The Company has historically followed a practice of maintaining low retentions in its primary and reinsurance business to reduce the variability of its earnings. As a result of this practice and the Company's focus on short-tail business, the Company's loss reserve levels historically have remained relatively stable from year to year despite changes in premium volume. The Company is continuing to cede portions of insurance risks while using its capital base to gradually increase, on a selective basis, its retention of certain property risks.
Because catastrophe loss events are by their nature unpredictable, historical results of operations may not be indicative of expected results of future operations. The Company markets its primary personal insurance products throughout the United States. While the Company seeks to reduce its exposure to catastrophic events through the purchase of reinsurance, the occurrence of one or more major catastrophes in any given period could have a material adverse impact on the Company's results of operations and financial condition and result in substantial outflows of cash as losses are paid. In addition, the increased underwritings of catastrophe related reinsurance, and potential residual market assessments may also lead to increased variability in the Company's loss ratio.
On December 31, 1996 the Company terminated the 75% pro rata reinsurance contract on its homeowners and dwelling lines of business (excluding HIG) produced through independent agents and also on its homeowners and dwelling lines of business in the financial services business. The cancellation enable the Company to increase its net writings in the personal lines of business.
COMPARISON OF THE FISCAL YEAR 1997 TO THE FISCAL YEAR 1996
Gross premiums written for primary insurance increased by $184.3 million, or 119.5%, to $338.5 million for the year ended December 31, 1997, from $154.2 million for the year ended December 31, 1996. Included in the $184.3 increase in gross premiums written for primary insurance was $131.5 million of gross premiums written by Shelby. The remaining increase of $52.8 million was primarily due to the transfer of business from assumed reinsurance to personal lines following the acquisition of Vesta County Mutual.
Net Income. For the reasons discussed above, net income increased by $10.4 million, or 20.7%, to $60.6 million for the year ended December 31, 1997, from $50.2 million for the year ended December 31, 1996.
Loss and loss adjustment expenses ("LAE") for primary insurance decreased by $1.2 million, or 2.5% to $46.8 million for the year ended December 31, 1996, from $48.0 million for the year ended December 31, 1995. Loss and LAE ratio for primary insurance for the year ended December 31, 1996 was 48.3% as compared to 52.6% for the year ended December 31, 1995.
Policy Acquisition Expenses and Other Operating Expenses. Policy acquisition expenses increased by $40.5 million, or 46.6% to $127.5 million for the year ended December 31, 1996, from $87.0 million for the year ended December 31, 1995. Other operating expenses include administrative costs not directly related to the generation of premium revenue, premium taxes and fees, interest on debt and goodwill amortization. Administrative costs (designated as operating expenses on the statement of operations) increased $2.4 million. Premium taxes and fees decreased $109 thousand. Interest on debt increased $4.8 million. Goodwill amortization increased $220 thousand.
Net Income. For the reasons discussed above, net income increased by $7.5 million, or 17.6%, to $50.2 million for the year ended December 31, 1996, from $42.7 million for the year ended December 31, 1995.
As a holding company with no other business operations, the Company relies primarily upon dividend payments from Vesta Fire and Shelby to meet its cash requirements (including its debt service) and to pay dividends to its stockholders. Transactions between Vesta Fire, Shelby and the Company, including the payment of dividends by Vesta Fire and Shelby, are subject to certain limitations under the insurance laws of Alabama. Specifically, Alabama and Texas law permits the payment of dividends in any year which, together with other dividends or distributions made within the preceding 12 months, do not exceed the greater of 10% of statutory surplus as of the end of the preceding year or the net income for the preceding year, with larger dividends payable only after receipt of prior regulatory approval. Hawaii law limits dividends to the lesser of 10% of statutory surplus as of the end of the preceding year or the net income for the preceding year without prior approval. Based upon restrictions presently in effect, the maximum amount available for payment of dividends to the Company by its insurance subsidiaries in 1998 without prior approval of regulatory authorities is approximately $35.5 million.
During 1997, the Company paid approximately $2.8 million in dividends on its common stock, and it is expected that the Company will pay approximately $2.8 million in 1998. The Company is also required to make semi-annual interest payments of $4.4 million on its $100 million of 8.75% Senior Debentures due 2025, and semi-annual interest payments of $4.3 million on its $100 million of 8.525% Junior Subordinated Deferrable Interest Debentures issued to Vesta Capital Trust I in connection with its sale of $100 million of 8.525% Capital Securities.
In order to provide further liquidity, the Company increased its line of credit to $200 million from $100 million effective April 8, 1997. The Credit Agreement relating to this line of credit contains certain covenants that require, among other things, the Company to maintain a certain consolidated net worth, maintain a certain amount of investment income available for the payment of interest expense, cause each insurance subsidiary to maintain a certain total adjusted capital and which limit the amount of indebtedness the Company can have. The Company is in compliance with these covenants.
As of December 31, 1997, the Company's investment portfolio consisted of cash and short-term investments (21.4%), U.S. Government securities (13.1%), mortgage-backed securities (9.3%), corporate bonds (29.9%), foreign government securities (0.6%), municipal bonds (22.6%) and equity securities (3.1%). According to Moody's, 95.2% of the Company's portfolio is rated A or better. The
On January 31, 1997, Vesta Capital Trust I, a Delaware business trust controlled by the Company, sold $100 million of its 8.525% Capital Securities. These securities have a 30 year maturity and are not redeemable except in certain limited circumstances. These securities were sold in a private placement transaction to qualified institutional buyers and were not registered under Securities Act of 1933 pursuant to an exemption from registration provided by Rule 144A promulgated thereunder. A portion of the proceeds from the sale of these capital securities were used to repay indebtedness under the Company's existing lines of credit and the remainder is for general corporate purposes.
After the close of business on June 30, 1997, the Company completed its acquisition of Shelby, which are property and casualty insurance companies headquartered in Ohio for $260.9 million. The acquired subsidiaries had $648 million of assets and approximately $217 million of stockholders' equity at June 30, 1997. The Company funded the payment of the purchase price for this acquisition with available cash on hand, short term investments, cash available from its insurance subsidiaries and with funds available under its line of credit. The Company does not believe that the payment of the purchase price as described above will have an adverse impact on the Company's liquidity.
The company is heavily dependent upon computer systems for all phases of its operations. The year 2000 issue--common to most corporations--concerns the inability of certain software and databases to properly recognize date sensitive information beginning January 1, 2000. This problem could result in a material disruption to the company's operations, if not corrected. The company has assessed and developed a detailed strategy to prevent or at least minimize problems related to the year 2000 issue. In 1997 resources were committed and implementation began to modify the affected information systems. Total costs related to the project are estimated to be approximately $3.5 million, of which $1.1 million was spent in 1997. Substantially all remaining costs will be expended in 1998. Implementation is currently on schedule. The degree of success of this project cannot be determined at this time. However, management believes that the final outcome will not have a material adverse affect on the operations of the company.
The Company does not believe its results have been materially affected by inflation due in part to the predominantly short-tail nature of its business. The potential adverse impacts of inflation include: (i) a decline in the market value of the Company's fixed maturity investment portfolio; (ii) an increase in the ultimate cost of settling claims which remain unresolved for a significant period of time; and (iii) an increase in the Company's operating expenses. Historically, the effect of inflation on the Company's reserves has not been material.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Vesta Insurance Group, Inc. and subsidiaries at December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1997, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
VESTA INSURANCE GROUP, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)
VESTA INSURANCE GROUP, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (AMOUNTS IN THOUSANDS)
Financial Statement Presentation: Vesta Insurance Group, Inc. (Vesta) was incorporated by Torchmark Corporation on July 9, 1993 and capitalized on July 16, 1993 with a $50 million contribution from Torchmark and the contribution from Torchmark of all of the outstanding common stock of J. Gordon Gaines, Inc., Liberty National Reinsurance Company, Ltd, and Vesta Fire Insurance Corporation and its wholly-owned subsidiaries. On November 18, 1993, the Company completed an initial public offering of common stock which resulted in proceeds to the Company of approximately $51 million. At year-end 1997, Torchmark held approximately 28% of the outstanding common stock of the Company with the balance publicly traded.
Nature of Operations: The Company is a holding company for a group of property and casualty insurance companies (the "Vesta Group") that offer treaty reinsurance and primary insurance on personal and commercial risks. The lead insurer in the Vesta Group is Vesta Fire Insurance Corporation ("Vesta Fire"). In both its reinsurance and primary insurance operations, the Company focuses primarily on property coverages. Gross premiums written by the Company in 1997 totalled $870.9 million. Gross premiums written in the reinsurance line were $532.4 million in 1997, substantially all of which were on personal (including automobile) risks and commercial property risks. Also, property (including auto physical damage) risks accounted for approximately 86% of the Company's gross premiums written in all lines in 1997.
The availability and cost of reinsurance and retrocessional coverage may vary significantly over time and are subject to prevailing market conditions. Pricing on both assumed and ceded reinsurance weakened slightly due to increased availability of reinsurance market capacity.
Use of Estimates in the Preparation of the Financial Statements: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. These estimates and assumptions are particularly important in determining the premiums in course of collection, reserves for losses and loss adjustment expenses and deferred policy acquisition costs.
Recognition of Premium Revenue: Earned premiums on primary business are generally recognized as revenue on a pro rata basis over the policy term. Earned premiums on assumed reinsurance are recognized as revenue when reported by the cedant. Also, due to the delay in reporting from its reinsurance cedants, the Company accrues unreported premium revenue on its assumed reinsurance business based on historical experience. Historically, the Company has made estimates for its reinsurance reports received subsequent to a period end on a combined underwriting and accident year basis. These accrued premiums are necessarily based on estimates and, while management believes that the accruals are reasonable, the ultimate reported premium may be less than or in excess of the amounts accrued.
Income Taxes: Vesta accounts for income taxes using the asset and liability method under which deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.
Goodwill: The company amortizes goodwill straight-line over a period of 15 years.
Stock Split: On January 22, 1996 Vesta distributed one share for every two shares owned by shareholders of record as of January 5, 1996 in the form of a stock dividend. All prior year share and per share data has been restated to give effect for the dividend.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLAR AMOUNTS IN THOUSANDS) NOTE B--STATUTORY ACCOUNTING (CONTINUED)
A schedule of fixed maturities held for investment by contractual maturity at December 31, 1997 is shown below on an amortized cost basis and on a fair value basis. Actual maturities could differ from contractual maturities due to call or prepayment provisions.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLAR AMOUNTS IN THOUSANDS) NOTE C--INVESTMENT OPERATIONS (CONTINUED)
Leases: The Company leases office space for its home office and HIG under operating lease arrangements. These leases contain various renewal options and escalation clauses. Rental expense for operating leases was $706 thousand, $1,014 thousand, and $1,206 thousand, for the years ending December 31, 1995, 1996, and 1997, respectively. Future minimum rental commitments required under these leases are approximately $1.5 million per year.
The following table summarizes certain amounts paid during the period as required by GAAP:
Vesta engages in assumed reinsurance transactions as part of its overall business strategy. The effect on premiums earned and losses and loss adjustment expenses of all assumed reinsurance transactions, including involuntary pools, are as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLAR AMOUNTS IN THOUSANDS) NOTE J--REINSURANCE (CONTINUED)
Income tax expense for the years ended December, 1995, 1996 and 1997 was allocated as follows:
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities included in other liabilities at December 31, 1996 and 1997 are presented below:
A valuation allowance for deferred tax assets, as of December 31, 1996 and 1997, was not necessary.
Vesta has a defined contribution retirement and savings plan and a supplemental executive retirement plan. These plans are fully funded at year- end 1997. Vesta's total cost for benefits under these plans since the Offering date was $319,337 for 1995, $348,125 for 1996 and $721,693 for 1997.
In April of 1997, Vesta increased the size of its line of credit to $200 million from $100 million. The interest charge on the funds borrowed is either (i) the London Interbank Rate plus 0.25% or (ii) the higher of the prime rate and the Federal Funds rate plus 0.5%, at the Company's discretion. At December 31, 1997 the London Interbank three month rate was 5.91% and the Federal Funds rate was 5.56%.There was a balance of $45 million under this line of credit at December 31, 1997. The line of credit contains covenants which (1) restricts the Company from incurring consolidated indebtedness greater than 42.5% of the sum of the Company's consolidated indebtedness and consolidated net worth, (2) requires the Company to maintain consolidated net worth to be equal to or greater than $350,000,000 plus 50% of the aggregate of consolidated net income for each fiscal quarter ending after September 30, 1996 up to and including the fiscal quarter then ending minus the aggregate amount of all dividends paid with respect to the Company's equity securities at any time after September 30, 1996, (3) requires the Company to maintain a ratio of consolidated income before interest and taxes to consolidated interest expense of 3.0 to 1.0, and (4) requires the Company to maintain total adjusted capital (within the meaning of Risk-Based Capital for Insurers Model Act ("Model Act")) of Vesta Fire to be equal to or greater than 150% of the applicable "Company Action Level RBC" (within the meaning of the model act).
Pro forma information regarding net income and earnings per share is required by FAS 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions for 1996 and 1997, respectively; risk-free interest rates of 6.37 percent and 5.75 percent; dividend yields of .37 and .27 percent; volatility factor of the expected market price of the Company's common stock of 34.0 and 38.75; and a weighted-average expected life of the options of ten years for both years.
The following summary sets forth activity under the Plan for the years ended December 31:
In 1993, the Company entered into restricted stock agreements under which Vesta granted 153,300 shares of common stock at $10.26 per share to officers of the Company in exchange for
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLAR AMOUNTS IN THOUSANDS) NOTE O--STOCK OPTIONS (CONTINUED)
In 1995, the Company entered into restricted stock agreements under which the Company granted 23,333 shares of restricted common stock to certain officers of the Company. The Company entered into restricted stock agreements under which the Company granted 23,144 and 20,915 shares of restricted common stock to certain employees of the Company and 5,664 and 9,632 shares of restricted common stock to certain directors of the Company in 1996 and 1997, respectively. The common stock with respect to all awards of restricted stock is being held by the Company until the restrictions lapse.
During 1996, the FASB issued Financial Accounting Statement No. 128, Earnings per Share, ("FAS128"). FAS128 specifies the computation, presentation and disclosure requirements for earnings per share, replacing the presentation of primary earnings per share with the presentation of basic earnings per share. For entities with complex capital structures, the presentation of fully diluted earnings per share is replaced with diluted earnings per share. FAS128 is effective for both interim and annual financial statements issued for periods ending after December 15, 1997, with earlier adoption prohibited. The Company adopted FAS128 on December 31, 1997, and, as required, all periods presented in the consolidated financial statements have been restated to reflect the adoption of the statement.
Presented below is a summary of the components used to calculate basic and diluted net income per share for the year ended December 31, 1997, 1996 and 1995: