During 1988, the Company purchased a 587 acre parcel of land in Caledonia Township (southeast of Grand Rapids, Michigan) and constructed a 260,000 square foot corporate headquarters building on part of this property. Approximately 36 acres of this parcel currently is used for the corporate headquarters and the balance of the parcel is held as investment property. The Company also leases several facilities in Cascade Township near Grand Rapids, Michigan for an additional 75,000 square feet of office, distribution, printing and warehouse space. The Company has other short-term leasehold interests in real property used for its claim service offices and captive agencies throughout the country.
The following section provides a narrative discussion about the Company's results of operation and financial condition. The following discussion should be read in conjunction with the Company's consolidated financial statements and related notes thereto presented in
Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1995 and 1994 24
Property and Casualty Statements of Income for the years ended December 31, 1996, 1995 and 1994 25
Parent Company and Other Statements of Operations for the years ended December 31, 1996, 1995 and 1994 25
The Company's property and casualty insurance subsidiaries are included in the accompanying financial statements in accordance with generally accepted accounting principles for insurance companies. These principles are summarized as follows:
a. Insurance premium is recognized as income over the terms of the policies.
b. Commissions, premium taxes and other costs of acquiring new business have been deferred and are being amortized by charges to income as the related premium is earned.
c. The liability for insurance losses and loss adjustment expenses is based upon (1) accumulation of case estimates for losses reported prior to the close of the accounting period, (2) estimates of incurred but unreported losses based upon past experience, and (3) estimates of expenses for investigating and adjusting claims. The liability for such losses is stated after estimated recoveries for salvage and subrogation.
The most significant estimates in the Company's balance sheet are the determination of prepaid policy acquisition costs and the reserve for insurance losses and loss adjustment expenses. Management's best estimate of prepaid policy acquisition costs is based on historical studies and assumptions made regarding costs incurred. Management's best estimate of insurance losses and loss adjustment expenses is based on past loss experience and consideration of current claim trends as well as prevailing social, economic and legal conditions. Although management's estimates currently are not expected to change in the foreseeable future, the costs the Company will ultimately incur could differ from the amounts assumed will be incurred based on the assumptions made.
In accordance with Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity Securities," the Company has classified its investments in fixed maturities and equity securities into two categories, "fixed maturities held to maturity" and "securities available for sale." Fixed maturities held to maturity and mortgage loans and land contracts are reported at amortized cost. The Company expects that the investments in these categories will be held to maturity and, therefore, no unrealized gains or losses are recognized on such investments. Securities available for sale are reported at market value. The unrealized gains and losses of the investments in this category are credited or charged directly to shareholders' equity, net of applicable taxes. Although the Company has the general intent and ability to hold securities segregated as securities available for sale to maturity, sales from this category may be undertaken due to changes in market conditions, relative yields available, tax planning and asset/liability management considerations.
Investment real estate consists primarily of land and buildings held for development and sale. Investment real estate is carried at cost less applicable accumulated depreciation. Investment real estate acquired through foreclosure is carried at the lower of cost or market. Depreciation expense on investment real estate was $249,000, $232,000 and $319,000 for 1996, 1995 and 1994, respectively.
Income per share amounts are computed based on the weighted average number of common shares outstanding during each year, including equivalents. There were average shares outstanding of 9,865,000 in 1996, 10,222,000 in 1995 and 10,604,000 in 1994.
Notes payable consist primarily of an unsecured credit agreement with a group of banks and a loan secured by a mortgage on the Company's corporate headquarters building. An unsecured credit agreement was entered into in April 1995 which provides for a revolving credit facility not to exceed $40 million and a term loan of $56 million, which reduced to $50 million on August 31, 1995. The credit agreement expires in April 2002. At December 31, 1996, the term loan had a balance of $50 million, the revolving credit facility had a balance of $8 million and the building mortgage had a balance of $34.2 million. In addition to the remaining $32 million available under the revolving credit facility, the Company has several uncommitted money market lines of credit with various banks, all of which may not exceed $10 million at any one time.
The Company does not hold or issue any other forms of derivative financial instruments.
The Company files a consolidated tax return with its subsidiaries, including its life insurance subsidiary, which was sold in 1996. For tax purposes, $10.5 million had been accumulated over the years by the life insurance subsidiary in a memorandum policyholders' surplus account and became taxable upon its sale. The resulting $3.7 million of tax has been charged against the gain on the sale and included in net income from discontinued operations in 1996.
The Company was party to both proportional and non-proportional reinsurance agreements in 1996.
Due from reinsurance companies balances are primarily premium amounts due from unconsolidated insurance affiliates for business assumed, and loss recoverables from a major U.S. reinsurance company. Assumed reinsurance is predominantly from unconsolidated affiliates.
The Company has a Long-Term Incentive Plan (LTIP) which provides awards to certain key employees based on the Company's return on shareholders' equity over three year periods. The LTIP was amended in December 1994 and approved by the shareholders for 70% of the awards to be paid in the Company's common stock. The awards are fully vested upon issuance; however, the stock is restricted to resale for three years from the date of the award. There were 8,413 shares and 9,804 shares issued under the plan for 1996 and 1995, respectively.
The Company accounts for its stock option plans in accordance with APB Opinion 25, Accounting for Stock Issued to Employees. Since the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation cost is recognized under APB Opinion 25. In accordance with SFAS No. 123, Accounting for Stock-Based Compensation, the Company is required to provide pro forma information regarding net income and earnings per share as if compensation costs for the Company's stock option plan had been determined using a fair value based estimate. The Company uses the Black-Scholes option-pricing model to determine the fair value of each option at the grant date with the following weighted average assumptions:
The following is a summary of the Company's stock option transactions during 1996 and 1995:
The cost of the aforementioned benefit plans, excluding post-retirement benefits, for 1996, 1995 and 1994 was $3,696,000, $4,339,000 and $4,307,000, respectively.
The Company maintains a defined benefit post-retirement plan for substantially all employees which provides certain health care, dental and life insurance benefits. Eligibility and benefits are based on age and years of service for the health care and dental benefits, which also require contributions from retirees under certain circumstances. The life insurance benefits are non-contributory and are calculated as a percentage of the employee's base annual compensation in the year of retirement. The benefit is reduced at age 70 to an ultimate benefit of $5,000. SFAS No. 106, "Employers' Accounting for Post-Retirement Benefits Other Than Pensions," requires companies to accrue post-retirement benefits during the employees' working years rather than expensing on a cash basis. The Company does not prefund its post-retirement benefit plan and has elected to amortize the transition obligation over a 20 year period.
The health care trend rate assumed was 7.5% for 1996, decreasing .25% per year to 6% in 2002 and thereafter. The dental trend rate was 6% per year. The rate of compensation increase regarding life insurance benefits was 5%. A 1% increase in the health care trend rate would increase the accumulated post-retirement benefit obligation as of December 31, 1996 by $157,000 and the net periodic benefit cost for the year then ended by $22,000.
The weighted average discount rate used in determining the accumulated post-retirement benefit obligation was 8%.
As a holding company, the principal source of the parent company's cash available for debt service and payment of dividends (other than through the use of borrowed funds or the employment of other assets) is dividends received from its principal property and casualty insurance subsidiary, Foremost Insurance Company. State regulatory requirements limit the amount of annual dividends Foremost Insurance Company can pay to the holding company without obtaining prior insurance department approval. These restrictions are not expected to significantly affect the holding company's ability to meet its foreseeable cash requirements. The amount of dividends which Foremost Insurance Company can pay to the holding company in 1997 without obtaining prior insurance department approval under the current statute is $29.7 million. In 1996 Foremost Insurance Company paid dividends in cash and other assets to the parent company totaling $31.6 million.
Policyholders' surplus for the combined property and casualty insurance companies at December 31, 1996 and 1995 was $201.3 million and $200.5 million, respectively. Statutory net income for the combined property and casualty insurance companies for the years ended December 31, 1996, 1995 and 1994 was $34.1 million, $49.3 million and $44.2 million, respectively.
In the event any person or group becomes the beneficial owner of 20% or more of the Company's common stock, or if a holder of 20% or more of the Company's common stock engages in self-dealing transactions, or if the Company becomes involved in a merger transaction, or sells 50% or more of its assets or earning power to another person, then each right not owned by the acquiring person or group will entitle its holder to purchase, at the right's then current exercise price, shares of the Company's common stock, or the common stock of the acquiring or surviving entity (or in certain circumstances, cash, property or securities of the Company) having a market value equal to twice the exercise price. While a stockholder group owns in excess of 20% of the Company's outstanding common stock, any increase of more than 2% in their aggregate ownership would also make the rights exercisable.
The Company has retained the law firm of which a director is a partner thereof and plans to continue to do so in the future for certain legal matters. Fees in the amount of $1,178,000 and $397,000 were paid to this law firm in 1996 and 1995, respectively.
BDO SEIDMAN, LLP - ---------------- BDO SEIDMAN, LLP February 14, 1997, except for Note 12 which is as of March 26, 1997 Grand Rapids, Michigan