formed company, Fremont General Credit Corporation ("FGCC"). At December 31, 1996, FGCC had assets of approximately $2 billion, and reported pre-tax income of $36.6 million.
Workers' compensation insurance operations posted income before taxes of $120.1 million for 1996, as compared to $85.0 million for 1995 and $62.2 million for 1994. The increase in income before taxes of 41% in 1996 as compared to 1995 is due predominately to lower claim frequency and the acquisition of Casualty, offset partially by lower income on the Company's California business. The 37% increase in income before taxes in 1995 as compared to 1994 is due primarily to the acquisition of Casualty, offset partially by lower income on the Company's California business. The combined ratio for 1996 was 94.4% compared to 100.4% and 97.6% for 1995 and 1994, respectively.
Also included within the property and casualty business segment are 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 Compensation Insurance Group, ("FCIG", formerly Fremont Insurance Group). Medical malpractice revenues were $31.6 million for 1996, as compared to $34.3 million and $33.0 million for 1995 and 1994, respectively. Income before taxes for the medical malpractice business was $3.8 million, $5.2 million and
$6.6 million for 1996, 1995 and 1994, respectively. The decrease in income before taxes in 1996 as compared to 1995 is due primarily to lower premiums earned. The decrease in income before taxes in 1995, as compared to 1994, is due primarily to an increase in the frequency and severity of reported claims. Expenses of FCIG include interest expense on debt and other obligations of $5.9 million, $6.7 million and $5.5 million, respectively, for 1996, 1995 and 1994, and overhead expenses of $0.7 million, $2.2 million and $3.1 million for the corresponding periods.
The financial services business segment posted increases of 2% and 28% in income before taxes for 1996 and 1995, respectively. Although income before taxes was relatively flat in 1996 as compared to 1995, the results in 1996 were negatively impacted by the establishment of a specific loan loss associated with one loan in the commercial finance loan portfolio. Also impacting the financial services segment in 1996 is the reduction in life insurance operations resulting from certain reinsurance and assumption agreements entered into between the Company and a reinsurer which became effective December 31, 1995 and January 1, 1996. These transactions essentially resulted in the sale of the life insurance operations. (See "Financial Services.") The increase in income before taxes of 28% in 1995 is consistent with the increase in financial services revenues and is due primarily to the significant growth in the average loan portfolio in 1995 to $1.5 billion from $1.1 billion in 1994. The average loan portfolio further grew to $1.6 billion in 1996. This segment, which consists principally of real estate lending, commercial finance and premium finance, recorded income before taxes of $36.6 million, $35.7 million and $28.0 million for 1996, 1995 and 1994, respectively.
consist primarily of loss and loss adjustment expenses, policy acquisition costs, other operating costs and expenses and, for the year ended December 31, 1994, dividends to policyholders.
Premiums. Premiums earned from the Company's workers' compensation insurance operations were $457.2 million for 1996, as compared to $575.0 million and $401.5 million for 1995 and 1994, respectively. Premiums were significantly lower in 1996 due primarily to lower premiums earned in California and to a lesser extent lower premiums earned in Illinois. Premiums were significantly higher in 1995 as compared to 1994, due primarily to the acquisition of Casualty, partially offset by lower premiums earned in California. For the year ended December 31, 1996, the Company's workers' compensation insurance premiums earned in its western region, consisting primarily of California, accounted for $171 million, or 37% of the Company's total workers' compensation insurance premiums earned for such period, representing decreases of $121 million and $230 million from west region premiums earned in 1995 and 1994, respectively. These decreases are 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. Additionally, an increase in 1995 in non-renewing policies also contributed to the lower premium volume in California. The increase in non-renewing policies occurs as a result of certain premium prices falling below required minimum pricing pursuant to the Company's underwriting standards. For the year ended December 31, 1996, the Company's workers' compensation insurance premiums earned in its mid-western region, consisting primarily of Illinois, accounted for $286 million, or 63% of the Company's total workers' compensation insurance premiums earned. Price competition in Illinois has impacted the Company's results of operations and will continue to affect such results, due in part to overall average decreases in advisory premium rates of 13.6% and 10.0% that became effective January 1, 1996 and 1997, respectively, and which workers' compensation insurance companies in Illinois tend to follow.
Net Investment Income. Net investment income within the property and casualty insurance operations was $111.6 million, $101.3 million and $62.2 million in 1996, 1995 and 1994, respectively. Significantly higher invested assets, due primarily to the acquisition of Casualty, resulted in increased investment income in 1996 and 1995 as compared to 1994. (See "Item 1. Business -- Investment Portfolio.")
Loss and Loss Adjustment Expense. Workers' compensation loss and loss adjustment expenses ("LAE") were $312.2 million, $436.7 million and $249.4 million in 1996, 1995 and 1994, respectively. In addition, the ratio of these losses and LAE to workers' compensation insurance premiums earned was 68.3%, 75.9% and 62.1% in 1996, 1995 and 1994, respectively. The decrease in the dollar amount of incurred loss and LAE in 1996 as compared to 1995 is due principally to lower claim frequency and severity in the Company's mid-west region and a lower level of incurred losses and LAE in the Company's west region resulting from lower insurance premiums earned on California policies which resulted from increased competition. (See "Premiums.") The increase in incurred loss and LAE in 1995 as compared to 1994 is due primarily to the acquisition of Casualty, partially offset by lower incurred loss and LAE in California. Additionally, the increase in the loss and LAE ratio in 1995 as compared to 1994 is partially due to lower premiums on California policies which resulted from increased competition in 1995. The decrease in California premiums was greater than the decrease in California incurred loss and LAE, thereby resulting in a higher loss and LAE ratio. The negative impact on the Company's profitability resulting from the higher loss and LAE ratio has been mitigated to an extent by the elimination of dividends accrued on California workers' compensation business beginning in 1995. The dividend elimination occurred as substantially all of the workers' compensation policies written beginning in 1995 were non-participating. This type of policy is not eligible for dividend consideration. (See "Dividends to Policyholders" and "Item 1. Business -- Insurance Operations -- Loss and Loss Adjustment Expense Reserves.")
Subsequent actual experience has resulted and could result in loss reserves being too high or too low. Future loss development could require reserves for prior periods to be increased, which would adversely impact earnings in future periods.
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 25.9%, 24.5% and 23.4% in 1996, 1995 and 1994, respectively. The increase in this ratio in 1996, as compared to 1995, was due primarily to higher operating costs and expenses, partially offset by lower agents' commission costs. The increase in this ratio in 1995, as compared to 1994, was due primarily to higher agents' commission costs.
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.") Also, the establishment of appropriate reserves necessarily involves estimates, and reserve adjustments have caused significant fluctuations in operating results from year to year.
Income before taxes in the financial services operations was $36.6 million, $35.7 million and $28.0 million for 1996, 1995 and 1994, respectively. Income before taxes was relatively flat in the financial services segment for 1996 as compared to 1995. The Company realized higher income before taxes in the real estate lending operation as lower loan loss experience resulted in a lower provision for loan losses. This was offset substantially by lower income in the commercial finance operation due primarily to a specific loan loss associated with one loan in the commercial finance loan portfolio. Additionally, lower income was earned in the life insurance operation due to certain reinsurance agreements which became effective on December 31, 1995 and January 1, 1996 and which resulted in a substantial reduction in the Company's life insurance operations in 1996. The 28% increase in income before taxes in 1995 as compared to 1994 is due primarily to the significant growth in the average loan portfolios, offset partially by increases in the provision for loan losses and other expenses. (See "Item 1. Business -- Financial Services Operations.")
The margin between the Company's interest income and cost of funds decreased in 1996 as compared to 1995, due primarily to an increase in lower yielding cash equivalents in the real estate lending operation and a decrease in net margins in the commercial finance operation resulting from an increase in the credit quality of the commercial loan portfolio, as well as to increased competition. These conditions affecting the commercial finance operation also existed in 1995 which resulted in net yields decreasing in 1995 as compared to 1994. Additionally, net yields decreased in 1995 due to changes in the mix of loans in the real estate lending operation. The change in portfolio mix occurred under a corporate strategy which began in 1993, to shift away from high rate, high risk loans secured by personal property or junior liens on real estate, to lower yielding commercial and residential first trust deed real estate loans. The lower yields on the commercial and residential real estate portfolios are compensated for by the improved underlying collateral and by the improved lien position on the collateral.
degree earnings will be sensitive to interest rate changes. The Company attempts to match interest rate sensitive assets and liabilities to minimize the effect of fluctuations in interest rates.
Non-performing assets decreased to $31.2 million at December 31, 1996 from $41.4 million at December 31, 1995. This decrease is due primarily to decreases in non-accrual loans in the real estate lending and commercial finance operations, offset partially by an increase in REO in the real estate lending operation. The decrease in non-accrual loans in the commercial finance lending operation is primarily due to one loan in the commercial finance portfolio classified as non-accrual at December 31, 1995 and subsequently charged-off
in 1996. Non-performing assets remained relatively stable at December 31, 1995 as compared to December 31, 1994.
The higher provision for loan losses in 1995 as compared to 1994 is consistent with the significant overall growth in the average total loans receivable. Charge-offs in 1995 as compared to 1994 decreased in the commercial finance operation and remained relatively stable in the real estate lending operation.
The property and casualty insurance operations must have cash and liquid assets available to meet their obligations to policyholders in accordance with contractual obligations, in addition to having the funds available to meet ordinary operating costs. These operations have several sources of funds to meet their obligations, including cash flow from operations, recoveries from reinsurance contracts and investment securities. By statute, the majority of the cash from these operations is required to be invested in investment grade securities to provide protection for policyholders. The Company invests in fixed income and preferred equity securities with an objective of providing a reasonable return while limiting credit and liquidity risk. The Company's investment portfolio had an unrealized gain of $4.0 million and $33.2 million at December 31, 1996 and 1995, respectively.
To facilitate general corporate operations, in August 1994 the Company obtained a revolving line of credit with a syndicated bank group that permitted borrowings of up to $150 million. In August 1995, the Company negotiated an increase of this line to $200 million, of which $10 million was outstanding as of December 31, 1996. In August 1997, this credit line converts to a term loan of up to $100 million, with scheduled semi-annual payments through August 2001. In addition, in July 1994 the Company replaced its internally financed loan to its Employee Stock Ownership Plan ("ESOP") with an external bank-financed loan totaling $11 million. The maximum principal amount of this loan was increased to $15 million in August 1995. The loan is due in seven equal annual installments that commenced on April 1, 1996 and is secured by certain shares held by the ESOP. The balance outstanding at December 31, 1996 was $11.7 million. The interest and principal payments are guaranteed by the Company. Interest is based on, at the Company's option, the bank's prime lending rate, LIBOR plus 1% or an applicable certificate deposit rate. The average rate at December 31, 1996 was 6.51%.
Net cash provided by (used in) operating activities of continuing operations was $(96.0) million, $39.5 million and $68.0 million for the years ended December 31, 1996, 1995 and 1994, respectively. Net cash
provided by (used in) operating activities decreased in 1996 as compared to 1995 due primarily to a decrease in claims and policy liabilities, a lower amortization of policy acquisition costs, higher discount amortization on fixed maturity investments, and a decrease in other liabilities due primarily to the settlement of accrued operating costs. These conditions were partially offset by higher net income, lower policy acquisition costs deferred, higher depreciation and amortization, and an increase in the change in accrued investment income. The decrease in claims and policy liabilities, the lower amortization of policy acquisition costs, and the lower policy acquisition costs deferred resulted primarily from lower premium volume in the Company's workers' compensation insurance business. The higher discount amortization on fixed maturity investments is due mainly to an acceleration of discount amortization on certain mortgage-backed securities during 1996. The higher depreciation and amortization in 1996 is due primarily to amortization on certain deferred stock-based compensation programs awarded in 1996. (See Note L of Notes to Consolidated Financial Statements.) The significant increase in the change in accrued investment income in 1996 as compared to 1995 is due primarily to the 1995 acquisition of Casualty which resulted in a significant increase in the accrual of investment income for 1995 and thereby negatively impacted net cash provided by operating activities in 1995. Net cash provided by (used in) operating activities decreased in 1995 over 1994 due primarily to the following items: (i) a smaller net decrease in agents' balances and reinsurance recoverables; (ii) the previously mentioned increase in accrued investment income; (iii) a greater decrease in claims and policy liabilities; (iv) and higher policy acquisition costs deferred, net of amortization. These conditions were partially offset by higher net income, a net increase in other liabilities, net of other assets and a significant increase in the provision for deferred income taxes. The decreases in agents' balances and claims and policy liabilities are primarily due to lower premium volume in the Company's California workers' compensation insurance business. Higher policy acquisition costs deferred are due primarily to increases in annuity contract receipts in the Company's life insurance operation. (See Note F of Notes to Consolidated Financial Statements.) The net increase in other liabilities, net of other assets, is due primarily to increased accruals for other operating costs.
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 adopted FASB 121 in the first quarter of 1996 and the effect of adoption was not material.
recorded earnings per share amounts will be required to be restated to conform to the new standard. The Company has not determined the earnings per share impact of adopting the new standard.
The Company's Consolidated Financial Statements, including supplementary data, are set forth in the "Index" on page 43 hereof.