The following table should be read in conjunction with, and is supplemented in its entirety by, the consolidated financial statements and the notes thereto. Financial data has been restated to take into effect the Transactions effective October 2, 1995. The financial data for the years 1995 through 1999 has been derived from the audited consolidated financial statements of the Company.
Kaye Group Inc. (the "Company"), a Delaware corporation, is a holding company which, through its subsidiaries, is engaged in a broad range of insurance brokerage, underwriting and related activities. The Company operates in two insurance business segments - the Insurance Brokerage Companies Operations comprised of the Retail Brokerage Business and the Program Brokerage Business, and the Property and Casualty Companies Operations ("Property and Casualty Companies" or "Insurance"), comprised of the Insurance Companies and Claims Administration (see Note 1 to the consolidated financial statements of the Company).
Year ended December 31, 1999 compared with the year ended December 31, 1998
Income before income taxes increased by $617,000 to $2,322,000 in 1999 from $1,705,000 in 1998. The increased operating result was primarily due to a reduction of expenses as a result of an increase in intercompany management fees allocated to the Property and Casualty Companies, as discussed below.
Total revenues in 1999 were $38,753,000 compared with $37,202,000 in 1998, an increase of $1,551,000 (4%). Gross commissions and fees grew by $3,325,000 (8%) as a result of new business and acquisitions exceeding lost business. The SRW acquisition generated $3,653,000 of gross revenues during 1999. Included in lost business were revenues that had been derived from a certain New York City - based entities' medical malpractice coverage. This portfolio of business represented the majority of the Retail Brokerage Operations revenues in this concentration of coverage placement. The commission expense rate (defined as commissions incurred to independent producers as a percentage of gross commissions and fees) to produce new and renewal business increased from 18% to 20% which resulted in a decrease in net commissions and fees of $860,000. Investment income decreased by $472,000 (26%) primarily due to lower fiduciary investments as a result of certain lost business.
Salaries and benefits increased by $1,023,000 (5%) to $22,346,000 in 1999 compared to $21,323,000 in 1998. The increase was the result of acquisitions and salary increments offset partially by headcount reductions, reduced incentive compensation and an increase in intercompany management fees allocated to the Property and Casualty Companies discussed previously.
Other operating expenses decreased by $1,231,000 (9%) to $12,215,000 in 1999 compared with $13,446,000 in 1998 mainly due to an increase in intercompany management fees allocated to the Property and Casualty Companies (discussed previously) as well as reduced insurance costs.
Income before income taxes decreased by $811,000 (8%) to $8,826,000 in 1999 from $9,637,000 in 1998. The decrease was due to an increase in the combined ratio due to an increase in intercompany management fees (discussed previously) offset by an increase in net premiums earned.
Net investment income increased by $29,000 (1%) to $2,949,000 in 1999 from $2,920,000 in 1998. The increase was due to an increase in investments.
Net realized loss was $16,000 in 1999 compared to a realized gain $85,000 in 1998. The realization of investment gains and losses is determined by market conditions and management's decision regarding the holding period of the portfolio.
The loss ratio (loss incurred expressed as a percentage of premiums earned) was 36% and 34% for 1999 and 1998, respectively. Exclusive of the intercompany claims management fee increase in 1999 discussed previously, the loss ratio would have been 35% and 34% for 1999 and 1998, respectively. This increase was due to the change in the mix of business toward assumed general liability, which traditionally experiences a higher loss frequency.
Net expenses before income taxes decreased in 1999 by $369,000 to $419,000 from $788,000 in 1998. The segment's sole investment in Arista Investors Corp. was reduced due to an initial liquidating distribution. Arista's management has indicated its intention to sell its remaining asset, its license to operate, and its stock. This initial liquidating distribution, partially offset by the corresponding reduction in fair market value of Arista stock, was accounted for in net investment income and is the primary reason for the positive variance along with lower interest expense due to the June 1998 restructuring of corporate debt.
Net income for the year ended December 31, 1998 increased by $2,925,000 to $7,282,000 or basic earnings per share of $0.86 compared to $4,357,000 or $0.62 for the same period last year as explained below. $931,000 of the increase was due to the elimination of minority interest (see Note 2 to the consolidated financial statements of the Company).
Net expenses before income taxes decreased in 1998 by $143,000 (15%) to $788,000 from $931,000 in 1997. This decrease was the result of lower interest expense and insurance costs partially offset by a provision for investment decline and costs related to the restructuring of debt.
The effective tax rate for 1998 and 1997 was, 31%, and 30%, respectively. The difference between the statutory tax rate and the effective tax rate in 1998 and 1997 was primarily related to tax exempt interest.
The Company maintains a substantial level of cash and liquid short term investments, which are used to meet anticipated payment obligations. At December 31, 1999 and 1998, the Company had cash and short term investments of $43,238,000 and $48,393,000, respectively, of which $25,610,000 and $33,218,000 represents premiums
collected and held in a fiduciary capacity which are generally not available for operating needs of the Company. Of the Company's total invested assets, fixed maturities and cash equivalents carried at market value of $22,270,000 and $13,747,000 as of December 1999 and 1998, respectively, are pledged or deposited into trust funds to collateralize the Company's obligations under reinsurance agreements.
During 1998, the Company paid off its revolving credit line of $6,094,000 early, and replaced it with a term loan of $5,000,000, at an interest rate reduction of approximately 50 basis points, thereby reducing debt by $1,094,000. As of December 31, 1999, $3,311,000 is outstanding on the Term Loan. In addition, the Company has available a $4,500,000 revolving line of credit with a bank. Both lines are collateralized by the stock of the Property and Casualty Companies. The proceeds are available for general operating needs and acquisitions. As of December 31, 1999, no amount is outstanding on the revolving line of credit.
The table below sets forth the composition of the Company's portfolio of fixed maturity investments by rating as of December 31, 1999 (in thousands):
The Company's insurance subsidiaries require capital to support premium writing. The guidelines set forth by the NAIC for OLRI suggest that a property and casualty insurer's ratio of annual statutory net premiums written to policyholders' surplus should not exceed 3 to 1. At December 31, 1999, OLRI, with a statutory surplus of $31,100,000, had a ratio of annual statutory net premiums written to its statutory surplus of approximately .85 to 1.
On December 21, 1999 the Board of Directors declared a quarterly dividend of $.025 per share, payable January 20, 2000 to stockholders of record on December 31, 1999. The Company is largely dependent upon dividends from the Insurance Companies to pay dividends to the stockholders. The Company's Insurance Companies are subject to regulations that restrict their ability to pay dividends.
Under Rhode Island Insurance Law, OLRI may pay cash dividends only from earned surplus determined on a statutory basis, subject to the maintenance of minimum capital and surplus of $3,000,000. Further, OLRI is restricted (on the basis of the lesser of 10% of OLRI's statutory surplus at the end of the preceding twelve-month period or 100% of OLRI's net income, excluding realized capital gains, for the preceding twelve-month period) as to the amount of dividends it may declare or pay in any twelve-month period without prior approval of the Department of Business Regulation of Rhode Island. Without special permission, at December 31, 1999, $3,110,000 was available for distribution.
In March 1998, the American Institute of Certified Public Accountants ("AICPA") issued Statement of Position ("SOP") 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use, which requires capitalization of external and certain internal costs incurred to obtain or develop internal-use computer software during the application development stage. SOP 98-1 is effective for fiscal years beginning after December 15, 1998. This statement did not materially impact the Company's consolidated financial statements.
In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 133 (as amended), Accounting for Derivative Instruments and Hedging Activities. This statement requires all derivatives to be recognized as either assets or liabilities in the statement of financial position and to be measured at fair value. This statement is effective for all fiscal quarters and fiscal years beginning after December 31,2000. Management believes that the statement will not have a material impact on the financial position of the Company.
Many computers, software programs and microprocessors embedded in certain equipment (collectively, "systems") were designed to accommodate only two-digit date fields to represent a given year (e.g., "98" represents 1998). It was thought possible that such systems would not be able to accurately process data containing information relating to dates before, during or after the year 2000. It was thought possible that such systems could fail entirely, although in many instances the consequences of a system not being "year 2000 complaint" were unknown.
Testing conducted by a team of informational technology personnel and operational line staff from January 1, 2000 through January 3, 2000 on its application operating software and hardware determined that the Company's Y2K remediation efforts had been successful. This has been confirmed by post January 3, 2000 normal operations being unimpeded by Y2K related issues.
The total cost to modify these existing production systems, which includes both internal and external costs of programming, coding, testing and software/hardware and equipment purchases was approximately $473,000 and has been reflected in the financial statements.