The majority of the Company's premiums have been written in Florida, a regulated pricing state where premiums for guaranteed cost products are based on state-approved rates. However, the Company also offers policies which are subject to premium reductions such as deductible plans, participating dividend plans, or loss sensitive plans. Pricing for these plans tends to be more competitively based, and the Company experienced increasing competition during 1997 and 1996 in pricing these plans. In addition, in October 1996, the Florida Insurance Commissioner ordered workers' compensation providers to reduce rates by an average of 11.2 percent for new or renewal policies written on or after January 1, 1997. Concurrently, with the premium reduction effective January 1, 1997, the 10 percent managed care credit was phased out. This credit had been offered since 1994 to employers who met certain criteria for participating in a qualified WCMCA. In addition, on October 9, 1997, Florida further reduced premium rates by 1.7 percent for new and renewal policies written on or after January 1, 1998. The State of North Carolina approved a 13.7% decrease in loss costs effective April 1, 1997. The Company adopted the loss costs in October 1997 which resulted in an overall 8.4% effective rate reduction.
Under Florida sunset laws applicable to some state sponsored funds, the SDTF would have expired on November 4, 1996, unless affirmative action was taken by the legislature to continue the SDTF. By action of the legislature, the SDTF was continued and not scheduled for further review under Florida sunset laws until the year 2000. However, in early 1997, the Florida legislature passed a bill substantially changing the SDTF. The SDTF will accept no claims with accident dates after December 31, 1997. Certain SDTF claims may have to be refiled for reimbursement and such filing will require a refiling fee. Additionally, companies accruing SDTF recoveries may be statutorily limited in the level of recoverable they may be allowed to carry. The bill provides for a funding mechanism through which companies writing workers' compensation insurance in Florida will be assessed an annual charge to cover payments made by the SDTF. The Company believes that even in the event of default by the SDTF, the existing reimbursements of the SDTF would become general obligations of the State of Florida. Management further believes that the recoveries recorded at December 31, 1996 will not be materially adversely affected by the new legislation.
Estimated recoveries from the SDTF were $45.2 million and $49.5 million at December 31, 1997 and 1996, respectively. The decrease in the estimated recoveries during 1997 resulted from $5.9 million of actual collections and a reduction in the estimated recoveries due to additional information regarding the impact of the legislative reform. Actual cash recoveries from the SDTF totaled $5.9 million, $2.5 million, and $0.9 million, respectively, for the years ended December 31, 1997, 1996 and 1995. For the year ended December 31, 1997, the effect of the change in the estimated SDTF recoveries on losses and loss adjustment expenses incurred was an increase of approximately $4.3 million. For the years ended December 31, 1996 and 1995, the effect of the changes in the estimated SDTF recoveries on losses and loss adjustment expenses incurred was a decrease of approximately $0.2 million and $5.8 million, respectively. SDTF assessments, which are based on net premiums written, were $8.0 million, $11.7 million and $12.9 million for the years ended December 31, 1997, 1996 and 1995, respectively.
While it is not possible to predict the result of any other legislative or regulatory proposals affecting the SDTF, changes in the SDTF's operations or funding which decrease the availability of recoveries or increase assessments payable by the Company could have a material adverse effect on the Company's business, financial condition, or results of operations.
The following table shows direct, assumed, ceded, and net earned premiums for the years ended December 31, 1997, 1996 and 1995:
Year Ended December 31, -------------------------------------- (Dollars in millions) 1997 1996 1995
----------------------------- Direct premiums earned $ 328.2 $ 326.9 $ 274.3 Assumed premiums earned 18.8 11.7 0.7 Premiums ceded to reinsurers (167.3) (165.0) (139.1) -------- -------- -------- Net premiums earned $ 179.7 $ 173.6 $ 135.9 ======= ======== ========
The comments below should be read in conjunction with the Financial Statements in Part IV, Item 14.
The infusion of approximately $68.9 million of capital into the Company's insurance subsidiaries from the IPO proceeds allowed the Company's insurance subsidiaries to increase their premium writing capacity and, as a result, to increase premiums during the last nine months of 1996 due to the expanded premium writing capabilities. Written premiums are earned pro rata over the policy period (usually 12 months), therefore, increased premiums written during the last nine months of 1996 will have a positive impact on earned premiums in 1996 and 1997.
Written premiums increased in the third and fourth quarters of 1996 and the first quarter of 1997 from the assumption reinsurance and loss portfolio agreements entered into by the Company's insurance subsidiaries during 1996 and from the other acquisitions made during 1996.
For the years ended December 31, 1997, 1996 and 1995, the Company ceded approximately 50 percent of its Florida premiums to AmRe under a quota share reinsurance agreement and 60 percent of the business written by RNIC under a separate quota share agreement (65 percent during 1996) with Chartwell. The increase in premiums ceded in 1997 and 1996 is directly related to the increase in direct premiums earned. As direct premiums earned decrease in the future, the ceded premiums will also decrease.
Commissions, general and administrative expenses for the years ended December 31, 1997, 1996 and 1995 were $70.8 million, $65.7 million and $48.2 million, respectively. The net increase of $5.1 million from 1996 to 1997 is primarily the result of a $6.3 million increase in the amortization of deferred acquisition costs; a $2.1 million increase in personnel expenses primarily related to severance payments incurred in connection with the June 1997 workforce reduction; a $5.9 million increase in accounting, auditing, consulting and legal expenses primarily resulting from the Company's inability to file its 1996 financial statements in a timely manner; a $2.8 million increase in postage, telephone and insurance expenses; a $13.0 million expense recognized in the fourth quarter of 1997 in connection with the proposed settlement of the securities class action lawsuit; an increase of $5.0 million relating to expenses associated with the NCCI pool participation; an increase in commissions paid to agents of $5.3 million; and a reduction in ceding commission income of $1.7 million. These expense increases were offset by reductions in marketing related travel expenses of $1.5 million, decreases in premium taxes of $8.5 million resulting from a decline in written premiums and a decline in bad debt expenses of $27.0 million. The net increase in expenses of $17.4 million from 1995 to 1996 was attributable primarily to significant increases in the Company's bad debts expenses and legal expenses combined with increased overall commissions, general and administrative expenses associated with higher premiums and personnel resulting from acquisitions and internal growth. The increases were offset by higher ceding commissions under the quota share reinsurance agreements, including $6.3 million of additional ceding commissions recognized under the AmRe quota share reinsurance agreement.
The Company has projected cash flows through June 1998 and believes it has sufficient liquidity and capital resources to support its operations.
The Company has recorded $45.2 million in accrued net recoverables from the SDTF, which it anticipates will be reimbursed over a number of years. For the years ended December 31, 1997, 1996 and 1995, the Company received net payments from the SDTF totaling $5.9 million, $2.5 million and $0.9 million, respectively.
Barring any adverse legislative change, the Company believes that it will ultimately collect the entire balance of SDTF recoverables and that periodic reimbursement will be received following submission of proof of claim and reimbursement requests. During its approximate 40-year history, the SDTF has historically paid reimbursement requests for claims it determined were eligible for reimbursement. The Company does not believe that SDTF will fail to meet its obligations to pay eligible reimbursement requests, although there can be no assurance in this regard. The failure of the SDTF to meet its obligations could adversely affect the liquidity of the Company.
The National Association of Insurance Commissioners ("NAIC") has adopted risk-based capital standards to determine the capital requirements of an insurance carrier based upon the risks inherent in its operations. The standards, which have not yet been adopted in Florida, require the computation of a risk-based capital amount which is then compared to a carrier's actual total adjusted capital. The computation involves applying factors to various financial data to address four primary risks: asset risk, insurance underwriting risk, credit risk, and off-balance sheet risk. These standards provide for regulatory intervention when the percentage of total adjusted capital to authorized control level risk-based capital is below certain levels. At December 31, 1997, the Company's insurance subsidiaries' statutory surplus was in excess of any risk-based capital action level requirements.
The Company has established an investment policy that focuses upon safety of principal, compliance with regulations, liquidity and diversification. As of December 31, 1997, approximately 75% of the Company's investment portfolio was rated Aa or above by Moody's, and the portfolio contained no securities with a rating of less than Baa. The Company does not hold any common stocks in its portfolio. The average duration of the portfolio, was approximately 2.5 years at December 31, 1997. The amortized cost and fair value of the Company's investment portfolio, at December 31, 1997, was $220.4 million and $223.7 million, respectively.
The following table summarizes the Company's investment portfolio at December 31, 1997 (in thousands): Tax Fair Equivalent Type of Investment Value Yield*