During 1998, the Company's Board of Directors increased to 6,000,000 the maximum number of its Common Shares that the Company is authorized to purchase. Through December 31, 1998, the Company repurchased in the open market 1,996,400 Common Shares for an aggregate cost of approximately $58,071,000. From January 1, 1999 through March 12, 1999, the Company acquired 1,738,570 Common Shares for an aggregate cost of approximately $52,119,000. As a result, as of March 13, 1999, the Company is authorized to repurchase 3,788,717 Common Shares.
In December 1998, a subsidiary of the Company repurchased for $42,200,000 plus accrued interest, $51,800,000 liquidation amount of 8.65% trust issued preferred securities of Leucadia Capital Trust I, a wholly-owned subsidiary of the Company. The difference between the book value and the amount paid was credited directly to shareholders' equity.
During 1998, the Company's previously announced agreement to sell substantially all of its interest in Caja to its Argentine partner was restructured and, in March 1999, the Company sold all of its interest in Caja to Assicurazioni Generali Group, an Italian insurance company, for $126,000,000 in cash and a $40,000,000 collateralized note maturing April 2001 from its Argentine partner. The Company will record a pre-tax gain of approximately $120,000,000 in its first quarter 1999 results of operations in connection with this transaction.
remaining life insurance subsidiaries, Charter and Intramerica, to Allstate for statutory surplus at the date of sale (approximately $62,200,000 at December 31, 1998), plus $3,575,000. The transaction is expected to result in a pre-tax gain of approximately $20,000,000, principally resulting from recognition of deferred gains from prior reinsurance transactions (including the September 1998 Allstate transaction described above). The transaction is subject to regulatory approvals and customary closing conditions and is expected to close in the second quarter of 1999.
As of December 31, 1998, the Company's consolidated debt was $722,601,000 as compared to $352,872,000 as of December 31, 1997. This increase is primarily related to the Company's acquisition of 95.4% of Fidei in 1998. At December 31, 1998, the principal amount of Fidei's Euro denominated outstanding debt, all of which is non-recourse to the Company, was approximately $249,400,000 (approximately 213,656,000 Euros). Inasmuch as Fidei's Euro demoninated assets will be sold over time and such assets are presently funded with Fidei's Euro demoninated debt, the Company has determined not to acquire a currency hedge for Fidei's Euro denominated debt.
The investment portfolios of the Company's insurance subsidiaries are principally fixed maturity investments; the balance of their portfolio consists largely of preferred securities. Of the fixed maturity securities, the majority consists of those rated "investment grade" or U.S. governmental agency issued or guaranteed obligations, although limited investments in "non-rated" or rated less than investment grade securities have been made from time to time.
Principally as a result of changes in market interest rates during 1998, the unrealized gain on investments at the end of 1997 of approximately $5,630,000 (net of taxes) decreased to an unrealized loss of approximately $982,000 (net of taxes) as of December 31, 1998. While this has resulted in a decrease in shareholders' equity, it had no effect on results of operations or cash flows.
The Company and certain of its subsidiaries have loss carryforwards and other tax attributes. The amount and availability of tax loss carryforwards are subject to certain qualifications, limitations and uncertainties. As described in the Notes to the Consolidated Financial Statements, significant additional amounts of loss carryforwards may be available under certain circumstances. In order to reduce the possibility that certain changes in ownership could impose limitations on the use of these carryforwards, the Company's certificate of incorporation contains provisions which generally restrict the ability of a person or entity from accumulating at least five percent of the Common Shares and the ability of persons or entities now owning at least five percent of the Common Shares from acquiring additional Common Shares.
Year Ended December 31, ----------------------- 1998 1997 1996 ---- ---- ----
During 1998, the Empire Group reviewed the adequacy of the reserves carried for its open claims' files, focusing on workers' compensation, commercial auto and other commercial liability lines of business. Such reviews are part of the Empire Group's normal ongoing practice. Particular emphasis during this review was placed on reserves carried for the workers' compensation line of business. As part of the review, substantially all open workers' compensation claim files were reviewed for every accident year up to and including 1998. The Empire Group also conducted a comprehensive review of reserves carried for other commercial liability lines of business in which approximately 28% of the open claim files were reviewed, with a primary focus on accident years 1995 to 1997. As a result of these reviews, the Empire Group revised its assumptions regarding average claims costs and probable ultimate losses and, accordingly, reserves were strengthened by $13,000,000 for workers' compensation and $14,000,000 for other commercial liability lines of business. Additionally, during 1998, the Empire Group reorganized the commercial auto claims department. As part of this realignment, more complex claims files were reviewed by the most experienced claims examiners and assumptions regarding average claims severity and probable ultimate losses were revised and reserves were strengthened by $14,000,000 for commercial automobile lines of business.
Finance revenues and operating profits reflect the level of consumer instalment loans, and for 1998, the sale of substantially all of the Company's executive and professional loan portfolio which resulted in a pre-tax gain of approximately $6,500,000, as discussed above. In addition, automobile loan losses declined in 1998 and 1997. In 1997, operating profit was also adversely affected by $3,500,000 in costs to settle litigation related to a lending program that is in liquidation. In 1996, operating profit was also affected by increased interest expense on customer banking deposits.
In 1998, investment and other income increased by approximately $16,300,000 primarily due to increased interest income ($63,700,000), the sale of the Company's executive and professional loan portfolio referred to above ($6,500,000) and increased income from real estate activities ($8,800,000), partially offset by reduced gains from sales of real estate and other assets ($40,700,000) and reduced income relating to the service business ($19,100,000). In 1997, investment and other income increased by approximately $81,800,000, primarily due to increased gains from sales of real estate properties ($63,500,000) including the sale of a New York City office building and increased interest income ($28,100,000) including earnings on the proceeds from the sales of the Colonial Penn Life Group and Colonial Penn P&C Group. Such increases were partially offset by reduced trading stamp and miscellaneous other revenues in 1997 and a litigation settlement gain recorded in 1996.
During 1998, due to declines in values that were deemed other than temporary, the Company recorded a pre-tax writedown of approximately $75,000,000 related to its investments in Russian and Polish debt and equity securities. Such writedowns are reflected in the caption "Net securities gains (losses)." At December 31, 1998, the remaining book value of the Company's investments in these debt and equity securities was approximately $19,000,000.
Equity in income (losses) of associated companies improved in 1998 as compared to 1997 primarily due to a reduction of approximately $48,400,000 in the Company's equity losses related to PIB resulting from
discontinuance of the equity method of accounting in early 1998 and income from an investment partnership of approximately $30,800,000. In December 1997, the Company invested $20,000,000 to acquire a limited partnership interest in this partnership. The partnership currently is in the process of liquidating and making final distributions. The Company does not anticipate that the amount of income to be realized from this investment will be significant in 1999. Equity in losses of associated companies increased in 1997 as compared to 1996 primarily due to start-up losses from the Company's equity investment in PIB of $50,481,000 in 1997 as compared to $17,104,000 in 1996. The equity in losses of associated companies included losses from the Company's investment in MK Gold of $4,251,000 in 1997 and $6,478,000 in 1996 and a write-off of $6,540,000 in 1996, representing the Company's investment in an unsuccessful well drilled by its Siberian oil exploration joint venture.
Interest expense primarily reflects the level of external borrowings outstanding throughout the periods. The reduction in interest expense in 1997 was primarily due to the decline in such borrowings.
The decrease in selling, general and other expenses in 1998 as compared to 1997 principally reflects decreased expenses of the manufacturing segment principally as a result of the sale of certain divisions in 1997, decreased pension expense due to the recognition of net curtailment gains of $6,500,000, a 1997 charge for estimated costs to settle litigation relating to a lending program that is in liquidation and lower provisions for bad debts. The decrease in selling, general and other expenses in 1997 as compared to 1996 principally reflects the Empire Group's decreased expenses related to reduced premium volume, decreased operating expenses of real estate properties, decreased expenses relating to certain investment activities and lower provisions for bad debts. This decrease was partially offset by the losses recorded by the manufacturing segment related to sold divisions and the charge for estimated costs to settle litigation relating to a lending program that is in liquidation.
The Company is in the process of evaluating its information technology systems to determine the potential impact of the Year 2000. The Year 2000 issue is the result of computer programs being written using two digits (rather than four) to define the applicable year. Any programs that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000, which could result in miscalculations or
system failures. As a result, before the end of 1999, computer hardware and software may need to be upgraded with new hardware and software which can distinguish 21st century dates from 20th century dates.
Since 1996, the Company has been evaluating its Year 2000 readiness. Its program to address its Year 2000 readiness consists of (i) the preparation of an inventory of all computer related hardware and software, all non-computer related hardware that may have embedded technology and all third parties that are material to the Company's business operations, (ii) the identification of a senior officer at each of the Company's operating subsidiaries and significant investments to be responsible for overseeing the implementation of the Year 2000 program and reporting on compliance therewith to the Company's senior management, (iii) the identification of mission critical aspects of the Company's business, and assessment of the Year 2000 readiness of such mission critical systems and components, (iv) the development of a plan to upgrade, repair or replace systems as required for Year 2000 compliance, (v) the development of a plan to test the readiness of all critical systems, (vi) making inquiry of material third parties as to the state of their Year 2000 compliance, and (vii) as appropriate, the development of a contingency plan for either non-compliant internal systems or non-compliant material third parties. Where appropriate, outside consultants have been engaged to advise the Company on its Year 2000 readiness. Substantially all of the Company's operations have completed the inventory and identification process and are in the process of upgrading and testing critical systems. The Company's primary focus during the balance of 1999 will be on continued testing of mission critical systems and software provider upgrades, as well as monitoring the readiness of material third parties.
The Year 2000 issue may affect other entities with which the Company transacts business. The Company has made inquiry of third parties with whom it has material relationships as to the Year 2000 compliance of such third parties. Many of such parties have reported plans to be fully compliant by the end of 1999 and most have reported substantial progress at the end of 1998. However, at this time the Company cannot predict the effect of the Year 2000 on its material third parties or the impact any deficiency in the Year 2000 readiness of such parties could have on the Company.
Through December 31, 1998, expenses incurred by the Company in connection with the Year 2000 issue (excluding expenses related to the Empire Group's acquisition of new systems, which was not motivated by Year 2000 concerns) did not exceed $500,000. Based upon current information, the Company does not expect that the Year 2000 issue will have a material effect on its consolidated financial position or consolidated results of operations.
1995. Such statements may relate, but are not limited, to projections of revenues, income or loss, capital expenditures, fluctuations in insurance reserves, plans for growth and future operations (including Year 2000 compatibility), competition and regulation as well as assumptions relating to the foregoing. Forward-looking statements are inherently subject to risks and uncertainties, many of which cannot be predicted or quantified. When used in this Report, the words "estimates", "expects", "anticipates", "believes", "plans", "intends" and variations of such words and similar expressions are intended to identify forward-looking statements that involve risks and uncertainties. Future events and actual results could differ materially from those set forth in, contemplated by or underlying the forward-looking statements. The factors that could cause actual results to differ materially from those suggested by any such statements include, but are not limited to, those discussed or identified from time to time in the Company's public filings, including general economic and market conditions, changes in foreign and domestic laws, regulations and taxes, changes in competition and pricing environments, regional or general changes in asset valuation, the occurrence of significant natural disasters, the inability to reinsure certain risks economically, the adequacy of loss reserves, prevailing interest rate levels, weather related conditions that may affect the Company's operations, the difficulty in identifying hardware and software that may not be Year 2000 compliant, the lack of success of third parties to adequately address the Year 2000 issue, vendor delays and technical difficulties affecting the Company's ability to upgrade or replace its hardware and/or software for Year 2000 compliance, and changes in the composition of the Company's assets and liabilities through acquisitions or divestitures. Undue reliance should not be placed on these forward-looking statements, which are applicable only as of the date hereof. The Company undertakes no obligation to revise or update these forward-looking statements to reflect events or circumstances that arise after the date of this Report or to reflect the occurrence of unanticipated events.