UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter ended September 30, 1996
Commission file number 1-10861
GUARANTY NATIONAL CORPORATION
.............................
(Exact name of registrant as specified in its charter)
Colorado 84-0445021
......... ...........
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
9800 South Meridian Boulevard
Englewood, Colorado 80112
..................................................
(Address of principal executive offices)
(Zip Code)
Registrant's telephone number, including area code (303)754-8400
.............
- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -
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
As of October 31, 1996 there were 14,975,497 shares of
Registrant's $1.00 par value common stock issued and outstanding
exclusive of shares held by Registrant.
GUARANTY NATIONAL CORPORATION
Form 10-Q Index
For the Quarter Ended September 30, 1996
Page
Number
PART 1. FINANCIAL INFORMATION
Item 1. Financial Statements
Independent Accountants' Review Report 3
Consolidated Financial Statements:
Consolidated Balance Sheets at September 30, 1996 and
December 31, 1995 4
Consolidated Statements of Earnings for the nine months
and three months ended September 30, 1996 and 1995 5
Consolidated Statements of Cash Flows for the nine months
ended September 30, 1996 and 1995 6
Notes to Consolidated Financial Statements 7
Item 2.Management's Discussion and Analysis of
Financial Condition and Results of Operations 11
PART 2. OTHER INFORMATION 17
SIGNATURES 18
PART 1 - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INDEPENDENT ACCOUNTANTS' REVIEW REPORT
Board of Directors and Shareholders
Guaranty National Corporation
We have reviewed the accompanying consolidated balance sheet of
Guaranty National Corporation and subsidiaries (the "Company") as
of September 30, 1996, and the related consolidated statements of
earnings and cash flows for the nine-month and three-month
periods ended September 30, 1996 and 1995. These financial
statements are the responsibility of the Company's management.
We conducted our review in accordance with standards
established by the American Institute of Certified Public
Accountants. A review of interim financial information consists
principally of applying analytical procedures to financial data
and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an
audit conducted in accordance with generally accepted auditing
standards, the objective of which is the expression of an opinion
regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material
modifications that should be made to such consolidated financial
statements for them to be in conformity with generally accepted
accounting principles.
We have previously audited, in accordance with generally
accepted auditing standards, the consolidated balance sheet of
the Company as of December 31, 1995, and the related consolidated
statements of earnings, changes in shareholders' equity and cash
flows for the year then ended (not presented herein); and in our
report dated February 20, 1996, we expressed an unqualified
opinion on those consolidated financial statements. In our
opinion, the information set forth in the accompanying
consolidated balance sheet as of December 31, 1995 is fairly
stated, in all material respects, in relation to the consolidated
financial statements from which it has been derived.
DELOITTE & TOUCHE LLP
Denver, Colorado
October 23, 1996
CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
ASSETS
September 30, December31,
1996 1995
............ ............
(Unaudited)
Investments (Note 3):
Fixed maturities held to $79,648 $75,017
maturity, at cost
Fixed maturities available 378,622 395,198
for sale, at market
....... .......
458,270 470,215
Equity securities, at market 86,960 85,085
Other long-term investments 13,397 11,521
Short-term investments 87,720 52,257
....... .......
Total investments 646,347 619,078
Cash 8,833 6,794
Accrued investment income 6,250 7,603
Accounts receivable, (less
allowance of $400 - 1996
and 1995) 49,636 51,638
Reinsurance recoverables and
prepaids, (less allowance
of $200 - 1996 and 1995) 79,078 81,825
(Note 4)
Property and equipment (less
accumulated depreciation of
$12,390 - 1996; $9,326 - 30,422 31,573
1995)
Deferred policy acquisition 44,101 37,637
costs
Goodwill (less accumulated
amortization of
$ 6,143 - 1996; $5,263 - 34,919 33,133
1995)
Deferred income taxes 2,671 4,216
Other assets 2,337 1,676
......... .........
Total assets $ 904,594 $ 875,173
......... .........
......... .........
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Unpaid losses $294,758 $290,156
Unpaid loss adjustment
expenses 62,342 64,478
Unearned premiums 159,384 146,205
Notes payable 101,875 103,000
Reinsurance payables
and deposits 8,045 8,290
Other liabilities 51,587 47,493
........ .......
Total liabilities 677,991 659,622
........ .......
Commitments and contingencies
(Note 6)
Shareholders' equity:
Preferred stock, $.10 par value;
authorized, 6,000,000 shares;
none issued and outstanding
Common stock, $1 par value;
authorized, 30,000,000 shares;
issued 14,975,497 shares - 1996
and 14,961,354 shares - 1995 14,975 14,961
Capital in excess of par 121,264 121,050
Retained earnings 77,584 64,664
Net unrealized investment gains 12,780 15,520
Deferred compensation on (644)
restricted stock
........ ........
Total shareholders' equity 226,603 215,551
........ ........
Total liabilities and
shareholders' equity $904,594 $875,173
.......... ........
.......... ........
See notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF EARNINGS
(In thousands, except per share amounts)
Nine Months Ended Three Months Ended
September 30, September 30,
1996 1995 1996 1995
..... ...... ...... ......
(Unaudited) (Unaudited)
Revenue:
Premiums earned (Note 4) $356,740 $ 271,751 $122,321 $110,679
Net investment income 28,418 21,641 9,899 8,264
Realized investment gains
(Note 3) 5,494 2,895 1,905 2,536
........ ......... ........ ........
390,652 296,287 134,125 121,479
........ ......... ........ ........
Expenses:
Losses and loss adjustment
expenses incurred (Note 4) 253,370 203,226 84,863 94,653
Policy acquisition costs 96,765 77,538 36,205 31,351
General and administrative 7,477 5,287 552 1,867
Interest 5,123 3,844 1,720 1,719
Nonrecurring tender offer 2,163
charge (Notes 5 and 6)
Other 1,166 631 383 238
........ ....... ........ .......
366,064 290,526 123,723 129,828
........ ....... ........ .......
Earnings (loss) before income
taxes 24,588 5,761 10,402 (8,349)
Income taxes 6,055 (745) 2,881 (4,236)
........ ....... ....... .......
Net earnings (loss) $ 18,533 $ 6,506 $7,521 $(4,113)
......... ....... ....... ........
......... ....... ....... ........
Earnings (loss) per common
share (Note 2) $ 1.24 $ 0.51 $ 0.50 $ (0.29)
......... ....... ....... ........
......... ....... ....... ........
Dividends per common share $ 0.375 $ 0.375 $ 0.125 $ 0.125
......... ........ ....... .......
......... ........ ....... .......
See notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Nine Months Ended
September 30,
1996 1995
...... ......
(Unaudited)
Operating Activities:
Premiums collected $372,512 $273,736
Net investment income collected 29,889 21,011
Losses and loss adjustment expenses paid (252,435) (188,060)
Policy acquisition costs and general and
administrative expenses paid (109,456) (84,769)
Interest paid (5,036) (4,124)
Nonrecurring tender offer charge (1,199)
Federal income taxes paid (7) (3,861)
Other receipts 3,681 5,617
......... .........
Net cash provided by operating activities 37,949 19,550
......... .........
Investing Activities:
Maturities of fixed maturities held to
maturity 7,635 8,220
Maturities of fixed maturities available
for sale 36,403 6,399
Sales of fixed maturities available for
sale 40,284 14,132
Sales of equity securities 29,758 22,142
Net change in short-term investments (35,336) (10,393)
Sales of property and equipment 290 442
Purchases of fixed maturities held to
maturity (20,780) (8,871)
Purchases of fixed maturities available for
sale (58,826) (31,003)
Purchases of equity securities (23,852) (17,090)
Net change in other long-term investments (1,876) (588)
Acquisition of subsidiaries, net of cash
acquired (94,664)
Purchases of property and equipment (2,926) (1,898)
......... .........
Net cash (used in) investing activities (29,226) (113,172)
......... .........
Financing Activities:
Repayment of notes payable (1,125) (38,000)
Proceeds from sale of common stock 24,240
Proceeds from issuance of notes payable 108,636
Dividends paid (5,613) (4,785)
Proceeds from exercise of stock options 54 550
......... .........
Net cash used provided by (used in) in
financing activities (6,684) 90,641
......... .........
Net increase (decrease) in cash 2,039 (2,981)
Cash, beginning of period 6,794 9,609
......... .........
Cash, end of period $ 8,833 $ 6,628
......... .........
......... .........
Non-Cash Financing Transactions:
Conversion of affiliate debt $ $(8,667)
Issuance of common stock 2,652
Conversion of affiliate debt from treasury
stock 6,015
Restricted stock forfeitures (126)
See notes to consolidated financial statements.
NOTE 1 - GENERAL
The accompanying unaudited consolidated financial statements of
Guaranty National Corporation and subsidiaries (the "Company")
have been prepared in accordance with generally accepted
accounting principles applicable to interim reporting and do not
include all of the information and footnotes required for
complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. Operating
results for the nine months ended September 30, 1996 are not
necessarily indicative of the results that may be expected for
the year ending December 31, 1996.
On July 18, 1995, the Company acquired Viking Insurance Company
of Wisconsin ("Viking") in a business combination accounted for
as a purchase. In 1995, Viking's results of operations were
included in the consolidated financial statements from the date
of acquisition forward. Calendar year 1996 is the first full
year in which Viking's operating results are included in the
consolidated financial statements.
Although these financial statements are unaudited, they have
been reviewed by the Company's independent accountants, Deloitte
& Touche LLP, for conformity with accounting requirements for
interim financial reporting. Their report on such review is
included herein. These financial statements should be read in
conjunction with the financial statements and related notes
included in the Company's Annual Report to Shareholders and
Form 10-K for the year ended December 31, 1995, for the more
complete explanations therein.
Certain reclassifications have been made to the 1995 financial
statements to conform with presentations used in 1996.
NOTE 2 - EARNINGS PER SHARE
Earnings per common share has been computed using the weighted
average number of shares and equivalent shares outstanding of
14,970,580 and 12,853,374 for the nine months ended September 30,
1996 and 1995, and 14,977,140 and 14,203,867 for the three months
ended September 30, 1996 and 1995, respectively. The common
stock equivalents are stock options which result in a dilutive
effect from assumed exercise of the options.
NOTE 3 - INVESTMENTS
At September 30, 1996 and December 31, 1995, the estimated
aggregate fair value of fixed maturities held to maturity was
$80,033,000 and $77,143,000, respectively, the cost of fixed
maturities available for sale was $374,746,000 and $383,135,000,
respectively, and the cost of equity securities was $71,173,000
and $73,271,000, respectively. At September 30, 1996 and
December 31, 1995, the Company had investments in non-investment
grade securities with a cost of $54,421,000 and $36,641,000,
which are carried at fair values of $54,691,000 and $36,356,000,
respectively.
Realized investment gains (losses), which include gains
(losses) on calls and maturities of fixed maturities, for the
nine and three months ended September 30, 1996 and 1995, and
write downs for other-than-temporary investment impairments of
approximately $434,000 for the nine months ended September 30,
1996, and approximately $1,650,000 and $900,000 for the nine and
three months ended September 30, 1995, are as follows (in
thousands):
Nine Months Ended Three Months Ended
September 30, 1996 September 30, 1996
Fixed maturities held to maturity:
Gains $ $
Losses
.................. ..................
.................. ..................
Fixed maturities available for sale:
Gains 1,485 537
Losses (788) (585)
.................. ...................
697 (48)
.................. ...................
Equity securities:
Gains 6,415 2,367
Losses (1,618) (414)
.................. ...................
4,797 1,953
.................. ...................
Total $ 5,494 $ 1,905
.................. ...................
.................. ...................
Nine Months Ended Three Months Ended
September 30, 1995 September 30, 1995
.................. ..................
Fixed maturities held to maturity:
Gains $ 49 $ 9
Losses (269)
................... ..................
(220) 9
................... ..................
Fixed maturities available for sale:
Gains 1,136 122
Losses (2,849) (909)
.................... ..................
(1,713) (787)
.................... ..................
Equity securities:
Gains 5,418 3,358
Losses (590) (44)
.................... ..................
4,828 3,314
.................... ..................
Total $ 2,895 $ 2,536
.................... ..................
.................... ..................
NOTE 4 - REINSURANCE
In the ordinary course of business, the Company reinsures
certain risks, generally on an excess of loss basis with other
insurance companies. Effective July 1, 1996, such reinsurance
arrangements serve to limit the Company's maximum loss per
occurrence on casualty losses to $400,000, on property losses to
$300,000 and for catastrophe losses to $600,000. Prior to July
1, 1996, such reinsurance arrangements served to limit the
Company's maximum loss per occurrence on individual risks to
$400,000 and for catastrophes to $500,000. Amounts recoverable
from reinsurers are recognized and estimated in a manner
consistent with the claim liabilities arising from the reinsured
policies and incurred but not reported losses.
Premiums, losses, and loss adjustment expenses, including the
effect of reinsurance, are comprised of (in thousands):
Nine Months Ended September 30, Three Months Ended September 30,
1996 1995 1996 1995
.............. .............. .............. ..............
Written Earned Written Earned Written Earned Written Earned
....... ...... ....... ...... ........ ...... ....... ......
Premiums:
Direct $373,079 $365,259 $292,611 $272,122 $125,687 $125,017 $118,922 $112,839
Assumed 32,905 27,546 26,445 37,080 9,915 8,270 9,763 11,319
Ceded (37,325) (36,065) (41,251) (37,451) (11,298) (10,966) (15,201) (13,479)
......... ........ ....... ......... ........ ........ ....... .........
Net $368,659 $356,740 $277,805 $271,751 $124,304 $122,321 $113,484 $110,679
......... ........ ....... ........ ........ ........ ........ ........
......... ........ ....... ........ ........ ........ ........ ........
% Assumed
to Net 8.93% 9.52% 7.98% 8.60%
......... ....... ........ ........
......... ....... ........ ........
Incurred Incurred Incurred Incurred
........ ........ ........ ........
Losses and loss
adjustment
expenses:
Direct $ 257,403 $210,655 $94,128 $92,731
Assumed 19,466 30,585 (630) 13,862
Ceded (23,499) (38,014) (8,635) (11,940)
........... ......... ........ .......
Net $ 253,370 $203,226 $84,863 $94,653
.......... ......... ........ .......
.......... ......... ........ .......
NOTE 5 - NONRECURRING TENDER OFFER CHARGE
On May 8, 1996, Orion Capital Corporation and certain of
its subsidiaries ("Orion" or "Purchasers") commenced a cash
tender offer (the "Offer") to purchase up to 4,600,000 shares of
common stock of the Company at price of $17.50 per share. At the
time the tender offer was made, Orion owned approximately 49.5
percent of the Company's outstanding common stock.
As a result of the Offer the Company incurred costs of
approximately $2,163,000, in the second quarter of 1996, for
legal fees, investment advisor fees, printing fees, director's
fees, and compensation expense resulting from the acceleration of
unvested restricted stock grants and stock options.
On July 2, 1996, Orion successfully completed the Offer and
purchased the 4,600,000 shares of the Company's common stock at
an amended price of $18.50 per share. According to the
Depository for the Offer, 6,774,515 shares of the Company's
shares were tendered and not withdrawn pursuant to the Offer.
The proration factor used by Orion to purchase the tendered
shares was .67901168. For further information related to the
Orion Offer refer to the Company's report on Schedule 14D-9,
filed with the Securities and Exchange Commission on May 22,
1996, and amendments thereto, filed on June 1, 1996, June 7, 1996
and June 19, 1996.
On July 17, 1996, Orion purchased an additional 120,000
shares of the Company's common stock in the open market. The
purchase of these additional shares brought Orion's ownership
level in the Company to 12,129,942 shares, or 81.0%
NOTE 6 - COMMITMENTS AND CONTINGENCIES
As part of the 1995 Viking acquisition, and based upon
Viking's favorable loss development since the acquisition date,
the Company estimates that it will pay the Seller additional
purchase price in the maximum amount agreed to in the purchase
agreement. This amount, which is approximately $4,333,000 plus
interest at 6.28%, will be payable to the Seller as of December
31, 1998. The Company has accrued this amount and the related
interest payable in the accompanying balance sheet.
As discussed in the Company's report on Schedule 14D-9, filed
with the Securities and Exchange Commission on May 22, 1996, as
amended on June 1, 1996, June 7, 1996 and June 19, 1996, three
separate complaints naming the Company and one or more of its
directors, and Orion, as defendants were filed on behalf of the
Company's shareholders, alleging that the Orion tender offer was
unfair and inadequate. On July 2, 1996, counsel for Orion and
the Company signed a Memorandum of Understanding providing for
the settlement and dismissal of the three cases, based on the
revisions which the Purchasers had made in the terms of the Offer
to Purchase. In the judgment of the Company's management, the
costs incurred to defend and settle these complaints will not
have a materially adverse effect on the results of the Company's
operations. The estimated settlement costs have been accrued in
the Company's financial statements as of September 30, 1996, as
part of the nonrecurring charge discussed in Note 5.
In addition to the three complaints described above, the
Company is subject to litigation in the normal course of
operating its insurance business. The Company is not engaged in
any such litigation which it believes would have a material
adverse impact on its financial condition or results of
operations, taking into account the reserves established
therefore and giving effect to insurance.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Results for the First Nine Months of 1996 Compared to the First
Nine Months of 1995
Guaranty National Corporation and its subsidiaries (the
"Company") manage their property and casualty business in three
operating units. Gross premiums written and GAAP combined ratios
by operating unit, for the nine months ended September 30, 1996
and 1995 are summarized below:
Nine Months Ended
September 30,
1996 1995
.... ....
(dollars in thousands)
Personal Lines:
Gross premiums written $192,629 $132,631
GAAP combined ratio 98.5% 104.7%
Commercial Lines:
Gross premiums written $156,254 $150,239
GAAP combined ratio 104.2% 108.6%
Collateral Protection:
Gross premiums written $57,101 $ 36,186
GAAP combined ratio 97.0% 95.6%
Total:
Gross premiums written $405,984 $319,056
GAAP combined ratio 100.2% 105.4%
On July 18, 1995, the Company completed its acquisition of
Viking Insurance Company of Wisconsin ("Viking"). The Viking
acquisition has enabled the Company to increase its nonstandard
private passenger automobile premiums, as well as allow the
Company to expand its personal lines business into new
territories, strengthen its personal lines market share position
in existing states, and provide further flexibility in marketing
the Company's personal lines products. Calendar year 1996 is the
first full year in which Viking's operating results are included
in the consolidated financial statements. During 1995, Viking's
operating results were included in the financial statements from
the acquisition closing date forward.
In July 1996, Company management announced a decision to
integrate the Viking and Guaranty National personal lines
divisions into one personal lines unit. As a result of this
decision, personal lines financial information will no longer be
delineated by division. Currently, the integration effort is
well under way. The Company intends to make the management and
staffing assignments first, and then to focus on agency,
geographic and product integration. A president of the personal
lines unit is expected to be named during the fourth quarter of
1996.
The personal lines unit gross premiums written increased 45%
for the first nine months of 1996 compared to the first nine
months of 1995. The premium volume growth was the result of the
Viking acquisition. Before the acquisition of Viking in 1995,
the Company did not write business in the state of California.
For the first nine months of 1996, this state accounted for
approximately $62,989,000, or 33%, of the unit's gross premiums
written. The increase resulting from the California business was
partially offset by decreases in gross premiums written in
several other states where above average rate increases have been
taken in an effort to improve profitability.
The personal lines unit loss ratio (incurred losses and loss
adjustment expense) for the first nine months of 1996 was 72.8%
compared to 78.1% for the first nine months of 1995. The
incurred losses component decreased 6.9 points and the loss
adjustment expense component increased 1.6 points from the prior
year. The decreased incurred losses component resulted from
lower claim severity, as well as incurred but not reported losses
being lower than expected. The increase in the loss adjustment
expense component is due to this unit's emphasis on fighting
insurance fraud, which has resulted in increased legal expenses
and increased staffing in the unit's Special Investigative Unit.
Also, in the third quarter of the prior year, the Company
strengthened its personal lines loss reserves by $5,010,000. No
such reserve strengthening occurred during the first nine months
of 1996.
The personal lines expense ratio was 25.7% for the first nine
months of 1996 compared to 26.6% for the first nine months of
1995. The decrease was primarily due to lower contingent
commission accruals and increased operating efficiencies.
During the third quarter of 1996, the Company evaluated the
commercial specialty and general divisions and decided that
combining these two divisions will enable the Company to operate
more efficiently and better serve its market. Thus, the
commercial specialty and general divisions will be combined into
one Guaranty National Insurance Company commercial division.
For the first nine months of 1996, the commercial lines unit
gross premiums written increased four percent, when compared to
the first nine months of 1995. This slight improvement was
primarily due to the expansion of existing programs and new
programs, as well as geographic expansion outside of the Rocky
Mountain region. In addition, in June 1995, the commercial lines
unit introduced an automobile physical damage program in
California. This program accounted for $3,593,000 of the total
increase in the commercial lines unit gross premiums written
during the first nine months of 1996, compared to the same period
in the prior year. However, due to the poor loss experience in
this program, notice of cancellation has been given to the agent.
Thus, the gross premiums written related to this program are
expected to decline significantly in the coming months.
Commercial automobile liability gross premiums written
decreased to 36% of total commercial lines premiums for the first
nine months of 1996 compared to 41% for the first nine months of
1995. This decline is a result of the Company's efforts over the
past few years to reduce commercial automobile liability gross
premiums written, and to increase other more profitable
commercial coverages.
The commercial lines unit loss ratio for the first nine months
of 1996 was 71.4% compared to 77.8% for the same period last
year. The incurred loss and loss adjustment expense components
decreased by 6.2 points and 0.2 points, respectively. The 1996
loss ratio reflected lower claims severity. In addition, the
high 1995 ratio was attributable to the loss reserve
strengthening charge of $8,961,000 in the third quarter of 1995.
The commercial lines expense ratio increased to 32.8% for the
first nine months of 1996, compared to 30.8% for the first nine
months of 1995. The fluctuation is attributable to the higher
program writings, such as the automobile physical damage program
discussed above, which have a higher commission rate, as well as
increased contingent commissions. Also, during the third quarter
of 1996, the commercial lines unit expensed approximately
$490,000 in costs associated with a software development project
which was abandoned.
The collateral protection unit's gross premiums written
increased 58% for the first nine months of 1996 compared to the
first nine months of 1995. This significant increase is
primarily due to geographic expansion in the Northeastern United
States and its newest product, mortgage fire insurance.
The collateral protection unit's loss ratio increased 11.3
points for the first nine months of 1996 compared to the first
nine months of 1995. The majority of the total increase, or 10.5
points, related to the incurred losses component. The remaining
0.8 point increase related to the loss adjustment expense
component. The higher loss ratio resulted from increased
frequency in the Northeast blanket vendor single interest and
Puerto Rico collateral protection programs. The unit has taken
actions to correct the higher loss ratio, including the
implementation of underwriting and pricing adjustments and
canceling problematic accounts.
The unit's expense ratio decreased to 34.6% for the first nine
months of 1996 compared to 44.5% for the first nine months of
1995. The improved expense ratio primarily relates to lower
agency contingent commissions, which have been proportionately
reduced by the increased loss ratio, discussed above.
The Company operates under a primary reinsurance contract that
provides both excess of loss and property catastrophe coverage up
to $6,000,000 per occurrence for all major lines of business.
The primary reinsurance contract for 1996 is with National
Reinsurance Corporation ("NRC"), which is now owned by General
Reinsurance Corporation, and serves to limit the Company's
maximum loss per occurrence on individual risks to $400,000 and
for catastrophes to $500,000, through June 30, 1996. As a
result of the acquisition of National Reinsurance Corporation by
General Reinsurance Corporation, the Company's contract allowed
for the renegotiation of the agreement at a more favorable rate,
effective July 1, 1996. Also, the contract will now terminate
December 31,
1997 rather than December 31, 1998. The Company's maximum loss
per occurrence on casualty losses remained at $400,000. However,
on property losses it was reduced to $300,000, and on catastrophe
losses it was increased to $600,000.
The Company has purchased an additional layer of catastrophe
coverage up to 95% of $14,000,000 per loss occurrence, for total
catastrophe protection of $20,000,000. The Company continues to
utilize facultative reinsurance for certain risks, primarily
umbrella and property coverages.
The Company's insurance operating units in total showed $789,000
of adverse development on 1995 and prior loss reserves, net of
reinsurance, in the first nine months of 1996. This compares to
$12,417,000 of adverse development in the first nine months of
1995 on 1994 and prior loss reserves, net of reinsurance. The
development equates to 0.3% and 6.9% of net loss reserves at
December 31, 1995 and 1994, respectively. The small amount of
adverse development in the first nine months of 1996 was mainly
due to general liability and collateral protection losses
developing higher than expected for both outstanding claims and
incurred but not reported losses. During 1995, the Company
recognized adverse loss reserve trends, primarily in the
automobile liability line of business, and significantly
strengthened loss reserves. During 1996, the loss reserve trends
have indicated that the Company reserved its claims adequately
as of September 30, 1996.
During the first nine months of 1996, the Company's known
exposure to environmental losses, such as asbestos and pollution
contamination, did not materially change. Based on the claim
activity to date and the nature of the business written, the
Company does not believe that it has a material exposure to
environmental losses.
For the nine month period ended September 30, 1996, the
Company's catastrophe losses amounted to approximately
$1,978,000, or nine cents per share, net of tax and reinsurance
recoveries. This compares to catastrophe losses during the first
nine months of 1995 of $1,430,000, or eleven cents per share, net
of tax and reinsurance recoveries. The catastrophic losses
mainly affected the commercial and personal lines operating
units, and primarily related to storms in the Central United
States. The Company experienced only minimal losses on the
hurricanes that occurred during the third quarter of 1996. The
Company's management believes that its prudent level of
reinsurance, as discussed above, and spread of coverage over a
variety of geographic areas, limits the Company's exposure to
catastrophic events.
On May 8, 1996, Orion Capital Corporation and certain of its
subsidiaries ("Orion"), commenced a cash tender offer (the
"Offer") to purchase up to 4,600,000 shares of the Company's
common stock. As a result of the Offer, the Company incurred
costs of approximately $1,778,000, net of tax, or $0.12 per
share, for expenses related to the Offer. These costs were
classified as nonrecurring in the Company's September 30, 1996
Consolidated Financial Statements. See Note 5 to the
Consolidated Financial Statements for further discussion of these
costs.
Overall, the Company's net earnings increased $12,027,000, to
$18,533,000 during the first nine months of 1996 when compared to
the first nine months of 1995. Net earnings per common share
were $1.24 as of September 30, 1996, versus $0.51 per common
share as of September 30, 1995. The majority of the improvement
in the Company's net earnings and net earnings per common share
was related to the prior year net earnings and earnings per
common share being substantially reduced by the reserve
strengthening charges within the personal and commercial units,
which were discussed above.
The Company's management continues to be optimistic about
future performance. Management expects the Company's year end
1996 operating earning per common share (earnings per common
share before realized capital gains and nonrecurring charges) to
slightly exceed the $1.50 operating earnings per common share
previously disclosed.
The Company's interest expense for the first nine months of
1996 increased 33% compared to the first nine months of 1995.
This increase was due to an increase in bank borrowings during
1995 related to the Viking acquisition. The 1995 increased
borrowings are pursuant to a reducing, revolving credit facility,
which provides for a floating interest rate. In order to reduce
the risk of changing interest rates, the Company hedged
$80,000,000 of the total borrowings until 1998 via two interest
rate swap agreements. The agreements give the Company a fixed
interest rate of approximately 6.5% on the total notional amount
hedged.
Pretax net investment income increased $6,777,000 in the first
nine months of 1996 compared to 1995, while after-tax net
investment income increased to $22,006,000 from $17,275,000 for
the same periods. These increases were mainly attributable to
the inclusion of the Viking portfolio beginning in July 1995, as
well as positive operating cash flow, which resulted in an
overall increase in average invested assets.
The investment yield, on an after-tax basis, for the first nine
months of 1996 decreased slightly to 4.7% as compared to 5.0% for
the first nine months of 1995. After-tax realized investment
gains in the first nine months of 1996 and 1995 were $3,571,000
and $1,882,000, respectively. This was despite the Company
recording other-than-temporary investment impairments of $282,000
and $1,073,000, after tax, for the nine month periods ending
September 30, 1996 and 1995, respectively. The increase in after-
tax realized investment gains is primarily related to the strong
stock market during the first nine months of 1996, in which the
Company sold certain equity securities that had appreciated in
value. The sale of these equity securities resulted in
approximately $3,118,000 of the total after-tax realized
investment gains. The majority of the Company's investment
portfolio continues to be invested in fixed maturities and short-
term investments which represented 84% of the portfolio at both
September 30, 1996 and December 31, 1995.
Securities are classified as available for sale and recorded at
fair value, unless they meet the Company's criteria for
classification as held to maturity. The Company's held to
maturity criteria include investment grade bonds with stated
maturities of less than ten years. The unrealized investment
gains on fixed maturities available for sale and on equity
securities as of September 30, 1996, were $3,876,000 and
$15,787,000, respectively. The unrealized investment gains on
fixed maturities available for sale and on equity securities as
of December 31, 1995 were $12,063,000 and $11,814,000,
respectively. The fair value of the Company's fixed maturity
investments generally varies inversely with changes in the
general level of interest rates. The fair value of federal
agency and other mortgage pool securities is subject to
additional market value volatility due to the impact of changes
in prepayment rates on the mortgages which underlie such
securities.
The Company's holdings in noninvestment grade bonds for the
first nine months of 1996 were approximately eight percent of
total invested assets, compared to approximately six percent of
total invested assets at December 31, 1995. Total investments
held by the Company include highly rated fixed maturities (rated
AAA or AA) of 51% at September 30, 1996 and 55% at December 31,
1995. The Company continues to maintain a low level of real
estate related investments, which consist primarily of federal
agency mortgage pools.
Results for the Quarters Ended September 30, 1996 and September
30, 1995
Gross premiums written and GAAP combined ratios by operating
unit, for the quarters ended September 30, 1996 and 1995, are
summarized below:
Three Months Ended
September 30,
1996 1995
.... ....
(Dollars in thousands)
Personal Lines:
Gross premiums written $65,385 $61,854
GAAP combined ratio 96.0% 110.7%
Commercial Lines:
Gross premiums written $51,111 $52,846
GAAP combined ratio 105.8% 130.0%
Collateral Protection:
Gross premiums written $19,106 $13,985
GAAP combined ratio 97.1% 95.1%
Total:
Gross premiums written $135,602 $128,685
GAAP combined ratio 99.4% 115.5%
The personal lines unit gross premiums written increased six
percent for the third quarter of 1996, compared to the third
quarter of 1995. The increase in gross premiums written was a
combination of the Viking acquisition, the unit's new products
and geographic expansion. The majority, or 14.1 points, of the
14.7 point decrease in the GAAP combined ratio was due to a
decrease in the unit's loss ratio. The lower loss ratio was
attributable to two main factors. First, claim severity
decreased during the third quarter of 1996 compared to the third
quarter of 1995. Second, in the prior year third quarter the
personal lines unit strengthened its loss reserves. No reserve
strengthening was made during the third quarter of 1996.
The commercial lines unit gross premiums written decreased
slightly by three percent during the third quarter of 1996,
compared to the third quarter of 1995. Of the total decline,
approximately 19% related to a decrease in gross premiums written
from the California automobile physical damage program which was
introduced in June 1995. As discussed above, this program was
canceled in June 1996 due to unfavorable loss experience. The
remaining decline in gross premiums written for the third quarter
of 1996, compared to the third quarter of 1995, resulted from
decreased gross premiums written in certain states which were
experiencing high loss ratios. The commercial lines unit GAAP
combined ratio decreased 24.2 points for the third quarter of
1996, compared to the third quarter of 1995. The decrease was
primarily due to a lower loss ratio, which was offset slightly by
a higher expense ratio, as discussed previously.
The collateral protection unit's gross premiums written
increased 37% for the third quarter of 1996, compared to the
third quarter of 1995. The increase was attributable to
geographic expansion and its newest product, mortgage fire
insurance. This unit's GAAP combined ratio increased 2.0 points
during the third quarter of 1996, compared to the same period of
1995. The deterioration was due to a 6.8 point increase in the
loss ratio, which was partially offset by a 4.8 point decrease in
the expense ratio. The loss ratio increase related to
unfavorable loss experience on the unit's Northeast blanket
vendor single interest and Puerto Rico collateral protection
business, as discussed above. The improvement in the expense
ratio resulted from lower agency contingent commissions.
Third quarter 1996 net earnings and net earnings per common
share were $7,521,000 and $0.50, respectively. This represented
a significant improvement from the third quarter of 1995, when
the Company reported a net loss and net loss per common share of
$4,113,000 and $0.29, respectively. The improvement resulted
primarily from the prior year third quarter being affected by an
after-tax reserve strengthening charge of $9,081,000, or $0.64
net loss per common share.
Liquidity and Capital Resources
Positive cash flow from operations of $37,949,000 was generated
for the first nine months of 1996 compared to $19,550,000 for the
first nine months of 1995. The $18,399,000 increase in operating
cash flow was primarily the result of higher premiums and net
investment income collected, as well as lower income tax
payments. These increases were partially offset by higher loss
and loss adjustment expense payments, acquisition expenses and
interest paid during the first nine months of 1996 compared to
the same period in the prior year. Additionally, the Company
paid less agency contingent commissions during the first nine
months of 1996, when compared to the first nine months of 1995.
Net cash used in investing activities was $29,226,000 and
$113,172,000 for the first nine months of 1996 and 1995,
respectively. The $83,946,000 decrease in funds used in
investing activities resulted mainly from a reduction in funds
used to acquire the subsidiaries. During the first nine months
of 1995, the Company acquired Viking. The decrease in funds used
to acquire subsidiaries was offset, in part, by increased
investment acquisitions of all types of investments. Although
the Company acquired more fixed maturities, equity securities and
short and long term investments during the first nine months of
1996, compared to the first nine months of 1995, it also had
increased sales and maturities of equity and fixed maturity
securities.
Net cash used in financing was $6,684,000 for the first nine
months of 1996, compared to net cash provided by financing
activities of $90,641,000 for the first nine months of 1995. The
cash provided by financing activities during the first nine
months of the prior year was used to finance the Viking
acquisition, which is discussed above. During the first nine
months of 1996, the company made approximately $1,125,000 in
principal payments on its 6.5% term loan. The Company will
continue to make quarterly principal payments on this loan, of
$187,500, until it is paid off on April 1, 1999. As of September
30, 1996, the Company had $10,000,000 of funds available under
its reducing, revolving credit facility. The Company declared and
paid a regular quarterly dividend of $.125 a share in each of the
first three quarters of 1996 and 1995.
The Company's level of short-term investments at September 30,
1996 and December 31, 1995 was 13.6% and 8.4%, respectively, of
total invested assets. The increase was a result of management's
decision to reduce the average duration of its investment
portfolio and to shift its investment mix to securities with more
liquidity. Overall, the Company maintains sufficient liquidity
in its investment portfolio through its short-term investment
holdings to meet operating cash requirements.
In May 1996, Viking moved its Freeport, Illinois operations
from a leased facility into an office building which was acquired
by Viking in February 1996, for approximately $1,000,000.
In conjunction with the Viking acquisition, there is an
additional purchase price amount which may ultimately be paid to
the seller depending on Viking's future loss development. The
Company has estimated this amount to be approximately $4,333,000,
and has included such amount within the balance sheet. See Note
6 to the Consolidated Financial Statements for further discussion
of this obligation.
On July 2, 1996, Orion consummated its cash tender offer, which
was discussed above, and purchased 4,600,000 shares of the
Company's common stock at a price of $18.50 per share. In
addition, on July 17, 1996 Orion purchased an additional 120,000
shares of the Company's common stock in the open market, bringing
their ownership percentage of the Company to 81%. See Note 5 to
the Consolidated Financial Statements for further discussion
related to these Orion transaction.
As a result of Orion's tender offer, the Company was served
with three separate complaints alleging that the Orion tender
offer price was unfair and inadequate. See Note 6 to the
Consolidated Financial Statements for more discussion related to
these complaints.
On July 16, 1996, the Board of Directors of Guaranty National
Corporation announced that James R. Pouliot, president of the
Viking Division, had been promoted to executive vice president,
and will succeed Roger B. Ware as president and chief executive
officer of the Company upon Mr. Ware's retirement in December
1996. In addition, on this same date, the Company's Board of
Directors elected W. Marston Becker, Vice Chairman and Chairman
and CEO-elect of Orion, to the Company's Board of Directors. Mr.
Becker's election increased the number of the Company's directors
from eleven to twelve.
On September 12, 1996, Orion announced that Larry D. Hollen,
President and Chief Operating Officer, had resigned from Orion
and as one of Orion's director representatives on the Board of
the Company. On October 29, 1996, Vincent Papa, Vice President
and Treasurer - Orion Capital Corporation and Chairman - Wm. H.
McGee & Co., Inc., was elected to replace Mr. Hollen on the
Company's Board of Directors. Additionally, on this same date,
Carroll D. Speckman retired from the Company's Board of
Directors. Mr. Dennis J. Lacey, CPA, replaced Mr. Speckman as
Chairman of the Audit Committee.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is routinely engaged in litigation incidental to
its business. At September 30, 1996, there were three lawsuits
outstanding, which were related to the Orion Offer. However,
during the third quarter of 1996 the Company signed a Memorandum
of Understanding with respect to the settlement and dismissal of
the three complaints. See Note 6 to the Consolidated Financial
Statements for further discussion related to these complaints.
In the judgment of the Company's management, there were no
pending legal proceedings at September 30, 1996, net of reserves
established therefore and giving effect to reinsurance, that will
have a materially adverse effect on the results of the Company's
operations.
ITEM 2. CHANGES IN SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTER TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.4 Commercial Umbrella Excess of Loss Facultative
Automatic Reinsurance Agreement No. 06AC960032,
effective February 1, 1996 to February 1, 1997, between Guaranty
National Insurance Company, Landmark American
Insurance Company, Peak Property and Casualty
Insurance Corporation, Guaranty National Insurance Company of
California and National Reinsurance Corporation.
10.5 Endorsement No. 2, dated July 1, 1996, to the
Multiple Line Excess of Loss Agreement
No. 3973-05.
(b) Reports on Form 8-K
No reports on Form 8-K have been filed by the
Registrant during the quarter.
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.
Guaranty National Corporation
By: s/Roger B.Ware
Roger B. Ware, President and
Chief Executive Officer
(Principal Executive Officer)
By: s/Michael L. Pautler
Michael L. Pautler, Senior Vice
President-Finance and Treasurer
(Principal Financial Officer)
By: s/Shelly J. Hengsteler
Shelly J. Hengsteler
Controller and Assistant Treasurer
(Principal Accounting Officer)
DATE: October 31, 1996