in the statements of operations pursuant to SFAS 109 and the Company's tax- sharing agreement with its former parent, Halliburton. Tax receipts under its intercompany tax-sharing arrangements with Halliburton were recorded as additions to stockholders' equity for the periods preceding the Distribution. For further information regarding federal and foreign income taxes, see Note 7 to Consolidated Financial Statements.
(3) The earnings per share amounts prior to 1997 have been restated to comply with Statement of Financial Accounting Standards No. 128. Earnings Per Share. For further discussion of earnings per share and the impact of Statement No. 128, see the notes to the consolidated financial statements. Earnings (loss) per share for periods preceding the distribution has been computed based upon the 11,448,208 shares of Company Common Stock distributed on January 23, 1996.
The property and casualty insurance industry's profitability may be affected significantly by the availability of insurance coverage, which varies according to levels of surplus in the industry, volatile and unpredictable developments, including natural and man-made disasters (such as hurricanes, windstorms, earthquakes, blizzards, fires and explosions), fluctuations in interest rates and other changes in the investment environment that affect market prices of insurance companies' investments and the income from those investments, inflationary pressures that may tend to affect the size of losses and judicial, legislative and regulatory decisions affecting insurers' liabilities. The demand for property and casualty insurance can also vary significantly, generally rising as the overall level of economic activity increases and falling as such activity decreases. Price competition has also been enhanced by a flight of commercial insureds to alternative risk mechanisms, often including a degree of self insurance.
The industry has experienced the effects of a number of well publicized catastrophic events in recent years, some of which have affected the Company. Growth in liabilities related to asbestos and environmental risks has also adversely affected the industry and is of significance to the Company. See "-- Results of Operations--1995 Third Quarter Charge" below.
The Company is managed in two divisions--the Highlands Division and the American Reliance Division. The Highlands Division consists of business managed by the Company's Houston, Texas office. In 1995, the Highlands Division classified three of its product lines as discontinued (the "Discontinued Lines"): business originated by its London operations; an umbrella/excess liability policy program; and assumed casualty and property reinsurance contracts. The Discontinued Lines are presented separately due to their significance to the Company's total underwriting loss which amounted to 19.2%, 22.6% and 55.1% of such loss for 1997, 1996 and 1995 respectively. Results of the Highlands Division exclude the Discontinued Lines which are presented separately.
The results for 1995 were significantly influenced by the underwriting results of the Discontinued Lines, including a $125 million pre-tax charge. See "1995 Third Quarter Charge."
The Highlands Division underwriting results primarily consist of relatively large commercial accounts ("Special Accounts Unit"), medium to small commercial accounts ("Commercial Insurance Unit"), insurance for Halliburton ("Insurance Services Unit"), commercial marine products ("Marine Unit") and surety products ("Surety Unit"). The Highlands Division excludes the Discontinued Lines which are presented separately below.
Accounts and Commercial Insurance Units. The declines have been partially offset by premium increases in the Marine Unit and increases in retrospectively rated policies for the Insurance Services Unit. Also contributing to declines in gross premiums written is the continued highly competitive pricing environment as insurers compete to retain business.
Gross premiums written for 1996 were negatively impacted by a reduction of $6.9 million of accrued premium adjustments and $3.1 million of improperly classified accrued premiums due from policyholders on retrospectively rated policies.
Net premiums written in 1996 were increased by an adjustment to ceded premiums written of $3.2 million related to prior years reinsurance treaties.
Net Premiums Earned. Net premiums earned for 1997, 1996 and 1995 were $122.8 million, $144.9 million and $187.2 million, respectively. The decrease of $22.1 million or 15.3% in 1997 is related to the same issues affecting gross and net premiums written.
Underwriting Expenses. Underwriting expenses for 1997, 1996 and 1995 were $41.4 million, $52.4 million and $67.8 million, respectively. The 1997 decrease of $11.0 million is the result of lower premium related expenses due to declining premiums and reduced operating costs. The year 1997 includes $4.0 million of expenses related to the Texas Workers' Compensation Insurance Facility (the "Facility"). These consist of a final industry assessment and industry litigation involving surpluses from the Facility that were previously received by the Company and not returned to certain policyholders. The expenses related to the Facility relate to underwriting years prior to 1995.
Net Premiums Written and Earned. Net premiums written and earned for the eight months ended December 31, 1997 were $159.8 and $188.8 million, respectively. Net premiums written and earned have been impacted by the same issues affecting gross premiums written. The sale of the NNCM book of business reduced net premiums written and earned by $5.9 and $2.6 million for the eight months ended December 31, 1997.
Loss and Loss Adjustment Expense Incurred. Loss and loss adjustment expense incurred for the eight months ended December 31, 1997 amounted to $129.0 million. Loss and loss adjustment expense incurred was reduced by $6.0 million of favorable development on prior years reserves.
Umbrella/Excess Liability Program. Beginning in the early 1970s, Highlands wrote policies that provided the customer with umbrella and excess liability coverage with respect to losses which exceeded another insurer's primary and excess policy coverages. The threshold at which coverage attached under such policies underwritten by the Company varied from $300,000 to $100 million and above. The limits of coverage under the Company's excess liability policies were generally $5 million up to $10 million (in excess of underlying policies) and the Company generally limited its exposure through substantial reinsurance. The program was canceled and underwriting operations ceased effective December 31, 1985. The Company's adverse loss experience on these policies has primarily emanated from asbestos and environmental pollution claims.
Loss and Loss Adjustment Expense Incurred. Loss and loss adjustment expense incurred amounted to $8.5 million, $17.1 million and $103.3 million for 1997, 1996 and 1995, respectively. The decline for 1997 reflects the decline in adverse loss reserve development related to years prior to 1996. See "--Loss and Loss Adjustment
As a result of changes in estimates of insured events in prior years, primarily asbestos and environmental claims, construction defect claims and catastrophe claims, the provision for loss and loss adjustment expense incurred (net of reinsurance recoveries of $112.5 million, $47.8 million and $152.9 million for 1997, 1996 and 1995, respectively) increased by $16.4 million in 1997, $22.9 million in 1996 and $143.6 million in 1995. The emergence of environmental, asbestos and construction defect claims over the last few years and the difficulty in accurately estimating the necessary reserves have significantly contributed to the Company's loss reserve development over this period. The Company's exposure to future catastrophe claims has been significantly reduced as a result of the Company's cessation of its Highlands (UK) business.
The Company's loss and loss adjustment expense reserves are reviewed at each year end by the Company's actuaries and external independent actuaries in connection with the process to establish the Company's reserve position.
recorded a charge to pre-tax earnings of $125.0 million during the nine months ended September 30, 1995. Of this amount, $117.0 million related to loss and loss adjustment expense reserves ($242.5 million before deducting reinsurance) and $8.0 million represented an increase in reserves related to litigation proceedings against the Company.
Highlands Group is a holding company, the principal assets of which at December 31, 1997 are all of the capital stock of Highlands Insurance Company and American Reliance, Inc. The Company's property and casualty insurance business is conducted by its direct and indirect wholly-owned insurance subsidiaries. The liquidity and capital resource considerations for the Highlands Group are different than those of the Company's insurance operations.
In connection with the acquisition, Highlands Group obtained a $65 million senior revolving credit facility from a consortium of banks led by the Chase Manhattan Bank. Highlands Group funded the cash portion of the acquisition by utilizing the credit facility and available working capital.
Management believes that Highlands Group's liquid assets and access to the capital markets enable it to meet its liquidity needs.
Insurance Operations. The principal sources of funds for the insurance subsidiaries are premiums and amounts earned from the investment of such premiums. The principal uses of funds by these subsidiaries are loss payments and related expenses, underwriting expenses, other operating expenses and dividends and tax sharing payments to Highlands Group.
Based on the Company's evaluation of the financial condition of its reinsurers, the Company has established reserves for potentially uncollectible reinsurance which amounted to $2.2 million and $2.4 million as of December 31, 1997 and 1996, respectively. Additionally, the Company has retained net $18.2 million and $16.9 million of ceded reserves related to potentially uncollectible reinsurance at December 31, 1997 and 1996. With respect to carriers that are not authorized reinsurers as determined by the appropriate department of insurance, the Company often receives collateral primarily in the form of bank letters of credit generally securing the reinsurance recoverable regarding reported losses and in some instances unreported losses. At December 31, 1997, such collateral totaled approximately $20.3 million. The Company's three largest reinsurance recoverable exposures at December 31, 1997 were approximately $129.7 million with underwriting syndicates at Lloyds (Highlands (U.K.) $91.7 million and U.S. Insurance Subsidiaries $38.0 million), $133.0 million with American
Re-Insurance Company and $55.0 million with General Reinsurance Company. American Re-Insurance Company and General Reinsurance Company are rated by A. M. Best "A+" and "A++", respectively.
Based on the foregoing schedule, the Company believes that the new processing platform for the Highlands Division will be fully operational by the end of 1999.
The statements included in this 1997 Annual Report regarding future financial performance and results and the other statements that are not historical facts are forward-looking statements. The words "expect," "project," "estimate," "predict," "anticipate," "believes" and similar expressions are also intended to identify forward-looking statements. Such statements are subject to numerous risks, uncertainties and assumptions, including but not limited to, the uncertainties relating to industry and market conditions, natural disasters and other catastrophes, and other risks and uncertainties described in this 1997 Annual Report and in the Company's other filings with the Securities and Exchange Commission. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual outcomes may vary materially from those indicated.