All of the other insurance operations of the Company are conducted from leased premises in or adjacent to major urban centers throughout the United States, Puerto Rico, Canada and in Bermuda. These operations, in the aggregate, occupy approximately 903,000 square feet, at an annual rental of approximately $13,650,000.
: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL Orion Capital Corporation ("Orion") and its wholly-owned subsidiaries (collectively the "Company") operate principally in the property and casualty insurance business. The Company reports its insurance operations in three segments. In addition, the miscellaneous income and expenses (primarily interest, general and administrative expenses and other consolidating elimination entries) of the parent company are reported as a fourth segment. The three insurance segments as of December 31, 1997 are as follows:
Regional Operations - this segment includes the workers compensation insurance products and services sold by the EBI Companies ("EBI").
- the Company's 24.7% interest in Intercargo Corporation ("Intercargo"), which sells insurance coverages for international trade.
Guaranty National Companies ("Guaranty National") - this segment specializes primarily in nonstandard automobile insurance and other property and casualty insurance.
The Company completed two tender offers which increased its ownership of Guaranty National from 49.5% to 81.0% in July 1996 and to 100% in December 1997. The Company has increased its ownership in Guaranty National to 100% to provide Guaranty National with additional financing options, on terms that may not be available to it as an independent entity, so that it can continue its expansion in the nonstandard personal automobile business.
All revenues and expenses of Guaranty National from the beginning of 1996 have been consolidated with those of the Company. Minority interest expense has been recorded for the portion of Guaranty National's earnings that is attributable to the shares not owned by the Company in 1996 and 1997 until Guaranty National became a wholly-owned subsidiary of the Company. For 1995 the Company's investment in Guaranty National is accounted for using the equity method.
In 1997, Guaranty National completed the acquisition of a nonstandard personal automobile insurance company and announced the acquisition of another. On December 16, 1997, Guaranty National purchased Unisun Insurance Company ("Unisun") from Michigan Mutual Insurance Company for $26,170,000 in cash including expenses. Unisun is the largest servicing carrier for the automobile insurance facility in South Carolina and also writes personal automobile insurance in the states of Alabama, Georgia and North Carolina. Unisun has been included in the Company's consolidated financial statements from the date of acquisition. Total net premiums written by Unisun for 1997 are approximately $20,000,000.
In November 1997, Guaranty National entered into an agreement to acquire the nonstandard personal automobile insurance business of North Carolina-based Strickland Insurance Group ("Strickland") for $42,600,000 in cash. Strickland is the second largest writer of nonstandard personal automobile insurance in North Carolina and also writes business in Florida, Arkansas, Tennessee and Virginia. In 1997, Strickland had total personal automobile net premiums written of approximately $46,000,000. The Strickland acquisition is expected to be completed by the second quarter of 1998, subject to regulatory approval. The Strickland and Unisun acquisitions will permit the Company to begin writing nonstandard personal automobile insurance in the southeastern region of the United States, which is a new region for the Company.
Beginning in 1998, the commercial business lines of Guaranty National has merged with Connecticut Specialty to form a new company named Orion Specialty. The Company believes that the integration of the closely related operations will strengthen its commercial specialty insurance programs. Orion Specialty has dual headquarters in Connecticut and Colorado.
The Company's insurance operations have experienced favorable trends for the past several years, as indicated by its combined ratio which has continued to improve from 103.2% in 1993 to 101.2% in 1994, 100.3% in 1995, 99.8% in 1996 and 99.7% in 1997. The Company's operating earnings (earnings after taxes excluding after-tax realized investment gains) are $85,691,000 for 1997, $72,944,000 for 1996 and $59,914,000 for 1995. On a per share diluted basis, operating earnings are $3.07, $2.63 and $2.11 for 1997, 1996 and 1995, respectively. For the five year period ended December 31, 1997, the Company's return on equity from operating earnings has averaged 13.8% per year.
Percent Change -------------- 1997 1996 1995 97/96 96/95 ---- ---- ---- ----- ----- (000s omitted)
Connecticut Specialty... $170,463 $173,724 $153,285 (1.9)% 13.3% DPIC.................... 198,765 195,546 184,130 1.7 6.2 McGee................... 57,103 41,575 14,977 37.4 177.6 -------- -------- -------- 426,331 410,845 352,392 3.8 16.6 Assumed reinsurance..... 10,567 79,003 72,446 (86.6) 9.0 -------- -------- -------- $436,898 $489,848 $424,838 (10.8)% 15.3% ======== ======== ========
Excluding premiums from the assumed reinsurance business sold in November 1996, this segment's net premiums written increased 3.8% and 16.6% for 1997 and 1996, respectively. Net premiums written by DPIC for professional liability insurance, the largest special program, increased 1.7% in 1997 and 6.2% in 1996. The increase in 1997 and 1996 is primarily attributable to continued high levels of policy renewals and new business offset in part by rate reductions in a very competitive professional liability insurance market.
Connecticut Specialty's net premiums written decrease of 1.9% is primarily attributable to a cancelled ocean marine program resulting in lower premiums in 1997 as compared to 1996 by $11,300,000, partly offset by increases in premiums from transportation programs, and low exposure professional liability programs. Further, net premiums written for most Connecticut Specialty programs increased in 1997 from 1996 due to higher retentions after a change in reinsurance effective May 1996. Connecticut Specialty's premiums increase of 13.3% in 1996 is attributable to higher premiums written in low exposure professional liability programs and higher retention for most programs after a change in reinsurance, partly reduced by lower premiums from its inland marine programs.
Starting in 1998, Connecticut Specialty and the commercial lines of Guaranty National have merged to form Orion Specialty. On a pro forma basis, Orion Specialty's net written premiums decreased by $6,813,000 to $402,809,000 in 1997 from $409,622,000 in 1996. As noted above, this decrease is primarily due to management's efforts to eliminate under- performing programs.
The percentage of treaty and facultative reinsurance assumed to total net premiums written for this segment is 2.4%, 16.1% and 17.1% in 1997, 1996 and 1995, respectively. This decline is due to the sale of the assumed reinsurance business.
Percent Change -------------- 1997 1996 97/96 96/95 ---- ---- ----- ----- (000s omitted)
The 30.3% net premiums written growth for Personal Lines in 1997 is due to newly-enacted legislation in the state of California which requires all drivers to maintain liability insurance. This change in California law resulted in a 75% increase in the Personal Lines one-month product business to approximately $155,000,000 in 1997.
Commercial Lines net premiums written decreased by 10.5% in 1997 due to lower production in nonstandard business, increased competition by standard carriers in the nonstandard marketplace, and the effect of both agent and program cancellations. The 16.3% premium volume growth for Collateral Protection in 1997 comes from increased writing in mortgage fire insurance and mechanical breakdown programs. Starting in 1998, Commercial Lines and Collateral Protection will be part of Orion Specialty and Guaranty National will be comprised of Personal Lines.
Guaranty National's net premiums written for 1996 were included in the Company's consolidated financial statements as a result of the Company's increase in ownership of Guaranty National to over 80% in 1996. Net premiums written for Guaranty National are $397,899,000 in 1995. The 30.4% increase for Personal Lines in 1996 is the result of Guaranty National's acquisition of Viking Insurance Company of Wisconsin in July 1995. The Commercial Lines premium increase of 5.9% in 1996, which resulted from the expansion of automobile physical damage and property programs, were partially offset by a planned reduction in commercial automobile liability premiums. The 46.3% increase in Collateral Protection for 1996 is primarily from two new products, automobile financing GAP and mortgage fire insurance.
The Company's premiums earned increased 4.4% ($56,928,000) to $1,357,680,000 in 1997 and increased 73.7% ($551,749,000) to $1,300,752,000 in 1996 from $749,003,000 in 1995. Premiums earned reflect the recognition of income from the changing levels of net premium writings, as well as the inclusion of Guaranty National's premiums earned of $481,648,000 in 1996.
1997 1996 1995 ---- ---- ---- (000s omitted) Net investment income ..................... $164,908 $145,391 $ 99,040 -------- -------- -------- Net realized gains (losses): Fixed maturities ........................ 3,986 2,067 (4,361) Equity securities ....................... 43,789 22,113 16,246 -------- -------- -------- 47,775 24,180 11,885 -------- -------- -------- Net unrealized appreciation (depreciation): Fixed maturities ........................ 40,640 (16,414) 89,932 Equity securities ....................... 18,381 18,461 34,002 -------- -------- -------- 59,021 2,047 123,934 -------- -------- -------- $271,704 $171,618 $234,859 ======== ======== ======== Net Investment Income
Fixed maturity investments which the Company has both the positive intent and the ability to hold to maturity are recorded at amortized cost. Fixed maturity investments which may be sold in response to, among other things, changes in interest rates, prepayment risk, income tax strategies or liquidity needs are classified as available-for-sale and are carried at market value. The carrying value of fixed maturity and short-term investments is $2,010,893,000 and $1,858,045,000 at December 31, 1997 and 1996, respectively, or approximately 78.8% and 80.0% of the Company's cash and investments.
The Company's investment philosophy is to achieve a superior rate of return after taxes, while maintaining a proper balance of safety, liquidity, maturity and marketability. The Company invests primarily in investment grade securities and strives to enhance the average return of its portfolio through limited investment in a diversified group of non-investment grade fixed maturity securities or securities that are not rated. The risk of loss due to default is generally considered greater for non-investment grade securities than for investment grade securities because the former, among other things, are often subordinated to other indebtedness of the issuer and are often issued by highly leveraged companies. At December 31, 1997 and 1996, the Company's investment in non-investment grade and non-rated fixed maturity securities were carried at $256,745,000 and $219,473,000, respectively. These investments represented a total of 10.1% and 9.5% of cash and investments and 6.6% and 6.3% of total assets at December 31, 1997 and 1996, respectively.
Net realized investment gains are $47,775,000 in 1997, $24,180,000 in 1996 and $11,885,000 in 1995. Sales of equity securities have resulted in net gains of $44,189,000, $22,428,000 and $16,531,000 and sales of fixed maturity investments have resulted in net gains (losses) of $6,004,000, $3,186,000 and $(311,000) in 1997, 1996 and 1995, respectively. Realized investment gains are reduced by provisions for losses on securities deemed to be other-than- temporarily impaired. These provisions amounted to $400,000 in 1997, $315,000
in 1996 and $285,000 in 1995 for equity securities and $2,018,000, $1,119,000 and $4,050,000 in 1997, 1996 and 1995, respectively, for fixed maturity investments. Such provisions, based on available information at the time, are made in consideration of the decline in the financial condition of the issuers of these securities.
The decrease in the 1997 ratio of loss and loss adjustment expense to premiums earned (the "loss ratio") is attributed to improvements in both the Regional Operations and Guaranty National segments, offset in part by higher losses for Special Programs. The decrease in the 1996 loss ratio is attributable to improvements in both the Regional Operations and Special Programs segments, offset in part by the consolidation of Guaranty National in 1996. The Company's efforts to reduce its loss costs have had a positive impact on profitability.
The increase in the 1997 loss ratio for Special Programs is mainly attributable to losses from certain programs cancelled by Connecticut Specialty. The 1997 loss ratio increase has been partly offset by the favorable effect of a change in this segment's mix of business, particularly the lower premiums and losses from the assumed reinsurance business that the Company exited in November 1996. The improvement in the 1996 loss ratio for
this segment is primarily attributable to a lower loss ratio for Connecticut Specialty, both from the change in its reinsurance during 1996 and the impact on 1995 results of certain cancelled programs which had unfavorable loss experience in 1995. These improvements are offset in part by reserve strengthening for the Company's pools and associations and reinsurance business in 1997 and 1996. As discussed above, the Company formed Orion Specialty through the merger of Connecticut Specialty and the Commercial Lines of Guaranty National. On a pro forma basis, Special Programs loss ratio for 1997 would be 72.1% with restatement to include Orion Specialty.
Provisions for losses and loss adjustment expenses include development of loss and loss adjustment expense reserves relating to prior accident years, which increased the calendar year combined ratio by 0.7 percentage points in both 1997 and 1996 and 1.6 percentage points in 1995. The loss ratios are adversely affected by loss development in the pools and associations, reinsurance, certain discontinued lines and program business, reduced by favorable development in the workers compensation insurance line of business from the improved application of loss prevention and loss control procedures.
As of December 31, 1997 and 1996, the Company has environmental claims- related loss and loss adjustment expense reserves, net of reinsurance recoverables, of $67,879,000 and $57,028,000, respectively. Claims counts are 551 and 632 at December 31, 1997 and 1996, respectively, for direct business written by the Company which excludes reinsurance pools and associations. Following industry practice, claim counts are generally established for each insured for each policy. For workers compensation claims, individual claimants are counted in claim counts. Changes in claims counts for 1997 and 1996 are primarily attibutable to EBI, which is not a significant component of the Company's environmental reserves. In estimating liabilities for environmental-related claims, the Company considers all pertinent information as it becomes available. The net reserve for environmental claims and IBNR increased $10,851,000 in 1997 and $22,469,000 in 1996 primarily due to higher claims reported to the Company by certain reinsurance pools and associations, which is the basis of establishing such reserve, and higher loss reserve estimates. The 1996 reserve increase also reflects the inclusion of Guaranty National.
Other expenses are $45,002,000, $42,932,000 and $24,740,000 in 1997, 1996 and 1995, respectively. The increases in both other income and other expenses for 1996 are primarily attributable to the inclusion of McGee's pool management revenue and expenses after it was acquired by the Company on June 30, 1995.
Equity in earnings of affiliates consists of earnings of $8,619,000 for 1997, a loss of $389,000 for 1996, and includes earnings of $1,038,000 for 1995 from the Company's investment in Intercargo. The Company records its share of Intercargo's results in the subsequent quarter. The 1997 earnings reflect a pre-tax gain of $6,988,000 from Intercargo's sale of Kingsway Financial Services. In 1995, Guaranty National was a non-majority owned affiliate of the Company and was therefore accounted for using the equity method. Included in equity in net earnings of affiliates from Guaranty National was $4,466,000 in 1995.
Earnings before federal income taxes and minority interest expense are $176,180,000, $127,356,000 and $88,035,000 for 1997, 1996 and 1995, respectively. The increases in pre-tax earnings of 38.3% and 44.7% for 1997 and 1996 reflect the increase in ownership of Guaranty National and improvement in insurance operations profitability of $25,229,000 and $27,026,000 and increases in realized investment gains of $23,595,000 and $12,295,000, respectively.
Guaranty National became a majority-owned subsidiary in July 1996, and its results have been consolidated in the Company's financial statements since the beginning of 1996. In December 1997, Guaranty National became a wholly- owned subsidiary of the Company. Minority interest expense of $7,036,000 and $8,692,000 is recorded for the after-tax portion of Guaranty National's 1997 and 1996, respectively, earnings attributable to stockholders of Guaranty National other than the Company.
Cash provided by operating activities decreased by $67,781,000 to $99,960,000 in 1997 from $167,741,000 in 1996 and increased $19,724,000 in 1996 from $148,017,000 in 1995. The decrease in operating cash flow for 1997 is the result of higher payments for losses, policy acquisition costs, policyholders' dividends and minority interest from subsidiary trust preferred capital securities, consistent with the Company's growth in recent years and including the payment of losses for the assumed reinsurance business the Company exited in November 1996 and certain cancelled program business. Partially offsetting these increased cash outflows are higher premiums collected, reflective of the Company's current rate of growth, as well as higher investment income collected. The increase for 1996 is attributable to including Guaranty National's cash flow in the Company's consolidated financial statements.
Cash used in investment activities increased by $75,001,000 to $207,370,000 in 1997 from $132,369,000 in 1996 and decreased $56,079,000 in 1996 from $188,448,000 in 1995. Cash is used in investment activities primarily for purchases of investments and acquisition activities. Investment purchases are funded by maturities and sales of investments, as well as by the net cash from positive operating cash flows after cash provided by or used in financing activities. Cash used in acquisition activities in 1997 includes $104,429,000 for the purchase of Guaranty National common stock, $24,464,000 for the purchase of Unisun (net of cash acquired), and a $2,000,000 purchase price deposit for the 1998 planned acquisition of Strickland. The total purchase price for Strickland is $42,600,000. In July 1996 the Company purchased Guaranty National common stock for cash of $88,206,000. In June 1995 Orion paid $22,000,000 in cash plus acquisition costs to acquire McGee.
Orion's uses of cash consist of debt service, dividends to stockholders and overhead expenses. These cash uses are funded from existing available cash, financing transactions and receipt of dividends, reimbursement of overhead expenses and amounts in lieu of federal income taxes from Orion's insurance subsidiaries. Orion has received $42,822,000, $35,286,000 and $30,546,000 in dividends, $8,114,000, $7,410,000 and $6,232,000 for overhead expenses and federal tax payments of $9,525,000, $7,455,000 and $4,500,000 from its insurance subsidiaries in 1997, 1996 and 1995, respectively. Payments of dividends by Orion's insurance subsidiaries must comply with insurance regulatory limitations concerning stockholder dividends and capital adequacy. State insurance regulators have broad discretionary authority with respect to limitations on the payment of dividends by insurance companies. Limitations under current regulations are well in excess of Orion's cash requirements.
December 31, 1997 and 1996, respectively. The Company's statutory operating leverage ratios of net premiums written to policyholders' surplus is 1.8:1 and 2.0:1 at December 31, 1997 and 1996, respectively.
On January 13, 1997 Orion issued $125,000,000 of 8.73% Junior Subordinated Deferrable Interest Debentures due January 1, 2037 (the "Debentures") to Orion Capital Trust I (the "Trust"), a Delaware statutory business trust sponsored by Orion. The Trust simultaneously sold $125,000,000 of 8.73% Capital Securities (the "Trust Preferred Securities") which have substantially the same terms as the Debentures. The net proceeds from the sale of the Trust Preferred Securities were used in part for the acquisition of Guaranty National common stock in December 1997. The Trust Preferred Securities may be redeemed without premium on or after January 1, 2007.
The 8.73% and 7.701% Capital Securities are subordinated to all liabilities of the Company. The Company may defer interest distributions on these Capital Securities; however, during any period when such cumulative distributions have been deferred, Orion may not declare or pay any dividends or distributions on its common stock.
The Company issued a 2-for-1 split of its common stock on July 7, 1997 to shareholders of record on June 23, 1997. The Company has repurchased 42,916 shares, 482,228 shares and 346,362 shares of its common stock at an aggregate cost of $1,533,000, $11,148,000 and $7,183,000 in 1997, 1996 and 1995, respectively. At December 31, 1997 the Company's remaining stock purchase authorization from its Board of Directors amounted to $3,169,000. In February 1998, the Board of Directors increased the authorization for purchases of the Company's common stock by an additional $25,000,000.
Orion and its subsidiaries are routinely engaged in litigation incidental to their businesses. Management believes that there are no significant legal proceedings pending against the Company which, net of reserves established therefor, are likely to result in judgments for amounts that are material to the financial condition, liquidity or results of operations of Orion and its consolidated subsidiaries, taken as a whole.
The Company has taken actions to understand the nature and extent of the work required to make its systems, products and infrastructure Year 2000 compliant including assessments of the readiness of external entities which it interfaces with such as vendors, customers and others. The Company began work several years ago to prepare its products and its financial, information and other computer-based systems for the Year 2000, including replacing and/or updating systems and is utilizing both internal and external resources. The Company continues to evaluate the estimated costs associated with these efforts based on actual experience. While final cost estimates are not complete, the Company believes, based on available information, that it will be able to manage its total Year 2000 transition without any material adverse effect on its business operations, products or financial prospects. The Company has expensed $2,382,000 of Year 2000 costs through 1997 and expects to incur between $9,500,000 and $12,500,000 of additional expenses in 1998 and 1999.
In June 1997, the FASB issued SFAS No. 130 "Reporting Comprehensive Income." This statement establishes standards for reporting and display of comprehensive income and its components in the financial statements. The Company will adopt this statement in first quarter of 1998. The Company is in the process of determining its preferred format. The adoption of this statement will have no impact on the Company's results of operations, financial position or cash flows.
All statements made in this Annual Report that do not reflect historical information are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. Such factors include, among other things, (i) general economic and business conditions; (ii) interest rate changes; (iii) competition and regulatory environment in which the Company operates; (iv) claims frequency; (v) claims severity; (vi) medical cost inflation; (vii) increases in the cost of property repair; (viii) the number of new and renewal policy applications submitted to the Company; and (ix) other factors over which the Company has little or no control. The Company disclaims any obligation to update or to publicly announce the impact of any such factors or any revisions to any forward-looking statements to reflect future events or developments.
The Audit and Information Services Committee of the Board of Directors is comprised of independent directors, and has general responsibility for oversight of financial controls and audit activities of the Company and its subsidiaries. The Audit and Information Services Committee, which reports to the Board, annually reviews the qualifications of the independent auditors and meets periodically with them, the internal auditors and management to review the plans and results of the audits. Both internal and independent auditors have free access to the Audit and Information Services Committee, without members of management present, to discuss the adequacy of the system of internal controls and any other matters which they believe should be brought to the attention of the Committee.
We have audited the accompanying consolidated balance sheets of Orion Capital Corporation and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of earnings, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1997. Our audits also included the financial statement schedules listed in the Index at Item 14(a)2. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedules based on our audits.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Orion Capital Corporation and subsidiaries as of December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997 in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.
Basis of Financial Statement Presentation - Orion Capital Corporation ("Orion") and its majority-owned subsidiaries (collectively the "Company") operate principally in the property and casualty insurance business. The Company reports its insurance operations in three segments - Regional Operations, Special Programs and Guaranty National Corporation. Regional Operations provides workers compensation insurance products through EBI Companies. Special Programs includes: (i) DPIC Companies ("DPIC"), which markets professional liability insurance, (ii) Connecticut Specialty, which writes specialty insurance programs, (iii) Wm. H. McGee & Co., Inc. ("McGee"), an underwriting management company that specializes in ocean marine, inland marine and commercial property insurance and (iv) a 24.7% interest in Intercargo Corporation ("Intercargo") which underwrites insurance coverages for international trade. The third segment, Guaranty National Corporation ("Guaranty National"), specializes in nonstandard commercial and personal automobile insurance. The miscellaneous income and expenses (primarily interest, general and administrative expenses and other consolidating elimination entries) of the parent company are reported as a fourth segment. The consolidated financial statements and notes thereto are presented in accordance with generally accepted accounting principles ("GAAP") for property and casualty insurance companies and include the accounts of Orion and its majority-owned subsidiaries. The Company's investments in unconsolidated affiliates are accounted for using the equity method (See Note C). All material intercompany balances and transactions have been eliminated. The preparation of the Company's consolidated financial statements in conformity with GAAP requires Company management to make estimates and assumptions that affect the amounts reported in these consolidated financial statements and accompanying notes. Actual results could differ from those estimates.
Cash - For purposes of the consolidated statement of cash flows, the Company considers only demand deposit accounts to be cash.
Revenue Recognition - Premiums are earned on a daily pro rata basis over the policy period. A provision is made for anticipated retrospective premium adjustments and audit premiums. Direct and assumed premiums are reduced for reinsurance ceded to other insurers.
Policy Liabilities and Reinsurance - Loss and loss adjustment expense liabilities are established in consideration of individual cases for reported losses and past experience for incurred but not yet reported losses ("IBNR"). Estimated reinsurance receivables are recognized in a manner consistent with the liabilities relating to the underlying reinsured contracts. At December 31, 1997 and 1996, long-term disability workers compensation loss reserves are carried at $52,907,000 and $54,832,000, respectively, in the consolidated financial statements at net present value using a statutory interest rate of 3.5%. Policyholders' dividends on participating policies are accrued at estimated payment rates as the related premiums are earned. Participating business represented 18% and 17% of premiums in-force at December 31, 1997 and 1996, respectively. As a percent of premiums earned, participating business amounted to 18% in 1997, 16% in 1996 and 24% in 1995.
Earnings Per Common Share - In the fourth quarter of 1997, the Company adopted Statement of Financial Accounting Standards No. 128, "Earnings per Share," for all periods presented. Basic earnings per share computations are based on the average number of shares of common stock outstanding during the year. Diluted earnings per share reflects the assumed exercise and conversion of all securities, including stock options. All common stock and per common
stock data presented has been restated to give effect to the 2-for-1 stock split of the Company's common stock issued on July 7, 1997.
The 1996 GNC Purchase was recorded as a step acquisition using the purchase method of accounting as of June 30, 1996. The assets and liabilities of Guaranty National were consolidated in the Company's financial statements and minority interest for approximately 19% of Guaranty's shareholders equity was recorded. Beginning in 1996, all revenues and expenses of Guaranty National have been consolidated with those of the Company, and minority interest expense has been recorded for the portion of Guaranty National's earnings that was attributable to the shares not owned by the Company.
On December 10, 1997, the Company purchased the remaining 19.7% or 2,970,000 shares of Guaranty National common stock that were held by minority interest shareholders for $36 per share in cash ("1997 GNC Purchase"). Immediately following the 1997 GNC Purchase, Guaranty National was merged into a wholly-owned subsidiary of the Company and delisted as a publicly traded company on the New York Stock Exchange. As part of the merger, 450,238 outstanding stock options granted by Guaranty National were converted into 358,090 stock options of the Company, with equivalent terms as the Guaranty National options except for the exercise price, which was adjusted to reflect the difference between the then current stock prices.
The 1997 GNC Purchase was recorded as a step acquisition using the purchase method of accounting. The aggregate purchase price was $116,082,000, including stock options converted of $8,356,000 and acquisition expenses of $800,000. The Company recorded the excess of the cost over the estimated fair value of the 19.7% interest in Guaranty National's net assets acquired during 1997 of $59,470,000 and eliminated the related minority interest. The excess of the cost over fair value will be amortized over 27 years, which is the remaining amortization period for goodwill recorded upon the Company's initial investment in Guaranty National.
Pro forma information, as if Guaranty National was 100% owned as of the beginning of 1996, is as follows for the year ended December, 31:
1997 1996 ---- ---- Total revenues ...................... $1,590,535 $1,491,212 ========== ========== Net earnings ........................ $ 116,930 $ 93,815 ========== ========== Net earnings per diluted share....... $ 4.16 $ 3.35 ========== ==========
On December 16, 1997, Guaranty National purchased Unisun Insurance Company ("Unisun") from Michigan Mutual Insurance Company for $26,000,000 in cash and incurred acquisition expenses of $170,000. Unisun is the largest automobile insurance facility carrier in South Carolina and also writes personal automobile insurance in the states of Alabama, Georgia and North Carolina. Total net premiums written by Unisun for 1997 were approximately $20,000,000. The acquisition of Unisun was accounted for as a purchase. The financial results of Unisun have been included in the Company's financial statements since the date of acquisition. The total consideration exceeded the estimated fair value of net assets of Unisun by $2,182,000, which is being amortized over 40 years. The pro forma consolidated results of the Company's operations, as if the Unisun purchase had been made as of the beginning of the year, would not be materially different than reported herein.
In November 1997, Guaranty National entered into an agreement to acquire the nonstandard private passenger automobile insurance business of North Carolina-based Strickland Insurance Group ("Strickland") for $42,600,000 in cash. Pursuant to the agreement, Guaranty National made a nonrefundable purchase price deposit of $2,000,000 to Strickland and incurred acquisition costs of $94,000 as of December 31, 1997. In 1997, Strickland had total private passenger automobile net premiums written of approximately $46,000,000. The acquisition is expected to be completed in the second quarter of 1998, subject to regulatory approval.
On June 30, 1995, Orion purchased all of the capital stock of McGee for $22,000,000 in cash, and incurred acquisition expenses of $355,000. McGee specializes in underwriting ocean marine, inland marine and commercial property insurance through an underwriting pool in the United States and one in Canada. The business is written by McGee on behalf of the insurance companies that comprise the pools. The Company's participation in the United States pool was approximately 15% and 37% in 1995 and 1996, respectively. Participation in the Canadian pool was 15% in 1995 and approximately 49% in 1996. The Company's rate of participation for 1997 is 52% in the United States and 61% in Canada. The acquisition was accounted as a purchase, and McGee's operations have been included in the Company's results of operations since July 1, 1995. The Company recorded $22,317,000 for the excess of cost over the estimated fair value of the net assets acquired, which is being amortized over a 30 year period.
Investments in affiliates include the Company's interest in Guaranty National through December 31, 1995, and the Company's 24.7% interest in Intercargo, a publicly-held company. The Company's financial statements include the portion of Guaranty National's 1995 earnings and Intercargo's results attributable to the Company's ownership on an equity accounting basis for applicable periods. The Company records its share of Intercargo's operating results in the subsequent quarter, after Intercargo has reported its financial results. The carrying values of the Company's investment in affiliates was $31,267,000 at December 31, 1997 and $22,170,000 at December 31, 1996, with market values of $25,165,000 and $16,262,000, respectively. The carrying value included $10,530,000 and $11,022,000 of goodwill at December 31, 1997 and 1996, respectively. In August, 1997, Intercargo recognized a gain before taxes of $49,443,000 from the sale of substantially all of its interest in Kingsway Financial Services. The Company reflected its portion of the Kingsway sale by recording a gain before taxes of $6,988,000 in the fourth quarter of 1997.
Other long-term investments had aggregate carrying values of $94,339,000 at December 31, 1997 and $90,129,000 at December 31, 1996 including mortgage loans on real estate of $2,249,000 and $1,187,000, respectively. Estimated market values of mortgage loans and other long-term investments approximate their carrying values. The carrying value of the Company's investments in principal- only securities and interest-only securities totalled approximately $12,400,000, or 0.5% of total invested assets at December 31, 1997.
The carrying value of securities on deposit with state regulatory authorities in accordance with statutory requirements totalled $223,423,000 and $236,328,000 at December 31, 1997 and 1996, respectively. Excluding investments in securities of the United States Government and its agencies, the Company did not have any investments in securities of any one issuer that exceeded $25,000,000. The Company had $214,000 and $2,227,000 of fixed maturity investments for which it was not accruing income for the years ended December 31, 1997 and 1996, respectively.
An analysis of the Company's calendar year net loss and loss adjustment expense reserves is summarized in the following table. The 1996 current year provision and payments include favorable loss development for Guaranty National of $995,000 and payments of $144,775,000 attributable to periods prior to the consolidation of Guaranty National's results in the Company's financial statements.
Note H - Company-Obligated Mandatorily Redeemable Preferred Capital Securities of Subsidiary Trust Holding Solely the Junior Subordinated Debentures of the Company.
On January 13, 1997, the Company issued $125,000,000 of 8.73% Junior Subordinated Deferrable Interest Debentures due January 1, 2037 (the "Debentures") to Orion Capital Trust I (the "Trust"), a Delaware statutory business trust sponsored by Orion. The Trust simultaneously sold $125,000,000 of 8.73% Capital Securities (the "Trust Preferred Securities") which have substantially the same terms as the Debentures. The Trust Preferred Securities are subordinate to all liabilities of the Company, and may be redeemed without premium on or after January 1, 2007. The Company may defer interest distri- butions on the Trust Preferred Securities; however, during any period when such cumulative distributions have been deferred, Orion may not declare or pay any dividends or distributions on its common stock. The Company registered the Trust Preferred Securities under the Securities Act of 1933 in April 1997. The Trust is consolidated in the Company's financial statements because it is wholly-owned by the Company. The sole assets of the Trust are the Debentures issued by Orion. Orion has given its partial guarantee, which when taken to- gether with the Company's obligations under the declaration of the Trust, the Debentures, and the indenture pursuant to which the Trust Preferred Securities are issued including its obligations to pay costs, expenses, debts and liabilities of the Trust (other than with respect to the Trust Preferred Securities), provides a full and unconditional guarantee of amounts due on the Trust Preferred Securities. The carrying value and estimated market value of the Trust Preferred Securities are $125,000,000 and $137,525,000, respectively, at December 31, 1997.
Rent expense amounted to $23,134,000, $19,824,000 and $14,112,000 for 1997, 1996 and 1995, respectively. Substantially all leases are for office space and equipment. A number of lease commitments contain renewal options ranging from one to thirty years.
In August 1997, several of the Company's subsidiaries were named as defendants in a class action lawsuit titled Bristol Hotel Management Corporation, et al., vs. Aetna Casualty & Surety Company, which was filed in the U.S. District Court for the Southern District of Florida. The lawsuit, brought on behalf of an alleged class of retrospectively rated workers compensation purchasers, claims, among other allegations, a conspiracy among insurers to charge illegally high prices for workers compensation insurance, breach of contract and fraud, Since that time, additional class action lawsuits with similar allegations have been brought against various subsidiaries of the Company in Georgia, Illinois, New Jersey, Pennsylvania and Tennessee as well as other insurers who did business in those states. The Company intends to vigorously defend these lawsuits.
Orion declared dividends on its common stock of $17,087,000, $14,290,000 and $12,078,000, or $.62, $.51 and $.43 per share in 1997, 1996 and 1995, respectively.
Effective as of September 11, 1996, Orion redeemed its old stockholder rights plan and adopted a new Stockholder Rights Plan ("Rights Plan"). Under the Rights Plan each outstanding share of common stock includes one preferred stock purchase right ("Rights"). The Rights Plan is designed to assure stockholders that they will receive equitable treatment in the event of a proposed takeover. Under the Rights Plan, each holder of a Right is entitled to buy two-hundredth of a share of Series B Junior Participating Preferred Stock. The Rights become exercisable (i) if an acquiror gains a 15% or greater beneficial ownership interest in Orion's outstanding common stock, on other than fair and favorable terms to all stockholders or (ii) following the commencement of a tender offer or exchange offer that would result in an acquiror owning 15% or more of Orion's outstanding common stock. Each Right not owned by such acquiror will enable the holder to purchase, at an initial purchase price of $100, common stock having a value of twice the Right's purchase price. In addition, under certain circumstances if Orion is involved in a merger each Right will entitle its holder to purchase, at the Right's then current purchase price, common shares of such other company having a value of twice the Right's purchase price.
The Company maintains a Stock Savings and Profit Sharing Plan ("Plan"), qualified under Internal Revenue Code Section 401(k), for eligible employees of the Company (except for employees of Guaranty National and McGee). Employee and employer matched contributions to the savings funds are limited to the extent allowable under the Plan and federal income tax law. The Plan also provides for defined contribution savings and retirement benefits that allow the Company to make annual contributions to the Plan based on a percentage of employees' compensation and the Company's operating earnings. Employees vest in the Company's contributions over a six-year period. The Company has adopted a Surplus Benefit Plan which provides deferred benefits for those employees who received less than the full employer contribution to the Company's 401(k) plan as a result of federal tax limitations on participation in the Plan.
Guaranty National has a defined contribution profit sharing plan ("Guaranty Plan"), which also qualifies under Section 401(k), for which substantially all of its employees are eligible. Guaranty National makes matching contributions to the Guaranty Plan in accordance with the limits of the Guaranty Plan and federal income tax law. Guaranty National has a non- qualified Supplemental Executive Retirement Plan ("SERP") for employees whose compensation meets a minimum requirement. The SERP provides deferred benefits for those employees who received less than the full employer contribution of the Guaranty Plan as a result of federal tax limitations on participation in the plan.
As of December 31, 1997, Unisun froze its defined benefit pension plan that covered substantially all of its employees. Benefits were based on years of service and the employee's highest consecutive five years' (out of the last ten calendar years) average annual compensation. At December 31, 1997 the plan assets of $7,055,000 exceed the projected benefit obligation of $5,829,000 by $1,226,000.
The Company maintains incentive plans for key employees, including the 1982 Long-Term Performance Incentive Plan ("1982 Plan"), and the Equity Incentive Plan (together the "Incentive Plans"). Orion has awarded both stock options and restricted stock to members of the Company's management under the Incentive Plans. All stock options are granted by Orion with exercise prices at fair market value at date of grant, and are intended to qualify to the maximum extent possible as incentive stock options. Stock options become exercisable from the first through fourth anniversaries of the date of grant, and expire ten years after the date of grant. Restricted stock is considered issued and outstanding when awarded. There are restrictions as to its transferability, which restrictions lapse in 25% increments over four or five year periods from the date of grant. As of December 31, 1997, the number of shares of stock reserved under the Incentive Plans is 2,094,481, of which 1,452,355 are for outstanding stock options and 215,567 and 426,559 are available for future awards under the 1982 Plan and the Equity Incentive Plan, respectively. Included in 1997 granted options were 358,090 of stock options relating to the 1997 GNC Acquisition of Guaranty National.
Orion granted 57,202 shares of restricted stock at a weighted average fair value of $43.95 per share during 1997, 92,636 shares at $25.61 during 1996 and 55,030 shares at $14.03 for 1995. As of December 31, 1997, the restrictions have not lapsed on 186,294 shares of restricted stock. The fair market value of restricted stock on the date of issuance is amortized over the vesting period during which the restrictions lapse.
The Company provides postretirement medical benefits to full-time employees (except for employees of Guaranty National), who have attained age 55 and have 10 years of consecutive service immediately prior to retirement with an increasing level of benefits for additional years of service up to 25. The postretirement health care plans are not funded. Recent changes to the plans for dependent coverage, coordination with other coverages and cost sharing arrangements have been reflected in the accumulated post retirement benefit obligation as of December 31, 1997. The accumulated postretirement benefit obligation of these plans included in other liabilities in the consolidated balance sheet is as follows:
Net postretirement benefit cost for the years ended December 31, 1997, 1996 and 1995 was $1,070,000, $1,072,000 and $1,203,000 consisting of service cost benefits earned of $936,000, $953,000 and $695,000 and interest on the accumulated postretirement benefit obligation of $640,000, $596,000 and $612,000, respectively, and amortization of unrecognized net gains of $506,000 in 1997, $477,000 in 1996 and $104,000 in 1995.
The expected health care cost trend rate used as of December 31, 1997 was 15.0% for 1998 and 8.5% for 1999, decreasing linearly each year until it reaches 5% for 2006 and future years. At December 31, 1996 the expected health care cost trend rates used were 15.0% for 1997 and 8.5% for 1998, ratably reduced to 5% for 2005 and later years. A one-percentage-point increase in the assumed health care cost trend rate for each year would increase the aggregate service cost and interest cost for 1997, 1996 and 1995 by $260,000, $265,000 and $245,000, respectively, and increase the accumulated postretirement benefit obligation as of December 31, 1997 and 1996 by $477,000 and $1,075,000, respectively. A one-percentage-point decrease in the health care cost rate would decrease service and interest costs and the accumulated post retirement benefit obligation by similar amounts. The assumed discount rate used in determining the accumulated postretirement benefit obligation was 7.0% at December 31, 1997 and 7.5% at December 31, 1996.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income." This statement establishes standards for reporting and display of comprehensive income and its components in the financial statements. The Company will adopt this statement in the first quarter of 1998. The Company is in the process of determining its preferred format. The adoption of this statement will have no impact on the Company's results of operations, financial position or cash flows.