The following table sets forth selected consolidated financial data of the Company for the periods indicated. The selected consolidated financial data for the five years ended December 31, 1997 set forth below are derived from the audited consolidated financial statements of the Company. The selected statutory data have been derived from the financial statements of Associated and Calvert prepared in accordance with statutory accounting practices ("SAP") and filed with insurance regulatory authorities. The following information should be read in conjunction with the Consolidated Financial Statements and the notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations", included elsewhere herein.
The accompanying consolidated financial statements have been prepared on the basis of generally accepted accounting principles ("GAAP"), which as to the two insurance subsidiaries differ from the statutory accounting practices ("SAP") prescribed or permitted by regulatory authorities, and include the accounts of the Company and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.
The preparation of the consolidated financial statements in conformity with GAAP requires the use of estimates and assumptions that affect amounts reported in the consolidated financial statements and the accompanying notes. Actual results could differ from such estimates.
Assumed reinsurance premiums written, commissions and unpaid losses and loss adjustment expenses are accounted for based principally on the reports received from the ceding insurance companies and in a manner consistent with the terms of the related reinsurance agreements.
Contingent commissions and retrospectively-rated premiums are accounted for on an earned basis and are accrued, in accordance with the terms of the applicable reinsurance agreement, based on the estimated ultimate level of profitability relating to such reinsured business. Accordingly, the profitability of the reinsured business is continually reviewed and as adjustments become necessary, such adjustments are reflected in current operations.
The liabilities for unpaid losses and LAE are based on the Company's estimates of the ultimate cost of unpaid losses reported prior to the close of the accounting period, IBNR losses, and the related LAE. These liabilities are estimated by management utilizing methods and procedures which it believes are reasonable and necessarily are subject to the impact of future changes in claim severity and frequency, as well as numerous other factors. Although management believes that the estimated liabilities for losses and LAE are reasonable, because of the extended period of time over which such losses are reported and settled, the subsequent development of these liabilities may not conform to the assumptions inherent in their determination and, accordingly, may vary from the estimated amounts included in the accompanying consolidated financial statements. To the extent that the actual emerging loss experience varies from the assumptions used in the determination of these liabilities, they are adjusted to reflect actual experience. Such adjustments, to the extent they occur, are reported in the period recognized.
The Company's liabilities for unpaid losses and LAE include estimates for certain types of latent exposures, such as environmental impairment and asbestos-related claims, relating to business written prior to 1985 and which are generally difficult to establish with traditional reserving techniques.
The establishment of appropriate reserves is an inherently uncertain process, and there can be no assurance that the ultimate liability, particularly with respect to latent exposures such as environmental impairment and asbestos, will not materially exceed the Company's current liability for unpaid loss and loss adjustment expense reserve estimates and have a material adverse effect on its future results of operations and financial condition. Furthermore, due to the inherent uncertainty of estimating such liabilities, particularly with respect to such latent exposures, it has been, and may over time continue to be, necessary to revise such estimated liabilities. However, on the basis of the Company's internal procedures, which analyze, among other things, its experience with similar cases and historical trends such as reserving patterns, loss payments, pending levels of unpaid claims, and product mix, as well as court decisions, economic conditions and public attitudes, management believes that adequate provision has been made for the Company's liabilities for unpaid losses and LAE as of December 31, 1997.
In February 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings Per Share", which the Company implemented in 1997. SFAS No. 128 establishes standards for computing and presenting earnings per share. Primary earnings per share have been replaced by basic earnings per share and calculated by dividing income available to common stockholders by the weighted average number of common shares outstanding during the period. Fully diluted earnings per share have been replaced by diluted earnings per share and calculated by including additional common shares that would have been outstanding if potentially dilutive shares had been issued during the period. Prior period earnings per share were not affected by the adoption of SFAS No. 128.
In June 1997, the FASB issued SFAS No. 131, "Disclosure about Segments of an Enterprise and Related Information", which will be effective for the Company beginning January 1, 1998. SFAS No. 131 redefines how operating segments are determined and requires disclosure of certain financial and descriptive information about a company's operating segments. This statement relates to presentation of information and will have no impact on results of operations or financial condition. Interim financial information will be required beginning in 1999 (with comparative 1998 information). The Company is currently evaluating the segment information disclosures required by SFAS No. 131.
In December of 1997, the American Institute of Certified Public Accountants issued Statement of Position No. 97-3 "Accounting by Insurance and Other Enterprises for Insurance- related Assessments" ("SOP 97-3"). SOP 97-3 establishes standards for accounting for guaranty-fund and certain other insurance related assessments. SOP 97-3 is effective for fiscal years beginning after December 15, 1998 and requires any impact of adoption to be reported as a change in accounting principle. The adoption of this statement is not expected to have a material effect on the Company's results of operations or financial condition.
At December 31, 1997 and 1996, the amortized cost and estimated fair values of investments in fixed maturities, by categories of securities, and short-term investments were as follows:
The following table provides a reconciliation of beginning and ending loss and LAE reserve balances of the Company for each of the years in the three-year period ended December 31, 1997 as computed in accordance with GAAP.
The provision for losses and LAE for claims occurring in prior years shows an unfavorable development of $6.8 million in 1997. The unfavorable development resulted principally from a pre-1985 book of Casualty business and certain pre-1987 reinsurance-assumed business, both previously discontinued.
The following table provides a reconciliation of beginning and ending loss and LAE reserve balances of the Company for each of the years in the three-year period ended December 31, 1997 for environmental impairment and asbestos-related liabilities.
At December 31, 1997, the reserve for unpaid environmental impairment losses and related LAE was approximately $6.8 million, net of reinsurance recoverables deemed probable of collection by the Company of approximately $5.2 million. The range of gross reserves for unpaid environmental impairment losses and LAE is estimated to be $12.0 million to $20.0 million and the range of reserves, net of reinsurance recoverable, for unpaid environmental impairment losses and LAE is estimated to be approximately $6.8 million to $9.5 million.
For the years ended December 31, 1997, 1996 and 1995, amounts relating to assumed and ceded reinsurance premiums written and earned and losses and LAE incurred reflected in the accompanying consolidated statements of income approximated the following:
At December 31, 1997 the Company held letters of credit of approximately $7.7 million securing amounts due from reinsurers.
During 1997, Associated maintained a six-layer property catastrophe reinsurance program which covered 95% of the annual aggregate amount of property claims up to $138.0 million per occurrence, subject to a retention of $2.5 million per occurrence.
Associated limits its net retention to $100,000 per risk for difference in conditions ("DIC"). Until October 1, 1996, Associated retained $250,000 per risk for casualty, architects' and engineers' professional liability, specialty lines, and commercial auto and up to $500,000 per risk for non-DIC property policies. Calvert reinsured various lines of business through quota share treaties, excess of loss treaties and facultative placements which limited Calvert's net retention per risk to a maximum of $200,000 for property and casualty.
The Company uses an asset and liability approach for financial accounting and reporting for income taxes. Under the asset and liability method, deferred tax assets and liabilities are recorded based on the difference between the financial statement and tax bases of assets and liabilities and the tax rates in effect when these temporary differences are expected to reverse. The principal assets and liabilities giving rise to such differences are loss and LAE reserves, unearned premiums, deferred policy acquisition costs, and net unrealized investment gains (losses).
The Company has not established a valuation reserve because it believes, based on its tax-planning strategies and projected future earnings, that it is likely that the net deferred tax asset will be fully realized.
A reconciliation of income taxes computed at the statutory federal income tax rate to the income tax provision is presented below:
In October 1995, the Company entered into an interest rate swap agreement with a commercial lending institution in order to reduce the impact of interest rate fluctuations on the Company's term loan. The interest rate swap was effected with respect to the first $15.5 million of scheduled principal amortizations of the $25.5 million loan. The impact of the swap was to create an effective fixed rate of 6.97% on the $15.5 million principal amount. As of December 31, 1997, the fair value of the interest rate swap approximated the carrying value.
The fair values of fixed maturities are based on quoted market prices. The fair value of short-term instruments approximates amortized cost. The fair value of cash and cash equivalents approximates amortized cost.
Associated, a California domiciled company, and Calvert, a Pennsylvania domiciled company, are required to file with the Department of Insurance of various states an annual convention statement, which is prepared in conformity with accounting practices prescribed or permitted by the respective states. These practices vary from GAAP principally in that policy acquisition costs are charged to expense when incurred, deferred federal income taxes are not recognized, investments are reflected at amortized cost, and nonadmitted assets are excluded from the balance sheet.
In June 1995, the Board of Directors declared a dividend of one right for each outstanding share of Common Stock. Each right entitles the holder to purchase from the Company a unit consisting of 1/100 of a share of Junior Participating Cumulative Preferred Stock at a price of $50 per unit. Initially, the rights will not be exercisable and will trade with the Common Stock. In the event a person or group acquires 20% or more of the Common Stock, or commences a tender offer for the outstanding shares, the rights become exercisable.
The rights may be redeemed by the Company at $.001 per right at any time prior to the acquisition by any person or group of 20% or more of the Company's shares. The rights have no voting power and will expire in June 2005, if not previously redeemed.
Property and equipment is classified with other assets in the accompanying consolidated balance sheets and is stated at cost, net of accumulated depreciation and amortization. Depreciation is computed using the straight-line method over the estimated useful lives of the related property and equipment and ranges principally from three to seven years.
The Company's stock option plans provide for granting of stock options to key employees and non-employee directors. Options are granted at a price not less than the market price on the date of grant. Options that have been granted under the plans will become exercisable in four annual installments of 25% each commencing on the second anniversary of the date of grant and will expire ten years from the date of grant.
The Financial Accounting Standards Board issued SFAS No. 123, "Accounting for Stock-Based Compensation." SFAS No. 123 provides an option either to continue the Company's current method of accounting for stock-based compensation, or to adopt the fair value method of accounting for stock-based employee compensation plans, which would require the Company to expense the fair value of its stock options at the date of grant over the vesting period.
The Company has continued to elect to follow Accounting Principle Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees", and related interpretations in accounting for its stock option and restricted stock plans. Accordingly, no compensation expense has been recognized for its stock-based compensation plans other than for restricted stock awards. Although the Company elected to continue to follow APB No. 25, it is required to provide additional disclosures including pro forma net income and earnings per share as if the Company adopted the fair value method for recognition purposes in 1995.
The following table summarizes outstanding and exercisable options as of December 31, 1997.
Pro forma (1) 1997 1996 1995 Net income $8,583 $5,974 $12,880 Basic earnings per share $1.28 $.90 $1.68
The Company maintains an annual incentive bonus plan for officers and other key employees. Bonuses are based upon predetermined objectives established by the Compensation Committee. The Company's total incentive bonus plan expense for the years ended December 31, 1997, 1996 and 1995 was $0.4 million, $0.6 million and $1.6 million, respectively.
Quarterly financial information (unaudited) for the year ended December 31, 1997 is presented below: