GEICO also maintains and continually upgrades sophisticated electronic data processing equipment and software and telecommunications facilities to enable it to process applications and claims efficiently. PAGE
Omitted in reliance on General Instruction J(2)(a) to Form 10-K; replaced by management's narrative analysis of the results of operations.
Effective January 2, 1996, the Corporation completed a merger with Berkshire Hathaway Inc. (Berkshire) and became a wholly-owned indirect subsidiary of Berkshire. The merger was approved by the Maryland Insurance Administration and the New York Insurance Department and by the Shareholders of the Corporation at a Special Meeting held on December 20, 1995. Berkshire, which owned approximately 51% of the outstanding voting Common Stock of the Corporation before the merger, paid all remaining holders of the Corporation's Common Stock $70 per share in cash in a taxable transaction. Pursuant to the Merger Agreement, the Corporation's Treasury Stock was retired, participants of the Stock Option Plans were entitled to receive the excess of $70 over the per share exercise price for each option held, and the Employee Stock
On April 4, 1995 GEICO announced an agreement with Aetna Life and Casualty (Aetna) to phase out of GEICO's homeowners business over the next three years. On July 24, 1995 GEICO began offering new homeowner customers Aetna policies. The great majority of GEICO's existing homeowner customers will be offered renewal policies in Aetna as their policies begin to expire after January 1, 1996. GEICO will act as the servicing agent for these policies. The agreement with Aetna had little impact on 1995 financial results. Homeowners policy counts declined 9.5% in 1995 reflecting reductions in new business and a reunderwriting and inspection program for properties in coastal areas exposed to catastrophic losses. Homeowner rates increased 2.3% in 1995 as the Company has tried to more accurately reflect catastrophe loss exposure in its rates.
Life insurance premiums from the sale of structured settlement annuities with life contingencies by Criterion Life were $2.4 million in 1995 compared to $2.9 million in 1994. Structured settlement sales without life contingencies, which are accounted for as investment contracts, totaled $14.7 million in 1995 and $16.2 million in 1994.
Interest on Loans Receivable -- Interest on loans receivable decreased 64.2% in 1995 to $3.7 million as Government Employees Financial Corporation (GEFCO), our finance subsidiary, continues to reduce its loans receivable. In April 1995, GEFCO sold $38 million of its remaining receivables and other assets and used the proceeds to reduce its short-term debt.
Other Revenue -- Other revenue was $14.9 million in 1995 compared to $14.7 million in 1994. Other revenue consists primarily of oil and gas revenue, commissions, and motor club dues.
Losses and loss adjustment expenses incurred increased 12.4% to $2,244.4 million in 1995. The statutory loss ratio for property and casualty insurance, which measures the portion of premiums earned paid or reserved for losses and related claims handling expenses, was 82.3% in 1995 compared to 82.1% a year ago.
Incurred losses from 1995 catastrophe events totaled approximately $51 million up from $31 million last year. Catastrophe losses added 1.9 points to the loss ratio in 1995 and 1.3 points in 1994.
Adjusting for the unusually severe winter weather during 1994's first quarter, auto claims frequency (that is, the number of claims in a given period relative to the car count) for property damage accidents was up 2 to 3% when compared with 1994, while bodily injury and uninsured motorists claim frequency was up about 2% for the year. The average auto claims severity (the average amount paid per claim) for all coverages was up approximately 4% over 1994, including about 7 to 8% for auto damage coverages and relatively flat bodily injury severity.
Other operating expenses were $244.1 million. Other operating expenses increased 5.2% in 1995 due in part to merger related expenses, primarily legal and consulting fees, of $5.6 million. Other operating expenses include $.6 million of incentive compensation expense in 1995 and $8.5 million in 1994 related to the overperformance of the Corporation's common stock portfolio compared to the S&P 500. Other operating expenses in 1994 also include $8.3 million to write down GEFCO's assets to estimated realizable values, and accrue expenses related to settlements and winding down GEFCO's operations.
The Corporation has not established a valuation allowance for its deferred tax assets because it believes it is "more likely than not" that all such amounts will be fully realized based upon the Corporation's past history of profitability and anticipated future earnings. The Corporation's level of taxable income during the last three years has resulted in cumulative current tax expense totaling approximately $242.3 million.
The Tax Reform Act of 1986 included provisions to increase significantly property and casualty insurance companies' current taxes payable by accelerating the reporting of taxable income and prorating investment income to tax indirectly 15% of the tax-exempt interest and the amount of dividends received deduction on securities purchased after August 7, 1986. The provisions, which accelerate taxable income, include discounting reserves for tax purposes, disallowing 20% of the increase in unearned premiums as a tax deduction, and reporting 20% of the reserve for unearned premiums at December 31, 1986 as taxable income ratably over six years beginning in 1987. The increase in current taxes resulting from these temporary differences, whereby income is reported sooner for tax purposes than for financial statement purposes, is offset by a deferred tax benefit with no impact on the total tax provision for financial statement purposes. Current tax expense on net income was $75.7 million in 1995 and $58.1 million in 1994 reflecting these provisions.
In the first quarter of 1994 the Corporation adopted Statement of Position No. 93-6 "Employers' Accounting for Employee Stock Ownership Plans" which requires employers to recognize compensation cost based on the fair value of the ESOP shares as of the date the shares are committed to be released, beginning with shares acquired after December 31, 1992. This statement was adopted effective January 1, 1994 on a prospective basis. Accordingly, the Corporation's income statement will reflect a charge or benefit to earnings for the appreciation or depreciation on shares purchased by the ESOP after 1992 when such shares are released for allocation to participant accounts.
In the first quarter of 1994 the Corporation adopted Statement of Financial Accounting Standards No. 112 "Employers' Accounting for Postemployment Benefits." The cumulative effect of adopting this statement at January 1, 1994 was a charge of $1.1 million, net of tax, which was included in the statements of income as a change in accounting principle. This statement will not have a significant impact on future operating expenses.
Net income totaled $247.6 million ($3.66 per share) compared to $207.8 million ($2.97 per share) in 1994. The cumulative effect of changes in accounting principles reduced net income per share by $.01 in 1994. The weighted average shares outstanding were 67,593,419 in 1995 compared to 69,992,442 in 1994.
The common stock portfolio, adjusted for purchases and sales, had a total aftertax gain (including unrealized gains and losses) of 24.9% in 1995 compared to 9.1% in 1994.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of GEICO Corporation and subsidiaries as of December 31, 1995 and 1994, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.
As discussed in Note A to the consolidated financial statements, the Corporation changed its methods of accounting for postemployment benefits in 1994 and for income taxes, postretirement benefits other than pensions, and investments in debt securities in 1993 to conform with recent pronouncements of the Financial Accounting Standards Board.
Employee Treasury Stock Total Stock, Ownership Shareholders' at Cost Plan Equity
GEICO Corporation (the Corporation) is principally an insurance organization whose subsidiaries include personal lines property and casualty insurers described in Note C. The Corporation provides private passenger automobile insurance to preferred-risk drivers through direct response methods and also offers standard and nonstandard risk automobile insurance. Approximately 70% of the Corporation's customers are located in California, Connecticut, Florida, Georgia, Maryland, New York, Texas and Virginia. The Corporation is vulnerable to catastrophe losses from hurricanes in these coastal states as well as natural disasters in other regions.
The consolidated financial statements include the accounts of the Corporation and its subsidiaries. Significant intercompany accounts and transactions have been eliminated.
The financial statements are presented in conformity with generally accepted accounting principles (GAAP). These principles differ from statutory accounting practices for the insurance subsidiaries. See Note D regarding statutory amounts of net income, shareholder's equity and limitations on dividends.
Property and casualty loss reserves are based on averages for automobile claims reported within the most recent three months, case-basis estimates for other reported claims and calculated estimates of unreported losses. The reserve for losses further includes additional amounts to reflect anticipated future economic and social conditions. The determination of these additional amounts includes consideration of studies of reserve levels performed by independent consulting actuaries. The reserve for losses has been reduced for anticipated salvage and subrogation recoveries. Loss adjustment expense reserves are based upon estimates of expenses to be incurred in the settlement of claims.
Management believes that its aggregate reserves for loss and loss adjustment expenses at December 31, 1995 are reasonable and adequate to cover the ultimate cost of losses on reported and unreported claims arising from accidents which had occurred by that date, but such reserves are necessarily based on estimates and the ultimate cost may vary from such estimates. As adjustments to these estimates become necessary, such adjustments are reflected in current operations. The methods used to develop these reserves are subject to continuing review and refinement.
Effective January 1, 1993, the Corporation adopted Statement of Financial Accounting Standards No. 106 "Employers' Accounting for Postretirement Benefits Other Than Pensions" which required employers to accrue postretirement benefits, such as health care and life insurance plans for retirees, over the period the employee works to earn the benefit rather than using a pay-as-you-go cash basis. The cumulative effect of adopting this statement was a charge of $3.9 million, net of tax, which is included in the consolidated statements of income as a change in accounting principle.
Effective January 2, 1996, the Corporation completed a merger with Berkshire Hathaway Inc. (Berkshire) and became a wholly-owned indirect subsidiary of Berkshire. The merger was approved by the Maryland Insurance Administration and the New York Insurance Department and by the Shareholders of the Corporation at a Special Meeting held on December 20, 1995. Berkshire, which owned approximately 51% of the outstanding voting Common Stock of the Corporation before the merger, paid all remaining holders of the Corporation's Common Stock $70 per share in cash in a taxable transaction. Pursuant to the Merger Agreement, the Corporation's Treasury Stock was retired, participants of the Stock Option Plans were entitled to receive the excess of $70 over the per share exercise price for each option held, and the Employee Stock Ownership Plan was terminated. These transactions will be recorded immediately prior to the merger in 1996. Merger related expenses, primarily legal and consulting fees, have been expensed in 1995 as incurred.
Resolute Group, Inc., a reinsurance subsidiary, stopped accepting new business in late 1987. Summary financial data are as follows:
GEFCO, a consumer finance subsidiary, is in the process of winding down its business. A substantial portion of its remaining loans receivable were sold in 1995. Summary financial data are as follows:
The Corporation's subsidiaries prepare their statutory financial statements in accordance with accounting principles and practices prescribed by regulatory authorities.
Realized gains on investments in subsidiaries and affiliates include a $23.5 million realized gain in 1993 on the sale of shares of AVEMCO Corporation, previously a 34% owned general aviation insurance company which was accounted for using the equity method.
Effective December 31, 1993 investments in fixed maturities are classified as available for sale and reported at market value. The unrealized appreciation on fixed maturities of $125.9 million at December 31, 1993 was reflected directly in shareholders' equity in 1993.
The consolidated unrealized appreciation on investments in equity securities at December 31, 1995, before deferred tax effects, consisted of gross gains of $489.5 million and gross losses of $11.9 million.
The market value and amortized cost of investments in fixed maturities at December 31, 1995 are shown below by their scheduled maturity dates. Asset-backed securities, consisting of mortgage-backed obligations of U.S. government corporations and agencies and corporate obligations collateralized by mortgage and other financial instruments, are included based on their estimated average remaining lives.
Loans receivable, which is net of valuation allowances, is comprised primarily of GEFCO's collateral loans, with maximum terms of 180 months. GEFCO has established valuation allowances to reflect amounts that might reasonably be expected to be realized upon the disposition of its loans receivable and remaining assets, either through sale or otherwise. At December 31, 1995, the loans were primarily collateralized by commercial real estate, and the accrual of interest income was suspended on $3.5 million of loans. During the years ended December 31, 1995 and 1994, principal cash collections on loans receivable, including amounts from sales of loans, were approximately $54.5 million and $32.7 million, respectively.
On November 8, 1988, California voters passed Proposition 103, which called for significant rate reductions and certain changes in the state's insurance laws. In May 1993, the Corporation's insurance subsidiaries affected by Proposition 103 entered into an agreement with the California Insurance Department as to their California insurance premium refund obligations. These companies agreed to pay an aggregate of $21 million to policyholders affected and these payments fully discharged and extinguished all obligations to roll back rates, make refunds or pay interest. Additionally, the rates and rate levels in use since November 8, 1988 were deemed approved. During 1989 and 1990 the Companies had accrued $14.3 million and $13.4 million, respectively, for potential premium refunds. As a result of the settlement, premium refunds of $21.0 million were paid, resulting in a $6.7 million pretax increase in operating earnings in 1993.
The Corporation has a credit agreement expiring July 1997 under which the Corporation, GEICO or GEFCO can borrow up to $150 million with total borrowings not to exceed $150 million. Amounts borrowed by GEICO and GEFCO are guaranteed by GEICO Corporation. GEFCO had borrowed $11.1 and $51 million under this agreement at December 31, 1995 and 1994, respectively. The agreement provides several options for interest and repayment terms and a facility fee of 12.50 basis points per annum.
Corporate and other interest expense in the consolidated statements of income has been reduced by $.2 million and $1.4 million in 1994 and 1993, respectively, representing interest that was capitalized as part of the cost to construct a new regional office building, which was completed in 1994.
The Corporation purchased 1,203,002; 2,745,934 and 453,854 shares of Common Stock in 1995, 1994 and 1993, respectively, for an aggregate cost of $61.9 million, $137.4 million and $26.1 million. The Corporation reissued 331,022; 132,436 and 63,997 shares of Common Stock for $16.6 million, $7.1 million and $4.0 million in 1995, 1994 and 1993, respectively.
The computation of earnings per share is based on the weighted average number of common shares assumed outstanding of 67,593,419 in 1995, 69,992,442 in 1994 and 71,417,006 in 1993.
The projected benefit obligation was determined using an assumed discount rate of 7.0% and 8.5%, an assumed long-term rate of return on plan assets of 8.5% and 8.5% and assumed average annual salary increases of 5.5% and 6.25% in 1995 and 1994, respectively.
Substantially all employees of the Corporation and its subsidiaries were covered under the GEICO Companies Employee Stock Ownership Plan (ESOP). The ESOP borrowed money and used the proceeds to purchase shares of the Corporation's Common Stock. The Corporation guaranteed the loans and made annual contributions sufficient to enable the ESOP to pay principal and interest to the extent it was not paid by dividends on the shares purchased with the debt proceeds. Shares were released based on the proportion of debt service paid in the year. The obligations of the Trust, $63.9 million and $50.0 million at December 31, 1995 and 1994, were included in the Corporation's long-term debt. An amount, representing the obligations of the Trust which has not yet been charged to compensation expense, was deducted from shareholders' equity. Additional accrued compensation in excess of the current year debt service was recorded as an expense based on the number of shares released to participants' accounts.
In 1996, pursuant to the merger with Berkshire, all remaining outstanding ESOP bank loans were paid in full from unallocated ESOP assets. The remaining unallocated ESOP assets were allocated among ESOP participants. The interests of all ESOP participants were vested and distributed, and the ESOP was terminated. As a result, a charge of $8.8 million will be made immediately prior to the merger in 1996 representing primarily the excess of the value of the unallocated new shares over the related debt.
The Corporation has a profit sharing plan covering substantially all employees. Employer contributions of a discretionary amount are declared by the Board of Directors based on profits. Employer contributions of $8.8 million, $8.6 million and $6.4 million were charged to expense in 1995, 1994 and 1993, respectively.
The Corporation provides certain health and life insurance benefits for eligible retirees. The health benefits continue through age 65.
The accumulated postretirement benefits obligation at December 31, 1995 was determined using an assumed discount rate of 7.0% and an assumed health care cost trend rate of 8.5% in 1996 decreasing to 5.5% in 2001 and thereafter. The accumulated postretirement benefits obligation at December 31, 1994 was determined using an assumed discount rate of 8.5% and an assumed health care cost trend rate of 12.5% in 1994 decreasing to 6.0% in 2001 and thereafter. An increase of 1 percent in the assumed health care cost trend rate in each year would increase the December 31, 1995 accumulated postretirement benefits obligation by approximately $.9 million and would increase the 1995 net periodic postretirement benefits cost by approximately $.1 million.
The Corporation and its subsidiaries have entered into noncancellable leases expiring at various dates through 2000 for both real estate and equipment, all of which are operating leases. The future minimum rental commitments as of December 31, 1995 for noncancellable leases with a remaining term of at least one year are $3.2 million, $2.8 million, $2.1 million, $.6 million and $.3 million for the years 1996 through 2000, respectively.
In the ordinary course of its insurance operations, the Corporation is affected by various regulatory, legislative and judicial actions. In the opinion of management, loss to the Corporation materially in excess of amounts provided for in the financial statements as a result of any such actions is not probable.