Over the past five years, premiums written in the Company's insurance operations have consistently increased, both as the result of acquisitions and through internal growth. In the third quarter of 1995, the Company's decision to strengthen loss reserves resulted in a loss for that quarter of $5,961,000. Otherwise, the Company has reported net income in each quarter beginning with the third quarter of 1992, when the phasing out of its prior non-insurance operations was substantially completed.
Except for the historical information contained in this Annual Report on Form 10-K, matters discussed herein may constitute forward-looking information. Such forward-looking information reflects the Company's current best estimates regarding future operations, but, since these are only estimates, actual results may differ materially from such estimates.
Underwriting results in the Company's General Agency division also improved in 1996 as compared to 1995, as the Company's combined ratio in this division improved from 116.4% in 1995 to 106.9% in 1996. The Company's 1995 results were affected by a $22.3 million strengthening of reserves for prior year losses (see results of operations for year ended December 31, 1995 compared to year ended December 31, 1994), and $16.5 million of the $22.3 million affected the General Agency division, contributing to the 116.4% combined ratio recorded during 1995. When comparing accident year loss ratios for 1995 and 1996 in the General Agency division, the results are similar. In the year ended December 31, 1995, the General Agency division 1995 accident year loss ratio was 69.8% as compared to a 1996 accident year loss ratio of 69.9%. The General Agency division was also able to improve its combined ratio through a reduction in expenses during 1996 as its expense ratio fell to 31.9% in 1996 as compared to 34.1% in 1995.
While the Company's income tax expense increased from $1.2 million for the twelve months ended December 31, 1995 to $3.2 million for the 1996 year, the Company's effective tax rate declined from 22.2% in 1995 to 9.6% in 1996. The Company's 1996 taxes were positively effected by the decrease in the valuation allowance relating to the unrealized loss from the Company's investment in Major Realty. In October 1995, Major Realty announced that its Board of Directors had determined that it was in the best interest of the stockholders to seek a merger partner or otherwise seek a transaction for the sale of the company. At December 31, 1996, the Company believed that the realization of the capital loss associated with such a transaction was more likely than not due to sufficient carryforwards of capital gains as well as the likelihood of future capital gains.
The Company's Non-Standard underwriting activities experienced unprofitable results for the first time in six years as a result of an increase in both the severity and frequency of losses, particularly in the area of physical damage losses. The Company has increased rates beginning in 1996 and continuing into 1997, reduced commissions in certain areas with poor experience, and canceled agents with loss ratio problems. This division is also beginning to see a slow improvement in its expense ratio, and the Company expects this improvement in the expense ratio to accelerate during 1997.
The Company experienced strong premium growth in its General Agency division as direct premiums written increased 26.5% for the year ended December 31, 1995 as compared to the year ended December 31, 1994, and net premiums earned grew 39.8% from 1994 to 1995. Earned premiums grew more rapidly than direct premiums as premium growth slowed progressively in each quarter of 1995. The growth in this division came from the continued growth in new business produced from the Company's Scottsdale office which was established in late 1993. The rate of premium growth in 1995 slowed due to an increase in the competitive environment for lines of business written in the General Agency division.
The Company's Program division also experienced excellent premium growth during 1995 as direct premiums written increased from $83.9 million in 1994 to $115.4 million in 1995, an increase of 37.5%. Net earned premium increased at a rate of 50.8% from $42.6 million in 1994 to $64.3 million in 1995. This premium growth was principally from new programs established during 1994 and 1995. The Company continues to seek and establish new lines of business within the Program division but competitive factors in the marketplace have resulted in somewhat lower growth rates than expected in many of these new programs.
After the Company completed its review of prior year losses, the new development pattern assumptions were used to estimate ultimate losses for the current 1995 accident year. These new assumptions, severe wind and hail storms in Texas during the second quarter of the year, and adverse results in a few of the Company's business lines such as nursing home liability, homeowners business in South Carolina and used car dealer business in California, combined to create a $5.7 million underwriting loss in the property and casualty divisions of the Company for the 1995 accident year. For the accident year 1995, the Company's accident year loss ratio was 70.7% for the property and casualty division. The Company's underwriting results in the Non-Standard Automobile division were fairly consistent from 1994 to 1995 with this division experiencing a loss ratio of 66.8% in 1995 as compared to 68.9% in 1994. Management intends to continue to closely monitor statistical and other information with respect to loss reserves, in particular those lines of insurance that are more difficult to predict. However, the estimates of loss reserves are inherently uncertain and such estimates may continue to change as more information becomes available.
Underwriting expenses for 1995 increased as a percentage of earned premium from 26.0% during 1994 to 26.7% during 1995. General and administrative expenses also increased by $0.5 million from 1994 to 1995, and expenses in the Company's Crop division net of ceding commissions from reinsurers and expense reimbursements from the Federal Government under the MPCI program decreased slightly from $0.8 million in 1994 to $0.7 million in 1995. The increase in the underwriting expense levels was principally attributable to increases in Non-Standard Automobile division expenses related to the implementation of new computer software programs designed to make the Company's product more saleable in the marketplace and to reduce expenses in future years as the division grows. In addition, the Company sought to strengthen its information systems and audit procedures within the Program and General Agency divisions. The cost of implementation of several new programs in the Program division also added to the higher expense ratio for 1995 as compared to 1994. The Company expects the implementation of the new computer program for the Non-Standard Automobile division as well as the investments in systems for the General Agency and Program divisions to begin to slowly reduce its expense ratio over the next few years. Offsetting these internal expense reductions, the Company is experiencing intense competition in the area of agent's commissions as capacity in the insurance marketplace continues to exceed demand.
The Company's net income during 1995 was also effected by the impact of income taxes. The Company received a benefit of $3.4 million from income taxes in 1994 as opposed to an expense of $1.2 million from income taxes in 1995. As a result of prior non-insurance operations, the Company generated significant tax loss carryforwards and other temporary differences, all of which were used by the end of 1994.
The Company has included a discussion of the liquidity and capital resources requirement of the Company and the Insurance Subsidiaries.
Dividends from the insurance subsidiaries of the Company are regulated by the regulatory authorities of the states in which each subsidiary is domiciled. The laws of such states generally restrict dividends from insurance companies to parent companies to certain statutorily approved limits. In 1997, the statutory limitation on dividends from insurance company subsidiaries to the parent without further insurance departmental approval is approximately $10.4 million. In addition to dividends from the insurance companies, the Company also may receive distributions from its non-insurance subsidiaries which are engaged in agency, premium finance and claim service operations.
The Company currently holds two surplus notes, each in the amount of $20 million, issued by one of its insurance company subsidiaries, bearing interest at the rate of 9% per annum, payable quarterly. Although repayment of all or part of the principal of this surplus note requires prior insurance department approval, no prior approval of interest payment is currently required.
In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 (SFAS No. 123), "Accounting for Stock-Based Compensation," which was effective for the Company on January 1, 1996. SFAS No. 123 requires expanded disclosures of stock-based compensation arrangements with employees and encourages (but does not require) compensation cost to be measured based on the fair value of the equity instrument awarded. Companies are permitted, however, to continue to apply APB Opinion No. 25, which recognizes compensation cost based on the intrinsic value of the equity instruments awarded. The Company will continue to apply APB Opinion No. 25 in its accounting for stock based compensation awards to employees and directors, while expanding its disclosures as required by SFAS No. 123.