Net income per common share and cash dividends declared per common share have been retroactively restated for additional shares issued as a result of a three for two stock split to stockholders of record as of December 18, 1995.
The Company's fixed maturity portfolio, composed primarily of high quality securities, grew by 7% to $719,040,000 in 1996. The portion of the portfolio that was investment grade (defined by the National Association of Insurance Commissioners ("NAIC") - Securities Valuation Office and issued with NAIC code class 1 or class 2), as of December 31, 1996 and 1995, was 95% and 94%, respectively, for the property and casualty segment, and 93% and 92%, respectively, for the life segment.
The Company considers itself a long-term investor, and classifies a majority of its fixed maturity securities as held-to-maturity. Available-for-sale fixed maturities comprise 9% of the total fixed maturity portfolio, and the Company holds no trading securities. Net unrealized losses of $1,415,000 were recorded in 1996 on the available-for-sale fixed maturity securities, compared to net unrealized gains of $4,243,000 in 1995.
During 1995, concurrent with its adoption of the implementation guide on Statement of Financial Accounting Standards ("SFAS") No. 115, the Financial Accounting Standards Board allowed a one-time reassessment of the SFAS No. 115 classifications of all securities currently held. Any reclassifications would be accounted for at fair value in accordance with SFAS No. 115 and any reclassifications from the held-to-maturity portfolio that resulted from this one-time reassessment would not call into question the intent of the Company to hold other debt securities to maturity in the future. We did use the opportunity under this one-time reassessment to reclassify $79,131,000 in securities from held-to-maturity to the available-for-sale category. In connection with this reclassification, gross unrealized gains of $5,145,000 and gross unrealized losses of $908,000 were recorded in available-for-sale securities and in stockholders' equity in 1995.
Accounts receivable are balances due from property and casualty insurance agents and brokers for premiums written less commissions, and losses receivable from assumed brokers. In 1996, this asset grew by $4,813,000 or 12%, due to premium growth and the Company's deferred payment plan.
RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1996, COMPARED TO THE YEAR ENDED DECEMBER 31, 1995 PROPERTY AND CASUALTY OPERATIONS
The decrease of $2,204,000 in premiums earned is attributable to a decrease in collected traditional life premiums of $2,854,000. One product, single premium whole life, saw a decrease of $3,591,000.
Other underwriting and operating expenses decreased $1,979,000 due to a larger deferral of expenses associated with acquisition of new business. An increase in premiums collected of $10,305,000 in the single premium deferred annuity block along with additional acquisition expenses is responsible for 50% of this decrease. The balance of the decrease is due to a combination of slight increases in premiums collected and refinement in the way deferrable acquisition expenses are determined and allocated.
RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1995, COMPARED TO THE YEAR ENDED DECEMBER 31, 1994 PROPERTY AND CASUALTY OPERATIONS
The Company's property and casualty segment reported record operating earnings of $30,718,000 in 1995, compared to $22,922,000 in 1994. Premiums earned increased 11%, or $19,142,000. Much of the growth was direct business concentrated in four midwestern states. In addition, the Company had to pay less for its ceded protection due to a decrease in ceded premium rates.
Loss and loss adjustment expenses increased 9% over 1994. An absence of significant exposure to 1995 catastrophes and a reduction in loss expenses contributed to the Company's favorable results. Gross losses incurred related to the 1994 Northridge earthquake were $3,847,000 in 1995, compared to $10,342,000 in 1994. Ceded losses incurred related to this catastrophe were $3,005,000 in 1995, compared to $4,319,000 in 1994. Gross incurred on other catastrophe losses for the years ending 1995, 1994 and 1993 were $10,089,000, $5,784,000 and $13,876,000, respectively. Ceded incurred on all other catastrophes for the years ending 1995, 1994 and 1993 were $114,000, $(17,000) and $158,000, respectively.
Interest credited increased $3,468,000 due to an increase in total universal life and annuity balances from an average of $281,000,000 during 1994 to $322,000,000 during 1995. Note that the interest credited increased by around 20%, while total average assets increased by only 15%. The balance of the increase was due to higher rates credited during 1995.
There were management changes within your Company during 1996. In November, Gary Huber, President and Chief Operating Officer resigned and Scott McIntyre Jr., Chairman of the Board and Chief Executive Officer, assumed the titles and responsibilities of President and Chief Operating Officer.
Your Company offers a multiple line of products for its agents and plans to continue. We are spending $2.5 to $3.0 million to update our personal lines administration system. When complete, our agents will be able to submit applications electronically and we will print policies in our agents' offices. Our life segment is growing and prospering. It continues to offer universal life and annuity products as well as traditional life products.
Contributing to our poor underwriting results were the disastrous results of the Addison Farmers' Insurance Company (this year we plan to change its name to the Addison Insurance Company) which had a combined ratio of 143% and continued poor loss ratios in the automobile liability, both private passenger and commercial lines. Addison Farmers' has new management. E. A. (Spike) Hulit transferred from our Lincoln Regional office to the Addison office and was named its president. In Lincoln, Spike did an outstanding job of turning around that office and giving it direction. Improving our automobile experience is this year's number one priority.
While the weather was not a major problem, on December 19 we were once again reminded what it meant to be in the business of insuring against the unexpected. A tanker with a Chinese crew lost power rounding a bend in the Mississippi River and crashed into the Riverwalk Mall in downtown New Orleans. We had seven properties insured in that development.
On December 31, 1996, a good friend of all our stockholders and a very special friend of mine retired. Thirty-eight years ago, Mary Schoop started with us typing policies part time. A year later, my father asked her to be my secretary and implied she had no choice. Since then, she has kept me out of a lot of trouble and I'll miss her. Many companies fill the pages of their annual reports with pictures of balding, middle-aged men in dark blue suits. While we have never succumbed to that temptation, Mary is an exception and you'll find her picture on page 37 of the annual report. Not only is she a lot better looking than the typical corporate officer, she's a much better dresser.
CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
The Company and its property and casualty subsidiaries market most forms of commercial and personal property and casualty insurance products, including fidelity and surety bonds and reinsurance. The business is generated through approximately 1,700 independent agencies and brokers in 35 states, with 66% of the Company's direct premiums originating in eight Midwestern states in 1996.
The accompanying Consolidated Financial Statements include United Fire & Casualty Company and its wholly owned subsidiaries, United Life Insurance Company, Lafayette Insurance Company, Insurance Brokers & Managers, Inc., Addison Farmers' Insurance Company, Addison Insurance Agency and Crabtree Premium Finance Company. All material intercompany items have been eliminated in consolidation.
The Company expects to realize a spread of approximately 1.5% to 1.75% between interest earned and interest credited on its Universal Life Plans and deferred annuities, for which the liability is equal to total policy account values plus deferred front-end loads.
For purposes of reporting cash flows, cash and cash equivalents include cash and non-negotiable certificates of deposit with original maturities of three months or less. Income taxes paid during 1996, 1995 and 1994 were $8,201,000, $8,801,000, and $5,784,000, respectively. The Company received $2,074,000 in interest on Federal income taxes in 1996, and paid $532,000 in interest on Federal income taxes in 1994. There were no other significant payments of interest other than interest credited on policyholders' accounts in 1996, 1995 or 1994.
The Company has a defined benefit postretirement health care plan that covers substantially all full-time employees. The plan pays stated percentages of most necessary medical and dental expenses incurred by retirees, after subtracting payments by Medicare or other providers and after a stated deductible has been met. Participants become eligible for the benefits if they retire from the Company after reaching age 59 1/2 with ten or more years of service and were a member of the group medical plan for ten consecutive years. The plan is contributory, with retiree contributions adjusted annually.
The Company adopted SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of", effective January 1, 1996. SFAS 121 requires the separation of long-lived assets and certain identifiable intangibles into two categories for purposes of accounting for an impairment of assets: those to be held and used and those to be disposed of. The Company has intangibles to be held and used from the purchase of Addison Farmers' Insurance Company and the assumption of a book of business in 1990. SFAS 121 requires that intangibles to be held and used should be reviewed whenever events or changes in circumstances indicate that the carrying value may not be recoverable. The Company has determined that its intangible assets are not impaired and has not written down their value.
A reconciliation of the amortized cost to fair values of investments in held-to-maturity and available-for-sale fixed maturities, marketable equity securities and other long-term investments as of December 31, 1996 and 1995 is as follows.
The Company estimated the fair value of its financial instruments, based on relevant market information or by discounting estimated future cash flows at estimated current market discount rates appropriate to the particular asset or liability shown.
The fair value of the liabilities for annuity products which are in a benefit payment phase, guaranteed investment contracts and structured settlements are based on a discount rate of 6.5% at December 31, 1996 and 1995. The fair value of annuities currently in an accumulation phase is based on the net cash surrender value.
The property and casualty insurance companies cede portions of their insurance business to other insurance companies on both a pro rata and excess of loss basis. Insurance ceded by the property and casualty insurance companies does not relieve their primary liability as the originating insurers. Earned premiums ceded were $27,106,000, $26,053,000 and $26,256,000 for the years ended December 31, 1996, 1995 and 1994, respectively. The Company believes all amounts are collectible with regard to reinsurance receivables. There are no concentrations of credit risk associated with reinsurance.
In 1996, the Company experienced favorable loss development of $29,129,000 on losses occurring in prior years. The lines of business contributing to this redundancy included commercial multiple peril, other liability, personal auto liability and workers' compensation lines.
Statutory stockholders' surplus and net income at December 31, 1996, 1995 and 1994 and for the years then ended are as follows.
The State of Iowa Insurance Department imposes certain capital requirements on insurance companies on a statutory basis. Under the applicable regulations, United Fire & Casualty Company is required to maintain minimum capital stock of $2,500,000 and minimum additional paid-in capital and retained earnings in the aggregate amount of $2,500,000. At December 31, 1996, United Fire & Casualty Company's capital stock was $35,759,000 and total statutory paid-in capital and retained earnings were $141,504,000
The amount of dividends that may be paid to stockholders without prior approval by the State of Iowa Insurance Department is limited to the excess of statutory retained earnings over contributed surplus. Contributed surplus as of December 31, 1996, was $8,069,000. Based upon this restriction, the Company could make a maximum of $125,366,000 in dividend distributions to stockholders in 1997. Dividend payments by the insurance subsidiaries to the Company are subject to similar restrictions in the states in which they are domiciled. The Company received no dividends from its subsidiaries in 1996 or 1995.
In addition, the insurance departments governing the Company and its subsidiaries have imposed risk-based capital ("RBC") requirements. The regulation is based on a model adopted by the NAIC. An RBC formula establishes capital requirements for insurance companies based on an individual company's major areas of risk, including assets, credit, underwriting and off-balance sheet risk. The results are used by the NAIC and state insurance departments to identify companies that merit regulatory attention or the initiation of regulatory action. At December 31, 1996 and 1995, the life and property and casualty segments had adjusted capital well in excess of the required capital levels.
The health care cost trend rate assumption has a significant effect on the amounts reported. To illustrate, increasing the assumed health care cost trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation as of December 31, 1996 by $1,232,000 and the aggregate of the service and interest cost components of net postretirement benefit expense for the year then ended by $178,000. The weighted-average discount rate used in determining the accumulated postretirement benefit obligation was 7.5% and 7.0% as of December 31, 1996 and 1995, respectively.
The Company conducts its operations principally in two industries, property and casualty insurance and life insurance.
Total revenue by industry includes sales to both outside customers and intersegment sales which are eliminated to arrive at the total revenues as reported in the Company's Consolidated Statements of Operations. Intersegment sales are accounted for on the same basis as sales to outside customers. The following table sets forth certain data for each of the Company's business segments.
The Company declared a three for two stock split in the form of a 50% stock dividend to stockholders of record as of December 15, 1994 and again, as of December 18, 1995. Cash dividends per common share of $.60 and $.55 were declared in 1996 and 1995, respectively. Net income per common share, weighted average common shares outstanding and cash dividends declared per common share have been retroactively restated for all periods presented.
Our audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The supplementary data (Schedule III - Supplementary insurance information, Schedule IV - Reinsurance, and Schedule VI - - Supplemental information concerning property and casualty insurance operations) are presented for purposes of additional analysis and are not a required part of the basic financial statements. This information has been subjected to the auditing procedures applied in our audit of the basic financial statements and, in our opinion, is fairly stated in all material respects in relation to the basic financial statements taken as a whole.
/s/ Arthur Andersen LLP ----------------------- Arthur Andersen LLP Chicago, Illinois February 20, 1997