In 1995, Meridian Mutual sold its 27,000-square-foot district service office facility in Louisville, Kentucky. Due to consolidations which led to staff reductions in the Louisville office, the Company and Meridian Mutual now jointly lease office space of approximately 6,500 square feet in Louisville. Meridian also leases a claim service center in Lansing, Michigan and a district service office in Columbus, Ohio.
Year Ended December 31, 1996 1995 1994 1993 1992 (In thousands, except per share data and ratios) Operating data: Premiums earned $167,304 $143,866 $135,002 $125,902 $108,097 Net investment income 14,908 14,564 13,996 13,569 12,620 Realized investment gains 3,794 1,538 286 890 540 Other income (expense) 563 (146) 54 (115) 182 Total revenues 186,569 159,822 149,338 140,246 121,439
Losses and loss adjustment expenses 130,101 99,124 93,971 86,622 75,980 General operating expenses 13,767 14,156 14,527 14,935 12,742 Interest expense 308 --- --- --- --- Amortization expenses 36,443 30,820 29,304 27,039 22,695 Total expenses 180,619 144,100 137,802 128,596 111,417
Income before taxes and change in accounting method 5,950 15,722 11,536 11,650 10,022 Income taxes 150 4,105 2,415 2,765 1,797 Income before change in accounting method 5,800 11,617 9,121 8,885 8,225 Changes in accounting method: Other post-retirement benefits --- --- --- --- (651) Accounting for income taxes --- --- --- 526 --- Net income $ 5,800 $ 11,617 $ 9,121 $ 9,411 $ 7,574
Dividends declared per share $ 0.32 $ 0.28 $ 0.24 $ 0.24 $ 0.18
Balance sheet data at end of period: Total investments (1) $281,689 $254,694 $219,461 $221,197 $169,277 Total assets 397,798 322,588 291,406 285,936 221,534 Total liabilities 275,624 204,346 197,154 191,490 154,935 Shareholders' equity 122,174 118,243 94,252 94,447 66,599 Shareholders' equity per share $ 18.02 $ 17.45 $ 13.98 $ 14.02 $ 13.42
The catastrophe activity of 1996 should not overshadow certain positive strides made during the year. A major development was the acquisition of Citizens Security Group Inc. and its subsidiaries, Citizens Fund Insurance Company and Insurance Company of Ohio on July 31, 1996. This acquisition fit well into the Company's plan for geographic expansion into additional Midwestern and North Central states. The acquisition expanded the Company's operating territory into four additional states: Minnesota, Missouri, North Dakota, and South Dakota; and increased its revenue base in Iowa, Ohio and Wisconsin. The Company also gained control of Citizens Security Mutual Insurance Company as a result of the acquisition. Direct written premiums for the Citizens Security Group were nearly $55 million for the full year. Underwriting results for Citizens Security were incorporated into the Company's pooling arrangement effective August 1, 1996. The Company continues to look for other acquisitions that meet its criteria.
During 1996, the Company continued the favorable trend of decreasing its operating expenses relative to premiums. Achieving continued reductions in per-unit costs and improvement in productivity remain key strategic goals. Meridian has developed an automated personal lines underwriting system that will enable policies meeting certain criteria to be issued without manual review, thus reducing costs without increasing risk. Meridian began testing this system in late 1996. By mid-1997, we expect to have most new Meridian homeowners and automobile business processed by automated underwriting. Additional efficiencies are expected to result from progress with commercial lines client-server processing and agency interface.
In 1996, the Company reported net income of $5.8 million, or $0.86 per common share . This compares to 1995 net income of $11.6 million, or $1.72 per share. The 1996 results were negatively impacted by a series of severe storms that produced an unusually large volume of property damage claims throughout the Company's operating territory. The after-tax impact of catastrophe and other weather-related non- catastrophic claims is estimated to be approximately $1.17 per share in 1996, compared to approximately $0.42 per share in 1995. The 1996 catastrophe losses represent the largest catastrophe loss total in the Company's history. The Company's statutory combined ratio for 1996 was 108.0 percent versus 100.2 percent for the comparable 1995 period. The Company's total revenues in 1996 were a record high of $186.6 million, a 16.7 percent increase over 1995's $159.8 million. The 1996 total includes five months of premiums and investment income from the Citizens Security Group companies which were acquired on July 31, 1996. The effect of the Citizens Security Group acquisition on total revenues was approximately $15.8 million, including approximately $14.7 million of net earned premiums and $1.1 million of net investment income. Incremental net income from the Citizens Security Group operation for the five month period ended December 31, 1996 was approximately $0.25 million, or $0.04 per share, net of goodwill amortization and interest expense.
The Company's largest source of revenue, net earned premiums, increased 16.3 percent in 1996 to $167.3 million compared to $143.9 million for the 1995 period. Aside from the 10.2 percent increase in premium volume that resulted from the Citizens Security Group acquisition, premiums earned by the Meridian operation increased approximately 6.1 percent, or $8.8 million, over the 1995 total. The Meridian growth was attributed to nearly all lines of business, with personal lines production increasing 6.8 percent, commercial lines 5.6 percent and farmowners achieving growth of 2.8 percent in earned premium volume. Commercial and personal automobile and homeowners were the primary lines of business contributing to the increased premium volume. Depressing the commercial lines growth was a reduction of approximately $1.2 million in assumed earned premiums from the National Workers' Compensation Pool. Total policy count for the Meridian products, on a pooled basis, increased by approximately 12,650 policies, or 5.3 percent over the 1995 in-force total.
In 1995, the Company reported record highs in net income of $11.6 million and earnings per common share of $1.72. This compared to 1994 net income of $9.1 million and $1.35 per share. The improved results were primarily attributed to increased revenues and a reduction in all three components of the combined underwriting and expense ratio. Total revenues increased 7.0 percent to $159.8 million from $149.3 million while the 1995 statutory combined ratio improved to 100.2 percent from 101.8 percent for 1994.
Net premiums earned for 1995 reflected 6.6 percent growth to $143.9 million from 1994's $135.0 million. This growth was attributed to nearly all major lines of business. Meridian's personal lines production for 1995 experienced growth of 8.7 percent. This was primarily attributed to the homeowners and private passenger automobile lines of business, which reflected earned premium growth of 9.7 percent and 7.6 percent, respectively. Farmowners achieved earnings growth of 10.2 percent while Meridian's commercial lines of business grew 3.1 percent over the 1994 level. The increase in commercial lines was attributed primarily to 8.9 percent growth in the commercial automobile line and 6.7 percent increase in voluntary workers' compensation business. Depressing the commercial lines growth was a reduction of nearly $600,000 in assumed earned premiums from the National Workers' Compensation Pool ("NWCP"). This partially resulted from actions taken by Meridian to control the type of workers' compensation business it would accept in states where the NWCP was unprofitable. The commercial lines growth was also hampered by soft market conditions, primarily in the state of Michigan where premium volume declined from the 1994 level. Meridian has addressed its products, rates and personnel in the state of Michigan and will continue to monitor these actions for improved results. Total policy count, on a pooled basis, for 1995 increased by approximately 7,000 policies, or 3.0 percent, over the 1994 total.
Approximately 85 percent of the Company's investment assets are held in fixed maturities, substantially all of which are believed to be readily marketable. Within the fixed maturity portfolio, the Company holds approximately 23 percent in mortgage-backed pass-through securities and collateralized mortgage obligations. The Company has attempted to reduce the prepayment risks associated with mortgage- backed securities by investing a majority of the collateralized mortgage obligations in planned amortization and very accurately defined tranches. These investments are designed to alleviate the risk of prepayment by providing predictable principal prepayment schedules within a designated range of prepayments. The Company has no exposure to high risk derivatives in its portfolio.
The Company's fixed income investment portfolio consists almost entirely of investment grade securities, the average quality of which is rated Aa / AA. The Company currently holds all of its fixed maturity investments in the "available-for-sale" category which are carried at market value. The Company at December 31, 1996 recorded unrealized gains in the bond portfolio of approximately $2.7 million, net of deferred income taxes. At year-end 1995, the Company recorded unrealized gains on the bond portfolio of approximately $4.1 million, net of deferred income taxes. Net unrealized appreciation of investments added $1.05 to the Company's $18.02 book value per share at December 31, 1996, similar to unrealized appreciation adding $1.01 per share to the $17.45 book value at December 31, 1995.
Beginning in 1994, state insurance regulators required companies to calculate Risk Based Capital ("RBC"). RBC is the capital required to cover the varying degrees of risk inherent in a company's assets, loss reserves, underwriting, and reinsurance. The "company action level" RBC is the minimum amount of capital required in order to avoid regulatory action. In 1996, the adjusted capital of the Company's insurance subsidiaries is well above the required minimum.
Inflation can have a significant impact on property and casualty insurers because premium rates are established before the amount of losses and loss adjustment expenses is known. The Company attempts to anticipate increases from inflation in establishing rates, subject to limitations imposed for competitive pricing.
We have audited the accompanying consolidated balance sheet of Meridian Insurance Group, Inc., and Subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Meridian Insurance Group, Inc., and Subsidiaries as of December 31, 1996 and 1995, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles.
Premiums earned $167,304,414 $143,865,821 $135,001,881 Net investment income 14,908,285 14,563,820 13,995,984 Net realized investment gains 3,793,778 1,538,281 285,701 Other income (expense) 562,198 (146,345) 54,623 Total revenues 186,568,675 159,821,577 149,338,189
MERIDIAN INSURANCE GROUP, INC., AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET as of December 31, 1996 and 1995
Shareholders' equity: Common shares, no par value, Authorized- 20,000,000, Issued-6,805,955 and 6,803,185, Outstanding-6,779,375 and 6,776,805 at December 31, 1996 and 1995, respectively 44,077,846 44,076,685 Contributed capital 15,058,327 15,058,327 Unrealized appreciation of investments, net of deferred income taxes 7,141,846 6,842,245 Retained earnings 55,895,962 52,265,410 Total shareholders' equity 122,173,981 118,242,667 Total liabilities and shareholders' equity $397,797,701 $322,588,216
MERIDIAN INSURANCE GROUP, INC., AND SUBSIDIARIES CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY for the Years Ended December 31, 1996, 1995 and 1994
Balance at January 1, 1994 $ 43,855,319 $ 15,058,327 $ 491,027 $ 35,041,862 Cumulative effect of accounting change for certain investments, net of deferred income taxes --- --- 4,417,201 --- Net income --- --- --- 9,121,063 Unrealized depreciation of investment securities, net of deferred income taxes --- --- (12,189,952) --- Dividends ($0.24 per share) --- --- --- (1,617,811) Vested restricted common shares 35,584 --- --- --- Exercise of stock options for 6,925 common shares 39,819 --- --- --- Balance at December 31, 1994 43,930,722 15,058,327 (7,281,724) 42,545,114 Net income --- --- --- 11,617,039 Unrealized appreciation of investment securities, net of deferred income taxes --- --- 14,123,969 --- Dividends ($0.28 per share) --- --- --- (1,896,743) Repurchase and retirement of 6,479 common shares (77,033) --- --- --- Exercise of stock options for 40,521 common shares 222,996 --- --- --- Balance at December 31, 1995 44,076,685 15,058,327 6,842,245 52,265,410 Net income --- --- --- 5,799,952 Unrealized appreciation of investment securities, net of deferred income taxes --- --- 299,601 --- Dividends ($0.32 per share) --- --- --- (2,169,400) Exercise of stock options for 4,042 common shares 23,241 --- --- --- Repurchase and retirement of 1,472 common shares (22,080) --- --- --- Balance at December 31, 1996 $ 44,077,846 $ 15,058,327 $ 7,141,846 $ 55,895,962
MERIDIAN INSURANCE GROUP, INC., AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS for the Years Ended December 31, 1996, 1995 and 1994
MERIDIAN INSURANCE GROUP, INC., AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Meridian Mutual writes a broad line of property and casualty insurance, including personal and commercial automobile; homeowners, farmowners and commercial multi-peril; and workers' compensation. Business is written through approximately 1,075 independent insurance agencies in the states of Illinois, Indiana, Iowa, Kentucky, Michigan, Ohio, Pennsylvania, Tennessee, and Wisconsin. Meridian Security is licensed in all states in which Meridian Mutual is licensed and writes personal and farm lines in Indiana, Iowa, Kentucky, Ohio, Tennessee, and Wisconsin through approximately 400 independent insurance agencies, many of which are cross-licensed with Meridian Mutual. Citizens Fund and Citizens Security Mutual offer a variety of personal and commercial insurance products in the states of Iowa, Minnesota, Missouri, North Dakota, Ohio, South Dakota, and Wisconsin through a network of 425 independent insurance agencies. ICO writes personal and commercial products in the state of Ohio through approximately 92 independent agencies.
Fixed maturity investments include bonds, notes, mortgage backed pass-through securities, collateralized mortgage obligations, other asset backed securities and sinking fund preferred stocks. The fixed maturity portfolio is invested entirely in securities classified as available for sale and is carried at quoted market values. Equity securities, consisting of unaffiliated common and perpetual preferred stocks, are reported at quoted market values. Short-term investments are recorded at cost, approximating market value. Other investments include a limited partnership recorded on the equity method and a mortgage loan stated at the aggregate unpaid balance.
Policy acquisition costs, principally commissions, premium taxes, and variable underwriting and policy issue expenses, have been deferred. Such costs are amortized as premium revenue is earned. The method used in computing deferred policy acquisition costs limits the amount of such deferred costs to their estimated realizable value, and also considers the effects of anticipated investment income, losses and loss adjustment expenses, and certain other costs anticipated to be incurred as the premium is earned. In connection with the acquisition of Citizens Fund and ICO, the Company allocated a portion of its cost to an asset representing the estimated equity in the unearned premium reserve of the acquired book of business. The asset is being amortized as the related premium revenue is earned.
Reserves for unpaid losses and loss adjustment expenses are based on both estimates of the ultimate costs of individual claims and on other non-discounted estimates, such as claims incurred but not reported and salvage and subrogation. The methods of making such estimates are continually reviewed and updated, and any reserve adjustments are reflected in current operating results.
1996 1995 1994 Realized gains (losses): Fixed maturities $ (456,602) $ 87,370 $ (118,358) Equity securities 4,559,380 1,458,589 404,059 Other invested assets --- (7,678) --- Total realized investment gains 4,102,778 1,538,281 285,701 Investment expenses 309,000 --- --- Net realized investment gains $ 3,793,778 $ 1,538,281 $ 285,701
Net change in unrealized depreciation of fixed maturities, held to maturity $ --- $ (367,533) $ (713,522)
The amortized cost and estimated market value of fixed maturity securities available for sale at December 31, 1996, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Estimated Amortized Market Cost Value Available for sale: Due in one year or less $ 2,220,935 $ 2,231,573 Due after one year through five years 42,239,968 42,740,774 Due after five years through ten years 48,664,611 49,914,445 Due after ten years through fifteen years 32,881,299 33,865,382 Due after fifteen years through twenty years 5,693,977 5,655,926 Due after twenty years 48,564,941 49,284,788 Subtotal 180,265,731 183,692,888 Mortgage-backed securities 54,090,640 54,650,152 Total fixed maturity securities $234,356,371 $238,343,040
The consolidated financial statements include the results of operations of the acquired entities from the date of acquisition. Unaudited pro-forma condensed consolidated results of operations presented below assume the acquisition and financing of the transaction had occurred at the beginning of each period presented:
1997 $ 625,000 1998 1,125,000 1999 1,625,000 2000 2,000,000 2001 2,125,000 Thereafter 4,375,000 Total payments outstanding $ 11,875,000
The principal balance of the bank loan as of December 31, 1996 approximates its market value. Interest paid on the loan during 1996 amounted to $187,887. The bank debt includes certain financial covenants, the most significant of which concern the amounts of risk based capital, statutory policyholders' surplus, total debt, debt to capitalization and debt service coverage (the relationship of dividends available from the Company's insurance subsidiaries to required principal and interest payments).
For the year ended December 31, 1996, approximately 88 percent of the Company's total premium volume was derived from its participation in the pooling agreement. In 1995 and 1994, approximately 90 percent and 84 percent, respectively, was derived from the pooling arrangement.
Prior to January 1, 1997, Meridian Security, Citizens Fund and ICO had no employees and were dependent on the business and operations of Meridian Mutual and Citizens Security Mutual. Meridian Mutual had a defined pension plan covering substantially all employees and a non-tax qualified retirement plan for certain key employees. Related pension costs allocated to the Company were immaterial to the results of operations for the periods ended December 31, 1996, 1995 and 1994. The Company also participated in the multi- employer plan for other post-retirement benefits offered by Meridian Mutual to employees, including medical benefits for early retirees (eligible upon attainment of age 55 and five years of service up to age 65) and group term life insurance that phases out over a five year period from the retirement date. Related costs allocated to the Company were approximately $53,000, $98,000 and $102,000 for 1996, 1995 and 1994, respectively.
Effective January 1, 1997, the Company became the employer of all employees that were formerly employed by Meridian Mutual and Citizens Security Mutual. This transfer allows for more freedom in compensation planning, such as more flexibility in the use of the Company's common stock as compensation, and to improve internal efficiencies by combining employee benefit plans. As a result of this transfer, all employee benefit plans that were previously under Meridian Mutual and Citizens Security Mutual were merged into Company plans.
Net balance at end of period 119,489,931 92,372,778 91,939,210 Plus reinsurance recoverables 41,819,308 31,204,462 31,815,440 Balance at end of period $161,309,239 $123,577,240 $123,754,650
Three types of reinsurance were purchased jointly by Meridian Mutual and Meridian Security. Treaty reinsurance automatically covers certain types of policies up to contracted limits. Facultative reinsurance is purchased on an individual risk basis and sets specific limits of coverage. Such coverage was purchased to cover liability and property exposures in excess of $200,000, up to the limits set forth in the individual treaty. Catastrophe reinsurance provides coverage for multiple losses caused by a single catastrophic event such as a windstorm or earthquake. The combined retention under this contract was $6,000,000 plus five percent of losses up to the $65,000,000 contract limit ($3,250,000 and $50,000,000, respectively, for years prior to 1996).
Two other catastrophe reinsurance treaties provide coverage for aggregate losses caused by multiple catastrophic events. The combined retention under the first of these aggregate excess contracts was based on 2.5 percent of subject earned premiums, plus five percent of losses up to the $8,000,000 contract limits, with a $175,000 deductible per catastrophic event. Retention under the second aggregate excess contact, effective May 10, 1996, was $500,000 per quarter, plus five percent of losses up to $4,500,000 per quarter, with a total contract limit of $12,000,000 and a $250,000 per event deductible.
1996 1995 1994 Premiums written: Direct $181,680,624 $152,596,128 $144,084,372 Assumed 3,730,504 7,269,782 6,132,096 Ceded (16,216,479) (11,102,025) (14,026,543) Net $169,194,649 $148,763,885 $136,189,925
Deferred, beginning of period $ 13,354,600 $ 11,977,429 $ 11,972,069 Additions: Commissions 30,593,227 25,797,651 23,444,057 Equity in acquired unearned premium reserve 2,312,841 --- --- Ceding commission --- 409,350 621,494 Premium taxes 2,458,670 1,625,370 2,108,746 Other 3,956,708 4,236,409 3,007,189 Total Additions 39,321,446 32,068,780 29,181,486 Amortization expense 35,985,771 30,691,609 29,176,126 Deferred, end of period $ 16,690,275 $ 13,354,600 $ 11,977,429
The Tax Reform Act of 1986 allowed for a fresh start deduction for reserve discounting requirements. This produced an aggregate tax benefit of approximately $900,000 of which the Company recognized approximately $17,000 in 1996. Prior to 1996, the Company had recognized approximately $855,000 of this benefit.
1996 1995 1994 Deferred tax assets: Unearned premium reserves $ 5,533,000 $ 4,336,000 $ 3,936,000 Loss and loss adjustment expense reserves and salvage and subrogation 6,336,000 4,980,000 5,346,000 Unrealized depreciation on investment securities --- --- 3,747,000 Other post-employment benefits 496,000 454,000 380,000 Other 875,000 --- 10,000 Total deferred tax assets 13,240,000 9,770,000 13,419,000
Deferred tax liabilities: Deferred policy acquisition costs 5,842,000 4,674,000 4,132,000 Investments 327,000 178,000 80,000 Unrealized appreciation on investment securities 3,849,000 3,607,000 --- Other 425,000 34,000 25,000 Total deferred tax liabilities 10,443,000 8,493,000 4,237,000 Net deferred tax asset $ 2,797,000 $ 1,277,000 $ 9,182,000
Subsidiary retained earnings available for distribution as dividends to the Company are limited by law to the statutory unassigned surplus of the subsidiaries on the previous December 31, as determined in accordance with the accounting practices prescribed or permitted by insurance regulatory authorities of the state of Indiana. Subject to this limitation, the maximum dividend that may be paid during a 12-month period, without prior approval of the insurance regulatory authorities is the greater of ten percent of statutory capital and surplus as of the preceding December 31 or net income for the preceding calendar year determined on a statutory basis. Meridian Security declared and paid dividends to the Company of $3,900,000 in 1996, $2,400,000 in 1995 and $2,200,000 in 1994. As of December 31, 1996, approximately $9,300,000 was available for distribution to the Company without prior approval of insurance regulatory authorities.
The following is selected information for the Company's insurance subsidiaries, as determined in accordance with accounting practices prescribed or permitted by the Department of Insurance of their state of domicile:
Statutory capital and surplus $105,506,000 $ 90,952,000 $ 74,716,000 Statutory net investment income $ 15,809,000 $ 14,733,000 $ 13,927,000 Statutory net income $ 3,307,000 $ 11,625,000 $ 10,097,000
In November 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based Compensation". This statement encourages, but does not require, companies to recognize compensation expense for grants of stock, stock options, and other equity instruments to employees based on the fair value method of accounting. The Company continues to account for stock options in accordance with Accounting Principles Board Opinion No. 25. Had compensation cost been determined using the fair value of the options at the grant dates in accordance with SFAS No. 123, the Company's net income and earnings per share for the periods ended December 31, 1996 and 1995 would have been reduced to the following pro-forma amounts: $143,000 and $53,000 and $0.02 and $0.01, respectively. The fair value of each option was estimated to be $13.63 and $13.43 on the date of the grant using the Black-Scholes model with the following assumptions for 1996 and 1995, respectively: risk free interest rates of 6.55 percent and 6.70 percent; dividend yield of 2.15 percent and 2.35 percent; and volatility of .314 and .358. As of December 31, 1996, options outstanding under these plans had an exercise price that ranged from $11.88 to $15.28 and a remaining weighted average contractual life of 6 years.
Stock options granted by the Company for the periods ended December 31, 1996, 1995 and 1994 are summarized in the following table:
1996 1995 1994 Weighted Weighted Weighted Price Shares Price Shares Price Shares
Portion thereof exercisable at December 31 $12.30 272,324 $11.52 278,781 $ 5.75 50,121
Quarter Ended March 31 June 30 September 30 December 31 Revenues $ 41,400 $ 43,262 $ 48,990 $ 52,917 Net income $ 595 $ 702 $ 1,806 $ 2,697 Net income per share $ 0.09 $ 0.10 $ 0.27 $ 0.40