Specialty Commercial - as of 1998 year end, this segment markets various specialty commercial products and services and includes professional liability insurance through DPIC Companies ("DPIC"); client-focused specialty insurance programs through Orion Specialty; underwriting management specializing in ocean marine, inland marine and commercial property insurance through Wm. H. McGee & Co., Inc. ("McGee"); insurance for international trade through the Company's 26% interest in Intercargo Corporation (" Intercargo"); and also includes the run-off operations of the Company's assumed reinsurance business, SecurityRe, which was sold in late 1996. McGee and Intercargo are expected to be sold in 1999 (see below).
Nonstandard Automobile - this segment specializes in nonstandard personal automobile insurance sold by OrionAuto, formerly known as Guaranty National Corporation.
Workers Compensation . $ 86.2 $ 86.8 $ 68.4 -0.8% 27.0% Specialty Commercial . 54.2 65.3 56.5 -16.9% 15.5% Nonstandard Automobile 37.1 40.7 23.3 -8.7% 74.8% -------- -------- -------- --- ---- 177.5 192.8 148.2 -7.9% 30.1% Other ................ (20.8) (16.6) (20.9) -25.6% 20.3% -------- -------- -------- --- ---- $ 156.7 $ 176.2 $ 127.3 -11.1% 38.3% ======== ======== ======== ==== ====
Miscellaneous income and expenses (primarily interest, general and administrative expenses and other consolidating elimination entries) of the parent company are reported as "Other" in the above table.
The net premiums written growth of 28.9% for Nonstandard Automobile in 1998 compared to 1997 is primarily due to the acquisitions of Strickland and Unisun, premium growth in the monthly product business in California and the northwestern United States , offset in part by rate reductions due to a competitive market. Premium growth in California is primarily attributed to enacted legislation requiring all drivers to maintain minimum liability insurance.
The loss ratio for Specialty Commercial increased in 1998 compared to 1997 primarily due to $27.8 million of loss reserve strengthening recorded in 1998 related to business being exited in connection with an Orion Specialty realignment. Excluding these charges, the loss ratio for Specialty Commercial would have been 69.7% in 1998. Additionally, the loss ratio for Specialty Commercial reflects reserve strengthening for the Company's pools and associations, and for the assumed reinsurance business exited in late 1996. These increases were partly offset by an improvement in DPIC's and McGee's loss ratios in 1998 as compared to 1997.
The ratios of policy acquisition costs and other insurance expenses to premiums earned (the "expense ratio") are 31.0% in 1998, 31.2% in 1997, and 30.1% in 1996. Policy acquisition costs include direct costs, such as commissions, premium taxes, and salaries that relate to and vary with the production of new and renewal business. These costs are deferred and amortized as the related premiums are earned, subject to a periodic test for recoverability. The increase in the expense ratio in 1997 as compared to 1996 is attributable to the Company's continued investment in building its loss prevention competencies and the costs of expanding in new territories and changing the EBI office operations. Additionally, the 1997 increase is the result of higher commissions at EBI and Orion Specialty including a change in reinsurance in 1996, which provides for lower ceding commissions. The ratio of policyholders' dividends to premiums earned (the "dividend ratio") was 1.6% in 1998 and 1.8% in both 1997 and 1996. The decrease in the dividend ratio for 1998 as compared to 1997 was due to a change in business mix at Orion Specialty resulting in a lower percentage of policies paying dividends to policyholders.
As of December 31, 1998, the Company had completed approximately 95% of its scheduled remediation of critical production systems for processing Year 2000 dates. This places the Company on or ahead of its plan for meeting Year 2000 processing needs. Non-critical systems will be tested and critical systems will be re-tested during 1999. The total costs to test or modify these existing systems, which include both internal and external costs of programming and testing, is estimated to be approximately $19.4 million, of which $15.8 million has been expensed ($2.4 million through 1997 and $13.4 million in 1998).
The major components of market risk affecting the Company are interest rate and equity risk. The Company has a fixed income investment portfolio, which includes non-redeemable preferred stocks and short term investments, with a market value of $2,139.8 million at December 31, 1998 that is subject to changes in value due to changes in market interest rates. Within the fixed income portfolio, certain mortgage-backed and asset-backed securities ($145.0 million of value at December 31, 1998) are exposed to accelerated prepayment risk generally caused by interest rate movements. Should interest rates decline, mortgage holders are more likely to refinance existing mortgages at lower rates. Acceleration of repayments could unfavorably affect future investment income, if reinvestment of the cash received from repayments is in lower yielding securities. Statistically, the Company's estimated prepayment risk was not significant at December 31, 1998.
Notes payable are recorded at face value less unamortized discount. The carrying value and estimated market value of notes payable at December 31 consist of the following:
On July 8, 1998 the Company entered into a credit agreement with a group of banks ("Bank Credit Facility") which provides for unsecured borrowings up to $150 million. The Bank Credit Facility expires on July 8, 2003 and provides for two one-year extension periods. The Company intends to use the Bank Credit Facility for general corporate purposes, which may include acquisitions. The Bank Credit Facility carries an annual facility fee on the unused amounts of the credit facility. Borrowings under the Bank Credit Facility bear interest at LIBOR (London Interbank Offered Rate) plus a margin based upon the Company's credit ratings. The Bank Credit Facility requires the Company to maintain certain financial covenants including a maximum debt to total capitalization ratio of 0.4 to 1.0, as defined, and a minimum combined statutory surplus of $650 million plus 30% of the Company's aggregate combined annual statutory net income. The Bank Credit Facility limits the Company's ability to incur secured indebtedness or certain contingent obligations except for indebtedness secured by liens specifically permitted by the Bank Credit Facility and additional secured indebtedness with a principal amount not exceeding 10% of the Company's consolidated net worth, as defined.
Note 12 - Postretirement Medical Benefits and Defined Benefit Pension Plans
The expected health care cost trend rates used to calculate the postretirement benefits obligation were 15.0% for 1998 and 8.5% for 1999, decreasing linearly each year until it reaches 5% for 2006 and future years. Assumed health care cost trend rates have a significant effect on the amounts reported for the postretirement medical benefit plans. A one percentage-point change in assumed health care cost trend rates would have the following effects:
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 $100, 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. Until 1998, the Rights Plan provided that, in the event of a change in control for a period of 180 days, Rights could be redeemed only by action of the continuing Directors. That restriction was removed in 1998.