(1) Certain subsidiaries of RISCORP were S Corporations prior to the reorganization [as referred to in Note 1(a) to the Company's consolidated financial statements] and were not subject to corporate income taxes.
(2) The 1995 shares exclude 2,556,557 shares of Class A Common Stock reserved for issuance pursuant to the exercise of stock options outstanding as of December 31, 1995, having a weighted average exercise price of $3.96 per share.
(3) The 1997 and 1996 shares include 790,336 and 225,503 shares, respectively, of Class A Common Stock pursuant to the contingency clauses in the acquisition agreement with IAA. See Note 4 to the Company's consolidated financial statements.
An analysis of certain balances contained in the December 31, 1999 and 1998 consolidated balance sheets is as follows:
The $1.6 million decrease in other assets from December 31, 1998 to December 31, 1999 resulted from the collection of interest in March 1999 from the sale to Zenith.
The $5.8 million and $7.3 million of other assets at December 31, 1999 and 1998, respectively, consisted of $4.6 million and $5.2 million of prepaid expenses and $1.2 million and $2.1 million of accrued investment income, respectively.
The $2.1 million decrease in deferred income taxes from December 31, 1998 to December 31, 1999 is due to the collection of taxes in March and October 1999.
The Company's operating results for the year ended December 31, 1999 resulted in a net loss of $7 million. The following comments pertain to the Company's revenues and expenses for the year ended December 31, 1999:
The $11.1 million of commissions, underwriting, and administrative expenses consisted of $1.2 million of management expenses, $1.7 million of accounting and auditing expenses, $2.9 million of legal expenses, $2.3 million of recurring operating expenses such as rent, telephone, insurance, and similar costs, $2 million of amortization of unearned compensation relating to The Phoenix Management Company, Ltd. restricted stock award, and $1 million of other expenses.
Depreciation and amortization expense was $0.1 million. The Company transferred all assets subject to amortization to Zenith in connection with the sale and retained $0.4 million of fixed assets (consisting principally of computer equipment) that are being depreciated over three years.
As previously discussed, on April 1, 1998, RISCORP and certain of its subsidiaries sold substantially all of their assets and transferred certain liabilities to Zenith, and the Company's operations have been limited after that date. The Company's operating results for the nine months ended December 31, 1998 resulted in a net loss of $61.6 million. The following comments pertain to the Company's revenues and expenses for the nine months ended December 31, 1998:
the restricted stock award to Phoenix. The remaining $8.3 million of operating expenses consisted of $2.8 million of accounting and auditing expenses, $1.7 million of recurring operating expenses such as rent, telephone, insurance, and similar costs, $1 million of adjustments to the Proposed Business Balance Sheet, $0.9 million of management expenses, $0.3 million of transition expenses incurred as a result of the sale to Zenith, and $1.6 million of other expenses.
Prior to 1996, the Company's at-risk operations were focused in Florida. During 1996, RISCORP acquired RNIC and its 19 licenses and assumed business from several self insurance funds outside of Florida which allowed RISCORP to diversify its at-risk operations. A comparison of the Company's direct written premiums for 1998 and 1997 (prior to reinsurance cessions or assumptions) by state is presented below (in millions):
Direct written premiums were reduced by the 65 percent quota-share reinsurance agreement (effective October 1996), with another reinsurer for certain non-Florida business. The 65 percent quota-share reinsurance agreement was reduced to 60 percent effective January 1, 1997 and was cancelled on a run-off basis on December 31, 1997.
The majority of the Company's premiums were written in Florida, a regulated pricing state where premiums for guaranteed cost products were based on state-approved rates. However, prior to the sale to Zenith, the Company also offered policies that were subject to premium reductions as high deductible plans, participating dividend plans, or other loss sensitive plans. Pricing for those plans tended to be more competitively based, and the Company experienced increased competition during 1997 and 1998 in pricing those plans. In addition, in October 1996, the Florida Insurance Commissioner ordered workers' compensation providers to reduce rates by an average of 11.2 percent for new and renewal policies written after 1996. Concurrently, with the premium reduction effective January 1, 1997, the 10 percent managed care credit was phased out. This credit had been offered since 1994 to employers who met certain criteria for participating in a qualified workers' compensation managed care arrangement. In October 1997, Florida further reduced premium rates by 1.7 percent for new and renewal policies written after 1997. North Carolina approved a 13.7 percent decrease in loss costs, effective April 1, 1997, that the Company adopted in October 1997, which resulted in an overall effective rate reduction of 8.4 percent.
Part of the Company's claims management philosophy was to seek recoveries for claims that were reinsured or that could be subrogated or submitted for reimbursement under various state recovery programs. As a result, the Company's losses and loss adjustment expenses were offset by estimated recoveries from reinsurers under specific excess-of-loss and quota-share
The following table shows direct, assumed, ceded, and net earned premiums for 1998 and 1997 (in millions):
In September 1995, the Company entered into a fronting agreement with another insurer that enabled the Company to begin expansion into states where the RISCORP insurance companies were not licensed. The fronting agreement was cancelled effective December 31, 1997. The cancellation of the fronting agreement and the sale to Zenith were the primary reasons that the assumed premiums decreased to $0.1 million in 1998 from $18.8 million in 1997. The assumed premiums from the fronting agreement were $7.1 million for 1997. Although the Company assumed premiums from several insurers, the fronting agreement generated the majority of the assumed premiums.
For 1997, the Company ceded 50 percent of its Florida premiums under a quota-share reinsurance agreement and 60 percent of the business written by RNIC under a separate quota-share agreement with Chartwell Reinsurance Company ("Chartwell"). The Company terminated the agreement with Chartwell at December 31, 1997; however, the reinsurer continues to receive premiums and to be responsible for its portion of all losses incurred on policies effective before the termination date. The decrease in ceded premiums to $22.7 million in 1998 from $167.3 million in 1997 was due primarily to the sale to Zenith and to the decrease in direct premiums earned discussed above.
Net investment income for 1998 and 1997 was $7.1 million and $16.4 million, respectively. Net investment income consists entirely of earnings from the investment portfolio, excluding realized gains and losses in 1997.
The loss ratios for 1998 and 1997 were 93 percent and 58 percent, respectively. The 35 percent increase in the 1998 loss ratio was due primarily to $10.3 million of adverse gross loss development during the first quarter of 1998 in the 1997 and prior accident years from certain business written in Florida, $2.6 million of gross favorable loss development in Alabama and North Carolina, and $0.3 million of gross adverse loss development in business written by RNIC and RPC in several smaller states.
Unallocated loss adjustment expenses for 1997 were $19.3 million. The unallocated loss adjustment expense ratio for 1998 and 1997 was 10 percent and 11 percent, respectively.
As of December 31, 1999 and 1998, RISCORP's insurance subsidiaries had combined statutory capital and surplus of $12 million and $156.5 million, respectively. The decline in combined statutory surplus from 1998 to 1999 is primarily the result of 1) the determination of the final purchase price to be paid by Zenith resulted in a $34.3 million loss on the sale being recorded by RISCORP's insurance subsidiaries, and 2) RISCORP's receiving and retaining of the proceeds from the sale to Zenith. Consequently, RISCORP's insurance subsidiaries recorded $94 million of receivables from RISCORP for their portion of those proceeds. Those receivable balances are classified as a non-admitted asset at December 31, 1999 because those receivables are more than 90 days past due. The individual capital and surplus of each of RISCORP's insurance subsidiaries exceeded the minimum statutory capital and surplus required by their respective state of domicile.
The National Association of Insurance Commissioners has adopted risk-based capital standards to determine the capital requirements of an insurance carrier based on the risks inherent in its operations. The standards, which have not yet been adopted in Florida, require the computation of a risk-based capital amount that is then compared to a carrier's actual total adjusted capital. The computation involves applying factors to various financial data to address four primary risks: asset risk, insurance underwriting risk, credit risk, and off-balance sheet risk. Those standards provide for regulatory intervention when the percentage of total adjusted capital to authorized control level risk-based capital is below certain levels. At December 31, 1999 and 1998, RISCORP's insurance subsidiaries' statutory surplus was in excess of any risk-based capital action level requirements.
RISCORP's investment securities are exposed primarily to interest rate risk. The interest rate exposure is a result of the effect of changes in interest rates on the fair market value of the Company's investments. The Company used a sensitivity analysis prepared by the Company's investment advisor to estimate the amount of sensitivity to interest rate changes. For example, given the duration of a security, the market value of that security will increase if market interest rates decrease. Likewise, the value of the security will decrease if market interest rates increase.
The term "Year 2000 issue" is a general term used to describe various problems that may result from the improper processing of date and date-sensitive calculations by computers and other machinery as the Year 2000 was approached and reached. Those types of problems could have resulted from hardware and software being unable to distinguish dates in the "2000's" from dates in the "1900's" and from other sources, such as the use of special codes and conventions that make use of a date field.
Neither the Company, its suppliers, nor the financial institutions with which the Company maintains banking or investment accounts, experienced any known Year 2000 computer problems.