On January 26, 1996, the Company entered into a lease agreement for new home office space in the City of Calabasas. The Company moved to this location in June 1997. The lease term is for a period of 15 years and covers approximately 63,000 square feet. The Company also has the option to purchase this new home office building and land three years into the lease period at a predetermined rate for the building, with the value of land based on then existing market rates.
The selected data presented on page 20 under the captions "Summary of Earnings," "Year End Financial Position" and "Operating Ratios" for, and as of the end of, each of the years in the five year period ended December 31, 1997, are derived from the consolidated financial statements of Amwest Insurance Group, Inc. and subsidiaries, which financial statements have been audited by KPMG Peat Marwick LLP, independent certified public accountants. The consolidated financial statements as of December 31, 1997 and 1996 and for each of the years in the three year period ended December 31, 1997 and the report thereon, are included elsewhere in this Annual Report on Form 10-K.
On March 14, 1996, the Company merged with Condor Services, Inc. in a transaction accounted for as a pooling of interests the "Merger"). The following analysis has been prepared as if Condor Services, Inc. ("CSI") were wholly owned for all periods presented herein.
Gross premiums written increased 11% from $97,242,000 in 1996 to $108,091,000 in 1997. Substantially all of this premium growth was due to written premium increases in the surety product lines. Management believes that the increase in premiums written is attributable to the impact of regionalization of contract surety underwriting function thereby allowing the Company to respond on a more timely basis to bond requests coupled with continued strong growth in commercial surety and the purchase of two surety agencies during 1997. The latter contributed approximately $1,800,000 of the increase in written premiums during 1997.
Net losses and loss adjustment expenses decreased 26% from $46,647,000 in 1996 to $34,657,000 in 1997. This resulted in a decrease in the loss and loss adjustment expense ratio from 53.1% in 1996 to 37.6% in 1997. The decreased loss ratio is primarily attributable to a decrease in the loss and loss adjustment expense ratio for contract performance and payment bonds from 52.9% in 1996 to 33.7% in 1997 as well as a decrease in adverse loss experience on the Company's private passenger automobile program in the State of Arizona. The loss ratio on contract performance and payment bonds in 1996 was negatively impacted by increased severity caused by a number of large losses reported in that year. Such losses were not experienced in 1997. The 1996 adverse loss experience on private passenger business in Arizona was due to general rate inadequacy for that program which the Company believes was corrected in 1997.
Policy acquisition costs as a percentage of net premiums earned increased from a ratio of 43.7% or $38,367,000 in 1996 to 49.2% or $45,379,000 in 1997. The increase is primarily attributable to a decline in contingent commissions earned by the Company due to changes in its reinsurance treaties coupled with higher commission rates paid on surety products due to intensified competitive pressures during 1997.
Net investment income and realized investment gains increased 10% from $9,008,000 in 1996 to $9,869,000 in 1997. This increase is primarily due to an increase in realized investment gains from $2,201,000 during 1996 to $3,473,000 during 1997. This increase was partially offset by a slight decrease in average annual yield on investments from 5.2% in 1996 to 5.1% in 1997.
Income (loss) before income taxes changed from a loss of $5,046,000 in 1996 to income of $7,435,000 in 1997 due to the factors outlined above.
Premiums written increased 3.3% from $94,184,000 in 1995 to $97,242,000 in 1996. The increase in premiums written is attributable primarily to court probate bonds written subsequent to the Company's acquisition of Southern California Bonding, Inc. in March of 1996.
Net premiums earned increased 3.2% from $85,170,000 in 1995 to $87,883,000 in 1996. The increase in net premiums earned reflects the increased premium writings.
Policy acquisition costs as a percentage of net premiums earned decreased from a ratio of 44.7% or $38,070,000 in 1995 to 43.7% or $38,367,000 in 1996. The relatively constant ratio reflects the costs associated with producing contract and commercial surety business through the Company's network of 30 branch offices, as well as commissions and premium taxes on the Company's other product lines.
On December 14, 1995 the Supreme Court of the State of California affirmed the decision of the Second District Court of Appeal overturning Insurance Code Section 1861.135 which exempted the surety insurance industry from major provisions of Proposition 103. Accordingly the Company is no longer exempted from the rate rollback and prior approval provisions contained in Proposition 103. The Company accrued $2,000,000 during the quarter ended December 31, 1995. On August 15, 1996, the Company entered into a Stipulation and Consent Order with the Insurance Commissioner of the State of California which required the Company's insurance subsidiaries to pay $1,928,370. The Proposition 103 refund checks were issued in January 1997.
Collateral interest expense decreased 28.3% from $1,698,000 in 1995 to $1,218,000 in 1996. This decrease is attributed to an overall reduction in funds held as collateral during 1996. At December 31, 1995 and 1996, the collateral balances accrued interest daily at an average rate of 3.5% and 3.8% per annum, respectively.
Net investment income and realized investment gains decreased 10.3% from $10,039,000 in 1995 to $9,008,000 in 1996. This decrease is primarily due to a decrease in the amount of invested assets from $131,014,000 at December 31, 1995 to $120,265,000 at December 31, 1996. Average annual yield on investments decreased from 5.7% in 1995 to 5.2% in 1996. Realized investment gains amounted to $2,176,000 during 1995 compared to $2,201,000 during 1996.
The effective tax rate was 18.4% for the year ended December 31, 1995. The effective rate of the tax benefit for 1996 is 46.8%. The primary reason for the variance from the corporate income tax rate of 34% is tax advantage income received on a portion of the Company's investment portfolio.
As of December 31, 1997, the Company had total cash and cash equivalents and investments of $124,480,000. Included in these amounts is an aggregate of $23,116,000 in funds held as collateral which are shown as a liability on the Company's consolidated balance sheet. As of December 31, 1997, the Company's investment balances were comprised of $98,746,000 in fixed maturities held at market, $10,297,000 in common equity securities, $2,894,000 in preferred equity securities, $6,455,000 in other invested assets and $2,281,000 in short-term investments.
In addition, cash collateral declined from $29,928,000 at December 31, 1996 to $23,116,000 at December 31, 1997. The Company reflects in its consolidated financial statements only funds received as collateral on which net earnings inure to the benefit of the Company. The decline in this amount is primarily attributed to decreased writings in those lines of business for which cash collateral is generally accepted. These include contractor's license bonds and sales tax bonds. The amount of cash collateral can also be impacted by the timing and payment of claims activity related to draws on irrevocable letters of credit and certificates of deposit.
Other than the Company's obligations with respect to funds held as collateral, the Company's obligations to pay claims as they arise, the Company's commitments to pay principal and interest on the bank debt and lease expenses as noted above, the Company has no significant cash commitments.
The Company used $1,252,000, generated $1,396,000 and used $1,539,000 in cash from operating activities in the fiscal years ended December 31, 1995, 1996 and 1997, respectively. The Company generated $10,363,000, $8,691,000 and $3,835,000 in cash for investing activities for the fiscal years ended December 31, 1995, 1996 and 1997, respectively. The Company used $10,143,000, $8,885,000, and $4,923,000 in cash from financing activities for the fiscal years ended December 31, 1995, 1996 and 1997, respectively. The cash used for financing activities in 1995, 1996 and 1997 were funded principally by investing activities.
Certain statements contained in this Form 10-K regard matters which are not historical facts and are forward looking statements. Because such forward looking statements include risks and uncertainties, actual results may differ materially from those expressed in or implied by such forward looking statements. Factors that could cause actual results to differ materially include, but are not limited to: A decline in demand for surety bonds or specialty property and casualty insurance, the ineffectiveness of changes made by management, a deterioration in results of any of the Company's product lines, or a general economic decline. The Company undertakes no obligation to release publicly the results of any revisions to these forward looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.