- -------- (1) Industry data is from Best's Aggregates and Averages for the Property Casualty Industry-Stock Companies. (2) Earnings per common share prior to 1993 reflects the reorganization and exchange of common and preferred shares between Citizens Corporation, The Hanover Insurance Company and Citizens Insurance Company of America, which occurred in February 1993, and the shares issued in conjunction with the initial public offering. Certain per common share data not applicable prior to 1993. (3) Total assets and reserve for losses and loss adjustment expenses have been restated to retroactively apply the provisions of Statement of Financial Accounting Standards No. 113, "Accounting and Reporting for Reinsurance of Short-duration and Long-duration Contracts."
Net premiums earned increased $17.7 million, or 2.2%, to $835.5 million during 1996, representing increases of $18.4 million, or 3.4% in the personal segment, and decreases of $0.7 million, or 0.2%, in the commercial segment. This overall growth is due to increases in net premiums earned of $11.4 million, or 22.5%, to $62.1 million in Ohio and Indiana resulting from expansion in these states. Price increases contributed to net premium growth in all major lines except the workers' compensation line where rate reductions and competitive conditions continue in Michigan. Continued growth in policies in force in the commercial automobile and commercial multiple peril lines of 3.7% and 13.2%, respectively, were offset by decreases in personal automobile and workers' compensation policies in force of 3.0% and 1.4% respectively.
Personal segment premiums represented 66.4%, 65.6% and 65.0% of total net premiums earned in 1996, 1995 and 1994, respectively.
Personal segment net premiums earned increased $40.1 million, or 8.1%, to $536.2 million in 1995. This increase reflects price increases in the personal automobile and homeowners lines, and was partially offset by the decrease in personal automobile policies in force of 5.8%. This decrease is attributable to the Company's selective reduction of writings in Michigan when rates were viewed as inadequate and to increased competition in affinity group franchise sales as a result of the January 1995 order by the Michigan Insurance Commissioner which has permitted competitors to offer similar products.
The personal segment underwriting loss in 1995 was $26.6 million compared to $32.3 million in 1994. The improvement in underwriting results reflects a return to more normal weather conditions in Michigan as well as favorable claims activity in both current and prior accident years in the personal automobile line attributable to improvements in severity. The 1995 underwriting results improved despite a $3.4 million increase in catastrophe losses in the personal segment, primarily in the homeowners line. Catastrophe losses were $7.2 million and $3.8 million in the personal segment in 1995 and 1994, respectively. The increase in policy acquisition expenses of $8.6 million, or 8.6%, to $108.1 million in 1995 primarily reflects the growth in net premiums earned. Other underwriting expenses increased $3.2 million, or 8.4%, to $41.1 million reflecting the growth in net premiums earned.
Net realized gains on investments before taxes were $15.0 million and $3.8 million in 1996 and 1995, respectively, compared to net realized losses of $1.1 million in 1994. Net realized gains in 1996 primarily resulted from sales of appreciated equity securities due to the Company's strategy of shifting to a higher level of debt securities. Net realized gains in 1995 were primarily the result of the sales of equity securities impacted by the overall rise in the market. Net realized losses in 1994 resulted primarily from increases in prevailing interest rates.
The Company maintains reserves to provide for its estimated ultimate liability for losses and LAE with respect to reported and unreported claims incurred as of the end of each accounting period. These reserves are estimates involving actuarial projections at a given point in time, of what management expects the ultimate settlement and administration of claims will cost based on facts and circumstances then known, predictions of future events, estimates of future trends in claims severity and judicial theories of liability and other factors. The inherent uncertainty of estimating insurance reserves is greater for certain types of property and casualty insurance lines, particularly workers' compensation, where a longer period may elapse before a definitive determination of ultimate liability may be made, and liability lines, where the technological, judicial, and political climates involving these types of claims are changing.
As part of an ongoing process, the reserves, net of reinsurance, have been re-estimated for all prior accident years and were decreased by $58.4 million, $47.0 million and $12.4 million in 1996, 1995, and 1994, respectively. The increase in favorable development of $11.4 million in 1996 reflects improved severity in the personal automobile line, where favorable development increased $28.6 million to $33.0 million in 1996, partially offset by less favorable development in the workers' compensation line. In 1995, the workers' compensation line had favorable development of $32.7 million, primarily as a result of the Company re-estimating reserves to reflect the Company's new claims cost management programs and the Michigan Supreme Court ruling, which decreases the maximum to be paid for indemnity cases on all existing and future claims. In 1996, the favorable development in the workers' compensation line of $21.8 million also reflected these developments.
The increase in favorable development of $34.6 million in 1995 from 1994 reflects improved severity in the personal automobile and workers' compensation lines. Favorable development in the personal automobile line increased $16.6 million from unfavorable development of $12.2 million in 1994 to favorable development of $4.4 million in 1995. Favorable development in the workers' compensation line increased $15.5 million from $17.2 million in 1994 to $32.7 million in 1995, due to the aforementioned change in claims cost management and the Michigan Supreme Court ruling.
Due to the nature of business written by the Company, the exposure to environmental liabilities is relatively small. Losses and LAE reserves related to environmental damage and toxic tort liability, included in the total reserve for losses and LAE were $20.6 million and $22.3 million at the end of 1996 and 1995, respectively, both net of reinsurance of $3.5 million. The Company does not specifically underwrite policies that include this coverage, but as case law expands policy provisions and insurers' liability beyond the intended coverage, the Company has been required to defend such claims. Due to their unusual nature and absence of historical claims data, reserves for these claims are not determined using historical experience to project future losses. Although these claims are not material, their existence gives rise to uncertainty and is discussed because of the possibility, however remote, that they may become material. The environmental liability could be revised in the near term if the estimates used in determining the liability are revised. Management believes that, notwithstanding the evolution of case law expanding liability in environmental claims, recorded reserves related to these claims are adequate and the Company is not aware of any litigation or pending claims that may result in additional material liabilities in excess of recorded reserves.
The Company maintains a reinsurance program designed to protect against large or unusual losses and LAE activity. This includes both excess of loss reinsurance and catastrophe reinsurance. Catastrophe reinsurance serves to protect the ceding insurer from significant aggregate losses arising from a single event such as windstorm, hail, hurricane, tornado, riot or other extraordinary events. The Company determines the appropriate amount of reinsurance based on the Company's evaluation of the risks accepted and analysis prepared by consultants and reinsurers and on market conditions including the availability and pricing of reinsurance. The Company has reinsurance for casualty business. Under the 1996 casualty program, the reinsurers are responsible for 100% of the amount of each loss in excess of $1.0 million per occurrence up to $30.5 million for general liability and workers' compensation. Additionally, this reinsurance covers workers' compensation losses in excess of $30.5 million to $60.5 million per occurrence. Under the Company's 1996 catastrophe reinsurance program, Citizens retains 5% of losses in excess of $10.0 million, up to $25.0 million. For losses in excess of $25.0 million and up to $180.0 million, the Company retains 10% of the loss. Amounts in excess of $180.0 million are retained 100% by the Company. In 1996, Citizens purchased aggregate catastrophe coverage which reinsures 90% of $5.0 million for aggregated catastrophe losses in excess of $5.0 million which individually exceed $1.0 million. Under this aggregate catastrophe coverage, Citizens is expected to recover $4.5 million. In the years ended December 31, 1996, 1995 and 1994, the Company did not exceed the minimum catastrophe levels, either individually or in the aggregate, to obtain recovery under its reinsurance agreements, except as described above.
Effective January 1, 1997, the Company modified its reinsurance program. The 1997 modifications include the purchase of additional casualty reinsurance and higher retention under the Company's catastrophe reinsurance program. Under the 1997 casualty reinsurance program, the Company added a layer which reinsured 100% of each loss in excess of $.5 million up to $1.0 million per occurrence. Under the 1997 catastrophe reinsurance program. Citizens retains the first $10 million of loss per occurrence, 5% of losses in excess of $10.0 million, up to $25.0 million, 55% of all aggregate loss amounts in excess of $25.0 million up to $45.0 million, and 10% of all aggregate loss amounts in excess of $45.0 million up to $180.0 million. Amounts in excess of $180.0 million are retained 100% by the Company.
arbitration and occurrence. Based on its review of its reinsurers' financial statements and reputations in the reinsurance marketplace, the Company believes that its reinsurers are financially sound.
At December 31, 1996 and 1995, the Company had reinsurance recoverable from the MCCA on paid and unpaid losses of $292.0 million and $354.9 million, respectively. Because MCCA is supported by assessments permitted by statute and all amounts billed by the Company to MCCA have been paid when due, the Company believes that it has no significant exposure to uncollectible reinsurance balances.
The reserve for losses and LAE at December 31, 1996 and 1995, is shown gross of reinsurance recoverable on unpaid losses of $466.4 million and $518.9 million, respectively. Losses and LAE ceded were $51.4 million, $134.1 million and $124.7 million in 1996, 1995, and 1994, respectively. Ceded premiums earned were $201.1 million, $206.3 million and $212.9 million in 1996, 1995, and 1994, respectively.
At December 31, 1996, $1,233.5 million, or 88.2%, of debt securities held by the Company were rated by the National Association of Insurance Commissioners ("NAIC") as investment grade (1 or 2 by the NAIC). The remaining $164.8 million were rated non-investment grade. At December 31, 1995, $1,202.3 million, or 93.2%, of the debt securities were rated investment grade. At December 31, 1996, 69.9% of debt securities were tax-exempt investments, compared to 71.2% at December 31, 1995. The Company may make modest extensions in portfolio incremental credit risk and adjustments to its taxable and tax- exempt positions in the future to seek to maximize after tax income.
Sources of cash for the Company's insurance subsidiaries are from premiums collected, investment income and maturing investments. Primary cash outflows are paid losses and LAE, policy acquisition expenses, other underwriting expenses and investment purchases. Cash outflows related to claim losses and LAE can be variable because of uncertainties regarding settlement dates for liabilities for unpaid losses and because of the potential for large losses either individually or in the aggregate. Accordingly, the Company's strategy is to monitor available cash and short-term investment balances in relation to projected cash needs by matching maturities of its investments with expected payments of current and longer term liabilities. The Company periodically adjusts its investment policy to respond to changes in short-term and long- term cash requirements.
Net cash provided by operating activities for the Company was $73.5 million, $120.0 million and $112.5 million in 1996, 1995, and 1994, respectively. The decrease in cash provided by operating activities in 1996 from 1995 is attributable primarily to the increase in payments for losses and LAE of $59.5 million to $605.0 million in 1996 compared to $545.5 million in 1995. The cash provided by operations in 1995 reflects more normal underwriting results and an increase over 1994 due to the high level of weather-related claims during 1994.
The Company expects to continue to pay dividends in the foreseeable future. However, payment of future dividends is subject to the Board of Directors' approval and dependent upon earnings and the financial condition of the Company.
Factors that may cause actual results to differ materially from those contemplated or projected, forecast, estimated or budgeted in such forward looking statements include among others, the following possibilities: (i) adverse catastrophe experience and severe weather; (ii) adverse loss development for events the Company insured in prior years; (iii) heightened competition, including the intensification of price competition, the entry
Citizens Corporation's Board of Directors annually appoints independent accountants to perform an audit of its consolidated financial statements. The financial statements have been audited by Price Waterhouse LLP, independent accountants, in accordance with generally accepted auditing standards. Their audit included consideration of the Company's system of internal control in order to determine the audit procedures required to express their opinion on the consolidated financial statements.
In February 1993, Citizens Insurance issued 1.0 million shares of Series A Preferred Stock to Hanover. Effective March 31, 1993, Citizens Corporation issued 1.0 million shares of its authorized Series A Preferred Stock to Hanover in exchange for the Citizens Insurance Preferred Stock. On June 30, 1995, Citizens Insurance redeemed its 1.0 million shares of Series A Preferred Stock from Citizens Corporation for $100.0 million and Citizens Corporation redeemed its 1.0 million shares of Series A Preferred Stock from Hanover for $100.0 million.
Premiums are recognized as earned using the daily pro rata method over the terms of the policies. Unearned premiums represent the portion of premiums written that relate to the unexpired term of the policies in force.
In November 1995, the Financial Accounting Standards Board issued a Special Report, A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities, which permitted companies to reclassify securities, where appropriate, based on the new guidance. As a result, the Company transferred all of its held-to-maturity category securities, with amortized cost and fair value of $35.0 million and $36.5 million, respectively, to the available-for-sale category, which resulted in a net increase in shareholders' equity of $1.0 million.
Realized gains or losses on sale of investments, which are included in the determination of net income, are determined on the specific-identification basis using amortized cost for debt securities and cost for equity securities and other investments. Investments with other than temporary declines in fair value are written down to estimated fair value. The related losses are recognized as realized losses.
Cash and cash equivalents includes cash on hand, amounts due from banks and highly liquid short-term investments. The Company considers all short-term investments with an original maturity of three months or less to be cash equivalents.
Deferred policy acquisition expenses consist of commissions, premium taxes and other costs that vary with and are primarily related to the production of new and renewal business. The deferral is subject to ultimate recoverability and is charged to expense over the period in which the related premiums are earned. Deferred policy acquisition expenses are reviewed for each product to determine that they do not exceed recoverable amounts, after considering anticipated investment income. If such costs are determined to be unrecoverable, they are expensed at the time of determination.
The reserve for losses and loss adjustment expenses (LAE) represents the accumulation of individual case estimates for reported losses and actuarial estimates for incurred but not reported losses and LAE. Assumed reserves are recorded as reported by the ceding organization. The reserve for losses and LAE is intended to cover the ultimate net cost of all losses and LAE incurred through the balance sheet date. The reserve is stated net of anticipated salvage and subrogation and gross of reinsurance ceded. Reinsurance recoverable on paid and unpaid
losses is shown as a separate line of the balance sheet. The reserve estimates are continually reviewed and updated. The ultimate liability may be more or less than the current estimate. The effects of changes in the estimated reserve are included in the results of operations in the period in which the estimates are revised.
The Company periodically purchases annuity contracts from various life insurance companies to settle claims currently. The present value of such annuities, where the Company remains primarily liable, is recorded in the accounts of the Company as both an other asset and other liability and amounted to $16.8 million and $16.2 million at December 31, 1996 and 1995, respectively.
Debt securities with an amortized cost of $8.5 million were on deposit with various states or government authorities as of December 31, 1996.
The following is a summary of the sources of net investment income:
Included in income from other investments was income from limited partnerships of $4.4 million for the year ended December 31, 1996. The Company had no income from limited partnerships for the years ended December 31, 1995 and 1994.
Under the Company's 1996 casualty program, the reinsurers are responsible for 100% of the amount of each loss in excess of $1.0 million per occurrence up to $30.5 million for general liability and workers' compensation. Additionally, this reinsurance covers workers' compensation losses in excess of $30.5 million to $60.5 million per occurrence. Under the Company's 1996 catastrophe reinsurance program, the Company retains 5% of losses in excess of $10.0 million, up to $25.0 million. For losses in excess of $25.0 million and up to $180.0 million, the Company retains 10% of the loss. Amounts in excess of $180.0 million are retained 100% by the Company. In addition, in 1996 the Company purchased aggregate catastrophe coverage which reinsures 90% of $5.0 million for aggregated catastrophe losses in excess of $5.0 million which individually exceed $1.0 million. Under this aggregate catastrophe coverage, Citizens is expected to recover $4.5 million. Citizens Insurance cedes 100% of business written in specific states to Hanover. Citizens Insurance also assumes certain business from Hanover which was written by Hanover on behalf of Citizens Insurance. Premiums receivable at both December 31, 1996 and 1995, include $1.6 million of premiums due to Citizens Insurance from Hanover on assumed business. In addition, other liabilities at December 31, 1996 and 1995, include $2.7 million and $2.0 million, respectively, of claim payments due from Citizens Insurance to Hanover on business assumed. Unearned premiums at December 31, 1996 and 1995, include $4.1 million and $3.7 million, respectively, and reserve for losses and LAE at December 31, 1996 and 1995, include $22.9 million and $24.1 million, respectively, from Hanover assumed business.
The Company is subject to concentration of risk with respect to reinsurance ceded through a pooling arrangement. As a condition to the ability to conduct personal automobile business in the state of Michigan, the Company is required under Michigan law to participate in a pooling arrangement with the Michigan Catastrophic Claims Association (MCCA). The Company is indemnified by the MCCA for personal protection insurance losses in excess of $0.25 million. At December 31, 1996, the MCCA was the only reinsurer which represented 10% or more of the Company's reinsurance business. The Company cedes a significant portion of its private passenger automobile premiums to the MCCA. Ceded premiums earned to MCCA in 1996, 1995, and 1994 were $50.5 million, $66.8 million and $80.0 million, respectively. Losses and LAE ceded to MCCA in 1996, 1995, and 1994 were ($52.9) million, $62.9 million and $24.2 million, respectively. In 1996, the MCCA's favorable development on prior year reserves exceeded the losses and LAE incurred during the year. The aggregate losses and LAE ceded to the MCCA have no impact on the Company's consolidated statements of income.
Net written and earned premiums and losses and LAE incurred included reinsurance activity as follows:
Reinsurance recoverables on paid and unpaid losses and ceded prepaid premiums were as follows:
As part of an ongoing process, the reserves, net of reinsurance, have been re-estimated for all prior accident years and were decreased by $58.4 million, $47.0 million and $12.4 million in 1996, 1995, and 1994, respectively. The favorable development in 1996 and 1995 primarily reflects the initiatives taken by the Company to manage medical costs in both the automobile and workers' compensation lines, as well as the impact of the Michigan Supreme Court ruling on workers' compensation indemnity payments, which decreases the maximum amount to be paid for indemnity cases on all existing and future claims. The increase in favorable development of $11.4 million in 1996 reflects improved severity in the personal automobile line, where favorable development increased $28.6 million to $33.0 million in 1996, partially offset by less favorable development in the workers' compensation line. In 1995, the workers' compensation line had favorable development of $32.7 million, primarily as a result of the Company re-estimating reserves to reflect the Company's new claims cost management programs and the Michigan Supreme Court ruling, which decreases the maximum to be paid for indemnity cases on all existing and future claims. In 1996, the favorable development in the workers' compensation line of $21.8 million also reflected these developments.
The Company regularly reviews its reserving techniques, its overall reserve position and its reinsurance. Based on (i) review of historical data, legislative enactments, judicial decisions, legal developments in impositions of damages, changes in political attitudes and trends in general economic conditions; (ii) review of per claim information; (iii) historical loss experience of the Company and the industry; (iv) the relatively short-term nature of most policies; and (v) internal estimates of required reserves, management believes that adequate provision has been made for loss reserves. However, establishment of appropriate reserves is an inherently uncertain process and there can be no certainty that current established reserves will prove adequate in light of subsequent actual experience. A significant change to the estimated reserves could have a material impact on the results of operations.
Determination of the projected benefit obligation was based on a weighted average discount rate of 7.0% at December 31, 1996 and 1995. The assumed long- term rate of return on plan assets was 9.0% for both years. The actuarial present value of the projected benefit obligation was determined using assumed rates of increase in future compensation levels of 5.5%. Plan assets are invested primarily in various separate accounts and the general account of First Allmerica Financial Life Insurance Company (FAFLIC), an affiliate of the Company. The Plan also holds stock of Allmerica Financial Corporation, the ultimate parent of the Company.
The plan changes effective January 1, 1996 resulted in an unrecognized negative prior service cost (change in eligibility and medical benefits) of $8.1 million and a curtailment (no future increases in life insurance) of $1.2 million. The negative prior service cost will be amortized over the average number of years to full eligibility (approximately 9 years or $0.9 million per year). The curtailment gain has been deducted from unrecognized loss.
For purposes of measuring the accumulated postretirement benefit obligation at December 31, 1996, health care costs were assumed to decrease to 9.0% in 1997, declining thereafter until the ultimate rate of 5.5% is reached in 2001 and remaining at that level thereafter. The health care cost trend rate assumption has a significant effect on the amounts reported. To illustrate, increasing the assumed health care cost trend rates by 1% in each
year would increase the medical accumulated postretirement benefit obligation as of December 31, 1996, by $0.8 million, or 8.7%, and the aggregate of the service and interest cost components of annual net periodic postretirement benefit expense by $0.1 million, or 9.7%.
The weighted-average discount rate used in determining the accumulated postretirement benefit obligation was 7.0% as of December 31, 1996 and 1995. The assumed rate of future annual salary increases was 5.5% at both valuation dates.
In October 1995 the FASB issued Statement of Financial Accounting Standards (SFAS No. 123) "Accounting for Stock-Based Compensation". The standard is effective for fiscal years beginning after December 15, 1995, and requires the Company either to apply a fair value measure to any stock-based compensation granted by the Company after December 31, 1994, or continue to apply the valuation provisions of existing accounting standards, but with pro-forma net income and earnings per share disclosures using a fair value methodology to value the stock-based compensation. Beginning the year ended December 31, 1996, the Company has elected to continue to apply the valuation provisions of existing accounting standards (APB 25). The pro-forma effect of applying SFAS No. 123 is not material.
Effective March 9, 1994, the Company adopted a Long Term Stock Incentive Plan (the "Plan"). Key employees of the Company and Citizens Insurance are eligible for awards pursuant to the Plan administered by the Compensation Committee of the Board of Directors (the "Committee") of Citizens Insurance. Under the terms of the Plan, options may be granted to eligible employees at a price not less than the market price of the Company's common stock on the date of grant. At December 31, 1996, 11,000, 9,000, 32,500, 40,000 and 8,000 option shares were outstanding at an option price of $15.25, $16.625, $16.875, $18.25 and $18.875 per share, respectively. At December 31, 1995, 70,500 option shares were outstanding at an option price of $16.50 per share. Option shares may be exercised subject to the terms prescribed by the Committee at the time of grant, otherwise options vest at the rate of 20% annually for five consecutive years and must be exercised not later than ten years from the date of grant. There were 1,500 options exercised during 1996. There were no options exercised in 1995. At December 31, 1996, there were 12,700 options exercisable and 98,000 option shares were available for future grant.
The Company has been named a defendant in various legal proceedings arising in the normal course of business. In the opinion of management, based on the advice of legal counsel, the ultimate resolution of these proceedings will not have a material effect on the consolidated financial statements. However, liabilities related to these proceedings could be established in the near term if estimates of the ultimate resolution of these proceedings are revised.