(2) 1996, 1995, 1994 and 1993 earnings per share amounts restated in accordance with the provisions of SFAS No. 128 adopted as of December 31, 1997.
The Company reported record net income of $16.9 million for 1997, which is a 26.1% increase over its net income of $13.4 for 1996. This increase is principally due to a 16.2% increase in gross written premiums, a 22.7% increase in net investment income and profitable underwriting which resulted in a 85.9% (GAAP basis) combined ratio (the sum of the net loss and loss adjustment expenses and acquisition costs and other underwriting expenses divided by net earned premiums). 1997 represented the fourth consecutive year since its 1993 initial public offering that the Company has reported growth in gross written premiums and net income while experiencing a combined ratio under 90%, which is substantially lower than the commercial property and casualty insurance industry as a whole. The Company believes that its continued profitable growth is attributable to the adherence to the Company's core philosophy of conservative underwriting guidelines and pricing discipline.
The Company's insurance subsidiaries are rated "A" (Excellent) by A.M. Best Company and have been assigned an "A" claims paying ability rating by Standard & Poor's.
Premiums: Gross written premiums grew $32.7 million (31.4%) to $136.9 million in 1996 from $104.2 million in 1995; gross earned premiums grew $22.3 million (22.4%) to $121.8 million in 1996 from $99.5 million in 1995; net written premiums increased $21.9 million (35.3%) to $84.0 million in 1996 from $62.1 million in 1995; and net earned premiums grew $13.9 million (23.9%) to $72.1 million in 1996 from $58.2 million in 1995. The overall growth in premiums and the varying growth rates for gross written premiums, gross earned premiums, net written premiums and net earned premiums are attributable to a number of factors:
- - Overall premium growth is primarily attributable to the following factors:
- The prior year's growth in the field production underwriting organization enabling expansion of the Company's marketing efforts to non profit organizations, the health and fitness industry and selected professional liability products.
Net Investment Income: Net investment income approximated $7.9 million in 1996 and $6.5 million in 1995. The increase of $1.4 million (21.5%) is due primarily to the increase in total investments as a result of cash flows provided from operating activities.
Net Realized Investment Gain (Loss): Net realized investment gains were $.3 million in 1996 compared to $.2 million in 1995.
Net Loss and Loss Adjustment Expenses: Net loss and loss adjustment expenses increased $6.9 million (20.8%) to $40.1 million in 1996 from $33.2 million in 1995 and the loss ratio decreased to 55.7% in 1996 from 57.1% in 1995. The increase in net loss and loss adjustment expenses was due primarily to the 23.9% growth in net earned premiums. Additionally, since there was relatively higher net earned premium growth on products with low loss experience, the percentage increase in net loss and loss adjustment expenses (20.8%) was lower than the 23.9% net earned premium growth.
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130, "Reporting Comprehensive Income", which is effective for years beginning after December 15, 1997. This statement establishes standards for the reporting and display of comprehensive income and its components. Comprehensive income is defined to include all changes in equity during a period except those resulting from investments by owners and distributions to owners. The Company will adopt SFAS No. 130 and begin reporting comprehensive income in the first quarter of 1998.
From time-to-time, the Company may publish statements which are not historical facts but are forward-looking statements relating to such matters as anticipated financial performance, business prospects, technological developments, new and existing products, expectations for market segment and growth, and similar matters. In connection with the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, the Company provides the following cautionary remarks regarding important factors which, among others, could cause the Company's actual results and experience to differ materially from the anticipated results or other expectations expressed in the Company's forward-looking statements.
The risks and uncertainties that may affect the operations, performance, development, results of the Company's business and the other matters referred to above include, but are not limited to: (i) changes in the business environment in which the Company operates, including inflation and interest rates; (ii) changes in taxes, governmental laws and regulations; (iii) competitive product and pricing activity; and (iv) difficulties of managing growth profitably.
We have audited the accompanying consolidated balance sheets of Philadelphia Consolidated Holding Corp. and Subsidiaries as of December 31, 1997 and 1996 and the related consolidated statements of operations, changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 1997. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
/s/ COOPERS & LYBRAND L.L.P. - ---------------------------- COOPERS & LYBRAND L.L.P.
(1) 1996 share information restated to reflect a two for one split of the Company's common stock distributed in November 1997, see Note 11.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (IN THOUSANDS, EXCEPT SHARE DATA)
The decision to purchase or sell investments is based on management's assessment of various factors such as foreseeable economic conditions, including current interest rates and the interest rate risk, and the liquidity and capital positions of the Company.
Investments in fixed maturities are adjusted for amortization of premiums and accretion of discounts to maturity date, except for collaterized mortgage and asset backed securities which are adjusted for amortization of premiums and accretion of discounts over their estimated lives. Certain collaterized mortgage and asset backed securities repayment patterns will change based on interest rate movements and, accordingly, could impact future investment income if the reinvestment of the repayment amounts are at lower interest rates than the underlying securities. Collaterized mortgage and asset backed securities amounted to $18,630,800 and $0 at December 31, 1997 and December 31, 1996, respectively. The collaterized mortgage and asset back securities held as of December 31, 1997 are short tranche securities possessing favorable prepayment risk profiles.
Policy acquisition costs, which include commissions, premium taxes, fees and other costs of underwriting policies, are deferred and amortized over the same period in which the related premiums are earned. Deferred acquisition costs are limited to the estimated amounts recoverable after providing for losses and expenses that are expected to be incurred, based
In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings per Share," specifying the computation, presentation, and disclosure requirements for earnings per share for entities with publicly held common stock. Under SFAS No. 128, basic and diluted per share amounts shall be presented for net income on the face of the statement of operations. Basic earnings per share excludes dilution and is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. The Company adopted the provisions of SFAS No. 128 as of December 31, 1997 and restated all prior period earnings per share data to conform with the provisions of this Statement.
Accounting Principles. The Philadelphia Indemnity Insurance Company ("PIIC") and the Philadelphia Insurance Company ("PIC") are domiciled in the Commonwealth of Pennsylvania. PIIC and PIC are required to report to certain regulatory agencies on the basis of Statutory Accounting Practices ("SAP"). The statutory financial statements are prepared in accordance with accounting practices prescribed or permitted by the Insurance Department of the Commonwealth of Pennsylvania. Prescribed statutory accounting practices include a variety of publications of the National Association of Insurance Commissioners ("NAIC"), as well as Commonwealth laws, regulations and general administrative rules. Permitted Statutory Accounting Practices encompass all accounting practices not so prescribed.
Under SAP, certain reserves are established in amounts which differ from amounts which would be provided in conformity with GAAP.
Financial Information: The statutory capital and surplus of PIIC as of December 31, 1997 and 1996 was $75,894,000 and $60,175,000, respectively. Statutory net income of PIIC for the years ended December 31, 1997, 1996 and 1995 was $8,839,000, $5,626,000, and $5,416,000, respectively.
Dividend Restrictions: The Insurance Subsidiaries are subject to various regulatory restrictions which limit the maximum amount of annual shareholder dividends allowed to be paid. The maximum dividend which PIIC may pay to Philadelphia Insurance during 1998 without prior approval is $8,839,000 and the maximum dividend which PIC may pay to Philadelphia Insurance during 1998 without prior approval is $5,494,000.
Risk-Based Capital: Risk-based capital is designed to measure the acceptable amount of capital an insurer should have based on the inherent specific risks of each insurer. Insurers failing to meet this benchmark capital level may be subject to scrutiny by the insurer's domiciliary insurance department and ultimately rehabilitation or liquidation. Based on the standards, PIIC's and PIC's capital and surplus at December 31, 1997 is in excess of the prescribed risk-based capital requirements.
The Company invests primarily in investment grade fixed maturities, the majority of which are rated "A" or better by Standard and Poor's. The cost, gross unrealized gains and losses, estimated market value and carrying value of investments as of December 31, 1997 and 1996 are as follows (in thousands):
The Company had no debt or equity investments in a single issuer totaling in excess of 10% of shareholders' equity at December 31, 1997.
There are no investments in fixed maturity securities that were non-income producing during the years ended December 31, 1997, 1996 and 1995. Investment expense includes $164,000, $60,000, and $84,000 in advisory fees paid to a related party in 1997, 1996 and 1995, respectively.
Realized pre-tax gains (losses) on the sale of investments for the years ended December 31, 1997, 1996 and 1995 are as follows (in thousands):
PIIC and PIC have investments, principally U.S. Treasury securities on deposit with the various states in which they are licensed insurers. At December 31, 1997 and 1996 the carrying value on deposit totaled $10,912,000 and $7,070,000, respectively.
The Company is required to maintain certain investments in trust accounts under reinsurance agreements with unrelated insurance companies that cede insurance risks to the Company. At December 31, 1997 and 1996 the Company had investments with a carrying value of $2,403,000 and $2,868,000, respectively, in trust accounts pursuant to a terminated quota share reinsurance agreement. Under the terms of this agreement, net premiums received by the Company were invested and held in a trust account to pay future claims. Interest income on these investments is distributed to the parties to the quota share agreement on a quarterly basis. The Company receives its interest in net trust investments in accordance with a formula that specifies certain percentages of funds to be released over a five-year period as losses are settled.
Included in property and equipment are costs incurred in developing or purchasing information systems technology of $2,516,500 and $2,447,600 in 1997 and 1996, respectively. Amortization of these costs was $180,200, $100,100, and $115,000 for the years ended December 31, 1997, 1996 and 1995, respectively. Depreciation expense excluding amortization of capitalized information systems technology costs was $858,200, $530,000, and $395,000, for the years ended December 31, 1997, 1996 and 1995, respectively.
As a result of changes in estimates of insured events of prior years, the Company reduced losses and loss adjustment expenses incurred by $1,716,000, $965,000 and $925,000 in 1997, 1996 and 1995, respectively. Such favorable development was due to losses emerging at a lesser rate than had been originally anticipated when the initial reserves for the applicable accident years were estimated.
Under the Company's stock option plan, stock options may be granted for the purchase of common stock at a price not less than the fair market value on the date of grant. Options outstanding as of December 31, 1994 are exercisable over a four to five year vesting period. Options issued in 1997, 1996 and 1995 are exercisable after the expiration of five years following the grant date. Under this plan, the Company has reserved 2,475,000 shares of common stock for issuance pursuant to options granted under the plan.
SFAS No. 123, "Accounting for Stock-Based Compensation," encourages, but does not require, companies to record compensation cost for stock-based employee compensation plans at a fair value. The Company has chosen to continue to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations. Accordingly, compensation cost for the Company's compensation instruments is measured as the excess, if any, of the quoted market price of the Company's stock at the date of the grant over the amount an employee must pay to acquire the stock.
The following is a summary of the Company's option activity, including weighted average option information:
(2) Restated to reflect a two for one split of the Company's common stock distributed in November 1997, see Note 11.
In addition, the Company has also established a non-qualified Directors Stock Purchase Plan ("Directors Plan") for the benefit of non-employee Directors. The aggregate maximum number of shares that may be issued pursuant to the Directors Plan is 50,000. Non-employee Directors, during monthly offering periods, may designate a portion of his or her fees to be used for the purchase of shares under the terms of the Directors Plan at a purchase price of the lesser of 85% of the fair market value of the shares on the first business day of the offering period or the last business day of the offering period. No shares have been issued pursuant to the Directors Plan as of December 31, 1997.
Since the Company has adopted the disclosure-only provisions of SFAS No. 123, no compensation cost has been recognized for the Company's compensation instruments. The following represents pro forma information as if the Company recorded compensation costs using the fair value of the issued compensation instruments (the results may not be indicative of the actual effect on net income in future years) (in thousands, except per average common share data):
The fair value of options at date of grant was estimated using the Black-Scholes valuation model with the following weighted average assumptions:
The Company is subject to routine legal proceedings in connection with its property and casualty insurance business. The Company is not involved in any pending or threatened legal or administrative proceedings which management believes can reasonably be expected to have a material adverse effect on the Company's financial condition or results of operations.
The Company currently leases office space to serve as its headquarters location and 38 field offices for its production underwriters. Rental expense for these operating leases was $916,700, $736,700, and $187,800 for the years ended December 31, 1997, 1996 and 1995, respectively.
The following quarterly financial information for each of the three months ended March 31, June 30, September 30 and December 31, 1997 and 1996 is unaudited. However, in the opinion of management, all adjustments (consisting of normal recurring adjustments) necessary to present fairly the results of operations for such periods, have been made for a fair presentation of the results shown (in thousands, except share and per share data):