The Company subleases its executive offices for an annual rent of approximately $0.1 million from Equity Group Investments, Inc. ("EGI"), a company affiliated with certain directors, officers, and stockholders of the Company. The executive offices are located at Two North Riverside Plaza, Chicago, Illinois 60606. Western Surety leases office space for its executive offices at 101 South Phillips Avenue, Sioux Falls, South Dakota 57102, under a lease expiring in 2002. Western Surety's office space, consisting of approximately 81,600 square feet, is leased from a partnership in which Western Surety owns a 50% interest. The annual rent, which is subject to annual adjustments, was $1.4 million as of December 31, 1995. Western Surety also leases a 14,760 square foot branch office in Dallas, Texas. Annual rent for the branch office was $0.2 million and the lease expires in 1996. United Capitol leases office space for its executive offices at 400 Perimeter Center Terrace, Suite 345, Atlanta, Georgia 30346, under a lease terminating June 30, 2000 with an annual rent of $0.4 million. Universal Surety leases office space for its executive offices at 950 Echo Lane, Suite 250, Houston, Texas 77024, under a lease terminating October 31, 1997 with an annual rent of $0.1 million. Universal Surety also leases space for branch offices in Austin, Dallas and San Antonio, Texas, and Overland Park, Kansas, for an additional annual rent of approximately $0.1 million.
On July 31, 1986, the Company emerged from voluntary bankruptcy proceedings under Chapter 11 of the United States Bankruptcy Code. As a result of operating losses from oil and gas operations prior to the Company's bankruptcy, the Company emerged from bankruptcy with approximately $300 million in net operating tax loss carryforwards ("NOLs"). Approximately $177 million of these NOLs were available at December 31, 1995 to reduce the Company's future federal taxable income. The Company believes that an analysis of results of operation and financial condition should include an analysis of the Company's ability to reduce its income tax payments through the utilization of NOLs.
The Company's operations have been focused in the property and casualty insurance business since 1990. Capsure's principal property and casualty insurance entities are Western Surety Company ("Western Surety"), acquired in August 1992, United Capitol Insurance Company ("United Capitol"), acquired in February 1990, and Universal Surety of America ("Universal Surety"), acquired in September 1994.
Since 1987, soft market conditions characterized by intense competition on rate and contract terms have prevailed in the property and casualty insurance industry. The industry continues to be relatively well-capitalized and under-leveraged on an operating basis which exerts continued pressure on rates and terms. Although the industry has sustained significant losses from catastrophes in 1992 through 1995, there has not been a meaningful improvement in market conditions. Due to the nature of its business, these market conditions have had little impact on Capsure's surety operations; however, United Capitol has been significantly affected by prevailing market conditions. United Capitol has responded to these difficult market conditions by maintaining a disciplined underwriting approach and electing to decline business that may result in unacceptable or inadequately compensated risk. Management believes prevailing market conditions are likely to persist for the near- and possibly long-term. Capsure will continue to focus its resources in lines of business where it has or can acquire the requisite underwriting and business processing experience and for which consistent long-term underwriting profits and acceptable returns on capital can reasonably be expected.
Western Surety specializes in writing small fidelity and noncontract surety bonds, referred to as "miscellaneous" bonds, and errors and omissions ("E&O") liability insurance and is licensed to write fidelity, surety and casualty insurance in all 50 states and the District of Columbia. Western Surety is rated A+ (Superior) by A.M. Best Company, Inc. ("A.M. Best"). Bonds underwritten by Western Surety are relatively low-risk, low-premium products where prompt service, easy-to-use forms and availability of an extensive array of bond products are emphasized. One of the largest writers of miscellaneous bonds in the United States, Western Surety has experienced overall growth in gross written premiums since 1990 in spite of the soft market. This growth is attributable to its product specialization, including new products and programs, underwriting expertise and broad distribution network as well as to legislatively mandated bond limit increases, and to bonding requirements legislated by various states and municipalities. Substantially all of Western Surety's bonds are mandated by various state statutes and local ordinances. Such factors have largely insulated Western Surety from the effects of prevailing market conditions in the broader commercial property and casualty insurance industry. Management believes, with respect to
Universal Surety specializes in the underwriting of small contract and miscellaneous surety bonds. Universal Surety is rated A (Excellent) by A.M. Best and is licensed in 21 states and the District of Columbia with most of its business generated in Texas (77% of 1995 gross written premiums). Contract bonds underwritten by Universal Surety, including those underwritten on behalf of Western Surety under the USA\Western program, are primarily contractor performance and payment bonds in amounts under $3.0 million for which underwriting expertise and distinctive service to agents are emphasized. Universal Surety underwrites primarily standard accounts and some specialty accounts for which it will utilize supplemental collateral arrangements and excess rates for contractors not qualified for standard surety rates. Universal Surety also reduces its exposure through participation in the Small Business Administration ("SBA") Surety Bond Guarantee Program. Under this program, the SBA will generally reimburse Universal Surety for between 80% and 90% of losses and loss adjustment expenses incurred on any SBA guaranteed bond in exchange for 20% of the premium. Contract bonds are more affected by prevailing market and general economic conditions than noncontract bonds.
United Capitol writes specialty property and casualty insurance primarily as an excess and surplus lines insurer. United Capitol is rated A (Excellent) by A.M. Best. United Capitol provides principally general liability insurance, including directors' and officers' liability ("D&O"), product liability and other liability coverages, to businesses which have hazardous, unique or unusual risks. Policies underwritten by United Capitol are relatively high-risk, high-premium products which require individual risk underwriting and pricing expertise. United Capitol has experienced significant declines in gross written premiums as it has adhered to its strategy of strict underwriting discipline and has declined to write what it believes to be underpriced business.
On February 29, 1996, the Company announced that it had signed an agreement to sell United Capitol Holding Company ("UCHC") and its subsidiaries, United Capitol, United Capitol Managers, Inc. ("Managers") and Fischer Underwriting Group, Incorporated ("Fischer") to a subsidiary of Frontier Insurance Group, Inc. Estimated net proceeds to Capsure will be approximately $75 million, which includes the purchase price for the capital stock of UCHC and the release of United Capitol's excess statutory surplus on or before closing. The agreement is subject to several conditions including approval by insurance regulatory authorities and other governmental authorities. The transaction is expected to close in the second quarter of 1996.
Capsure is exiting the E&S marketplace in order to focus on its surety operations and other admitted lines. Management has concluded that United Capitol's prospects can be best enhanced and realized by ownership under a larger company than Capsure. The sale of United Capitol will liberate approximately $75 million of Capsure's capital. Capsure is considering alternative uses of this capital including funding of acquisitions, stock repurchases, payment of stockholder dividends and some combination of the foregoing.
RESULTS OF OPERATIONS The components of income are summarized as follows (dollars in thousands):
INSURANCE UNDERWRITING Underwriting results are summarized in the following table (dollars in thousands):
Gross written premiums increased 8.8%, or $9.0 million, for the year ended December 31, 1995, primarily due to an increase of $12.8 million for the inclusion of the full year results of Universal Surety in 1995, partially offset by reduced premium volume at United Capitol. Universal Surety contributed $16.9 million of gross written premiums in 1995. Western Surety experienced a 2.0% increase in gross written premiums, primarily due to the growth in the new agents' and brokers' E&O product introduced in 1994. United Capitol's gross written premiums decreased 22.9%, or $6.2 million, in 1995 as its premium volume, particularly in the increasingly competitive asbestos abatement line, continued to be significantly affected by prolonged soft market conditions. Significant declines in the asbestos abatement and other primary casualty business were partially offset by an increase in property writings.
Underwriting income increased $29.6 million for the year ended December 31, 1995, primarily due to significant net favorable development of prior years' loss reserves. The consolidated combined ratio decreased to 54.6% in 1995 from 83.5% in 1994. The consolidated loss ratio decreased to (7.5)% in 1995 from 25.2% in 1994. The surety and fidelity loss ratio decreased to 8.9% in 1995 from 15.8% in 1994, primarily due to $4.0 million in fourth quarter net favorable development of prior years' loss reserves at Western Surety. United Capitol's loss ratio decreased to (109.6)% in 1995 from 61.1% in 1994. Excluding the effects of favorable development, United Capitol would have reported loss ratios of 59.3% and 98.3% in 1995 and 1994, respectively.
United Capitol's claims development through December 31, 1995, has been favorable relative to expectations based on industry experience. Due to the limited prior operating experience of United Capitol and the long-tail nature of its business, management previously relied principally upon industry development patterns and expected loss ratios in estimating incurred but not reported ("IBNR") losses. Given the availability of nine full years of experience and the growing evidence of favorable loss trends relative to industry indications, management concluded in the fourth quarter of 1995 that it was appropriate to place greater reliance on United Capitol's own development patterns and emerging loss ratios in estimating IBNR. United Capitol reduced loss and loss adjustment expenses by $23.2 million in 1995 for net favorable development related to prior years, substantially all of which pertains to this change in estimate. This loss reserve reduction increased Capsure's consolidated income before taxes by $23.2 million, and net income by $15.1 million, or $0.98 per share.
The consolidated expense ratio increased to 62.1% in 1995, compared to 58.3% in 1994. The surety and fidelity expense ratio increased slightly to 68.5% in 1995 from 67.7% in 1994, reflecting increased operating expenses, particularly, wage and postal expense increases. United Capitol's expense ratio increased to 22.9% in 1995 compared to 22.5% in 1994.
Underwriting income for the year ended December 31, 1994, was virtually unchanged as compared to the prior year despite increased net earned premiums. The consolidated combined ratio increased to 83.5% in 1994 from 82.3% in 1993. The consolidated loss ratio increased to 25.2% in 1994 from 23.2% in 1993, reflecting less favorable development of prior years' loss reserves at United Capitol than was experienced in 1993. United Capitol's loss ratio increased to 61.1% in 1994 from 47.5% in 1993. Excluding the effects of favorable development, United Capitol would have reported loss ratios of 98.3% and 110.3% in 1994 and 1993, respectively. The surety and fidelity loss ratio decreased to 15.8% in 1994 from 16.7% in 1993, primarily due to favorable development of prior years' loss reserves and increased salvage recoveries at Western Surety.
Amortization expense was $16.9 million for the year ended December 31, 1995, and $3.4 million in 1994 and 1993. Amortization expense in 1995, 1994 and 1993 included $1.2 million, $1.3 million and
term investments at December 31, 1995 compared to the prior year primarily related to investments held at United Capitol.
Cash flow at the parent company level is derived principally from dividend and tax sharing payments from its insurance subsidiaries. The principal obligations at the parent company level are to service debt and pay operating expenses. At December 31, 1995, the carrying value of the Company's invested assets of the non-insurance operations, principally at the parent company level, was comprised of $11.6 million of equity securities, $4.7 million of short-term investments and $0.3 million of cash. At December 31, 1994, the carrying value of the Company's invested assets of the non-insurance operations, principally at the parent company level, was comprised of $7.6 million of equity securities, $4.6 million of short-term investments, $0.8 million of other investments and $0.3 million of cash.
The Company's consolidated net cash flow provided by operating activities was $30.7 million, $29.3 million and $32.1 million for the years ended December 31, 1995, 1994 and 1993, respectively. Consolidated operating cash flow (pretax income excluding the write-off of deferred loan fees, net investment gains and amortization and impairment of goodwill and intangibles) for the year ended December 31, 1995, was $58.8 million as compared to $27.8 million in 1994 and $26.9 million in 1993.
Principal and interest payments required under the Credit Facility are funded principally by dividend and intercompany tax sharing payments received from Capsure's insurance subsidiaries.
Capsure's insurance subsidiaries are subject to regulation and supervision by the various state insurance regulatory authorities in which they conduct business, including regulations with respect to the payment of dividends. Without prior regulatory approval in 1996, Capsure's insurance subsidiaries may pay stockholder dividends of $23.8 million in the aggregate. In 1995, 1994 and 1993 Capsure received $40.9 million (including $21.6 million of dividends requiring prior approval), $21.0 million (including $5.0 million of dividends requiring prior approval) and $11.8 million, respectively, in dividends from its insurance subsidiaries.
On May 24, 1995, the Board of Directors of the Company approved a stock repurchase plan. The plan authorizes the Company to repurchase up to 500,000 shares of its common stock. These shares may be purchased from time to time in the public market or through privately negotiated transactions. As of December 31, 1995, no shares have been repurchased under this plan.
On February 29, 1996, the Company announced that it had signed an agreement to sell United Capitol Holding Company ("UCHC") and its subsidiaries, United Capitol, Managers and Fischer, to a subsidiary of Frontier Insurance Group, Inc. Estimated net proceeds to Capsure will be approximately $75 million, which includes the purchase price for the capital stock of UCHC and the release of United Capitol's excess statutory surplus on or before closing. The agreement is subject to several conditions including approval by insurance regulatory authorities and other governmental authorities. The transaction
Another critical factor affecting the Company's financial condition is the Company's policies with respect to loss and loss adjustment expense reserves. Each of Capsure's insurance subsidiaries employs prudent reserving approaches in establishing the estimated liability for unpaid loss and loss adjustment expenses due to the inherent difficulty and variability in the estimation process. The liability for unpaid losses and loss adjustment expenses is based on estimates of (a) the ultimate settlement value of reported claims, (b) IBNR claims, (c) future expenses to be incurred in the settlement of claims and (d) claim recoveries. The liability for unpaid losses and loss adjustment expenses is an accounting estimate and, similar to other accounting estimates, there is the potential that actual future loss payments will differ from the initial estimate. The methods of determining such estimates and the resulting estimated liability are continually reviewed and updated. Changes in the estimated liability are reflected in operating income in the year in which such changes are determined.
Capsure's insurance subsidiaries require capital to support premium writings. In accordance with industry and regulatory guidelines, the net written premiums to surplus ratio of a property and casualty insurer should not exceed 3 to 1 (the terms of the Credit Facility limit this ratio further to 2.75 to 1 for Western Surety and Universal Surety and 2 to 1 for United Capitol). On December 31, 1995, Western Surety's statutory surplus was $33.3 million and its net written premiums to surplus ratio was 2.1 to 1. On December 31, 1995, Universal Surety's statutory surplus was $9.2 million and its net written premiums to surplus ratio was 1.7 to 1. On December 31, 1995, United Capitol's statutory surplus was $68.0 million and its net written premiums to surplus ratio was 0.2 to 1. The Company believes that each insurance company's statutory surplus is sufficient to support its current and anticipated premium levels.
contractor and others required to be in the abatement area are not intended to be covered by United Capitol's policies. Through the date hereof, there have been no valid claims against United Capitol's asbestos abatement liability policies alleging bodily injury arising from exposure to asbestos. Management believes that none of the other insurance products offered by Capsure's insurance subsidiaries creates any potential material environmental exposure.
IMPACT OF ADOPTING STATEMENTS OF FINANCIAL ACCOUNTING STANDARDS ("SFAS") As discussed in Note 1 to the consolidated financial statements, the Company adopted SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," effective January 1, 1994, and SFAS No. 109, "Accounting for Income Taxes," effective January 1, 1993.