OGGI's main offices are located at 2929 Lititz Pike, Lancaster, Pennsylvania in a 33,000 square foot facility owned by Old Guard. Old Guard Fire owns a 25,000 square foot office facility near the main office at 147 West Airport Road in Lancaster. First Patriot leases 7,500 square feet of office space in Quakertown, Pennsylvania and First Delaware and New Castle occupy 6,750 square feet of leased office space in Smyrna, Delaware.
On February 21, 1997, OGGI purchased a 21,500 square foot facility situated on 8 acres of land adjacent to OGGI's headquarters. The purchase price was $1.1 million. The parcel of land allowed for the expansion of an additional 50,000 square foot facility. This expansion was begun in late 1997 and was completed in the fall of 1998. In addition, Old Guard Fire has listed the Airport Road facility for sale.
In March 1999, OGGI announced its intention to close the operation in Quakertown and integrate those functions within its Lancaster office. The lease on the space in Quakertown will be allowed to expire in late 1999.
Net Investment Income. Net investment income increased $303,000, or 5.2%, to $6.2 million in 1998 from $5.9 million in 1997 while average cash and invested assets increased $3.0, or 2.6%. In addition to the increase in average invested assets, investment income increased in 1998 because of $169,000 of distributions from limited partnerships which did not make distributions in 1997. For 1998, the yield on average cash and invested assets was 5.2% compared to 5.3% for 1997.
Net Realized Investment Gains. Net realized investment gains were $1.3 million for 1998 compared to $2.3 million in 1997, a decrease of $1.0 million or 44.6%. The decrease in realized gains were a result of the market volatility in the fourth quarter of 1998 which increased the spread between bid and ask prices making the sale of bonds and convertible securities unattractive and a loss of $817,000 related to the acquisition of New Castle. The loss resulted from writing down the carrying value of OGGI's surplus note investment in New Castle, forgiveness of interest on the note and costs related to the transaction.
Other Revenue. Other revenue increased $1.7 million, or 419.8%, in 1998 to $2.1 million from $414,000 in 1997. This increase is attributable to increased management fees from Neffsville Mutual Fire Insurance Company and New Castle.
Ceded premiums written decreased $12.5 million to $21.9 million in 1997 compared to 1996. The decrease in premiums ceded was directly attributable to the effects of reducing from 20% to 15% the quota share reinsurance agreement with our primary reinsurer, American Re. Ceded premiums written under this agreement amounted to $9.4 million and $20.1 million for 1997 and 1996, respectively. The remaining decrease in ceded premiums written related to a restructuring of our property reinsurance program effective January 1, 1997, from a combination of pro-rata and excess of loss to 100% excess of loss. This change in the property reinsurance program resulted in a $2.9 million decrease in ceded premiums written. Decreases in ceded premiums as a result of the aforementioned changes in our property reinsurance were offset by a $1.6 million increase associated with the acquisition of First Delaware.
Net premiums written increased $18.4 million, or 38.5%, in 1997 to $66.1 million from $47.7 million in 1996. For the same comparative periods, net premiums earned increased $8.8 million, or 16.5%, to $62.4 million from $53.6 million. The increases in net premiums written and net premiums earned were directly attributable to the effects of reducing the quota share reinsurance agreement with American Re as well as the other factors discussed above.
Net Investment Income. Net investment income increased $1.4 million, or 30.7%, to $5.9 million in 1997 from $4.5 million in 1996 while average cash and invested assets increased $28.2 million, or 31.8%. For 1997, the yield on average cash and invested assets was 5.3% compared to 5.1% for 1996. The increase in average cash and invested assets can be attributed primarily to the $33.7 million in net proceeds from OGGI's subscription offering in February 1997 and the increase in gross unrealized gains on investments of $2.8 million.
Underwriting Expenses. Underwriting expenses, which include amortization of deferred policy acquisition costs and operating expenses, increased $6.0 million, or 32.8%, in 1997 to $24.4 million from $18.4 million in 1996. The increase is primarily due to a $4.5 million reduction in ceded commissions arising out of the decrease in the quota share reinsurance agreement and a $1.4 million increase in other underwriting expenses. The other underwriting expense increase can be attributed to the acquisition of First Delaware that contributed $650,000 to the increase and initiatives undertaken by OGGI's subsidiaries to upgrade their computer systems and to reunderwrite the homeowners book of business.
Net cash provided (used) by operating activities was $5.1 million, $4.1 million and $(10.7) million during 1998, 1997, and 1996, respectively. Negative cash flow from operating activities during 1996 was primarily attributable to the net loss for the period and an increase in reinsurance receivables and prepaid reinsurance premiums as a result of implementing the quota share agreement with American Re.
In 1998, investing activities used cash of $6.8 million primarily because of the expansion of our home office which was completed in the fall of 1998 and continued investments in technology. In 1997, investing activities used cash of $33.5 million primarily because of the investment of the net proceeds from the subscription offering and the continuing costs of improvements to our computer systems. In 1996, investing activities provided cash of $7.4 million primarily as a result of decreases in the fixed income portfolio needed to fund unprofitable operations in that year.
In February 1996, OGGI and American Technologies, Inc., a California based software lessor, entered into a lease financing agreement in connection with the acquisition by OGGI of a new policy processing software system for approximately $2.5 million. The terms of the lease financing agreement provide for an aggregate lease facility up to $1.5 million. The implied interest rate under the lease is 9.5%. As of December 31, 1996, the lease facility was fully utilized. During 1998, this lease was repaid.
The ESOP borrowed $4.1 million from an unaffiliated lender and $100,000 from OGGI to purchase 10% of the common stock issued in OGGI's subscription offering (see Note 1). The loans bear an 8.45% interest rate, and will require the ESOP to make monthly payments of $50,417 for a term of 10 years. The loan is secured by the shares of common stock purchased and the earnings thereon. Shares purchased with such loan proceeds will be held in a suspense account for allocation among participants as the loan is repaid. OGGI expects to contribute sufficient funds to the ESOP to repay such loan, plus such other amounts as OGGI's Board of Directors may determine at its discretion.
In June 1997, SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," was issued. SFAS No. 131 establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports issued to shareholders. SFAS No. 131 also establishes standards for related disclosures about products and services, geographic areas and major customers. SFAS No. 131 is effective for fiscal years beginning after December 15, 1997. OGGI has determined that it manages one operating segment which is comprised of its property and casualty business.
Vendors and external agents also have been contacted by phone and/or letter to request information regarding their year 2000 status. OGGI has received some responses to date but all vendors have not yet responded. Alternative vendors have been identified for those vendors that do not respond.
Although OGGI expects to finish testing its year 2000 compliance by June 30, 1999, it has considered contingencies in case any of its fatal or critical assets, not already confirmed as compliant, fail year 2000 compliance testing. For such assets, OGGI has identified alternatives that will not cause significant interruptions to service or operation.
Many experts now believe that the year 2000 problem may have a material adverse impact on the national and global economies. In addition, it seems likely that if businesses are materially damaged as a result of the year 2000 problems, at least some such businesses may attempt to recoup their losses by claiming coverage under various types of insurance policies. And, although management has concluded that under a fair reading of the various policies of insurance issued by it, no coverage for year 2000 problems should be considered to exist and has included exclusionary language on certain policies beginning in 1998, it is not possible to predict whether or to what extent any such coverage could ultimately be found to exist by courts in the various jurisdictions. Accordingly, important factors which could cause actual results to differ materially from those expressed in the forward looking statements include, but are not limited to, the inability of OGGI to accurately estimate the impact of the year 2000 problem on the insurance issued by, or other business operations of OGGI.
Certain statements contained in the Management's Discussion and Analysis and other statements made throughout this report constitute "forward-looking statements" (as such term is defined in the Private Securities Litigation Reform Act of 1995). Such forward-forwarding statements involve certain assumptions, risks and uncertainties that could cause actual results to differ materially from those included in or contemplated by the statements. These assumptions, risks and uncertainties include, but are not limited to those associated with factors affecting the property-casualty insurance industry generally, including price competition, size and frequency of claims, escalating damage awards, natural disasters, fluctuations in interest rates and general business conditions; OGGI's dependence on investment income; the geographic concentration of OGGI's business in the Northeast United States; the adequacy of OGGI's liability for losses and loss adjustment expenses; government regulation of the insurance industry and the other risks and uncertainties discussed or indicated in all documents filed by OGGI with the Securities and Exchange Commission. OGGI expressly disclaims any obligation to update any forward-looking statements as a result of developments occurring after the release of this report.
Effective January 1, 1997, OGGI acquired 80% of the outstanding common stock of First Delaware for $3.3 million, which included a capital infusion of $1.5 million. Pro forma results for 1996, including First Delaware as if it had been 80% owned during that period and as if OGGI had converted to stock form, are as follows:
The accompanying consolidated financial statements have been prepared in conformity with generally accepted accounting principles. All significant intercompany transactions have been eliminated in consolidation. Certain amounts in the 1997 and 1996 financial statements have been reclassified to conform to the current year presentation.
Cash and cash equivalents are carried at cost, which approximates fair value. OGGI considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.
OGGI classifies fixed income and marketable equity securities as trading or available for sale. In addition, fixed income securities may be classified as held to maturity. Each security are evaluated at the time of purchase and periodically reevaluated. Held to maturity securities are carried at amortized cost. Available for sale securities are carried at fair value, with the unrealized gains and losses, net of deferred income tax, reported as a separate component of shareholders' equity. Currently, no securities are classified as trading.
The liability for losses and loss adjustment expenses include amounts determined on the basis of claims adjusters' evaluations, estimates of losses incurred but not reported calculated using historical experience and other estimates. Any adjustments resulting from changes in estimates are reflected in current operating results. Estimated amounts of salvage and subrogation recoverable on paid and unpaid losses are reflected as a reduction of the liability for losses and loss adjustment expenses.
Stock-based compensation plans are accounted for under 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 a stock option grant only if the current market price of the underlying stock exceeded the exercise price. Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation," permits entities to recognize as expense, over the vesting period, the fair value of all stock-based awards on the date of grant. Alternately, SFAS No. 123 allows entities to apply the provision of APB Opinion No. 25 and provide pro forma net income and earnings per share disclosures for employee stock option grants as if the fair value method defined in SFAS No. 123 had been applied. OGGI has elected to apply the provisions of APB Opinion No. 25 and provide pro forma disclosures under SFAS No. 123.
Financial instruments which potentially expose OGGI to concentrations of credit risk consist primarily of cash and short-term investments, premiums in course of collection, investments and balances recoverable from reinsurers. Insureds primarily consist of individuals and commercial and agricultural businesses.
No one insured accounted for a significant amount of premiums earned or premiums in course of collection in 1998, 1997 or 1996.
OGGI's insurance subsidiaries prepare their statutory financial statements in accordance with accounting principles and practices prescribed or permitted by the Insurance Department of the respective company's state of domicile. Prescribed statutory accounting practices include state laws, regulations, and general administrative rules, as well as a variety of publications of the National Association of Insurance Commissioners (NAIC). Permitted statutory accounting practices encompass all accounting practices that are not prescribed; such practices differ from state to state, may differ from company to company within a state, and may change in the future.
Risk based capital is designed to measure the acceptable amount of capital an insurer should have based on the inherent risks of the insurer's business. Insurers failing to meet adequate capital levels may be subject to insurance department scrutiny and ultimately rehabilitation or liquidation. Based on established standards, OGGI's insurance subsidiaries maintain surplus in excess of prescribed risk based capital requirements.
Statutory surplus and net income (loss), determined in accordance with accounting practices prescribed or permitted by insurance regulatory authorities are as follows:
Net investment income, net realized investment gains and change in unrealized investment gains on investments are as follows for each of the three years ended December 31:
Collateralized mortgage obligations consist of mortgage pass-through holdings and securities backed by credit card receivables, auto loans and home equity loans. These securities follow a structured principal repayment schedule and are of high credit quality rated "AA" or better by Standard & Poor's. These securities are presented separately in the maturity schedule due to the inherent risk associated with prepayment on early authorization. The average duration of this portfolio is 2.4 years.
The gross realized gains and losses on investment securities in 1998, 1997 and 1996, are as follows:
Insurance laws require that certain amounts be deposited with various state insurance departments for the benefit and protection of policyholders. The amortized cost of fixed income securities on deposit with governmental authorities was $924,399 and $820,402 at December 31, 1998 and 1997, respectively.
The liability for losses and loss adjustment expenses reflects management's best estimate of future amounts needed to pay claims and related settlement costs with respect to insured events which have occurred, including events that have not been reported. In many cases, significant periods of time, ranging up to several years, may elapse between the occurrence of an insured loss, the reporting of the loss, and the payment of that loss. As part of the process in determining these amounts, historical data is reviewed and consideration is given to the impact of various factors, such as legal developments, changes in social attitudes, and economic conditions.
Management believes that its liability for losses and loss adjustment expenses are fairly stated, in accordance with generally accepted actuarial principles and practices. However, estimating the ultimate claims liability is a complex and judgmental process inasmuch as the amounts are based on management's informed estimates and judgments using data currently available. As additional experience and data become available regarding claim payments and reporting patterns, legislative developments, and economic conditions, the estimates are revised accordingly and the impact is reflected currently in the consolidated financial statements.
Property and equipment consisted of the following at December 31, 1998 and 1997:
Land $ 767,407 $ 767,407 Buildings and improvements 10,230,801 4,992,202 Furniture, fixtures, equipment and software 11,730,183 7,599,114
During 1997 and 1996, Old Guard, Old Guard Fire and First Patriot maintained a 15% (20% in 1996) quota share reinsurance agreement with their primary reinsurer, American Re-Insurance Company. The agreement provided for a 30% (35% in 1996) ceding commission on net business written. Effective January 1, 1998, the agreement was cancelled on a run-off basis. This agreement was intended to provide protection from high frequency and low severity type losses. The following summarizes activity under this treaty in 1998, 1997 and 1996:
Reinsurance recoverable, under this agreement, on paid and unpaid losses was $2,641,973 and $5,565,726 at December 31, 1998 and 1997, respectively.
The per share weighted-average fair value of options granted during 1998 and 1997 was $5.05 and $ 10.75, respectively. The fair value of each option grant is estimated on the date of grant using an option-pricing model and the following weighted-average assumptions:
Information regarding activity in OGGI's stock options plan is presented below:
Granted in 1998 5,000 Forfeited in 1998 (14,095) Total granted at December 31, 1998 133,278
Options totaling 18,585 and 8,000 at December 31, 1998 and 1997, respectively, were not included in the computation of diluted earnings per share because the options' exercise price was greater than the average market price of the common shares. Earnings per share for 1996 are computed on a pro forma basis assuming the subscription offering took place on January 1, 1996.
The carrying amounts of cash and cash equivalents, short- term investments and long-term debt approximate their fair value.
Neffsville is provided management services by OGIM for a fee as determined under a management agreement. Management fees recognized by OGIM under the aforementioned management agreements are as follows:
Effective January 1, 1998 Old Guard reinsured 100% of New Castle's premiums losses and loss adjustment expenses in return for a commission of 35% of ceded premiums written. During 1997, Old Guard participated in a portion of New Castle's reinsurance program. The following summarizes the business assumed from New Castle for the year ended December 31, 1997 and for the nine months ended September 30, 1998, the date New Castle became a subsidiary of OGGI (See note 1).
Summary financial information for Southern as of and for the year ended December 31, 1998 is as follows:
OGGI, the Insurance Companies and the individual defendants filed a motion to dismiss the complaint in May 1997. In December 1997, the Court granted the motion with respect to two of the constitutional counts and denied the motion with respect to the remaining nine counts, including five of the constitutional claims.
Old Guard Group, Inc. Schedule II. Condensed Financial Information of Registrant - Balance Sheet (Parent Company) As of December 31, 1998 and 1997
Old Guard Group, Inc. Schedule II. Condensed Financial Information of Registrant - Statement of Income (Parent Company) For the Years Ended December 31, 1998 and 1997
OLD GUARD INSURANCE GROUP SCHEDULE VI - SUPPLEMENTAL INFORMATION CONCERNING PROPERTY & CASUALTY INSURANCE OPERATIONS AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996