The following table sets forth summary consolidated financial information of the Company for each of the years in the five-year period ended December 31, 1999 derived from the Company's audited consolidated financial statements. See the Consolidated Financial Statements of the Company including notes thereto included herein.
The Company is a holding company with sixteen wholly owned subsidiaries. See "BUSINESS-General" included herein for a description of the Company.
General. The Company's 1999, 1998 and 1997 results of operations reflect intense market competition in the marine and aviation lines.
Revenues. Gross written premium increased from $171.2 million in 1997 to $172.2 million in 1998 and decreased to $167.1 million in 1999. The following table sets forth the Company's gross written premium by line of business along with ceded and net written premium in the aggregate for the periods indicated:
Marine Premium. In 1999, marine premium increased 35.2% from 1998 due to the capacity provided to Syndicate 1221 by NCUL and Millennium in the aggregate increasing from 39.5% in 1998 to 52.5% in 1999. NCUL wrote $24.7 million of marine premium in 1997 through providing capacity to Syndicate 1221 and one unaffiliated syndicate.
Engineering and Construction Premium. In 1999, the Robertson Consortium managed by MTC began writing engineering and construction business consisting of coverage for construction projects including machinery, equipment and loss of use due to delays. Previously, the engineering and construction business was written by Somerset Asia Pacific Limited in Australia and Somerset UK, wholly-owned subsidiaries of the Company, for Navigators Insurance. The Australia office was closed in 1999 along with the Singapore office which provided risk management services for the Australia office.
Onshore Energy. In 1999, the Robertson Consortium also began writing onshore energy business which principally focuses on the oil and gas, chemical and petrochemical, and power generation industries with coverages primarily for property damage and machinery breakdown. The business was previously written by Navigators Insurance.
The offer will be made at 1.8 pence per (pound)1 of capacity which is the minimum price that the Company is obliged to offer, being the highest price paid for capacity during the last 12 months. Whether or not, or to what extent the offer is accepted by the offerees is to some extent dependent on the price offered. As such, it is unlikely that the acceptance will result in a cost that is material to the Company. For the purposes of guidance, each 10% of capacity accepting will result in a cost to the Company of approximately (pound)120,000 (converts to $194,000). In addition, it is anticipated the administrative and legal costs of making the offer will be approximately (pound)25,000 (converts to $40,000). If the Company were to exceed the 90% control threshold as a result of the offer, Lloyd's Major Syndicate Transactions Byelaw (No. 18 of 1997) allows for a Minority Buy-out to be effected. In such a transaction the remaining participants are required to give up their capacity in return for compensation which must be at least equal to the offer price preceding the buy-out.
The Company provides letters of credit to Lloyd's to support its Syndicate 1221 capacity. If the amount of capacity controlled increases, the Company will be required to supply additional letters of credit or other collateral acceptable to Lloyd's, or to reduce the capacity of Syndicate 1221.
Aviation Premium. Aviation gross written premium decreased 99% from 1998 to 1999 and 33.1% from 1997 to 1998 as the result of Navigators Insurance's withdrawal from aviation business effective October 1998, other than a small amount of war and satellite business, due to inadequate pricing in the aviation insurance market.
Program Insurance Premium. The program insurance, currently written by Anfield, consists primarily of general liability insurance for contractors and a small amount of commercial multi-peril insurance for restaurants and taverns.
Ceded Premium. In the ordinary course of business, the Company reinsures certain insurance risks with unaffiliated insurance companies for the purpose of limiting its maximum loss exposure, protecting against catastrophic losses, and maintaining desired ratios of net premiums written to statutory surplus. The decrease in the ceded premium from 1998 to 1999 resulted from the decrease in engineering and aviation business which were heavily reinsured. The increase in the ceded premium from 1997 to 1998 resulted from the engineering and construction business and the program business, which were heavily reinsured, and from increasing the reinsurance on the marine business. In addition, beginning July 1, 1998, Navigators Insurance began writing 100% of the marine risks and then ceded 40% to the pool members for the 1998 underwriting year and 25% for the 1999 underwriting year.
Net Written Premium. Net written premium increased 6.3% from 1998 to 1999 primarily due to increases in the marine premium partially offset by decreases in other lines of business as described above. The 2.6% decrease in net written premium from 1997 to 1998 was primarily due to the reduction in fourth quarter 1998 aviation premium and competitive pressure in the marketplace partially offset by the increase in the Lloyd's marine premium and Navigators Insurance increasing its participation in the marine pool to 60% in 1998 from 48% in 1997.
Commission Income. Commission income decreased 93% from 1998 to 1999 due to Navigators Insurance increasing its participation in the marine pool from 60% in 1998 to 75% in 1999 which decreased the commission income, the losses related to unrecoverable reinsurance which reduced the profit commission, the Company's reduction of its commission income estimates due to the extremely competitive rate environment and less profit commission earned by MTC in 1999 than in 1998. Commission income increased 29.2% from 1997 to 1998 due to the profit commission earned by MTC from the 1996 underwriting year partially offset by Navigators Insurance increasing its participation in the marine pool to 60% in 1998 from 48% in 1997.
Net Investment Income. Net investment income increased 5.1% from 1998 to 1999 and 5.4 % from 1997 to 1998 primarily due to the investment income allocated to NCUL and Millennium from the investments at the Lloyd's Syndicates on which they participate. Such investments represent funds due from the syndicates to the Company.
Other Operating Expenses. The 2.5% increase in other operating expenses from 1998 to 1999 was primarily due to the acquisition of Anfield on April 2, 1999 and increased expenses in the Lloyd's operations due to the Company's increased participation in its Lloyd's syndicate, partially offset by reduced expenses from the closing of the Somerset Asia Pacific Limited office in Australia from which the company incurred a foreign exchange loss of $346,000. Other operating expenses increased 9.1% in 1998 over 1997 primarily due to the acquisition of MTC in January 1998, and increased expenses relating to Somerset UK and Somerset Asia Pacific Limited.
Interest Expense. The change in the interest expense for 1997, 1998 and 1999 was due to higher loan balances and fluctuations in interest rates.
Income Taxes. The income tax (benefit) expense was ($1.7) million, $3.7 million and $4.6 million for 1999, 1998 and 1997, respectively. The effective tax rates for 1999, 1998 and 1997 were 32.3%, 24.2% and 27.0%, respectively. The tax benefit in 1999 compared to the tax expense in 1998 was primarily due to operating losses. The decrease in the 1998 rate compared to the 1997 rate was primarily due to revenues in the foreign operations beginning to utilize some of the operating losses generated by those operations. The Company had alternative minimum tax ("AMT") carryforwards of $6.4 million, $4.7 million and $5.1 million at December 31, 1999, 1998 and 1997, respectively. The AMT carryforwards were primarily attributable to the tax benefits from municipal bond interest. The Company began reducing its municipal bond portfolio in 1997.
Invested assets and cash (excluding fiduciary funds held by the Somerset Companies and Anfield) decreased from $257.2 million at December 31, 1998 to $246.7 million at December 31, 1999. The decrease was primarily due to the fair value of the fixed income portfolio moving from an unrealized gain at December 31, 1998 to an unrealized loss at December 31, 1999. Investment income was $14.4 million in 1997, $15.2 million in 1998 and $16.0 million in 1999. The average yield of the portfolio, excluding net realized capital gains, was 5.6% in 1997, 5.9% in 1998, and 5.8% in 1999 reflecting the prevailing interest rates during those years and the decrease in the tax-exempt portfolio beginning in 1997. As of December 31, 1999, all fixed maturity securities and equity securities held by the Company were classified as available-for-sale.
The average rating of the Company's fixed maturity investments is AA by Standard & Poor's and Aa by Moody's. The Company has no significant exposure to credit risk since the Company's fixed maturity investment portfolio primarily consists of investment grade bonds. The portfolio has an average maturity of less than seven years. Management continually monitors the composition and cash flow of the investment portfolio in order to maintain the appropriate levels of liquidity. This ensures the Company's ability to satisfy claims or expenses as they become due.
The increase for reserves for losses and loss adjustment expenses and the related increase in the reinsurance receivable on paid and unpaid losses and loss adjustment expenses at December 31, 1999 as compared to 1998, was primarily due to energy and engineering claims reported in 1999 which were heavily reinsured, and the Lloyd's "reinsurance to close" loss portfolio for the 1997 underwriting year.
On December 21, 1998, the Company entered into a new bank credit facility which replaced the prior facility. The new credit facility provides a $25 million revolving line of credit at an interest rate of either, at the Company's election, the base commercial lending rate of one of the banks or at LIBOR plus 0.875%. The line of credit facility reduces each quarter by amounts between $1.0 million and $2.25 million beginning January 1, 2000 until it terminates on November 19, 2003. At December 31, 1999 and 1998, $24 million and $23.5 million in loans were outstanding, respectively, under the revolving line of credit facility at an interest rate of 7.1% and 5.9%, respectively. The credit facility also provides for a $60 million letter of credit facility which is utilized primarily by NCUL and Millennium to participate in Lloyd's Syndicate 1221 managed by MTC. At December 31, 1999 and 1998, letters of credit with an aggregate face amount of $42.2 million and $29.2 million, respectively, were issued under the letter of credit facility. These letters of credit have not been drawn upon.
The bank credit facility is collateralized by shares of common stock of the Company's major subsidiaries. It contains covenants common to transactions of this type, including restrictions on indebtedness and liens, limitations on mergers and the sale of assets, maintaining certain consolidated total stockholders' equity, statutory surplus, minimum liquidity, loss reserves and other financial ratios. At December 31, 1999, the Company complied with all covenants except for one related to the surplus of the Insurance Companies for which a waiver and an amendment curing the noncompliance was received from the banks providing the credit facility.
The "Year 2000 Issue" or "Y2K Issue" is a term used to describe the predicted problems that could have arisen as a result of the inability of some computer programs and embedded chips to distinguish dates beginning with 19 from dates beginning with 20. This Y2K Issue could hav resulted in a variety of potential problems for all businesses from inaccurate processing of dates and date-sensitive calculations to system failures and disruptions in operations. The Company had considered the Y2K Issue a high priority since 1996 and had taken certain steps to address this important aspect of its operations. The Company had formed an Executive Committee comprised of senior management from all departments to address the issues. The efforts were rewarded as no computer related Y2K problems were experienced. The Company will continue to monitor the situation but remains confident that there will not be any future computer related Y2K problems.
For invested assets, modified duration modeling is used to calculate changes in fair values. Durations on invested assets are adjusted for call, put and interest rate reset features. Duration on tax exempt securities is adjusted for the fact that the yield on such securities is less sensitive to changes in interest rates compared to Treasury securities. Invested asset portfolio durations are calculated on a market value weighted basis, including accrued investment income, using holdings as of December 31, 1999.