The Company owns its corporate offices which provide approximately 35,000 square feet of office space and additional parking. Future expansion will be possible by converting the parking area into office space.
(2) Includes after tax net realized gains of $400,000, $457,000, $212,000, $307,000, and $70,000 for 1999, 1998,1997, 1996, and 1995, respectively.
(3) Based on shares of Common Stock outstanding of 27,119,833, 20,896,563, 20,874,224, 21,087,407 and 21,525,221 at the end of 1999, 1998, 1997, 1996 and 1995, respectively. Common Stock outstanding at December 31, 1999 assumes conversion of the Series A Convertible Preferred stock that was issued in conjunction with the GMSP transaction.
On October 4, 1999 the Company sold to Goff Moore Strategic Partners, L.P., a Texas limited partnership ("GMSP") for an aggregate purchase price of $31,620,000 (a) 31,620 shares of the Company's Series A Convertible Preferred Stock, which are convertible into shares of the Company's Common Stock, par value $.10 per share ("Common Stock"), at a conversion price of $5.10 per share, (b) a five year Warrant to purchase an aggregate of 1,550,000 shares of Common Stock at an exercise price of $6.375 per share and (c) a seven year Warrant to purchase an aggregate of 1,550,000 shares of Common Stock at an exercise price of $8.50 per share. The Company and its insurance company subsidiaries entered into Investment Management Agreements with GMSP, pursuant to which GMSP will manage their respective investment portfolios. Proceeds from the GMSP Transaction are available for acquisitions, investments and other corporate purposes.
COMMERCIAL LINES grew 10% in 1999 following a 12% decrease in 1998. Commercial auto contributed 7 points to the increase in 1999 with Texas, Florida and Georgia accounting for the majority. In 1998 Kentucky commercial auto as well as the decision to exit certain other unprofitable commercial auto classes contributed 6 points to the decrease. The garage product decreased in both years accounting for 3 points in 1999 and in 1998. Continued pricing pressure and new entrants to the garage market in both years are the primary reasons. The general liability line contributed 3 points to the increase in 1999 primarily as a result of growth in Texas. In 1998 general liability recorded small decrease as a result of continued pricing pressure and competitors entering the market. PERSONAL LINES increased in 1999 as a result of the Florida nonstandard personal auto business the Company began writing in late 1998.
Insurance service revenues decreased $1,078,997 in 1999 from 1998 primarily as a result of the run-off of the plan servicing business and the sale of the computer software operation. These decreases were offset to some extent by revenues from the claim adjusting operation.
The ratio of commissions to gross premiums written was 21% in 1999, 26% in 1998 and 22% in 1997. The ratio in 1998 is above 1999 and 1997 primarily due to a reduction in reinsurance commission income of approximately $3,318,000 that was recorded in 1998. This was a result of unfavorable development in C & CAE incurred in 1998, mentioned previously. The ratio of commissions to premiums earned was 25% for 1999 and 1998 versus 21% for 1997. The 1999 ratio is above 1997 primarily due to the increase in the growth rate of gross premiums written in 1999. The increase in the ratio in 1998 is a result of the reduction in reinsurance commission income in 1998.
Interest expense from the note payable and amortization expense related to the goodwill on the Lalande acquisition increased primarily as a result of recording a full year of expenses in 1999 versus approximately three months of expenses in 1998.
The effective tax rates of 15% for 1999 and 19% for 1997 are primarily the result of tax-exempt income comprising a major portion of income before taxes. For 1998 the Company generated a current tax benefit as a result of the loss from operations. The large increase in the deferred tax benefit in 1998 is primarily the result of the large increase recorded to C & CAE reserves in 1998. The effective tax benefit rate for 1998 of 45% is above the Federal statutory rate largely because of tax-exempt interest income. For the Company, the fresh start adjustment (tax benefit) was immaterial for all years presented. A reconciliation between income taxes computed at the Federal statutory rates and the provision for income taxes is included in Note 6 of Notes to Consolidated Financial Statements.
The primary sources of the Company's liquidity are funds generated from insurance premiums, net investment income and maturing investments. The short-term investments and cash are intended to provide adequate funds to pay claims without selling fixed maturity investments. At December 31, 1999, the Company held short-term investments and cash that the Company believes is adequate liquidity for the payment of claims and other short-term commitments. This amount is larger than normal because the funds received from GMSP in October 1999 had not been fully invested in bonds, stocks and alternative investments at December 31, 1999.
The increase in investments is primarily attributable to the capital received in the GMSP transaction described previously. In the fourth quarter of 1999 all bonds classified as held to maturity were transferred to the available for sale classification and adjusted to fair value. The amortized cost at the date of transfer for these bonds $41,069,988 and the fair value was $41,036,014 resulting in an unrealized loss before Federal income taxes of $33,974. The company made this change since it no longer invests in bonds with the intent of holding them to maturity. Premiums receivable and ceded unpaid claims and claim adjustment expenses increased primarily as a result of the personal lines business written in 1999. Deferred policy acquisition costs (DAC) increased primarily because of the increase in unearned premiums. Current Federal income taxes recoverable decreased primarily due to the receipt of the refund for the 1998 year. The increase in other assets is primarily related to an increase in funds on deposit with reinsurers for 1999.
Unpaid claims and claim adjustment expenses decreased primarily due to commercial lines CAE reserves decreasing as a result of the large number of prior accident year claims closed in 1999, as well as material decreases in plan servicing and fronting reserves. Unearned premiums increased because of the increase in premiums written mentioned previously. Commissions payable decreased primarily because of balances settled in 1999 on commercial reinsurance treaties. Reinsurance balances payable increased primarily because of the increased activity in personal lines.
There has been concern that there would be worldwide computer problems in early 2000 due to their failure to properly recognize a year that begins with "20" instead of the familiar "19" and because the Year 2000 is
a leap year. To address these and related concerns, the Company appointed a Year 2000 team involving personnel from all business units to assess the Year 2000 readiness of the Company and those with whom it does business, and then address any problems found. The Company contracted with a major consulting vendor to perform due diligence assessment and testing of its Year 2000 project. While assessing the Company's readiness, the vendor identified some programs that required additional remediation and re-testing. The Company believes that all identified non-conforming programs have been corrected and that it has not experienced any material Year 2000 related system failures or disruptions. The Company, however, plans to continue to monitor its systems and operations and to address any date-related problems that may arise.
The Company reviewed the insurance policies written by it and its underwriting guides to determine Year 2000 exposure. The Company made a decision to exclude Year 2000 exposures from all insurance policies written by it and began adding exclusions in November 1997. The Company believes Year 2000 liabilities are not fortuitous in nature and would not be covered under its insurance policies. The Company believes that its coverage exposure with respect to Year 2000 losses will not be material. However, changes in social and legal trends may establish coverage unintended for Year 2000 exposures by re-interpreting insurance contracts and exclusions. Litigation with respect to Year 2000 claims and the attendant costs are to be expected. It is impossible to predict what exposure insurance companies may bear for Year 2000 losses.
The Company estimates that its costs in 1998 and 1999 of addressing the Year 2000 problem aggregated approximately $920,000, including modifying or replacing software and other systems, hiring Year 2000 solution providers and internal assessment, remediation and testing. These costs were funded by internally generated funds. No material additional Year 2000 costs are anticipated.