Operating Results for the Three Years Ended December 31, 1996 - -------------------------------------------------------------
The loss before income taxes for 1995 was $1,101,000. This loss was primarily driven by three factors; the foremost factor was adverse loss development on discontinued property and casualty products. The adverse development aggregated $2,400,000 which included a $1,200,000 year end reserve increase on the discontinued REO product. The adverse development was partially offset by a $500,000 favorable development on the discontinued medical business. The second factor was the incurral of legal fees related to the REO program litigation during 1995, including the Company's legal action against the entities involved in the REO program. These actions caused the incurral of legal fees of $550,000 in 1995. Lastly, during 1995 the Company incurred approximately $350,000 in severance expenses related to departed employees.
The loss before income taxes for 1994 was $4,905,000. A significant portion of the 1994 loss was related to the write off of Galaxy ($3,829,000) and Galaxy's first quarter loss ($205,000), for a total Galaxy loss of $4,034,000. In addition, several discontinued property and casualty lines continued to show adverse loss development in 1994, partially offset by positive results from the credit and extended service contract product lines.
The Company made concerted efforts in the last three years to reduce general and administrative expenses. General and administrative expenses have decreased by 4.2% in 1996 compared to 1995 and by 16.3% in 1995 compared to 1994. These expense control initiatives have allowed the Company to concentrate on its traditional profit producing lines of business (credit insurance and extended service contracts) and to begin programs in selected Property & Casualty lines in which the current management team has experience.
Gross premium writings for 1996 were $58.4 million compared to $55.4 million for 1995. The increase in 1996 was primarily the result of increases in premium levels related to the new lines of business. See Table II on page 15.
The Company plans to concentrate its efforts on growing the credit, extended service contract and the newly introduced property and casualty program product lines.
The Company's cash flows from operations have generally been adequate for its current operating needs. Cash flows from operating activities in 1995 were adversely impacted by the reinsurance transaction dated December 29, 1995 described in "Note F" in the Notes to Consolidated Financial Statements. The Company's credit insurance policy terms and related liabilities are generally limited to a four-year period during which the consumer makes payments on the loan. The Company's liability on extended service contracts typically extends for either one-year or five-year periods. The Company's long haul trucking and charter bus business generally is written for a term of one year with the casualty claim related liabilities extending beyond that period. The Company, therefore, maintains liquidity in its investment portfolio to correspond with the liabilities outstanding on its lines of business. At December 31, 1996, the estimated duration of the Company's fixed income investment portfolio was 3.0 years while the estimated liability duration was approximately 3.5 years. Currently, an interest rate change of 1% would impact the fair value of the fixed maturity portfolio and stockholders' equity by a decline of approximately $2 million if interest rates rose and an increase of approximately $2 million if interest rates declined.
The Company limits the extent of its risks on fixed maturity securities by generally avoiding securities whose cost significantly exceeds par, by purchasing securities which are backed by stable collateral, and by concentrating on securities that are either planned amortization or sequential pay classes. The collateralized mortgage obligations and asset backed securities owned have primarily short to intermediate average lives. At December 31, 1996, the Company did not have a significant amount of higher risk mortgage or asset backed securities. There are negligible default risks on the mortgage and asset backed security portfolios as a whole as the vast majority of the assets are either guaranteed by U. S. government-sponsored entities or are supported in the securitization structure by junior securities enabling the assets to achieve high investment grade status.
Ohio domiciled insurance companies are subject to Ohio law which regulates the ability of insurance companies to pay dividends. The regulation limits the annual dividend or distribution of an insurer to the greater of (1) net income of the previous year or (2) 10% of unassigned surplus as of the end of the previous year. In addition, all dividends must come from earned surplus to qualify as a non-extraordinary dividend. Amounts greater than this would be considered extraordinary dividends and could not be paid without permission of the Ohio Department. Based on this regulation, ALIC could pay a dividend of $1,543,315 without Ohio Department approval to ACCEL in 1997 and ANIC would require Ohio Department approval to pay any dividend to ACCEL during 1997.
On July 25, 1996, the Company commenced an offering of non-transferable rights to stockholders of record as of June 18, 1996 (see Rights Offering under Certain Events). The Rights Offering concluded on August 28, 1996 and generated $3,261,780 in cash proceeds. A supplemental offering to employees, agents and customers concluded on September 30, 1996 and generated $141,862 in cash proceeds of which $113,355 had been received by the Company as of December 31, 1996. The cash proceeds from these offerings have been used to repay intercompany advances ($2,647,000), for the redemption of Subordinated Notes which were not tendered in the Rights Offering ($600,000) (see "Note D" in the Notes to Consolidated Financial Statements), and for general corporate purposes.
Also, under the provisions of the Rights Offering, the Company permitted Chase Insurance Holdings Corporation ("CIHC") and its affiliates to tender the principal amount of their Subordinated Notes (See "Note D" in the Notes to Consolidated Financial Statements) for cancellation as consideration (in lieu of cash) for the purchase of shares of common stock pursuant to the Rights Offering. On August 23, 1996, CIHC and its affiliates tendered $5,619,046 principal amount of their Subordinated Notes plus an additional $83,759 of accrued interest thereon under the terms of the Rights Offering. At the conclusion of the offering, CIHC and its affiliate had reduced their holding of Subordinated Notes to $0.
On December 29, 1995, the Company issued new senior notes (the "Senior Notes") totaling $16,500,000 at 9.50%, maturing on April 1, 2001. The proceeds from these notes were used to retire the loan outstanding under an existing credit agreement (see "Note D" in the Notes to Consolidated Financial Statements) and to liquidate an intercompany loan between ACCEL and an insurance company subsidiary. In addition, as of January 1, 1996, ALIC entered into a reinsurance agreement with an unaffiliated company to reinsure its in-force credit business. The Senior Notes are payable to the same unaffiliated company which is a party to the reinsurance agreement dated January 1, 1996. This agreement is structured such, that as future profits emerge on this block of business, these profits are held by the reinsurance company, and ultimately applied to pay interest on and to redeem the Senior Notes. Profits in excess of the amount required to retire the Senior Notes are to be returned to ALIC. As of December 31, 1996, $1,500,000 of the profits on this block of business were released to ALIC in the form of the aforementioned Senior Notes issued by ACCEL. This release resulted in a balance of $15,000,000 of Senior Notes outstanding as of December 31, 1996.
At December 31, 1995, the loan had an unpaid balance of $525,239. The market value of the underlying shares was $161,000. The Company revalued this loan to market value as of December 31, 1995 to allow for the release of shares to participants' accounts at an average price which more closely approximated recent market values on the Company's common stock. The decrease in the loan in 1995 was reflected through a decrease in additional paid-in capital in the accompanying consolidated balance sheets. The unpaid balance of the loan ($32,000 at December 31, 1996) has been reflected as a reduction in common stockholders' equity in the accompanying consolidated balance sheets.
The Company currently has three material lines of business that are in run-off status: the REO line, the farmowner's multi-peril and ancillary inland marine products and the auto dealers' commercial multi-peril line. Also, for information regarding Galaxy, see "Note K" in the Notes to Consolidated Financial Statements.
The estimates for policy reserves are continually under review and adjusted as necessary as experience develops or new information becomes known; such adjustments are included in current operations. These liabilities are necessarily subject to the impact of future changes in claim severity, frequency and other factors. Although considerable variability is inherent in such estimates, based on recent evaluations management believes that the current level of policy reserves will be adequate to cover anticipated claim liabilities. Accordingly, the ultimate amounts required for settlement of policy benefits may vary significantly from the amounts included in the accompanying consolidated financial statements.
The Company has reviewed Financial Accounting Standards Board ("FASB") Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" which became effective in 1996, and has determined this FASB statement will not impact the Company. The Company has also reviewed FASB Statement No. 123, "Accounting for Stock-Based Compensation" ("FASB 123") which became effective in 1996. The Company has elected to disclose the impact of FASB 123 in the Notes to the Consolidated Financial Statements and not adopt the statement for financial statement reporting as permitted by FASB 123. The Company has also reviewed FASB Statement No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" which becomes effective in 1997, and does not expect this FASB statement to have a material impact on the financial condition of the Company.
Rights Offering: On July 25, 1996, the Company commenced a Rights Offering to stockholders of record as of June 18, 1996. The non-transferable subscription rights entitled stockholders of record to receive one right for each share of stock held and each right entitled the holder thereof to purchase one and one-half shares of the common stock of the Company at a subscription price of $2.25 per share. The rights expired on August 28, 1996. No commission or compensation was paid in connection with the Rights Offering. As part of the Rights Offering, the Company permitted the outstanding Subordinated Notes held by CIHC and its affiliates to be tendered for cancellation as consideration (in lieu of cash) for the purchase of shares of common stock pursuant to the Rights Offering.
Write Off of Investment In RGL and Galaxy: During December 1986, ACCEL invested $1,370,000 (a 20% interest) in RGL. Galaxy, a wholly owned subsidiary of RGL, was writing commercial property insurance, property and casualty, and assumed treaty reinsurance.
Due to the significance of the statutory loss and the loss of the Company's control of Galaxy as a result of the insolvency, the Company wrote off its investment in RGL ($3.8 million) during the second quarter of 1994. As a result of this action, the consolidated results of operations for 1994 include a charge to operations of $3.8 million, representing the Company's net investment in Galaxy as of April 1, 1994, in addition to operating losses of $205,000 incurred during the first quarter. The Company wrote down its investment in RGL to zero and deconsolidated RGL as of April 1, 1994.
During 1996, the Liquidation Bureau, acting on behalf of the New York Property/Casualty Insurance Security Funds (the "Guaranty Fund"), informally advised the Company that on behalf of the Guaranty Fund it intended to seek indemnification or reimbursement from ANIC for claims paid by the Guaranty Fund to Galaxy insureds on policies which may have been covered by the Certificates. The Liquidation Bureau has provided some information in response to the Company's request for accounting data and other information with respect to the Liquidation Bureau's analysis of the Guaranty Fund's right to indemnification; however, the Company has not been able to evaluate or quantify the magnitude of the potential claim, if any, for indemnification or reimbursement. The Company has taken the position that the Guaranty Fund has no right to seek indemnification unless Galaxy insureds who hold properly issued Certificates have executed assignments and evidences of subrogation. Even if any Galaxy insureds properly made such a claim directly to ANIC, the Company has been advised by its legal counsel that if ANIC paid any such claim, it would have the right, under assignment and subrogation agreements with its insureds, to assert all rights that the insureds could have asserted to recover the loss amounts from any other source, including the Guaranty Fund. In early 1997, the Liquidation Bureau requested of Companys' counsel the basis for the position taken by the Company. A written analysis supporting Company's position was subsequently issued to the Liquidation Bureau.
The lawsuit sought to recover funds improperly withdrawn from the account established for the payment of claims under the program; for damages due to business expenses improperly charged against such funds; and for improper administration of the program. ACCEL and ANIC entered into an arrangement whereby ANIC's rights under the lawsuit were transferred to ACCEL in exchange for a $4,000,000 collateral loan issued to ANIC which was recorded as a capital contribution. The transaction and related agreements were approved by the Ohio Department. The loan agreement and accompanying promissory note called for interest at the 13 week Treasury Bill rate plus 100 basis points. The principal of $4,000,000 was paid in full on December 29, 1995.
Consolidated Results ------------------------------------- (Thousands of dollars, except ratios) 1996 1995 1994 --------- --------- --------- Gross premiums written $ 58,412 $ 55,443 $ 60,504 ========= ========= ========= Net premiums earned $ 45,957 $ 40,853 $ 47,600 ========= ========= ========= RATIOS: Policy benefits to net premiums earned 53.0% 49.2% 52.5% Commissions and selling expenses and general and administrative expenses to gross premiums written 50.7% 57.0% 52.3% Commissions and selling expenses, reinsurance expense recovery and change in deferred policy acquisition costs to net premiums earned 44.3% 49.3% 43.6% Taxes, licenses and fees to gross premiums written 3.2% 3.1% 3.1%
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of ACCEL International Corporation and subsidiaries as of December 31, 1996 and 1995, and the consolidated results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1996, in conformity with generally accepted accounting principles. Also in our opinion, the related 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.
Investments--Notes B and F: Investments available for sale, at fair value: Fixed maturities (cost: 1996--$58,889,000; 1995--$53,427,000) $ 58,281 $ 53,204 Equity securities (cost: 1996--$5,514,000; 1995--$5,433,000) 5,511 5,451 Short-term investments (cost: 1996--$10,670,000; 1995--$4,278,000) 10,703 4,278 Other invested assets at cost (fair value: 1996--$346,000; 1995--$364,000) 346 364 --------- --------- 74,841 63,297
Receivables: Premiums in process of transmittal--Note E, less allowance (1996--$223,000; 1995--$154,000) 7,286 1,779 Amounts due from reinsurers--Note F, less allowance (1996 and 1995--$125,000) 11,138 9,119 Recoverable federal income taxes--Note G 1,019 70 --------- --------- 19,443 10,968
Policy Reserves and Liabilities: Unearned premium reserves--Note F $ 81,820 $ 82,080 Insurance claims--Notes F and H 25,256 22,761 Other 7 11 --------- --------- 107,083 104,852 Other Liabilities: Funds held under reinsurance agreements--Note F 2,920 3,072 Deferred reinsurance commissions--Note F 13,902 15,663 Amounts due reinsurers--Note F 6,133 4,442 Notes payable--Notes D and F 15,000 22,531 Commissions payable 5,163 5,010 Accounts payable and other liabilities 2,788 2,353 Deferred federal income taxes--Note G 4,678 5,024 --------- --------- 50,584 58,095 --------- --------- 157,667 162,947 --------- --------- Commitments and Contingencies--Notes F and N
Basis of Presentation: The accompanying consolidated financial statements of ACCEL International Corporation ("ACCEL") and subsidiaries (collectively referred to herein as the "Company") have been prepared in accordance with generally accepted accounting principles which, as to the insurance company subsidiaries, differ in some respects from statutory accounting practices prescribed or permitted by state insurance departments. The significant accounting policies followed by the Company that materially affect financial reporting are summarized below.
Principles of Consolidation: The accompanying consolidated financial statements include the accounts of ACCEL and its wholly-owned subsidiaries, except for Randjill Group Ltd. ("RGL") (see Note K). All significant intercompany accounts and transactions have been eliminated in the consolidated financial statements.
Description of Business: ACCEL is an insurance holding company incorporated in Delaware in June 1978 as the successor to an Ohio corporation, formerly Acceleration Corporation, organized in 1969. The Company has been engaged in the sale and underwriting of credit life and credit accident and health insurance, extended service contracts, commercial auto and other specialty casualty products. The credit insurance and extended service contract products continue to be offered to consumers, principally through automobile dealers, financial institutions and other business entities. The specialty casualty products are offered through general agents. The Company is subject to competition from other insurers throughout the states in which it writes business. The Company is also subject to regulation by the Insurance Departments of states in which it is licensed, and undergoes periodic examinations by those departments.
Legal/Regulatory Risk is the risk that changes in the legal or regulatory environment in which an insurer operates will create additional expenses not anticipated by the insurer in pricing its products. That is, regulatory initiatives, new legal theories or insurance company insolvencies through guaranty fund assessments may create costs for the insurer beyond those currently recorded in the consolidated financial statements. The Company mitigates this risk by operating throughout the United States, thus reducing its exposure to any single jurisdiction, and also by employing underwriting and loss adjusting practices which identify and minimize the adverse impact of this risk.
Accounting Estimates: In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosures of contingent assets and liabilities as of the date of the consolidated financial statements and revenues and expenses for the reporting period. Actual results could differ significantly from those estimates.
Fair value for fixed maturity, equity and asset and mortgage backed securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments at amortized value (see Note B).
The fair value of notes payable is estimated using discounted cash flow analyses, based on ACCEL's current incremental borrowing rates for similar types of borrowing arrangements (see Note G).
Federal Income Taxes: ACCEL and its subsidiaries file a consolidated federal income tax return. The provision for income taxes is based on income for financial reporting purposes, after permanent differences. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under this method, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established when necessary to reduce the deferred tax assets to the amounts expected to be realized.
Reinsurance: Reinsurance premiums ceded and reinsurance recoveries on policy benefits incurred are deducted from the respective income and expense accounts. Assets and liabilities related to reinsurance ceded are reported on a gross basis. Amounts related to reinsurance contracts, where it is not reasonably possible for the reinsurer to realize a significant loss, are recorded based on the deposit accounting method.
Stock Option Plans: Prior to January 1, 1996, the Company accounted for its stock option plans in accordance with the provisions of Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. As such, compensation expense would be recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. On January 1, 1996, the Company adopted the Financial Accounting Standards Board's (FASB) Statement No. 123, Accounting for Stock-Based Compensation, which permits entities to recognize as expense over the vesting period the fair value of all stock-based awards on the date of grant. Alternatively, FASB No. 123 also allows entities to continue to apply the provisions of APB Opinion No. 25 and provide pro forma net income and pro forma earnings per share disclosures for employee stock option grants made in 1995 and future years as if the fair-value-based method defined in FASB No. 123 had been applied. The Company has elected to continue to apply the provisions of APB Opinion No. 25 and provide the pro forma disclosure provisions of FASB No. 123 (see Note I).
At December 31, 1996 and 1995, investments in cash and securities with a carrying value of $10,056,000 and $9,108,000, respectively, were on deposit with state insurance departments to satisfy regulatory requirements. Cash and securities with a carrying value of $22,502,000 and $19,879,000 at December 31, 1996 and 1995, respectively, were on deposit as security funds in connection with reinsurance treaties.
Other invested asset gains 169 26 501 ----------- ----------- ----------- $ 484 $ 455 $ 808 =========== ========== ===========
Year Ended December 31, 1996 1995 1994 ----------- ----------- ----------- (Thousands of dollars) Fixed maturities $ 3,865 $ 5,669 $ 6,307 Equity securities 288 181 113 Short-term investments 440 927 333 Other 55 431 469 ----------- ----------- ----------- 4,648 7,208 7,222 Investment expenses (232) (720) (544) ----------- ----------- ----------- Net investment income $ 4,416 $ 6,488 $ 6,678 =========== ========== ===========
Gross Gross Amortized unrealized unrealized Fair cost gains losses value ---------- ---------- ---------- --------- (Thousands of dollars)
December 31, 1995 - ----------------- U. S. Treasury and U. S. government agency securities $ 9,310 $ 274 $ - $ 9,584 State and political subdivision securities 1,255 35 - 1,290 Mortgage-backed securities 15,887 66 (104) 15,849 Collateralized mortgage obligations 11,587 53 (604) 11,036 Asset-backed securities 13,740 203 (206) 13,737 U. S. corporate securities 1,000 26 - 1,026 Redeemable preferred stocks 648 34 - 682 --------- ---------- --------- --------- Total $ 53,427 $ 691 $ (914) $ 53,204 ========= ========== ========= =========
One asset-backed security held by the Company was written down by $150,000 and $200,000 in 1996 and 1995, respectively. These write downs are included in realized gains in the accompanying consolidated statements of operations.
Of the Subordinated Notes described above, a significant portion were held by Chase Insurance Holdings Corporation ("CIHC"), a company related through common ownership by a stockholder and director of the Company.
At December 31, 1994, the effective interest rate and outstanding loan balance under a credit agreement (the "Credit Agreement") were 8.75% and $13,000,000, respectively. On February 7, 1995 the Company renegotiated the terms of the Credit Agreement. Under the amended Credit Agreement, the quarterly principal payments scheduled to begin in 1995 were waived. Specific principal payments totaling up to $1.5 million were due on June 30, 1995 and December 31, 1995. The loan was to be payable in full on June 30, 1997
The Company's reinsurance program includes an agreement covering certain of its direct credit business, the reinsurance of other direct business ceded on a quota share basis and direct business ceded to producer-owned reinsurance companies.
Direct Business Ceded--Credit Business Quota Share: The Company has an agreement in place which covers a substantial portion of its credit insurance business. The agreement contains an experience adjustment computation that results in the ultimate cost of this agreement being a stated percentage related to the business covered by the agreement. The Company ultimately retains a substantial part of the insurance risk, the underwriting income or loss and the investment income on net funds.
The effect of this agreement is to increase statutory capital and surplus of ALIC, a wholly owned subsidiary of ACCEL, by $14,416,000 and $14,512,000 as of December 31, 1996 and 1995, respectively.
Concurrent with this termination, the Company entered into a reinsurance agreement with a different unaffiliated reinsurer (which is also the buyer of the Senior Notes discussed in Note D) to reinsure a substantial portion of the in-force credit life and accident and health insurance business, including the amounts recaptured. This agreement is structured in such a way that as future profits emerge on this block of business, a substantial portion of the Company's share of the profits will be used over the next four to five years to pay fees and interest to the reinsurer and redeem the new Senior Notes of $16,500,000 (see Note D). In connection with this agreement, approximately $40,000,000 of assets were transferred to the reinsurer on December 29, 1995, as agreed to by all parties. The unearned premium reserves and liability for insurance claims subject to cession under this treaty approximated $48,616,000 and $9,919,000, respectively, as of January 1, 1996.
Direct Business Ceded--To Producer-Owned Reinsurance Companies: The Company has agreements to cede certain credit life and credit accident and health insurance to reinsurance companies owned by certain automobile dealers, financial institutions or agents. Under these arrangements, the assuming entities participate in the profits or losses of the insurance produced by them, and the Company may retain a nominal percentage of the applicable business. These treaties generally provide that the Company receives a ceding fee and is reimbursed for certain commissions and claims.
Other Reinsurance: Credit life and credit accident and health premiums assumed by the Company relating to business written in Pennsylvania by an unaffiliated carrier, amounted to $3,633,000, $6,308,000 and $7,640,000 in 1996, 1995 and 1994, respectively. Unearned premium reserves and the liability for insurance claims at December 31, 1996 include $8,279,000 and $3,352,000, respectively ($10,904,000 and $3,243,000 at December 31, 1995, respectively), for risks assumed under this agreement.
As of December 31, 1992, the Company entered into a reinsurance agreement with unaffiliated reinsurers whereby the Company cedes 100% of the premiums written in connection with vendor's single interest insurance. In mid 1994, a substantial part of the remaining in-force business was assumed by an unaffiliated reinsurer, and resulted in a return of premiums. The VSI product was forced-placed when the borrower could not demonstrate coverage for the automobile that was securing the loan with the lending institution. Premiums ceded under this agreement were $(63,000), $(858,000) and $(6,024,000) for 1996, 1995 and 1994, respectively. Policy benefit expense in 1996, 1995 and 1994, respectively, has been reduced by $83,000, $104,000 and $1,407,000 in conjunction with these agreements.
The Company also entered into reinsurance agreements with several unaffiliated reinsurers related to certain property and casualty lines of business written by the Company. Unearned premium reserves and the liability for insurance claims associated with these agreements at December 31, 1996 are $5,572,000 and $5,820,000, respectively ($2,645,000 and $2,240,000 at December 31, 1995, respectively).
The following data summarizes certain aspects of the Company's reinsurance activity for 1996, 1995 and 1994.
Premiums written and earned in 1996, 1995 and 1994 are summarized as follows:
Policy benefits incurred in 1996, 1995 and 1994 are summarized as follows:
The Company files a consolidated income tax return with its subsidiaries, including its life insurance subsidiary. For tax purposes, certain amounts have been accumulated by the life insurance subsidiary in a memorandum tax account designated as "policyholders' surplus" that will be taxed only when distributed to shareholders. Policyholders' surplus on a tax basis was $4,489,000 at December 31, 1996. Management considers the likelihood of distributions from this account to be remote; therefore, no federal income tax has been provided for such distributions in the accompanying consolidated financial statements.
As of December 31, 1996, approximately $4,700,000 could be distributed to shareholders before a distribution would be designated as from the policyholders' surplus account.
Year Ended December 31, 1996 1995 1994 --------- --------- --------- (Thousands of dollars) Income tax (benefit) at statutory rate $ 605 $ (374) $(1,668) Amortization of goodwill 36 36 36 Dividends-received deduction (64) (54) (38) Special deductions of life insurance subsidiaries (273) - (297) Tax-exempt interest (14) (18) (21) Valuation allowance (372) 761 (599) Write off of subsidiary - - 1,302 Other, net (112) 8 1,618 --------- --------- --------- Federal income tax expense (benefit) $ (194) $ 359 $ 333 ========= ========= =========
The tax effects of temporary differences that give rise to significant components of the net deferred tax liability at December 31, 1996 and 1995 are summarized as follows:
The Company has determined the valuation allowance related to the deferred tax assets based on its analysis of future deductible amounts. This analysis included a schedule of the deductibility of non-life items against life company taxable income pursuant to Section 801 of the Internal Revenue Code and a determination of the realization of losses generated by available for sale securities.
The Company has $2,923,000 of net operating losses that are available to reduce future income taxes and will expire in 2010.
The following table provides a reconciliation of beginning and ending liability balances for the Company's insurance claims for 1996, 1995 and 1994.
Policy benefits for insured events of the current year 13,307 10,860 20,556
Liability for insurance claims at end of year $ 25,256 $ 22,761 $ 23,159 ========= ========= ========
The table above reflects decreases in the liability for insurance claims resulting from discontinued lines of business and the write off of Galaxy Insurance Company ("Galaxy"), a wholly owned subsidiary of RGL (see Note K). Increases in policy benefits incurred for events of prior years relate to management's reevaluation of discontinued lines of business.
ACCEL's Board of Directors approved an Employee Stock Ownership Plan ("ESOP") during 1989. In 1990, the ESOP entered into an agreement with ALIC to borrow up to $1,000,000 for the purchase of ACCEL's common stock. At December 31, 1996, the unpaid balance on this loan was $32,000.
During 1982, ACCEL adopted a stock option plan (the "82 Plan") under which shares of common stock were made available to eligible officers and key personnel. Under the terms of the 82 Plan, the option price had to be at least 100% of the fair value at the date of grant, and, accordingly, there were no charges to income resulting from grants. Options were granted at prices ranging from $2.769 to $11.750 per share from April 1982 through April 1992. The options become exercisable after one year of continuous employment in installments of 50% at the end of the first and the second year from the date of grant and expired ten years from the date of grant. A total of 300,000 (349,672 after giving effect to all subsequent stock dividends) shares had been reserved for options under the 82 Plan.
During 1987, ACCEL adopted the 1987 Incentive Stock Option Plan (the "87 Plan"). The 87 Plan provided for incentive stock options with respect to a maximum of 300,000 (347,287 after giving effect to all subsequent stock dividends) shares of common stock of ACCEL prior to the expiration of the 87 Plan in April 1997. During June of 1991, ACCEL's Board of Directors and shareholders approved the First Restatement of the 1987 Stock Incentive Plan (the "Restated Plan"). The Restated Plan replaced the 87 Plan except as to options granted and outstanding under the 87 Plan. The Restated Plan reserved an additional 450,000 shares for key employees and 50,000 shares for non-employee directors. Options could be granted prior to expiration of the Restated Plan covering shares subject to lapsed or terminated options. Of the total options outstanding under the Restated Plan, 235,254 were exercisable at December 31, 1996. At December 31, 1996, no shares were reserved for future grants.
During May 1995, two new Key Employees were granted stock options under ACCEL's Restated Plan. Under the terms of their arrangement with ACCEL, both were granted stock options for ACCEL's common stock in lieu of salary for their first year of service. Options for 150,000 shares were granted at an option price per share of $2.125, the fair value of ACCEL's common stock on the date of grant. The options vest immediately and become exercisable one year following the date of grant; however, they would become exercisable immediately upon either a) a change of control of ACCEL, or b) an involuntary termination. The options would have been forfeited if employment with ACCEL had been voluntarily terminated prior to May 23, 1996. The options lapse five years from the effective date of grant.
At the end of their first year of service the status of these two key employees was evaluated by the Compensation Committee and based on the value of their services, began receiving compensation effective June 1, 1996. As part of their compensation both were granted stock options pursuant to the 1996 Stock Incentive Plan (the "96 Plan"). Options for 165,000 shares were granted at an option price per share of $2.50, the fair value of ACCEL's common stock on the date of grant. The terms are identical to the aforementioned options granted in May 1995.
Options granted 420,371 - - Average option price per share 2.514 - - Options lapsed - - -
Options granted - 231,500 89,000 Average option price per share - $ 2.125 $ 4.500 Options lapsed 45,526 25,000 118,759
Options exercised 110,000 - - Average exercised price 2.125 - -
At December 31, 1996 and 1995, there were 579,629 and 0 additional shares available for grant under the 1996 Plan and the Restated Plan, respectively. The per share weighted-average fair value of stock options granted during 1996 and 1995 was $1.20 and $0.79 on the date of grant using the Black Scholes option-pricing model with the following weighted-average assumptions: 1996 - expected dividend yield 0%, risk-free interest rates ranging from 6.85% to 7.09% (based on the date of the grant), and expected lives of 5 to 10 years (based on the terms of the grant); 1995 - expected dividend yield 0%, risk-free interest rate 7.00%, and expected lives of 5 to 10 years (based on the terms of the grant).
Net income (loss) per As reported $ .36 $ (.33) common share Pro forma .34 (.36)
December 31, 1996 1995 1994 --------- --------- --------- (Thousands of dollars) Identifiable assets: Life/Health $138,723 $144,164 $139,262 Property/Casualty 49,840 38,977 40,428 Other 745 366 258 --------- --------- --------- Total $189,308 $183,507 $179,948 ========= ========= =========
NOTE K--WRITE OFF OF INVESTMENT IN RANDJILL GROUP LTD. AND GALAXY INSURANCE COMPANY
During December 1986, ACCEL invested $1,370,000 (a 20% interest) in RGL. Galaxy, a wholly owned subsidiary of RGL, wrote commercial property insurance, property and casualty, and assumed treaty reinsurance.
Pursuant to an Order of Liquidation dated October 7, 1994, issued by the Supreme Court of the State of New York, the Liquidation Bureau of the New York Department (the "Liquidation Bureau") took control of Galaxy on October 11, 1994.
The Plan allows all employees who meet certain eligibility requirements and choose to participate to defer a percentage of their salary and contribute to the Plan on a tax deferred basis. The employee contributions to the Plan are used to fund the savings element of the Plan. The Company contributions become part of the Plan and are used to purchase shares of ACCEL's common stock in the open market.
In 1990, the Plan entered into an agreement with ALIC to borrow up to $1,000,000 for the purchase of ACCEL's common stock. The Plan purchased 136,887 shares (adjusted for the 1990 5% common stock dividend) under this loan agreement with ALIC at a cost of $1,000,000. In addition to the shares purchased under the loan agreement, the Plan has purchased 90,088 common shares at a cost of $603,000. The loan, which bears interest at 10%, is being repaid from Company contributions to the Plan.
At December 31, 1995, the loan had an unpaid balance of $525,000. The market value of the underlying shares was $161,000. The Company revalued this loan to market value as of December 31, 1995. This allowed the release of shares to participants' accounts at an average price which more closely approximates recent market values on the Company's stock. The decrease in the loan in 1995 has been reflected through a decrease in additional paid-in capital in the accompanying consolidated balance sheets. The unpaid balance of the loan ($32,000 and $161,000 at December 31, 1996 and 1995, respectively), has been reflected as a reduction in common stockholders' equity in the accompanying consolidated balance sheets.
The operating results of AICL were translated into U. S. dollars using the average exchange rates in effect during the respective period. The consolidated results of operations included $137,000 and $82,000 of pre-tax loss from AICL for the years ended December 31, 1995 and 1994, respectively.
Included in foreign currency translation adjustments were unrealized exchange gains of $85,000 in 1995.
Due to the nature of its operations, the Company is at all times subject to pending and threatened legal actions that arise in the normal course of its activities. In management's opinion, based on the advice of outside counsel, the accompanying consolidated financial statements would not be materially affected by the ultimate outcome of any legal proceedings or contingent liabilities.
The Company intends to fully investigate each claim which the Liquidation Bureau, acting on behalf of the Guaranty Fund, formally asserts is entitled to the benefits of a Certificate to determine whether such Certificate was properly endorsed by ANIC and issued with proper authority and if so, whether proper agreements, assignments and evidences of subrogation have been executed. The Company intends to vigorously defend any claims for indemnification or reimbursement made by the Liquidation Bureau, on behalf of the Guaranty Fund, with respect to the Certificates. Although the Company is not in a position to estimate the magnitude of the potential claims for indemnification or reimbursement, it does not believe that the ultimate resolution of such claims will have a material adverse effect on the financial condition or results of operations of the Company.
The Company currently leases office space under two operating leases which expire in 2000 and 2001. These leases are accounted for as operating leases. Minimum rental commitments in effect at December 31, 1996 are as follows:
Year Payable Annual Minimum Rentals ------------ ---------------------- 1997 $ 336,000 1998 338,000 1999 340,000 2000 322,000 2001 147,000 ---------- Total $1,483,000 ==========
During 1995, the Company sold its investment in First International Bancorp, an affiliate of CIHC, to entities associated with CIHC. The sales price was $1,250,000; no gain or loss was realized on the disposition.
In 1993, the National Association of Insurance Commissioners ("NAIC") adopted the life and health and property and casualty Risk-Based Capital (RBC) formulas. These model acts require every insurer to calculate its total adjusted capital and RBC requirement, and provides for an insurance commissioner to intervene if the insurer experiences financial difficulty. These model acts became law in Ohio, the Company's insurance subsidiaries' state of domicile, in March 1996. The formula includes components for asset risk, liability risk, interest rate exposure, and other factors. Each of the Company's insurance subsidiaries exceed all required RBC levels as of December 31, 1996.
Quarterly consolidated results of operations for 1996 and 1995 are summarized as follows:
First Second Third Fourth Quarter Quarter Quarter Quarter --------- --------- --------- --------- (Thousands of dollars, except per share data) ---- Premiums written $16,697 $17,169 $15,288 $ 9,258 Premiums earned 10,065 11,498 13,176 11,218 Policy benefits 5,091 5,594 7,429 6,224 Net income 46 46 160 1,852
The 1996 net income per common share amounts, in the aggregate, do not equal the amount on the 1996 consolidated statement of operations due to the Rights Offering (see Note D).
In 1996, ACCEL received a total of $4,291,085 in proceeds from a legal action brought by the Company against a non-affiliated marketing organization. With the approval of the Ohio Department the proceeds from the settlement were shared equally between ACCEL and ANIC. These proceeds have been categorized as other income in the accompanying 1996 consolidated statement of operations.
In accordance with General Instruction G(3), the information required by this Item 10 is incorporated by reference herein from the material under the headings "Election of Directors" and "Executive Compensation" contained in the Company's definitive proxy statement filed with the Commission relating to the annual meeting of stockholders to be held on May 20, 1997.
The executive officers, their respective ages and business experience are as follows: Thomas H. Friedberg (57), Chairman of the Board, President and Chief Executive Officer; Douglas J. Coats (63), Executive Vice President; Cynthia A Moore (34), Senior Vice President and Chief Financial Officer; Nicholas Z. Alexander (61), Senior Vice President, Secretary and General Counsel; Larry L. Main (48), Senior Vice President-Auto After Market Group; and Kurt L. Mueller (48), Vice President, Treasurer and Controller; William E. Merritt, Jr. (61), Senior Vice President of Claims and Bryce E. Farmer (45), Senior Vice President of Administration.
Mr. Coats joined the Company on May 23, 1995, when he was appointed Executive Vice President and a member of the Board of Directors. Prior thereto, he was Executive Vice President of Ranger Insurance Company, Houston, Texas for more than five years.
Ms. Moore joined the Company and on August 28, 1996, she was elected Senior Vice President and Chief Financial Officer. Prior thereto she was an Audit Executive with Ernst & Young LLP for more than five years.
Mr. Farmer joined the Company in February 1996 and was elected Senior Vice President Administration on March 12, 1996. Prior thereto he had been Senior Vice President-Corporate Development with Universal Underwriters Group, Overland Park, Kansas between June 1993 and November 1995. Prior thereto, he had been with Ranger Insurance Company, Houston, Texas for more than five years as Senior Vice President-Administration.
In accordance with General Instruction G(3), the information required by this Item 11 is incorporated by reference herein from the material under the headings "Executive Compensation" and "Incentive Stock Option Plans" contained in the Company's definitive proxy statement filed with the Commission relating to the Company's annual meeting of stockholders to be held on May 20, 1997.
In accordance with General Instruction G(3), the information required by this Item 12 is incorporated by reference herein from the material under the headings "Security Ownership and Certain Beneficial Owners" contained in the Company's definitive proxy statement filed with the Commission relating to the Company's annual meeting of stockholders to be held on May 20, 1997.
ITEM 14(a) (l) and (2)--INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES COVERED BY INDEPENDENT AUDITORS' REPORT