(2) The Company intends to relocate the Cal Re Pasedena, California operations to New York prior to the September 1995 lease expiration.
(3) The Company relocated the operations of its subsidiary, Morgard, Inc., from Rosemont, Pennsylvania to New York at lease expiration.
The industry experienced an extended down cycle from 1979 to the end of 1984. Underwriting losses in that period grew significantly as a result of an increase in the frequency and severity of reported losses. The industry was affected by expanding theories of tort and insurance liability and by growing exposure to long-tail risks, including asbestos and pollution claims, which were not adequately taken into account in the pricing, terms and conditions of insurance and reinsurance contracts being written during that period. At the same time, premium rates declined as interest rates increased and insurers and reinsurers sought premium income to invest at these higher rates. These conditions led to a decline in the surplus of reinsurers and the insolvency or voluntary withdrawal from the market of a number of insurance and reinsurance companies.
Beginning in mid-1987, the insurance and reinsurance industry experienced increased competition and reduced premium rates. In addition, ceding companies increased their retentions, resulting in
less available business to be reinsured, increased competition and lower premium rates in the reinsurance industry. This competitive environment, which has continued into 1995, has seen little improvement in rates compared with recent years, with the exception of rates for certain property reinsurance coverages.
Property catastrophe losses in 1989 caused a reduction in London market reinsurance and retrocessional capacity for property reinsurers at the end of 1990, and a consequent increase in certain property reinsurance rates in 1991. Record insured catastrophe losses in 1992, which approximated $23 billion including those caused by Hurricanes Andrew and Iniki and the Los Angeles riots, led to increases in property catastrophe reinsurance rates, as well as improved rates, terms and conditions on certain other property coverages. These record losses in 1992 also caused a further shortage of catastrophe retrocessional capacity and led to an influx of new capital to reinsurers primarily providing catastrophe coverage. Approximately $5 billion of capital was raised by these companies, the majority of which are located in Bermuda. However, the demand for catastrophe protection has continued and conditions have remained at favorable levels for reinsurers as the occurrences of catastrophe losses has continued subsequent to the record 1992 year. Following a 1993 year that produced $5.7 billion of catastrophe losses, the estimated 1994 level of $15 billion has made the past 12 months the second most costly period for catastrophes in the history of the U.S. insurance industry. Of this total, $10.4 billion was produced by the earthquake in California ("Northridge earthquake") a loss that has been exceeded in magnitude only by Hurricane Andrew in 1992.
The Company believes that the reinsurance industry currently is experiencing a consolidation in which larger reinsurers will write a greater proportion of total industry premiums, as ceding companies and intermediaries place increasing importance on size and financial strength in the selection of reinsurers. The aggregate statutory surplus of the Company's operating subsidiaries was $243.4 million as of December 31, 1994, ranking the Company's combined reinsurance operations as the 17th largest based on the statutory surplus of reinsurers reporting to the Reinsurance Association of America (RAA) as of December 31, 1994.
During the first quarter of 1994, the Company merged its two principal operating subsidiaries, SCOR Reinsurance Company and General Security Assurance Corporation of New York, to form a single operating entity for the Company's assumed reinsurance business. The Company also intends to merge two of its other operating subsidiaries, The Unity Fire and General Insurance Company and General Security Insurance Company, subject to approval by such companies' Boards of Directors and state regulatory authorities, to form a single broadly
The underwriting results of a property and casualty insurer or reinsurer are discussed frequently by reference to its loss ratio, underwriting expense ratio and combined ratio. The loss ratio is the result of dividing losses and loss expenses incurred by net premiums earned. The underwriting expense ratio is the result of dividing underwriting expenses by net premiums written for purposes of Statutory Accounting Practices ("SAP") and net premiums earned for purposes of Generally Accepted Accounting Principles ("GAAP"). The combined ratio is the sum of the loss ratio and the underwriting expense ratio. A combined ratio under 100% generally indicates underwriting profits and a combined ratio exceeding 100% generally indicates underwriting losses. Underwriting profit is only one element of overall profitability, which also includes investment results, interest expense and the effects of income taxation. Accordingly, the combined ratio alone should not be used to measure overall profitability. Except as indicated, the ratios discussed below have been calculated on a GAAP basis.
The following table sets forth the Company's GAAP combined ratios and the components thereof for the periods indicated, and the SAP combined ratio for the Company's insurance and reinsurance subsidiaries and for the reinsurance industry based on statistics distributed by the RAA. The GAAP ratios include the operating expenses of the holding company and the operations of the non insurance subsidiaries, in addition to the operating expenses of the insurance and reinsurance subsidiaries. The SAP expense ratios include only the operating expenses of the insurance and reinsurance subsidiaries. In addition, the GAAP loss ratio takes into consideration the recoveries under certain retrocessional agreements with SCOR S.A., whereas these recoveries are included in other income for SAP purposes. A reconciliation between the Company's GAAP consolidated net income and statutory net income of the insurance and reinsurance subsidiaries is included in Note 11 to the Company's Consolidated Financial Statements.
Year Ended December 31, 1994 1993 1992 GAAP RATIOS (Total Company) Loss ratio 83.8% 66.2% 83.6% Commission ratio 26.0 26.0 29.1 U/W, admin. and other expense ratio 13.2 12.9 14.7 Expense ratio 39.2 38.9 43.8 Combined ratio 123.0% 105.1% 127.4%
During 1994 the Company repurchased in the open market $3.9 million in principal amount of the Debentures and recognized an extraordinary gain of $351,000, or $0.02 per share, net of tax.
Net losses and loss expenses incurred decreased 3% in 1993 to $156.3 million from $160.5 million in 1992. The loss ratio was 66.2% for 1993 as compared with 83.6% for 1992. During 1993 the Company incurred $13.7 million of net losses ($19.1 million of gross losses) resulting from property catastrophe events, primarily the World Trade Center bombing, the East Coast blizzard, the Midwest floods and the California fires, which adversely affected the loss ratio by 5.8 points. During 1992 the Company incurred $50.9 million of net losses ($162.6 million of gross losses) resulting from property catastrophe events, primarily Hurricanes Andrew and Iniki and the Los Angeles riots, which added 28.4 points to the loss ratio. Of these amounts, Hurricane Andrew accounted for $37.9 million of net incurred losses and $137.1 million of gross incurred losses.
During 1993 and 1992, the Company ceded $88.9 million and $90.8 million of earned premiums, respectively. The Company recovered from retrocessionnaires $57.3 million and $177.1 million of losses during 1993 and 1992, respectively. Ceded premiums in 1992 included $12.1 million of reinstatement premiums paid by the Company. Ceded losses in 1992 included $111.7 million of losses resulting from property catastrophe events.
with 14.7% for 1992. The effect of net reinstatement premiums related to Hurricane Andrew added 0.5 points to the 1992 ratio. The increase in underwriting, administration and other expenses in 1993 was principally related to compensation expenses, the majority of which was an increase in costs associated with the Company's retirement plans. In addition, as discussed in Note 3 to the Company's Consolidated Financial Statements, the Company has made various acquisitions. The pre-tax effect on operations from recent acquisitions, including the amortization of goodwill and acquired licenses, was a charge of $2.6 million in 1993 compared with a charge of $1.8 million in 1992. The operations of the acquired companies are not expected to have a material effect on the Company's liquidity or results of operations.
Interest expense increased 75% to $8.0 million in 1993 from $4.6 million in 1992. The increase was due to $3.5 million of interest expense recognized on the Debentures.
As a result of the Company's implementation, as of January 1, 1993, of EITF 93-6, $2.6 million (after an income tax benefit of $1.4 million), or $0.14 per share, is included as a reduction to 1993 income for the cumulative effect of this accounting change.
December 31, 1994, 1993 and 1992, respectively. Although the Company's income from operations before Federal income taxes and cumulative effect of accounting changes was $630,000 for 1992, a net operating loss for tax purposes resulted after the elimination of tax- exempt investment income. A reconciliation between income taxes computed at the statutory rate and SCOR U.S.'s provisions for income taxes for the years ended December 31, 1994, 1993 and 1992, is included in Note 9 to SCOR U.S.'s Consolidated Financial Statements.
The Omnibus Budget Reconciliation Act of 1993 (the "Act") was signed into law in August 1993. The Act provided for an increase in the corporate tax rate to 35% from the previous 34% rate. As a result of the revaluation of the Company's net deferred tax assets to reflect the change in tax rates, the Company recognized a net benefit of $472,000, or $.03 per share, in 1993. This benefit is included in the provision for Federal income taxes attributable to income from operations. In addition, as a result of the new tax rate, it is likely that the Company will pay taxes at a higher effective rate in future years to the extent that the Company generates taxable earnings.
GAAP requires the establishment of a valuation allowance for deferred income tax benefits where it is more likely than not that some portion of the deferred income tax benefits will not be realized. Management believes, based on the Company's historical record of generating taxable income and its expectations of future earnings, that the Company's taxable income in future years will be sufficient to realize the net deferred income tax benefits reflected on its consolidated balance sheet as of December 31, 1994. In addition, management believes certain tax planning strategies exist, including its ability to alter the mix of its investment portfolio to taxable investments from tax-exempt investments, which could be implemented if necessary to ensure sufficient taxable income to realize fully its net deferred income tax benefits. Management also believes that the Company's net deferred income tax benefits related to unrealized depreciation of fixed maturity investments is recoverable through its ability to hold these investments to maturity. Accordingly, SCOR U.S. has not established a valuation allowance with respect to its net deferred income tax benefits.
The Company's commercial paper bears interest at short-term rates in effect at each respective issuance date. To the extent interest rates increased during 1994, interest expense has been affected adversely. In addition, prices of fixed maturity investments generally decline as market interest rates increase. Accordingly, the fair value of the Company's fixed maturity portfolio holdings has decreased during the recent period of increasing interest rates. SCOR U.S. also pursues an investment strategy that tends to mitigate interest rate risk by establishing a maturity distribution profile of fixed maturity investments sufficient to fund loss and loss expense obligations when they become due. In addition, management believes that SCOR U.S. and its operating companies pursue a conservative investment strategy which avoids significant exposure to credit risk.
On March 29, 1993, SCOR U.S. sold at par $86.25 million of 5.25% Convertible Subordinated Debentures due April 1, 2000 through a private offering. The Debentures are not redeemable by the Company prior to April 3, 1996 and are convertible into approximately 3.4 million shares of SCOR U.S. common stock at a conversion price of $25.375 per share. Expenses incurred in the offering of approximately $1.8 million were deferred and are being amortized over the life of the Debentures. The Company contributed $50 million of the net proceeds to SCOR Re.
On October 1, 1990 SCOR U.S. renewed a $20.0 million note which was payable on that date. The new note is due and payable on October 3, 1995 and bears interest at a fixed annual rate of 9.575%. The Company has entered into an interest rate swap agreement related to this note with a commercial bank. The swap agreement has a maturity date of October 1, 1995 and provides for the Company to make floating rate payments in exchange for fixed rate payments due on the loan. The floating rate, which resets every six months and is capped at 12.380%, was 11.068% as of December 31, 1994. The Company most likely will refinance this debt when due and is currently exploring various options.
SCOR U.S. has established a commercial paper program which allows it to raise up to $50.0 million. At December 31, 1994, $11.3 million of commercial paper was outstanding.
SCOR U.S. has a $30.0 million revolving line of credit with a bank which serves as a backstop for its commercial paper program. No borrowings have been made under this facility.
The primary sources of liquidity for the SCOR U.S. insurance and reinsurance subsidiaries are net cash flow from operating activities, the maturity or sale of investments, and capital contributions from SCOR U.S. Net cash provided by operating activities was $1.3 million for 1994 compared with $27.8 million for 1993. Cash flow from operating activities during 1994 was adversely affected by continued property catastrophe paid loss activity as well as the payment of several large previously reserved casualty claims. The Company has not suffered any adverse effect in the timing of recoveries or credit worthiness of retrocessionnaires due to the recent catastrophe activity . Loss payments associated with the recent catastrophe activity are not expected to have an adverse material effect on the Company's short-term or long-term liquidity.
Effective January 1, 1991, SCOR Re and certain of the Company's other operating subsidiaries operate under a reinsurance pooling agreement pursuant to which the net amounts under all new and renewal business written by each such company are pooled. The net balances of the pool are then distributed to each company in accordance with established proportions.
anticipated loss and loss expense obligations as they become due. The Company's long-term obligations primarily consist of the Debentures and the claims liabilities of its principal operating subsidiaries, which at December 31, 1994 averaged approximately 4.5 years.
The Company may be subject to gains and losses resulting from currency fluctuations because some of its investments are denominated in currencies other than United States dollars, as are some of its net loss reserve liabilities. The Company makes investments denominated in foreign currencies to mitigate, in part, the effects of currency fluctuations on its results of operations. Investments denominated in foreign currencies do not constitute a material portion of the Company's investment portfolio and, in the opinion of management, are sufficient to meet its foreign currency obligations. Net gains (losses) resulting from foreign currency transactions during 1994, 1993 and 1992 were ($156,000), ($929,000) and $555,000, respectively.
Stockholders' equity at December 31, 1994 was $239.4 million, a decrease of $51.3 million from December 31, 1993. This decrease resulted primarily from the net loss of $7.8 million for the year, unrealized depreciation of investments carried at fair value, net of tax effect, of $38.3 million and by cash dividends declared of $6.5 million.
The NAIC is currently developing an Investments of Insurers Model Act, which, if adopted by the individual states, would establish uniform limitations upon the type and amounts of investments insurers may hold. Based upon the current proposals of this Model Act, which are subject to review and change, the Company does not believe a uniform standard would significantly affect the current investment mix or operations of its insurance and reinsurance subsidiaries.
In the first quarter of 1993, the Company adopted Statement of Financial Accounting Standards No. 113 "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts" ("SFAS 113"). The adoption of SFAS 113 did not have a material effect on the Company's financial position or its results from operations.
In the first quarter of 1992, the Company adopted Statement of Financial Accounting Standards No. 109 "Accounting for Income Taxes" ("SFAS 109"), which changed the method of accounting for income taxes. As a result of adopting SFAS 109, the Company recognized a cumulative benefit of the change in accounting principle of $2.4 million, or $0.13 a share, as of January 1, 1992.
The FASB has issued Statement of Financial Accounting Standards No. 112, "Employers' Accounting for Post Employment Benefits" ("SFAS 112"), which is effective for 1994 financial statements. SFAS 112 establishes accounting standards for employers who provide benefits for former or inactive employees after employment but before retirement. SCOR U.S. provides no such applicable post retirement benefits and therefore is not affected by SFAS 112.