The following table sets forth certain historical selected consolidated financial data of the Company which has been derived from the audited consolidated statements of the Company for and as of the end of each of the years ended December 31, 1991, 1992, 1993, 1994 and 1995.
The Company's insurance products include force-placed insurance policies which have stated terms of either up to ninety (90) days ("short-term policies") or six (6) months to one (1) year ("longer-term policies"), most of which are longer-term policies. Premiums for longer-term policies are recorded as revenues when earned. The Company's policies are canceled at a relatively high rate because they generally remain in effect only until financial institutions receive proof that borrowers have obtained their own insurance. At the time the policies are issued, a reserve is established to provide for return of premiums for anticipated cancellations, which has the effect of decreasing net premiums written. The reserve historically has been established at approximately 64% of premiums. Premiums are written directly by the Insurance Subsidiary or by third party insurance companies in certain states where the Insurance Subsidiary is not licensed or where its products are not approved. Over the periods indicated below, the Company assumed 30% to 100% of premiums directed to third party insurance companies after paying ceding commissions. The following table summarizes premiums written net of cancellations during the periods indicated (in thousands):
From 1986 through 1991, there were no losses reported to the Company which resulted in liability to reinsurers under the Company's reinsurance policies. During 1992, 1993 and 1994, the Company ceded losses of $1,267,000, $423,000 and $213,000, respectively, to reinsurers, for losses occurring in 1992 and for which it has been fully reimbursed. There were no losses ceded in 1995. The Company seeks to limit its exposure with respect to any failure by a reinsurer to fulfill its obligations by evaluating the financial condition and rating of members of its reinsurance pool (the Company's policy is to only purchase reinsurance with U.S. insurers rated "A" or better by A.M. Best) at the time of such purchase and by diversifying the reinsurance pool.
The Company's effective income tax rate was 32%, 33% and 34% for 1993, 1994 and 1995, respectively, reflecting the 35% federal statutory income tax rate and the net effect of state taxes, less the beneficial effect of tax-exempt investment income earned during the periods. See Note 7 of Notes to Consolidated Financial Statements.
In March 1995, the Financial Accounting Standard Board issued Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of long-lived Assets and for long-lived Assets to be disposed of." This statement requires that long-lived assets and certain identifiable intangibles to be held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In determining the recoverability of an asset's carrying value, the Company would estimate the future cash flow expected to result from the use of the assets and its eventual disposition. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset, an impairment loss would be recognized. Measurement of an impairment loss for long-lived assets and identifiable intangibles that the Company expects to hold and use should be based on the fair value of the assets. SFAS No. 121 applies to financial statements for fiscal years beginning after December 15, 1995. The Company will adopt the requirements of SFAS No. 121 in 1996 and has yet to determine the impact of adoption.
The following table sets forth certain items as a percent of total revenues for the periods indicated.
YEAR ENDED DECEMBER 31, 1994 VERSUS YEAR ENDED DECEMBER 31, 1995
Total revenue increased from $34.8 million in 1994 to $35.9 million in 1995, an increase of $1.1 million or 3.2%. Net premiums written decreased from $20.0 million in 1994 to $15.0 million in 1995, a decrease of $5.0 million or 25.0%. The decrease in net premiums was principally due to two factors: (1) approximately $4.3 million less business in 1995 from one customer which ceased writing premiums with the Company in early 1995, and; (2) 1994 premiums written included $1.4 million from a significant customer whose loan processing portfolio was sold by the RTC in late 1994 and therefore, the customer did not contribute to premiums in 1995. These decreases were partially offset by additional business from new customers.
Net premiums earned decreased from $20.9 million in 1994 to $17.0 million in 1995, a decrease of $3.9 million or 18.7%. The decrease was primarily related to the same factors which caused the decline in net premiums written during the period.
Total revenue decreased from $39.7 million in 1993 to $34.8 million in 1994, a decrease of $4.9 million or 12.4%. Net premiums written decreased from $22.5 million in 1993 to $20.0 million in 1994, a decrease of $2.5 million or 11.1%. Approximately $1.0 million of the decrease was due to the Resolution Trust Corporation's decision to sell a significant customer's loan servicing portfolio and another $450,000 is due to the accrual for the refund of premiums earned in 1989 in response to a California Supreme Court decision in favor of the California Department of Insurance's uniform rate of return formula (see Note 9 of Notes to Consolidated Financial Statements). In 1993, the Company also benefitted from the assumption of books of business which increased premiums written for 1993 by a net amount of $1.3 million over 1994. The balance was due to a reduction in premiums ceded under reinsurance treaties.
Loss and LAE was $9.0 million in 1993 (38.4% of net premiums earned) and $7.9 million in 1994 (37.7% of net premiums earned). When losses incurred for both 1993 and 1994 are adjusted for losses assumed from the California FAIR Plan ($750,000 in 1993 for losses arising out of the brush fires in Southern California and $600,000 in 1994 for losses arising out of the earthquake in Southern California) then both years have a loss ratio of approximately 35% to earned premiums.
As a result of the above factors, operating income before provision for income taxes decreased from $5.3 million in 1993 to a $1.6 million loss in 1994, a decrease of $6.9 million or 130.0%.
The Insurance Subsidiary collects and invests premiums written in advance of the payments for associated claims. In the absence of a catastrophic loss, this timing difference between premium collection and claims payment, combined with investment income, normally provides short-term funds in excess of normal operating demands for cash. As of December 31, 1995, the Company had cash and short-term investments aggregating $13.9 million.
Industry and regulatory guidelines suggest that a property and casualty insurers' annual statutory net written premium should not exceed approximately three times its policyholders' surplus. The Company's surplus ratio is significantly lower than such guidelines. For the year ended December 31, 1995, the Company's net written premium to policyholder surplus ratio was .60 to 1. See "Business -- Insurance Operations -- Insurance Operating Ratios".
The Company's financial results can be significantly affected by a number of factors, including the volume of force-placed insurance and the rate of cancellation of insurance policies, the addition or loss of significant customers, significant changes in the number of loans or leases being tracked for major customers and catastrophic loss events. For example, in 1992 the Company incurred net losses relating to the Los Angeles riots and Hurricane Andrew of $612,000 and $527,000, respectively. In November 1993, the Company received claims of approximately $650,000 from policyholders for losses arising out of the October and November 1993 series of fires in Southern California. The Company also received an assessment of $725,000 from the California Fair Plan Association, a mandatory insurance pool for certain California real estate, relating to losses from those fires. In addition, revenues from the Company's Flood Zone Determination Services are directly related to the volume of mortgage loan originations, both new and refinanced, and any change in the level of such activity could have a material impact on the Company's performance. See "Significant Customers", "The Insurance Industry", and "Management's Discussion and Analysis of Financial Condition and Results of Operations".
The Company derives a significant amount of its revenues from insurance premiums and investment income. In the event that, for whatever reason, the Company experiences abnormally high losses, purchases reinsurance from reinsurers who will not or cannot pay losses submitted, or other adverse developments occur, then any such event or combination of events could have a material adverse impact on the Company. In addition, insurance companies and others have often been sued under certain legal theories, such as bad faith handling or settlement of claims, which could subject the Company to liability in excess of policy limits. An adverse outcome of any such lawsuit could have a material negative impact on the Company.
The Company is required to maintain reserves to cover its estimated ultimate liability for loss and loss adjustment expenses with respect to reported losses and incurred but not reported claims. These reserves are estimates of what the Company expects the ultimate settlement and administration of claims will cost, and are based on known facts and circumstances, predictions of future events, estimates of future trends in claims severity and other variable, subjective factors. No assurances can be given that such estimates will be adequate to cover actual losses incurred by the Company. Any significant changes in the Company's estimate of ultimate losses on reported claims may materially adversely affect the results of the Company's operations in the period reported. The Company has in the past experienced adverse developments in its loss reserves. The Company's loss and loss adjustment expense reserves are reviewed on an annual basis by unaffiliated actuaries. The Company's most recent actuarial review of such reserves as of December 31, 1995 concluded that the reserves (i) met the requirements of the insurance laws of California; (ii) were computed in accordance with accepted loss reserving standards and principles and (iii) make a reasonable provision for all unpaid loss and loss expense obligations of the Company under the terms of its policies and agreements.
The Company also maintains a reserve for return premiums which is based upon the Company's historical experience. As is prevalent in the force-placed insurance industry, a substantial amount of the Company's net premiums written are refunded to policyholders. The amount of such refunds can be affected by, among other things, inaccurate or untimely data submitted by customers, which the Company uses as a basis for recording written premiums or the loss of a significant customer. No assurance can be given that the reserve for return premiums will be adequate to cover actual refunded premiums paid by the Company in the future. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Insurance Operations".
The Company's business is partially dependent upon its ability to cede risks insured by the Company to reinsurers. The amount, availability and cost of reinsurance are subject to prevailing market conditions, beyond the control of the Company, which can affect the Company's level of business and profitability. The Company is ultimately liable for the reinsured risk if for any reason the reinsurers do not cover or will not pay the Company for the losses of the insureds. As a result of the increased cost and more limited availability of reinsurance, in the future, the Company may elect to retain a higher portion of the risk historically ceded to reinsurers. If the Company were to retain a higher proportion of insured risks, it would increase its exposure to
The Company derives a substantial portion of its total revenues from fees for Flood Zone Determination Services. These services are primarily provided to assist lenders in complying with federal laws which in many instances require lenders to determine whether property being financed is located in a federally-designated flood zone and require borrowers to obtain flood insurance. Any significant change in federal legislation or secondary market requirements limiting these requirements on lenders or borrowers, or the development by competitors of significantly enhanced service or delivery systems could have a material adverse effect on the Company's business or operating results.