First Central Insurance ceded premiums of approximately $21,726,000 on approximately $72,294,000 of direct written premium whereas, in 1994, premiums of approximately $10,163,000 were ceded on approximately $65,593,000 of direct written premium. The increase in ceded premiums for 1995 was due to an increase in reinsurance rates and also a change in accounting procedures (see"Premiums Written and Earned"). Paid losses recovered by First Central Insurance in 1995 and 1994 amounted to approximately $6,592,000 and $2,967,000, respectively.
A contingent commission from Swiss Re, based on First Central Insurance's 1994 loss ratio with them, in the amount of $91,226 was received in February 1995. For the year ended December 31, 1995 a contingent commission, in the amount of $62,110, was due to First Central Insurance.
The business capacity of an insurance company is based on its liquidity and capital resources. Insurance statutes and regulations which apply to insurers require maintenance of prescribed amounts in capital and surplus as well as statutory deposits with insurance authorities. The assets of insurers are maintained in statutorily prescribed investments. Insurers are also required to set up and have reserves for losses and loss adjustment expenses. Furthermore, substantial statutory and regulatory restrictions are imposed upon an insurer's ability to declare and pay cash dividends. See "Investments and Investment Portfolio", "Regulation", "Dividends" and "Losses and Loss Adjustment Expense Reserves" for a discussion of the foregoing factors as they relate to First Central Insurance. See also "Reinsurance".
Management is unaware of any trend which is reasonably likely to result in a further increase or decrease in First Central's or First Central Insurance's liquidity or capital resources except, as First Central Insurance's assets and investments have increased, the availability of investable funds have resulted in increased investment income and improved cash flow, and hence some increased liquidity of First Central Insurance. However, First Central may from time to time repurchase shares of its common stock if the appropriate conditions exist. In addition, the liquidity of the investment portfolio of an insurance company is important to its ability to maximize investment return which is a significant component of overall profitability. The portfolio of First Central Insurance included holdings of short- term investments with a maturity period of one year or less equal to 2.9%, 10.7% and, 6.4% in 1995, 1994, and 1993, respectively, of the total investments.
First Central intends to fund its interest payment obligations (currently $569,700 per year) under its outstanding Debentures from the dividends it receives or may receive from First Central Insurance. Currently, the maximum amount which may be distributed as dividends by First Central Insurance is approximately $2,635,000.
The Tax Reform Act of 1986 (the "1986 Tax Act"), and the Revenue Reconciliation Act of 1990 (the "1990 Tax Act"), contain provisions which significantly affect the taxation of insurance companies. Some of the major provisions of the 1986 Tax Act and the 1990 Tax Act are summarized below.
In February 1992, the Financial Accounting Standards Board ("FASB") issued Statement No. 109, "Accounting for Income Taxes," which First Central was required to adopt on January 1, 1993. The adoption changed the method of accounting for deferred income taxes from the deferred method to the liability method. Under the deferred method, First Central deferred the past tax effects of timing differences between financial reporting and taxable income. The liability method requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the reported amounts of assets and liabilities and their tax bases.
The adoption of Statement No. 109 did not have a significant effect on the January 1, 1993 balance sheet or on the results of operations for the year ended December 31, 1993.
On January 17, 1995 First Central Insurance purchased the premises in which it's corporate offices are located for a purchase price of $4,000,000 in cash. Prior to purchasing the Building, management analyzed the relative benefits and costs of the purchase verses, among other things, the renewal of (i) First Central Insurance's lease which was to expire on November 30, 1995 and (ii) Mercury's lease in the same building which was to expire on March 31, 1995 (See "Item 2 Properties").
Except for the purchase of the premises described above, neither First Central, First Central Insurance, nor Mercury made any material commitment for capital for 1995 and, does not anticipate any for 1996.