The Company's executive office is located at 600 Fifth Avenue, New York, New York. Other executive offices and the home office of the wholly-owned insurance operations of the Company is located in Farmington, Connecticut. The Company's New York executive office facilities consist of approximately 12,000 square feet and are leased at an average annual rental, over ten years,
of $465,000. The Farmington office consists of approximately 140,000 square feet and is leased at an annual rental of $4,310,000. DPIC owns its office building, which consists of approximately 42,000 square feet, in Monterey, California. The Guaranty National Companies owns facilities in Englewood, Colorado; Madison, Wisconsin; Salem, Oregon; and Freeport, Illinois. Those facilities consist, in the aggregate, of approximately 272,000 square feet.
The Company believes that its current facilities are suitable and adequate for their present use and anticipated requirements.
On July 2, 1996, the Company completed a tender offer for 4,600,000 shares of Guaranty National common stock. Together with the open-market purchase of 120,000 additional shares on July 17, 1996, the Company has increased its ownership of Guaranty National from 49.5% to 81.0%. The aggregate purchase price, including expenses, of approximately $88,206,000 was paid in cash. The Company increased its investment in Guaranty National as management believes it will provide a favorable investment return. The Company's increased ownership percentage allows the Company's management to become more involved in setting the strategic direction of Guaranty National. It will also allow the inclusion of Guaranty National in Orion's consolidated federal income tax return.
On June 30, 1995, Orion purchased all of the capital stock of McGee for $22,000,000 in cash. McGee specializes in underwriting ocean marine, inland marine and property insurance through an underwriting pool in the United States and one in Canada. The business is written by McGee on behalf of the insurance companies that comprise the pools. Orion's subsidiary, Security Insurance Company of Hartford, which has been a pool member for over 100 years, is a member of both the United States and Canadian pools. The Company's participation in the United States pool was 7%, 14.5% and 37% in 1994, 1995 and 1996, respectively. Participation in the Canadian pool was 10% in 1994, 15% in 1995 and approximately 49% in 1996. The Company has agreed to increase its rate of participation for 1997 to 52% in the United States and 60.5% in Canada.
Net premiums written increased 76.1% ($576,685,000) to $1,334,121,000 in 1996 from $757,436,000 in 1995 and 6.4% ($45,381,000) in 1995 from $712,055,000 in 1994. The consolidation of Guaranty National increased the Company's 1996 net premiums written by $491,232,000. The results by segment are as follows:
- Regional Operations' net premiums written increased 6.1% ($20,443,000) to $353,041,000 in 1996 from $332,598,000 in 1995 and 18.9% ($52,860,000) in 1995 from $279,738,000 in 1994. The premiums written increases were primarily attributable to EBI's program of selective geographic expansion and penetration, which included the opening of 18 branch offices in 1995 and 1996. The offices were opened in territories where the Company believes it will benefit from its service oriented approach. The increases were partially offset by the impact of legislative reforms in certain states which have led to an increasingly competitive workers compensation insurance marketplace with lower premium rates and a concomitant decrease in commission expenses as well as a reduction in losses.
- - Special Programs' net premiums written increased 15.3% ($65,010,000) to $489,848,000 in 1996 and decreased 1.7% ($7,479,000) to $424,838,000 in 1995 from $432,317,000 in 1994. Net premiums written by DPIC for professional liability insurance, the largest special program, were $195,546,000, $184,130,000 and $173,205,000 in 1996, 1995 and 1994, respectively. The premium increases of 6.2% in 1996 and 6.3% in 1995 (15.4% excluding a $13,704,000 premium refund received in 1994 from the discontinuation of a reinsurance contract) reflect both new business and a continuation of a high level of policy renewals in a very competitive market. Premium volume for Connecticut Specialty increased 28.0% ($47,037,000) to $215,299,000 in 1996 and decreased 8.3% ($15,165,000) to $168,262,000 in 1995 from $183,427,000 in 1994. Connecticut Specialty's premiums were increased in both 1996 and 1995 from greater participation in the underwriting pools managed by McGee and from increased premiums written in low exposure professional liability programs. The increase in 1996 was also impacted by higher retention for most programs after a change in reinsurance in May 1996, and offset in part by lower premiums from other marine coverages. The decrease in 1995 resulted from the cancellation in the second half of 1994 of a personal injury protection program in Florida and an automobile physical damage program in Texas, where the Company had unfavorable loss experience. The percentage of treaty and facultative reinsurance assumed to total net premiums written for this segment amounted to 16.1%, 17.1% and 17.5% in 1996, 1995 and 1994, respectively. In November 1996, the Company sold the renewal book of business of its reinsurance operations in order to concentrate on businesses where the Company can better service specialized niche markets.
Premiums earned increased 73.7% ($551,749,000) to $1,300,752,000 in 1996 from $749,003,000 in 1995 and 8.4% ($57,780,000) in 1995 from $691,223,000 in 1994. The 1996 increase was attributable to the inclusion of Guaranty National's premiums earned of $481,648,000, as well as the recognition in income of increased premium writings from other operations.
with after-tax yields of 5.4%, 5.5% and 5.0%, respectively. Net investment income increased in 1996 by the inclusion of Guaranty National's net investment income of $40,089,000, as well as by increased earnings on a higher investment base, notwithstanding a growing portfolio of lower yielding tax- advantaged securities and the cash outlay to acquire Guaranty National common stock. The year-to-year changes in net investment income also reflect increases in equity earnings from limited partnership investments of $6,889,000 from 1995 to 1996 and $8,510,000 from 1994 to 1995. Approximately one-half of the 1996 increase in limited partnership earnings is attributable to the inclusion of Guaranty National's partnership earnings. Earnings from limited partnership investments can vary considerably from year-to-year. However, the Company's long-term experience with these investments has been quite favorable. The increase in net investment income for 1995 is also attributable to a higher average portfolio yield on a higher investment base. Net investment income was increased in both years by income generated from the deployment of operating cash flow of $167,741,000 in 1996 and $148,017,000 in 1995. The carrying value of the Company's investment portfolio amounted to $2,309,767,000 at December 31, 1996 and $1,602,861,000 at December 31, 1995.
The following table sets forth certain ratios of insurance operating expenses to premiums earned for the Company: Year Ended December 31, ------------------------------- 1996 1995 1994 ---- ---- ---- Loss and loss adjustment expenses ....... 67.9% 68.4% 72.1% Policy acquisition and other insurance expenses .............................. 30.1 29.0 27.0 ----- ----- ----- Total before policyholders' dividends . 98.0 97.4 99.1 Policyholders' dividends ................ 1.8 2.9 2.1 ----- ----- ----- Total after policyholders' dividends .. 99.8% 100.3% 101.2% ===== ===== =====
The loss ratio for Regional Operations was 58.8% in 1996, 62.4% in 1995 and 67.1% in 1994. The improvement in the loss ratio for Regional Operations results from the very favorable loss development and loss experience achieved by EBI through its service oriented approach of working with its customers to prevent losses and reduce claim costs. EBI has also had growth in high- deductible policies where experience has been favorable.
Special Programs' loss ratio was 72.6% in 1996, 72.9% in 1995 and 75.4% in 1994. The improvement in the 1996 loss ratio for this segment is primarily attributable to a lower loss ratio for Connecticut Specialty, both from the change in its reinsurance during 1996 and the impact on 1995 results of certain cancelled programs which had unfavorable loss experience in 1995 and 1994. These improvements were offset in part by reserve strengthening for the Company's pools and associations and reinsurance businesses and higher initial reserving for DPIC in 1996. The decrease in the 1995 loss ratio for this segment was primarily the result of favorable loss experience for DPIC and the cancellation of the personal injury protection and automobile physical damage Connecticut Specialty programs.
Provisions for losses and loss adjustment expenses include development of loss and loss adjustment expense reserves relating to prior accident years, which increased the calendar year combined ratio by .7 percentage point in 1996, 1.6 percentage points in 1995 and 2.5 percentage points in 1994. The loss ratios were adversely affected by loss development in the pool and association and reinsurance businesses, as well as from discontinued lines and certain program business. This adverse development was reduced for 1994 through 1996 by favorable development in the workers compensation insurance and professional liability lines of business from the improved application of loss prevention and loss control procedures.
Management believes that the Company's reserves for loss and loss adjustment expenses make reasonable and sufficient provision for the ultimate cost of all losses on claims incurred. However, there can be no assurance that changes in loss trends will not result in additional development of prior years' reserves in the future. Variability in claim emergence and settlement patterns and other trends in loss experience can result in future development patterns different than expected. The Company believes that any such development will continue at the low levels experienced in recent years, considering actions that have been taken to increase reserving levels, improve underwriting standards and emphasize loss prevention and control. The Company's loss ratios in recent years, including development of prior years' losses, have compared favorably with loss ratios experienced by the industry.
Interest expense was $24,687,000 in 1996, $15,943,000 in 1995 and $13,597,000 in 1994, increasing 54.8% in 1996 and 17.3% in 1995. Interest expense increased in 1996 from the inclusion of interest on Guaranty National's $100,000,000 bank debt, and increased in both 1995 and 1996 due to higher average debt outstanding after the issuance of $100,000,000 of Senior Notes by Orion on July 17, 1995, offset in part by the repayment of Orion's bank debt at that time.
Federal income taxes on pre-tax operating results and the related effective tax rates amounted to $32,033,000 (25.2%), $20,413,000 (23.2%) and $16,301,000 (22.8%) in 1996, 1995 and 1994, respectively. The Company files consolidated federal income tax returns. The Company's effective tax rates for 1996, 1995 and 1994 are less than the statutory tax rate of 35% primarily because of income derived from tax-advantaged securities.
The liability for deferred taxes established by the Company through June 30, 1996 for its share of Guaranty National's undistributed earnings has been reversed, resulting in a reduction of $21,547,000 in the amount of goodwill recorded from the purchase of Guaranty National shares, with no effect on net income.
Cash used in financing activities was $27,336,000 for 1996. Cash of $37,778,000 was provided by financing activities in 1995 and cash of $32,582,000 was used in 1994. Orion borrowed $12,000,000 under its bank line of credit in June 1995 to finance part of the McGee acquisition. In July 1995 Orion issued $100,000,000 of senior debt and repaid all of its outstanding bank debt. Cash used in financing activities includes dividend payments, debt repayments and payments related to the Company's common stock repurchase program. Orion increased the quarterly dividend rate on its common stock by 11.1% and 15.0% in the third quarters of 1994 and 1995, respectively, and by an additional 8.7% and 12.0% in the first and fourth quarters of 1996, respectively.
On June 2, 1995 Guaranty National entered into a $110,000,000 credit agreement (the "Credit Agreement") with several participating banks. The Credit Agreement provides for an unsecured reducing revolving credit facility, which was used to fund the Viking acquisition, to retire the outstanding balance of $29,000,000 under Guaranty National's previous revolving line of credit, and for working capital and general corporate purposes. As of December 31, 1996, the outstanding loan balance under the Credit Agreement was $100,000,000, with an interest rate of 6.24%. Principal payments are due beginning April 15, 1999, until the loan is retired in 2002. Guaranty National has two interest rate swap agreements with banks which effectively change the interest rate exposure on $80,000,000 of the loan to a fixed rate of approximately 6.3% through March 16, 1998. Guaranty National is in compliance with the various covenants and restrictions in the Credit Agreement.
On January 13, 1997 Orion issued $125,000,000 of 8.73% Junior Subordinated Debentures due January 1, 2037 to Orion Capital Trust I, a Delaware statutory business trust sponsored by Orion. Orion Capital Trust I then sold $125,000,000 of 8.73% Capital Securities which mature on January 1, 2037 (the "Capital Securities") in a private placement. The net proceeds from the sale of the Capital Securities will be used for general corporate purposes. The Capital Securities are subordinate to all liabilities of the Company, and may be redeemed without premium on or after January 1, 2007. Orion agreed to register the Capital Securities under the Securities Act of 1933, and has accordingly filed a registration statement with the Securities and Exchange Commission.
The Company has a system of internal controls which it believes provides reasonable assurance that assets are safeguarded from loss or unauthorized use, that transactions are recorded in accordance with management's policies and that the financial records are reliable for preparing financial statements. The system of internal controls includes written policies and procedures which are communicated to all appropriate personnel and updated as necessary.
Other long-term investments had aggregate carrying values of $90,129,000 at December 31, 1996 and $62,925,000 at December 31, 1995 including mortgage loans on real estate of $1,187,000 and $1,979,000, respectively. Estimated market values of mortgage loans and other long-term investments approximate their carrying values. The carrying value of the Company's investments in principal- only securities and interest-only securities totalled approximately $6,277,000, or .3% of total invested assets, at December 31, 1996.
The carrying value of securities on deposit with state regulatory authorities in accordance with statutory requirements totalled $236,328,000 and $237,732,000 at December 31, 1996 and 1995, respectively. Excluding investments in securities of the United States Government and its agencies, the Company did not have any investments in securities of any one issuer that exceeded $25,000,000. The Company had $2,227,000 and $1,441,000 of fixed maturity investments for which it was not accruing income for the years ended December 31, 1996 and 1995, respectively.
Reinsurance recoverables and prepaid reinsurance includes prepaid reinsurance of $86,916,000 at December 31, 1996 and $68,525,000 at December 31, 1995.
Establishing reserve liabilities for environmental claims is subject to significant uncertainties that make reserve estimation difficult. Legal decisions have tended to expand insurance coverage beyond the intent of the policies. The Company does not use discounting in determining its reserves for environmental claims. IBNR of $38,699,000 and $21,739,000 is included in net reserves for environmental claims at December 31, 1996 and 1995, respectively.
(000s omitted) 1997 ....................................... $ 16,541 1998 ....................................... 14,433 1999 ....................................... 12,072 2000 ....................................... 8,941 2001 ....................................... 6,528 2002 and thereafter ........................ 55,051 -------- Minimum lease commitments ................ $113,566 ========
Rent expense amounted to $19,824,000, $14,112,000 and $11,519,000 for 1996, 1995 and 1994, respectively, net of sublease rentals of $9,000 in 1994. Substantially all leases are for office space and equipment. A number of lease commitments contain renewal options ranging from one to thirty years.
Orion declared dividends on its common stock of $14,290,000, $12,078,000 and $10,828,000, or $1.03, $.86 and $.76 per share in 1996, 1995 and 1994, respectively.
Effective as of September 11, 1996, Orion redeemed its old stockholder rights plan and adopted a new Stockholder Rights Plan (the "Rights Plan"). Under the Rights Plan each outstanding share of common stock includes one preferred stock purchase right (the "Rights"). The Rights Plan is designed to assure stockholders that they will receive equitable treatment in the event of a proposed takeover. Under the Rights Plan, each holder of a Right is entitled to buy two-hundredth of a share of Series B Junior Participating Preferred Stock. The Rights become exercisable (i) if an acquiror gains a 15% or greater beneficial ownership interest in Orion's outstanding common stock, on other than fair and favorable terms to all stockholders or (ii) following the commencement of a tender offer or exchange offer that would result in an acquiror owning 15% or more of Orion's outstanding common stock. Each Right not owned by such acquiror will enable the holder to purchase, at an initial purchase price of $200, common stock having a value of twice the Right's purchase price. In addition, under certain circumstances if Orion is involved in a merger each Right will entitle its holder to purchase, at the Right's then current purchase price, common shares of such other company having a value of twice the Right's purchase price.
The Company maintains a Stock Savings and Retirement Plan (the "Plan"), qualified under Internal Revenue Code Section 401(k), for eligible employees of the Company (except for employees of Guaranty National and McGee). Employee and employer matched contributions to the savings funds are limited to the extent allowable under the Plan and federal income tax law. The Plan also provides for defined contribution savings and retirement benefits that allow the Company to make annual contributions to the Plan based on a percentage of employees' compensation. Employees vest in the Company's contributions over a six-year period. The Company has adopted a Surplus Benefit Plan which provides deferred benefits for those employees who received less than the full employer contribution to the Company's 401(k) plan as a result of federal tax limitations on participation in the Plan.
McGee maintains a Profit Sharing Plan (the "McGee Plan") which is also a 401(k) plan for eligible employees of McGee. Employee and employer contributions are limited by the McGee Plan and federal income tax law. Employer contributions vest over a seven-year period. McGee has noncontributory defined benefit retirement plans covering all eligible employees, and a nonqualified supplemental retirement plan for certain key employees. At December 31, 1996 and 1995 the accumulated benefit obligation of the defined benefit plans were approximately $20,620,000 and $20,205,000, and plan assets for these plans were approximately $20,695,000 and $19,233,000, respectively.
The Company maintains a number of incentive plans for key employees, including the 1982 Long-Term Performance Incentive Plan (the "1982 Plan"), and the Equity Incentive Plan (together the "Incentive Plans"). Orion has awarded both stock options and restricted stock to members of the Company's management under the Incentive Plans. All stock options are granted by Orion with exercise prices at fair market value at date of grant, and are intended to qualify to the maximum extent possible as incentive stock options. Stock options become exercisable from the first through fourth anniversaries of the date of grant, and expire ten years after the date of grant. Restricted stock is considered issued and outstanding when awarded. There are restrictions as to its transferability, which restrictions lapse in 25% increments over four or five year periods from the date of grant. As of December 31, 1996, the number of shares of stock reserved under the Incentive Plans is 1,114,534, of which 446,859 are for outstanding stock options and 96,084 and 571,591 are available for future awards under the 1982 Plan and the Equity Incentive Plan, respectively. A summary of the status of Orion's stock option plans as of December 31, 1996, 1995 and 1994 and changes during the years ending on those dates is presented below:
The weighted average fair value of options granted during 1996 was $14.58 per share. The fair value of options granted was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions: dividend yield of 1.9%, expected volatility of 19.0%, risk free interest rate of 6.0% and expected life of 7.1 years.
The Company applies Accounting Principles Board Opinion No. 25 and related interpretations in accounting for stock options granted under the Incentive Plans. Accordingly, no compensation cost has been recognized for stock options awarded to employees. Had compensation cost for the Company's stock option plans been determined based on the fair value at the grant dates for the 1996 awards under those plans consistent with the method of FASB Statement 123, the Company's net earnings and earnings per share for the year ended December 31, 1996 would have been $86,477,000, or $6.22 per share.
Orion granted 46,318 shares of restricted stock at a weighted average fair value of $51.22 per share during 1996, 27,515 shares at $28.06 during 1995 and 70,015 shares at $32.86 for 1994. As of December 31, 1996, the restrictions have not lapsed on 117,531 shares of restricted stock. The fair market value of restricted stock on the date of issuance is amortized over the vesting period during which the restrictions lapse.
The total expense for 1996, 1995 and 1994 for the above savings, retirement and pension benefit plans for employees and directors amounted to $9,473,000, $6,588,000 and $4,659,000, respectively.
Net postretirement benefit cost for the years ended December 31, 1996, 1995 and 1994 was $1,072,000, $1,203,000 and $1,243,000 consisting of service cost benefits earned of $953,000, $695,000 and $813,000 and interest on the accumulated postretirement benefit obligation of $596,000, $612,000 and $539,000, respectively, and amortization of unrecognized net gains of $477,000 in 1996, $104,000 in 1995 and $109,000 in 1994.
The expected health care cost trend rate used as of December 31, 1996 was 15% for 1997 and 8.5% for 1998, decreasing linearly each year until it reaches 5% for 2005 and future years. At December 31, 1995 the expected health care cost trend rates used were 9% for 1996 and 1997, ratably reduced to 5% for 2005 and later years. A one-percentage-point increase in the assumed health care cost trend rate for each year would increase the aggregate service cost and interest cost for 1996, 1995 and 1994 by $265,000, $245,000 and $289,000, respectively, and increase the accumulated postretirement benefit obligation as of December 31, 1996 and 1995 by $1,075,000 and $1,304,000, respectively. A one-percentage-point decrease in the health care cost rate would decrease service and interest costs and the accumulated post retirement benefit obligation by similar amounts. The assumed discount rate used in determining the accumulated postretirement benefit obligation was 7.5% at December 31, 1996 and 7.0% at December 31, 1995.
The Company's industry segments are described above in Note A. Guaranty National's results of operations are included on a consolidated basis for 1996 and accounted for using the equity method for 1995 and 1994. Identifiable assets of the Regional Operations and Special Programs segments are primarily allocated based on the cash flows of these segments. Financial information for the Company's segments for 1996, 1995 and 1994 is shown below: