(1) In 1997, the Company adopted SFAS 128, Earnings per Share. Prior years' amounts have been restated in accordance with SFAS 128.
The Company is a holding company with thirteen wholly owned subsidiaries. See "BUSINESS-General" included herein for a description of the Company.
General. The 1995 results reflect development of losses from the 1994 Northridge Earthquake. During 1995 the total reported gross losses on direct property claims arising from the Northridge Earthquake increased $18.3 million from $125.4 million to $143.7 million. The Company also added gross bulk reserves of $11 million at September 30, 1995. On a net basis, the incurred losses relating to the Northridge Earthquake represented pre-tax charges of approximately $10.7 million in 1995. There was no further development of the losses from the Northridge Earthquake in 1996, however there was development of $343,000 in 1997. There can be no assurance that additional losses will not be reported or adjustments made to existing reserves.
In November 1988, the voters of the State of California approved Proposition 103, which required most property and casualty insurance companies, among other things, to reduce rates charged to California insureds to a level 20% below November 8, 1987 levels. On March 19, 1996, the Company agreed with the Commissioner to settle its rollback liability under Proposition 103. The settlement cost the Company approximately $2.0 million net of recoveries from reinsurers, of which approximately $1.0 million was recorded in each of 1995 and 1996.
Revenues. Gross written premium decreased from $148.9 million in 1995 to $142.5 million in 1996 and increased to $171.2 million in 1997. The following table sets forth the Company's gross written premium by line of business and net written premium in the aggregate for the periods indicated:
Inland Marine Premium. As of June 1997, the Company no longer writes inland marine business (other than onshore energy). The Somerset Companies produced the inland marine business written by the Insurance Companies.
Specialty Reinsurance and Program Insurance Premium. Navigators reinsurance business was produced and managed by one of the Somerset Companies. This reinsurance premium consisted primarily of excess of loss and quota share property, surety, and other specialty reinsurance lines. Navigators did not renew this reinsurance business after 1995 except for a few specialty treaties. The program insurance, which began in 1995, has been reduced for 1997 and currently consists of one managing general agent writing primarily general liability for contractors.
Net Earned Premium. The 8% increase in net earned premium from 1996 to 1997 was primarily due to the increase in the net written premium. The 10% decrease in net earned premium from 1995 to 1996 was primarily due to the decrease in the 1995 net written premium and the effect the property business run-off had on the 1995 net earned premium.
Net Investment Income. Net investment income increased 6% to $14.4 million in 1997 from $13.6 million in 1996 due to the increase in invested assets and the decrease of municipal bonds in the portfolio, partially offset by a decrease in fiduciary funds held by the Somerset Companies resulting in less investment income from the funds. Net investment income decreased 4% to $13.6 million in 1996 from $14.1 million in 1995 due to decreased fiduciary funds held by the Somerset Companies, the effect on invested assets from payments of earthquake losses and generally lower yields.
Net losses and loss adjustment expenses incurred. The ratio of net loss and loss adjustment expenses incurred to net earned premium was 61.9%, 62.2%, and 69.5% in 1997, 1996 and 1995, respectively. The 1997 loss ratio improved modestly over 1996. The improvement in the 1996 loss ratio compared to 1995 was primarily due to a return to more normal experience after reserving for the losses from the Northridge Earthquake.
$519,000 of contingent commissions receivable recorded in 1995 on certain ceded contracts which had loss development during 1996.
Other operating expenses. Other operating expenses increased 8.9% to $22.2 million primarily due to expenses incurred by Somerset (UK) in London, Somerset Asia in Australia and NCUL. The 9.4% decrease from 1995 to 1996 reflected the staff cuts in 1995 partially offset by the opening of the new offices in London and Australia in late 1996.
Equity Income in Affiliated Company. The Company holds an equity interest in Riverside, which through its wholly owned subsidiary, Riverside Corporate Underwriters Limited, is admitted to underwrite at Lloyd's of London as a corporate name with limited liability. The Company records its share of Riverside's underwriting results when sufficient information becomes available to provide reasonable estimates of earned premiums and losses. During 1996, primarily in the third quarter, the Company recorded its share of the 1994 and 1995 after tax underwriting earnings amounting to $1.4 million. During 1997, the Company recorded $376,000 of after tax underwriting earnings from its investment in Riverside.
Net Income. The Company's net income decreased in 1997 to $12.5 million from $16.8 million in 1996. The 1996 net income of $16.8 million improved over the $12.6 million of income in 1995 in which year the Company suffered the adverse impact of the Northridge Earthquake.
Cash flow from operations was $12.5 million, $7.3 million and $26.6 million for 1997, 1996 and 1995, respectively. Operating cash flow has been used primarily to acquire additional investment assets with net purchases during 1997, 1996 and 1995 of $17.6 million, $11.5 million and $12.8 million, respectively.
Invested assets and cash (excluding fiduciary funds held by the Somerset Companies) have grown from $235.5 million at December 31, 1995 to $240.7 million at December 31, 1996 to $258.6 million at December 31, 1997. Investment income during this period was $14.1 million in 1995, $13.6 million in 1996 and $14.4 million in 1997. The average yield of the portfolio, excluding net realized capital gains, was 5.6% in 1995, 5.4% in 1996, and 5.7% in 1997 reflecting the prevailing interest rates during those years and the decrease in the tax-exempt portfolio in 1997. As of December 31, 1997, all fixed maturity securities and equity securities held by the Company were classified as available-for-sale.
The majority of the invested assets are in municipal bonds rated "A" or better by Standard & Poor's or Moody's. The Company has no significant exposure to credit risk since the Company's fixed maturity investment portfolio does not contain any non-investment grade bonds. The portfolio has an average maturity of less than seven years. Management continually monitors the composition and cash flow of the investment portfolio in order to maintain the appropriate levels of liquidity. This ensures the Company's ability to satisfy claims or expenses as they become due.
On August 5, 1994, the Company entered into a Credit Agreement with three banks which was amended and restated on November 19, 1996 (the "Amended Credit Agreement"). The Amended Credit Agreement provided for a $20 million revolving credit loan facility and a $30 million letter of credit facility. The revolving credit loan facility bears interest, at the election of the Company, at either the base commercial lending rate of one of the banks or at LIBOR plus 1%. At December 31, 1996, $17 million in loans were outstanding under the revolving credit loan facility at an interest rate of 6.5% and letters of credit with an aggregate face amount of $27.1 million were issued under the letter of credit facility.
Total stockholders' equity was $131.2 million at December 31, 1997, a 13.6% increase for the year primarily as the result of the Company's earnings in 1997.
The Company's reinsurance has been placed with various U.S. companies rated "A-" or better by A.M. Best Company, Inc., as well as with foreign insurance companies and with selected syndicates of Lloyd's of London ("Lloyd's"). Certain syndicates at Lloyd's ("Loss Syndicates") and the Lloyd's market as a whole have reported significant losses in recent years. The Company has not placed any material amounts of reinsurance with these Loss Syndicates. Pursuant to the implementation of Lloyd's Plan of Reconstruction and Renewal, a significant portion of the Company's recoverables from the Loss Syndicates are now reinsured by Equitas ( a separate UK Department of Trade and Industry authorized reinsurance company established to reinsure outstanding liabilities of all Lloyd's members for all risks written in the 1992 or prior years of account).
The Company is a specialty insurance company and periods of moderate economic recession or inflation tend not to have a significant direct effect on the Company's underwriting operations. They do, however, impact the Company's investment portfolio. A decrease in interest rates will tend to decrease the Company's yield on its invested assets.
Management considers the potential impact of these economic trends in estimating loss reserves. Management believes that the underwriting controls it maintains, and the fact that the majority of Navigators' business is in lines of insurance which have relatively short loss payout patterns, assist in estimating ultimate claim costs more accurately and lessen the potential adverse impact of the economy on the Company.