- ---------- (1) Revenues for real estate information services include revenues in 1997 from PinTax subsequent to the PinTax Acquisition. Total expenses include expenses from PinTax subsequent to the PinTax Acquisition.
National Insurance Group provides specialized information services through technology, tracking services, outsourcing services and related insurance products to mortgage bankers and financial institutions located throughout the United States.
The Company's primary sources of revenues are fees billed to customers who use Flood Zone Determination Services, Real Estate Tax Services, premiums and commissions earned from its specialized insurance products, Tracking and Outsourcing Services and investment income. Flood inquiry fees are generated by Flood Zone Determination Services and are based on the number of flood inquiries rendered. The Company provides either one-time flood
The Company's effective income tax rate was 34%, 18%, and 31% for 1995, 1996 and 1997, respectively, reflecting the 35% federal statutory income tax rate and the net effect of state taxes, less the beneficial effect of tax-exempt investment income earned during the periods. See Note 8 of Notes to Consolidated Financial Statements.
In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income. SFAS No. 130 establishes standards for the reporting and display of comprehensive income and its components in a full set of general purpose financial statements. Comprehensive income is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. SFAS No. 130 is effective for fiscal years beginning after December 15, 1997. The Company does not believe that SFAS No. 130 will have a material impact on its financial statements.
In June 1997, the FASB issued SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. SFAS No. 131 requires publicly-held companies to report financial and other information about key revenue-producing segments of the entity for which such information is available and utilized by the chief operating decision maker. Specific information to be reported for individual segments includes profit or loss, certain revenue and expense items and total assets. A reconciliation of segment financial information to amounts reported in the financial statements would be provided. SFAS No. 131 is effective for fiscal years beginning after December 15, 1997. The Company does not believe that SFAS No. 131 will have a material impact on the Company's financial statements.
On September 18, 1997, the Company's newly formed PinTax subsidiaries acquired substantially all the assets and assumed certain liabilities of ARTS. The acquisition agreement, dated August 15, 1997, as amended (the "Agreement"), was entered into by and among ARTS, the shareholders of ARTS, the Company and New Arts. As consideration for the acquisition of certain assets of ARTS, New Arts paid $9.8 million in cash, including transaction costs, and agreed to assume certain liabilities of ARTS. Pursuant to the Agreement, if the cash revenue received by the Company on certain contracts of PinTax exceeds certain targets for the twelve months ending April 30, 1998, the Company is required to pay additional consideration of up to $4 million according to a formula as set forth in the Agreement ("Additional Consideration"). Fifty percent of the Additional Consideration may be paid in the form of a three year note bearing interest at eight percent per annum. The remaining fifty percent of the Additional Consideration may be paid in cash. See Note 22 of Notes to Consolidated Financial Statements.
"life of loan" contracts is recognized over the estimated life of the loans in proportion to the amount of expenses incurred to service the real estate property tax tracking on the subject loans. Since the bulk of expenses incurred in providing real estate property tax tracking on the loans occurs in the first year, a majority of the "life of loan" revenue is recognized within the first year of servicing. The remainder of the revenue is amortized in accordance with the estimated rate at which loans are paid off or otherwise are removed from the servicing portfolio. As a result of this revenue recognition policy, PinTax records a deferred revenue reserve on its balance sheet. As of December 31, 1997, deferred "life of loan" tax servicing revenue was approximately $7.0 million. This is approximately the same amount of deferred revenue as of the date of the PinTax Acquisition.
Net premiums earned increased from $13.6 million in 1996 to $19.0 million in 1997, an increase of $5.5 million, or 40.1%. The increase was primarily due to an increase in net written premiums, as previously described.
Real estate information services revenue (consisting of revenue from Pinnacle and PinTax) increased from $18.5 million in 1996 to $23.5 million in 1997, an increase of $5.0 million, or 27.0%. Approximately $2 million of the increase was the result of PinTax, which was acquired in September 1997. The remainder of the increase was the result of higher flood zone determination volumes from existing customers. The Company's overall price level for its real estate information services did not materially change in 1997.
Loss and LAE was $4.0 million in 1996 (29.5% of net premiums earned) and $6.5 million in 1997 (34.0% of net premiums earned), an increase of $2.5 million, or 62.0%. The increase was due to an increase in the number and average size of claims. The average loss per new claim reported increased from $5,513 in 1996 to $7,693 in 1997. The number of new claims increased from 726 reported in 1996 to 843 reported in 1997.
Commissions paid to nonaffiliates decreased from $2.0 million (14.4% of premiums earned) in 1996 to $1.8 million (9.6% of premiums earned) in 1997, a decrease of $117,000, or 6.0%. The reduction in commissions paid to nonaffiliates was a result of relatively higher growth in net written and earned premiums from clients which do not earn commissions on the Company's insurance products.
Tracking fees increased from $4.8 million in 1995 to $5.5 million in 1996, an increase of $700,000 or 14.5%. The increase was primarily due to new business from two new customers.
Loss and LAE was $6.0 million in 1995 (35.5% of net premiums earned) and $4.0 million in 1996 (29.5% of net premiums earned), a decrease of $2.0 million or 33.8%. The decline in losses and LAE was a direct result of fewer losses and loss adjustment expenses incurred during 1996 than in 1995. The loss ratio for the fourth quarter of 1996 was very favorable and contributed approximately one-half of the decrease when compared to 1995. The average loss per new claim reported decreased from $6,316 in 1995 to $5,513 in 1996. The number of new claims decreased from 957 reported in 1995 to 726 reported in 1996.
volume increases in the Flood Zone Determinations Services business. Personnel expenses as a percent of total revenue decreased from 47.0% in 1995 to 46.6% in 1996.
Non-recurring expenses decreased from $4.1 million in 1995 to $0 in 1996. In 1995, the Company accrued an additional $4.1 million for the constitutionally mandated roll-back of insurance premiums under Proposition 103.
Liquidity is a measure of a company's ability to secure sufficient cash to meet its contractual obligations and operating needs. National is a holding company with no operations and no sources of income itself except interest or investment income. The principal assets of National are the stock of its Subsidiaries. National is, and for the foreseeable future will continue to be, dependent on the dividends from its Subsidiaries to meet its liquidity requirements, including debt service obligations. Dividends payable to National by GPIC are subject to certain regulatory restrictions which are described below.
The Company's primary sources of cash are from operating income and lines of credit. In 1997, the Company derived a substantial portion of its operating cash from the operating profits from Pinnacle, as well as the net premiums written from GPIC. The Company has reserved certain amounts of the net written premiums it received in 1997 for a variety of purposes, including reserves for return premiums, unearned premiums and loss reserves. The Company believes that its cash flow from operations, existing cash balances and lines of credit will be sufficient to meet its working capital needs for the foreseeable future.
GPIC collects and invests premiums written in advance of the payments for associated claims. In the absence of a catastrophic loss, this timing difference between premium collection and claims payment, combined with investment income, normally provides short-term funds in excess of normal operating demands for cash. As of December 31, 1997, the Company had cash and short-term investments aggregating $10.4 million.
Industry and regulatory guidelines suggest that a property and casualty insurers' annual statutory net written premium should not exceed approximately three times its policyholders' surplus. The Company's surplus ratio is significantly lower than such guidelines. For the year ended December 31, 1997, the Company's net written premium to policyholder surplus ratio was .8 to 1. See "Business--Insurance Operations--Insurance Operating Ratios".
Inflation or deflation and other factors generally affect the rate of investment return in the securities and financial markets, and increases and decreases in such investment return rates have a corresponding effect on the Company's investment income.
There is no public securities market for certain investments held by the Company. As of December 31, 1997, such investments were limited partnership interests with an original cost of $220,000.
These factors, together with statements regarding certain risks and uncertainties contained in other parts of this Report, may affect the Company's operating results. Investors should read this section in connection with any forward-looking statement made in this Report, including statements preceded or followed by the words "believes", "anticipates", "expects", "aware" or similar expressions as they relate to the Company or its management.
In 1997, Advanta Mortgage Corp. accounted for 11.8% of consolidated revenues of the Company. During the second half of 1997 the Company received notice that Advanta Mortgage Corp. and one other customer would not renew their hazard tracking, outsourcing and lender-placed insurance contracts. Such customers accounted for 7.3% of consolidated revenues in 1995, 11.2% in 1996 and 18.8% in 1997. Management believes that the decrease in revenue due to the loss of these customers may be delayed and offset, in part, by changes in certain reserves potentially arising from the customers' departures, and additional business from new and existing customers. The decrease in revenue will also be delayed by the rate at which the unearned premium for such customers is earned over the year 1998. The Company is presently unable to estimate the amount of such offsets, which are dependent upon numerous factors, including, without limitation, the general health of the mortgage banking and vehicle financing industries and of the
Company's customers; interest rates, general economic conditions, the realization of expected new business from new and existing customers and other factors. The loss of such customers may affect adversely the results of operations and earnings of the Company in 1998.
The Company derives a substantial portion of its total revenues from fees for Flood Zone Determination Services. These services are primarily provided to assist lenders in complying with federal laws which in many instances require lenders to determine whether property being financed is located in a federally-designated Special Flood Hazard Area ("SFHA") and require borrowers to obtain flood insurance. Any significant change in federal legislation or secondary market requirements limiting these requirements on lenders or borrowers, or the development by competitors of significantly enhanced service or delivery systems could have a material adverse effect on the Company's business or operating results.
The Company's financial results can be significantly affected by a number of factors, including, but not limited to, the amount of net written premium and the rate of cancellation of insurance policies, the addition or loss of customers, changes in the number of loans or personal property leases being tracked for customers, increases or decreases in interest rates, and catastrophic loss events. For example, in 1992 GPIC incurred net losses relating to the Los Angeles riots and Hurricane Andrew of $612,000 and $527,000, respectively. In November 1993, GPIC received claims of approximately $650,000 from policyholders for losses arising out of the October and November 1993 series of fires in Southern California. The Company also received an assessment of $725,000 from the California Fair Plan Association, a mandatory insurance pool for certain California real estate, relating to losses from those fires. In addition, revenues from the Company's Flood Zone Determination Services and Real Estate Tax Services are directly related to the volume of mortgage loan originations, both new and refinanced, and any change in the level of such activity could have a material impact on the Company's performance. The number of loans or leases for which the Company provides Tracking and Outsourcing Services may increase or decrease depending upon, among other things, the number of new loans or leases serviced by its customers and the volume of loans or leases paid off or sold to others. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Factors Affecting Operating Results - The Insurance Industry".
The Company derives a significant amount of its revenues from insurance premiums and investment income. In the event that, for whatever reason, GPIC experiences abnormally high losses, purchases reinsurance from reinsurers who will not or cannot pay losses submitted, or other adverse developments occur, then any such event or combination of events could have a material adverse impact on the Company. In addition, insurance companies and others have often
been sued under certain legal theories, such as bad faith handling or settlement of claims, which could subject GPIC to liability in excess of policy limits. An adverse outcome of any such lawsuit could have a material negative impact on the Company.
Traditional insurance companies underwrite risks individually or by class, following an in-depth analysis of such risks. Although GPIC applies underwriting techniques to a small portion of insured risks, the immediate coverage required by purchasers of lender-placed insurance and REO Insurance generally requires GPIC to write specialized insurance within predesignated limits and geographic areas, at a flat rate, without the application of traditional underwriting criteria to individual risks. Accordingly, GPIC may be insuring individual risks that it might not have insured had it applied traditional analysis to such risks. In addition, GPIC may not have adequate spread of risk in a particular geographic area. See "Business - Insurance Operations - Underwriting".
GPIC's business is partially dependent upon its ability to cede to reinsurers risks insured by GPIC. The amount, availability and cost of reinsurance are subject to prevailing market conditions, beyond the control of GPIC, which can affect GPIC's level of business and profitability. GPIC is ultimately liable for the reinsured risk if for any reason the reinsurers do not cover or will not pay GPIC for the losses of the insureds. As a result of the anticipated increased cost and more limited availability of reinsurance, in the future, GPIC may elect to retain a higher portion of the risk historically ceded to reinsurers. If GPIC were to retain a higher proportion of insured risks, it would increase its exposure to significant losses relating to properties insured by GPIC. This increased exposure could have a material adverse effect on the Company's results of operations. See "Business - Regulation - Reinsurance".
Pinnacle indemnifies its customers for certain losses resulting from erroneous flood inquiry determinations, where a borrower was not properly advised whether the collateral was located in or out of an SFHA. While to date Pinnacle
has experienced no significant losses in this regard and maintains reserves equal to its estimate of incurred but unreported indemnification losses, there can be no assurance such reserves will prove adequate in the future.