The Company is a holding company that, through its subsidiaries, underwrites specialty property and casualty insurance in sectors of the insurance industry that are generally considered difficult to insure. Many of the coverages written by the Company can be categorized as excess and surplus lines, which generally means that the risks are nonstandard, or that the policies in respect of the risks are written with unusual limits or at deviated rates. The property and casualty insurance industry is highly cyclical. The excess and surplus lines sectors of the property and casualty insurance industry are often subject to greater cyclicality and volatility than the industry in general. During soft markets, large standard lines insurers often utilize excess capacity to assume risks in excess and surplus and specialty lines. During hard markets, such insurers tend to abandon the excess and surplus and specialty lines to the carriers that concentrate in these sectors. Thus, capacity in these lines will fluctuate substantially, often with fluctuations in revenues or profits, or both.
Gross Premiums Written. Gross premiums written were $156.9 million for the year ended December 31, 1996 compared to $157.0 million for the year ended December 31, 1995. In 1996, the Company's gross premiums written experienced increases in the following lines of business: a $4.6 million increase in premiums from specialty lines, primarily due to a new animal mortality program; a $3.4 million increase in A&E liability due to expanded marketing and enhanced coverages offered; and a $2.3 million increase in casualty premiums, primarily due to new programs, but offset in part by business lost because of competitive market conditions in other casualty business written. Such increases were offset by a $6.7 million decrease in DIC premiums, resulting from the sharing of premiums with a companion carrier and, to a lesser extent, from an increase in competition with respect to certain types of DIC risks; a $3.4 million decrease in premiums from other property, due to increased competition, mitigated in part by new business from plate glass and fire policies; and a $0.2 million decrease in commercial automobile, where the non- renewal of a truck leasing program offset growth resulting from new business written.
Net Premiums. Net premiums written increased 4.9% to $94.6 million for the year ended December 31, 1996 from $90.2 million for the year ended December 31, 1995. This resulted primarily from a shift in the mix of business toward lines with higher net retention levels. Also, the Company paid $2.2 million of catastrophe reinsurance reinstatement premiums in 1995, which had the effect of increasing ceded premiums and reducing net premiums written.
Net Realized Gains on Investments. For the year ended December 31, 1996, the Company realized a net gain of $1.2 million, compared with a net gain of $3.6 million for the year ended December 31, 1995. Portfolio sales were effected in each year to optimize the mix of taxable and tax-exempt securities.
Other Income. For the year ended December 31, 1996, the Company recorded $1.1 million of underwriting management fees for DIC business underwritten on behalf of a companion carrier.
Losses and Loss Adjustment Expenses. Losses and LAE increased by 13.5% to $57.7 million for the year ended December 31, 1996 from $50.8 million for the year ended December 31, 1995, due to additional losses and reserve strengthening for a truck leasing program ($5.3 million) and used- car dealers program ($2.2 million), each discontinued during 1995; an increase of $2.2 million in reserves for environmental impairment and asbestos-related exposures on business written prior to 1985; other reserve increases pertaining to previous accident years; and, more generally, increases in earned premium exposures. Such increases were partially offset by reserve redundancies resulting from favorable development of A&E case reserves and a re-estimate of other property liabilities. In 1995, the Company recorded catastrophe losses of $1.9 million related to hailstorms and the Northridge earthquake of 1994.
Interest Expense. Interest expense was $1.8 million for the year ended December 31, 1996, compared with $0.6 million for the year ended December 31, 1995. Interest expense resulted from a term loan of $25.5 million borrowed in 1995 to finance the purchase of 1.5 million shares of the Company's common stock. Interest expense was lower in 1995 because it accrued only from the date of the take-down, in September.
Income Taxes. Income taxes were $53,000 for the year ended December 31, 1996, compared with $4.0 million for 1995. In 1996, income taxes were reduced by the tax benefit from additional reserve strengthening on discontinued lines of business, increased underwriting expenses and tax-exempt investment income. In 1995, the income tax expense was reduced by the tax benefit from net claims costs and reinstatement premiums relating to the Northridge earthquake and tax-exempt investment income.
Material Event. The Company writes a substantial amount of DIC coverage in California, including the San Fernando Valley area, which was struck by a major earthquake on January 17, 1994. As a result of losses sustained in that event, the Company recorded net pre-tax costs of $8.2 million for the year ended December 31, 1994. The costs consisted of $4.3 million of claims expense and $3.9 million of reinsurance reinstatement premiums. In 1995, the Company recorded additional net pre-tax charges of $3.0 million for expected additional loss development. These charges consisted of $0.8 million of claims costs and $2.2 million of reinsurance reinstatement premiums.
Gross Premiums Written. Gross premiums written increased 12.8% to $157.0 million for the year ended December 31, 1995 from $139.2 million for the year ended December 31, 1994. The increase in gross premiums written was attributable to a $9.2 million increase in premiums from other property, due to new business and a hardening of property markets; a $5.6 million increase in casualty premiums, resulting from additional general liability policies written; a $4.3 million increase in commercial automobile premiums, resulting from new policies written; and a $2.0 million increase in DIC premiums, resulting from changes in market conditions for earthquake coverages. Such increases were partially offset by a $1.8 million decrease in premiums from specialty lines, due to the discontinuance of a used car dealers program, and a $1.5 million decrease in premiums caused by competitive market conditions in the A&E business.
Net Premiums. Net premiums written increased 30.3% to $90.2 million for the year ended December 31, 1995 from $69.2 million for the year ended December 31, 1994 as a result of most of the factors described above, which were enhanced by increased retention levels in commercial automobile policies and plate glass policies. Also, catastrophe reinsurance reinstatement premiums ceded with respect to DIC policies decreased by $1.7 million in 1995.
Net Investment Income. Net investment income increased 20.9% to $15.8 million for the year ended December 31, 1995 from $13.1 million for the year ended December 31, 1994. The increase is primarily due to additional funds available for investment in 1995. To a lesser extent, net investment income, which is reported before taxes, increased as a result of a greater component of taxable securities in 1995 than in 1994.
Losses and Loss Adjustment Expenses. Losses and LAE increased by 25.4% to $50.8 million for the year ended December 31, 1995 from $40.5 million for the year ended December 31, 1994, primarily due to increases in earned premium exposures and catastrophe losses of $1.9 million, from Texas hailstorms and additional reserves for the Northridge earthquake. In 1994, the Company recorded net claims costs of $4.3 million from the Northridge earthquake and additional reserves for specialty lines, partially offset by favorable development in other property reserves, as well as A&E coverages.
Income Taxes. Income taxes were $4.0 million for the year ended December 31, 1995, compared with $0.2 million for 1994. In 1994, the income tax expense was impacted by net claims costs and reinstatement premiums relating to the Northridge earthquake, net realized losses on investments, and a shift from taxable to tax- exempt investments.
Weighted Average Shares Outstanding. Average shares outstanding were 7.6 million in 1995, compared with 8.1 million in 1994, reflecting the effect of the purchase by the Company of 1.5 million shares of the Company's Common Stock in September of 1995.
At December 31, 1996, the Company maintained cash and cash equivalents of $23.4 million to meet payment obligations. In addition, the Company's investment portfolio could be substantially liquidated without any material financial impact. Substantially all of the cash and investments of the Company at December 31, 1996 were held by its subsidiaries.
In September 1995, the Company purchased 1.5 million shares of its Common Stock from Willis Corroon for a total purchase price of $25.5 million, including related expenses. The Company financed its purchase of such shares through the proceeds of borrowing from commercial lending institutions. As a result of the interest on this indebtedness, the Company's corporate overhead expenses increased by approximately $1.8 million.
There was no significant impact on the Company's operations as a result of inflation during 1996, 1995 and 1994. However, there can be no assurance that inflation will not have a material impact on the Company's operations in the future.