- --------------- (1) The Company acquired Casualty Insurance Company on February 22, 1995.
(3) Effective January 1994, FASB 115 changed the accounting treatment afforded the Company's investment portfolio wherein unrealized gains and losses on securities designated by the Company as available for sale are included, net of deferred taxes, as a component of stockholders' equity.
More recently, on February 22, 1995, the Company completed the acquisition of all outstanding stock of Casualty Insurance Company ("Casualty") and its wholly-owned subsidiary Workers' Compensation and Indemnity Company ("WCIC") from the Buckeye Union Insurance Company ("Buckeye"). Casualty underwrites workers' compensation insurance primarily in Illinois and several other mid-western states, as well as a modest amount through WCIC in California. Casualty currently is the largest underwriter of workers' compensation insurance in Illinois and has provided the Company with a significant presence in the mid- western region. The Casualty acquisition has provided geographic diversity within the Company's workers' compensation insurance business segment and the Company's 1995 revenues from workers' compensation insurance premiums were evenly divided between the west and mid-west regions. The Company believes this geographic diversity mitigates potential fluctuations in earnings from cyclical downturns in various regional economies.
The Company's balance sheet at December 31, 1995 has been significantly impacted by the acquisition of Casualty. The purchase price was $250 million, comprised of $225 million in cash and $25 million in a note payable to Buckeye. In addition, $6.5 million of costs were incurred in connection with the acquisition bringing the total cost to $256.5 million. The acquisition was treated as a purchase for accounting purposes and approximately ten months of Casualty's operating results are included in the Company's results of operations for the year ended December 31, 1995. At the acquisition date, the assets acquired and liabilities assumed, net of the purchase price and purchase accounting adjustments, are summarized in the following table:
In 1990, the Company acquired Fremont Investment & Loan (formerly Investors Thrift), a California thrift and loan that now serves more than 23,000 customers through its 12 branches. The thrift and loan operations are primarily engaged in commercial and residential real estate lending. For commercial real estate loans, principal amounts primarily range between $1 to $5 million and for residential real estate loans, principal amounts are generally below $300,000. The Company's operating strategy is to pursue growth of the
Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. Actual results could differ materially from those projected in the forward-looking statements as a result of a variety of factors, including the risk factors set forth within Management's Discussion and Analysis of Financial Condition and Results of Operations and elsewhere herein.
By providing diverse insurance and financial services to small and medium-sized businesses, the Company has achieved growth in both revenues and net income during the three years ended December 31, 1995. Higher revenues and net income in 1995 were also achieved through the acquisition of Casualty. The
The Company's professional medical liability, corporate and other segment is composed principally of revenues and expenses that pertain to the Company's professional medical liability business ("medical malpractice"), as well as miscellaneous expenses associated with the Company's downstream property and casualty insurance holding company, Fremont Insurance Group, Inc., ("Fremont Insurance Group"). Medical malpractice revenues were flat at $34.3 million in 1995 as compared to $33.0 million for 1994. Medical malpractice revenues increased in 1994 from $29.2 million in 1993 due primarily to a shift in underwriting focus towards those medical specialties that had higher premiums. Income before taxes for the medical malpractice business was $5.2 million, $6.6 million and $10.2 million for 1995, 1994 and 1993, respectively. The decrease in income before taxes in 1995 and 1994, as compared to 1993, is due primarily to an increase in the frequency and severity of reported claims. Expenses of Fremont Insurance Group include
interest expense on debt and other obligations of $6.7 million, $5.5 million and $4.5 million, respectively, for 1995, 1994 and 1993, and overhead expenses of $2.2 million, $3.1 million and $3.3 million for the corresponding periods. Since the operations of Fremont Insurance Group consist primarily of interest expense and overhead expenses management does not expect it to operate at a profit.
The financial services business segment posted increases of 28% and 31% in income before taxes for 1995 and 1994, respectively. These increases are consistent with increases in financial services revenues and are due primarily to the significant growth in the average loan portfolio over the three year period ended December 31, 1995 from $783 million in 1993 to $1.5 billion in 1995. Contributing to this growth in the average loan portfolio is the acquisition of approximately $366 million in primarily commercial real estate loan portfolios which were completed during the last six months of 1994. This segment, which consists principally of real estate lending and commercial finance operations, recorded income before taxes of $35.7 million, $28.0 million and $21.5 million for 1995, 1994 and 1993, respectively.
Corporate revenues consisted primarily of investment income, while corporate expenses consisted primarily of interest expense and general and administrative expense. The corporate loss before income taxes was $18.5 million, $7.7 million and $9.2 million for 1995, 1994 and 1993, respectively. The increase in the corporate loss before taxes in 1995 over 1994 was due primarily to increased interest expense and decreased investment income. The increase in interest expense is due primarily to additional debt incurred in the acquisition of Casualty, along with modest increases in administrative expenses. The decrease in corporate loss before taxes in 1994 compared to 1993 was primarily due to increased investment income and higher intercompany interest income from the Company's subsidiaries.
Income tax expense of $32.3 million, $25.8 million and $21.6 million for 1995, 1994 and 1993, respectively, represent effective tax rates of 32%, 32% and 34% on pretax income of $100.3 million, $81.6 million and $64.3 million for the corresponding periods. The Company's effective tax rates for all years presented are lower than the enacted federal income tax rate of 35%, due primarily to tax exempt investment income which reduces the Company's taxable income.
Premiums. Premiums earned from the Company's workers' compensation insurance operations were $575.0 million in 1995, as compared to $401.5 million and $426.8 million in 1994 and 1993, respectively. Premiums were significantly higher in 1995 due primarily to the acquisition of Casualty, partially offset by lower premiums earned in California. For the year ended December 31, 1995, the Company's workers' compensation insurance premiums earned in its western region, consisting primarily of California, accounted for $292 million, or 51% of the Company's total workers' compensation insurance premiums earned for such period, representing a decrease of $109 million from 1994. This decrease was due primarily to the increased price competition resulting from California's adoption of an open rating system and the repeal of the minimum rate law. See "Workers' Compensation Regulation." This increased price competition has led to (i) lower premium rates and (ii) a lower average policy size due to the Company's shift in focus to smaller employers.
Net Investment Income. Net investment income within the property and casualty insurance operations was $101.3 million, $62.2 million and $65.7 million in 1995, 1994 and 1993, respectively. Significantly higher invested assets, due primarily to the acquisition of Casualty, resulted in increased investment income in 1995 as compared to 1994 and 1993. The effects of lower invested assets and lower investment yields during 1994 resulted in net investment income levels lower as compared to 1993. See "Item 1. Business -- Investment Portfolio."
Policy Acquisition Costs and Other Operating Costs and Expenses. The ratio of policy acquisition costs and other operating costs and expenses to premiums earned is referred to as the expense ratio, which was 24.5%, 23.4% and 21.3% in 1995, 1994 and 1993, respectively. The increase in this ratio in 1995 and 1994, as compared to 1993, was due primarily to higher agents' commission costs.
Dividends to Policyholders. In 1995 there were no dividends accrued. This is compared to $49.7 million and $45.2 million in dividends accrued in 1994 and 1993, respectively. The ratio of dividends accrued to workers' compensation insurance premiums earned therefore decreased to 0% in 1995 from 12.4% and 10.6% in 1994 and 1993, respectively. The significant decrease in dividends accrued is due in part to a change in the type of workers' compensation insurance policy written on and after January 1, 1995. In 1995, the Company's workers' compensation insurance policies, both in California and those underwritten by Casualty, were predominately written as non-participating, which does not include provisions for dividend consideration. In 1994 and prior, the Company's policies were predominately written as participating, thereby obligating the Company to consider the payment of dividends. This shift in policy type is due primarily to the increased competition in the California market which has resulted from the repeal of the minimum rate law, effective January 1, 1995. The Company anticipates that this shift to non-participating policies will continue and be a characteristic element of the competitive environment established by the July 1993 California legislation. See "Workers' Compensation Regulation."
Variability of Operating Results. The Company's profitability can be affected significantly by many factors including competition, the severity and frequency of claims, interest rates, regulations, court decisions, the judicial climate, and general economic conditions and trends, all of which are outside of the Company's control. These factors have contributed, and in the future could contribute, to significant variation of results of operations in different aspects of the Company's business from quarter to quarter and year to year. With respect to the workers' compensation insurance business, changes in economic conditions can lead to reduced premium levels due to lower payrolls as well as increased claims due to the tendency of workers who are laid off to submit workers' compensation claims. Legislative and regulatory changes can also contribute to variable operating results for workers' compensation insurance businesses. For example, in 1995, the Company experienced the negative impact of lower premiums and lower profitability on the Company's California workers' compensation business due to increased price competition resulting from legislation enacted in California in July 1993 which, among other things, repealed the minimum rate law effective January 1, 1995. See "Workers' Compensation Regulation." The Company anticipates that its workers' compensation insurance premiums earned in California will continue to decrease as a result of this increased price competition, which could adversely affect the Company's results of operations and financial condition. See "Premiums." Also, the establishment of appropriate reserves necessarily involves estimates, and reserve adjustments have caused significant fluctuations in operating results from year to year.
The Company's financial services operations are principally engaged in commercial and residential real estate lending through Fremont Investment & Loan and asset-based lending through Fremont Financial. The Company also has small life insurance and premium finance operations included in this segment. See Note P of Notes to Consolidated Financial Statements. Revenues consist principally of interest income and, to a lesser extent, life insurance premiums, fees and other income.
Revenues increased 39% in 1995 and 23% in 1994, due primarily to greater loan interest and fee revenue attributable to the growth in the average loan portfolios of the real estate lending and commercial finance operations from $1.1 billion in 1994 to $1.5 billion in 1995. Contributing to this growth in the average loan portfolio was the acquisition of approximately $366 million in primarily commercial real estate loan portfolios which were completed during the last six months of 1994. In 1995, no portfolios of commercial real estate loans were purchased, primarily due to increased competition which resulted in inadequate yields or unacceptable risk profiles for the portfolios considered.
Income before taxes in the financial services operations was $35.7 million, $28.0 million and $21.5 million for 1995, 1994 and 1993, respectively. The 28% increase in income before taxes in 1995 as compared to 1994 is due primarily to continued growth in the loan portfolios, offset partially by increases in the provision for loan losses and other expenses. The 31% increase in 1994 as compared to 1993, is due primarily to the growth in the loan portfolios and a lower provision for loan losses. See "Item 1. Business -- Financial Services Operations."
The following table identifies the interest income, interest expense, average interest-bearing assets and liabilities, and interest margins for the Company's thrift and loan and commercial finance subsidiaries:
commercial finance operation. The collateral securing this loan is closely monitored by the Company and the Company believes it currently has adequate reserves in the allowance for possible loan losses to cover any potential loss on this loan. The decrease in REO assets during 1995 relates entirely to the real estate lending operation. At December 31, 1995, the balance in REO includes eight commercial real estate properties totaling $4.4 million. Non-performing assets increased $21.1 million at December 31, 1994 as compared to the prior year end due primarily to a $16.6 million increase in REO assets in the real estate lending operation.
The Company's thrift and loan subsidiary finances its lending activities primarily through customer deposits, which have grown from $747 million at December 31, 1994 to $926 million at December 31, 1995. In January 1995, Fremont Investment & Loan became eligible for financing through the Federal Home Loan Bank of San Francisco. This financing is available at varying rates and terms. As of December 31, 1995, $170 million was available under the facility and no borrowings were outstanding.
On February 22, 1995, the Company completed the acquisition of Casualty which resulted in the disbursement of funds totaling $256.5 million, comprised of $231.5 million in cash and $25 million in a note payable to the seller. In September 1995, the note payable to the seller was refinanced using the Company's existing revolving line of credit. The cash used to fund the acquisition includes $55 million in borrowings under the Company's existing line of credit and the remainder from internally generated funds. See "General. "
The amortized cost of the Company's invested assets were $1.91 billion, $.99 billion, and $1.06 billion at December 31, 1995, 1994 and 1993, respectively. Contributing to the $.92 billion increase in the invested assets was approximately $512 million resulting from the Casualty acquisition and $199 million increase in net annuity receipts in the Company's life insurance operation. The modest decrease in 1994 as compared to 1993 is due primarily to a decrease in premium volume. As of July 1, 1995 the Company's held to maturity portfolio totaling $319.4 million was transferred to available for sale in accordance with the provisions of Financial Accounting Standards Board Statement 115 ("FASB 115"), "Accounting for Certain Investments in Debt and Equity Securities." In addition, at this date there was a net unrealized gain of $9.9 million (net of deferred taxes of $5.3 million) on the held to maturity portfolio which was transferred to stockholders' equity. The transfer became necessary as the Company sold certain investment securities in July which were classified as held to maturity at June 30, 1995. These investment sales were part of an overall review and restructuring of the investment portfolio performed in conjunction with the investing of cash received in the acquisition of Casualty. This review and restructuring caused the Company to consider the appropriateness of the remaining held to maturity investments, which resulted in the reclassification.
standards for its member institutions, and Fremont Investment & Loan was in compliance with these standards as of December 31, 1995. See "Item 1. Business -- Regulation -- Thrift and Loan Regulation." In August 1994 an additional $23 million was contributed to the capital of Fremont Investment & Loan to support the growth in the loan portfolio during 1994.
In March 1995, the Financial Accounting Standards Board ("FASB") issued Statement No. 121 ("FASB 121"), "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of ", which requires impairment losses to be recorded on long-lived assets used in operations, including intangible assets, when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. FASB 121 also addresses the accounting for long-lived assets that are expected to be disposed of. The Company will adopt FASB 121 in the first quarter of 1996 and, based on current circumstances, the effect of adoption will not be material.