The Company owns its corporate offices which provide approximately 35,000 square feet of office space and additional parking. Future expansion will be possible by converting the parking area into office space. The Company owns a 3.28 acre tract of land in Fort Worth, Texas and all improvements located thereon, including a 10,000 square foot office building. The Company currently has this property under lease.
The selected consolidated financial data presented below for, and as of the end of each of the years ended December 31, have been derived from the consolidated financial statements of the Company which have been audited by KPMG LLP, independent certified public accountants. The consolidated balance sheets as of December 31, 1998 and 1997, and the consolidated statements of operations, shareholders' equity and comprehensive income and cash flows for each of the years in the three-year period ended December 31, 1998, and the report thereon are included elsewhere in this document. The information presented below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations," consolidated financial statements and the notes thereto, and the other financial information included herein.
On August 28, 1998, the Company announced that its Board of Directors had determined to commence pursuit of additional strategic alternatives to maximize shareholder value, including a possible sale of the Company, and had engaged Wasserstein Perella & Co., Inc. to assist in the process. This process is continuing.
The discussion below primarily relates to the Company's insurance operations, although the selected consolidated financial data appearing elsewhere is on a consolidated basis. The revenue item "Insurance services" includes revenues from the computer software, the plan servicing, the premium finance and the fronting reinsurance operations. The expense item "Underwriting and operating expenses" includes the operating expenses of these operations.
COMMERCIAL AUTO was down 12% in 1998 from 1997 and down 9% in 1997 from 1996. In 1998 the continued run-off of the Kentucky commercial auto business accounted for the majority of the unfavorable variance. Additionally, the decision to exit certain other unprofitable classes contributed to the decrease. In 1997, Kentucky contributed 4 points of decrease with Georgia, New Jersey, Pennsylvania and Virginia accounting for the remaining 5 points of decrease. A decision was made during 1997 to discontinue writing Kentucky coal truck risks and a New Jersey taxi cab program because of adverse claim results. In Georgia, Pennsylvania and Virginia competition had dramatically intensified with regard to pricing and additional writers. The AUTO GARAGE product line decreased 14% in 1998 and 13% in 1997. Continued pricing pressure and new entrants to the market account for the decreases in both years. The GENERAL LIABILITY line decreased 4% in 1998 after a decrease of 10% in 1997. For 1998 continued pricing pressure and competitors entering the market produced the decrease. California and Florida accounted for 6 points and 2 points of the 1997 decrease, respectively. An underwriting decision was made in California to not renew large general contractors. In Florida, increased competition from new and existing companies contributed to the decrease. OTHER LINES increased in 1998 primarily as a result of mobile home business the Company began writing in 1998.
For 1998, gross premiums written percentages by significant state/product line are as follows: Texas commercial auto (22%), Texas general liability (7%), Pennsylvania commercial auto (5%), and Florida auto garage (5%), with no other individual state/product line comprising 5% or more. The persistency rate remained at 46% for both years. Premiums earned decreased 10% in 1998 to $92,203,393 and decreased 4% in 1997 to $102,255,979 as a direct result of the level of premiums written.
Net investment income increased 1% in 1998 over 1997 and increased 6% in 1997 over 1996. The increase in 1997 was the result of growth in the portfolio due to continued positive cash flows from operations. The return on average investments for 1998 is 4.6% versus 4.7% in 1997 and 4.8% in 1996. Inflation can cause interest rates to increase, which would cause the Company's interest income to increase. The Company achieves a higher after tax net income by investing predominantly in tax-exempt securities as compared to taxable fixed income securities. At December 31, 1998, 88% of the Company's investments were in investment grade tax-exempt bonds with an average maturity of approximately 3.8 years. On a taxable equivalent basis the return on average investments was 6.2% in 1998, 6.5% in 1997 and 6.6% in 1996. The Company has the ability to hold its fixed maturity securities until their maturity date. The Company does not actively trade its bonds; however, it does classify certain bond securities as available for sale. At December 31, 1998, approximately 9% of the Company's investments were in U.S. Treasury securities and 2% were in short-term money market funds. The Company does not have any non-performing fixed maturity securities.
The Company recorded net realized capital gains of $692,510 in 1998 versus $326,905 in 1997 and $471,956 in 1996. All of these gains were generated from the bonds available for sale category of the fixed maturity portfolio.
Revenues in the APS computer software operation decreased 8% in 1998 from 1997 and increased 39% in 1997 from 1996. The Company has announced an agreement for the sale of the APS operation and expects to close in April 1999.
The increase in commissions from 1997 to 1998 is primarily due to a decrease in commission income of approximately $3,318,000 as a result of reducing previously accrued reinsurance commission income due to adverse development in C & CAE incurred. The reinsurance commission income had been accrued in prior years based on a lower expected ultimate C & CAE ratio. The decrease in commissions from 1996 to 1997 is related to the decrease in gross premiums written. The ratio of commissions to premiums earned was 25% for 1998 versus 21% for 1997 and 23% for 1996. The increase in 1998 is a result of the decrease in reinsurance commission income. The decrease in 1997 was related to the decrease in the commission expense rate in 1997 because of lower contingent commissions resulting from higher C & CAE ratios.
The primary sources of the Company's liquidity are funds generated from insurance premiums, net investment income and maturing investments. The short-term investments and cash are intended to provide adequate funds to pay claims without selling fixed maturity investments. At December 31, 1998, the Company held short-term investments and cash of $8,731,198 which the Company believes is adequate liquidity for the payment of claims and other short-term commitments.
The decrease in investments is primarily attributable to negative cash flows from operating activities which is the result of the large amount of claim payments made during 1998. Ceded unpaid claims and claim adjustment expenses as well as ceded unearned premiums increased largely as a result of the increase in fronting reinsurance activity mentioned previously. Deferred Federal income taxes increased for reasons mentioned previously. Goodwill has been recorded in conjunction with the Lalande Group purchase made in the fourth quarter of 1998.
The unrealized gains or losses on fixed maturities available for sale are presented, net of tax, as a separate component of shareholders' equity entitled Accumulated Other Comprehensive Income. The net unrealized gain on the fixed maturities classified as held to maturity was $1,189,912 at December 31, 1998.
The Company is not aware of any current recommendations by the regulatory authorities, which if implemented, would have a material effect on the Company's liquidity, capital resources or results of operations. The Company's statutory capital exceeds the benchmark capital level under the Risk Based Capital formula for its major insurance companies.
Company (Excluding Lalande) Readiness The Company began addressing its Year 2000 readiness in 1996, excluding the Lalande Group whose acquisition by the Company was completed on October 23, 1998. The Company appointed a Year 2000 team involving personnel from all business units responsible for implementing the project, while the department Vice Presidents formed the Year 2000 steering committee. The project scope encompassed information technology, including hardware and software whether developed internally or externally, building systems, vendors, banks, agents, reinsurers and the Company's exposure relating to policy coverage.
1999. The foregoing readiness analysis does not apply to software for certain discontinued operations which are in a runoff phase.
The Company is establishing contingency plans for hardware and software failures with respect to the Year 2000 problem. Since the Company's mission critical systems and hardware are believed to be Year 2000 compliant and have been assessed by an outside vendor, the Company does not expect any material Year 2000 failures. The Company believes that it has reviewed all material business partners' readiness, and has been advised that their mission critical systems and software are believed to be Year 2000 compliant. If, in the event the Company becomes aware of a strategic partner's failure to be prepared, the Company will evaluate using another vendor.
Statements made in this report that are not strictly historical may be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that all forward-looking statements involve certain risks and uncertainties that could cause actual results to differ materially from those contained in the forward-looking statements. Important factors include, but are not limited to, (a)
heightened competition, including price competition from existing competitors, from newly formed competitors and from the entry into the Company's markets of standard insurance companies which historically have not competed in the Company's specialty markets, (b) overcapitalization of the insurance industry, (c) contraction of the markets for the Company's various lines of business, (d) development and performance of new specialty programs, (e) the ongoing level of claims and claims-related expenses, (f) adequacy of claim reserves, (g) the ability to complete value-adding acquisitions, (h) the ability of the Company to fully integrate the recently acquired Lalande Group and its customers and managers into the Company's business, (i) the ability to consummate the APS asset sale on the agreed terms, (j) the results of the pursuit by the Board of Directors of additional strategic alternatives to maximize shareholder values, (k) effects of Year 2000 problems encountered by the Company and those with whom it deals, and (l) general economic conditions and fluctuations in interest rates.
The following Consolidated Financial Statements Schedules are on pages 64 through 75: