The Company leases approximately 45,091 square feet for its home office at 3760 River Run Drive, Birmingham, Alabama under a long-term operating lease from Torchmark Development Corporation, a wholly owned subsidiary of Torchmark Corporation. The Company considers the office facilities to be suitable and adequate for its current and anticipated level of operations.
HIG leases approximately 24,755 square feet for its operations at 1001 Bishop Street Pacific Tower, Honolulu, Hawaii under a long-term operating lease. The Company considers the office facilities to be suitable and adequate for HIG's current and anticipated level of operations.
Because catastrophe loss events are by their nature unpredictable, historical results of operations may not be indicative of expected results of future operations. The Company markets its primary personal insurance products principally in the southeastern United States and Hawaii, an area known for hurricane risk. While the Company seeks to reduce its exposure to catastrophic events through the purchase of reinsurance, the occurrence of one or more major catastrophes in any given period could have a material adverse impact on the Company's results of operations and financial condition and result in substantial outflows of cash as losses are paid. In addition, the increased underwritings of catastrophe related reinsurance, and potential residual market assessments may also lead to increased variability in the Company's loss ratio.
Gross premiums written for primary insurance decreased by $9.9 million, or 6.0%, to $154.2 million for the year ended December 31, 1996, from $164.1 million for the year ended December 31, 1995, due to a $13.9 million decrease in commercial lines premiums and a $4.0 million increase in personal lines premiums. Gross premiums written for commercial products decreased 23.6%, to $44.6 million for the year ended December 31, 1996, compared to $58.4 million for the year ended December 31, 1995, due primarily to the Company's re- underwriting of its book of business in an effort to increase profitability in commercial lines. Gross premiums on personal lines rose 3.8% from $105.6 million for the year ended December 31, 1995 to $109.6 million for the year ended December 31, 1996. The increase was primarily attributable to the acquisition of HIG in June of 1995.
Net premiums written for primary insurance decreased by $6.3 million, or 6.2%, to $94.6 million for the year ended December 31, 1996, from $100.9 million for the year ended December 31, 1995. The decrease in net premiums written was largely attributable to a pro-rata reinsurance facility entered into by Vesta Fire Insurance Corporation ("Vesta Fire") to provide capital flexibility to take advantage of growth opportunities.
Net premiums earned increased by $130.1 million, or 34.1%, to $511.9 million for the year ended December 31, 1996, from $381.8 million for the year ended December 31, 1995. The increase in net premiums earned is primarily attributable to the increase in net written premiums for the year ended December 31, 1996.
Losses and Loss Adjustment Expenses Incurred. Losses and loss adjustment expenses ("LAE") increased by $76.0 million, or 34.7%, to $295.0 million for the year ended December 31, 1996, from $219.0 million for the year ended December 31, 1995. The dollar amount of loss and loss adjustment expenses incurred increased during 1996 due to the growth in premiums earned. The loss and LAE ratio for the year ended December 31, 1996 was 57.6% as compared to 57.4% for the year ended December 31, 1995.
Gross premiums written for primary insurance increased by $51.4 million, or 45.6%, to $164.1 million for the year ended December 31, 1995, from $112.7 million for the year ended December 31, 1994, due to a $9.4 million increase in commercial lines premiums and a $41.9 million increase in personal lines premiums. Gross premiums written for commercial products increased 19.2%, to $58.4 million for the year ended December 31, 1995, compared to $49.0 million for the year ended December 31, 1994, due primarily to increased sales of property casualty products to a certain class of accounts and an increase in transportation business. Gross premiums on personal lines rose 65.9%, from $63.7 million for the year ended December 31, 1994 to $105.6 million for the year ended December 31, 1995. The increase was primarily attributable to the acquisition of HIG in June of 1995.
Net premiums written for primary insurance increased by $34.3 million, or 51.5%, to $100.9 million for the year ended December 31, 1995, from $66.6 million for the year ended December 31, 1994.
Net Investment Income. Net investment income increased by $5.0 million, or 38.3%, to $18.0 million for the year ended December 31, 1995, from $13.0 million for the year ended December 31, 1994. The weighted average yield on invested assets (excluding realized and unrealized gains) was 5.8% for the year ended December 31, 1995, compared with 5.3% for the year ended December 31,
1994. The increase in net investment income is primarily attributable to an increase in average invested assets relating to the receipt of proceeds from the sale by the Company of $100 million of its 8.75% Senior Debentures due 2025, operating cash flow, and the increase in yield on invested assets.
The Company is a holding company whose principal asset is its investment in the capital stock of the companies constituting the Vesta Group, a group of wholly owned property and casualty insurance companies including Vesta Fire. The several insurance company subsidiaries comprising Vesta Group are individually supervised by state insurance regulators. Vesta Fire is the principal operating subsidiary of the Company.
During 1996, the Company paid approximately $2.8 million in dividends on its common stock, and it is expected that the Company will pay approximately $2.8 million in 1997. The Company is also required to make semi-annual interest payments of $4.4 million on its $100 million of 8.75% Senior Debentures due 2025, and semi-annual interest payments of $4.3 million on its $100 million of 8.525% Junior Subordinated Deferrable Interest Debentures issued to Vesta Capital Trust I in connection with its sale of $100 million of 8.525% Capital Securities.
In order to provide further liquidity, the Company replaced its $40 million line of credit with a new $100 million line of credit. The line of credit is with a group of domestic banks pursuant to a Credit Agreement dated September 24, 1996 (the "Credit Agreement"). The Credit Agreement relating to this line of credit contains certain covenants that require, among other things, the Company to maintain a certain consolidated net worth, maintain a certain amount of investment income available for the payment of interest expense, cause each insurance subsidiary to maintain a certain total adjusted capital and which limit the amount of indebtedness the Company can have. The Company is in compliance with these covenants.
The principal sources of funds for the Company's insurance subsidiaries are premiums, investment income and proceeds from the sale or maturity of invested assets. Such funds are used principally for the payment of claims, operating expenses, commissions and the purchase of investments. On a consolidated basis, net cash provided from (used in) operations for the year ended December 31, 1996 and 1995, was $13.8 million and $19.9 million, respectively. Net cash provided from operations in 1996 and 1995 was due principally to the large increase in premiums written. Cash flow during 1996 was adversely affected by the settlement of the unearned premium portfolio transfer on the Company's pro rata reinsuance facility.
As of December 31, 1996, the Company's investment portfolio consisted of cash and short-term investments (25.8%), U.S. Government securities (8.8%), mortgage-backed securities (1.8%), corporate bonds (24.3%), foreign government securities (0.5%), municipal bonds (36.9%) and equity securities (1.9%). According to Moody's, 97.6% of the Company's portfolio is rated A or better. The Company expects current cash flow to be sufficient to meet operating needs, although invested assets have been categorized as available for sale in the event short-term cash needs exceed available resources. The Company adjusts its holdings of cash, short-term investments and invested assets available for sale according to its seasonal cash flow needs. Beginning in June of each year, the Company begins to increase its holdings of cash and short-term investments. This practice facilitates the Company's ability to meet its higher short-term cash needs during the hurricane season. See "Business--Investments."
Any statement contained in this report which is not a historical fact, or which might otherwise be considered an opinion or projection concerning the Company or its business, whether express or implied, is meant as and should be considered a forward-looking statement as that term is defined in the Private Securities Litigation Reform Act of 1996. Forward-looking statements are based on assumptions and opinions concerning a variety of known and unknown risks, including but not necessarily limited to changes in market conditions, natural disasters and other catastrophic events, increased competition, changes in availability and cost of reinsurance, changes in governmental regulations, and general economic conditions, as well as other risks more completely described in the Company's filings with the Securities and Exchange Commission, including its most recent Annual Report of Form 10-K. If any of these assumptions or opinions prove incorrect, any forward-looking statements made on the basis of such assumptions or opinions may also prove materially incorrect in one or more respects.
We have audited the consolidated financial statements of Vesta Insurance Group, Inc. and subsidiaries as listed in Item 8 and the supporting schedules as listed in Item 14(a)(2). These financial statements and financial statement schedules are the responsibility of Vesta's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.
VESTA INSURANCE GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOW (DOLLAR AMOUNTS IN THOUSANDS)
Financial Statement Presentation: Vesta Insurance Group, Inc. (Vesta) was incorporated by Torchmark Corporation on July 9, 1993 and capitalized on July 16, 1993 with a $50 million contribution from Torchmark and the contribution from Torchmark of all of the outstanding common stock of J. Gordon Gaines, Inc., Liberty National Reinsurance Company, Ltd, and Vesta Fire Insurance Corporation and its wholly-owned subsidiaries. On November 18, 1993, the Company completed an initial public offering of common stock which resulted in proceeds to the Company of approximately $51 million. At year-end 1996, Torchmark held approximately 27% of the outstanding common stock of the Company with the balance publicly traded.
Nature of Operations: The Company is a holding company for a group of property and casualty insurance companies (the "Vesta Group") that offer treaty reinsurance and primary insurance on personal and commercial risks. The lead insurer in the Vesta Group is Vesta Fire Insurance Corporation ("Vesta Fire"). In both its reinsurance and primary insurance operations, the Company focuses primarily on property coverages. Gross premiums written by the Company in 1996 totalled $769.6 million. Gross premiums written in the reinsurance line were $615.4 million in 1996, substantially all of which were on personal (including automobile) risks and commercial property risks. Also, property (including auto physical damage) risks accounted for approximately 89% of the Company's gross premiums written in all lines in 1996.
The availability and cost of reinsurance and retrocessional coverage may vary significantly over time and are subject to prevailing market conditions. Pricing in this business has weakened slightly due to increased availability of reinsurance market capacity.
Investments: Investment securities are classified in three categories at date of purchase and accounted for as follows: (i) Debt securities which are purchased with the positive intent and ability to hold to maturity are classified as held-to-maturity and reported at amortized cost; (ii) Debt and equity securities which are bought and held principally for the purpose of selling them in the near term are classified as trading securities and reported at fair value, with unrealized gains and losses included in earnings; and (iii) Debt and equity securities which are not classified as either held- to-maturity or trading securities are classified as available for sale and reported at fair value, with unrealized gains and losses excluded from earnings and reported in a separate component of stockholders' equity.
Short-term investments are carried at cost and include investments in certificates of deposit and other interest-bearing time deposits with original maturities of one year or less. If an investment becomes permanently impaired, such impairment is treated as a realized loss and the investment is adjusted to net realizable value.
Recognition of Premium Revenue: Earned premiums are generally recognized as revenue on a pro rata basis over the policy term.
Insurance subsidiaries of Vesta are required to file statutory financial statements with state insurance regulatory authorities. Accounting principles used to prepare these statutory financial statements differ from GAAP. Consolidated net income and stockholders' equity on a statutory basis for the insurance subsidiaries were as follows:
On September 13, 1993, Vesta Fire Insurance Corporation, a wholly owned subsidiary of the Company ("Vesta Fire"), and Liberty National Life Insurance Company ("Liberty National"), a wholly owned subsidiary of Torchmark, entered into a Marketing and Administrative Services Agreement, pursuant to which Vesta Fire marketed certain of its industrial fire insurance products through agents of Liberty National. Under this agreement, Liberty National pays to Vesta Fire an amount equal to all premiums collected by Liberty National after deducting all expenses incurred by Liberty National which are directly attributable to the industrial fire insurance products and after deducting a fee for administrative services. Such fee for 1994, 1995 and 1996 was $2,849 thousand, $2,305 thousand and $1,702 thousand, respectively. This agreement was terminated effective April 30, 1995, and these products are no longer marketed through Liberty National agents. However, Liberty National continues to service the existing business.
Restrictions on Dividends: Vesta relies on dividends from its subsidiaries to meet its cash requirements and to pay dividends to its stockholders. The payment of dividends by Vesta's insurance subsidiaries are subject to certain limitations imposed by the insurance laws of the States of Alabama, Hawaii and Texas. The restrictions are generally based on certain levels of surplus, investment income and operating income, as determined under statutory accounting practices. Alabama, Texas and most other states that regulate Vesta's operations permit dividends in any year which together with other dividends or distributions made within the preceding 12 months, do not exceed the greater of (i) 10% of statutory surplus as of the end of the preceding year or (ii) the net income for the preceding year, with larger dividends payable only upon prior regulatory approval. Hawaii law limits dividends to the lesser of (i) and (ii) without prior approval. Certain other extraordinary transactions between an insurance company and its affiliates, including sales, loans or investments which in any twelve-month period aggregate at least 3% of its admitted assets or 25% of its statutory capital and surplus, also are subject to prior approval by the Department of Insurance. Based upon restrictions presently in effect, the maximum amount available for payment of dividends to the Company by its insurance subsidiaries in 1997 without prior approval of regulatory authorities is approximately $50.7 million.
Risk-Based Capital Requirements. The NAIC adopted risk-based capital requirements that require insurance companies to calculate and report information under a risk-based formula which attempts to measure statutory capital and surplus needs based on the risks in a company's mix of products and investment portfolio. The formula is designed to allow state insurance regulators to identify potential weakly capitalized companies. Under the formula, a company determines its "risk-based capital" ("RBC") by taking into account certain risks related to the insurer's assets (including risks related to its investment portfolio and ceded reinsurance) and the insurer's liabilities (including underwriting risks related to the nature and experience of its insurance business). Risk-based capital rules provide for different levels of regulatory attention depending on the ratio of a company's total adjusted capital to its "authorized control level" ("ACL") of RBC. Based on calculations made by the Company, the risk-based capital levels for each of the Company's insurance subsidiaries did not trigger regulatory attention.
Concentrations of Credit Risk: Vesta maintains a highly-diversified investment portfolio with limited concentrations in any given region, industry, or economic characteristic. At December 31, 1996, the investment portfolio consisted of securities of the U.S. government or U.S. government backed securities (9%); mortgage backed securities, GNMA collateral (2%); investment grade corporate bonds (24%); cash and short-term investments (26%); securities of state and municipal governments (36%); securities of foreign governments (1%); and corporate common stocks (2%). Corporate equity and debt investments are made in a wide range of industries. All of Vesta's investments at year-end 1996 were rated investment-grade.
The following table summarizes Vesta's non-cash transactions, which are not reflected on the Statement of Cash Flow, as required by GAAP:
The effect on premiums earned and losses and loss adjustment expenses incurred of all reinsurance ceded transactions are as follows:
Income tax expense for the years ended December, 1994, 1995 and 1996 was allocated as follows:
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities included in other liabilities at December 31, 1995 and 1996 are presented below:
A valuation allowance for deferred tax assets, as of December 31, 1995 and 1996, was not necessary.
Vesta has a $100 million line of credit. The line of credit is with a group of domestic banks pursuant to a Credit Agreement dated September 24, 1996 (the "Credit Agreement"). The interest charge is either (i) the London Interbank Rate plus 0.25% or (ii) the higher of the prime rate and the Federal Funds rate plus 0.5%, at the Company's discretion. At December 31, 1996 the London Interbank three month rate was 5.5625% and the Federal Funds rate was 5.25%.There was a balance of $22 million under this line of credit at December 31, 1996. The line of credit contains covenants which (1) restricts the Company from incurring consolidated indebtedness greater than 42.5% of the sum of the Company's consolidated indebtedness and consolidated net worth, (2) requires the Company to maintain consolidated net worth to be equal to or greater than $250,000,000 plus 50% of the aggregate of consolidated net income for each fiscal quarter ending after September 30, 1996 up to and including the fiscal quarter then ending minus the aggregate amount of all dividends paid with respect to the Company's equity securities at any time after September 30, 1996, (3) requires the Company to maintain a ratio of consolidated income before interest and taxes to consolidated interest expense of 3.0 to 1.0, and (4) requires the Company to maintain total adjusted capital (within the meaning of Risk-Based Capital for Insurers Model Act ("Model Act")) of Vesta Fire to be equal to or greater than 150% of the applicable "Company Action Level RBC" (within the meaning of the model act).
In 1995, the Company entered into restricted stock agreements under which the Company granted 23,333 shares of restricted common stock to certain officers of the Company. In 1996, the Company entered into restricted stock agreements under which the Company granted 23,144 shares of restricted common stock to certain officers of the Company and 5,664 shares of restricted common stock to certain directors of the Company. The common stock with respect to all awards of restricted stock is being held by the Company until the restrictions lapse.
On January 31, 1997, Vesta Capital Trust I, a Delaware business trust controlled by the Company, sold $100 million of its 8.525% Capital Securities. These securities have a 30 year maturity and are not redeemable except in certain limited circumstances. These securities were sold in a private placement transaction to qualified institutional buyers under Rule 144A and were not registered under the Securities Act of 1933. A portion of the proceeds from the sale of these capital securities were used to repay indebtedness under the Company's existing lines of credit and the remainder will be used for general corporate purposes.