SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
[X] For the fiscal year ended December 31, 1997
Commission File Number: 0-6478
FOREMOST CORPORATION OF AMERICA
(Exact Name of Registrant as Specified in its Charter)
Delaware 38-1863522
(State of Incorporation) (I.R.S. Employer Identification No.)
5600 Beech Tree Lane, Caledonia, Michigan 49316
(Address of Principal Executive Offices) (Zip Code)
Post Office Box 2450, Grand Rapids, Michigan 49501
(Mailing Address) (Zip Code)
Registrant's Telephone Number, Including Area Code: (616) 942-3000
Securities Registered pursuant to Section 12(b) of the Act:
Common Stock, $1 Par Value New York Stock Exchange
(Title of Class) (Name of Each Exchange on
Which Registered)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No ________
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
State the aggregate market value of the voting stock held by non-affiliates of
the registrant. The aggregate market value shall be computed by reference to the
price at which the stock was sold, or the average bid and asked prices of such
stock, as of a specified date within 60 days prior to the filing.
Aggregate Market Value as of March 2, 1998: $481,374,659
Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date.
Common stock outstanding at March 2, 1998: 27,524,531 shares
Documents Incorporated By Reference
Portions of the registrant's proxy statement for its April 30, 1998, annual
meeting of stockholders are incorporated by reference in Part III.
FOREMOST CORPORATION OF AMERICA
Table of Contents
Page No.
Part I
Item 1. Business 1
Item 2. Properties 10
Item 3. Legal Proceedings 10
Item 4. Submission of Matters to a Vote of Security Holders 11
Supplemental Item Executive Officers of the Registrant 12
Part II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters 14
Item 6. Selected Financial Data 15
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 16
Item 8. Financial Statements and Supplementary Data 23
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Condition 54
Part III
Item 10. Directors and Executive Officers of the Registrant 55
Item 11. Executive Compensation 55
Item 12. Security Ownership of Certain Beneficial Owners
and Management 55
Item 13. Certain Relationships and Related Transactions 55
Part IV
Item 14. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K 56
Signature Page Signatures of Registrant's Directors 59
PART I
Item 1. BUSINESS
Foremost Corporation of America (the "Company") is a holding company which,
through its subsidiaries, provides property and casualty insurance primarily for
mobile homes and recreational vehicles. The Company believes that in 1997 it was
the leading writer of mobile home property and casualty insurance in the United
States. The Company also writes private passenger automobile and homeowners
insurance.
The Company sells its property and casualty insurance to mobile home and
recreational vehicle owners through independent agents and general agents, as
well as through dealer agents. The Company also writes its property and casualty
insurance on a direct response basis.
The Company's principal subsidiary, Foremost Insurance Company, Grand
Rapids, Michigan ("Foremost Insurance"), was founded in 1952. The Company was
incorporated in Delaware in 1967 and acquired all the outstanding capital stock
of Foremost Insurance in that year. The Company's principal executive offices
are located at 5600 Beech Tree Lane, Caledonia, Michigan 49316. The mailing
address is P.O. Box 2450, Grand Rapids, Michigan 49501, and the telephone number
is (616) 942-3000. As used herein the "Company" means Foremost Corporation of
America and its subsidiaries unless the context indicates otherwise.
The Company is rated A+ (Superior) by A.M. Best & Co. which is the second
highest of the 15 rating categories in the A.M. Best rating system. In addition,
in 1997 the Company was, for the third consecutive year, rated among the top 50
insurance companies in the United States with respect to safety, consistency and
performance by Ward's Financial Group ("Ward's"), a management consulting and
investment banking firm specializing in the insurance industry. Ward's measures
the results of approximately 2,600 property and casualty insurance companies
over a five-year period and from those results chooses the top 50 companies.
During 1997, the Company's business was concentrated in the property and
casualty insurance market.
All statements other than statements of historical fact contained in the
Form 10-K, including statements in the "Business" and "Management's Discussion
and Analysis of Financial Condition and Results of Operations" are
forward-looking statements. Forward-looking statements in the Form 10-K
generally are accompanied by words such as "anticipate," "believe," "estimate,"
"project," "expect" or similar statements. Such forward-looking information
involves important known and unknown risks and uncertainties and other factors
that may cause the actual results, performance or achievements of the Company to
be materially different from any future results, performance or achievements
expressed or implied by such forward-looking statements. Although the Company
believes that the expectations reflected in such forward-looking statements are
reasonable, no assurance can be given that such expectations will prove correct.
Factors that could cause the Company's results to differ materially from the
results discussed in such forward-looking statements include competition from
other insurance companies, the uncertainty of reserve estimates, general
economic conditions, the effects of governmental regulation and the effects of
weather-related catastrophes. All forward-looking statements in the Form 10-K
are expressly qualified in their entirety by the cautionary statements in this
paragraph and current and potential stockholders are cautioned not to place
undue reliance on the forward-looking statements made in this 10-K.
1
Property and Casualty Insurance
The Company's largest business segment is property and casualty insurance
concentrated primarily in the mobile home and recreational vehicle markets. The
Company's property and casualty insurance is written by Foremost Insurance,
Foremost Signature Insurance Company, American Federation Insurance Company and
Foremost Property and Casualty Insurance Company (all four insurers may be
referred to herein collectively as "P&C subsidiaries").
Through its P&C subsidiaries, the Company writes mobile home and
recreational vehicle property and casualty insurance. The Company also writes
dwelling fire, homeowners and automobile insurance. During 1996, the Company
discontinued writing collateral protection insurance, which assists a lender by
tracking insurance coverage on mobile home loans and ensuring continuity of such
coverage. Foremost Property and Casualty Insurance Company primarily writes
mobile home property and casualty insurance on a direct response basis pursuant
to the Company's exclusive endorsement by the American Association of Retired
Persons ("AARP"). See "Marketing -- Direct Response Channel." In addition, the
Company writes automobile and homeowners property and casualty insurance based
upon endorsements by third parties on a direct basis.
The Company's property and casualty insurance operations cover all states
and the District of Columbia, although not all lines of insurance are sold in
all jurisdictions. The following table presents the amounts and percentages of
premium written by the Company's property and casualty insurance operations in
the ten leading states during 1997:
State Dollars % of Total Premium
- ----------------------- ----------------------- -----------------------
Texas $ 75,402,220 17.5
Florida 40,887,260 9.5
California 39,706,114 9.2
Michigan 21,340,005 4.9
Washington 16,738,798 3.9
South Carolina 15,545,082 3.6
Georgia 15,408,151 3.6
North Carolina 14,642,484 3.4
Pennsylvania 14,468,366 3.4
Alabama 12,129,126 2.8
----------------------- -----------------------
TOTAL $266,267,606 61.8
A substantial portion of premium written in Texas is written by
Foremost County Mutual Insurance Company, a Texas county mutual insurance
company, and reinsured by the Company (included in "premium written and assumed"
in the notes to the Consolidated Financial Statements).
The Company's insurance subsidiaries are subject to statutory
restrictions and to supervision by state insurance regulatory agencies in all
jurisdictions in which such subsidiaries transact insurance business. For
information concerning such restrictions and supervision, including rate
regulations, see "Business--Government Regulation."
Other Operations
Secondary Market Financial Services-
In August of 1982, Foremost Financial Services Corporation ("FFSC")
developed a Manufactured Housing Pass-Through program. Under this program FFSC
issued certificates which are privately placed with institutional investors. The
certificates evidence undivided interests in pools of manufactured housing
retail installment obligations ("Contracts"). FFSC is contractually obligated to
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the certificate holders for servicing of the Contracts. The certificates do not
represent an interest in or obligation of FFSC, however, FFSC is obligated, in
the event of delinquencies or deficiencies in payments on the Contracts, to
advance cash obligations to the extent such advances are reimbursable under the
primary insurance policies or the pool insurance policy. Each Contract is
covered by a primary policy of private credit insurance written by Foremost
Insurance, which also wrote the pool credit insurance policies. Under these
secondary market programs, FFSC is currently the Master Servicer of
approximately 3,900 contracts with principal balances aggregating approximately
$18.5 million. The Company discontinued writing private credit insurance in 1985
and the entire Manufactured Housing Pass-Through program is in a run-off mode.
Insurance Agencies-
The Company owns several insurance agencies: Foremost Affiliated Insurance
Services, Inc., Foremost Home Brokers, Inc., Foremost Express Insurance Agency,
Inc., Western Star Underwriters, Inc., Pacific Way Insurance Agency, Inc.,
Frontier Insurance Agency, Inc., Corvette General Agency, Inc., Sunrise
Insurance Agency, Inc., Sunrise Insurance Agency of Arizona, Inc., Sunrise
Insurance Agency of Texas, Inc., and Knight Agency, Inc. These agencies generate
commission income by selling the Company's specialty insurance products to
selected markets.
Marketing
The Company's primary marketing strategy has been to provide insurance
products through three distribution channels: general and independent insurance
agents (agency); mobile home and recreational vehicle dealer agents
(point-of-sale); and direct contact with insureds (direct response).
Agency Channel-
The Company writes insurance through numerous independent and a select
group of general agents. These agents, many of whom also represent one or more
competing insurance companies, are independent contractors selected and
appointed by the Company. Under the Company's agency agreement, each agent is
authorized to sell and bind insurance policies in accordance with procedures
specified in the agency agreement. The Company's marketing force focuses on
developing and maintaining relationships in this channel. The Company also owns
a number of captive agencies which operate like an independent agency, except
that they generally only sell the Company's insurance products.
Point-of-Sale Channel-
The Company sells its insurance through mobile home and recreational
vehicle dealer agents. The primary product sold through mobile home dealer
agents is mobile home property and casualty insurance. The primary product sold
through recreational vehicle dealer agents is recreational vehicle property and
casualty insurance. The Company provides open lot commercial insurance products
for certain property risk exposure of mobile home dealers. The Company's
marketing force develops and maintains relationships with mobile home and
recreational vehicle dealer agents.
Direct Response Channel-
The Company utilizes its direct response operation for the offering of
mobile home, recreational vehicle, automobile and homeowners insurance to
insureds primarily through third party endorsements. In December of 1989, the
Company entered into a seven-year agreement with AARP (the "AARP Agreement")
pursuant to which AARP has granted the Company the exclusive right to offer the
Company's mobile home insurance to AARP members. The AARP Agreement was amended
in 1997 extending the term through the year 2004. The AARP Agreement also
3
provides for early termination under certain circumstances, including the
unilateral right of AARP to terminate the AARP Agreement in the event of a
change in control of the Company (as defined in the AARP Agreement). The Company
markets its AARP mobile home policies exclusively on a direct response basis and
the Company owns the renewal rights to the AARP policies.
On June 7, 1996, the Company entered into a seven-year agreement with First
USA Federal Savings Bank ("FUSA") pursuant to which FUSA has granted the Company
the exclusive right to offer automobile and homeowners insurance to FUSA
customers, including its credit card customers. FUSA is the nations fourth
largest issuer of credit cards. The Company markets the policies to FUSA
customers on a direct response basis and, at year end 1997, automobile insurance
was available to FUSA customers in approximately 24 states, and homeowners
insurance was available in approximately 21 states. The Company intends to add
other states and expects that such insurance eventually will be available in
most states.
During 1997, the Company entered into a multi-year agreement with an agent
that represents the Amway Distributors Benefits Association and markets personal
lines insurance to approximately 1.2 million independent distributors of Amway
Corporation in the United States. In January of 1998, the Company also entered
into an agreement with Old Kent Bank to market personal lines insurance to
customers and employees of Old Kent Bank and its affiliates. Both of these
national programs are available in approximately 24 states for automobile
insurance and 21 states for homeowners insurance. The Company also utilizes a
direct response mail and telemarketing operation to sell its property and
casualty policies to insureds in cases where the Company owns the renewal rights
to policy expirations.
Trademarks
The Company holds a number of registered and common law trademarks that
identify the Company's products and services. The trademarks that are most
widely used by the Company include "Foremost" and the "interlocking F." Although
the registration of "Foremost" will expire on July 29, 2006, and the
"interlocking F" on October 13, 2007, further renewals for periods of 20 years
currently are available under federal trademark laws.
The Company believes that consumers identify its products and services by
its trademarks and that its trademarks are valuable assets. The Company is not
aware of any infringing uses or any prior claims of ownership of its trademarks
that could materially affect its current business. It is the policy of the
Company to pursue registration of its primary marks whenever possible and to
vigorously defend its trademarks against infringement or other threats to the
greatest extent practicable under the laws of the United States. The Company is
also the holder of several other proprietary rights. The Company protects all of
its proprietary rights to the greatest extent practicable under applicable law.
Underwriting
The objectives of the Company's underwriting and ratemaking strategy is to
achieve underwriting profits as well as to generate investable assets. Each of
the Company's P&C subsidiaries designs its own coverages and sets its own rates
for its policies; however, the Company's P&C subsidiaries incorporate some of
the standard coverages and rates developed by ratemaking bureaus. Each
prospective policy is underwritten and rated based upon a combination of factors
which include, in the case of mobile homes, type of mobile home, location and
other risk characteristics. Through this practice the Company seeks to write
policies only for those risks which meet its underwriting criteria.
The Company believes that a key factor in its underwriting process is the
4
use of its extensive historical mobile home data base, which includes a
computerized data base of over 15 million earned policy years of experience with
mobile home insurance policies. This data base enables the Company to better
identify and quantify the loss experience associated with numerous risk
characteristics and is employed in the design of the coverage and rating used to
classify insurance risks.
The significant increase in catastrophe events since 1989 requires that the
Company manage its risk concentrations, especially in areas prone to hurricane,
flood and earthquake. Over the last several years the Company has implemented
various restrictions on new business writings in some areas and also has
implemented non-renewals of policies in certain coastal areas running from Maine
to Texas on the Atlantic Ocean and the Gulf of Mexico (including Florida) and
California on the West Coast, to limit the Company's exposure to these
catastrophes. During 1997, the Company took action against another catastrophic
risk by starting the process of eliminating flood coverage from the majority of
the Company's mobile home policies. By the end of 1998, the Company anticipates
that approximately 80% of its policies will have the flood coverage removed from
mobile home policies, which will dramatically reduce the Company's exposure to
loss due to flooding.
Claims
Approximately 97% of the Company's claims are handled by its own staff of
claim adjusters and the remainder by independent adjusters. Independent claim
adjusters are primarily used by the Company to assist in handling claims in
areas where insurance volume does not warrant the maintenance of a staff
adjuster and for certain non-mobile home related claims. If a claim or loss
cannot be settled and results in litigation, the Company retains outside counsel
to represent the Company. In view of the Company's commitment to mobile home and
recreational vehicle property and casualty insurance, the Company conducts
training programs for its adjusters on mobile home and recreational vehicle
construction and the settlement of mobile home and recreational vehicle claims.
The Company believes that the extensive use of its own trained claims adjustment
staff as opposed to independent adjusters permits it to more expeditiously
settle claims and limit underwriting losses and loss adjustment expenses. The
Company intends to follow the same approach in its automobile and homeowners
business by training its own adjusters as justified by the volume of business in
geographic areas.
Loss and Loss Adjustment Expense Reserves
The Company maintains reserves for the payment of losses and loss
adjustment expenses for both reported and unreported claims. Loss reserves are
estimated at a given point in time at what the insurer expects to pay in
incurred losses based on facts and circumstances then known. Loss adjustment
expense reserves are intended to cover the ultimate cost of settling all losses
and defending lawsuits resulting from such losses. The amount of loss reserves
and loss adjustment expense reserves for reported claims primarily is based upon
a case-by-case evaluation of the type of claim involved, the circumstances
surrounding each claim and the policy provisions relating to the type of loss.
The amount of loss reserves and loss adjustment expense reserves for incurred
but not reported claims is determined on the basis of historical information by
line of insurance. Neither generally accepted accounting principles nor
statutory reserves represent an exact calculation of future benefit liabilities
but are instead estimates made by the Company using actuarial and statistical
methods. Ultimate liability may be greater or lower than reserves, and there can
be no assurance that any such reserves would be sufficient to fund future
liabilities in all circumstances. Reserves are monitored closely and are
reviewed by the Company quarterly using new information on reported claims. The
Company obtains a certification of the adequacy of its reserves as of each
December 31st by independent actuaries. The Company does not discount to a
present value that portion of its loss reserves expected to be paid in future
periods. Inflation is reflected in the reserving process through analysis of
cost trends and reviews of historical reserving results.
5
Limits of Insurance Coverage and Reinsurance
The Company offers property coverage based on the actual cash value, or
replacement cost, of the risk, depending on the coverage form written. The
Company's published limits of liability for mobile home physical damage varies
by state, with the highest limit being $125,000 for the states of Arizona,
California, Oregon and Washington, with the countrywide average mobile home
insured at approximately $24,000. The Company's published limits of liability
for its homeowners physical damage is typically $700,000. The Company maintains
an excess of loss reinsurance policy for its homeowners programs, ceding 95% of
each individual loss in excess of $250,000. Personal effects coverage is written
at a percentage of the dwelling amount, usually 20-75%, depending on the
coverage form written. The Company's published limits on liability coverage
range from $25,000 to $500,000 per liability occurrence for mobile homes, and
vary with other products depending on the needs and qualification of the
policyholders. The Company reinsures 100% of any single liability which exceeds
$500,000.
A reinsurance transaction occurs when an insurance company transfers
(cedes) a portion of its exposure on business written by it to a reinsurer which
assumes that risk for a premium. Although the ceding of the insurance risk does
not discharge the original insurer from its primary liability to its
policyholder, it is the practice of insurers for accounting purposes to treat
the reinsured risks, to the extent of the insurance ceded, as though they were
risks for which the original insurer is not liable since the original insurer
only would assume liability in those situations where the reinsurer is unable to
meet the obligations assumed under the reinsurance agreements.
The Company's P&C subsidiaries maintain reinsurance protection for
catastrophes which indemnify the Company for aggregate catastrophe loss in
excess of the Company's retention up to the reinsurance treaty limits. The
aggregate reinsurance treaty also is subject to certain deductibles. The
Company's P&C subsidiaries also maintain single occurrence catastrophe
reinsurance for certain counties in the state of Florida and the entire states
of Washington and Georgia, which indemnifies the Company for the major part of
each single incurred loss in excess of the Company's retention up to the
reinsurance treaty limits. During 1997, the Company's P&C Subsidiaries obtained
single occurrence excess catastrophe reinsurance to cover their exposure to
flood losses in the states of California, Kansas, Missouri, New York, Oregon,
Pennsylvania, Texas and Washington. This reinsurance contract indemnifies the
Company for the major part of a single incurred flood loss in excess of the
Company's retention up to the reinsurance treaty limit. The Company reviews its
catastrophe retention and reinsurance coverage limits annually and adjusts such
limits as appropriate.
The Company monitors the financial condition of the reinsurers and attempts
to place its coverage only with substantial, financially sound carriers. Due to
fluctuations in capacity in the reinsurance market, there can be no assurance
that the Company's reinsurance agreements will be continued on current terms.
The severity of weather-related and similar catastrophes in recent years
has demonstrated to insurers, including the Company's insurance subsidiaries,
that most assumptions on the damage potential of catastrophes were too
optimistic. The Company's insurance subsidiaries maintain records showing
concentrations of risks in catastrophe prone areas of the United States. The
Company's insurance subsidiaries regularly assess their concentration of
underwriting exposures in catastrophe prone areas and develop strategies to
manage their exposure to catastrophic events, subject to regulatory constraints.
Government Regulation
The Company's insurance subsidiaries are subject to regulation and
6
supervision by state insurance regulatory agencies in all jurisdictions in which
such subsidiaries are licensed to transact insurance business. Such regulation
and supervision relates to, among other things, capital and surplus
requirements, solvency standards, payments of dividends to stockholders,
licensing to permit the transaction of business, licensing of agents, policy
form and rate regulation, deposits of securities, methods of computing reserves
and investment standards and diversification. These regulations are intended
primarily to protect policyholders rather than stockholders. Such subsidiaries
also are required to file detailed annual and other reports with the regulatory
agencies in each of the states in which they do business and their business and
accounts are subject to examination at any time by such agencies. Under
insurance statutes and procedures established by the National Association of
Insurance Commissioners ("NAIC"), the Company's insurance subsidiaries are
examined periodically by one or more of the supervisory agencies on behalf of
states in which these subsidiaries do business for both financial condition and
market conduct practices. The last financial examination of the Company's
property and casualty insurance subsidiaries was completed in 1996 which
examination covered the period from January 1, 1993 through December 31, 1995,
except Foremost County Mutual Insurance Company which was examined in 1996 for
the period from July 1, 1994 through December 31, 1995; American Federation
Insurance Company which was examined in 1996 for the three-year period ending
December 31, 1994, and Foremost Property and Casualty Insurance Company which
was examined in 1996 for the period January 1, 1989 through December 31, 1995.
The insurance laws of most states generally provide that all property and
casualty insurance companies which do business in their state must belong to a
statutory property and casualty guaranty association. The purpose of these
guaranty associations is to protect policyholders by requiring solvent property
and casualty insurance companies to pay certain insurance claims of insolvent
insurers. The rules of such guaranty associations assess insurers in order to
pay these claims proportionately to such insurer's share of voluntary premiums
written in the given state. While most guaranty associations provide a procedure
for recoupment of assessments through rate increases, rate surcharges or premium
tax credits, there is no assurance that insurers recover these assessments, and
the time value of money becomes a cost to the insurer assessed. The Company's
share of these assessments are not expected to have a material impact on the
business of the Company's P&C subsidiaries.
Many states have formed statutory residual market associations or plans to
write certain higher risk property and casualty insurance, which risks are not
eligible for the private market. These associations cover such risks as wind and
water in coastal areas, assigned risk for automobile, workers' compensation,
FAIR plans for homeowners and various other joint underwriting associations due
to capacity shortfalls in the private market. By statute, each private insurer
writing voluntary business of the type written under the residual market plans
in the state must be a member of these associations and, depending on the plan,
may be required to accept certain of these risks and also is required to
participate in the profit or loss of the association or plan. Exposures under
these plans are higher than voluntary writings because the plans accept higher
risk business and rates charged for this business are often lower than
actuarially required due to political influence of the governmental agency
operating these plans. In recent years, the Florida Residential Property and
Casualty Joint Underwriting Association and the Florida Windstorm Underwriting
Association have grown in the amount of exposures assumed due to the growth of
wind and water exposure in Florida with continued real estate development. The
shortage of private capacity after Hurricane Andrew in 1992, compounded by the
inability of private insurers and such Florida associations to secure regulatory
approval of adequate rates for business written in the coastal areas, has caused
further growth of exposures in these Florida associations. Florida also has
imposed a non-renewal moratorium which places annual limits on the amount of
business an insurer may non-renew in that state.
7
Unprecedented catastrophe losses in recent years have prompted insurers to
more aggressively limit their exposures to catastrophes. Such actions have in
turn created insurance availability problems in certain areas. In response to
this environment, activity at the state regulatory level has occurred. During
1995, the California legislature authorized the establishment of the California
Earthquake Authority, which will provide an alternative facility to California
consumers for obtaining insurance to cover the earthquake peril. A similar
situation exists in Florida where a state-sponsored insurance facility has
accepted a significant number of insureds as a response to insurance companies
continuing to limit the amount of their Florida business.
Insurers also are required by the states to provide coverage to insureds
who would not otherwise be considered eligible by the insurers. Each state
dictates the types of insurance and the level of coverage which must be provided
to such involuntary risks. The Company's insurance subsidiaries' shares of these
involuntary risks is mandatory and generally a function of their respective
share of the voluntary market by line of insurance in each state.
In recent years, increased scrutiny of state-regulated insurer solvency
requirements by certain members of the Unites States Congress resulted in NAIC
developing industry minimum risk based capital ("RBC") requirements, and
establishing a formal state accreditation process designed to more closely
regulate solvency, minimize the diversity of approved statutory accounting and
actuarial practices and increase the annual statutory statement disclosure
requirements. RBC formulas are designed to identify an insurer's minimum capital
requirements based upon the inherent risks (e.g., asset default, credit and
underwriting) of its operations. In addition to the minimum capital
requirements, RBC formula and related regulations identify various levels of the
capital adequacy and corresponding actions that the state insurance departments
should initiate. As of December 31, 1997, all of the Company's property/casualty
affiliates had adjusted capital amounts in excess of Company Action Levels.
As the Company has implemented steps to reduce its exposure to catastrophes
in catastrophe prone areas, it has encountered resistance to non-renewal actions
from insurance regulators of the state of Florida. However, the Company
currently believes that it will be able to continue its efforts to manage
catastrophe exposures, but with some delays and compromises imposed by state
insurance regulators.
Various states have enacted laws which require registration and periodic
reporting by insurance companies which are members of holding company systems.
The Company's insurance subsidiaries are subject to such legislation and are
registered under such statutes where required. Typically this legislation
requires (i) disclosure of all material members of the holding company system;
(ii) approval by the appropriate insurance commissioner of certain acquisitions
and mergers; (iii) disclosure and regulation of certain intra-system
transactions which are subject to certain standards; and (iv) advance notice of
proposed extraordinary dividends or other large distributions which are subject
to disapproval by the appropriate insurance commissioner. Under the terms of
applicable state insurance statutes, any person or entity desiring to purchase
more than a specified percentage (commonly 10%) of the Company's outstanding
voting securities would be required to obtain regulatory approval of the
purchase.
The federal government also has the power to regulate the insurance
business if the various states fail to regulate such business. Except in a few
limited areas, the federal government has not exercised its power. The United
States Congress has considered the issue of federal regulation of certain
aspects of the insurance industry and it is possible that it may adopt federal
legislation in the future. Although Congress has not issued laws regarding the
regulation of insurance, fair housing activists, including private advocacy
groups, the United States Department of Housing and Urban Development's ("HUD")
Office of Fair Housing and Equal Opportunity and the United States Department of
Justice, have taken steps to limit or attack the use of certain risk-based
8
methods for underwriting and pricing homeowners insurance under the Federal Fair
Housing Act, even though the act does not apply to insurers by its terms. Such
activity has increased over the past several years. Although regulation of
insurance is reserved to the states, these fair housing activists have had some
success both in the courts and through private settlements in regulating certain
insurance practices which they claim deprive people of housing through unfair
and discriminatory "redlining." Recent efforts to challenge risk-based insurance
practices have been facilitated through the legal concept of "disparate impact,"
that a policy or practice based on race-neutral criteria may nevertheless
constitute illegal discrimination if it has a disproportionate adverse impact on
minorities. If fair housing activists and the executive branch of the federal
government succeed in challenging certain underwriting and pricing practices,
insurers may have to abandon certain practices that, while based on risk-based
criteria, may yield a disparate racial impact. This could result in less
variation in rates according to individual risks and a higher average premium
for most risks to subsidize high loss groups of customers. Despite activists'
efforts, the United States Congress, in its 1997 and 1998 Appropriations Bill,
included a statement reaffirming that regulating property insurance was not
intended to be covered by the Fair Housing Act, prohibits HUD from using funds
for insurance regulatory activities and also limits the funds that HUD can use
for grants to private advocacy groups for actions under the Fair Housing Act.
Competition
All lines of business in which the Company engages are competitive. Large
national companies account for much of the competition, although the types of
insurance coverages sold by the Company are usually a relatively small portion
of those companies' businesses. Such national competitors are larger and have
greater resources available to them than the Company. In addition to large
national companies that compete in the Company's markets, other companies
specialize in the same types of insurance coverages and compete directly with
the Company, primarily in limited geographical areas. The Company competes
primarily on the basis of value although some of the Company's competitors use
price competition with respect to both premium rates and commission rates
offered to agents.
Working Capital
The Company maintains liquid assets in excess of an amount needed to pay
its current operating expenses and claims.
Dependency Upon Single Customer
No single customer of the Company accounted for 10% or more of the
Company's consolidated revenues in 1997, 1996 and 1995 and no material part of
the business is dependent upon a single customer or a few customers, the loss of
any one or more of whom would have a materially adverse effect on the business
of the Company.
Environmental Regulations
Compliance with federal, state or local provisions regulating the discharge
of materials into the environment, or otherwise relating to the protection of
the environment, will not have a material adverse affect on the Company's
expenditures or earnings.
Employees
The Company and its subsidiaries employed approximately 1,156 persons as of
December 31, 1997. The Company presently considers its employee relations to be
good.
9
Financial Information By Business Segment
Financial information by business segment for the five years ended December
31, 1997 appears in Note 13 to the Consolidated Financial Statements included in
Item 8. below.
Item 2. PROPERTIES
During 1988, the Company purchased a 587 acre parcel of land in Caledonia
Township (southeast of Grand Rapids, Michigan) and constructed a 260,000 square
foot corporate headquarters building on part of this property. Approximately 36
acres of this parcel currently is used for the corporate headquarters and the
balance of the parcel is held as investment property. During 1997, the Company
began construction of a 98,000 square foot office facility on part of its
Caledonia Township property to house its growing workforce. The Company also
sold approximately 26 acres of its property to the State of Michigan for a right
of way for the M-6 Interstate Highway. The Company also leases several
facilities in Cascade Township near Grand Rapids, Michigan for an additional
75,000 square feet of office, distribution, printing and warehouse space. The
Company has other short-term leasehold interests in real property used for its
claim service offices and captive agencies throughout the country.
Item 3. LEGAL PROCEEDINGS
The Company and its subsidiaries routinely are engaged in litigation as
plaintiff and defendant in the normal course of business. In the opinion of
management all of these proceedings, as well as the proceedings described below,
are not expected to have a material adverse effect on the Company's consolidated
financial position, cash flows or operating results. The aggregate ultimate
liability, if any, of the Company and its subsidiaries for the following claims
is not determinable at December 31, 1997.
The Company was named as a defendant in a number of similar individual
lawsuits and several related class actions filed in various county Circuit
Courts in the state of Alabama and in the United States District Court for both
the Northern and Southern Districts of Alabama (the "Alabama Litigation"). The
cases in the Alabama Litigation have sought both compensatory and punitive
damages. In general, the complaints alleged that the Company or its Alabama
agents failed to disclose information about insurance coverages and premium
structure, misinformed policyholders about coverages or policy provisions and in
other ways misrepresented the nature and extent of insurance sold in Alabama.
The Company denies all allegations and is vigorously defending each suit. The
compensatory damages, if any, in the cases have been nominal for each individual
claimant. The primary risk exposure facing the Company involves the plaintiffs'
claims for punitive damages.
During the past year, the principal individual and class actions against
the Company in the Alabama Litigation have been settled or resolved. In
connection with the settlement of a group of the individual actions, three
Alabama circuit courts have entered orders providing that, with respect to all
claims or theories alleged in the cases settled, the portion of the settlement
amount allocated to punitive damages is sufficient to both fully punish the
Company and to deter others from engaging in similar activities. In connection
with the settlement of the principal Alabama class action, the Company has
obtained general releases from Alabama policyholders resolving further claims
against the Company, except for claims by persons who affirmatively "opted out"
of the settlement. The Company believes that these individual and class action
settlements have significantly reduced the Company's risk exposure in the
Alabama Litigation, and intends to continue its vigorous defense of the fewer
remaining lawsuits.
In November 1995, an Iowa jury returned a verdict of $688,000 in
10
compensatory damages and $8 million in punitive damages against Foremost
Insurance Company and other affiliated companies in a diversity action filed in
the United States District Court for the Northern District of Iowa, Central
Division, for alleged fraud, breach of contract and misappropriation of trade
secrets in the termination of an agent's contract. The Company believes the
verdict was erroneous and filed post-judgment motions for a judgment
notwithstanding the jury verdict, a new trial and remittitur. On July 3, 1997,
the trial court set aside the $8 million punitive damage verdict, but denied the
Company's other post-trial motions. In December of 1997, the court conducted a
new trial to determine whether punitive damages were warranted and, on January
21, 1998, the court awarded $4 million in punitive damages. The Company strongly
believes that the punitive damage award is excessive and is not supported by the
facts. The Company is appealing both the prior compensatory award and the
punitive damages assessed by the trial court. The Company has not accounted for
the damages in its financial statements, because the amount of the loss cannot
be reasonably estimated.
In April 1996, national class actions were filed by the same group of
plaintiffs' attorneys in Wisconsin, Illinois and Florida state courts against
the Company and certain other defendants alleging misrepresentations in
connection with the sale of force-placed collateral protection insurance. The
complaints seek unspecified compensatory and punitive damages. The Wisconsin
case was conditionally class certified by the Wisconsin state court, before
service of the complaint. This case initially was removed by the defendants to
federal court, but has since been remanded to the Circuit Court for Waupaca
County, Wisconsin, where defense motions are now pending to dismiss all claims
and decertify the national class. The Company believes that the ex parte
conditional certification of the class by the Wisconsin state court was
erroneous and that the plaintiffs' claims lack merit. The case filed in the
Circuit Court of the Sixth Judicial Circuit, Champaign County, Illinois,
initially was dismissed by the trial court on the Company's motion. Plaintiffs
then filed amended pleadings, and the Company renewed its motion to dismiss,
which is now pending before the trial court. The action filed in the Circuit
Court of the Eleventh Judicial Circuit in and for Dade County, Florida, has been
stayed. The Company is vigorously defending all of these cases and believes that
none has merit. The Company has not established a specific reserve for these
related actions, because the amount of the Company's liability exposure, if any,
cannot be reasonably estimated.
In August 1996, a plaintiff brought a state class action in the District
Court of Travis County, Texas, 201st Judicial District, against the Company
alleging misrepresentations in connection with the sale of the Company's
recreational vehicle and mobile home insurance products in Texas. The complaint
seeks unspecified compensatory and punitive damages. The Company is vigorously
defending the case both as to the plaintiff's demand for class certification and
on the merits of the claims. The Company has not established a specific reserve
for this action, because the amount of the Company's liability exposure, if any,
cannot be reasonably estimated.
In September 1997, a plaintiff brought a state class action in the United
States District Court the Southern District of Mississippi, Hattiesburg
Division, alleging the failure to disclose information about insurance coverages
and premium structure under policies sold in Mississippi. The Company has denied
all allegations, and is vigorously defending the suit, both as to the
plaintiff's demand for class certification and on the merits of the claims. The
Company has not established a specific reserve for this action, because the
amount of the Company's liability exposure, if any, cannot be reasonably
estimated.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year covered by this report.
11
Supplemental Item. - EXECUTIVE OFFICERS OF THE REGISTRANT
The following table shows the names and ages of all executive officers of
the Company, the positions and offices held by such person and the period during
which each person served as an officer. The term of office of each person is
generally not fixed since each person serves at the discretion of the Board of
Directors of the Company. The information concerning executive officers who are
not directors has been omitted from the registrant's Proxy Statement for the
April 30, 1998 Annual Meeting of Stockholders pursuant to Instruction 3 of
Regulation S-K Item 401(b).
Richard L. Antonini
Age: 55
Officer Since: 1972
Mr. Antonini became Chairman of the Board on December 17, 1991, President
on May 8, 1986 and Chief Executive Officer on July 24, 1986. Before that he
was Executive Vice President and Chief Financial Officer since June 29,
1983. From January 1, 1980 to June 28, 1983, he served as Executive Vice
President and Treasurer. Prior to that, he served as Senior Vice President
and Treasurer. Mr. Antonini has been a Director of the Company since 1973.
Kenneth C. Haines
Age: 38
Officer Since: 1994
Mr. Haines was elected to the office of Controller of the Company on
September 1, 1994 from the position of Assistant Controller. Mr. Haines has
been employed by Foremost Insurance Company, a subsidiary of the Company,
since September 1986.
John J. Hannigan
Age: 50
Officer Since: 1987
Mr. Hannigan was elected to the office of Executive Vice President of the
Company on March 1, 1987. Mr. Hannigan joined Foremost Insurance Company, a
subsidiary of the Company, as Vice President in 1983 and was elected to the
position of Executive Vice President of that Company in 1986.
David A. Heatherly
Age: 47
Officer Since: 1987
Mr. Heatherly was elected to the office of Executive Vice President of the
Company on March 1, 1987. Mr. Heatherly joined Foremost Insurance Company,
a subsidiary of the Company, as Vice President in 1984 and was elected to
the position of Executive Vice President of that company in 1986.
12
Larry J. Orange
Age: 55
Officer Since: 1987
Mr. Orange was elected to the office of Executive Vice President of the
Company on March 1, 1987. Mr. Orange has been employed by Foremost
Insurance Company, a subsidiary of the Company, since 1969 and as a Vice
President since 1980. Mr. Orange is also President of Foremost Financial
Services Corporation. Mr. Orange was elected Director of the Company in
1993.
F. Robert Woudstra
Age: 52
Officer Since: 1983
Mr. Woudstra was elected to the office of Executive Vice President of the
Company on March 1, 1987 and has been Treasurer since June 29, 1983. Mr.
Woudstra has been treasurer of Foremost Insurance Company, a subsidiary of
the Company since 1976. Mr. Woudstra was elected Director of the Company in
1988.
Paul D. Yared
Age: 48
Officer Since: 1982
Mr. Yared was elected to the office of Senior Vice President of the Company
on December 10, 1992 and has been the Company's Secretary and General
Counsel since January 1, 1986. Mr. Yared has been employed as a corporate
attorney for the Company and its subsidiaries since 1974.
13
PART II
Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS
PRICE RANGE OF COMMON STOCK
The Company's common stock has been listed on the New York Stock Exchange
since April 17, 1996 under the symbol "FOM." Prior to April 17, 1996, the
Company's common stock was traded on The Nasdaq Stock Market under the symbol
"FCOA." The Company declared a three-for-one stock split for holders of record
on January 5, 1998. The following table sets forth the high and low sale prices
for the Company's Common Stock for the periods indicated, as reported by the New
York Stock Exchange or The Nasdaq Stock Market, as applicable. The stock prices
shown below have been retroactively adjusted to reflect the three-for-one stock
split.
1997 High Low
- ---- ------- -------
First Quarter............................................. $20.20 $19.05
Second Quarter ........................................... 20.00 17.70
Third Quarter ............................................ 20.31 18.50
Fourth Quarter ........................................... 23.56 19.19
1996 High Low
- ---- ------- -------
First Quarter ............................................ $20.17 $16.92
Second Quarter ........................................... 19.37 17.32
Third Quarter............................................. 19.05 18.05
Fourth Quarter ........................................... 20.00 18.00
The number of stockholders of record of the common stock was approximately
1,154 on March 2, 1998.
DIVIDENDS
The Company has paid regular cash dividends on its Common Stock each year
since 1978. In 1997 and 1996 the Company paid a regular quarterly dividend of
$.09 per share of Common Stock, an annualized rate of $.36 per share, as
adjusted for the three-for-one stock split. On December 17, 1997, the Company
announced a three-for-one stock split payable on January 20, 1998 to
stockholders of record on January 5, 1998. On February 2, 1998, the Company
declared its first quarter dividend of $.09 per share. The Company expects to
continue to pay dividends but its ability to pay future dividends necessarily
will depend upon its earnings and financial condition.
The Company's principal source of funds for the payment of dividends on its
Common Stock is dividend income from its insurance subsidiaries, including
Foremost Insurance Company. The ability of these insurance subsidiaries to pay
dividends to the Company is governed by applicable insurance laws. The
information in Note 11 of the Consolidated Financial Statements, included at
Item 8. below, explains the current state regulatory requirements that may
restrict the ability of the Company's insurance subsidiaries to pay dividends to
the Company.
14
Item 6. SELECTED FINANCIAL DATA
FIVE YEAR SELECTED FINANCIAL DATA
Consolidated Financial Information 1997 1996 1995 1994 1993
- ----------------------------------- ----------- ----------- ----------- ----------- -----------
(All dollar amounts, except share
data and ratios, in thousands)
Insurance premium written and
assumed - continuing operations .. $ 434,964 $ 421,100 $ 426,988 $ 416,244 $ 397,750
Net insurance premium earned -
continuing operations ............ $ 429,210 $ 427,565 $ 426,282 $ 409,929 $ 399,640
Total income - continuing operations $ 469,756 $ 461,126 $ 457,453 $ 440,126 $ 433,070
Net income - continuing operations . $ 50,756 $ 23,168 $ 43,238 $ 27,436 $ 30,048
Net income ......................... $ 50,866 $ 23,529 $ 45,325 $ 29,697 $ 32,240
Earnings per share - continuing
operations ....................... $ 1.82 $ 0.79 $ 1.41 $ 0.86 $ 0.93
Earnings per share ................. $ 1.82 $ 0.80 $ 1.48 $ 0.93 $ 1.00
Total assets ....................... $ 744,780 $ 721,578 $ 746,052 $ 703,751 $ 725,253
Invested assets - continuing
operations - at cost ............. $ 481,300 $ 468,559 $ 472,745 $ 433,373 $ 445,808
Invested assets - continuing
operations - at market ........... $ 513,460 $ 494,775 $ 494,346 $ 428,724 $ 466,888
Short-term debt outstanding ........ $ 2,687 $ 2,434 $ 4,199 $ 9,981 $ 7,795
Long-term debt outstanding ......... $ 89,514 $ 92,417 $ 95,048 $ 97,425 $ 105,568
Stockholders' equity ............... $ 255,451 $ 231,422 $ 244,197 $ 206,626 $ 213,122
Stockholders' equity per share ..... $ 9.22 $ 8.07 $ 8.11 $ 6.64 $ 6.63
Return on beginning stockholders'
equity - continuing operations .... 21.9% 9.5% 20.9% 12.9% 16.2%
Return on beginning stockholders'
equity ............................ 22.0% 9.6% 21.9% 13.9% 17.4%
Average shares outstanding ......... 27,891,076 29,593,929 30,665,397 31,810,752 32,159,553
Shares outstanding at year end ..... 27,700,872 28,686,972 30,104,340 31,097,988 32,163,429
Dividends paid per share ........... $ 0.36 $ 0.36 $ 0.36 $ 0.36 $ 0.36
Price range - high ................. $ 23.57 $ 20.17 $ 17.33 $ 12.50 $ 12.06
Price range - low .................. $ 17.71 $ 16.92 $ 11.83 $ 10.08 $ 10.50
Price/earnings ratio ............... 10-13 21-25 8-12 11-13 11-12
Number of stockholders ............. 1,147 1,202 1,272 1,338 1,381
Number of employees ................ 1,156 1,077 1,015 1,008 1,093
Property and Casualty Information:
Statutory policyholders' surplus ... $ 220,522 $ 201,320 $ 200,458 $ 181,269 $ 176,245
Ratio of net premiums written to
statutory policyholders' surplus .. 1.9 2.0 2.1 2.1 2.1
Ratio of loss and loss expense
reserves to statutory
policyholders' surplus ............ 0.4 0.5 0.5 0.5 0.6
Combined loss and expense
ratio-GAAP basis .................. 91.0% 98.7% 91.1% 96.3% 95.9%
15
The selected financial data shown on the prior page for the Company for
each of the five years in the period ended December 31, 1997, has been derived
from consolidated financial statements of the Company, which have been audited
by the Company's independent auditors, BDO Seidman, LLP. The data should be read
in conjunction with the consolidated financial statements and related notes
thereto, Supplementary Financial Data and "Management's Discussion and Analysis
of Financial Condition and Results of Operations" presented in Items 7 and 8 of
this Form 10-K. All share and per share data have been restated in accordance
with Financial Accounting Standards Board No. 128 and retroactively adjusted for
the increased shares resulting from the three-for-one stock split distributed in
January 1998.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following section provides a narrative discussion about the Company's
results of operation and financial condition. The following should be read in
conjunction with the Company's Consolidated Financial Statements and related
notes thereto.
RESULTS OF OPERATIONS
Written Premium
Written premium for the property and casualty segment was $435 million in
1997, which represents an increase of 3.3% over the $421 million written in
1996. The 1996 writings were 1.4% less than the $427 million written in 1995,
while 1995's total was up 2.6% from the previous year.
Within the property and casualty segment, combined written premium for the
Company's specialty line products of mobile home, motorhome and travel trailer
increased 2% in 1997 to $405.1 million following a decline of 1% in 1996 and an
increase of 3% in 1995 when written premium in these lines was $397 million and
$401.4 million, respectively. Over the years, the growth in these lines has been
slowed by the Company's catastrophe exposure management programs. The Company's
BASIC product, a dwelling fire and ACV homeowners insurance program distributed
through independent agents, experienced solid growth in 1997. This specialty
product had $7.4 million written in 1997. The Company expects moderate growth in
these specialty lines in the future as it continues to pursue profitable
opportunities.
The Company's standard lines of automobile and homeowners insurance
combined for total written premium of $24.6 million in 1997, an increase of 37%
over the $18 million written in 1996, which was 7% less than the $19.3 million
written in 1995. The Company's direct marketing of auto and homeowners insurance
through third-party endorsements expanded during 1997 as these programs are now
available in 24 states. The Company also signed more third party endorsements
during 1997. The Company believes that these endorsements provide favorable
growth opportunities in the future.
On October 13, 1997, the Company signed an extension of the exclusive
endorsement of the Company by the American Association of Retired Persons
(AARP), to offer mobile home insurance to its members through the year 2004. The
results of this program, since its inception in 1989, encouraged both parties to
extend their relationship five years beyond the original agreement's expiration
date.
Underwriting Results and Loss Reserves
The combined loss and expense ratio for the Company's property and casualty
insurance operations was 91.0% in 1997 compared to 98.7% in 1996 and 91.1% in
1995. The underwriting profit from these operations was $38.6 million in 1997,
$5.5 million in 1996, and $38.2 million in 1995. The Company believes that its
emphasis on rate adequacy, disciplined underwriting, catastrophe exposure
16
management and strategic expense reduction and management programs, have
contributed significantly to the Company's positive underwriting results over
the last several years.
Catastrophe losses' impact on property and casualty results declined in
1997 to, net of reinsurance, $36.9 million, compared to the record levels in
1996 of $69.7 million and $51.9 million in 1995. The only major storms of 1997
occurred in the Northwest during the first quarter of the year. The record
catastrophe losses of 1996 resulted from significant storms in the Northwest and
Northeast portions of the country during the first and fourth quarters. These
storms created massive damage in Oregon, Washington, Pennsylvania and New York.
Hurricane Fran also struck North Carolina in the third quarter of 1996. During
1995, hurricanes Opal and Erin along with spring and winter storms in
California, Oregon and Washington, contributed to the third worst catastrophe
year in the Company's history.
Management monitors its exposure to catastrophic risk and has taken
aggressive action in coastal areas and earthquake prone areas to reduce the
Company's risk to hurricane and earthquake losses. During 1997, the Company took
action against another catastrophic risk by starting the process of eliminating
flood from the majority of the Company's mobile home policies. By the end of
1998, the Company anticipates that approximately 80% of its policies will have
flood coverage removed, which will dramatically reduce the Company's exposure to
loss due to flooding. In 1995, the Company started a coastal strategy which
eliminated approximately 24,000 policies in the coastal counties from Maine to
Texas. This program of coastal policy reduction was substantially completed by
June 30, 1996. The Company has further reduced its exposure to hurricane loss by
not writing any significant amount of new business in Florida since 1992.
Management has pursued the reduction of the Company's earthquake exposure by
non-renewing 21,000 policies in California with units greater than $50,000 in
value since 1994. Attrition also has contributed to the reduction of earthquake
exposure, pushing the total policy decline in California to approximately 50,000
since 1994. Since July 1, 1995, the Company's policies only provide earthquake
coverage on an optional basis, which has reduced exposure to catastrophic loss
due to earthquakes. Management will continue to take appropriate actions in the
future where deemed necessary.
Management is committed to controlling expenses and has aggressively
managed the Company's acquisition costs and general and administrative expenses.
All expense categories are closely monitored and employees are constantly
challenged to develop ideas and programs to continually improve results. These
actions have helped reduce the Company's expense ratio from a high of 42.7 in
1988 to its current level of 34.0 in 1997.
The Year 2000 issue is the result of computer programs being written using
two digits to define the applicable year instead of four. The problem exists
when time sensitive software may recognize a date using "00" as the year 1900
rather than the year 2000. By nature, the insurance industry is highly dependent
upon computer systems because of significant transaction volumes and a date
dependency for many of its applications. The Company has done a comprehensive
review of its computer programs to identify the systems that would be affected
by the Year 2000 problem. The Company has a comprehensive, written plan, which
regularly is updated and monitored by technical personnel. Plan status is
regularly reviewed by management of the Company. The Company also has hired an
outside consulting firm to assist in this conversion process and is half way
through the modification of its computer programs to the four digit fields.
Management also has reviewed its Year 2000 exposure to third party customers,
distributors, suppliers and banking institutions. They have determined the
exposure to be limited but are in the process of obtaining certification of
compliance letters.
The Company will continue to assess the impact of the Year 2000 issue on
the remainder of its computer-based systems and applications throughout 1998 and
17
1999. The Company's goal is to perform tests of its systems and applications
during 1998 and 1999 and to have all systems and applications compliant with the
century change by the middle of 1999, allowing the remaining time to be used for
validation and testing.
The Company spent approximately $3.8 million to remediate Year 2000 issues
in 1997 and expects that it will spend approximately $4 million and $1 million
in 1998 and 1999, respectively. These costs primarily will consist of
professional fees paid to third party providers of remedial services. It is the
Company's policy to expense all costs associated with these systems changes. The
Company also may invest in new or upgraded technology which has definable value
lasting beyond 2000. In these instances, where Year 2000 compliance is merely
ancillary, the Company may capitalize and depreciate such an asset over its
estimated useful life.
Based on currently available information, management does not presently
anticipate that the costs to address the Year 2000 issues will have a material
adverse impact on the Company's financial conditions, results of operations or
liquidity.
The costs of the project and the date on which the Company believes it will
complete the Year 2000 modifications are based on management's best estimates.
There can be no guarantee that these estimates will be achieved and actual
results could differ from those anticipated. Specific factors that might cause
differences include, but are not limited to, the ability of other companies on
which the Company's systems rely to modify or convert their systems to be Year
2000 compliant, the ability to locate and correct all relevant computer codes
and similar uncertainties.
In conjunction with the new direct marketing of automobile and homeowners
insurance, the Company has invested in a new policy processing system that is
being developed and is expected to be operational in the fall of 1998. The $4.1
million cost incurred in connection with this system during 1997 was capitalized
and will be expensed over the life of the system starting in 1998. The total
cost of the project is currently estimated to be approximately $12 million.
The Company considers that the effects of inflation are unlikely to be a
significant factor in the results of operations given the relatively short term
nature of premiums receivable and expected loss payments from reserves for
losses and loss expenses. The anticipated effect of inflation is implicitly
considered when estimating reserves for losses and loss expenses, product
pricing and investment decisions.
The Company engages an outside actuarial firm to attest to the adequacy of
its carried property and casualty reserves. This firm has rendered their opinion
for the year ended December 31, 1997, and they attest to the adequacy of the
Company's held reserves. The Company is committed to maintaining adequate loss
reserves and places a high priority on balance sheet integrity.
The Company discontinued writing private credit insurance in 1985, and
established a reserve to cover anticipated losses from the run-off of the
product. The experience in the run off of this business has been positive, and
accordingly, management reduced the reserve by $650,000 in both 1997 and 1996,
and $1.9 million in 1995. These reductions are not reflected in the underwriting
results of the insurance operations, but are a component of the parent company
and other operational results. The majority of these policies will run off in
1999. Management believes that the aggregate reserves for this discontinued
product are adequate at December 31, 1997, but will continue to review and
adjust such reserves as needed.
Sale of Life Insurance Subsidiary
On June 11, 1996, the Company completed the sale of its life insurance
subsidiary, Foremost Life Insurance Company, to Woodmen Accident and Life
18
Company. The sale yielded net after-tax proceeds of $17.4 million and the
Company incurred an after- tax loss of $698,000 as a result of the sale. The
majority of the net proceeds were utilized to repurchase the Company's common
stock under the stock buy-back program approved by the Board of Directors. The
financial results of the life insurance segment and the sale are reflected in
the financial statements as discontinued operations.
In 1989 and 1990, Foremost Life Insurance Company assumed credit life
premiums under various reinsurance treaties. In the fourth quarter of 1990, the
ceding companies were declared insolvent and placed into liquidation. In
accordance with the sales document, in June of 1996 the amount reserved to cover
these reinsurance treaties was transferred to an escrow account. On July 31,
1997, the Company and the Liquidator settled all outstanding reinsurance and
legal issues regarding these treaties. The escrow account was closed with the
Company recording an after tax gain of $110,000 which is included in
discontinued operations.
LIQUIDITY AND CAPITAL RESOURCES
Cash Flow
In the years 1995 through 1997, the Company and its subsidiaries generated
positive cash flow of $130.6 million from operations, and paid back $13.2
million on long-term borrowings. The Company paid $31.8 million in dividends
during the same period and repurchased $62.5 million of its common stock. For
year to year comparisons of cash flow items, see the "Consolidated Statements of
Cash Flows" on page 27.
The Company expects continuing positive cash flow from operations.
Additionally, the investment portfolios of the Company's insurance operations
have been structured to provide liquidity for operations. The portfolios are
structured so that on average, approximately $27 million of investments mature
every year over the next ten years, and are available for reinvestment or use in
operations as required. The insurance products written by the Company's
insurance subsidiaries are primarily property coverages which result in rapid
claim payments. The average maturity of investments is between five and six
years, which provides adequate asset/liability matching.
Significant cash requirements in the future include the Year 2000 and new
policy processing system projects that were discussed previously, along with the
construction of a new 98,000 sq. ft. building in the Company's Kraft Lake Office
Park to be used in operations. This $10 million project is to be completed by
the fall of 1998 and will be funded from operations. As of December 31, 1997,
$1.5 million of construction in progress is included in real estate and
equipment. The Company believes that its liquid assets plus cash flow from
operations will be adequate to meet all foreseeable cash requirements.
In February 1994, the Company's Board of Directors approved a stock
buy-back program on a pre split basis, of up to 1 million shares, which was
raised to 2 million shares by subsequent Board approval of 500,000 share
increments in March and December of 1996. In December 1997, the Board of
Directors raised the program to 3 million shares by authorizing the repurchase
of an additional 1 million shares. Since the inception of this buy-back program,
the Company has repurchased 1,762,238 shares. During 1997, the Company
repurchased 480,258 of its shares, of which 143,646 were repurchased from
employees who exercised stock options during the year. After the adjustment for
the three-for-one stock split in January 1998, the total shares available under
the authorization for the repurchase program is 3,666,786 shares. The Company
will continue to evaluate the purchase of its common stock from excess capital.
At December 31, 1997, the Company's capital structure consisted of
27,700,872 common shares outstanding, which reflects the Company's three-for-one
stock split payable on January, 20 1998.
19
The Company's insurance subsidiaries are subject to certain restrictions on
their ability to transfer funds to the parent company in the form of cash
dividends, loans or advances without regulatory approval. These restrictions are
not expected to impair the ability of the Company to meet its cash obligations.
Capital
In 1995, the Company negotiated and entered into a credit agreement under
which its lenders committed to provide a seven year non-amortizing $50 million
term loan and a five year $40 million revolving credit facility. At year end
1997, $50 million remained outstanding on the term loan, and $8 million was
outstanding on the revolving credit facility. In addition to the remaining $32
million available under the revolving credit facility, the Company has an
uncommitted line of credit facility which may not exceed $20 million at any one
time. This unsecured credit agreement expires on June 30, 1998.
During 1995, the Company entered into an interest rate swap agreement to
effectively fix the interest rate at 7.15% on the $58 million outstanding under
the new credit agreement. The swap will expire on August 31, 2000. In November
1997, the swap agreement was amended with the following changes: the interest
rate was dropped to 7.095%; the maturity was extended to August 31, 2002 and the
notional amount will be decreased from $58 million to $50 million on August 31,
2000. The interest rate swaps are non-amortizing. The Company's exposure to
credit risk is limited to interest movements and is considered to be negligible.
The Company does not hold or issue any other forms of derivative financial
instruments.
INVESTMENTS
After-tax investment income decreased by 3% in 1997, after increasing by 1%
in 1996 and 7% in 1995. The decline in 1997 and the relatively flat results for
1996 were primarily due to the impact of catastrophe loss payments and common
stock buy-backs on the Company's cash flow and investable asset base in the
first quarter of 1997 and for the entire year of 1996. Declining interest rates
also impacted the investment income results of 1997 and 1996. The increase in
1995 resulted from positive cash flow generated from the strong underwriting
performance during that year.
The relatively strong stock market and the Company's investing strategy
allowed unrealized capital gains to grow to $32 million at year end 1997
compared to $25 million at year end 1996 and $21 million at year end 1995. The
Company was also able to realize after-tax gains of $7.9 million in 1997
compared to $2.0 million in 1996 and $312,000 in 1995.
The Company's financial results over the last several years allows
management to take a longer term, total return view of investments. As
opportunities become available, the Company has and expects to continue the
strategy of increasing its asset allocation to total return investments. These
investments consist of common and preferred stock as well as lower-rated bonds
and other assets that achieve equity-like returns over a market cycle.
At December 31, 1997 the Company held securities in its investment
portfolio which were either unrated or less than investment grade, high-yield
corporate debt securities, including certain preferred stocks and limited
partnerships. These securities had a cost basis of $31.5 million, with an
aggregate market value of $33.9 million and none of them individually exceeded
$5.8 million. These securities have different risks than other investment grade
securities. Risk of loss upon default by the borrower is greater with these
investments than with other corporate or governmental debt securities because
these securities are generally unsecured and are often subordinated to other
creditors of the issuer. These issuers usually have high levels of indebtedness
20
and are more sensitive to adverse economic conditions than are investment grade
issuers.
The remaining three real estate properties which were foreclosed upon in
1991 totaling $3.8 million were sold or disposed of during 1996 without any
adjustments to their carrying values. No adjustments were made to the carrying
values of these foreclosed assets during 1995. The Company has no further
foreclosed real estate, nor are any of its real estate related securities in
default at December 31, 1997.
In accordance with FASB Statement No. 115, "Accounting for Certain
Investments in Debt and Equity Securities," the Company has classified a portion
of its fixed maturity investments and its equity securities into a category
entitled "securities available for sale" which are adjusted to reflect market
value. Due to the restrictive definition of assets qualifying to be categorized
as held to maturity, most of the Company's fixed investment securities are
considered to be available for sale, and are therefore adjusted to reflect
market values. Unrealized investment gains and losses on securities available
for sale are credited or charged directly to stockholders' equity net of
applicable tax provisions or credits. The net unrealized gain on securities
available for sale was an $20.9 million at December 31, 1997, and $16.4 million
at December 31, 1996. Although the Company has the general intent and ability to
hold most of its fixed maturities to maturity, sales may be made from this
category due to changes in market conditions, relative yields available, tax
planning and asset/liability management considerations. Since the Company does
not purchase fixed maturity investments with a view to resale, the "available
for sale" classification does not denote a trading account.
At December 31, 1997, the Company had $29.1 million of its consolidated
assets in cash and other short-term investments.
INCOME TAXES
In accordance with FASB Statement No. 109, "Accounting for Income Taxes,"
the Company has recognized certain tax assets whose realization depends upon
generating future taxable income. The Company believes that it will realize
these tax assets through the generation of future taxable income and other tax
planning strategies. There are no tax credit or capital loss carryforwards as of
December 31, 1997.
LITIGATION
The Company and its subsidiaries routinely are engaged in litigation as
plaintiff and defendant in the normal course of business. In the opinion of
management, all litigation matters are not expected to have a material adverse
effect on the Company's consolidated financial position, operating results, and
cash flows. The aggregate ultimate liability, if any, of the Company and its
subsidiaries for litigation is not determinable at December 31, 1997.
For further discussion of the Company's litigation matters, please refer to
Part 1, Item 3.
RISK BASED CAPITAL
The National Association of Insurance Commissioners requires property and
casualty insurance companies to calculate and report information under a Risk
Based Capital ("RBC") formula in their statutory annual statements. The RBC
requirements are intended to assist regulators in identifying inadequately
capitalized companies. The RBC calculation is based on the type and mix of risks
inherent in the companies business and includes components for underwriting,
asset, interest rate and other risks. The Company's insurance subsidiaries
21
substantially exceeded their RBC statutory surplus standards as of December 31,
1997.
RECENT ACCOUNTING PRONOUNCEMENTS
As required, the Company adopted and incorporated into its Consolidated
Financial Statements for the year ended December 31, 1997, the following two
Financial Accounting Standards Board ("FASB") Statements; Statement No. 125,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities", and Statement No. 128, "Earnings Per Share." The adoption of
these pronouncements did not have a significant impact on the Company's
financial statements.
During 1997, FASB issued two statements that were applicable to the
Company. Statement No. 130, "Reporting Comprehensive Income," establishes
standards for reporting comprehensive income and its components. Statement No.
131, "Disclosures about Segments of an Enterprise and Related Information,"
establishes standards for the way businesses report information about operating
segments. The American Institute of Certified Public Accountants ("AICPA")
issued a Statement of Position, "Accounting by Insurance and Other Enterprises
for Guaranty-Fund and Certain Other Insurance-Related Assessments," which
establishes standards of accounting for these items. These new statements and
standards are effective for fiscal years beginning after December 31, 1997 and
will not have a material impact on the Company's financial statements upon
adoption.
22
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Consolidated Financial Statements and Supplementary Financial Data
Page No.
Financial Statements:
Consolidated Balance Sheets at December 31, 1997 and 1996 24
Consolidated Statements of Income for the years ended
December 31, 1997, 1996 and 1995 25
Consolidated Statements of Stockholders' Equity for the years
ended December 31, 1997, 1996 and 1995 26
Consolidated Statements of Cash Flows for the years ended
December 31, 1997, 1996 and 1995 27
Property and Casualty Statements of Income for the years
ended December 31, 1997, 1996 and 1995 28
Parent Company and Other Statements of Operations for the
years ended December 31, 1997, 1996 and 1995 28
Notes to Consolidated Financial Statements 29-52
Independent Accountants' Report 53
Supplementary Data - Results by Quarter 54
23
FOREMOST CORPORATION OF AMERICA AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 1997 1996
--------- ---------
(In thousands, except share data) Assets:
Investments-
Fixed maturities held to maturity ..................... $ 1,974 $ 2,342
Securities available for sale:
Fixed maturities ..................................... 376,868 339,860
Equity securities .................................... 83,677 93,485
Mortgage loans and land contracts on real estate ...... 12,350 12,222
Investment real estate (net of $1,412 and $1,600
accumulated depreciation) ............................ 11,920 15,169
Short-term investments ................................ 26,656 30,746
--------- ---------
Total investments .................................... 513,445 493,824
Cash ................................................... 2,409 5,141
Accrued investment income .............................. 6,293 5,565
Premiums receivable (net of $75 allowance for
uncollectible accounts, respectively) ................. 71,541 68,076
Due from reinsurance companies ......................... 20,645 21,416
Other receivables (net of $20 allowance for
uncollectible accounts, respectively) ................. 2,568 5,125
Prepaid policy acquisition costs ....................... 74,179 70,231
Prepaid reinsurance premiums ........................... 979 1,056
Real estate and equipment .............................. 38,341 34,439
Other assets ........................................... 14,380 16,705
--------- ---------
Total assets .......................................... $ 744,780 $ 721,578
========= =========
Liabilities:
Unearned premium ....................................... $ 246,429 $ 241,313
Insurance losses and loss adjustment expenses .......... 82,722 93,420
Accounts payable and accrued expenses .................. 33,022 34,053
Notes and other obligations payable .................... 92,201 94,851
Income taxes ........................................... 20,853 11,456
Other liabilities ...................................... 14,102 15,063
--------- ---------
Total liabilities ..................................... 489,329 490,156
--------- ---------
Stockholders' Equity:
Common stock $1 par - shares authorized 35,000,000,
issued 32,467,000 and 14,000,000, respectively ........ 32,467 14,000
Additional paid-in capital ............................. 120,536 138,852
Unrealized appreciation of securities available
for sale, net of applicable taxes ..................... 20,894 16,423
Retained earnings ...................................... 237,621 196,818
Restricted stock - deferred compensation ............... (4) (4)
--------- ---------
Total ................................................. 411,514 366,089
Treasury stock at cost, 4,766,376 and 4,437,676 shares . (156,063) (134,667)
--------- ---------
Total stockholders' equity ............................ 255,451 231,422
--------- ---------
Total liabilities and stockholders' equity ............ $ 744,780 $ 721,578
========= =========
<FN>
- ---------
See accompanying notes to consolidated financial statements
</FN>
24
FOREMOST CORPORATION OF AMERICA AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Year Ended December 31, 1997 1996 1995
--------- --------- ---------
(In thousands except per share data)
Income:
Property and casualty premium earned ........ $ 429,210 $ 427,565 $ 426,282
Net investment income ....................... 25,813 27,116 27,308
Realized gains .............................. 12,181 3,098 480
Other ....................................... 2,552 3,347 3,383
--------- --------- ---------
Total income .............................. 469,756 461,126 457,453
--------- --------- ---------
Expense:
Insurance losses and loss expenses .......... 244,608 276,175 244,081
Amortization of prepaid policy
acquisition costs ......................... 125,760 122,795 125,115
Operating ................................... 20,188 25,101 18,183
Interest .................................... 8,307 8,191 9,711
--------- --------- ---------
Total expense ............................. 398,863 432,262 397,090
--------- --------- ---------
Income before taxes ..................... 70,893 28,864 60,363
Income tax provision .......................... (20,137) (5,696) (17,125)
--------- --------- ---------
Net income - continuing operations .......... 50,756 23,168 43,238
Net income - discontinued operations .......... 110 361 2,087
--------- --------- ---------
Net income .................................. $ 50,866 $ 23,529 $ 45,325
========= ========= =========
Earnings per share of common stock:
Net income - continuing operations .......... $ 1.82 $ 0.79 $ 1.41
Net income - discontinued operations ........ -- 0.01 0.07
--------- --------- ---------
Net income ................................ $ 1.82 $ 0.80 $ 1.48
========= ========= =========
Earnings per share of common stock - diluted
Net income - continuing operations .......... $ 1.79 $ 0.77 $ 1.39
Net income - discontinued operations ........ -- 0.01 0.07
--------- --------- ---------
Net income ................................ $ 1.79 $ 0.78 $ 1.46
========= ========= =========
<FN>
- ---------
See accompanying notes to consolidated financial statements
</FN>
25
FOREMOST CORPORATION OF AMERICA AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF
STOCKHOLDERS' EQUITY
Unrealized Restricted
Additional Appreciation Stock- Total
Common Paid-in (Depreciation) Retained Deferred Treasury Stockholders'
Stock Capital of Securities Earnings Compensation Stock Equity
--------- ---------- -------------- ---------- ------------- --------- ------------
(In thousands except share data)
Balances - January 1, 1995 ................ $ 14,000 $ 139,380 $ (3,365) $ 149,671 $ (16)$ (93,044) $ 206,626
Net income ................................ 45,325 45,325
Unrealized appreciation of
securities available for sale,
net of tax .............................. 17,167 17,167
Stock Options Exercised
Shares Issued .......................... (10) 77 67
Shares Repurchased ..................... (81) (81)
Cash dividends - $.36 per share ........... (11,052) (11,052)
Purchase of treasury stock ................ (14,269) (14,269)
Other ..................................... (26) 11 429 414
Balances- --------- ---------- -------------- ---------- ------------ -------- ------------
December 31, 1995 ....................... 14,000 139,344 13,802 183,944 (5) (106,888) 244,197
Net income ................................ 23,529 23,529
Unrealized appreciation of
securities available for sale,
net of tax .............................. 2,621 2,621
Stock Options Exercised
Shares Issued .......................... (595) 4,005 3,410
Shares Repurchased ..................... (3,256) (3,256)
Cash dividends - $.36 per share ........... (10,655) (10,655)
Purchase of treasury stock ................ (28,856) (28,856)
Other ..................................... 103 1 328 432
Balances- --------- ---------- -------------- --------- ----------- --------- -----------
December 31, 1996 ....................... 14,000 138,852 16,423 196,818 (4) (134,667) 231,422
Net income ................................ 50,866 50,866
Unrealized appreciation of
securities available for sale,
net of tax .............................. 4,471 4,471
Stock Options Exercised
Shares Issued .......................... (4) 5,836 5,832
Shares Repurchased ..................... (8,209) (8,209)
Three-for-one stock split ................. 18,467 (18,467)
Cash dividends - $.36 per share ........... (10,063) (10,063)
Purchase of treasury stock ................ (19,369) (19,369)
Other ..................................... 155 346 501
Balances- --------- ---------- -------------- --------- ----------- --------- -----------
December 31, 1997 ....................... $ 32,467 $ 120,536 $ 20,894 $ 237,621 $ (4) $(156,063) $ 255,451
========= ========== ============== ========= =========== ========= ===========
<FN>
- ---------
See accompanying notes to consolidated financial statements.
</FN>
26
FOREMOST CORPORATION OF AMERICA AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31, 1997 1996 1995
--------- --------- ---------
(In thousands)
Operating Activities:
Net income from continuing operations ........ $ 50,756 $ 23,168 $ 43,238
Adjustments to reconcile net income to net
cash provided by operating activities:
Change in:
Unearned premium .......................... 5,116 (7,640) (901)
Insurance losses and loss adjustment exp... (10,698) (351) 3,049
Prepaid policy acquisition costs .......... (3,948) 2,329 (175)
Premiums receivable ....................... (3,465) 2,553 (2,695)
Other receivables ......................... 3,152 3,166 24,049
Accrued investment income ................. (728) 310 134
Accounts payable and accrued expenses ..... (1,031) (1,675) 1,567
Income tax liability ...................... 3,261 2,353 (486)
Provision for private credit
insurance loss reserves .................. (714) 193 (1,381)
Other - net ............................... 2,758 (4,288) 4,579
Provision for depreciation and amortization 2,087 2,108 2,460
Amortization of fixed maturities ........... 744 1,061 1,725
Deferred income taxes ...................... 3,665 (2,639) (364)
Net realized gains and losses .............. (12,181) (3,098) (479)
--------- --------- ---------
Net cash from operating activities ........ 38,774 17,550 74,320
--------- --------- ---------
Investing Activities:
Purchases of securities and loans made ....... (155,606) (128,857) (170,811)
Purchases of real estate and equipment ....... (6,549) (495) (189)
Sales of securities .......................... 97,984 77,882 106,010
Maturities of securities and receipts
from repayments of loans .................... 47,719 46,761 54,022
Sales of real estate and equipment ........... 5,312 4,023 2,312
Net proceeds from sale of subsidiary ......... -- 17,437 --
(Increase) decrease in short-term investments 4,090 9,022 (31,104)
--------- --------- ---------
Net cash from (for) investing activities .... (7,050) 25,773 (39,760)
--------- --------- ---------
Financing Activities:
Repayments of long-term debt ................. (2,650) (2,396) (8,159)
Acquisition of treasury shares ............... (19,369) (28,855) (14,269)
Dividends paid ............................... (10,063) (10,655) (11,052)
Increase (decrease) in short-term debt ........ -- (2,000) --
Exercise of stock options: Receipts ......... 5,836 4,005 77
Exercise of stock options: Repurchases ...... (8,210) (3,256) (81)
--------- --------- ---------
Net cash for financing activities ........... (34,456) (43,157) (33,484)
--------- --------- ---------
Cash increase (decrease) ............ (2,732) 166 1,076
Cash at beginning of year ..................... 5,141 4,975 3,899
--------- --------- ---------
Cash at end of year ................. $ 2,409 $ 5,141 $ 4,975
========= ========= =========
<FN>
- ---------
See accompanying notes to consolidated financial statements.
</FN>
27
PROPERTY AND CASUALTY INSURANCE
STATEMENTS OF INCOME
Year Ended December 31, 1997 1996 1995
--------- --------- ---------
(In thousands)
Premium written and assumed ................... $ 434,964 $ 421,100 $ 426,988
Less reinsurance ceded ........................ 647 1,147 1,542
--------- --------- ---------
Net premium written ......................... $ 434,317 $ 419,953 $ 425,446
========= ========= =========
Premium earned ................................ $ 429,210 $ 427,565 $ 426,282
--------- --------- ---------
Insurance losses and loss expenses ............ 244,608 276,175 244,081
Amortization of prepaid policy acquisition costs 125,772 122,860 125,266
Operating expenses ............................ 20,220 23,072 18,724
--------- --------- ---------
Total losses and expenses ................... 390,600 422,107 388,071
--------- --------- ---------
Underwriting income ....................... 38,610 5,458 38,211
Investment and other income, less expenses .... 25,880 26,838 27,472
Realized gains ................................ 12,181 3,198 480
--------- --------- ---------
Income before taxes ......................... 76,671 35,494 66,163
Income tax provision .......................... (22,453) (8,300) (19,315)
--------- --------- ---------
Net income .................................. $ 54,218 $ 27,194 $ 46,848
========= ========= =========
PARENT COMPANY AND OTHER
STATEMENTS OF OPERATIONS
(Excluding equity in income of
consolidated subsidiaries)
Year Ended December 31, 1997 1996 1995
--------- --------- ---------
(In thousands)
Income:
Financial service fees and interest ......... $ 730 $ 764 $ 2,061
Commissions ................................. 514 587 503
Other income ................................ 7,513 9,013 7,626
Realized gains (losses) ..................... -- (100) --
--------- --------- ---------
Total income ............................ 8,757 10,264 10,190
--------- --------- ---------
Expense:
Operating ................................... 6,532 9,025 6,616
Interest .................................... 8,003 7,869 9,374
--------- --------- ---------
Total expense ........................... 14,535 16,894 15,990
--------- --------- ---------
Loss before taxes ........................... (5,778) (6,630) (5,800)
Income tax credit ............................. 2,316 2,604 2,190
--------- --------- ---------
Net loss .................................... $ (3,462) $ (4,026) $ (3,610)
========= ========= =========
<FN>
- ----------------
See accompanying notes to consolidated financial statements.
</FN>
28
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES
Business
The Company is a holding company which, through its subsidiaries, provides
property and casualty, and other insurance products to those who buy, sell or
finance mobile homes and recreational vehicles. The Company also writes
automobile and homeowners property and casualty insurance.
Principles of Consolidation
The accounts of the Company and its subsidiaries have been included in the
accompanying financial statements. Intercompany investments and all significant
intercompany balances and transactions have been eliminated in consolidation. To
more clearly reflect the operations of the segments of the consolidated group,
certain intercompany charges, consisting principally of rent, interest and
commissions, have been included in the operating income and expenses of the
segments, but are eliminated from consolidated revenues and expenses.
Insurance Companies
The Company's P&C subsidiaries are included in the accompanying financial
statements in accordance with generally accepted accounting principles for
insurance companies. These principles are summarized as follows:
a. Insurance premium is recognized as income over the term of the policies.
b. Commissions, premium taxes and other costs of acquiring new business have
been deferred and are being amortized by charges to income as the related
premium is earned.
c. The liability for insurance losses and loss adjustment expenses is based
upon (1) accumulation of case estimates for losses reported prior to the
close of the accounting period, (2) estimates of incurred but unreported
losses based upon past experience, and (3) estimates of expenses for
investigating and adjusting claims. The liability for such losses is stated
after estimated recoveries for salvage and subrogation.
Use of Estimates in Preparation of Financial Statements
The preparation of financial statements in accordance with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities, and
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Significant Estimates
The most significant estimates in the Company's balance sheet are the
determination of prepaid policy acquisition costs and the reserve for insurance
losses and loss adjustment expenses. Management's best estimate of prepaid
policy acquisition costs is based on historical studies and assumptions made
regarding costs incurred. Management's best estimate of insurance losses and
loss adjustment expenses is based on past loss experience and consideration of
current claim trends as well as prevailing social, economic and legal
conditions. Although management's estimates currently are not expected to change
in the foreseeable future, the costs the Company will ultimately incur could
differ from the amounts that are assumed to be incurred based on the assumptions
made.
29
Investments
In accordance with Statement of Financial Accounting Standards (SFAS) No.
115, "Accounting for Certain Investments in Debt and Equity Securities," the
Company has classified its investments in fixed maturities and equity securities
into two categories, "fixed maturities held to maturity" and "securities
available for sale." Fixed maturities held to maturity and mortgage loans and
land contracts are reported at amortized cost. The Company expects that the
investments in these categories will be held to maturity and, therefore, no
unrealized gains or losses are recognized on such investments. Securities
available for sale are reported at market value. The unrealized gains and losses
of the investments in this category are credited or charged directly to
stockholders' equity, net of applicable taxes. Although the Company has the
general intent and ability to hold securities segregated as securities available
for sale to maturity, sales from this category may be undertaken due to changes
in market conditions, relative yields available, tax planning and
asset/liability management considerations.
The Company's debt securities investment portfolio is predominantly
comprised of investment grade securities.
Investment real estate consists primarily of land and buildings held for
development and sale. Investment real estate is carried at cost less applicable
accumulated depreciation. Depreciation expense on investment real estate was
$251,000, $249,000 and $232,000 for 1997, 1996 and 1995, respectively.
Short-term investments are reported at cost, which approximates market.
Realized investment gains and losses, based on specific identification of
securities sold, are reported separately, on a pretax basis, as part of total
income.
Reinsurance
The Company carries reinsurance coverages primarily to protect itself
against catastrophic losses, but also to limit losses on individual claims for
benefit payments and certain other risks.
Reinsurance contracts do not relieve the Company from its primary
obligation to the policyholder; consequently, a contingent liability exists to
the extent that losses recoverable under reinsurance treaties are not paid to
the Company by reinsurers. The Company performs due diligence to ensure that
reinsurers with whom the Company has reinsurance contracts are financially able
to perform under the terms of the contract.
In accordance with SFAS No. 113, "Accounting and Reporting for Reinsurance
of Short-Duration and Long-Duration Contracts," the Company's reinsurance
receivables and prepaid reinsurance premiums are reported as assets and are not
netted against unearned premiums and the liability for losses and loss
adjustment expenses.
The Company considers its catastrophe reinsurance costs to be an additional
loss cost. Ceded reinsurance premiums, losses and commissions for these
coverages are combined and presented in the insurance losses and loss expenses
line. All non-catastrophe reinsurance amounts are reflected in their respective
line items in the accompanying Consolidated Statements of Income. References to
reinsurance ceded in the segment Statements of Income are for non-catastrophe
reinsurance only.
30
Fair Value of Financial Instruments
The following methods and assumptions were used to estimate market or fair
value:
Assets-
Investment Securities
Quoted market prices for specific instruments owned, or for
similar securities, are used to determine market value.
Mortgage Loans and Land Contracts
The present value of future cash flows is used to determine
market value. The rates used are the current rates at which loans with
similar terms would be made to borrowers with similar credit ratings.
Short-Term Investments
The recorded book value is presumed to be a reasonable estimate
of market value.
Liabilities-
Mortgage Note
The present value of future cash flows and the prepayment penalty
are used to determine estimated fair value. The rate used was based on
quoted market prices for similar issues.
Variable Rate Notes
For financial instruments bearing variable interest rates, it is
presumed that recorded book values are reasonable estimates of fair
value.
Interest Rate Swap Agreements
The fair value of interest rate swaps is the estimated amount the
Company would pay or receive to terminate the agreement at the
reporting date, taking into account current interest rates.
The fair values for all other financial instruments are reported at their
carrying amounts which approximates market value.
Real Estate and Equipment
Real estate and equipment owned by the Company is carried at cost less
accumulated depreciation. Depreciation is computed over the estimated useful
lives of the assets, primarily by the straight-line method for financial
reporting and accelerated methods for income tax purposes.
The Company capitalizes certain costs associated with software developed
for its own use. Such costs are amortized over the expected useful lives of the
software. These capitalized costs are included in equipment and other.
Income Taxes
The Company accounts for certain income and expenses in different periods
for financial reporting and income tax purposes. Deferred income taxes are
provided in the accompanying financial statements for the temporary differences
between taxes currently payable and taxes based on financial income. The Company
utilizes the liability method to account for deferred income taxes by applying
statutory tax rates in effect at the balance sheet date to differences between
the book cost and tax basis of assets and liabilities. The resulting deferred
tax liabilities or assets are adjusted to reflect changes in tax laws or rates
by means of charges or credits to income tax expense.
31
Advertising
The Company expenses the costs of advertising as incurred. Advertising
expense was $1,836,000 in 1997, $3,375,000 in 1996 and $2,021,000 in 1995.
Supplemental Cash Flow Information
The Company does not consider any of its assets cash equivalents for the
purposes of the Consolidated Statements of Cash Flows.
Interest paid was $8,278,000 in 1997, $8,177,000 in 1996 and $9,089,000 in
1995.
Income taxes paid were $11,950,000, $12,900,000 and $21,557,000 for 1997,
1996, and 1995, respectively.
Earnings Per Share
Earnings per share amounts are computed based on the weighted average
number of common shares outstanding during each year.
Net Outstanding Per-Share
Income Shares Amount
--------- ----------- ----------
For the Year Ended 1995:
Basic EPS ............................... $ 45,325 30,665 $ 1.48
Outstanding Stock
Options ................................. 471
--------- ----------- ----------
Diluted EPS ........................... $ 45,325 31,136 $ 1.46
========= =========== ==========
For the Year Ended 1996:
Basic EPS ............................... $ 23,529 29,594 $ 0.80
Outstanding Stock
Options ................................. 644
--------- ----------- ----------
Diluted EPS ........................... $ 23,529 30,238 $ 0.78
========= =========== ==========
For the Year Ended 1997:
Basic EPS ............................... $ 50,866 27,891 $ 1.82
Outstanding Stock
Options ................................. 555
--------- ----------- ----------
Diluted EPS ........................... $ 50,866 28,446 $ 1.79
========= =========== ==========
All outstanding common share amounts, additional paid-in capital and
related earnings per share calculations have been retroactively adjusted to
reflect the three-for-one stock split distributed in January 1998, except for
treasury shares.
Credit Risk
The Company performs ongoing risk and credit evaluations of its agents and
insureds. Insurance is written throughout the United States with concentration
in the southern and southwestern states.
32
The Company primarily utilizes the services of one banking institution for
its cash depository accounts. The Company performs risk and credit evaluations
of this institution on a routine basis.
Reclassifications
Certain reclassifications have been made in the 1996 and 1995 financial
statements to conform to those classifications used in 1997.
33
NOTE 2 - INVESTMENTS
The amortized cost and estimated market values of investments in financial
instruments held by the Company are as follows:
Gross Gross
Amortized Unrealized Unrealized Market
December 31, 1997 Cost Gains Losses Value
--------- ---------- ---------- ----------
(In thousands)
Fixed maturities held to maturity:
Bonds:
Obligations of states and
political subdivisions ........ $ 1,974 $ 50 $ (35) $ 1,989
--------- --------- --------- ---------
Total fixed maturities held
to maturity ................. 1,974 50 (35) 1,989
--------- --------- --------- ---------
Securities available for sale:
Fixed maturities:
Bonds:
U.S. Treasury Securities
and obligations of U.S.
government agencies .......... 72,468 1,941 (8) 74,401
Obligations of states and
political subdivisions ....... 257,885 10,742 (182) 268,445
Corporate securities .......... 26,347 969 (15) 27,301
Mortgage-backed securities .... 5,980 115 (37) 6,058
--------- --------- --------- ---------
Total bonds .................. 362,680 13,767 (242) 376,205
Redeemable preferred stocks .... 649 14 -- 663
--------- --------- --------- ---------
Total fixed maturities
available for sale ........... 363,329 13,781 (242) 376,868
--------- --------- --------- ---------
Equity securities:
Common stocks .................. 49,986 20,175 (3,330) 66,831
Preferred stocks ............... 15,085 1,843 (82) 16,846
--------- --------- --------- ---------
Total equity securities
available for sale ........... 65,071 22,018 (3,412) 83,677
--------- --------- --------- ---------
Mortgage loans and land contracts 12,350 995 -- 13,345
Short-term investments ........... 26,656 -- -- 26,656
--------- --------- --------- ---------
Total financial assets .......... $ 469,380 $ 36,844 $ (3,689) $ 502,535
========= ========= ========= =========
34
Gross Gross
Amortized Unrealized Unrealized Market
December 31, 1996 Cost Gains Losses Value
--------- ---------- ---------- ---------
(In thousands)
Fixed maturities held to maturity:
Bonds:
Obligations of states and
political subdivisions ........ $ 2,342 $ 59 $ (60) $ 2,341
-------- --------- --------- ---------
Total fixed maturities held
to maturity ................. 2,342 59 (60) 2,341
-------- --------- --------- ---------
Securities available for sale:
Fixed maturities:
Bonds:
U.S. Treasury Securities
and obligations of U.S.
government agencies .......... 68,148 1,695 (33) 69,810
Obligations of states and
political subdivisions ....... 229,375 8,311 (259) 237,427
Corporate securities .......... 29,612 927 (95) 30,444
Mortgage-backed securities .... -- -- -- --
--------- --------- --------- ---------
Total bonds .................. 327,135 10,933 (387) 337,681
Redeemable preferred stocks .... 2,187 13 (21) 2,179
-------- --------- --------- ---------
Total fixed maturities
available for sale ........... 329,322 10,946 (408) 339,860
-------- --------- --------- ---------
Equity securities:
Common stocks .................. 49,357 14,998 (1,813) 62,542
Preferred stocks ............... 29,401 2,096 (554) 30,943
-------- --------- --------- ---------
Total equity securities
available for sale ........... 78,758 17,094 (2,367) 93,485
-------- --------- --------- ---------
Mortgage loans and land contracts 12,222 952 -- 13,174
Short-term investments ........... 30,746 -- -- 30,746
-------- --------- --------- ---------
Total financial assets .......... $453,390 $ 29,051 $ (2,835) $ 479,606
======== ========= ========= =========
35
The amortized cost and market values of fixed maturities are shown below by
contractual maturity. Actual maturities will differ from contractual maturities
because securities may be called or prepaid with or without prepayment
penalties.
Held to Maturity Available for Sale
--------------------- ---------------------
Amortized Market Amortized Market
December 31, 1997 Cost Value Cost Value
---------- ---------- ---------- ----------
(In thousands)
Due to mature (years):
One or less ....................... $ - $ - $ 36,927 $ 37,227
After one through five ............ 654 688 95,339 98,009
After five through ten ............ 431 431 129,571 138,037
After ten ......................... 889 870 94,863 96,874
--------- --------- --------- ---------
Total ............................ 1,974 1,989 356,700 370,147
Mortgage-backed securities ......... -- -- 5,980 6,058
Redeemable preferred stocks ........ -- -- 649 663
--------- --------- --------- ---------
Total fixed maturities ............ $ 1,974 $ 1,989 $ 363,329 $ 376,868
========= ========= ========= =========
The change in unrealized gains and losses on fixed maturity and equity
security investments is summarized as follows:
Year Ended December 31, 1997 1996 1995
--------- --------- ---------
(In thousands)
Fixed maturities .............................. $ 3,017 $ (4,776) $ 18,289
Equity securities ............................. 3,879 $ 9,625 6,712
--------- --------- ---------
Combined ..................................... $ 6,896 $ 4,849 $ 25,001
========= ========= =========
To conform with statutory requirements, bonds and certificates of deposit
in principal amounts totaling $12,925,000 were on deposit with various
regulatory agencies at December 31, 1997.
The mortgage loans and land contracts are primarily the result of financing
sales associated with the development of an office park, an industrial park and
a condominium development by the Company. At December 31, 1997, 99.9% of the
mortgage loans and land contracts were categorized as commercial, and .1% as
residential. Investment real estate consists of vacant land for a future office
park. The majority of mortgage loans, land contracts and investment real estate
is concentrated in Michigan.
36
Pretax investment income by source is summarized as follows:
Year Ended December 31, 1997 1996 1995
--------- --------- ---------
(In thousands)
Fixed maturities .............................. $ 22,209 $ 22,914 $ 23,437
Equity securities ............................. 3,593 4,059 2,908
Mortgage loans and real estate ................ 596 552 36
Short-term investments ........................ 1,706 1,630 2,282
--------- --------- ---------
Total ........................................ 28,104 29,155 28,663
Investment expense ............................ 2,291 2,039 1,355
--------- --------- ---------
Net investment income ........................ $ 25,813 $ 27,116 $ 27,308
========= ========= =========
Realized gains and losses are summarized as follows:
Year Ended December 31, 1997 1996 1995
--------- --------- ---------
(In thousands)
Fixed maturities .............................. $ 377 $ 256 $ (1,475)
Equity securities ............................. 10,264 2,765 2,013
Real estate ................................... 1,540 77 (58)
--------- --------- ---------
Net gain .................................... $ 12,181 $ 3,098 $ 480
========= ========= =========
Proceeds from sales of investments in fixed maturities totaled $40,642,000
in 1997, $49,488,000 in 1996 and $66,544,000 in 1995. Gross gains of $617,000,
$893,000 and $708,000 and gross losses of $240,000, $499,000 and $1,209,000 were
realized on those sales in 1997, 1996 and 1995, respectively.
37
NOTE 3 - PREPAID POLICY ACQUISITION COSTS
Acquisition costs are recognized on all premium written by the Company.
Such costs are amortized over policy terms which are principally annual, but
which range up to seven years. Policy acquisition costs deferred and amortized
are as follows:
1997 1996
--------- ---------
(In thousands)
Balance at January 1, $ 70,231 $ 72,560
--------- ---------
Policy acquisition costs incurred:
Commission and brokerage ................................ 76,253 73,766
General and administrative .............................. 43,581 36,397
Taxes, licenses and fees ................................ 9,881 10,310
Reinsurance cost (recoveries) ........................... (7) (7)
--------- ---------
Total .................................................. 129,708 120,466
--------- ---------
Charged to expense ....................................... (125,760) (122,795)
--------- ---------
Balance at December 31, ................................. $ 74,179 $ 70,231
========= =========
NOTE 4 - REAL ESTATE AND EQUIPMENT
Real estate and equipment utilized by the Company is summarized as follows:
December 31, 1997 1996
--------- ---------
(In thousands)
Owned land and buildings ................................. $ 45,433 $ 43,733
Equipment and other ...................................... 7,069 3,016
--------- ---------
Total cost .............................................. 52,502 46,749
Less accumulated depreciation ............................ 14,161 12,310
--------- ---------
Real estate and equipment - net ......................... $ 38,341 $ 34,439
========= =========
Included in owned land and buildings is $1.5 million of construction in
progress at year end 1997. This $10 million project is to be completed by the
fall of 1998.
Depreciation expense on real estate and equipment utilized by the Company
was $1,860,000 in 1997, $1,854,000 in 1996 and $2,212,000 in 1995.
Included in equipment and other in 1997 is $4.053 million of capitalized
software.
38
NOTE 5 - LIABILITY FOR INSURANCE LOSSES AND LOSS ADJUSTMENT EXPENSES
The incurred and paid activity in the liability for insurance losses and
loss adjustment expenses is as follows:
1997 1996
--------- ---------
(In thousands)
Balance at January 1, .................................... $ 93,420 $ 93,771
Less reinsurance recoverables ........................... 750 2,409
--------- ---------
Net balance January 1, ................................. 92,670 91,362
--------- ---------
Incurred related to:
Current year ............................................ 239,724 277,298
Prior years ............................................. 4,884 (1,123)
--------- ---------
Total incurred ......................................... 244,608 276,175
--------- ---------
Paid related to:
Current year ............................................ 193,582 223,518
Prior years ............................................. 61,298 51,349
--------- ---------
Total paid ............................................. 254,880 274,867
--------- ---------
Net balance at December 31, ........................... 82,398 92,670
Plus reinsurance recoverables ............................ 324 750
--------- ---------
Balance at December 31, ................................. $ 82,722 $ 93,420
========= =========
The prior year reserve development in 1997 resulted from catastrophe losses
occurring in late 1996 and early 1997. As this development resulted from
property claims, it is not expected to increase in future years.
NOTE 6 - NOTES AND OTHER OBLIGATIONS PAYABLE
Notes and other obligations payable consist of the following:
December 31, 1997 1996
--------- ---------
(In thousands)
Current portion of long-term notes payable ............... $ 2,505 $ 2,272
Current portion of capital lease obligations ............. 182 162
--------- ---------
Total short-term debt ................................... 2,687 2,434
--------- ---------
Long-term notes payable .................................. 87,161 89,882
Obligations under capitalized leases ..................... 2,353 2,535
--------- ---------
Total long-term debt .................................... 89,514 92,417
--------- ---------
Total .................................................. $ 92,201 $ 94,851
========= =========
39
Notes payable consist primarily of an unsecured credit agreement with a
group of banks and a loan secured by a mortgage on the Company's corporate
headquarters building. An unsecured credit agreement was entered into in April
1995 which provides for a revolving credit facility not to exceed $40 million
and a term loan of $56 million, which reduced to $50 million on August 31, 1995.
The credit agreement expires in April 2002. At December 31, 1997, the term loan
had a balance of $50 million, the revolving credit facility had a balance of $8
million and the building mortgage had a balance of $31.7 million. In addition to
the remaining $32 million available under the revolving credit facility, the
Company has an uncommitted line of credit facility which may not exceed $20
million at any one time. This unsecured credit agreement expires on June 30,
1998.
The credit agreement and mortgage loan agreement subject the Company to
certain restrictions and covenants related to, among others: the payment of
dividends; minimum net worth levels; the sale, lease, transfer or other disposal
of properties and assets other than in the ordinary course of business; new
indebtedness; the assumption or creation of liens; and maintenance of certain
ratios.
Borrowing rates on the term loan and revolving credit facility of the
credit agreement are based on eurodollar and negotiated rates. During 1995, the
Company entered into a interest rate swap agreement with a financial
institution. The notional principle amount of the swap is $58 million and it
matures on August 31, 2000. This agreement effectively fixed the interest rate
on the entire $58 million outstanding under the credit agreement to 7.15%. In
November 1997, the swap agreement was amended with the following changes: the
interest rate was dropped to 7.095%; the maturity was extended to August 31,
2002 and the notional amount will be stepping down from $58 million to $50
million on August 31, 2000. The interest rate swap is non-amortizing. The
Company's exposure to credit risk is limited to interest movements and is
considered to be negligible.
The borrowing rate on the mortgage loan is fixed at 9.8%.
The Company does not hold or issue any other forms of derivative financial
instruments.
Maturities of long-term debt for each of the five years succeeding December
31, 1997 are as follows:
Year Ending December 31:
(In thousands)
1998 $ 2,687
1999 3,205
2000 11,537
2001 3,917
2002 54,332
Thereafter 16,523
---------
Total $92,201
=========
40
The fair value of financial liabilities and off-balance-sheet financial
instruments are as follows:
December 31, 1997 1996
------------------ ------------------
Net Book Fair Net Book Fair
Value Value Value Value
-------- -------- -------- --------
(In thousands)
Financial liabilities:
Mortgage note ......................... $ 31,666 $ 36,931 $ 34,154 $ 39,266
Variable notes ........................ 58,000 58,000 58,000 58,000
-------- -------- -------- --------
Total financial liabilities .......... $ 89,666 $ 94,931 $ 92,154 $ 97,266
======== ======== ======== ========
Off-balance sheet financial instruments:
Interest rate swap agreements ...... $ - $ 1,069 $ - $ (626)
======== ======== ======== ========
NOTE 7 - INCOME TAXES
The Company files a consolidated tax return with its subsidiaries,
including its life insurance subsidiary, until it was sold in 1996. For tax
purposes, $10.5 million had been accumulated by the life insurance subsidiary in
a memorandum policyholders' surplus account and became taxable upon its sale.
The resulting $3.7 million of tax has been charged against the gain on the sale
and included in net income from discontinued operations in 1996.
The provisions (credits) for income taxes in the Consolidated Statements of
Income are made up of the following components:
Year Ended December 31, 1997 1996 1995
-------- -------- --------
(In thousands)
Current federal income tax expense ............... $ 16,473 $ 8,335 $ 17,489
Deferred federal income tax expense .............. 3,664 (2,639) (364)
-------- -------- --------
Income tax provision ............................ $ 20,137 $ 5,696 $ 17,125
======== ======== ========
41
Deferred tax liabilities (assets) are composed of the following:
December 31, 1997 1996
-------- --------
(In thousands)
Policy acquisition costs related to
unearned premium .......................................... $ 27,402 $ 26,730
Unrealized gains on securities ............................. 11,251 8,843
Excess tax over book basis of fixed assets ................. 2,202 1,911
System Development Cost .................................... 1,524 --
Other ...................................................... 1,489 1,473
-------- --------
Gross deferred tax liabilities ............................ 43,868 38,957
-------- --------
Unearned premium adjustments ............................... (17,182) (16,867)
Difference between book and tax reserves ................... (3,098) (4,078)
Deferred compensation ...................................... (2,777) (2,740)
Post-retirement benefit accruals ........................... (1,019) (811)
Alabama litigation accrual ................................. (215) (1,452)
Other ...................................................... (2,682) (2,187)
-------- --------
Gross deferred tax assets ................................. (26,973) (28,135)
-------- --------
Net deferred tax liability ............................... $ 16,895 $ 10,822
======== ========
In addition to the Company's net deferred tax liability, the liability
for income taxes includes a current tax liability of $3,958,000 and $634,000 at
December 31, 1997 and 1996, respectively.
A reconciliation of the federal statutory tax rate to the Company's
effective tax rate is as follows:
% of Pre-tax Income
-------------------------
Year Ended December 31, 1997 1996 1995
------ ------ ------
Federal statutory tax rate ....................... 35.0% 35.0% 35.0%
Increase (reduction) in income taxes
relating to:
Tax-exempt municipal bond interest ............. -5.1% -11.7% -5.5%
Dividends received deduction ................... -0.9% -2.4% -0.7%
Tax credits and other .......................... -0.6% -1.2% -0.4%
------ ------ ------
Effective tax rate ............................ 28.4% 19.7% 28.4%
====== ====== ======
NOTE 8 - REINSURANCE
The Company was party to both proportional and non-proportional reinsurance
agreements in 1997.
Amounts due from reinsurance companies balances are primarily premium
amounts due from unconsolidated insurance affiliates for business assumed, and
loss recoverables from a major U.S. reinsurance company. Assumed reinsurance is
predominantly from unconsolidated affiliates.
42
The following amounts summarize the effect of reinsurance on the Company's
financial statements:
Year Ended December 31, 1997 1996 1995
--------- --------- ---------
(In thousands)
Direct:
Written premiums ............................. $ 363,933 $ 353,421 $ 358,933
Earned premiums .............................. 360,646 361,004 360,750
Insurance losses and loss expenses ........... 205,508 234,115 201,453
Assumed:
Written premiums ............................. 71,032 67,678 68,055
Earned premiums .............................. 69,189 67,741 67,119
Insurance losses and loss expenses ........... 28,652 25,911 27,348
Ceded - Catastrophe:
Written premiums ............................. 9,446 17,198 6,075
Earned premiums .............................. 9,546 16,171 16,149
Insurance losses and loss expenses ........... (9) 98 84
Ceded - Non-Catastrophe:
Written premiums ............................. 647 1,147 1,542
Earned premiums .............................. 625 1,180 1,587
Insurance losses and loss expenses ........... (35) 664 1,348
NOTE 9- EMPLOYEE BENEFIT PLANS
Money Purchase Pension Plan
The Company provides a Money Purchase Pension Plan for all employees with
one or more years of service. Under the Money Purchase Pension Plan, the Company
is required to make annual contributions equal to 6% of the eligible
compensation of all eligible plan participants.
Profit-Sharing Retirement and Savings Plan
The Company also provides a Profit-Sharing Retirement and Savings Plan for
all employees with one or more years of service. Under this plan the Company can
make discretionary profit-sharing contributions as a percentage of eligible
compensation. In 1997 and 1996, contributions equal to 5% of eligible
compensation of all eligible employees were made by the Company. The savings
feature of the plan is a 401(k) plan that allows for voluntary contributions by
employees and provides a 50% Company-paid match of the employee's contribution,
limited to 2% of the employee's eligible income.
Retirement Supplement Plan
The Company provides a Retirement Supplement Plan for certain key employees
which provides monthly lifetime payments or lump sum payments upon retirement or
disability, and lump sum payments to beneficiaries upon death. The retirement
benefit is based on a percentage of the participant's final average earnings,
less the participant's Money Purchase Pension Plan and Profit Sharing Plan
benefits (excluding 401(k) plan benefits). The retirement benefits expected to
be paid total $3,511,000. Life insurance contracts have been purchased to fund
the retirement benefits. Key employees would receive their entire retirement
benefit in the event of a change in control of the Company and their subsequent
termination. The maximum contingent liability as of December 31, 1997 relating
to the change in control provision is approximately $5,569,000.
43
Deferred Compensation Plan
The Company has a non-qualified Deferred Compensation Plan for the benefit
of certain key employees. The plan allows for the participants to defer a
percentage of their base salary and incentive payments, and provides a declared
rate of return on an annual basis. The Company purchases life insurance
contracts on plan participants to fund the plan.
Long-Term Incentive Plan
The Company has a Long-Term Incentive Plan (LTIP) which provides awards to
certain key employees based on the Company's return on stockholders' equity over
three year periods. The LTIP was amended in December 1994 and approved by the
stockholders for 70% of the awards to be paid in the Company's common stock. The
awards are fully vested upon issuance; however, the stock is restricted for
resale for three years from the date of the award. There were 21,846 shares and
25,239 shares issued under the plan for 1997 and 1996, respectively.
Stock Option Plan
The Company has a non-qualified stock option plan which authorizes the
granting of options to purchase 650,000 shares of the Company's common stock to
certain key employees. During 1995, the Company's Board of Directors authorized,
and the stockholders' approved, an additional 400,000 shares of the Company's
common stock for future grants under the plan, making a total of 1,050,000
shares authorized under the plan. Adjusting the authorized options for the
three-for-one stock split issued on January 20, 1998, provides a total of
3,150,000 shares authorized under the plan. The options, granted at market
value, vest at either a three or four year period, with a maximum term of 10
years.
The Company accounts for its stock option plans in accordance with APB
Opinion 25, Accounting for Stock Issued to Employees. Since the exercise price
of the Company's employee stock options equals the market price of the
underlying stock on the date of grant, no compensation cost is recognized under
APB Opinion 25. In accordance with SFAS No. 123, "Accounting for Stock-Based
Compensation", the Company is required to provide pro forma information
regarding net income and earnings per share as if compensation costs for the
Company's stock option plan had been determined using a fair value based
estimate. The Company uses the Black-Scholes option-pricing model to determine
the fair value of each option at the grant date with the following weighted
average assumptions:
1997 1996
---------- ----------
Dividend / Share $.36 $.36
Expected Volatility 27.6% 26.9%
Risk-free Interest Rate 5.9% 6.5%
Expected Lives 8 yrs. 8 yrs.
Under the accounting provisions of SFAS No. 123, the Company's net income
and earnings per share would have been reduced to the pro forma amounts
indicated below:
1997 1996
---------- ----------
Net Income:
As reported $50,866,000 $23,529,000
Pro forma $50,291,000 $23,065,000
Earnings per share
As reported $1.82 $.80
Pro forma $1.80 $.78
44
The following is a summary of the Company's stock option transactions
during 1997 and 1996:
1997 1996
-------------------- --------------------
Weighted- Weighted-
Average Average
Exercise Exercise
Shares Price Shares Price
--------- --------- --------- ---------
Outstanding at January 1, .......... 2,214,513 $ 10 2,400,258 $ 9
Granted .......................... 115,500 $ 21 117,300 $ 18
Exercised ........................ 430,938 $ 11 302,670 $ 7
Forfeited ........................ 2,250 $ 16 375 $ 11
--------- --------- --------- ---------
Outstanding at December 31, .... 1,896,825 $ 11 2,214,513 $ 10
========= ========= ========= =========
Options exercisable at December 31, 1,627,640 $ 10 1,734,714 $ 9
========= ========= ========= =========
Weighted-average fair value of
options granted during the year .. $ 7.72 $ 6.70
========= =========
The following table summarizes information about the Company's stock
options outstanding at December 31, 1997:
Options Outstanding Options Exercisable
--------------------------------------------------- -------------------------
Weighted
Average Weighted Weighted
Range of Number Remaining Average Number Average
Exercise Outstanding Contractual Exercise Outstanding Exercise
Price at 12/31/97 Life Price at 12/31/97 Price
- --------------- ------------ ----------- --------- ----------- ---------
$ 6.08 - $ 7.00 731,025 3.6 years $ 7 731,025 $ 7
$10.42 - $12.67 934,500 4.8 years $ 12 856,458 $ 12
$18.33 - $21.04 231,300 9.3 years $ 20 40,157 $ 19
------------ ------------ --------- ----------- ---------
$ 6.08 - $21.04 1,896,825 4.9 years $ 11 1,627,640 $ 10
============ ============ ========= =========== =========
Restricted Stock Plan
The Company also has a restricted stock plan under which certain key
employees were issued 194,442 shares of the Company's common stock in 1988,
representing all of the shares available under the plan. The shares are
registered in the name of the participant, who has all the rights of a
stockholder, subject to restrictions as to transfer until the shares vest.
Compensation expense is recorded over the periods in which the shares vest. The
unamortized market value of the shares awarded is shown separately in
stockholders' equity. As of December 31, 1997, 189,594 were vested, 204 shares
were issued and non-vested and 4,644 shares remained unissued from forfeitures.
45
In 1995, the Company adopted and the stockholders' approved a restricted
stock plan for the Company's Directors. Under the plan, the Company's Directors
may elect to receive shares of the Company's common stock in lieu of their
annual retainer fees. The shares are issued at market value and are registered
in the name of the participant, who has all the rights of a stockholder, subject
to restrictions as to transfer until they vest. Vesting occurs upon the
completion of the Director's term. Up to 60,000 shares may be issued under the
plan. In 1997 and 1996, 1,686 shares and 1,626 shares were issued, respectively.
The cost of the aforementioned benefit plans, excluding post-retirement
benefits, for 1997, 1996 and 1995 was $4,378,000, $3,696,000 and $4,339,000,
respectively.
Post-Retirement Benefit Plan
The Company maintains a defined benefit post-retirement plan for
substantially all employees which provides certain health care, dental and life
insurance benefits. Eligibility and benefits are based on age and years of
service for the health care and dental benefits, which also require
contributions from retirees under certain circumstances. The life insurance
benefits are non-contributory and are calculated as a percentage of the
employee's base annual compensation in the year of retirement. The benefit is
reduced at age 70 to an ultimate benefit of $5,000. SFAS No. 106, "Employers'
Accounting for Post-Retirement Benefits Other Than Pensions," requires companies
to accrue post-retirement benefits during the employees' working years rather
than expensing on a cash basis. The Company does not prefund its post-retirement
benefit plan and has elected to amortize the transition obligation over a
20-year period.
The plan's funded status reconciled with the amounts included in other
liabilities in the Company's Consolidated Balance Sheets is as follows:
December 31, 1997 1996
--------- ---------
(In thousands)
Accumulated post-retirement benefit obligation:
Retirees ................................................ $ 1,989 $ 1,283
Fully eligible active plan participants ................. 1,346 1,049
Other active plan participants .......................... 3,207 3,128
--------- ---------
Total .................................................. 6,542 5,460
Plan assets .............................................. -- --
--------- ---------
Accumulated post-retirement benefit obligation
in excess of plan assets ................................ 6,542 5,460
Unrecognized:
Transition obligation ................................... 4,061 4,332
Actuarial gain .......................................... (429) (1,188)
--------- ---------
Accrued post-retirement benefit liability .............. $ 2,910 $ 2,316
========= =========
46
Net periodic post-retirement benefit costs included the following
components:
Year Ended December 31, 1997 1996 1995
--------- --------- ---------
(In thousands)
Service cost .................................. $ 312 $ 341 $ 274
Interest on accumulated post-retirement
obligation ................................... 425 405 391
Amortization of:
Transition obligation ....................... 271 271 271
Actuarial gain .............................. (38) (42) (48)
--------- --------- ---------
Total costs .................................. $ 970 $ 975 $ 888
========= ========= =========
The health care trend rate assumed was 7.25% for 1997, decreasing .25% per
year to 6% in 2002 and thereafter. The dental trend rate was 6% per year. The
rate of compensation increase regarding life insurance benefits was 5%. A 1%
increase in the health care trend rate would increase the accumulated
post-retirement benefit obligation as of December 31, 1997 by $170,413 and the
net periodic benefit cost for the year then ended by $23,284.
The weighted average discount rate used in determining the accumulated
post-retirement benefit obligation was 8%.
NOTE 10 - LEASE COMMITMENTS
The Company leases buildings and the majority of its furniture and
equipment under capital and operating leases. Operating leases generally include
renewal options for periods ranging from two to seven years and require the
Company to pay utilities, taxes, insurance and maintenance expenses.
The following is a schedule of future minimum lease payments under
cancelable and noncancelable operating leases for each of the five years
succeeding December 31, 1997 and thereafter, excluding renewal options:
Year Ending December 31:
(In thousands)
1998 4,465
1999 3,678
2000 2,037
2001 1,171
2002 287
Thereafter 1
47
The following is a schedule of future minimum lease payments under the
Company's capitalized finance leases together with the present value of the net
minimum lease payments as of December 31, 1997:
Year Ending December 31:
(In thousands)
1998 $ 468
1999 468
2000 468
2001 480
2002 486
Thereafter 1,622
-------
Total minimum lease payments 3,992
Less amount representing interest 1,457
-------
Present value of net minimum lease payments $2,535
=======
Rental expense charged to operations in 1997, 1996 and 1995 amounted to
$5,354,000, $5,109,000 and $4,693,000, respectively, including amounts paid
under short-term cancelable leases.
NOTE 11 - STATUTORY INFORMATION
As a holding company, the principal source of the Company's cash available
for debt service and payment of dividends (other than through the use of
borrowed funds or the employment of other assets) is dividends received from its
principal property and casualty insurance subsidiary, Foremost Insurance
Company. State regulatory requirements limit the amount of annual dividends
Foremost Insurance Company can pay to the Company without obtaining prior
insurance department approval. These restrictions are not expected to
significantly affect the Company's ability to meet its foreseeable cash
requirements. The amount of dividends which Foremost Insurance Company can pay
to the Company in 1998 without obtaining prior insurance department approval
under the current statute is $39.8 million. In 1997 Foremost Insurance Company
paid dividends in cash and other assets to the Company totaling $32.0 million.
The insurance department allowed a $4.0 million extraordinary dividend in 1997.
At December 31, 1997, $74.9 million of consolidated stockholders' equity
represents net assets of the Company's insurance subsidiary that cannot be
transferred in the form of dividends, loans or advances to the Company.
Policyholders' surplus for the combined property and casualty insurance
companies at December 31, 1997 and 1996 was $220.5 million and $201.3 million,
respectively. Statutory net income for the combined property and casualty
insurance companies for the years ended December 31, 1997, 1996 and 1995 was
$49.8 million, $34.1 million and $49.3 million, respectively.
NOTE 12 - COMMITMENTS AND CONTINGENCIES
Agreements and Contracts
The Company has assigned its interest as tenant in a capital lease
obligation. In the event of default by the assignee, a contingent liability
exists of approximately $1.6 million at December 31, 1997.
48
The Company is a party to a long-term agreement with a service company
which provides data processing services and equipment. Under the agreement the
Company is required to pay minimum service charges and resource charges or
credits depending on the volume of transactions processed. The minimum service
charges are approximately $15.1 million per year and are subject to annual cost
of living increases. The agreement expires on December 31, 2001.
Stock Purchase Rights
In 1989 the Company's Board of Directors declared a dividend of one common
stock purchase right for each share of the Company's outstanding common stock.
As a result of the three-for-one stock split distributed on January 20, 1998,
each outstanding share of common stock presently represents one-third of a right
which may become exercisable in certain circumstances to purchase three
one-hundredths of a share of the Company's common stock at a purchase price of
$36.67 per right. The rights are not currently exercisable.
In the event any person or group becomes the beneficial owner of 20% or
more of the Company's common stock, or if a holder of 20% or more of the
Company's common stock engages in self-dealing transactions, or if the Company
becomes involved in a merger transaction, or sells 50% or more of its assets or
earning power to another person, then each right not owned by the acquiring
person or group will entitle its holder to purchase, at the right's then current
exercise price, shares of the Company's common stock, or the common stock of the
acquiring or surviving entity (or in certain circumstances, cash, property or
securities of the Company) having a market value equal to twice the exercise
price.
The rights expire on December 14, 1999 and may be redeemed by the Company
for $.01 per right at any time until the 10th day following the public
announcement that a person or group has acquired 20% or more of the Company's
common stock. The Company has reserved 275,246 shares of its common stock for
issuance upon exercise of the rights.
Litigation
The Company and its subsidiaries are routinely engaged in litigation in the
normal course of business. In the opinion of management, these proceedings, as
well as the litigation described in Part I, Item 3. are not expected to have a
material adverse effect on the Company's consolidated financial position, cash
flows or operating results. Further liability, if any, of the Company and its
subsidiaries for litigation is not determinable at December 31, 1997.
NOTE 13 - INFORMATION BY BUSINESS SEGMENTS
The Company's operations are principally in the property and casualty
segment of the insurance industry. Its property and casualty insurance
subsidiaries primarily furnish insurance to the mobile home and recreational
vehicle markets. Insurance is written throughout the United States with
concentrations in the southern and southwestern states. The nature of the
Company's insurance operations expose it to risk in the case of numerous, severe
catastrophic events. To minimize this risk, the Company performs ongoing
evaluations of its insurance exposures, utilizes reinsurance when appropriate
and performs credit and risk evaluations of its agents and insureds.
49
Detailed operating information for the property and casualty segment is
presented herein. There are no significant intercompany transactions among the
segments.
1997 1996 1995 1994 1993
------ ------ ------ ------ ------
Net Insurance Premium Written
and Assumed (In millions)
Property and casualty:
Mobile home .......................... $356.7 $349.2 $352.3 $341.5 $324.3
Recreational vehicle ................. 48.4 47.9 49.1 49.7 46.5
Automobile ........................... 14.1 10.3 12.4 14.1 16.8
Basics ............................... 7.4 4.4 3.3 2.0 0.8
Homeowners ........................... 3.1 3.3 3.6 3.5 3.9
Commercial products .................. 1.1 1.2 1.5 0.8 2.4
Collateral protection ................ 0.7 0.7 1.0 0.7 0.5
Other ................................ 3.5 4.1 3.8 3.9 2.5
------ ------ ------ ------ ------
Total ................................ 435.0 421.1 427.0 416.2 397.7
Less reinsurance ceded ................ 0.7 1.1 1.5 0.7 2.9
------ ------ ------ ------ ------
Total ................................ $434.3 $420.0 $425.5 $415.5 $394.8
====== ====== ====== ====== ======
Net Insurance Premium Earned
(In millions)
Property and casualty:
Mobile home ............................ $354.9 $354.1 $353.2 $335.7 $325.4
Recreational vehicle ................... 48.0 49.1 49.3 47.8 45.2
Automobile ............................. 12.3 11.0 12.9 15.7 17.4
Basics ................................. 5.7 3.4 2.5 1.4 0.2
Homeowners ............................. 3.1 3.5 3.6 3.6 4.0
Commercial products .................... 1.4 1.2 1.0 0.9 2.9
Collateral protection .................. 0.2 1.1 0.8 0.6 0.6
Other .................................. 3.6 4.2 3.0 4.2 4.0
------ ------ ------ ------ ------
Total .................................. $429.2 $427.6 $426.3 $409.9 $399.7
====== ====== ====== ====== ======
50
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
(In thousands)
Income Before Taxes -
Continuing Operations
Property and casualty:
Underwriting income ......... $ 38,610 $ 5,458 $ 38,211 $ 15,372 $ 16,571
Investment and other income
(including realized gains
and losses): ............... 38,061 30,036 27,952 25,117 27,513
-------- -------- -------- -------- --------
Total property and casualty 76,671 35,494 66,163 40,489 44,084
Other-net (parent company &
non-insurance operations)(1) (5,778) (6,630) (5,800) (4,852) (4,125)
-------- -------- -------- -------- --------
Income before taxes -
continuing operations ..... $ 70,893 $ 28,864 $ 60,363 $ 35,637 $ 39,959
======== ======== ======== ======== ========
Identifiable Assets
(In millions)
Property and casualty ....... $ 693.1 $ 662.2 $ 669.8 $ 625.1 $ 640.4
Parent company and other (2) 51.7 59.4 57.8 61.0 66.0
-------- -------- -------- -------- --------
Total ...................... $ 744.8 $ 721.6 $ 727.6 $ 686.1 $ 706.4
======== ======== ======== ======== ========
<FN>
- ----------
(1) General Corporate expenses were $1,699,000, $1,604,000 and $1,945,000 and
interest expense was $4,766,000, $4,401,000 and $5,696,000 in 1997, 1996 and
1995, respectively.
(2) Identifiable corporate assets were $14.7 million, $18.3 million and $11.8
million in 1997, 1996 and 1995, respectively.
</FN>
NOTE 14 - RELATED PARTY TRANSACTIONS
A director and major stockholder has investment advisory agreements with
the Company and currently manages approximately 16% of the Company's investment
portfolio. During 1997 and 1996, $1,045,000 and $745,000 of fees and commissions
were earned under these agreements. This director also has been advised by
another director in regards to the management of certain investments for the
Company.
NOTE 15 - DISCONTINUED OPERATIONS
On June 11, 1996, the Company completed the sale of its life insurance
subsidiary, Foremost Life Insurance Company, to Woodmen Accident and Life
Company. The sale yielded net after-tax proceeds of $17.4 million and the
Company incurred and after-tax loss of $698,000 as a result of the sale. The
loss was due primarily to the effects of taxes related to policyholders'
surplus. For tax purposes, $10.5 million had been accumulated by the life
insurance subsidiary in a memorandum policyholders' account and became taxable
upon its sale. The resulting $3.7 million of tax has been charged against the
gain on the sale and included in net income from discontinued operations in
1996. The majority of the net proceeds was used to purchase the Company's common
stock under the approved stock buy-back program.
51
In 1990 and 1989, the Company assumed credit life premium under various
reinsurance treaties. Under the terms of these treaties, the Company was
obligated to reimburse the ceding companies only if the overall incurred loss
ratio exceeded a certain percentage. In the fourth quarter of 1990, the ceding
companies were declared insolvent and placed into liquidation. On June 11, 1996,
with the sale of the Foremost Life Insurance Company, the amount reserved to
cover these reinsurance treaties was transferred to an escrow account. On July
31, 1997, the Company and the liquidator settled all outstanding reinsurance and
legal issues regarding these treaties. The escrow account was closed with the
Company recording an after-tax gain of $110,000 for 1997. The financial results
of the life insurance segment and the sale are reflected in the financial
statements as discontinued operations for all years presented.
LIFE INSURANCE STATEMENTS OF INCOME
Year Ended December 31, 1997 1996 1995
(In thousands) -------- -------- --------
Premium written and assumed ...................... $ -- $ 8,988 $ 22,048
Less reinsurance ceded ........................... -- 80 251
-------- -------- --------
Net premium written ............................ $ -- $ 8,908 $ 21,797
======== ======== ========
Premium earned ................................... $ -- $ 8,908 $ 21,797
-------- -------- --------
Death and other benefits ......................... -- 6,227 15,052
Amortization of prepaid policy acquisition costs . -- 2,167 5,342
Operating expenses ............................... -- 41 147
-------- -------- --------
Total losses and expenses ...................... -- 8,435 20,541
-------- -------- --------
Underwriting income .......................... -- 473 1,256
Investment and other income, less expenses ....... 169 747 2,040
Realized gains (losses) .......................... -- 10 (111)
-------- -------- --------
Income before taxes ............................ 169 1,230 3,185
Income tax provision ............................. (59) (171) (1,098)
-------- -------- --------
Net income ..................................... 110 1,059 2,087
Net loss resulting from sale ..................... -- (698) --
-------- -------- --------
Net income from discontinued operations ........ $ 110 $ 361 $ 2,087
======== ======== ========
52
INDEPENDENT ACCOUNTANTS' REPORT
To the Stockholders and Board of Directors
Foremost Corporation of America
Grand Rapids, Michigan
We have audited the accompanying consolidated balance sheets of Foremost
Corporation of America as of December 31, 1997 and 1996, and the related
consolidated statements of income, stockholders' equity and cash flows for each
of the three years in the period ended December 31, 1997. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Foremost
Corporation of America at December 31, 1997 and 1996, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting principles.
Our audits of the consolidated financial statements were performed for the
purpose of forming an opinion on those financial statements taken as a whole.
The supplemental statements on page 28 are presented for additional analysis and
are not a required part of the consolidated financial statements. Such
information has been subjected to the auditing procedures applied in the audits
of the consolidated financial statements and, in our opinion, is fairly stated
in all material respects in relation to the consolidated financial statements
taken as a whole.
s/BDO SEIDMAN, LLP
- ------------------
BDO SEIDMAN, LLP
February 17, 1998
Grand Rapids, Michigan
53
Supplementary Data
RESULTS BY QUARTER
Consolidated Statements of Income
1st 1st 2nd 2nd 3rd 3rd 4th 4th
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
1997 1996 1997 1996 1997 1996 1997 1996
--------- --------- --------- --------- --------- --------- --------- ---------
(In thousands except per share data)
Total income from continuing operations .... $ 115,054 $ 115,051 $ 119,257 $ 115,687 $ 117,156 $ 115,057 $ 118,289 $ 115,331
========= ========= ========= ========= ========= ========= ========= =========
Income (loss):
Property & casualty insurance ............. $ 5,702 $ 42 $ 14,801 $ 11,179 $ 15,067 $ 9,027 $ 18,648 $ 6,946
Parent company and other .................. (893) (1,095) (1,341) (1,298) (644) (1,145 $ (584) (488)
--------- --------- --------- --------- --------- --------- --------- ---------
Total continuing operations .............. 4,809 (1,053) 13,460 9,881 14,423 7,882 18,064 6,458
Discontinued operations ................... -- 969 90 (586) 20 -- -- (22)
--------- --------- --------- --------- --------- --------- --------- ---------
Net income ............................... $ 4,809 $ (84) $ 13,550 $ 9,295 $ 14,443 $ 7,882 $ 18,064 $ 6,436
========= ========= ========= ========= ========= ========= ========= =========
Change in unrealized appreciation
(depreciation) of securities available
for sale, net of tax ..................... $ (3,215) $ (2,477) $ 2,465 $ (1,783) $ 6,119 $ 2,637 $ (898) $ 4,244
========= ========= ========= ========= ========= ========= ========= =========
Earnings per share of common stock:
Net income:
Continuing operations ................... $ 0.17 $ (0.03) $ 0.49 $ 0.33 $ 0.52 $ 0.27 $ 0.65 $ 0.22
Discontinued operations ................. -- $ 0.03 -- $ (0.02) -- -- -- --
--------- --------- --------- --------- --------- --------- --------- ---------
Net income ............................ $ 0.17 -- $ 0.49 $ 0.31 $ 0.52 $ 0.27 $ 0.65 $ 0.22
========= ========= ========= ========= ========= ========= ========= =========
Average shares outstanding ................. 28,435 30,135 27,738 29,883 27,701 29,664 27,701 28,702
========= ========= ========= ========= ========= ========= ========= =========
Earnings per share of common stock - Assuming Dilution:
Net income:
Continuing operations ................... $ 0.16 $ (0.03) $ 0.48 $ 0.32 $ 0.51 $ 0.26 $ 0.64 $ 0.22
Discontinued operations ................. -- $ 0.03 -- $ (0.02) -- -- -- --
--------- --------- --------- --------- --------- --------- --------- ---------
Net income ............................ $ 0.16 -- $ 0.48 $ 0.30 $ 0.51 $ 0.26 $ 0.64 $ 0.22
========= ========= ========= ========= ========= ========= ========= =========
Average shares outstanding ................. 29,149 30,833 28,386 30,525 28,318 30,301 28,281 29,351
========= ========= ========= ========= ========= ========= ========= =========
Dividends per share ........................ $ 0.09 $ 0.09 $ 0.09 $ 0.09 $ 0.09 $ 0.09 $ 0.09 $ 0.09
========= ========= ========= ========= ========= ========= ========= =========
Price range of common stock:
High ..................................... $ 20.20 $ 20.17 $ 20.00 $ 19.37 $ 20.31 $ 19.05 $ 23.56 $ 20.00
========= ========= ========= ========= ========= ========= ========= =========
Low ...................................... $ 19.05 $ 16.92 $ 17.70 $ 17.32 $ 18.50 $ 18.05 $ 19.19 $ 18.00
========= ========= ========= ========= ========= ========= ========= =========
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
54
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information regarding directors of the Company contained in the
definitive Proxy Statement of the Company relating to its April 30, 1998 Annual
Meeting of Stockholders under the captions "Election as Directors," "Board of
Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance" are
incorporated herein by reference. The information regarding Executive Officers
is provided in the Supplemental Item following Item 4. of Part I above.
Item 11. EXECUTIVE COMPENSATION
The information regarding executive compensation contained in the
definitive Proxy Statement of the Company relating to its April 30, 1998 Annual
Meeting of Stockholders under the captions "Executive Compensation,"
"Compensation of Directors, and "Report of the Compensation Committee" is
incorporated herein by reference.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information regarding security ownership of certain beneficial owners
and management contained in the definitive Proxy Statement of the Company
relating to its April 30, 1998 Annual Meeting of Stockholders under the captions
"Security Ownership of Certain Beneficial Owners" and "Securities Ownership of
Management" is incorporated herein by reference.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information regarding relationships and related transactions contained
in the definitive Proxy Statement of the Company relating to its April 30, 1998
Annual Meeting of Stockholders under the captions "Executive Compensation,"
"Compensation of Directors" and "Certain Relationships and Related Transactions"
is incorporated herein by reference.
55
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES, AND REPORTS ON FORM 8-K
Item 14(a)1. List of Financial Statements
The following Financial Statements are filed as part of this Form 10-K
Report:
Page No.
Consolidated Balance Sheets at December 31, 1997 and 1996 24
Consolidated Statements of Income for the years ended
December 31, 1997, 1996 and 1995 25
Consolidated Statements of Stockholders' Equity for the years
ended December 31, 1997, 1996 and 1995 26
Consolidated Statements of Cash Flows for the years ended
December 31, 1997, 1996 and 1995 27
Property and Casualty Statements of Income for the years ended
December 31, 1997, 1996 and 1995 28
Parent Company and Other Statements of Operations for the years
ended December 31, 1997, 1996 and 1995 28
Notes to Consolidated Financial Statements 29-52
Independent Accountants' Report 53
Supplementary Data - Results by Quarter 54
Item 14(a)2. Financial Statement Schedules
The following Financial Statement Schedules are filed as part of this Form
10-K report:
Page No.
Independent Accountants' Report on Schedules 60
Schedule II - Condensed Financial Information of Registrant 61-63
Schedule III - Supplementary Insurance Information 64
All other schedules have been omitted as not applicable or the required
information is given in the financial statements, including the notes thereto.
56
Item 14(a)3. List of Exhibits
Exhibit Number Description of Exhibit
3(a) Restated Certificate of Incorporation. (Incorporated
by reference to Company's Annual Report on Form 10-K
for the year ended December 31, 1985 dated
February 27, 1986)
3(b) Certificate of Amendment of Restated Certificate of
Incorporation dated May 8, 1987. (Incorporated by
reference to the Company's Annual Report on Form 10-K
for the year ended December 31, 1987, dated February 29,
1988)
3(c) Certificate of Amendment of Restated Certificate of
Incorporation dated May 6, 1988. (Incorporated by
reference to the Company's Annual Report on Form 10-K
for the year ending December 31, 1988, dated February
28, 1989)
3(d) Bylaws of the Company, as amended. (Incorporated by
reference to the Company's Annual Report on Form 10-K
for the year ending December 31, 1988, dated February
28, 1989)
4(a) Specimen Certificate of Common Stock of registrant
(Incorporated by reference to the Company's Annual
Report on Form 10-K for the year ending December
31,1997, dated March 17, 1997).*
4(b) Rights Agreement. (Incorporated by reference to
Exhibit 2.1 of the Company's Registration Statement
on Form 8-A, effective January 8, 1990)
4(c) Restated Certificate of Incorporation, as amended. See
Exhibit 3(a), 3(b), and 3(c) above.
4(d) Bylaws. See Exhibit 3(d) above.
10(a) Company's Annual Incentive Plan, restated January 1,
1996 (Incorporated by reference to the Company's Annual
Report on Form 10-K for the year ending December 31,
1997, dated March 17, 1997).*
10(b) Company's Long-Term Incentive Plan dated December 8,
1994, as amended December 5, 1996 (Incorporated by
reference to the Company's Annual Report on Form 10-K
for the year ending December 31, 1997, dated March 17,
1997).*
10(c) Company's Retirement Supplement Plan, as amended
effective January 1, 1994.* (Incorporated by reference
to the Company's Annual Report on Form 10-K for the year
ended December 31, 1993, dated February 24, 1994)
- -------------
* Management Contract or compensatory plan or arrangement.
57
10(d) Company's Non-Qualified Stock Option Plan, dated
February 23, 1995.* (Incorporated by reference to the
Company's Annual Report on Form 10-K for the year ending
December 31, 1994, dated February 23, 1995)
10(e) Amended and Restated Agreement made as of the 1st day of
January 1998 between the Company and the American
Association of Retired Persons.
10(f) Director's Deferred Compensation Plan, as amended
effective January 1, 1994.* (Incorporated by reference
to the Company's Annual Report on Form 10-K for the year
ended December 31, 1993, dated February 24, 1994)
10(g) Executive Deferred Compensation Plan, as amended
effective January 1, 1994.* (Incorporated by reference
to the Company's Annual Report on Form 10-K for the year
ended December 31, 1993, dated February 24, 1994)
10(h) Employment Agreements dated as of January 1, 1990
between the Company and certain of its employees.*
(Incorporated by reference to the Company's Annual
Report on Form 10-K for the year ended December 31,
1989, dated February 22, 1990)
10(i) Directors' Restricted Stock Plan, dated December 8,
1994.* (Incorporated by reference to the Company's
Annual Report on Form 10-K for the year ending December
31, 1994, dated February 23, 1995)
12 Statement Re Computation of Ratios.
21 Subsidiaries of the Registrant.
23 Consent of Independent Public Accountants.
27 Financial Data Schedule.
28 Information from Reports Furnished to State Insurance
Regulatory Authorities.
- -------------
* Management contract or compensatory plan or arrangement.
The Company will furnish a copy of any exhibit listed above to any
stockholder without charge upon written request to Mr. Paul D. Yared, Senior
Vice President, Secretary and General Counsel, P.O. Box 2450, Grand Rapids,
Michigan 49501.
Item 14(b). Reports on Form 8-K
A Form 8-K was filed on December 17, 1997 reporting on the Company's 3:1
stock split distributed on January 20, 1998 and the Company's authorization
of additional repurchases for its ongoing stock repurchase program.
58
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
FOREMOST CORPORATION OF AMERICA
Date: March 6, 1998 By s/R. L. Antonini
-----------------
R. L. Antonini
Chairman of the Board, President &
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated:
Signature Title Date
s/R. L. Antonini Chairman of the Board, March 6, 1998
- --------------------- President and Chief
R. L. Antonini Executive Officer
(Principal Executive Officer)
s/Michael de Havenon Director March 6, 1998
- ---------------------
Michael de Havenon
s/John C. Canepa Director March 6, 1998
- ---------------------
John C. Canepa
s/Arthur E. Hall Director March 6, 1998
- ---------------------
Arthur E. Hall
s/Richard A. Kayne Director March 6, 1998
- ---------------------
Richard A. Kayne
s/Larry J. Orange Executive Vice President March 6, 1998
- --------------------- and Director
Larry J. Orange
s/Joseph A. Parini Director March 6, 1998
- ---------------------
Joseph A. Parini
s/Robert M. Raives Director March 6, 1998
- ---------------------
Robert M. Raives
s/Michael B. Targoff Director March 6, 1998
- ---------------------
Michael B. Targoff
s/F. Robert Woudstra Executive Vice President, March 6, 1998
- --------------------- Treasurer and Director
F. Robert Woudstra (Principal Accounting and
Financial Officer)
59
INDEPENDENT ACCOUNTANTS' REPORT REGARDING SCHEDULES
Foremost Corporation of America
Grand Rapids, Michigan
The audits referred to in our report dated February 17, 1998 relating to
the Consolidated Financial Statements of Foremost Corporation of America and
Subsidiaries which is contained in Item 8. of this Form 10-K, included the audit
of financial statement schedules listed in the accompanying index. These
financial statement schedules are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statement schedules based upon our audits.
In our opinion, the financial statement schedules, present fairly, in all
material respects, the information set forth therein.
s/BDO SEIDMAN, LLP
- ------------------
BDO SEIDMAN, LLP
February 17, 1998
Grand Rapids, Michigan
60
SCHEDULE II
FOREMOST CORPORATION OF AMERICA (PARENT ONLY)
CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
CONDENSED BALANCE SHEETS
December 31, 1997 1996
-------- --------
(In thousands)
Assets:
Investment in unconsolidated subsidiaries ............. $308,314 $285,485
Other invested assets ................................. 1,800 6,100
Cash .................................................. 36 28
Due from affiliates ................................... 363 631
Real estate and equipment (net of
accumulated depreciation) ........................... 34,044 34,179
Other assets .......................................... 13,433 12,688
-------- --------
Total assets ....................................... $357,990 $339,111
======== ========
Liabilities:
Notes payable ......................................... $ 89,666 $ 92,154
Due to affiliates ..................................... 908 3,293
Other liabilities ..................................... 11,965 12,242
-------- --------
Total liabilities .................................. 102,539 107,689
-------- --------
Stockholders' Equity:
Common stock ........................................... 32,467 14,000
Other stockholders' equity ............................. 222,984 217,422
-------- --------
Total stockholders' equity ........................... 255,451 231,422
-------- --------
Total liabilities and stockholders' equity ........... $357,990 $339,111
======== ========
<FN>
- ----------
See Notes to Consolidated Financial Statements in Item 8.
</FN>
61
SCHEDULE II (Cont.)
FOREMOST CORPORATION OF AMERICA (PARENT ONLY)
CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
CONDENSED STATEMENTS OF INCOME
Years Ended December 31, 1997 1996 1995
--------- --------- ---------
(In thousands)
Income:
Intercompany income ......................... $ 6,260 $ 6,635 $ 6,726
Investment and other ........................ 950 1,222 505
Realized gains on investments ............... -- 10,042 --
--------- --------- ---------
Total income .............................. 7,210 17,899 7,231
--------- --------- ---------
Expense:
Operating ................................... 3,910 4,255 4,963
Interest .................................... 8,003 7,869 9,374
--------- --------- ---------
Total expense ............................. 11,913 12,124 14,337
--------- --------- ---------
Income (loss) before tax and income
of unconsolidated subsidiaries ........ (4,703) 5,775 (7,106)
Income tax (provision) credit ................. 1,939 (4,375) 2,648
--------- --------- ---------
Income (loss) before income
of unconsolidated subsidiaries ............ (2,764) 1,400 (4,458)
Income of unconsolidated subsidiaries * ....... 53,630 22,129 49,783
--------- --------- ---------
Net income .................................. $ 50,866 $ 23,529 $ 45,325
========= ========= =========
<FN>
- ----------
* Includes dividends to parent company of: $ 37,500 $ 32,600 $ 37,240
========= ========= =========
See Notes to Consolidated Financial Statements in Item 8.
</FN>
62
SCHEDULE II (Cont.)
FOREMOST CORPORATION OF AMERICA (PARENT ONLY)
CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
CONDENSED STATEMENTS OF CASH FLOWS
Year Ended December 31, 1997 1996 1995
-------- -------- --------
(In thousands)
Net cash for operating activities ................ $(13,643) $ (5,581) $ (2,734)
Investing Activities:
Maturities of invested assets .................. -- -- 34
Net proceeds from sale of subsidiary ........... -- 23,604 --
Purchases of real estate and equipment ......... (1,713) (29) (42)
Distributions from subsidiaries - net .......... 37,086 32,600 36,540
(Increase) decrease in short-term investments .. 4,300 (5,750) (400)
-------- -------- --------
Net cash from investing activities ........... 39,673 50,425 36,132
-------- -------- --------
Financing Activities:
Repayment of long-term debt .................... (2,488) (2,258) (8,047)
Increase (decrease) in short-term debt ......... -- (2,000) --
Acquisition of treasury shares ................. (19,369) (32,111) (14,351)
Dividends paid ................................. (10,063) (10,655) (11,052)
Receipts from exercise of stock options ........ 5,898 2,165 68
-------- -------- --------
Net cash for financing activities ............ (26,022) (44,859) (33,382)
-------- -------- --------
Cash increase (decrease) ................... 8 (15) 16
Cash at beginning of year ........................ 28 43 27
-------- -------- --------
Cash at end of year ............................ $ 36 $ 28 $ 43
======== ======== ========
<FN>
- ----------
See Notes to Consolidated Financial Statements in Item 8.
</FN>
63
SCHEDULE III
FOREMOST CORPORATION OF AMERICA AND SUBSIDIARIES
SUPPLEMENTARY INSURANCE INFORMATION
Future
policy Benefits,
benefits, claims, Amortization
Prepaid losses, losses prepaid
policy claims Net and policy Other Net
acquisition and loss Unearned Premium investment settlement acquisition operating premium
Segment cost expenses premiums revenue income expenses costs expenses* written
- ---------------------------- ----------- ---------- -------- -------- ---------- ---------- ------------ --------- --------
(In thousands)
Year Ended December 31, 1997
Property and casualty .... $ 78,232 $ 82,722 $246,429 $429,210 $ 25,721 $ 244,608 $ 125,760 $ 13,673 $434,317
Parent and Other ......... -- -- -- -- 92 -- -- 6,515 --
------------ ---------- -------- -------- ---------- ---------- ------------ -------- --------
Total .................. $ 78,232 $ 82,722 $246,429 $429,210 $ 25,813 $ 244,608 $ 125,760 $ 20,188 $434,317
============ ========== ======== ======== ========== ========== ============ ======== ========
Year Ended December 31, 1996
Property and casualty .... $ 70,231 $ 93,420 $241,313 $427,565 $ 26,686 $ 276,175 $ 122,795 $ 16,123 $419,953
Parent and Other ......... -- -- -- -- 430 -- -- 8,978 --
------------ ---------- -------- -------- ---------- ---------- ------------ -------- --------
Total .................. $ 70,231 $ 93,420 $241,313 $427,565 $ 27,116 $ 276,175 $ 122,795 $ 25,101 $419,953
============ ========== ======== ======== ========== ========== ============ ======== ========
Discontinued Operations .. $ -- $ -- $ -- $ 8,908 $ 745 $ 6,227 $ 2,167 $ 41 $ 8,908
============ ========== ======== ======== ========== ========== ============ ======== ========
Year Ended December 31, 1995
Property and casualty .... $ 72,560 $ 93,771 $248,953 $426,282 $ 27,212 $ 244,081 $ 125,115 $ 11,835 $425,446
Parent and Other ......... -- -- -- -- 96 -- -- 6,347 --
------------ ---------- -------- -------- ---------- ---------- ------------ -------- --------
Total .................. $ 72,560 $ 93,771 $248,953 $426,282 $ 27,308 $ 244,081 $ 125,115 $ 18,182 $425,446
============ ========== ======== ======== ========== ========== ============ ======== ========
Discontinued Operations .. $ 1,492 $ 3,733 $ 2,677 $ 21,797 $ 2,036 $ 15,052 $ 5,342 $ 147 $ 21,797
============ ========== ======== ======== ========== ========== ============ ======== ========
<FN>
- ----------
* Allocations of other operating expenses are based on a number of assumptions
and estimates and results would change if different methods were applied.
See Notes to Consolidated Financial Statements in Item 8.
</FN>
64