SOUTHERN REGION CHARLOTTE, NORTH CAROLINA 3 Coliseum Centre 2550 West Tyvola Road, Suite 400
CONSUMER HEALTH NETWORK PLUS, LLC 371 Hoes Lane, Suite 101 Piscataway, New Jersey 08854
PDA SOFTWARE SERVICES, INC. 7701 College Boulevard Overland Park, Kansas 66210
2. Flood business is included in statutory underwriting results in accordance with prescribed statutory accounting practices. On a GAAP basis only, flood servicing revenue and expense has been reclassified from underwriting results to Diversified Insurance Services. Prior years have been restated to reflect this reclass.
4. The 1993 underwriting loss included a $9 million restructuring charge for the cost of the early retirement program, along with severance benefits provided to terminated employees.
6. The 1993, 1992 and 1991 underwriting losses included assessments from the Market Transition Facility of New Jersey in the amount of $12 million, $8 million and $11 million, respectively.
7. Net income for 1992 increased by $26 million due to the adoption of two accounting policies, Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("FASB 109"), and a change in the method of deferring policy acquisition costs. FASB 109 increased net income by $20 million ($0.76 per basic share and $0.70 per diluted share) and the change in deferred policy acquisition costs increased net income by $6 million ($0.23 per basic share and $0.21 per diluted share).
8. Regulatory and rating agencies use the statutory premiums to surplus ratio as a measure of solvency, viewing an increase in the ratio as a possible increase in solvency risk. Management and analysts also view this ratio as a measure of the effective use of capital since, as the ratio increases, revenue per dollar of invested capital increases, indicating the possible opportunity for an increased return.
9. Changes in both the GAAP and statutory combined ratios are viewed by management and analysts as indicative of changes in the profitability of underwriting operations. A ratio over 100% is indicative of an underwriting loss, and a ratio below 100% is indicative of an underwriting profit.
SELECTIVE INSURANCE AND SUBSIDIARIES FINANCIAL REVIEW (IN MILLIONS, EXCEPT SHARE AND PER SHARE DATA)
(2) - Refer to the Glossary of Insurance Terms on page 60 of this report on Form 10-K for definitions of specific measures.
Net premiums written for 1999 increased by 8% to $812 million which correspondingly resulted in an 11% increase in net premiums earned. The increase in net premiums written occurred across all insurance Strategic Business Units ("SBUs") and generated approximately $195 million of direct premiums written attributable to new business. This growth was primarily due to (i) the full-year impact of increasing the number of field underwriters; (ii) the Company's expansion into the Midwest and New England; and (iii) the increase in personal lines new business offset by the effects of the New Jersey rate rollback. The Company's field underwriting work force of about 80 agency management specialists ("AMSs") drives the expansion efforts and generates new business in existing regions. The AMS is the key contact between the independent agent and Selective, working side-by-side with agents to evaluate new business opportunities and develop strong relationships. As a result of our geographic diversification efforts, we have increased the percentage of business generated outside New Jersey to 54% by year-end 1999 and 49% at year-end 1998, up from 35% just seven years earlier.
In addition to its core insurance activities, the Company also provides various inter-related services, through its Diversified Insurance Services segment. This segment is a growing percentage of the Company's revenue base, increasing $33 million or 231% in 1999, including revenues generated by businesses acquired. In 1999, two strategic acquisitions were made in this segment: a professional employer organization ("PEO") and a preferred provider organization ("PPO"). The PEO provides human resource administration, including benefits, payroll and employee management services, and risk and compliance management products and services, including workers' compensation insurance. The PEO will provide a mechanism to cross-sell other products and services such as commercial policies and personal lines policies. A PPO develops networks of medical providers and leases these networks to insurers, large employers, third party administrators, unions and other entities that pay medical claims. In return for bringing the medical providers patients, the PPO negotiates discounts for their customers. The PPO acquisition expands medical service fees while at the same time supports a critical part of the Company's current managed care program. The balance of the Diversified Insurance Services segment includes federal flood insurance services, a managed care company, and software development and program administration services.
Net investment income earned for 1999 decreased 2%, or $2 million to $97 million. The level of investment income was negatively impacted by: (i) lower yields on the reinvested proceeds from maturities and redemptions of $309 million during 1999 and 1998; (ii) use of cash to purchase common shares of the Company (totaling $46 million in 1999 and $38 million in 1998); and (iii) cash acquisitions of Diversified Insurance Services businesses.
Policy acquisition costs expressed as a percentage of net premiums earned for 1999 decreased 0.7 points to 31.9%. The lower ratio was primarily a result of a decrease in the commissions incurred due to lower profit sensitive commission incentives to agents and a decrease in the annual cash incentive award for employees. Productivity, as measured by net premiums written per employee, in 1999 was $471,000, up 4% from $455,000 in 1998.
During 1998, the Company generated approximately $204 million of net premiums written attributable to new business, after deducting reinsurance costs of approximately $9 million, a 31% increase over 1997. The new business growth was partially attributable to adding 23 field underwriters, called AMSs, to bring the overall total to 83 in 1998. New business is carefully reviewed by regional managers and the SBUs to ensure that it falls within our underwriting standards.
The Personal Lines SBU 1998 net premiums written, excluding the effect of the Conversion, increased 4%, or $9 million. This increase is primarily due to a reduction in the amount of premium ceded under the New Jersey Homeowners Quota Share Reinsurance Program, which added $12 million in homeowners net premiums written ($4 million of which is due to a one-time buyout of prior year ceded reinsurance unearned premium reserves). In addition, the Personal Lines SBU introduced enhanced products in some of the Company's territories in order to expand its personal insurance segment.
The Diversified Insurance Services business segment generated $14 million of net revenue, an increase of 71% over 1997. The strategy underlying this segment is to use our core competencies to generate fee sources that do not share the risk bearing nature of our insurance underwriting activities.
The ratio of losses and loss expenses incurred to net premiums earned increased 2.1 points to 70.3%. The increase in this ratio was primarily attributable to severe fire and weather-related catastrophe claims. During 1998, the Company incurred $10 million of net losses from catastrophe claims, which amounted to 1.4 points of the loss and loss expense ratio for 1998, as compared to $2 million, or 0.3 points for 1997.
The 1998 loss and loss expense ratio for the commercial SBUs was 69.8%, an increase of 3.0 points over 1997. The ratios for 1998 and 1997, after removing the effect of weather-related catastrophe losses, were 68.1% and 66.5%, respectively, a 1.6 point increase. This deterioration occurred mostly in the property and workers' compensation lines of insurance. The workers' compensation line of insurance loss and loss expense ratio for 1998 was 78.5%. The deterioration of 14.1 points was due principally to continued competitive pricing conditions.
Productivity in 1998, as measured by net premiums written per employee, was approximately $455,000, up from $435,000 for 1997 (the average was $454,000 in 1997 before adjustment for the Conversion's $30 million renewal premium). The increase is due primarily to growth in net premiums written in 1998.
The Company had a total net deferred tax asset at December 31, 1999 of $16 million, compared to a $7 million net deferred tax liability at December 31, 1998. The change of $23 million in the deferred tax accounts at December 31, 1999 reflects the decrease in unrealized gains on the available-for-sale investment portfolio. The fair value of the portfolio decreased $58 million ($38 million net of tax) resulting primarily from a decline in market value on debt securities available-for-sale due to rising interest rates.
Based on the Company's tax loss carryback availability, and the historic levels of current taxable income and pretax financial statement income, the Company believes that it is more likely than not that the existing deductible temporary differences will reverse during periods in which the Company will generate net taxable income or have adequate carryback availability. However, there can be no assurance that the Company will generate any earnings or any specific level of earnings in future years.
The Parent's cash requirements principally include: (i) dividends to stockholders; (ii) interest payments on its outstanding debt; (iii) annual principal payments of $7 million on the original $50 million principal amount of 7.84% Senior Notes, due November 15, 2002 ("7.84% Senior Notes"); and (iv) general corporate expenses. As of December 31, 1999, these cash requirements, net of applicable income taxes, aggregated approximately $29 million annually (assuming the current dividend level). The Parent acquired cash from the sale of its common stock under various stock plans and the dividend reinvestment program, and from investment income, all of which approximated $4 million and reduced the Parent's annual cash requirements from $29 million to $25 million. In addition to these cash flow requirements, the Parent is obligated to pay $6 million, during 2000, related to a 1999 subsidiary acquisition.
Cash provided by operating activities amounted to $64 million, $57 million and $51 million in 1999, 1998 and 1997, respectively. The $7 million increase in operating cash flow for 1999 compared with 1998 is primarily attributable to higher levels of net premiums written, partially offset by an increase in paid losses, due in part to catastrophe losses ($20 million in 1999 compared with $8 million for 1998) and a $6 million increase in Federal income taxes paid.
Since cash inflow from premiums is received in advance of required cash outflow to settle claims, the Company accumulates funds which it invests. Total investments at December 31, 1999 were $1.7 billion, representing 68% of total assets. The Company's investment program is structured with staggered maturities so that liquidation of debt securities, available-for-sale should not be necessary in the ordinary course of business. Cash outflow requirements can be unpredictable due to uncertainties regarding settlement dates for unpaid claims and the potential for large and/or catastrophic losses occurring either individually or in the aggregate. The Company maintains reinsurance programs to ensure the availability of funds and to protect the Company against unusually serious occurrences or catastrophes in which a number of claims could produce an extraordinary aggregate loss.
The Company is currently exploring the possibility with its investment bankers of raising capital through the issuance of senior
The Company is subject to regulation under applicable insurance statutes, including insurance holding company statutes, of the various states in which the Company operates. Insurance regulation is intended to provide solvency and other safeguards for policyholders rather than to protect stockholders of insurance holding companies. Insurance laws of the various states provide regulatory agencies with broad administrative powers, including the power to grant or revoke licenses to transact insurance business, and to regulate trade practices, investments, premium rates, the deposit of securities, the form and content of financial statements, insurance policies, accounting practices, the maintenance of specified reserves and capital, the payment of dividends, and establish maximum levels of profits or returns for a line of insurance.
In New Jersey, a state from which both Alta and CHN derive substantial revenue, proposed regulations implementing the Health Care Quality Act may deem insured health benefit plans who contract with PPOs to be Managed Care Plans. Managed Care Plans may be required, through PPO contracts, to provide enrollees with information regarding the plan and the network and also to afford providers with certain protections.
In addition to evaluating and addressing Y2K issues relating to possible business interruption, the Company has Y2K exposure relating to insurance policy coverages for which reinsurance is in effect to mitigate potential losses. As of February 29, 2000, no claims have been reported.
The Company records its ceded reinsurance transactions on a gross basis on the balance sheet which results in reinsurance recoverables on unpaid losses and loss expenses and ceded unearned premiums (prepaid reinsurance premiums). The Company also discloses reinsurance amounts for ceded premiums written and earned and ceded loss and loss expenses incurred.
The Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standard No. 123, "Accounting for Stock-Based Compensation" ("FASB 123") establishes financial accounting and reporting standards for stock-based compensation plans. As permitted by FASB 123, the Company will continue to use the accounting method prescribed by Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to Employees" ("APB 25"). Companies using APB 25 are required to make pro forma footnote disclosures of net income and earnings per share as if the fair value method of accounting, as defined in FASB 123, had been applied.
Policy acquisition costs are directly related to the writing of an insurance policy and are deferred and amortized over the life of the policies in order to facilitate a matching of revenues and expenses. These costs include labor costs, commissions, premium taxes and assessments, Boards, Bureaus and Dues, travel, and other underwriting expenses incurred in the acquisition of premium. The deferred policy acquisition costs are limited to the sum of unearned premiums and anticipated investment income less anticipated losses and loss adjustment expenses, policyholder dividends and other expenses for maintenance of policies in force. The investment yields assumed for each reporting period, which are based upon the Company's actual average investment yield, before-tax, were 5.6%, 5.7% and 6.0% for 1999, 1998 and 1997, respectively.
The internal assumptions considered by the Company in the estimation of the IBNR amounts for both environmental and non-environmental reserves at the Company's reporting dates are based on: (i) an analysis of both paid and incurred loss and loss expense development trends; (ii) an analysis of both paid and incurred claim count development trends; (iii) the exposure estimates for reported claims; (iv) recent development on exposure estimates with respect to individual large claims and the aggregate of all claims; (v) the rate at which new environmental claims are being reported; (vi) actuarial modeling of environmental claims; and (vii) patterns of events observed by claims personnel or reported to them by defense counsel. External factors identified by the Company in the estimation of IBNR for both environmental and non-environmental IBNR reserves include: legislative enactments, judicial decisions, legal developments in the determination of liability and the imposition of damages; and trends in general economic conditions, including the effects of inflation. Adjustments to IBNR are made periodically to take into account changes in the volume of business written, claims frequency and severity, the mix of business, claims processing and other items as described that are expected by management to affect the Company's reserves for losses and loss expenses over time.
Reserves are reviewed for adequacy on a periodic basis. When reviewing reserves, the Company analyzes historical data and estimates the impact of various factors such as: (i) per claim information; (ii) Company and industry historical loss experience; (iii) legislative enactments, judicial decisions, legal developments in the imposition of damages, and changes in political attitudes; and (iv) trends in general economic conditions, including the effects of inflation. This process assumes that past experience, adjusted for the effects of current developments and anticipated trends, is an appropriate basis for predicting future events. There is no precise method, however, for subsequently evaluating the impact of any specific factor on the adequacy of reserves because the eventual deficiency or redundancy is affected by many factors. Based upon such reviews, the Company believes that the estimated reserves for losses and loss expenses are adequate to cover the ultimate cost of claims. The changes in these estimates, resulting from the continuous review process and the differences between estimates and ultimate payments, are reflected in the consolidated statements of income for the period in which such estimates are changed.
Premiums written include direct writings plus reinsurance assumed and estimates of premiums earned but unbilled on the workers' compensation line of insurance, less reinsurance ceded to other insurers. Premiums written are recognized as revenue over the period that coverage is provided using the semi-monthly pro rata method. Unearned premiums and prepaid reinsurance premiums represent that portion of premiums written that are applicable to the unexpired terms of policies in force.
The Company uses the asset and liability method of accounting for income taxes. Deferred Federal income taxes arise from the recognition of temporary differences between financial statement carrying amounts and the tax basis of the Company's assets and liabilities, as well as tax on net unrealized gains or losses on securities, available-for-sale. A valuation allowance is established when it is more likely than not that some portion of the deferred tax asset will not be realized. The effect of a change in tax rates is recognized in the period of enactment.
(2) Indebtedness: The fair value of the convertible subordinated debentures is based on quoted market prices. The fair values of the 7.84% Senior Notes due November 15, 2002 and the 8.77% Senior Notes due August 1, 2005 were estimated using a cash flow analysis based upon Selective's current incremental borrowing rate for the remaining term of the loan.
(c) Gross and net unrealized gains (losses) on securities, available-for-sale are as follows:
(d) The amortized cost, estimated fair values and gross unrealized gains (losses) of debt securities, held-to-maturity at December 31, 1999 and 1998, respectively, are as follows:
(g) The amortized cost and estimated fair value of debt securities at December 31, 1999, by contractual maturity are shown below. Mortgage-backed securities are included in the maturity tables using the estimated average life. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
(h) Certain investments were on deposit with various state regulatory agencies to comply with insurance laws with carrying values of $12,880,000 and $13,197,000 as of December 31, 1999 and 1998, respectively.
(j) The components of comprehensive income, both gross and net of tax, for 1999, 1998 and 1997 are as follows:
(1) On August 12, 1994, the Company entered into a $54,000,000 note purchase agreement with various lenders covering the 8.77% Senior Notes. The Company is required to pay $18,000,000 principal amount in each year commencing on August 1, 2003 and ending on August 1, 2005, inclusive, together with accrued interest thereon. The unpaid principal amount of the 8.77% Senior Notes accrues interest and is payable semiannually on February 1 and August 1 of each year, until the principal is paid in full.
Both note purchase agreements contain restrictive covenants that limit the Company's ability to declare dividends or incur additional indebtedness. At December 31, 1999, the amount available for dividends to stockholders under said restrictions was $149,115,000.
The insurance subsidiaries are contingently liable to the extent that any reinsurer becomes unable to meet its contractual obligations. The Company reviews the financial condition of its existing reinsurers for any potential write-offs of uncollectible amounts. At December 31, 1999, the Company had prepaid reinsurance premiums and net reinsurance recoverables with American Re-Insurance Company (rated "A++ Superior" by A.M. Best Company, Inc.) and a state insurance fund that amounted to $76,492,000 and $72,676,000, respectively. The Company has a $35,000,000 trust fund agreement with American Re-Insurance Company to secure a portion of the Company's recoverable amounts.
The Company has a noncontributory defined benefit retirement income plan covering substantially all employees who meet eligibility requirements. The Company's funding policy provides that payments to the pension trust shall be equal to the minimum funding requirements of the Employee Retirement Income Security Act plus additional amounts that may be approved by the Company from time to time. The Company has made various amendments to the plan in order to comply with certain Internal Revenue Code changes.
The plan's assets are generally invested in debt and equity securities. The debt securities are invested 100% in investment grade quality securities. The reconciliations of the plan are as follows:
The Company provides life insurance benefits ("postretirement benefits") for retired employees. Substantially all the Company's employees may become eligible for these benefits if they reach retirement age while working for the Company and meet a minimum of ten years of eligibility service. Those who retired prior to January 1, 1991, receive decreasing life insurance coverage that grades to an ultimate amount after ten years. Those retiring on or after January 1, 1991, receive life insurance coverage in an amount equal to 50% of their annual salary amount in effect at the end of their active career. The estimated cost of these benefits is accrued over the working lives of those employees expected to qualify for such benefits as a level percentage of their payroll costs.
The Company has adopted the pro forma footnote disclosure-only provisions of FASB 123. Based on the fair value method consistent with the provisions of FASB 123, the Company's net income and earnings per share would have been reduced to the following pro forma amounts indicated below:
The fair value of each option grant is estimated on the date of grant using the Black Scholes option-pricing model with the following weighted average assumptions for 1999, 1998 and 1997, respectively: (i) risk free interest rate of 5.45%, 4.84% and 5.27% for the employee stock purchase plan and 5.40%, 4.76% and 6.04% for all other option plans; (ii) expected life of six months for the employee stock purchase plan for all years and eight, five, and five years for all other option plans for 1999, 1998, and 1997, respectively; (iii) dividend yield of 3.2%, 2.4% and 2.4%; and (iv) an expected volatility of 26%, 23%, and 21% for the employee stock purchase plan and 22%, 23% and 21% for all other option plans for 1999, 1998, and 1997, respectively.
Options exercisable and their weighted average exercise price at year end are 1,772,082 and $16.78, 1,754,448 and $16.35 and 1,663,290 and $15.05 for 1999, 1998 and 1997, respectively.
The following table summarizes information about stock options outstanding and exercisable under the stock option plans at December 31, 1999:
During the vesting period, dividends are earned and held in escrow on the restricted shares subject to the same vesting period and conditions as set forth in the award agreement. Effective September 3, 1996, dividends earned on the restricted shares are rein vested in the Company's common stock at fair value. The Company issued through the dividend reinvestment feature (net of forfeitures), 17,118, 12,870 and 8,825 restricted shares in 1999, 1998 and 1997, respectively, from the dividend reinvestment plan reserves.
Deferred compensation expense is recognized for the fair value of the restricted shares when granted and is adjusted for the increases or decreases in the fair value of the Company's common stock for share awards subject to performance-related objectives and is amortized ratably over the vesting period. The unamortized amount is accounted for as a reduction of stockholders' equity. At December 31, 1999, 1998 and 1997, respectively, deferred compensation of $6,246,000, $5,613,000 and $6,239,000 was recorded as a reduction of stockholders' equity and the amounts amortized to expense in 1999, 1998 and 1997, respectively, were $2,785,000, $1,593,000 and $2,733,000.
In May 1996, the shareholders approved the stock compensation plan for nonemployee directors, effective January 1, 1997. The purpose of this plan is to provide for the payment of the annual compensation for the directors' services in shares of the Company's common stock. The amount of common shares available for issuance under the plan is 370,769. The Company issued 10,127 shares, 7,872 shares and 11,232 shares during 1999, 1998 and 1997, respectively and charged to expense $438,000, $243,000 and $290,000, respectively.
The Company maintains a dividend reinvestment plan, under which 262,419 shares of common stock are available for issuance. Shares purchased under this plan are issued at fair value.
Under a common stock repurchase program authorized by the Board of Directors on July 29, 1996 and extended on July 28, 1998, May 7, 1999, November 2, 1999 and February 3, 2000, the Company can repurchase up to 8,000,000 shares. In 1999, 1998 and 1997, the Company acquired 2,505,000 shares, 1,774,000 shares and 336,000 shares, respectively, at a total cost of $45,716,000, $37,750,000 and $8,498,000, respectively. The total amounts of stock repurchased under this program since July 29, 1996 through December 31, 1999 is 4,872,000 shares at a total cost of $96,253,000.
Selective's ability to declare and pay dividends on common stock is affected by the ability of its insurance subsidiaries to declare and pay dividends to Selective under the regulatory limitations of the states in which the insurance subsidiaries are domiciled. All of the jurisdictions in which the insurance subsidiaries are domiciled, including New Jersey, New York, North Carolina and South Carolina regulate the payment of dividends.
In all such jurisdictions, domestic insurers are prohibited from paying "extraordinary dividends" without approval of the insurance commissioner of the relevant state. In addition to the regulation of extraordinary dividends, New Jersey and South Carolina require notice to the relevant state regulatory authorities of the declaration of both ordinary and extraordinary dividends and distributions. During the notice period, the relevant state regulatory authority may disallow all or part of the proposed dividend if it determines that the insurer's surplus, with regard to policyholders, is not reasonable in relation to the insurer's outstanding liabilities and adequate to its financial needs or, in the case of New Jersey, if the regulatory authority determines that the insurer is otherwise in a hazardous financial condition.
Based on the 1999 statutory financial statements, the maximum dividends that can ultimately be paid to Selective in 2000 by Selective Insurance Company of America, Selective Way Insurance Company, Selective Insurance Company of the Southeast, Selective Insurance Company of South Carolina and Selective Insurance Company of New York are $26,314,000, $12,416,000, $3,870,000, $4,810,000 and $3,639,000, respectively. The statutory capital and surplus of the insurance subsidiaries in excess of these ordinary dividend amounts must remain within the insurance subsidiaries in the absence of the approval of a request for an extraordinary dividend.
On February 2, 1999, Selective's Board of Directors approved the amended and restated stockholder rights plan. The rights to purchase one two-hundredth of a share of Selective Series A Junior Preferred Stock at an exercise price of $80 are attached to all shares of Selective common stock and are exercisable ten days after an announcement that a person or group has acquired 15% or more of the common stock (Acquiring Person) or ten business days after a person commences or announces its intent to make a tender offer which would result in their acquiring 15% or more of the common stock (Acquiring Person). If a person or group becomes an Acquiring Person, each right will entitle the holder, other than the Acquiring Person, to purchase the number of Selective common shares having a market value of two times the exercise price of $80.
Before an Acquiring Person acquires 50% or more of the common shares, Selective's Board may exchange rights, other than the rights of an Acquiring Person, at an exchange ratio of one share of common stock per right. The rights expire February 2, 2009, unless Selective's Board redeems them at $.01 per right before a person or group triggers the plan or unless Selective's Board exchanges them for common stock.
(a) The following is a reconciliation of the differences between the Statutory Financial Statements and the Generally Accepted Accounting Principles ("GAAP") Financial Statements:
The underwriting results of the Insurance Operations segment are determined taking into account net premiums earned, incurred losses and loss expenses, policy acquisition costs and other underwriting expenses and policyholders dividends. Similarly, management of the investment portfolio is separate from the insurance underwriting segment and, therefore, has been classified as a segment. The Diversified Insurance Services business is managed independently from the other segments and, therefore, has been classified separately. The Diversified Insurance Services segment consists of medical managed care operations, professional employer organizational services, preferred provider organizational operations, software development and program administration services and the flood business managed by the Company for the National Flood Insurance Program. The segments' results are determined taking into account the net revenues generated in each of the businesses, less the costs of operation.
Certain officers of Selective exercised stock options by giving Selective promissory notes ($992,000) in payment for the stock purchased. The Company's noninterest bearing notes are secured by shares of the Company's common stock. The promissory notes are full recourse and subject to certain employment requirements. At December 31, 1999, the outstanding principal amount was $485,000.
At December 31, 1999, the Company established a range of reasonably possible losses for known environmental exposures of approximately $12,000,000 to $47,000,000 on a gross basis, and $10,000,000 to $41,000,000, on a net basis. At December 31, 1999, the Company's reserves for environmental claims amounted to $54,304,000 on a gross basis (including IBNR reserves of $23,663,000) and $48,504,000 (including IBNR reserves of $21,863,000) on a net basis. The Company's case reserves for known environmental claims, excluding IBNR, were $30,641,000 on a gross basis and $26,641,000 on a net basis in connection with 2,114 claims, including multiple claimants who are associated with the same site or incident. These claims involved about 1,424 lawsuits. Of the 2,114 total environmental claims, 1,700 claims are asbestos related, of which 1,119 involve only two insureds. One such insured manufactured asbestos-containing products, while the other supplied asbestos-containing products. The reserve associated with these two insureds amounted to $2,517,000 on a gross basis and $1,917,000 on a net basis. About 83 of the total environmental claims involve approximately 20 landfills. The landfill sites account for reserves of approximately $13,664,000 on a gross basis and $13,464,000 on a net basis. The remaining claims, which represent about $14,460,000 on a gross basis and $11,260,000 on a net basis, involve leaking underground storage tanks, air pollution, as well as other asbestos claims. Litigation costs associated with environmental claims have been significant, particularly for landfill claims.
While the number of asbestos type claims has been increasing, these claims represent only 9% of the company's total environmental exposure as of December 31, 1999. The Company has also experienced a shift in its non-asbestos environmental exposure. The number of traditional environmental claims, such as landfill and leaking underground storage tank claims, has remained constant or in some cases has decreased, while the number of short-tail exposure claims such as oil truck spills and Exterior Insulation Finishing System ("EIFS") have increased. These claims tend to have lower litigation costs and generally can be settled in a shorter time frame than traditional environmental claims.
IBNR reserve estimation is often difficult because, in addition to other factors, there are significant uncertainties associated with critical assumptions in the estimation process such as average clean-up costs, third-party costs, potentially responsible party shares, allocation of damages, insurer litigation costs, insurer coverage defenses and potential changes to state and federal statutes. Moreover, normal historically-based actuarial approaches do not apply because relevant history is not available. In addition, while models can be applied, such models can produce significantly different results with small changes in assumptions.
The Company has established a range of reasonably possible IBNR losses for non-environmental net claims at December 31, 1999, of approximately $424,000,000 to $531,000,000 and at December 31, 1998, of approximately $438,000,000 to $542,000,000. For each major product line of business, incurred and/or paid loss and loss expense projections were calculated using standard actuarial techniques on both an optimistic and pessimistic basis to construct an IBNR range for that product line. The overall range for non-environmental IBNR was selected based on statistical combinations of the ranges of the individual product lines. The Company's net IBNR reserves for non-environmental claims were $493,000,000 and $500,000,000 at December 31, 1999, and 1998, respectively.
The Company has communicated to agents and policyholders that it will not cover Y2K losses, with the possible exception of certain losses involving property damage or bodily injury which cannot be quantified at this time. The Company is using the Insurance Services Office Y2K exclusionary endorsements on most new and renewal commercial lines policies. In addition, the Company's casualty excess of loss treaty was amended, effective July 1, 1998, to include as covered losses all Y2K losses aggregated as a single event, with protection totaling $38 million in excess of a $12 million retention. The coverage protects against any Y2K claim which is asserted in the 36 month period beginning on July 1, 1998.
(d) The Company has various operating leases for office space and equipment. Such lease agreements, which expire at various times, are generally renewed or replaced by similar leases. Rental expense under these leases amounted to $7,933,000, $5,979,000 and $4,772,000 for the years ended December 31, 1999, 1998 and 1997, respectively.
On July 27, 1999, the Company acquired all of the net assets of Consumer Health Network Plus, LLC (formerly Consumer Health Network, Inc.), a nationally accredited preferred provider organization, for cash of $6,010,000 including the related acquisition costs. The acquisition has been accounted for using the purchase method of accounting, and included $4,633,710 of goodwill which is being amortized on a straight-line basis over 15 years. The amount of goodwill amortization for 1999 was $130,000.
On November 14, 1997, the Company acquired all of the net assets of Alta Services LLC (formerly MCSI/MRSI), a non-risk bearing managed care company, for cash of approximately $8,291,000 including the related acquisition costs. The purchase agreement provides for future contingent consideration of up to $10,000,000 if certain growth and profitability objectives are achieved through the year 2001. If these objectives are met, the additional consideration will be recorded as an increase in goodwill and amortized over the remaining life of the asset. The acquisition has been accounted for using the purchase method of accounting and included approximately $8,060,000 of goodwill, which is being amortized on a straight-line basis over nine years. The amount of goodwill amortization for 1999, 1998, and 1997 was $878,880, $878,880 and $150,000, respectively.
The operating results of all of the above acquisitions have been included in the consolidated statement of income from their respective date of acquisition. On the basis of a pro forma consolidation of the results of operations as if the acquisitions had taken place at the beginning of 1999, 1998, or 1997 rather than their respective acquisition dates, there would not have been a materially different result from the reported amounts in either of the 1999, 1998 or 1997 reporting years. Additionally, such pro forma amounts would not necessarily be indicative of what the actual consolidated results of operations might have been if the acquisition had been effective at the beginning of 1999, 1998 or 1997.
CATASTROPHE LOSS -- a severe loss, usually involving many risks from one occurrence such as fire, hurricane, earthquake, windstorm, explosion and other similar events.
DIVERSIFIED INSURANCE SERVICES -- a strategic combination of various inter-related services that are closely associated with the insurance business and will allow for the Company as a whole to bring an integrated business solution to our customers by offering a broader array of products and services.
DIVIDENDS TO POLICYHOLDERS RATIO -- a measurement of dividends paid to workers' compensation policyholders to premiums earned.
GAAP COMBINED RATIO -- a measure of underwriting profitability determined by dividing the sum of all GAAP expenses (losses, loss adjustment expenses, underwriting expenses, and dividends to policyholders) by GAAP net premiums earned for the period.
MANAGED CARE -- a method of controlling health care costs by using a network of medical professionals to provide care consistent with cost-efficient guidelines and protocols.
PREMIUMS WRITTEN -- the cost of insurance coverage, often described as "written." Written premiums refer to premiums for all policies sold during a specific accounting period.
REINSURANCE -- insurance coverage that insurance companies buy from reinsurance companies to limit their potential claim losses on a particular risk or on a group of risks. All or part of a policy can be reinsured, as can entire types of business. Reinsurance "spreads the risk" among a number of insurance companies, reducing the impact of losses on individual companies and thereby allowing them to provide more insurance than they otherwise would be able to sell.
STATUTORY ACCOUNTING -- accounting practices prescribed or permitted by state insurance departments. Insurance companies follow these practices when preparing annual statements. Statutory accounting stresses evaluation of a company's solvency.
STATUTORY COMBINED RATIO -- a measurement commonly used within the property and casualty insurance industry to measure underwriting profit or loss. It is a combination of an underwriting expense ratio, a loss and loss expense ratio and dividends to policyholders ratio.
UNDERWRITING -- the insurer's process of reviewing applications submitted for insurance coverage, deciding whether to accept all or part of the coverage requested, and determining the applicable premiums.