UNITED STATES
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
For fiscal year ended December 31, 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
..............
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Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
Common Stock, $1.00 Par Value New York Stock Exchange
Securities registered pursuant to section 12(g) of the Act:
None
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. ( )
The aggregate market value of the voting stock held by non-
affiliates of the Registrant (2,789,405 shares) as of the close of
business on February 28, 1997, was $49,860,614 based on a $17.875
price per share.
As of February 28, 1997, there were 14,975,497 shares of
Registrant's $1.00 par value common stock issued and outstanding
exclusive of shares held by Registrant.
Documents incorporated by reference: The information required
under Part III (Items 10, 11, 12 and 13) of Form 10-K is included
within the definitive proxy statement to be filed within 120 days
after the end of Registrant's Fiscal Year.
Guaranty National Corporation
Index
Part 1 Page Page
Item 1. Business 3 Item 8. Financial Statements
and Supplementary Data 33
General Description 3
Recent Corporate History 4 Item 9. Changes in and Disagreements
Operations 5 with Accountants on Accounting
Underwriting Activities 5 and Financial Disclosure 58
Claims 9
Reinsurance 10 Part III
Investment Portfolio 10
Reserves 12 Item 10. Directors and Executive
Rating 17 Officers of the Registrant 20, 58
Competition 17
Regulation 17 Item 11. Executive Compensation 58
Employees 19
Item 12. Security Ownership of Certain
Item 2. Properties 19 Beneficial Owners and Management 58
Item 3. Legal Proceedings 19 Item 13. Certain Relationships and
Related Transactions 58
Item 4. Submission of
Matter to a Vote of
Security Holders 19
Information Concerning
Executive Officers of
the Company 20 Part IV
Part II Item 14. Exhibits, Financial Statement
Schedules and Reports on Form 8-K 58
Item 5. Market for
Registrant's
Common Equity and
Related Consolidated FinancialStatements 58
Stockholder Matters 21 Financial Statement Schedules 58
List of Exhibits 59
Item 6. Selected Reports on Form 8-K 63
Financial Data 22
Item 7. Management's
Discussion Signatures of the Registrant 64
and Analysis of
Financial Condition
and Results of Operations 24 Signatures of the Directors 65
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PART 1
ITEM 1. BUSINESS
General Description
Guaranty National Corporation ("Guaranty") and its subsidiaries
(collectively, the "Company") principally underwrite and sell
specialty property and casualty insurance coverages which are not
readily available in traditional insurance markets. Personal and
commercial automobile insurance accounted for approximately 84% of
the Company's net premiums written during 1996. The Company's
personal lines business unit principally writes nonstandard
automobile insurance for individuals who do not qualify for
preferred or standard insurance because of their payment history,
driving record, age, vehicle type, or other factors, including
market conditions for standard risks. The Company's commercial
lines unit principally writes nonstandard commercial automobile
coverage. However, approximately 29% of the total commercial lines
unit net premiums written consists of standard commercial coverage.
Typical risks include local and intermediate trucking, garages,
used car dealers, public and private livery, and artisan
contractors. Other commercial lines coverages include property,
general liability, umbrella and excess insurance, standard multi-
peril packages and other coverages.
Nonstandard risks generally involve a potential for poor claims
experience because of increased risk exposure. Premium levels for
nonstandard risks are substantially higher than for preferred or
standard risks. In personal lines, the Company's loss exposure is
limited by the fact that nonstandard drivers typically purchase low
liability limits, often at a state's statutory minimum. The
nonstandard insurance industry is also characterized by the
insurer's ability to minimize its exposure to unprofitable business
by effecting timely changes in premium rates and policy terms in
response to changing loss and other experiences. In those states
where prior approval for rate changes is required, the Company has
generally gained approval in a timely manner. The Company also
writes business in states where prior approval to effectuate rate
changes is not required. Generally, nonstandard risks written by
the Company require specialized underwriting, claims management,
and other skills and experience.
The Company historically has focused its operations in the
nonstandard markets where it expects that its expertise and market
position will allow it to generate an underwriting profit. An
indicator of underwriting profit is a generally accepted accounting
principles ("GAAP") combined ratio of less than 100%. During 1996,
the Company's GAAP combined ratio was 100.1%, and in four of the
last six years the Company has achieved a GAAP combined ratio of
less than 100%. The Company's average GAAP combined ratio for all
its lines for the six-year period ending 1996 was 100.3%.
In July 1995, the Company acquired Viking, which is a property
and casualty insurance company writing non-standard personal
automobile insurance. The Viking acquisition has enabled the
Company to change its business mix, expand its personal lines
business into new territories, strengthen personal lines market
share in existing states, and provide flexibility in marketing the
Company's personal lines products. Additionally, Viking controls
Viking County Mutual Insurance Company ("VCM"), a Texas mutual
organization. As a result, the Company and its affiliates receive
100% reinsurance services in the state of Texas from VCM.
In 1995, the personal lines business was written through two
divisions: the Guaranty National division and the Viking division.
However, in 1996 Company management integrated the Guaranty
National and Viking personal lines divisions into one personal
lines business unit. As a result, personal lines information will
no longer be delineated by division.
The personal lines business unit provides nonstandard personal
automobile coverage, primarily in the state of California and the
Rocky Mountain and Pacific Northwest regions. This coverage is
sold through approximately 8,900 independent agents located in 28
states. In addition, this unit markets business through three
general agents.
Overall, the Company seeks to distinguish itself from its
personal lines competitors by providing a superior, highly
automated and responsive level of service to its agents and
insureds. In addition to high quality service, the Company's
personal lines business unit provides ease of payment for insureds
through low monthly installments.
Prior to 1996, the commercial lines business was written through
the commercial standard, commercial general and commercial
specialty divisions. However, during 1996, the Company's
management evaluated the commercial specialty
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and general divisions and decided that reorganizing these two
divisions into a contracts and brokerage division and a separate
programs department, would enable the Company to operate more
efficiently and to better serve its respective markets. The
commercial standard division will, however, remain separate. As a
result of this reorganization decision, the financial results of
the commercial lines unit will be discussed in total.
The nonstandard commercial lines business primarily offers
commercial coverages for transportation risks, regional programs,
specialized coverages for small to medium-sized businesses, and
umbrella coverages for a broad range of organizations. This
nonstandard commercial business is written through 69 general
agents and various brokers throughout the United States except for
some Northeastern states. These general agents specialize in
particular types of risks and/or geographic locations. The
Company's objective for its nonstandard commercial business is to
maintain long-term, mutually profitable relationships with a small
number of select general agents who follow strict underwriting
guidelines.
Colorado Casualty Insurance Company ("CCIC"), an insurance
subsidiary of the Company, writes primarily standard commercial
lines business. CCIC an insurance company writes small, standard
commercial package policies. The standard commercial business is
primarily written in the Rocky Mountain region, but has recently
expanded to states outside of the Rocky Mountain region, mainly in
the Southeast Region of the United States. CCIC has been
successful in serving a niche market of approximately 600 small to
medium retail agents. In addition, CCIC utilizes seven general
agents as branch offices. The standard business produced by CCIC
complements the nonstandard focus of the commercial lines unit.
The Company also writes collateral protection insurance,
primarily insuring automobiles pledged as security for loans for
which the borrower has not maintained physical damage coverage as
required by the lender. This business is written through 34
general agents across the country and in the Commonwealth of Puerto
Rico.
Personal lines, commercial lines and collateral protection
represented 48%, 37%, and 15%, respectively, of the Company's gross
premiums written during 1996.
A.M. Best Company currently rates Guaranty National Insurance
Company and its subsidiaries "A (Excellent)" and Viking Insurance
Company of Wisconsin and its affiliate "A- (Excellent)." A.M. Best
ratings are based upon factors of concern to policyholders, agents
and reinsurers and are not primarily directed toward the protection
of investors.
Recent Corporate History
On July 2, 1996, Orion Capital Corporation and certain of its
subsidiaries ("Orion") completed a cash tender offer (the "Offer")
and purchased 4,600,000 shares of the Company's common stock at a
price of $18.50 per share. Additionally, on July 17, 1996, Orion
purchased 120,000 shares of the Company's common stock in the open
market. The purchase of the tendered shares and the shares bought
in the open market brought Orion's ownership in the Company to 81%.
Prior to the Offer and open market purchases, Orion had owned
approximately 49% of the Company's common stock since November 20,
1991, when 51% of the Company's common stock was sold in a public
offering by Orion. From 1988 to 1991, Orion had owned all of the
Company's common stock.
In June 1995, the Company sold 1,550,000 shares of its common
stock in a European offering, at a price of $15.7575 per share.
The shares were placed with institutional investors located
principally in the United Kingdom and continental Europe. The
proceeds from the European placement were used to partially fund
the purchase price and related expenses of the Viking acquisition.
In conjunction with the 1995 European private placement, and in
order to increase the Company's stockholders equity and to
facilitate the procurement of financing for the Viking acquisition,
the Company and Orion amended the $20,896,000 subordinated notes
held by Orion ("Orion Notes") to include a common stock conversion
feature. In June 1995, the Company converted $8,667,000 of the
Orion Notes into 550,000 shares of common stock. The remaining
balance of the Orion Notes was converted into 776,128 shares of
common stock in October 1995, after shareholder
approval of the conversion.
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Operations
The Company, which is incorporated in the state of Colorado, has
three operating units: commercial lines, personal lines and
collateral protection. The Company has six insurance subsidiaries:
Guaranty National Insurance Company ("GNIC"), Landmark American
Insurance Company ("LAIC"), Peak Property and Casualty Insurance
Corporation ("PEAK"), CCIC, Guaranty National Insurance Company of
California ("GNICOC") and Viking Insurance Company of Wisconsin
("VICW"). Its six insurance subsidiaries are authorized as
multiple-line insurance carriers and may insure all types of
property and liability risks. With the recent approval to write in
the state of Michigan, one or more of the Company's subsidiaries
are now authorized in all states. The Company has an agreement
with and has used Orion to permit it to underwrite risks through
Orion's insurance subsidiaries in the states where the Company is
not authorized to write certain lines of business. The Company
also owns Intercon General Agency, Inc. ("Intercon"), through which
the collateral protection business is marketed, Auto Insurance
Centers, Inc. ("AIC"), an independent agency which produces
personal automobile business for the Company and other carriers in
Arizona and Indiana, and Guaranty National Warranty
Services ("GNWS"), through which automobile warranty business is
marketed and claims settled.
Underwriting Activities
In underwriting nonstandard automobile risks, the Company sets
premium rates which are substantially higher than standard rates.
Policy coverage periods are generally one or six months on personal
automobile policies, commercial policy coverage periods are
generally one year, while collateral protection policy coverage
periods generally range from one month to one year, although some
policies are issued for the term of the underlying loan. The
business of the Company and its insurance subsidiaries is not
materially dependent upon any single customer, group of customers,
or group of agents.
The following table sets forth the volume of direct premiums
written, premiums assumed, gross premiums written, premiums ceded
to reinsurers and net premiums written during the years indicated.
Year Ended
December 31,
1996 1995 1994
____ ____ ____
(In thousands)
Direct premiums written $493,660 $414,694 $295,714
Premiums assumed 44,376 36,819 69,277
-------- -------- --------
Gross premiums written 538,036 451,513 364,991
Premiums ceded (46,804) (53,614) (42,066)
-------- -------- --------
Net premiums written $491,232 $397,899 $322,925
======== ======== ========
Personal Lines Business Unit. The personal lines business
unit principally provides nonstandard private passenger automobile
insurance, with additional coverages offered for artisan-type light
trucks and motorcycles in selected states. The focus of
nonstandard automobile insurance relates to two customer types:
first, those who do not qualify for preferred or standard insurance
because of age, driving record, vehicle type or other factors;
second, those customers who have low down payment needs or are
transitioning from an uninsured to an insured status.
A critical decision reached during 1996 was to fully integrate
the personal lines operations of Viking and Guaranty National
Personal Lines. Prior to this decision, these two operations ran
as independent divisions. The decision to consolidate and
integrate was reached after a careful analysis of the nonstandard
market. Over the past ten years, the marketing of nonstandard
automobile insurance has evolved from a "cost-plus" orientation
where claims costs and operating expenses were totaled, a profit
margin added and the product price determined, to a "commodity"
orientation where absolute cost of product delivery has gained
significantly in importance in assuring market success.
Company management expects that the decision to integrate the
Viking and Guaranty National Personal Lines operations will
facilitate reduction of any overlap of functions plus gain
significant advantages through economies of scale. The anticipated
end result will be a lower expense ratio, which will lead to better
pricing and a better market position. A second advantage of this
integration is the creation of important new product offerings.
The personal lines business unit's motto of "Easy to Start, Easy to
Stay" requires a product pipeline with consumer need-satisfying
products designed to match as broad a cross-section of nonstandard
customers as possible. The one-month product focus at Viking
complements the six-month product focus at Guaranty National to
form the foundation for offering a packaged,
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multiple policy term, multiple commission level and multiple
customer quality level product for the independent agent
distribution network. Test marketing of the combined packaged
products commenced in the state of Indiana in late 1996.
Product design and pricing of the integrated personal lines
business unit will be completed using a product management
approach. Product managers have "ownership" of the product design,
pricing and marketing strategy for a multiple-state area. Product
managers rely on a combination of traditional insurance actuarial
pricing techniques plus innovative niche pricing methodologies in
an effort to identify and market to important market niches.
Customer service and policy processing operations are a
critical part of the personal lines business unit. Operation
centers are currently located in Freeport, Illinois; Denver,
Colorado; Salt Lake City, Utah; and Salem, Oregon. Multiple
locations in multiple time zones contribute to efficient volume
routing, as well as providing a convenient disaster recovery
mechanism. In the customer service area, use of an Interactive
Voice Response system permits efficient, automated answering of
routine agent and customer questions.
The ability to interact efficiently with a geographically
diverse agent force has become a critical building block for
successful market players. During 1996, significant attention and
resources were devoted to two different electronic interface
methodologies. In California, a large portion of new business
submissions were received electronically. Electronic interface
activities were also present in several other states. Furthermore,
efforts in 1997 will concentrate on establishing the best
technological platform to significantly expand agent electronic
interface. The advantages of electronic interface to the agent
include quicker policy issuance, quicker identification of
underwriting problems with a particular application submission, and
less paperwork. From the Company standpoint, electronic interface
permits better field underwriting, prior to the submission of a
policy application, through a higher level of accuracy of the data
on the application, plus an elimination of duplication of data
entry. With significant electronic agent interface the Company's
focus shifts from processing to customer service, which permits a
better alignment between the Company and the agents' needs.
Effective electronic interface also facilitates lower operating
costs, which contributes to long-term success in the nonstandard
marketplace.
The personal lines business unit distributes its products
through independent agents. The personal lines business unit's
independent agents are paid commissions at competitive rates,
including cash incentive payments which are contingent on
profitability as measured by the agent's loss ratio and premium
volume. Overall, these contingent commissions accounted for
approximately five percent of the total compensation paid to such
agents in 1996. During 1997, two important steps in building the
independent agent network will be the cross-appointment of Viking
and Guaranty National Personal Lines agents, as well as evaluation
of increased coverage in selected markets.
California continues to be the largest premium volume state
for the personal lines business unit. Volume in this state
approached $90,000,000 during 1996. Effective January 1, 1997,
California became a mandatory insurance state, which historically
has led to significant new business opportunities in the one-month
product line.
The personal lines business unit markets policies in 28
states, primarily in the state of California, as discussed above,
and the Rocky Mountain and Pacific Northwest regions. In 1996, new
states entered by this unit were Pennsylvania and Rhode Island.
The table below shows the Company's gross premiums written for
personal automobile insurance in the eight states in which it wrote
the largest amount of such business in 1996 and corresponding
volume in 1995, as compared to total personal gross premiums
written.
Year Ended December 31,
------------------------------------
1996 1995
------------------------------------
(Dollars in thousands)
California (a) $88,756 34.5% $29,846 15.1%
Washington 24,082 9.4 17,611 8.9
Utah 19,525 7.6 21,461 10.9
Oregon 17,121 6.7 17,137 8.7
Arizona 15,408 6.0 14,517 7.4
Colorado 13,776 5.4 16,549 8.4
Texas 10,564 4.1 9,596 4.9
Idaho 7,953 3.1 6,663 3.4
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(a) The gross premiums written in California are written
through Viking. If Viking's gross premiums written for the entire
calendar year 1995 had been included, the state of California would
have represented $67,099,000, or 23.8%, of total 1995 personal
lines business unit gross premiums written.
Commercial Lines Unit. The Company's commercial lines unit is
comprised of three divisions covering a broad range of nonstandard
and standard product lines and classes. Lines of business consist
of automobile insurance and, to a lesser extent, general liability,
property, and umbrella and excess insurance coverages. The
emphasis in the current and previous few years has been to reduce
commercial automobile liability and emphasize more profitable
commercial coverages. A breakdown of gross premiums written by
specific product lines is provided for the years indicated below:
Year Ended December 31,
---------------------------------------------
1996 1995 1994
------------- ------------ -------------
(Dollars in thousands)
Automobile liability $72,467 36.0% $80,153 40.0% $100,684 51.6%
Property 38,144 18.9 30,655 15.3 23,789 12.2
Automobile physical damage 36,528 18.1 32,405 16.2 21,480 11.0
General liability 35,477 17.6 34,456 17.2 32,498 16.7
Umbrella 18,921 9.4 22,559 11.3 16,577 8.5
------- ---- ------- ---- ------- ----
Total $201,537 100.0% $200,228 100.0% $195,028 100.0%
======== ===== ======== ===== ======== =====
Nonstandard commercial lines automobile risks are generally
comprised of insurance for local and intermediate trucking, such as
sand and gravel haulers; garages, such as used car dealers and
automobile repair facilities; and public vehicles, such as buses
and limousines. Typically, automobile physical damage has been
written on accounts along with automobile liability coverages.
However, in 1995, this unit began underwriting programs with
physical damage coverage only. One of these programs insured
private passenger risks in the state of California, but due to poor
loss experience in this program, notice of cancellation was given
to the agent during 1996.
In addition to the automobile line, the commercial unit offers
general liability coverage for the premise liability protection
needed by businesses in higher risk classes and small artisan
contractors. This unit writes property coverages on risks such as
vacant buildings, bars, restaurants and motor-truck cargo. It also
writes commercial umbrella and excess coverages across a broad
spectrum of business classes, and standard commercial package
policies for small businesses in small cities and rural areas. The
commercial program division writes several multi-line programs such
as day care centers and convenience stores.
The Company has historically generated better-than-industry
operating results in commercial lines through controlled pricing,
risk selection, and agency management. However, beginning in 1993,
the Company experienced a deterioration in commercial automobile
liability underwriting results. As a result, the commercial lines
unit business strategies were revised. These revisions included
the termination of unprofitable agents, the implementation of more
stringent underwriting practices and pricing increases, a re-
evaluation of states in which the Company had written commercial
business, and an evaluation of states in which to seek commercial
business opportunities. These revised business strategies have
helped the commercial automobile liability underwriting results
improve in 1996.
Commercial lines' business is written throughout the United
States, with a limited presence in the Northeast region. The table
below shows the Company's commercial lines concentration of gross
premiums written in the eight states in which the Company it wrote
the its largest amounts of such business in 1996 and corresponding
volume in the corresponding gross premiums written in 1995, as
compared to total commercial gross premiums written.
Year Ended December 31,
----------------------------------
1996 1995
----------- --------------
(Dollars in thousands)
Texas $24,844 12.3% $25,890 12.9%
California 24,326 12.1 30,807 15.4
Colorado 15,503 7.7 14,569 7.3
Florida 11,817 5.9 8,550 4.3
Arizona 10,718 5.3 10,592 5.3
Louisiana 8,349 4.1 7,342 3.7
New Mexico 8,317 4.1 7,837 3.9
Utah 6,783 3.4 6,331 3.2
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Nonstandard commercial lines products and programs are marketed
primarily through general agents, most of whom specialize in
particular types of nonstandard or difficult to place risks. Some
of these general agents also specialize in certain geographic
locations. Nonstandard commercial agent relationships are
established by the Company only after an extensive review of the
agent's underwriting expertise, historical loss experience,
financial condition, and other considerations. Such a review is
necessitated by the Company's philosophy of establishing an agent
relationship only if it has long-term potential. Such long-term
affiliations are generally beneficial to both the Company and the
agent. Currently, the length of the average nonstandard commercial
general agency relationship is eight years.
Strict underwriting controls are a primary objective of the
nonstandard commercial business. The Company has devoted extensive
resources to the development and maintenance of detailed
underwriting guidelines and related training so that its agents can
consistently price and select risks. Management believes that
these are important factors in maintaining strong relationships
with its agents.
Nonstandard commercial policies are either underwritten directly
by the Company, such is the case with umbrella business, or, for
risks that are bound by the general agents, re-underwritten by the
Company. The Company has 60 days from the policy effective date to
cancel any policy that does not meet its nonstandard commercial
underwriting standards. A monthly reporting system provides the
Company and each agent with information relating to the agent's
underwriting activities to date, premiums written as compared to
the Company's business plan for the agent, and other pertinent
data. The Company also performs on-site reviews and underwriting
audits of general agents on an ongoing basis. Underwriting
authority is given to each agent in accordance with a three tier
structure based on the Company's review of the agent's past
performance and expertise.
Standard commercial products, written by CCIC, are primarily
marketed through rural small to medium retail agents in the Rocky
Mountain region., who are granted only limited underwriting
authority. In addition, to further geographic expansion efforts,
CCIC has appointed seven general agents who have been granted
underwriting and policy issuance authority. The retail agents are
granted only limited binding authority. The retail agents submit
business to CCIC, or its general agents, who underwrite the risk
prior to policy issuance. CCIC maintains underwriting manuals that
are used for rating and evaluating risks by the general agents and
home office underwriters. CCIC performs periodic underwriting
reviews of the general agents to ensure compliance with established
underwriting standards. The selection and appointment of CCIC
retail and general agents is based on criteria to those discussed
above for nonstandard commercial agents. above.
The Company's commercial lines unit has incentive bonus programs
which are contingent on profitability as measured by the agent's
loss ratio and premium volume. Such contingent commissions
accounted for approximately nine percent of the total compensation
the Company paid to such agents by the Company in 1996.
Collateral Protection Unit. Collateral protection insurance
coverage primarily insures automobiles pledged as security for
loans for which the borrower has not produced evidence of physical
damage coverage as required by the lender. This coverage is
currently marketed in 41 states, the District of Columbia and the
Commonwealth of Puerto Rico through general agents. In addition,
this unit offers nonstandard private passenger insurance in
California and Kansas.
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In recent years, this unit has grown by expanding its marketing
into the Northeastern United States and into the Commonwealth of
Puerto Rico, as well as by product expansion. Specifically, during
1995, Intercon introduced its newest product, mortgage fire
insurance. Mortgage fire insurance is forced placed fire insurance
on real estate with no other fire coverage. A breakdown of gross
premiums written by specific product lines is provided for the
years indicated below:
Year Ended December 31,
---------------------------------------
1996 1995 1994
-------- -------- ---------
Forced placed
collateral protection $21,265 26.9% $31,989 59.1% 22,125 57.0%
Blanket vendor single
interest 18,573 23.5 9,945 18.4 7,157 18.4
Automobile physical damage 13,185 16.7 7,697 14.2 8,001 20.6
GAP 12,596 15.9 713 1.3
Forced placed mortgage fire 5,979 7.6 1,328 2.4
Automobile liability 5,803 7.3 755 1.4
Other 1,688 2.1 1,711 3.2 1,557 4.0
------- ---- ------- ---- ------- ----
Total $79,089 100.0% $54,138 100.0% $38,840 100.0%
======= ===== ======= ===== ======= =====
The table below shows the Company's gross premiums written
for the collateral protection unit in the eight states in which it
wrote the largest amount of such business in 1996 and corresponding
volume in 1995, as compared to total collateral protection gross
premiums written.
Year Ended December 31,
---------------------------------
1996 1995
--------- ---------
(Dollars in thousands)
New Jersey $10,569 13.4% $ 917 1.7%
New York 10,399 13.1 5,619 10.4
California 8,682 11.0 9,650 17.8
Florida 8,295 10.5 2,959 5.5
Texas 7,454 9.4 7,684 14.2
Kansas 6,523 8.2 1,718 3.2
Oklahoma 5,839 7.4 4,896 9.0
Puerto Rico 5,259 6.6 8,541 15.8
The collateral protection unit has an incentive bonus
program for most agents which is contingent on profitability as
measured by the agent's loss ratio and premium volume. Such
contingent commissions accounted for approximately 11% of the total
compensation paid to such agents by this unit in 1996.
Claims
The Company's claims operations are handled in separate claims
departments within each respective operating unit, rather than
being handled by a centralized department. This structure allows
each operating unit to administer all claims and direct all legal
and adjustment aspects of the claim process. The specialized
nature of the operating units' nonstandard product lines requires
specific skills to settle claims successfully. To achieve this,
each operating unit maintains a separate staff of highly trained
claim adjusters. Independent adjusters are utilized from time to
time in certain geographic areas. The goal of each operating unit
is to establish initial contact directly with claimants within 48
hours of a claim being reported.
To maximize operating efficiencies the nonstandard commercial
unit operates from a centralized department in the Englewood,
Colorado office. The department is organized to closely align
claim staff with underwriting departments. A nationwide TeleClaim (trademark
symbol) number is used which gives claimants the ability to telephone in
claim reports. The on-line computer system used by this unit is
simultaneously updated allowing for quick claim department
response. This system is designed to provide the agents for this
unit, as well as the insureds, a high level of quality claims
service.
The personal lines business unit administers claims operations
through branch offices. These branch offices perform all of the
administrative, legal and adjustment aspects of the claim process.
Independent adjusters are used periodically for claims.
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Claims integration is an important focus of the personal lines
business unit. Work is well underway in integrating the Viking and
Guaranty National Personal Lines claims organizations, which should
both improve operational efficiency and contribute to delivering
better customer service. Best operating practices from each
organization will be identified and form the basis for an expanded
claims presence in 1997.
Part of the personal lines business unit's claims focus is a
strong emphasis on a Special Investigative Unit (SIU). SIU has
evolved to be an indispensable part of any successful claims
operation, especially in the nonstandard marketplace. The SIU
trains the adjuster force to identify fraudulent claims,
establishes procedures for handling those claims, and completes
individual file field investigations when appropriate. During
1996, personal lines claim results improved significantly, partly
as the result of the influence of SIU.
Reinsurance
The Company purchases reinsurance to reduce liability on
individual risks and to protect against catastrophic losses.
Reinsurance involves an insurance company transferring or "ceding"
all or a portion of its exposure on insurance written by it to
another insurer (the "reinsurer"). The reinsurer assumes the
exposure in return for a portion of the premium. The ceding of
insurance does not discharge the insurer from its primary liability
for the full amount of the policies should the reinsurer fail to
meet its obligations under the reinsurance agreement.
In 1993, the Company entered into a reinsurance treaty with
National Reinsurance Corporation ("NRC") covering all major lines
of business. Beginning in 1996, the commercial standard division
property business was also covered under this treaty. In 1996, NRC
was acquired by General Reinsurance Corporation ("General Re"), and
as a result of this acquisition the Company's contract was
renegotiated under the terms of the reinsurance treaty. This
agreement is the Company's primary reinsurance contract, and
provides both excess of loss and property catastrophe coverage up
to $6,000,000 per occurrence. From January 1, 1996 through June
30, 1996, the Company's maximum loss per occurrence was limited to
$400,000 on individual risks and to $500,000 for catastrophes.
Effective July 1, 1996, the Company's rate was lowered and the
retentions were modified. The maximum loss per occurrence on
casualty losses remained at $400,000, but on property losses it was
reduced to $300,000 and on catastrophe losses it was increased to
$600,000. The NRC contract expires in 1997 and is subject to
typical renewal and cancellation provisions. General Re is rated
"A++ (Superior)" by A.M. Best.
In 1996, the Company also had in effect a property catastrophe
treaty with a group of reinsurers. The two largest reinsurers in
this group are Nationwide Mutual Insurance Company and Munich
Reinsurance of Germany, both of which were rated "A+ (Superior)" by
A.M. Best. The treaty coverage provided an additional layer of
catastrophe coverage up to 95% of $14,000,000 per loss occurrence,
in excess of the $6,000,000 coverage provided by the primary
reinsurance contract, described above. Thus, this treaty brought
the Company's total catastrophe protection to $20,000,000.
Additionally, the Company uses facultative reinsurance for
individual large risks, primarily umbrella and property coverages,
and quota-share reinsurance for certain programs.
Investment Portfolio
The Company's investment philosophy is to achieve an attractive
long-term rate of return while maintaining a high level of quality
and liquidity in its portfolio. The Company maintains a
diversified portfolio comprised of a broad spectrum of issuers and
types of securities. At December 31, 1996 and 1995, 85% and 84%,
respectively, of the Company's total invested assets consisted of
investments in fixed maturities and short-term investments. Other
long-term investments are principally comprised of interests in
several investment limited partnerships and a surplus debenture
issued by VCM to Viking. The Company has no direct real estate or
mortgages in its investment portfolio as of December 31, 1996,
other than investments in federal agency mortgage pools.
Securities are classified as available for sale and carried at
estimated fair value, unless they meet the Company's criteria to be
classified as held to maturity. Such criteria include investment
grade bonds with stated maturities less than ten years. The
average stated maturity of the Company's fixed maturity portfolio
is nine and a half years as of December 31, 1996, excluding
investments of $48,316,000 in federal agency mortgage pools which
have a stated maturity of up to 30 years, but are generally
expected to prepay significantly earlier. Furthermore, the Company
has
-10-
significant holdings in fixed maturity available for sale
securities which can be prepaid prior to maturity based on
predetermined call dates. The Company estimates that the average
duration of the fixed maturity portfolio is approximately four
years using interest rate assumptions as of December 31, 1996.
Since 1984, the Company's investment portfolio has been managed
primarily by Orion's investment managers, except for a portion of
the equity securities portfolio which, starting in 1992, has been
managed by an unaffiliated portfolio manager. The Company directs
and oversees the investments of both portfolio managers. For its
investment management services, Orion was paid an annual fee of
$650,000 in 1996. The Orion investment management contract will
continue in effect for one year unless terminated by either party
upon 90 days prior written notice. The fee paid to the outside
manager is based on a percent of the market value of the assets
managed.
The following tables set forth the composition, by amortized
cost and estimated fair value, of the investment portfolio of the
Company at December 31, 1996 and 1995, detailing the fixed
maturities by rating category, utilizing Standard & Poor's rating,
and reflecting the segregation of the fixed maturities portfolio.
Both the fixed maturities and equity investments consist primarily
of readily marketable securities. Securities which are not rated
by independent rating services are assigned the equivalent rating
usedas assigned by the National Association of Insurance
Commissioners at December 31, 1996. The after-tax net investment
yield (reduced by investment expenses) on average invested assets
shown below is determined on a GAAP basis.
December 31, 1996
----------------------------------------
Estimated
Amortized Cost Fair Value (a)
--------------- ---------------
(Dollars in thousands)
Fixed maturities held to maturity:
AAA $ 46,287 7.2% $ 46,454 7.0%
AA 27,832 4.3 28,650 4.3
A 6,152 1.0 6,326 0.9
--------- ----- --------- -----
80,271 12.5 81,430 12.2
Fixed maturities available
for sale:
AAA 167,503 26.1 169,465 25.3
AA 82,639 12.9 86,012 12.9
A 49,569 7.7 50,471 7.6
BBB 27,499 4.3 27,865 4.2
BB 24,586 3.8 24,781 3.7
B 30,483 4.8 31,381 4.7
D 136 0.1 315 0.0
---------- ---- --------- -----
382,415 59.7 390,290 58.4
---------- ---- --------- -----
Total fixed maturities 462,686 72.2 471,720 70.6
Equity securities:
Common stocks 42,689 6.7 59,415 8.9
Nonredeemable preferred stocks 26,969 4.2 28,687 4.3
----------- ---- --------- ----
Total equity securities 69,658 10.9 88,102 13.2
Other long-term investments 13,585 2.1 13,600 2.0
Short-term investments 94,993 14.8 94,993 14.2
----------- ---- --------- ----
Total investments $640,922 100.0% $668,415 100.0%
=========== ===== ========= =====
Net after-tax investment
yield on average invested assets 4.8%
===
(Continued)
-11-
December 31, 1995
------------------------------------------
Estimated
Amortized Cost Fair Value (a)
--------------- --------------
(Dollars in thousands)
Fixed maturities held
to maturity:
AAA $33,915 5.7% $34,643 5.6%
AA 32,930 5.5 34,071 5.5
A 6,160 1.0 6,414 1.0
BBB 2,012 0.3 2,015 0.3
------- --- ------- ---
75,017 12.5 77,143 12.4
Fixed maturities available
for sale:
AAA 171,097 28.7 176,036 28.3
AA 93,151 15.7 98,149 15.8
A 54,771 9.2 56,588 9.1
BBB 27,475 4.6 28,069 4.5
BB 23,364 3.9 23,394 3.8
B 12,848 2.2 12,732 2.1
D 429 0.1 230 0.0
-------- ---- ------- ----
383,135 64.4 395,198 63.6
-------- ---- ------- ----
Total fixed maturities 458,152 76.9 472,341 76.0
Equity securities:
Common stocks 41,994 7.1 52,139 8.4
Nonredeemable preferred
stocks 31,277 5.3 32,946 5.3
------- ---- ------- ----
Total equity securities 73,271 12.4 85,085 13.7
Other long-term investments 11,521 1.9 11,572 1.9
Short-term investments 52,257 8.8 52,257 8.4
------- ----- ------- ----
Total investments $595,201 100.0% $621,255 100.0%
======== ===== ======== =====
Net after-tax investment
yield on average invested assets 5.0%
===
(a) Represents the estimated fair value as defined in Note 1 to
the Consolidated Financial Statements.
The financial condition of the issuers of securities owned by
the Company is closely monitored and, in cases where the values of
investments are deemed to be other than temporarily impaired,
realized losses are recognized. In 1996, no realized losses were
recognized for other-than-temporary investment impairments.
However, in 1995, after-tax, other-than-temporary investment
impairments of $1,388,000 were recorded as realized losses. At
December 31, 1996 and 1995, total, after-tax, other-than-temporary
investment impairments were $1,105,000 and $1,388,000,
respectively.
As of December 31, 1996, the largest holding by the Company
of securities of a single issuer, other than investments in
securities of the United States Government and its agencies, was
revenue bonds issued by The Chicago, Illinois Metro Water District,
with a market value of $6,102,000. These revenue bonds were rated
AA by Standard & Poor's.
Reserves
Loss reserves and loss adjustment expense ("LAE") reserves,
collectively ("loss reserves"), represent estimates of amounts
needed in the future to pay losses, and the expenses related to the
final settlement of such losses, with respect to insured events
which have occurred as of the balance sheet date. Such reserves
are determined using the Company's, as well as the industry's,
historical experience with claims arising from reported losses and
LAE in a particular line of business. Loss and LAE reserves are
estimates of the ultimate costs of claims incurred but not settled,
before any losses that are recoverable under reinsurance contracts.
Since the settlement of such claims is dependent upon numerous
complex factors, the Company closely monitors its loss and LAE
reserves for each line of business, and the factors underlying the
methods used in determining such amounts, on a regular basis.
Several methods are used to analyze loss reserves by line of
business, including paid and incurred loss development. Other
factors that are analyzed and considered in the determination of
loss reserves include: incurred claim counts and average claim
costs; claim
-12-
emergence and settlement patterns and changes in such patterns from
year to year; trends in the frequency and severity of loss; changes
in reinsurance coverages; changes in the mix and classes of
business; and changes in claims handling procedures as determined
by discussions with claims and operating staff and through claims
audits.
The reserve estimation process is reviewed quarterly, and is
adjusted to consider all pertinent information that is currently
available. During the third quarter of 1995, the Company performed
an analysis of the results for the first six months of 1995. This
analysis indicated several adverse claim trends which ultimately
led to a special actuarial review of the Company's loss reserves.
After conclusion of the actuarial review, the Company strengthened
its loss reserves by recording a pre-tax charge to earnings in
September 1995, of $13,971,000. Of the total $13,971,000 charge,
approximately half was attributed to 1994 and the prior two
accident years. No such reserve strengthening occurred or was
required during 1996.
Company management believes that the loss and LAE reserves of
the Company's insurance subsidiaries make reasonable provisions for
the ultimate net cost of all losses and claims incurred at year end
1996. Notwithstanding the foregoing, no assurances can be given
that further reserve development may not occur in the future as the
process of establishing loss and LAE reserves is, by nature,
imprecise. Any and all adjustments to loss and LAE reserves are
reflected in the operating results of the periods in which they are
made.
Accident Year Loss and LAE Analysis. An accident year is
an accumulation period for loss and LAE experience that is updated
in subsequent calendar years until all losses and LAE related to
that given period have been settled. Accident year loss ratios
relate losses associated with accidents whose occurrence lies
within a given calendar year to premiums earned during the same
year.
The table below shows that the Company's reported calendar
year loss ratio decreased in 1996, compared to 1995. The
significant increase in the calendar year loss ratio for 1995,
compared to 1994, reflected the Company's reserve strengthening
charge, which is discussed above, for losses and LAE expenses
relating to business written in prior years. The following table
also shows that the Company's accident year loss ratio, developed
through December 31, 1996, has increased over the last three years.
Reported
Accident Year Calendar Year
Year Loss Ratio Loss Ratio
1996 70.3% 70.1%
1995 70.1 75.3
1994 69.2 66.3
-13-
Calendar Year Loss Reserve Analysis. An analysis of the
Company's calendar year loss and LAE reserves is presented below:
Direct and Direct and
Assumed less Ceded (Net) Assumed (Gross)
Year Ended December 31, Year Ended December 31,
---------------------------- --------------------------
1996 1995 1994 1996 1995 1994
----- ---- ----- ---- ---- ----
(In thousands) (In thousands)
Balance at
beginning of
year $286,339 $179,775 $165,800 $354,634 $241,221 $220,965
Reserves
acquired as
a result of
a business
combination 80,692 80,964
--------- -------- -------- -------- ------- --------
Adjusted
beginning
reserves 286,339 260,467 165,800 354,634 322,185 220,965
Add:
Provision for
incurred losses
and LAE:
Current year 338,779 280,726 212,458 381,202 308,787 227,282
Prior years (995) 12,787 1,047 903 32,792 19,793
------- ------- ------- ------- ------- -------
337,784 293,513 213,505 382,105 341,579 247,075
Less:
Payments for
incurred losses
and LAE:
Current year 194,667 159,208 111,418 200,902 162,548 112,647
Prior years 144,775 108,433 88,112 167,429 146,582 114,172
-------- ------- ------- ------- ------- -------
339,442 267,641 199,530 368,331 309,130 226,819
-------- ------- ------- ------- ------- -------
Balance at end
of year $284,681 $286,339 $179,775 $368,408 $354,634 $241,221
======== ======== ======== ======== ======== ========
Included in gross 1995 and 1994 payments, above, were $13,000,000
and $15,375,000, respectively, of claim payments on prior years
resulting in adverse gross development due to the claims originally
being established net of reinsurance. These claims should have been
established gross of losses that were recoverable under reinsurance
contracts. The recoveries were collected from reinsurers resulting
in no adverse development on a net basis. There were no claim
payments of this nature during 1996. Also, included above, in net
1995 payments on prior years' business is $13,142,000 of payments
made by Viking, which are not included in the Company's reserve
development.
The adverse (favorable) development of loss reserves
attributable to major lines of business for the years indicated is
as follows:
Direct and Direct and
Assumed less Ceded (Net) Assumed (Gross)
Year Ended December 31, Year Ended December 31,
-------------------------- --------------------------
1996 1995 1994 1996 1995 1994
---- ---- ---- ---- ---- ----
(In thousands) (In thousands)
Personal lines $(4,038) $ 2,504 $ (550) $(4,547) $ 2,277 $ (990)
Commercial lines 1,675 10,056 1,563 3,957 30,288 20,749
Collateral protection 1,368 227 34 1,493 227 34
------ ------- ------ ------- ------- -------
$ (995) $12,787 $1,047 $ 903 $32,792 $19,793
======== ======= ====== ======= ======= =======
The favorable development in personal lines in 1996 was mainly
due to estimated incurred but not reported losses at the beginning
of the year developing lower than expected, as well as the
successful implementation of claims operational changes, which
resulted in better than expected development on 1995 personal lines
acquired reserves. In 1996, except for storm related claims in the
first quarter, claim frequency levels stabilized, while claim
severity improved. The adverse development in personal lines in
1995 was principally caused by the reserve strengthening recorded
in the third quarter of 1995, as discussed above. This
strengthening decision was made, in part, because the private
passenger automobile liability outstanding claims and incurred but
not reported losses developed higher than expected. Other
contributing factors to the 1995 adverse development included
continued higher trends in frequency of automobile claims. The
favorable development in personal lines in 1994 was the result of
claims settling for lower amounts than expected and lower re-
estimates of incurred but not reported losses.
The adverse development in commercial lines in 1996 was mainly
attributable to general liability losses and loss adjustment
expenses developing higher than expected on reported claims. The
adverse development in commercial lines in 1995 related
predominately to commercial automobile liability outstanding claims
and incurred but not reported
-14-
losses developing higher than expected due to higher claim severity
in 1992 through 1994. This adverse development in the commercial
automobile line of business was a significant component of the
strengthening of the Company's loss reserves during the third
quarter of 1995, as discussed above. The remaining 1995 adverse
development in commercial lines was from general liability and
other smaller lines of business. The reason for the adverse
development in 1994 relates primarily to loss development on
professional, general and commercial automobile liability claims
occurring prior to 1985. Adverse development on accident years
1985 and prior was insignificant to the total commercial lines'
adverse development in 1996, compared to $920,000 and $1,300,000 of
adverse development in 1995 and 1994, respectively. This reflects
a continued decrease from the level incurred in prior calendar
years.
The development in general liability during 1995 and 1994
resulted from the continued settlement of environmental claims.
Environmental claims reported to the Company to date, such as
asbestos and pollution contamination, have primarily related to
policies written during the period 1978 to 1984. In 1985, the
Company added an absolute pollution exclusion clause to general
liability policies to significantly reduce exposure to such
claims. The Company's known exposure to environmental losses is
not considered to be material as they have amounted to
approximately three percent of cumulative payments on general
liability claims for the accident years 1978 to 1984 and there are
less than $600,000 in net outstanding claim reserves, and
approximately $2,000,000 in total loss and loss adjustment expense
reserves, at December 31, 1996. Based on the claim activity to
date and the nature of the business written during this period and
subsequent periods, the Company does not believe that there is a
material exposure to such risks in the future. The adverse
development in professional liability relates to medical
malpractice coverages on hospitals. These classes of risk were
not written subsequent to 1985.
The increased adverse development in the collateral protection
unit during 1996 was primarily due to an under- estimation of
unreported claims, as of December 31, 1995, for the Blanket Vendor
Single Interest and Puerto Rico business.
The following tables present the development of the balance sheet
reserve liability on a net basis for 1996 through 1986 and a gross
basis for 1996 through 1992. The amounts shown for each year on
the top line of the net development table represents the Company's
estimate of its liability for future payments of losses and LAE as
of the balance sheet date. The upper portion of the table
represents the cumulative amount of the initial liability that has
been paid in the succeeding years. The lower portion of the table
represents a re-estimation of the initial balance sheet liability
at the end of each succeeding year. The bottom line of the table
represents the change from the initial estimate to the latest re-
estimate. The gross development table shows a reconciliation of
gross and net loss and LAE reserves, and shows the gross basis
cumulative deficiency in a more condensed format. As indicated
below, the Company anticipates the gross loss and LAE development
to be more volatile. Therefore, the Company utilizes reinsurance
for its less predictable business in order to minimize its loss
exposure and to reduce the volatility of its net earnings.
-15-
Reserve Development
Direct and Assumed, less Ceded (Net)
Year Ended December 31,
--------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992 1991 1990 1989 1988 1987 1986
------ ------ ------ ------ ------ ------ ------ ------ ------ ----- ------
(In millions)
Liability for
unpaid
losses
and LAE-net $284.7 $286.3 $179.8 $165.8 $144.5 $133.9 $132.2 $117.4 $102.7 $87.7 $74.1
Paid (cumulative) as of:
One year later 144.8 95.3 88.1 71.2 66.2 68.3 63.3 53.0 42.7 39.2
Two years later 144.1 130.3 112.8 103.1 105.3 92.6 80.4 67.9 62.6
Three years later 152.8 133.5 125.5 125.0 109.9 92.2 82.7 79.6
Four years later 142.4 135.0 136.5 119.5 100.6 88.5 89.8
Five years later 138.6 140.8 125.1 106.6 94.0 92.5
Six years later 143.0 127.8 109.8 98.5 96.5
Seven years later 128.5 111.8 100.4 100.7
Eight years later 111.9 102.0 102.2
Nine years later 102.0 103.2
Ten years later 103.2
Liability re-estimated
as of:
End of year 284.7 286.3 179.8 165.8 144.5 133.9 132.2 117.4 102.7 87.7 74.1
One year later 285.3 192.6 166.8 146.8 136.9 134.2 118.5 105.4 92.5 84.1
Two years later 199.0 172.3 148.6 140.9 139.0 122.3 105.2 95.9 93.6
Three years later 175.8 152.2 142.4 142.8 125.6 106.3 94.4 96.6
Four years later 152.9 143.4 144.8 128.0 108.5 95.7 96.7
Five years later 143.0 145.9 129.5 110.8 97.9 96.9
Six years later 145.9 130.6 112.8 101.1 99.3
Seven years later 130.6 113.8 102.8 102.6
Eight years later 113.9 103.9 104.2
Nine years later 104.0 105.1
Ten years later 105.2
Net cumulative
redundancy
(deficiency) 1.0 (19.2) (10.0) (8.4) (9.1) (13.7) (13.2) (11.2) (16.3) (31.1)
Reserve Development
Direct and Assumed (Gross)
Year Ended December 31,
------------------------------------------------
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
(In millions)
Liability for unpaid
losses and LAE-net $284.7 $286.3 $179.8 $165.8 $144.5
Reinsurance recoverable 83.7 68.3 61.4 55.2 47.0
------ ------ ------ ------ ------
Liability for unpaid
losses and LAE - gross 368.4 354.6 241.2 221.0 191.5
Liability re-estimated
as of:
End of year 368.4 354.6 241.2 221.0 191.5
One year later 355.5 274.0 240.8 194.2
Two years later 283.0 267.3 213.6
Three years later 273.2 233.6
Four years later 237.4
Gross cumulative
(deficiency) (0.9) (41.8) (52.2) (45.9)
A redundancy means that the latest estimate of the liability
for losses and LAE is lower than the liability that was initially
estimated. Whereas, a deficiency means that the latest estimate of
the liability for losses and LAE is higher than the liability that
was initially estimated. Conditions and trends, previously
discussed, that have affected development of
-16-
liability in the past may not necessarily occur in the future.
Accordingly, it may not be appropriate to extrapolate future
redundancies or deficiencies based on these tables.
Rating
During 1996, A.M. Best continued its rating of GNIC and its
subsidiaries as "A (Excellent)," and of VICW and its affiliate of
"A- (Excellent)." In general, A.M. Best ratings are based on an
analysis of the financial condition and operation of an insurance
company as they relate to the industry. These ratings are not
primarily designed for investors and do not constitute
recommendations to buy, sell or hold any security. A.M. Best
ratings fall into the following categories: A++ and A+ (Superior);
A and A- (Excellent); B++ and B+ (Very Good); C++ and C+ (Fair); C
and C- (Marginal); and D (Below Minimum Standards).
Management believes that a significant change in its A.M. Best
rating could affect its business, including its relationships with
its independent agents, positively in the case of an upgrade or
negatively in the case of a downgrade.
Competition
The insurance business is highly competitive. There are
approximately 3,200 property and casualty insurance companies in
the United States, although most of them are not significant
competitors for the specialty lines which the Company underwrites.
Some competing companies offer more diversified insurance coverage
and have greater financial resources than the Company. Competition
may include lower premiums, specialized products, more complete and
complex product lines, greater pricing flexibility, superior
service, different marketing techniques, or better agent
compensation. The Company largely limits its business to the
relatively small market for nonstandard lines of insurance, and
more recently to standard lines of commercial insurance in a
limited geographic area.
Management believes that one of its competitive advantages is
specializing in limited insurance lines. This specialization
allows the Company to refine its underwriting and claims
techniques, which in turn, provide agents and insureds with
superior service. In addition, management believes that the
"A (Excellent)" rating received from A.M. Best gives the Company a
competitive advantage over competitors with lower ratings.
Regulation
The Company's insurance subsidiaries are subject to regulation,
primarily by the states of their incorporation. GNIC, PEAK and
CCIC are incorporated in Colorado, LAIC is incorporated in
Oklahoma, GNICOC is incorporated in California, and VICW is
incorporated in Wisconsin. Each of the subsidiaries is are also
subject to regulation by other jurisdictions in which it they sell
insurance.
State regulatory agencies have broad administrative
powers, including powers relating to the licensing of insurers and
their agents, the form and content of policy forms and sales
literature, approval of cancellation procedures, premium notice
requirements, the form and content of financial statements, reserve
requirements, and limitations on permitted investments. In
general, such regulation is for the protection of policyholders
rather than shareholders.
All insurance companies must file annual statements with certain
regulatory agencies and are subject to regular and special
examinations by those agencies. The last regulatory financial
examination of GNIC was completed by the Colorado Insurance
Department in 1994 covering the four year period ended December 31,
1993. An examination of LAIC by the Oklahoma Insurance Department
was completed in 1994 covering the three year period ended
December 31, 1993. CCIC's latest examination was completed by the
Colorado Insurance Department in 1994 covering the two year period
ended December 31, 1993. PEAK's latest examination was completed
by the Colorado Insurance Department for the one year period ended
December 31, 1993. The last regulatory examination of GNICOC was
completed by the California Insurance Department for the period
ended December 31, 1990. However, GNICOC is currently under exam
as of December 31,1995. The Company's management does not expect
the results of the examination to have a material adverse impact on
the Company. The most recent examination of VICW was completed by
the Wisconsin Insurance Department for the five year period ended
December 31, 1993. No significant adjustments resulted from any of
these examinations.
In some instances, various states routinely require deposits of
assets for the protection of policyholders either in those states
or for all policyholders. As of December 31, 1996, securities
representing approximately four percent of
-17-
carrying value of the Company's investment portfolio were on
deposit with various state treasurers or custodians. Such deposits
must consist of securities which comply with standards that the
particular state has established.
The Company is also subject to state laws regulating insurance
holding company systems. Most states have enacted legislation or
adopted administrative regulations affecting insurance holding
companies and the acquisition of control of insurance companies, as
well as transactions between insurance companies and persons
controlling them. The nature and extent of such legislation and
regulations currently in effect vary from state to state. However,
most states require administrative approval of the acquisition of
10% or more of the outstanding shares of an insurance company
incorporated in the state. The acquisition of 10% of such shares
is generally deemed to be the acquisition of "control" for the
purpose of the holding company statutes and requires not only the
filing of detailed information concerning the acquiring parties and
the plan of acquisition, but also administrative approval prior to
the acquisition. In many states the insurance authority may find
that "control" in fact does or does not exist in circumstances
where there is no control over day-to-day management or where a
person owns or controls either a lesser or a greater amount of
securities.
The state jurisdictions in which the Company's insurance
subsidiaries are authorized to transact business on an admitted
basis all require participation in their respective guaranty funds.
Insurers authorized to transact business in such jurisdictions are
required to cover losses of insolvent insurers and can be assessed
generally between one to two percent of direct premiums written in
that jurisdiction each year to pay the claims of insolvent
insurers. In 1996 and 1995,the net assessments paid by the Company
totaled $303,000 and $131,000, respectively. The likelihood and
amount of any future assessment cannot be reasonably estimated
until after an insolvency has occurred. Insurance companies also
must participate in automobile insurance plans and other
specialized coverage plans (windstorm, etc.) mandated by some
states in which they sell insurance.
Most states have insurance laws requiring that rate schedules
and other information be filed with the state's regulatory
authority, either directly or through a rating organization with
which the insurer is affiliated. The regulatory authority may
disapprove a rate filing if it finds that the rates are inadequate,
excessive, or unfairly discriminatory. Rates vary by class of
business, hazard covered and size of risk. Nonstandard and special
risks are generally not limited to the standard rates of national
rating bureaus. The Company is permitted to file rates which are
usually higher than those charged for standard risks, reflecting
the higher probability of loss. Several states have recently
adopted laws or their legislatures are considering proposed laws
which, among other things, limit the ability of insurance companies
to effect rate increases and orto cancel, orreduce or not renew
coverage with respect to existing policies, particularly personal
auto insurance.
A number of state legislatures and the United States Congress
are considering, or have now enacted, some type of legislative
proposals which alter the rules for tort claims and increase the
states' or federal authority to regulate insurance companies. In
some instances, these initiatives have expanded the states'
regulation over rates and have also and also have increased data
reporting requirements. The Company is not aware of any proposed
state legislation which would have a material adverse impact on
business.
Although the federal government generally does not directly
regulate the business of insurance, federal initiatives often
effect the business in a variety of ways. There are various
current proposed federal measures which may significantly affect
the Company's insurance business, including, among other proposals,
superfund reform and automobile-choice no-fault legislation. The
economic and competitive effects on the Company of these proposals
will depend upon the final form such of any legislation which may
be enacted. might take.
The state of domicile of the Company's insurance subsidiaries
require that they furnish to it financial and other information
concerning the operations of companies within a holding company
system. All transactions within a holding company system affecting
insurers must be fair and reasonable, and the insurer's
policyholders' surplus following any transaction must be both
reasonable in relation to its outstanding liabilities and adequate
for its needs. Notice to applicable regulators is required prior
to the consummation of certain transactions affecting insurance
subsidiaries of the holding company system.
The principal source of cash available to Guaranty is
dividends from GNIC and VICW. The ability of GNIC and VICW to
declare dividends is governed by the insurance laws of the state of
incorporation. The Colorado dividend restriction law limits the
annual dividend a Colorado domiciled insurance company may pay to
its parent holding company during a twelve-month period to the
greater of 10% of GNIC's statutory surplus or the statutory net
income, excluding realized capital gains, as reported at the end of
the preceding calendar year. When a dividend is declared by
-18-
GNIC, the Colorado Insurance Department must be notified of such
declaration within five days thereafter, and at least ten business
days before the payment of the dividend. The Wisconsin dividend
restriction law limits the annual dividend a Wisconsin domiciled
insurance company may pay to its parent holding company during a
twelve-month period to the lesser of 10% of VICW's statutory
surplus as of the end of the preceding calendar year or the greater
of either the statutory net income of VICW for the preceding
calendar year, less realized capital gains, or the aggregate of the
net income of VICW for the three calendar years preceding the date
of the dividend, less realized capital gains for those calendar
years minus dividends paid or credited and distributions made
within the first two of the preceding three calendar years. See
Note 13 to the Consolidated Financial Statements for disclosure of
statutory policyholders' surplus and the maximum annual dividends
currently payable by GNIC and VICW. No state insurance laws or
regulations restrict dividend payments by Guaranty.
Insurance regulators have broad powers to prevent reduction of
statutory surplus to inadequate levels, and there is no assurance
that dividends of the maximum amounts calculated under any
applicable formula would be permitted.
Employees
As of December 31, 1996, the Company had approximately 1,030
employees. The Company's employees are not members of any labor
union. The Company believes that it smaintains good relations with
its employees are good.
ITEM 2. PROPERTIES
The Company's relocated operations are principally located in a
150,000 square foot facility located in Englewood, Colorado, a
64,000 square foot building located in Madison, Wisconsin, a 23,000
square foot building in Salem, Oregon and a 35,000 square foot
facility in Freeport, Illinois. All four of these facilities are
owned by the Company, and are currently adequate for the Company's
needs and are anticipated to remain adequate for future needs.
ITEM 3. LEGAL PROCEEDINGS
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, which
is discussed above, 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 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 1996 consolidated financial
statements. See Note 17 to the Consolidated Financial Statements
for further discussion of these costs.
In addition to the three complaints described above, the Company
is subject to litigation in the normal course of operating its
insurance business. In the judgment of the Company's management,
at December 31, 1996 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 operation, taking into
account the reserves established therefore and giving effect to
insurance.
ITEM 4. SUBMISSION OF MATTER TO A VOTE OF SECURITY HOLDERS
None.
-19-
INFORMATION CONCERNING EXECUTIVE OFFICERS OF THE COMPANY
The following is a summary of certain information regarding the
executive officers of the Company. All officers of Guaranty and
its subsidiaries serve at the pleasure of their respective Boards
of Directors.
James R. Pouliot has been President and Chief Executive
Officer (CEO) of the Company since December 1996 and CEO of Viking
from 1992. Mr. Pouliot has been a Company Director since 1995.
Prior to taking over as President and CEO of the Company, Mr.
Pouliot served as Executive Vice President and CEO-Elect from July
1996. From 1990 to 1992, Mr. Pouliot served as Vice President of
Marketing for Great American Insurance Company; age 43.
Richard M. Beverage has been Senior Vice President (SVP)-Chief
Actuary for the Company since February 1996. From 1992 through
1996, Mr. Beverage was a Senior Manager - Reserving Studies with
Deloitte & Touche LLP. He served as Chief Pricing Actuary for
Zurich-American Insurance Company of Illinois from 1991 through
1992; age 45.
Shelly J. Hengsteler has been Controller and Assistant Treasurer
and Principal Accounting Officer of the Company since January 1996.
Ms. Hengsteler joined Guaranty National in 1989. From 1991 until
1994, she was a Financial Reporting Manager and from 1994 through
1995 she served as Director of Corporate Finance; age 34.
Arthur J. Mastera has been SVP-Chief Administrative Officer of
the Company since October 1996. Prior to becoming Chief
Administrative Officer, Mr. Mastera was President of the Guaranty
National Personal Lines Division since November 1995. Mr. Mastera
rejoined GNIC as SVP-Administration and Corporate Information
Systems in February 1992. From 1989 until 1992, he was Senior Vice
President of Planning and Administration at Orion Capital
Companies. Mr. Mastera originally joined GNIC in 1983; age 56.
Jacqueline L. Melton has been SVP of the Company since December
1996. She has also been SVP-GNIC and SVP-Human Resources since
1991. Ms. Melton joined GNIC in 1980 and from 1986 to 1991 she
served as Vice President of Human Resources; age 46.
Michael L. Pautler joined GNIC in 1981 and since 1988 has been
SVP-Finance and Treasurer of the Company;
age 42.
Fred T. Roberts has been SVP of the Company and President of the
Commercial Lines Unit since November 1995. He served as SVP of
GNIC Claims from 1984 to 1995; age 55.
Charles B. Ruzicka has been SVP-Information Systems since
December 1996. From August 1996, until assuming his current
position, Mr. Ruzicka was Vice President-Personal Lines Information
Systems. From 1993 through 1996, Mr. Ruzicka was Vice President of
Viking. From 1987 to 1993, Mr. Ruzicka was employed with
Progressive Insurance Company and was a Vice President from 1992
through 1993; age 43.
Philip H. Urban has been SVP of the Company and President of the
Personal Lines Business Unit since November 1996. From 1990 to
1996, Mr. Urban was SVP-Personal Lines for Great American Insurance
Company; age 44.
-20-
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
(a) Principal Market.
The principal market on which the Company's Common
Stock is traded is the New York Stock Exchange.
(b) Stock Price and Dividend Information
The table below presents the high and low market prices
and dividend information for the Company's Common Stock for 1996 and 1995.
Cash
Stock Prices Dividends
High Low Declared
---- --- ---------
1996:
Quarter Ended December 31 $17.125 $15.375 $0.125
Quarter Ended September 30 17.875 13.50 0.125
Quarter Ended June 30 18.00 15.00 0.125
Quarter Ended March 31 17.00 13.375 0.125
------
Total $0.50
======
1995:
Quarter Ended December 31 $16.875 $13.75 $0.125
Quarter Ended September 30 19.00 15.75 0.125
Quarter Ended June 30 18.50 15.25 0.125
Quarter Ended March 31 18.25 15.50 0.125
------
Total $0.50
======
(c) Approximate Number of Holders of Common Stock
The approximate number of holders of the Company's
Common Stock, as of February 28, 1997, was 2,400, including both
record and beneficial shareholders in security position listings.
-21-
ITEM 6. SELECTED FINANCIAL DATA
The following table summarizes information with respect to the
operations of the Company for the five-year period ended December 31, 1996.
Year Ended December 31,
-----------------------------------------------------
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
(In thousands, except per share amounts and ratios)
Income Statement Data:
Gross premiums written $538,036 $451,513 $364,991 $322,613 $300,293
Premiums ceded 46,804 53,614 42,066 38,573 60,506
-------- -------- -------- -------- --------
Net premiums written $491,232 $397,899 $322,925 $284,040 $239,787
Premiums earned $481,648 $390,017 $321,638 $257,540 $220,033
Net investment income 39,439 30,976 23,576 22,551 22,701
Realized investment gains 8,455 3,291 3,007 5,996 2,342
Other income 2 69 424
-------- --------- -------- -------- -------
Total revenue 529,542 424,284 348,223 286,156 245,500
-------- --------- -------- -------- -------
Losses and loss
adjustment expenses 337,784 293,513 213,505 173,500 144,586
Policy acquisition
costs 133,931 110,341 93,103 76,725 64,946
General and
administrative 10,422 6,458 7,206 6,280 5,395
Interest 6,851 5,708 3,218 2,592 2,565
Other expenses (a) 3,673 932 1,604 2,433 676
-------- -------- ------- -------- ------
Total expenses 492,661 416,952 318,636 261,530 218,168
-------- -------- ------- -------- -------
Earnings before
income taxes 36,881 7,332 29,587 24,626 27,332
Income taxes 9,375 (1,597) 7,036 5,341 7,061
-------- --------- -------- --------- ------
Earnings before
accounting changes 27,506 8,929 22,551 19,285 20,271
Cumulative accounting
changes 1,106
-------- ---------- -------- --------- ------
Net earnings $27,506 $ 8,929 $22,551 $20,391 $20,271
========= ========== ======== ========= =======
Earnings per share
before
accounting change $ 1.84 $ 0.67 $ 1.86 $ 1.54 $ 1.62
Cumulative accounting
changes .09
------- ------- ------- ------- -------
Net earnings per
common share $ 1.84 $ 0.67 $ 1.86 $ 1.63 $ 1.62
======= ======= ======= ======= =======
Weighted average common
and equivalent
shares outstanding 14,973 13,324 12,136 12,538 12,479
======= ====== ====== ======= ======
Statutory Operating Ratios:
Loss 70.1% 75.3% 66.3% 67.3% 65.7%
Expense 31.2 30.3 30.5 31.3 32.4
---- ---- ---- ---- ----
Combined 101.3% 105.6% 96.8% 98.6% 98.1%
===== ===== ==== ==== ====
GAAP Operating Ratios:
Loss 70.1% 75.3% 66.3% 67.4% 65.7%
Expense 30.0 30.0 31.2 32.2 32.0
---- ---- ---- ---- ----
Combined 100.1% 105.3% 97.5% 99.6% 97.7%
===== ===== ==== ==== ====
Dividends:
Dividends paid
per common share $ 0.50 $ 0.50 $ 0.50 $ 0.50 $ 0.50
(Continued)
-22-
Year Ended December 31,
-----------------------------------------------------
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
(In thousands, except per share amounts and ratios)
Balance Sheet Data:
Total cash and
investments $671,229 $625,872 $387,942 $386,250 $327,572
Total assets (b) 929,092 875,173 605,088 575,083 477,484
Unpaid losses and
loss adjustment
expenses (b) 368,408 354,634 241,221 220,965 191,508
Notes payable 101,688 103,000 52,896 38,896 32,896
Shareholders' equity 238,039 215,551 144,759 152,489 130,123
Statutory
policyholders'
surplus 253,815 220,621 133,229 122,452 105,931
Book value per share $15.90 $14.41 $12.02 $12.22 $10.44
Ratio of Net Premiums
Written to
Policyholders'
Surplus (b) 1.94 2.19 2.42 2.32 2.26
(a) 1996 includes a nonrecurring tender offer charge of
$2,163,000; 1994 includes a nonrecurring relocation charge of $838,000;
1993 includes a $1,750,000 nonrecurring charge for settlement of litigation.
(b) 1995 net premiums written to policyholders surplus ratio was
calculated using a full year of Viking net premiums written, rather than
using Viking net premiums written from the acquisition closing date forward.
-23-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
General
Guaranty National Corporation ("Guaranty") and its subsidiaries
(collectively, the "Company") manage their property and casualty
business in three operating units: commercial lines, personal
lines and collateral protection insurance. Gross premiums written
and GAAP combined ratios by operating unit for the three years
ended December 31, 1996, 1995 and 1994, respectively, are
summarized below:
Year Ended December 31,
----------------------------------
1996 1995 1994
---- ---- ----
(Dollars in thousands)
Personal lines:
Gross premiums written $257,410 $197,147 $131,123
GAAP combined ratio 97.6% 104.9% 96.5%
Commercial lines:
Gross premiums written $201,537 $200,228 $195,028
GAAP combined ratio 105.5% 108.5% 98.6%
Collateral protection:
Gross premiums written $79,089 $54,138 $38,840
GAAP combined ratio 96.3% 95.7% 97.1%
Total:
Gross premiums written $538,036 $451,513 $364,991
GAAP combined ratio 100.1% 105.3% 97.5%
On July 18, 1995, the Company completed its acquisition of
Viking. The Viking acquisition has enabled the Company to increase
its nonstandard private passenger automobile premiums, as well 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 its 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 consolidated financial statements from the
acquisition closing date forward. See Note 3 to the Consolidated
Financial Statements for further discussion related to the Viking
acquisition.
In July 1996, Company management announced a decision to
integrate the Viking and Guaranty National personal lines divisions
into one personal lines business unit. This decision was reached,
in part, by the recognition of a trend in the nonstandard personal
lines insurance industry which emphasizes the importance of a lower
expense ratio. During the fourth quarter of 1996, a personal lines
business unit President was named. The new President and the
personal lines leadership group have begun to make management and
staffing assignments for the personal lines business unit, and to
focus on agency, geographic and product integration. The personal
lines integration effort will continue throughout 1997. In
addition to the decision to integrate the personal lines business
unit, Company management evaluated the commercial specialty and
general divisions during the third quarter of 1996. This
evaluation led to a decision to reorganize into a contracts and
brokerage division and a programs department. Company management
expects this reorganization will enable the Company to operate more
efficiently and to better serve its respective markets. The
commercial standard division will, however, remain separate.
Reorganization activities within these two commercial divisions
will continue into 1997. As a result of these recent management
decisions, the financial results of the personal lines business
unit will no longer be delineated by division and the financial
results of the commercial lines unit will be discussed in total.
The Company's investment philosophy is aimed at achieving an
attractive long-term rate of return while maintaining a high level
of quality and liquidity in its portfolio. The Company maintains a
diversified portfolio comprised of a broad spectrum of industries
and types of securities. At December 31, 1996 and 1995, the
Company's portfolio consisted primarily of investments in fixed
maturities and short-term investments. Such investments
represented 85% and 84%, respectively, of the Company's total
invested assets. At December 31, 1996, the total equity securities
portfolio at estimated fair value was comprised of $59,415,000 in
common stocks and $28,687,000 in nonredeemable preferred stocks.
The remaining investments at December 31, 1996, were primarily
several investment limited partnerships. In addition, during 1995,
Viking County Mutual ("VCM"), a county mutual organization
-24-
controlled by Viking, issued a $1,300,000 surplus debenture to
Viking. See Note 14 to the Consolidated Financial Statements for
further discussion of this surplus debenture. As of December 31,
1996, the Company had no direct real estate or mortgages in its
investment portfolio, other than investments in federal agency
mortgage pools.
The Company maintains 62% of its investment portfolio in
investment grade (rated "BBB" or above) fixed maturities. It
invests a portion of its assets in noninvestment grade (rated "BB"
or below) bonds and preferred stocks in order to increase its
overall yield on its investment portfolio. At December 31, 1996,
the Company had noninvestment grade fixed maturity securities of
$55,205,000 with an estimated fair value of $56,477,000. Such
securities were approximately eight percent of total invested
assets at December 31, 1996, compared to approximately six percent
at December 31, 1995. Securities which are not rated by
independent rating services are assigned the comparable rating of
the National Association of Insurance Commissioners. At
December 31, 1996, less than one percent of total fixed maturity
investments were not current on interest payments.
Results of Operations
Year Ended December 31, 1996 Compared to the Year Ended December
31, 1995
Overall, gross premiums written increased 19% to $538,036,000 in
1996, from $451,513,000 in 1995. The majority of the growth was
attributable to increases in the Company's personal lines and
collateral protection operating units. Consolidated net premiums
written for 1996 increased $93,333,000, or 23%, compared to 1995,
due to a higher volume and change in mix of business. Premiums
ceded to reinsurers, as a percentage of gross premiums written,
decreased approximately three percent during 1996. The decline
resulted primarily from a reduction in commercial lines premiums,
as a percentage of total premiums. Commercial coverages are more
heavily reinsured than the premiums from the personal lines and
collateral protection units, which write business at lower limits
than the commercial lines unit.
The personal lines business unit experienced a $60,263,000, or
31%, increase in gross premiums written in 1996 compared to 1995.
The premium volume growth was the result of the Viking acquisition.
Prior to the acquisition of Viking in 1995, the Company did not
write personal lines business in the state of California. During
1996, this state accounted for 34% of the unit's total gross
premiums written. The remaining net increase in this unit's gross
premiums written represented the net effect of both increases in
other states in which Viking writes business, and decreases in
gross premiums written in several states where actions have been
focused on improving the unit's profitability.
The personal lines business unit GAAP combined ratio decreased
to 97.6% for the year ended December 31, 1996. The 7.3 point
improvement was the result of a lower loss ratio (incurred losses
and loss adjustment expense). The lower loss ratio resulted from a
9.3 point decrease in the incurred losses component, which was
offset by a 2.0 point increase in the loss adjustment expense
component. The decreased incurred losses component was primarily
due to lower claim severity, as well as estimated incurred but not
reported losses at the beginning of the year developing lower than
expected. The increased loss adjustment expense component was due
to this unit's emphasis on improved claim handling and on fighting
insurance fraud, which resulted in increased legal expenses and
increased staffing in the unit's Special Investigative Unit.
Additionally, in the prior year the Company strengthened its
personal lines loss and loss adjustment expense reserves by
$5,010,000. Conversely, during 1996, prior year reserves were
decreased as the result of lower than expected claim costs on
settlement.
The commercial lines unit gross premiums written increased
slightly, by $1,309,000, to $201,537,000 in 1996, compared to
1995. The increase is the net effect of both increases in the
commercial standard division offset by decreases in certain
nonstandard lines of business, primarily commercial automobile
liability. In accordance with the Company's ongoing, planned,
business mix change, which has been in progress over the past few
years, commercial automobile liability gross premiums written were
reduced to 36% of total commercial lines premiums for 1996 compared
to 40% for 1995. While commercial automobile liability gross
premiums written declined during 1996, the unit's 1996 property
gross premiums written increased from 15% to 19% of total
commercial lines gross premiums written, compared to the prior
year. Also, in July 1995, this unit introduced an automobile
physical damage program in California, which was 50% quota-share
reinsured. This program accounted for $1,765,000 of the total
increase in, and $10,454,000 of the 1996 commercial lines unit
gross premiums written. However, due to poor loss experience in
this program, the agent has been given notice of cancellation. As
a result, the Company expects the gross premiums written for this
program to be insignificant during 1997. The expected 1997 premium
decline on this California physical damage program is expected to
be offset by increased premium production in the commercial
standard lines of business.
-25-
The commercial lines unit GAAP combined ratio decreased by 3.0
points to 105.5% in 1996, compared to 1995. The decrease resulted
primarily from a 5.9 point improvement in the unit's loss ratio,
which was partially offset by a 2.9 point deterioration in the
unit's expense ratio. The lower loss ratio was attributable to
lower overall commercial claims frequency and severity during 1996.
Also, the 1995 loss ratio was unusually high because of the loss
and loss adjustment expense reserve strengthening for prior year
claims recorded in 1995. No significant reserve strengthening
occurred during 1996. The higher expense ratio was due to more
commercial business written in programs having higher commission
rates, as well as increased contingent commissions.
Collateral protection insurance, the Company's third operating
unit, increased 1996 gross premiums written 46% to $79,089,000,
compared to 1995. This significant increase was primarily due to
this unit's two newest products, GAP and mortgage fire insurance.
The gross premiums written from GAP and mortgage fire insurance
increased approximately $16,534,000 over the prior year.
Additionally, premiums from this unit's automobile business
increased approximately $10,266,000 in 1996, compared to 1995.
These increases were partly offset by a $3,282,000 decrease in
gross premium written in Puerto Rico.
The collateral protection unit GAAP combined ratio increased 0.6
points for 1996, compared to the prior year. The increase was due
to an 8.1 point increase in the unit's loss ratio for 1996,
compared to 1995. The higher loss ratio was a result of increased
frequency in the Northeast blanket vendor single interest and
Puerto Rico collateral protection programs. The unit has
implemented underwriting and pricing adjustments and has canceled
problematic accounts in an effort to correct the higher loss ratio.
The unit's higher loss ratio was partially offset by its lower
expense ratio. The expense ratio for 1996 was 36.0%, compared to
43.5% for 1995. The improvement in the expense ratio related to
lower agency contingent commissions, which were proportionately
reduced by the increased loss ratio.
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 was with National Reinsurance
Corporation ("NRC"), which is now owned by General Reinsurance
Corporation ("General Re"), and served 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. Effective
July 1, 1996, as a result of the acquisition of NRC by General Re,
the Company's contract was renegotiated under the terms of the
treaty at a more favorable rate and the retentions were modified.
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. Also, the contract will terminate December 31, 1997
rather than December 31, 1998.
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, and quota-share reinsurance.
The Company's insurance operating units, in total, experienced
$995,000 of favorable development in 1996 on 1995 and prior loss
reserves, net of reinsurance. This compares to $12,787,000 of
adverse development in 1995 on 1994 and prior loss reserves, net of
reinsurance. The development equates to (0.3%) and 7.1% of loss
reserves carried at December 31, 1995 and 1994, respectively. The
small amount of redundant development in 1996 was primarily due to
estimated incurred but not reported (IBNR) losses at the beginning
of the year developing lower than expected, as well as better than
expected settlement on 1995 personal lines acquired reserves. The
favorable development within the personal lines business unit was
partially offset by general liability losses and loss adjustment
expenses on reported claims developing higher than expected, and
collateral protection incurred but not reported losses developing
higher than expected. The high adverse development in 1995 on
prior accident years was primarily due to personal and commercial
automobile liability losses on both reported and unreported claims
developing higher than expected.
During 1996, the Company's known exposure to environmental
losses, such as asbestos and pollution contamination, did not
materially change. Based on the minimal 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.
During 1996, the Company's catastrophic losses amounted to
$1,689,000, or $0.11 per share, net of tax and reinsurance
recoveries. This compares to $1,615,000 in catastrophic losses, or
$0.12 per share, net of tax and reinsurance recoveries, during
1995. The catastrophic losses mainly affected the commercial and
personal lines operating units, and primarily related to storms in
the Central United States, Hurricane Fran and Hurricane Bertha.
-26-
Company 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.
The Company's 1996 interest expense increased $1,143,000, or
20%, compared to 1995. This increase was due to an overall
increase in bank borrowings during mid-1995. The 1995 borrowings
were used to fund the Viking acquisition, and 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, in 1995 the Company entered into two interest rate swap
agreements to hedge $80,000,000 of the total borrowings until 1998.
These agreements have given the Company a fixed interest rate,
including the applicable London Interbank Offered Rate (LIBOR)
margin outlined in the Company's reducing, revolving credit
facility, of approximately 6.3% on the $80,000,000. See Note 11 to
the Consolidated Financial Statements for further discussion of the
interest rate swap transactions.
Pretax net investment income increased $8,463,000 in 1996,
compared to 1995, and after-tax net investment income increased
$5,592,000 for the same period. These increases were primarily due
to an overall increase in average invested assets, which resulted
primarily from the July 1995, addition of the Viking investment
portfolio and positive operating cash flow. Additionally, the
Company had stronger earnings from its limited partnership
investments during 1996, when compared to 1995. Specifically,
earnings from limited partnership investments increased $1,718,000
during 1996. The investment portfolio yield, on an after-tax
basis, decreased slightly to 4.8% in 1996, compared to 5.0% in
1995.
After-tax realized investment gains in 1996 and 1995, were
$5,496,000 and $2,139,000, respectively. The significant increase
in 1996 after-tax realized investment gains, compared to 1995, was
predominately due to the strong stock market during 1996. The sale
of equity securities resulted in approximately 94% of the total
realized investment gains.
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 December 31, 1996 Consolidated
Financial Statements. See Note 17 to the Consolidated Financial
Statements for further discussion of these costs.
The income tax expense was 25.4% of pre-tax income in 1996
versus a 21.8% income tax benefit of pre-tax income in 1995. The
1996 income tax expense differed from the Federal statutory rate
due to nontaxable interest income and the dividends received
deduction on stock dividends. The 1995 income tax benefit resulted
from a combination of underwriting losses and nontaxable interest
income and dividends received deduction.
Overall, the Company's net earnings increased $18,577,000, to
$27,506,000, for the year ended December 31, 1996, compared to the
year ended December 31, 1995. Net earnings per common share were
$1.84 at year end 1996, versus $0.67 at year end 1995. The
majority of the improvement in the Company's net earnings and net
earnings per common share was attributable to increased
profitability in the Company's personal lines business unit. In
the prior year, net earnings and net earnings per common share were
substantially reduced by a $9,081,000, or $0.68 per share, net of
tax, reserve strengthening charge within the personal and
commercial units.
Year Ended December 31, 1995 Compared to the Year Ended December
31, 1994
Gross premiums written increased 24% to $451,513,000 in 1995,
from $364,991,000 in 1994. The personal lines business unit,
experienced a $66,024,000, or 50%, increase in gross premiums
written in 1995 compared to 1994. The majority of the premium
volume growth was a result of the acquisition of Viking, which
accounted for $61,766,000 of the overall increase in the personal
lines business unit gross premiums written during 1995. The
remaining increase in gross premiums written was primarily due to
expansion into Indiana, Louisiana, and Ohio.
The personal lines business unit GAAP combined ratio increased
to 104.9% for the year ended December 31, 1995. The increase was
the result of a higher loss ratio caused by the reserve
strengthening recorded in the third quarter of 1995, combined with
higher frequency of automobile physical damage claims, as well as
catastrophe losses. The increased loss ratio was offset slightly
by a lower expense ratio resulting from improved operating
efficiencies.
-27-
During 1995, the commercial lines unit gross premiums written
remained relatively constant, with only a three percent increase,
when compared to 1994. This consistent level was a result of
standard division new business generated outside the Rocky Mountain
region, as well as the expansion of existing specialty programs and
umbrella business, and the introduction of a new automobile
physical damage program in California. These increases were offset
by decreases in other commercial lines of business. In accordance
with the Company's planned business mix change, commercial
automobile liability gross premiums written were reduced to 40% of
total commercial lines premiums for 1995 compared to 52% for 1994.
The commercial lines unit GAAP combined ratio increased by 9.9
points to 108.5% in 1995, due primarily to a higher loss ratio
resulting from the reserve strengthening in commercial automobile
liability recorded in the third quarter of 1995, and continued high
severity in 1995. In addition, the commercial lines unit expense
ratio increased slightly during 1995 compared to 1994.
Collateral protection insurance increased gross premiums written
39% to $54,138,000. This significant increase was primarily due to
geographic expansion in the Commonwealth of Puerto Rico, increased
market penetration in existing states, and growth in blanket single
interest insurance product line, as well as the introduction of a
new product, mortgage fire. The new business written in Puerto
Rico comprised 16% of gross premiums written by the collateral
protection unit during the twelve months ended December 31, 1995.
The growth in the blanket single interest, GAP and mortgage fire
product lines increased collateral protection gross premiums
written by approximately $4,829,000 during 1995.
The collateral protection business is characterized by a loss
ratio that is significantly lower, and an expense ratio that is
significantly higher, than most other lines of business. However,
during 1995 this unit improved its expense ratio by 5.0 points due
to lower overall agency commissions. Additionally, during 1995
more blanket single interest policies were sold, which normally
have a lower acquisition cost.
The consolidated net premiums written increased $74,974,000, or
23%, in 1995, compared to the previous year, primarily due to a
higher volume of business as explained above. Premiums ceded to
reinsurers, as a percentage of gross premiums written, remained
constant during 1995. Increased commercial lines reinsurance costs
were offset by increased personal lines business, which has a lower
reinsurance charge than commercial lines due to the lower liability
limits on personal lines policies. The Company maintains
reinsurance treaties which cover almost all lines of business on an
excess of loss basis, and which limit the Company's liability on
catastrophe losses.
In an analysis of the results for the first six months of 1995,
the Company observed several adverse claim trends which led to a
special actuarial review of the Company's loss (losses and loss
adjustment expenses) reserves. This extensive actuarial review
indicated that higher frequency and severity trends were causing
the unanticipated higher claim costs. As a result, the Company
strengthened its loss reserves by recording a pre-tax charge to
earnings of $13,971,000 during the third quarter. Approximately
one-half of this $13,971,000 charge was attributed to 1994 and the
prior two accident years.
The Company's loss ratio in 1995 was 75.3%, up from the 66.3%
reported in 1994. The significant increase in the loss ratio was
mainly due to the reserve strengthening, which was recorded in the
third quarter of 1995, as discussed above. The commercial lines
loss ratio increased 9.7 points to 78.0%, primarily as a result of
the reserve strengthening and higher severity in 1995. In personal
lines, the loss ratio increased to 78.6% from 69.4%, due to the
reserve strengthening, as well as higher frequency of automobile
physical damage claims, and catastrophe losses. The collateral
protection unit loss ratio increased in 1995 to 52.2% compared to
48.6% in 1994.
Including the reserve strengthening charge, the Company's
insurance operating units, in total, experienced $12,787,000 of
adverse development in 1995 on 1994 and prior loss reserves, net of
reinsurance. This compares to $1,047,000 of adverse development in
1994 on 1993 and prior loss reserves, net of reinsurance. The
development equates to 7.1% and 0.6% of loss reserves carried at
December 31, 1994 and 1993, respectively. The adverse development
in 1995 was principally caused by commercial automobile and private
passenger automobile liability outstanding claims and incurred but
not reported losses developing higher than expected. The remainder
was from general liability and other lines.
During 1995, the Company's known exposure to environmental
losses, such as asbestos and pollution contamination, did not
materially change. Based on the minimal claim activity to date and
the nature of the business
-28-
written, primarily automobile coverage, the Company does not
believe that it has a material exposure to environmental losses.
During 1995, the Company experienced catastrophic losses, net of
reinsurance recoveries, amounting to $1,615,000, or $0.12 per
share, net of tax and reinsurance recoveries. This compares to
$1,080,000 in catastrophic losses, or $0.09 per share, net of tax
and reinsurance recoveries, during 1994. For the most part the
catastrophic losses affected the commercial and personal lines
operating units, and primarily related to hurricanes and wind and
hail storms.
The Company's expense ratio in 1995 was 30.0% compared to 31.2%
in 1994. The improvement in the expense ratio is due to higher
personal lines business unit premiums coupled with improved
operating efficiencies in this unit.
As a result of an overall increase in borrowings during 1995,
the Company's interest expense increased $2,490,000, or 77%,
compared to 1994. The borrowings were used to finance the Viking
acquisition, discussed above and in more detail in Note 6 to the
Consolidated Financial Statements. The borrowings are pursuant to
a reducing, revolving credit facility entered into in June 1995,
which provides for a floating interest rate. In order to reduce
the risk of changing interest rates, during the third quarter of
1995 the Company hedged $80,000,000 of the total borrowings until
1998, by entering into two interest rate swap agreements, giving
the Company a fixed interest rate. See Note 11 to the Consolidated
Financial Statements for further discussion of the interest rate
swap transactions.
Pretax net investment income increased $7,400,000 in 1995,
compared to 1994, and after-tax net investment income increased
$5,698,000 for the same period. These increases are primarily due
to a 30% increase in average invested assets, which resulted
primarily from the addition, effective July 18, 1995, of the Viking
investment portfolio and positive operating cash flow. Viking's
investment portfolio amounted to approximately $177,400,000 at the
date of acquisition. Excluding Viking, the Company's after-tax net
investment income increased 14%, to approximately $21,601,000, in
1995. The investment yield, on an after-tax basis, remained
constant at approximately five percent. After-tax realized
investment gains in 1995, and 1994, were $2,139,000 and $1,955,000,
respectively. Other-than-temporary investment impairments of
$1,388,000, after-tax, were recorded during 1995, while no
impairments were deemed necessary during 1994.
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 unrealized gain on
the fixed maturities held to maturity portfolio was $2,126,000 as
of December 31, 1995. The market value of the Company's fixed
maturity investments generally varies inversely with changes in the
general level of interest rates. The market 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 income tax benefit was 21.8% of pre-tax income in 1995
versus income tax expense of 23.8% in 1994. The 1995 income tax
benefit was a combination of underwriting losses and nontaxable
interest income and dividends received deduction.
Overall, the Company's net earnings decreased $13,622,000, for
the year ended December 31, 1995, compared to the year ended
December 31, 1994. Net earnings per common share were $0.67 for
1995, versus $1.86 for 1994. For the year ended December 31, 1995,
the strengthening of the Company's loss reserves accounted for
$9,081,000, or $0.68 per share, net of tax, of the decrease. The
remaining decrease in earnings per share for the year is
attributable to the increased loss ratios within the commercial and
personal operating units.
Liquidity and Capital Resources
The Company's operations have produced positive operating cash
flow during the past nine years. Net cash provided by operating
activities was $44,436,000, $29,101,000, and $39,478,000 for 1996,
1995 and 1994, respectively. The increase in operating cash flow
in 1996, compared to 1995, was mainly the result of higher premiums
and net investment income collected, as well as lower income tax
payments. Additionally, the Company paid less agency contingent
commissions during the current year, compared to the prior year.
These fluctuations were partially offset by higher levels of loss
and loss adjustment expense payments, policy acquisition costs and
interest paid during 1996, compared to 1995. Overall, during 1996
the ratio of losses and loss adjustment expenses paid to losses and
loss adjustment expenses incurred increased approximately 9%, when
compared to this same ratio for 1995.
-29-
Net cash used in investing activities amounted to $38,506,000,
$120,685,000, and $35,171,000 for 1996, 1995 and 1994,
respectively. The $82,179,000 decrease in cash used in investing
activities during 1996, compared to 1995, mainly related to a
decline in cash used to acquire subsidiaries. As discussed above,
in the prior year the Company acquired Viking. However, in the
current year there were no acquisitions of subsidiaries. The
decrease in funds used to acquire subsidiaries was offset, in part,
by a net increase in purchases of all types of investments. The
increased investment purchases were partially offset by increased
sales and maturities of equity and fixed maturity securities.
Net cash used in financing activities was $8,736,000 in 1996,
versus net cash provided by financing activities of $88,769,000 and
$1,315,000 in 1995 and 1994, respectively. The net cash provided
by financing activities during 1995 was used to finance the Viking
acquisition. During 1996, the Company paid approximately
$1,313,000 in principal payments on its 6.5% term loan, which is
discussed in Note 6 to the Consolidated Financial Statements. As
of December 31, 1996, the Company had $10,000,000 available under
its reducing, revolving credit facility. The Company declared and
paid a regular quarterly dividend of $0.125 in each of the four
quarters during 1996.
The Company's 1996 book value per share increased $1.49, to
$15.90. This increase was primarily due to the significant
increase in the Company's net earnings during 1996, compared to
1995, coupled with an increase in the unrealized investment gains
caused by the strong stock markets during 1996.
The Company's level of short-term investments at December 31,
1996 and 1995 was 14.2% and 8.4%, respectively, of total
investments. The increase resulted from management's decision to
reduce the average duration of its investment portfolio and to
shift its investment mix to securities with more liquidity.
Company management believes that it maintains sufficient liquidity
in its investment portfolio through its short-term investment
holdings to meet anticipated claim payments and other insurance
payment requirements.
Securities are classified as available for sale and carried at
estimated fair value, unless they meet the Company's criteria to be
classified as held to maturity. Such criteria include investment
grade bonds with stated maturities less than 10 years. The
unrealized investment gains on fixed maturities available for sale
and on equity securities as of December 31, 1996, were $7,875,000
and $18,444,000, respectively. Overall, the unrealized gains on
equity securities increased $6,630,000 during 1996, compared to
1995, due to the strong stock market. The December 31, 1996
unrealized gain on the fixed maturities held to maturity portfolio
was $1,160,000. The estimated fair value of the Company's fixed
maturity investments generally varies inversely with changes in the
general level of interest rates. The estimated fair value of
federal agency and other mortgage pool securities is subject to
additional fair value volatility due to the impact of changes in
prepayment rates on the mortgages which underlie such securities.
Guaranty's projected use of cash consists of debt service,
dividends to shareholders, income taxes, and administrative
expenses. These required cash disbursements will be funded
primarily from existing available cash and dividends from Guaranty
National Insurance Company ("GNIC") and Viking Insurance Company of
Wisconsin ("VICW"). GNIC paid no dividends to Guaranty during
1996. However, VICW paid dividends in the amount of $8,687,000 to
Guaranty in 1996. Payment of dividends by GNIC and VICW must
comply with insurance regulatory limitations. Under current
regulations, permitted dividends exceed Guaranty's projected cash
requirements. The Colorado dividend restriction law limits the
annual dividend which can be paid by GNIC to the greater of 10% of
the insurer's statutory surplus or statutory net income, excluding
realized capital gains, as reported at the end of the preceding
calendar year. The Wisconsin dividend restriction law limits the
annual dividend that VICW may pay to Guaranty to the lesser of 10%
of VICW's statutory surplus as of the end of the preceding calendar
year or the greater of either the statutory net income of VICW for
the preceding calendar year, less realized capital gains, or the
aggregate of the net income of VICW for the three calendar years
preceding the date of the dividend, less realized capital gains for
those calendar years minus dividends paid or credited and
distributions made within the first two of the preceding three
calendar years. Under these laws, approximately $25,307,000, in
total, is available to pay dividends to Guaranty in 1997. The
Company believes both GNIC and VICW will be in position to pay
comparable dividends to Guaranty in the future. Management
believes that in addition to the $10,000,000 available under the
Company's reducing, revolving credit facility, Guaranty has
substantial sources of further liquidity, if necessary, from
capital markets and bank borrowings.
On July 2, 1996, Orion consummated its cash tender offer,
which is 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, increasing
their ownership percentage of
-30-
the Company from 49% to 81%. See Note 17 to the Consolidated
Financial Statements for further discussion related to these Orion
transactions.
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 12 to the Consolidated
Financial Statements for more discussion related to these
complaints.
On July 18, 1995, the Company acquired Viking for approximately
$94,681,000 in cash, including acquisition expenses and net of cash
acquired. In return, the Company received the common stock of
Viking, with net assets valued at $86,613,000. Additionally,
because Viking controls VCM, the Company and its affiliates receive
100% reinsurance services in the state of Texas from VCM. See Note
9 to the Consolidated Financial Statements for further discussion
of the 100% reinsurance arrangement.
From 1991 through 1995, the Company was indebted to Orion under
a $20,896,000 subordinated note agreement. However, subsequent to
the date of the original agreement various refinancing arrangements
and amendments were made. The last of these modifications took
place on June 14, 1995, and added a common stock conversion
feature. Thereafter, on June 22, 1995, the Company converted
$8,667,000 of the Orion Notes into 550,000 shares of common stock.
The remaining balance of these notes, $12,229,000, was converted
into 776,128 shares of common stock on October 30, 1995. Of the
total 1,326,128 common shares issued to Orion during 1995, as part
of the note conversion, 415,000 of these shares were re-issued
treasury shares. At December 31, 1994, the Company had a total of
438,200 shares of treasury stock, at a cost of $6,342,000, which
had been repurchased during 1994 pursuant to its stock repurchase
plan. However, in 1995 all of the treasury shares repurchased
during 1994 were re-issued either to Orion or in connection with
awards and the exercise of stock options under the Company's 1991
Long-Term Performance Incentive Plan.
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. This
additional purchase price amount is estimated to be $4,333,000.
See Note 3 to the Consolidated Financial Statements for further
discussion of this obligation. There are no other significant
contingencies or commitments known to management that would have a
material impact on the Company's liquidity or financial condition.
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 $1,300,000. In May
1994, the Company consolidated its Colorado operations to a new
facility, which provides facilities to support future growth.
Expenditures for the new facility totaled $16,208,000, primarily
funded from operating cash flow. Total nonrecurring relocation
charges were $838,000 in 1994.
On August 26, 1994, the Company acquired General Electric
Mortgage Insurance Corporation of California ("GEMIC") for
$6,363,000 in cash and received in exchange the common stock of
GEMIC, which had net assets valued at $5,508,000. The Company
renamed GEMIC as Guaranty National Insurance Company of California
("GNICOC"). The Company is utilizing GNICOC for its California
commercial and collateral protection business, reducing the need
for 100% reinsurance services from Orion. GNICOC retained no
liabilities from its previously written business and other
operations.
On December 17, 1996, James R. Pouliot was promoted to President
and Chief Executive Officer, following Roger B. Ware's retirement
on this same date. Also, during 1996, the Company's Board of
Directors elected W. Marston Becker, who was named Chairman and CEO
of Orion, to the Company's Board of Directors.
-31-
Forward Looking Statements
Some of the statements made in this Form 10-K Report, as well as
statements made by the Company in periodic press releases, oral
statements made by the Company's officials to analysts and
shareholders in the course of presentations about the Company and
conference calls following earnings releases, constitute "forward-
looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995 (the "Reform Act"). Such forward-
looking statements involve known and unknown risks, 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
the forward-looking statements. Such factors include, among other
things, (i) general economic and business conditions; (ii) interest
rate changes; (iii) competition and regulatory environment in which
the Company operates; (iv) claims frequency; (v) claims severity;
(vi) severe adverse weather conditions; (vii) the cost of
automobile repair; (viii) the number of new and renewal policy
applications submitted by the Company's agents; and (ix) other
factors over which the Company has little or no control.
-32-
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF MANAGEMENT
The management of Guaranty National Corporation is responsible
for the consolidated financial statements and the information
included therein. The consolidated financial statements are fairly
presented and have been prepared in accordance with generally
accepted accounting principles and are appropriate in the
circumstances, and, where necessary, include amounts based on
management's informed estimates and judgments.
The Company has an internal control structure which it believes
provides reasonable assurance that assets are safeguarded from loss
or unauthorized use, transactions are recorded in accordance with
management's policies and that the financial records are reliable
for preparing consolidated financial statements. The internal
control structure includes written policies and procedures which
are communicated to all appropriate personnel and updated as
necessary.
Compliance with the internal control structure is continuously
maintained and monitored by management. The internal audit staff
of the Company evaluates and reports on the adequacy of and
adherence to these controls, policies and procedures. In addition,
as part of its audit of the consolidated financial statements,
Deloitte & Touche LLP, the independent auditors for the Company,
evaluate the Company's internal control structure to the extent
they consider necessary to express an opinion on the consolidated
financial statements. Recommendations concerning the internal
control structure are provided by both the internal auditors and
Deloitte & Touche LLP, and management takes actions which are
believed to be appropriate responses to these recommendations.
The Audit Committee of the Board of Directors is comprised of
independent directors, and has general responsibility for oversight
of financial controls and audit activities of the Company and its
subsidiaries. The Audit Committee, which reports to the Board,
annually reviews the qualifications of the independent auditors and
meets periodically with them, the internal auditors and management
to review the plans for and results of the audits. Both internal
and independent auditors have free access to the Audit Committee,
without members of management present, to discuss the adequacy of
the internal control structure and any other matters which they
believe should be brought to the attention of the Audit Committee.
s/James R. Pouliot s/Michael L. Pautler
James R. Pouliot Michael L. Pautler
President and Chief Executive Officer Senior Vice President -
Finance and Treasurer
-33-
INDEPENDENT AUDITORS' REPORT
Board of Directors and Shareholders
Guaranty National Corporation
We have audited the accompanying consolidated balance sheets of
Guaranty National Corporation and subsidiaries ("the Company") as
of December 31, 1996 and 1995, and the related consolidated
statements of earnings, changes in shareholders' equity, and cash
flows for each of the three years in the period ended December 31,
1996. 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, such consolidated financial statements present
fairly, in all material respects, the financial position of
Guaranty National Corporation and subsidiaries at December 31, 1996
and 1995 and the results of their operations and their cash flows
for each of the three years in the period ended December 31, 1996
in conformity with generally accepted accounting principles.
s/Deloitte & Touche LLP
DELOITTE & TOUCHE LLP
Denver, Colorado
February 14, 1997
-34-
GUARANTY NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
ASSETS
December 31,
-----------------------
1996 1995
---- ----
Investments:
Fixed maturities held to maturity, at cost $ 80,271 $ 75,017
Fixed maturities available for sale, at market 390,290 395,198
------- -------
470,561 470,215
Equity securities, at market 88,102 85,085
Other long-term investments 13,585 11,521
Short-term investments available for sale,
at market 94,993 52,257
------- -------
Total investments 667,241 619,078
Cash 3,988 6,794
Accrued investment income 7,971 7,603
Accounts receivable, (less allowance of
$171 - 1996; $374 - 1995) 45,557 51,638
Reinsurance recoverables and prepaids,
(less allowance of $200 - 1996; $200 - 1995 ) 90,781 81,825
Property and equipment, (less accumulated
depreciation of $13,508 - 1996; $9,326 - 1995) 29,833 31,573
Deferred policy acquisition costs 44,456 37,637
Goodwill, (less accumulated amortization
of $6,423 -1996; $5,263 - 1995) 34,639 33,133
Other assets 4,626 5,892
-------- --------
Total assets $929,092 $875,173
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Unpaid losses $303,266 $290,156
Unpaid loss adjustment expenses 65,142 64,478
Unearned premiums 154,242 146,205
Notes payable 101,688 103,000
Reinsurance payables and deposits 7,268 8,290
Other liabilities 59,447 47,493
-------- --------
Total liabilities 691,053 659,622
-------- --------
Commitments and contingencies
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;
14,961,354 shares - 1995 14,975 14,961
Capital in excess of par 121,272 121,050
Retained earnings 84,685 64,664
Deferred compensation on restricted stock (644)
Net unrealized investment gains 17,107 15,520
-------- --------
Total shareholders' equity 238,039 215,551
-------- --------
Total liabilities and shareholders' equity $929,092 $875,173
======== =========
See notes to consolidated financial statements
-35-
GUARANTY NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
(In thousands, except per share amounts)
Year Ended December 31,
-----------------------------------
1996 1995 1994
---- ---- ----
Revenue:
Premiums earned $481,648 $390,017 $321,638
Net investment income 39,439 30,976 23,576
Realized investment gains 8,455 3,291 3,007
Other income 2
-------- -------- --------
529,542 424,284 348,223
Expenses:
Losses incurred 279,108 248,771 180,865
Loss adjustment expenses 58,676 44,742 32,640
Policy acquisition costs 133,931 110,341 93,103
General and administrative 10,422 6,458 7,206
Interest 6,851 5,708 3,218
Nonrecurring charges 2,163 838
Other 1,510 932 766
-------- ------- --------
492,661 416,952 318,636
-------- ------- --------
Earnings before income taxes (benefit) 36,881 7,332 29,587
Income taxes (benefit) 9,375 (1,597) 7,036
-------- -------- --------
Net earnings $27,506 $ 8,929 $22,551
======== ======== ========
Earnings per common share $ 1.84 $ 0.67 $ 1.86
======== ========= ========
See notes to consolidated financial statements
-36-
GUARANTY NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Deferred Unrealized
Capital Compensation Investment
Common in Excess Retained on Restricted Gains Treasury
Stock of Par Earnings Stock (Losses) Stock
------ --------- -------- ------------- ---------- -------
Balance,
January
1, 1994 $12,480 $83,991 $45,888 $ (663) $10,793 $
Net earnings 22,551
Change in
unrealized
investment
(losses),
less
applicable
deferred taxes (17,854)
Purchase of
treasury
stock (6,636)
Exercise of
stock options
and issuance
of restricted
stock, net of
cancellation 74 (368) 294
Amortization of
deferred
compensation on
restricted
stock 8 250
Cash dividends
declared and
paid (6,049)
------ --------- -------- ------------- ---------- -------
Balance
Decenber
31, 1994 12,480 84,073 62,390 (781) (7,061) (6,342)
Net earnings 8,929
Change in
unrealized
investment
gains, less
applicable
deferred taxes 22,581
deferred taxes
Exercise of
stock options
and issuance
of restricted
stock, net of
cancellations 20 329 (126) 327
Amortization of
deferred
compensation on
restricted
stock 8 263
Sale of common
stock 1,550 22,670
Conversion of
affiliate debt 911 13,970 6,015
Cash dividends
declared and
paid (6,655)
------- --------- -------- ------------- ---------- -------
Balance,
December
31, 1995 14,961 121,050 64,664 (644) 15,520
1995
Net earnings 27,506
Change in
unrealized
investment
gains, less
applicable
deferred taxes 1,587
Exercise of
stock options,
net of
cancellation 14 222
Amortization of
deferred
compensation on
restricted
stock 644
Cash dividends
declared and
paid (7,485)
------- --------- -------- ------------- ---------- -------
Balance,
December
31, 1996 $14,975 $121,272 $84,685 $ $17,107 $
======= ======== ======= ============ ========= ========
See notes to consolidated financial statements.
-37-
GUARANTY NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
Year Ended December 31,
----------------------------------
1996 1995 1994
----- ---- ----
Operating Activities:
Premiums collected $496,686 $396,621 $321,000
Net investment income collected 35,102 29,938 22,969
Losses and loss adjustment
expenses paid (339,442) (267,641) (199,530)
Policy acquisition costs
and general and
administrative expenses paid (145,711) (119,821) (93,495)
Interest paid (6,817) (6,005) (3,043)
Nonrecurring charges paid (1,302) (978)
Federal income taxes paid (2,470) (5,359) (6,108)
Other receipts (payments) 8,390 1,368 (1,337)
--------- ---------- --------
Net cash provided by
operating activities 44,436 29,101 39,478
--------- ---------- --------
Investing Activities:
Maturities of fixed maturities
held to maturity 9,795 12,096 10,231
Maturities of fixed maturities
available for sale 56,553 20,219 8,281
Sales of fixed maturities
available for sale 49,931 40,158 37,147
Sales of equity securities 40,373 28,367 19,185
Net change in short-term investments (42,584) (20,039) 7,535
Sales of property and equipment 303 590 274
Purchases of fixed maturities held
to maturity (20,780) (10,138) (16,570)
Purchases of fixed maturities
available for sale (100,536) (74,652) (57,989)
Purchases of equity securities (29,512) (21,480) (21,883)
Net change in other long-term
investments 1,433 1,825 (1,376)
Purchases of property and equipment (3,482) (2,950) (13,643)
Acquisition of subsidiaries, net of
cash acquired (94,681) (6,363)
---------- --------- ---------
Net cash used in investing
activities (38,506) (120,685) (35,171)
---------- --------- ---------
Financing Activities:
Proceeds from issuance of
notes payable 130,654 14,000
Repayment of notes payable (1,313) (60,000)
Dividends paid to shareholders (7,485) (6,655) (6,049)
Purchase of treasury stock (6,636)
Proceeds from issuance of common stock 24,220
Proceeds from exercise of stock
options 62 550
--------- -------- --------
Net cash (used in) provided by
financing activities (8,736) 88,769 1,315
--------- -------- --------
Net (Decrease) Increase in Cash (2,806) (2,815) 5,622
Cash, Beginning of
Year 6,794 9,609 3,987
--------- ------- --------
Cash, End Of Year $3,988 $6,794 $9,609
========= ======= ========
Non-Cash Financing Transactions:
Conversion of affiliate debt $ $ (20,896) $
Issuance of common stock in
conversion of affiliate debt 14,881
Conversion of affiliate debt
from treasury stock 6,015
Restricted stock forfeitures (126)
(Continued)
-38-
GUARANTY NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
Year Ended December 31,
---------------------------------------
1996 1995 1994
----- ---- ----
Reconciliation of Net Earnings
to Net Cash Provided By
Operating Activities:
Net earnings $27,506 $ 8,929 $22,551
Adjustments:
Depreciation 4,392 3,490 2,692
Non-cash investment income (3,969) (275) (401)
Realized investment gains (8,455) (3,291) (3,007)
Amortization of goodwill 1,160 883 766
Deferred tax provision (benefit) 4,164 (3,543) 24
Other 1,061 979 774
Changes in assets and liabilities:
Accrued investment income (368) (763) (206)
Accounts receivable 6,081 (2,782) (2,248)
Reinsurance recoverables and
prepaids (8,956) (6,679) (8,070)
Deferred policy acquisition costs (6,819) (3,775) 187
Other assets (44) 250 (25)
Unpaid losses 13,110 26,620 15,778
Unpaid loss adjustment expenses 664 5,829 4,478
Unearned premiums 8,037 12,375 3,506
Reinsurance payables and deposits (1,022) (821) (4,261)
Other liabilities 7,894 (8,325) 6,940
--------- ---------- ---------
Total adjustments and changes 16,930 20,172 16,927
--------- ---------- ---------
Net Cash Provided by Operating
Activities $44,436 $29,101 $39,478
========= ========== =========
See notes to consolidated financial statements.
-39-
GUARANTY NATIONAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
Nature of Operations - Guaranty National Corporation and
its subsidiaries (the "Company") is a corporation based in
Englewood, Colorado which principally underwrites and sells
specialty property and casualty insurance coverages that are
generally not available in traditional insurance markets. The
Company manages its business under three operational areas based on
function: commercial lines, personal lines and collateral
protection.
The Company's insurance subsidiaries are authorized as multiple-
line insurance carriers and may insure all types of property and
liability risks. The insurance coverages provided by these
insurance carriers are generally known as nonstandard risks due to
the potential for poor claims experience because of increased risk
exposure. The insurance subsidiaries market insurance coverage
throughout the United States, and one or more of these subsidiaries
are admitted in all states.
Basis of presentation - The consolidated financial
statements and notes thereto are presented in accordance with
generally accepted accounting principles ("GAAP") for property and
casualty insurance companies. The preparation of the Company's
consolidated financial statements in conformity with generally
accepted accounting principles requires Company management to make
estimates and assumptions that affect the amounts reported in these
consolidated financial statements and accompanying notes. Actual
results could differ from those estimates.
From November 1, 1988, through November 19, 1991, Orion Capital
Corporation and its affiliates ("Orion") owned 100% of Guaranty
National Corporation and subsidiaries outstanding common stock.
The assets and liabilities of the Company were revalued at the time
of the 1988 Orion purchase. The accompanying consolidated
financial statements reflect the recording of these acquisition
adjustments by Orion. Orion's current ownership is approximately
81%.
In 1995, the Company acquired control of, but not ownership of,
Viking County Mutual Company ("VCM"). VCM is a Texas mutual
organization which performs 100% reinsurance services in the state
of Texas for its affiliated companies. VCM is not included in the
consolidated financial statements.
As discussed in Notes 9 and 14, there are various transactions
with Orion and VCM which include certain expenses paid to Orion and
VCM and other transactions with Orion affiliates and VCM. In the
opinion of management, the transaction amounts with Orion are
reasonable and representative of expenses that would have been
incurred in transactions with unrelated parties.
Certain reclassifications have been made to the 1995 and 1994
consolidated financial statements to conform with the presentation
used in 1996.
Principles of consolidation - The consolidated financial
statements include the accounts of Guaranty National Corporation
("Guaranty") and its wholly-owned subsidiaries, Intercon General
Agency, Inc. ("Intercon"), Auto Insurance Centers, Inc. ("AIC"),
Guaranty National Warranty Services ("GNWS"), Guaranty National
Insurance Company ("GNIC") and Viking. GNIC includes its wholly-
owned subsidiaries, Landmark American Insurance Company ("LAIC"),
Colorado Casualty Insurance Company ("CCIC"), Peak Property and
Casualty Insurance Corporation ("PEAK"), and Guaranty National
Insurance Company of California ("GNICOC"). All significant
intercompany accounts and transactions have been eliminated in
consolidation.
Significant accounting policies - This summary of significant
accounting policies is presented to assist in understanding the
Company's consolidated financial statements:
a. Investments - Investments in bonds and redeemable
preferred stocks are carried in the accompanying consolidated
balance sheets as fixed maturities. Fixed maturities for which the
Company has the positive intent and ability to hold until maturity
are carried at amortized cost. Fixed maturities classified as
available for sale are carried at estimated fair value with any
unrealized gains or losses reflected in shareholders' equity, net
of applicable deferred taxes. Losses considered other than
temporary are recorded in earnings as a realized loss. The
Company's criteria used to identify fixed maturities held to
maturity as of December 31, 1996 and 1995, generally includes
investment grade bonds
-40-
with stated maturities less than 10 years. All other fixed
securities are classified as available for sale and may be sold in
response to changes in interest rates, anticipated prepayments,
liquidity needs or other economic factors. Select issues with
maturities beyond 10 years may be classified as held to maturity
due to certain factors, including expected early call provisions.
Investments in common stocks and nonredeemable preferred stocks
are classified as available for sale and are carried at estimated
fair value, with any unrealized gains or losses of securities
reflected in shareholders' equity, net of applicable deferred
taxes. Losses considered other than temporary are recorded in
earnings as a realized loss.
Estimated fair value for securities is generally based on last
sales prices, listed bid prices, bid quotations received from
security dealers or, when estimated fair values are not readily
available through market sources, fair value estimates are based on
quoted market prices of similar instruments. Mortgage loans are
carried at their unpaid balance and are classified as other long-
term investments. Estimated fair value for mortgage loans is
calculated by discounting scheduled cash flows through maturity
using estimated market discount rates. Other long-term
investments, which are principally comprised of interests in
several investment limited partnerships, are generally carried at
equity value which approximates estimated fair value. Short-term
investments, which include certificates of deposit, money market
accounts, and commercial paper maturing within one year of the
balance sheet date, are carried at cost which approximates
estimated fair value.
Realized investment gains and losses are recognized on the
specific identification method, and amortization of premiums and
discounts is determined using the interest method.
b. Losses and loss adjustment expenses - Losses and loss
adjustment expenses ("LAE") are charged to operations as incurred.
Losses and LAE liabilities are determined on the basis of claims
adjusters' evaluations and estimates based on historical experience
including estimates of incurred but not reported losses and salvage
and subrogation recoveries. Such liabilities are recorded gross of
applicable reinsurance. The Company does not discount the
liability for unpaid losses and LAE. Management believes that the
recorded liabilities are a reasonable provision for all losses and
loss adjustment expenses incurred. Notwithstanding the foregoing,
no assurances can be given that further reserve development may not
occur in the future as the process of establishing loss and LAE
reserves is, by nature, imprecise. The estimates are continually
reviewed and as adjustments to these estimates become necessary,
such adjustments are reflected in current operations.
c. Revenue recognition - Unearned premiums are generally
computed on a daily pro-rata method over the term of the policies
in-force and are carried gross of related reinsurance.
Historically, the Company has not experienced significant losses
related to receivables because of short payment terms and the lack
of concentrations of credit risk. Thus, the carrying amount
approximates estimated fair value.
d. Deferred policy acquisition costs - Policy acquisition
costs are deferred and charged to operations over the periods in
which the related premiums are earned. The determination of
recoverability of such deferred costs includes anticipated
investment income.
e. Property, equipment and depreciation - Property and
equipment are recorded at cost. Depreciation is computed using the
straight-line method over the estimated useful lives.
f. Income taxes - Deferred tax assets and liabilities are
recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax basis.
Deferred tax assets and liabilities are measured using enacted tax
rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or
settled.
g. Goodwill - The excess of Viking's cost over fair value of
net assets acquired is being amortized by the straight-line method
over 40 years. The excess of Orion's cost over fair value of net
assets acquired and other goodwill recorded in the consolidated
balance sheet is being amortized by the straight-line method over
31 to 36 years. Reflected in other expenses is amortization of
goodwill of $1,160,000, $883,000, and $766,000 for the years ended
December 31, 1996, 1995 and 1994, respectively.
h. Statement of cash flows - For purposes of the
consolidated statements of cash flows, the Company considers only
demand deposit accounts to be cash.
-41-
i. Earnings per share - Earnings per share for 1996, 1995
and 1994 has been computed by dividing net earnings by the number
of weighted average shares and equivalent shares outstanding of
14,973,332, 13,324,200 and 12,135,505, respectively. The common
stock equivalents are stock options which result in a dilutive
effect from assumed exercise of the options.
j. Employee stock compensation plans - The Company follows
Accounting Principles Board Opinion (APB) No. 25, "Accounting for
Stock Issued to Employees." The exercise price of stock options
issued to employees equals the market price of the stock on the
measurement date, and therefore, the Company does not record
compensation expense on stock options granted to employees.
Restricted stock issued to employees is considered issued and
outstanding when awarded, and is recorded as deferred compensation.
2. Statutory Accounting Practices
The accompanying consolidated financial statements are prepared
under GAAP which differs materially from practices prescribed by
statutory accounting rules and regulations. Under such practices,
GNIC consolidated policyholders' surplus reported to the state
regulatory authorities as of December 31, 1996 and 1995 was
$164,473,000 and $133,749,000, respectively, and Viking Insurance
Company of Wisconsin ("VICW") consolidated policyholders' surplus
as of December 31, 1996 and 1995 was $89,342,000 and $86,872,000,
respectively. SStatutory net income, as reported to state
insurance departments, is as follows (in thousands):
GNIC VICW
Year ended December 31, 1996 $20,450 $ 9,366
Year ended December 31, 1995 7,875 15,866
Year ended December 31, 1994 26,324
3. Acquisitions
On July 18, 1995, the Company acquired Viking in a business
combination accounted for as a purchase. Viking is a property
and casualty insurance company writing nonstandard personal
automobile insurance, primarily in the state of California.
The results of operations of Viking are included in the
accompanying consolidated financial statements since the date
of acquisition.
The total cost of the acquisition was $97,225,000, with
total cash paid of approximately $94,681,000, including
acquisition expenses and net of $878,000 cash acquired. The
total consideration exceeded the fair value of the net assets
of Viking by approximately $10,612,000. The total acquisition
cost differs from the announced total consideration paid of
$103,000,000 due to transaction expenses, the contingent
purchase price adjustments, discussed below, and a $12,000,000
extraordinary dividend taken by Talegen Holdings, Inc.
("Seller") from Viking just prior to the sale.
Included in the cost of the acquisition was $3,250,000 paid
to the Seller as additional purchase price, in anticipation of
favorable development of Viking's recorded 1994 and prior
accident year loss and LAE reserves. The Company has agreed to
pay the Seller, as additional purchase price, two-thirds of any
favorable loss development up to $15,000,000, and one-third of
any favorable development between $15,000,000 and $20,000,000.
The amounts payable will be reduced by 35% to compensate for
the applicable tax rate. The Company and the Seller will
initially settle any additional purchase price as of December
31, 1998, and will finalize the settlement as of December 31,
2001. If adverse development results, the Seller will repay to
the Company an offsetting amount, after allowance for the tax
adjustment, not to exceed the initial $3,250,000 paid to the
Seller at the time of acquisition.
Any payments to or receivables from the Seller, as a result
of the positive or negative loss development, will include
accrued interest from the acquisition closing date at an annual
rate equal to 6.28%, for the initial loss development
settlement payment as of December 31, 1998. For the final loss
development settlement payment, as of December 31, 2001, the
interest rate will equal the mid-term Applicable Federal Rate
(as defined in the Internal Revenue Service Code) in effect as
of January 1, 1999.
Management estimates that a payment in excess of the
$3,250,000 already paid will ultimately be made to the Seller,
and has included this estimated amount of approximately
$4,333,000, as well as the corresponding
-42-
interest payable, in the accompanying consolidated financial
statements. Loss and LAE reserves of Viking were recorded at
the date of acquisition at amounts consistent with the
Company's estimates of additional purchase price that will be
paid.
The following summarized pro forma information (unaudited)
assumes the Viking acquisition had occurred on January 1, 1995
and 1994 (in thousands, except per share amounts):
Twelve Months Ended
December 31,
1995 1994
Total Revenue $512,718 $509,657
======= =======
Net Income 7,765 30,014
======= =======
Earnings Per Share $ 0.53 $ 2.05
======= =======
The above amounts reflect adjustments used in recording the
purchase, such as adjustments for interest on notes payable
issued as part of the purchase price, amortization of goodwill,
and fees eliminated as a result of the acquisition.
4. Investments
The amortized cost and estimated fair values of investments in
fixed maturity and equity securities are as follows (in thousands):
December 31,
----------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ---------
1996
- ----
Fixed maturity securities
held to maturity:
U.S. Treasury and
U.S. Government agencies $30,674 $ 170 $ 106 $30,738
State and municipal 47,605 1,202 146 48,661
Corporate 1,992 39 2,031
------ ------ ------ ------
80,271 1,411 252 81,430
Fixed maturity securities
available for sale:
U.S. Treasury and
U.S. Government agencies 112,115 1,222 548 112,789
State and municipal 156,439 6,150 165 162,424
Corporate 113,861 3,290 2,074 115,077
------- ------ ------ -------
382,415 10,662 2,787 390,290
------- ------ ------ -------
Total fixed maturity securities $462,686 $ 12,073 $ 3,039 $471,720
======= ======= ====== =======
Equity securities:
Common stocks $ 42,689 $ 17,966 $ 1,240 $ 59,415
Nonredeemable preferred stocks 26,969 3,096 1,378 28,687
------- ------- ------ -------
Total equity securities $ 69,658 $ 21,062 $ 2,618 $ 88,102
======= ======= ====== =======
-43-
December 31,
--------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------- ---------- ----------- --------
1995
- ----
Fixed maturity securities
held to maturity:
U.S. Treasury and
U.S. Government agencies $ 17,943 $ 896 $ $ 18,839
State and municipal 53,907 1,564 400 55,071
Corporate 3,167 66 3,233
------- ------ ------- -------
75,017 2,526 400 77,143
Fixed maturity securities
available for sale:
U.S. Treasury and
U.S. Government agencies 123,209 3,000 126,209
State and municipal 176,461 8,298 161 184,598
Corporate 83,465 2,884 1,958 84,391
------- ------ ------ -------
383,135 14,182 2,119 395,198
======= ====== ====== =======
Total fixed maturity securities $458,152 $16,708 $ 2,519 $472,341
======= ====== ====== =======
Equity securities:
Common stocks $ 41,994 $12,767 $ 2,622 $ 52,139
Nonredeemable preferred
stocks 31,277 3,654 1,985 32,946
------- ------ ------ -------
Total equity securities $ 73,271 $16,421 $ 4,607 $ 85,085
======= ====== ====== =======
For a summary of the amortized costs and estimated fair
value of fixed investment maturities at December 31, 1996 and 1995,
by contractual maturity, see Note 7.
Net investment income is summarized as follows (in thousands):
Year Ended December 31,
------------------------------------
1996 1995 1994
---- ---- ----
Type of investment:
Fixed maturities held to maturity $ 4,090 $ 7,531 $ 7,653
Fixed maturities available
for sale 24,369 15,886 10,999
Common stocks 1,686 1,420 1,147
Nonredeemable preferred stocks 2,393 2,432 2,557
Short-term investments 4,570 2,439 1,145
Other 3,702 2,397 1,166
------ ------ ------
Total investment income 40,810 32,105 24,667
Less investment expenses 1,371 1,129 1,091
------ ------ ------
Net investment income $39,439 $30,976 $23,576
====== ====== ======
-44-
Realized investment gains and losses, which include a write-
downs for other-than-temporary investment impairments of $2,135,000
as of December 31, 1995, are as follows (in thousands):
Year Ended December 31,
-----------------------------------
1996 1995 1994
---- ---- ----
Fixed maturities held to maturity:
Gains $ $ 360 $ 174
Losses (269) (21)
------ ------ ------
91 153
Fixed maturities available for sale:
Gains 1,815 1,566 2,374
Losses (1,322) (2,869) (2,657)
----- ----- -----
493 (1,303) (283)
Equity securities:
Gains 9,950 6,227 3,192
Losses (1,988) (1,724) (55)
----- ----- -----
7,962 4,503 3,137
----- ----- -----
Total $ 8,455 $ 3,291 $ 3,007
===== ===== =====
Net change in unrealized gains (losses) in the estimated fair
value of investments is as follows (in thousands):
Year Ended December 31,
--------------------------------------
1996 1995 1994
---- ---- ----
Fixed maturities held to maturity $ (967) $ 4,999 $ (7,819)
Fixed maturities available for sale (4,188) 24,044 (20,675)
Equity securities 6,630 10,697 (6,672)
------ ------ -------
Total $ 1,475 $39,740 $(35,166)
====== ====== =======
To augment the average yield on its investment portfolio, the
Company invests a portion of its fixed maturity assets in "high
yield" bonds and preferred stocks, which are investments of a
quality considered to be noninvestment grade (rated "BB" or below).
Such securities are generally considered to have a higher potential
of loss due to default because they are unsecured, subordinated to
other debt and/or issued by highly leveraged companies. At
December 31, 1996 and 1995, the Company had investments in "high
yield" securities of $55,205,000 and $36,641,000 with estimated
fair values of $56,477,000 and $36,356,000, respectively.
The Company closely monitors the financial condition of issuers
of securities that it owns, and if conditions are deemed
appropriate, the Company ceases to accrete, discount, accrue
interest or record "pay in-kind" interest or dividends. The
Company had $315,000 and $230,000 of fixed maturities at estimated
fair value at December 31, 1996 and 1995, respectively, which had
been non-income producing for a portion of the previous twelve
months. All fixed maturities at December 31, 1994 had been income
producing during the year. At December 31, 1996 and 1995, total
other-than-temporary investment impairments amounted to $1,700,000
and $2,135,000, respectively. There were no other-than-temporary
investment impairments at December 31, 1994. In 1995, and as a
result of the Statement of Financial Accounting Standards (SFAS)
No. 115 "Implementation Guide" the Company transferred certain
fixed maturities from the held to maturity portfolio to the
available for sale portfolio. The amortized cost of this transfer
was $41,643,000 and the unrealized gain was $916,000. During 1994,
the Company transferred fixed maturity securities from the held to
maturity portfolio to the available for sale portfolio due to the
decrease in credit ratings of three issuers. The amortized cost of
this transfer was $4,219,000 and the unrealized loss was $450,000.
Concentrations of credit risk exist for groups of issuers
when they have similar economic characteristics that would cause
their ability to meet their obligations to be similarly affected by
changes in economic or other conditions. At December 31, 1996, the
Company holds $35,543,000 of fixed maturity and equity securities
of public utilities and $210,029,000 of fixed maturities of state
and local governments; these holdings are not collateralized. The
Company does not have a concentration of credit risk with any one
issuer of fixed income or equity securities.
-45-
5. Property and Equipment
In May 1996, Viking moved its Freeport, Illinois operations from
a leased facility to an office building which was acquired by
Viking. Viking purchased the building in February 1996, for
approximately $1,300,000.
In conjunction with the Viking acquisition, in July 1995,
the Company acquired two Viking owned properties, as well as
various Viking owned equipment. The Viking owned properties
consist of Viking's corporate office building located in Madison,
Wisconsin, and a regional claims office located in Salem, Oregon.
The estimated fair value of these two facilities, as well as the
equipment, totaled approximately $7,028,000 at July 18, 1995, the
acquisition closing date.
During 1994, the Company relocated its Colorado operations
to a new home office facility. See Note 17 for further discussion
of this relocation.
6. Notes Payable
On June 2, 1995, the Company entered into a $110,000,000 credit
agreement ("Credit Agreement") with several participating banks.
The Agreement provides for an unsecured reducing revolving credit
facility, used in part to fund the Viking acquisition (See Note 3),
to retire the outstanding balance of $29,000,000 under the
Company's previous revolving line of credit, and for working
capital and general corporate purposes.
The Credit Agreement was amended and restated as of December 16,
1996, in order to obtain a more favorable commitment fee and London
Interbank Offered Rate (LIBOR) margin, to adjust the repayment
schedule and terms, and to modify certain of the debt covenants.
Under the amended and restated Credit Agreement, principal payments
are required beginning April 15, 1998, until the loan is retired in
2002. The Company made an early principal payment during 1995 in
the amount of $2,000,000, and therefore, the next principal payment
is due on April 15, 1999. Interest is payable quarterly, and
interest rates are based on the floating LIBOR rate. As of
December 31, 1996, the outstanding loan amount under this Agreement
was $100,000,000, with an interest rate of 6.24% (see Note 11).
Loan fees are being amortized over the seven year life of the loan.
The Credit Agreement contains covenants with respect to
minimum net worth and statutory surplus, the maximum ratio of net
written premiums to surplus, the minimum fixed charge coverage
ratio, the minimum level of total adjusted capital (within the
meaning of the Risk-Based Capital for Insurers Model Act as
promulgated by the National Association of Insurance
Commissioners), and limitations on other items, such as permitted
investments and disposition of material assets. The Company is
currently in compliance with the affirmative, negative and
financial covenants of the Agreement.
On June 14, 1995, the Company amended the $20,896,000
subordinated notes ("Orion Notes") held by Orion, to include a
common stock conversion feature. On June 22, 1995, the Company
converted $8,667,000 of the Orion Notes into 550,000 shares of
common stock. On October 30, 1995, the Shareholders of the Company
approved the conversion of the remaining balance of the Orion Notes
into 776,128 shares of common stock.
As of December 31, 1996, the Company had a remaining principal
balance of $1,688,000 under its 6.5% term loan, which was entered
into during 1994 in order to purchase furniture and fixtures for
the new home office facility. This term loan is secured by the
furniture and fixtures purchased. Quarterly principal and interest
payments are due on this loan until April 1, 1999.
Maturities of notes payable are as follows: 1997-$562,500; 1998-
$750,000; 1999- $22,375,000; 2000-$24,000,000; 2001-$26,000,000;
2002 and thereafter-$28,000,000.
-46-
7. Fair Value of Financial Instruments
The amortized cost and estimated fair value of fixed investment
maturities at December 31, 1996 and 1995, by contractual maturity,
are shown below (in thousands). Expected maturities will differ
from contractual maturities because issuers may have the right to
call or prepay obligations with or without call or prepayment
penalties.
December 31,
--------------------------------------------------
Available for Sale Held to Maturity
------------------ ----------------
Estimated Estimated
Amortized Fair Amortized Fair
Cost Value Cost Value
--------- --------- --------- ---------
1996
- ----
Due in one year or less $ 46,601 $ 46,700 $ 2,000 $ 2,000
Due after one year
through five years 95,761 96,236 39,321 40,333
Due after five years
through ten years 63,395 66,057 33,330 33,615
After ten years 128,284 132,981 5,620 5,482
Federal agency and
other mortgage pools 48,374 48,316
------- ------- ------- ------
$382,415 $390,290 $ 80,271 $81,430
======= ======= ======== ======
1995
Due in one year or less $ 33,100 $ 33,342 $ 9,816 $ 9,861
Due after one year
through five years 98,425 99,124 26,346 27,411
Due after five years
through ten years 66,832 68,829 28,489 29,905
After ten years 132,220 139,818 10,366 9,966
Federal agency and
other mortgage pools 52,558 54,085
------- ------- ------ ------
$383,135 $395,198 $ 75,017 $ 77,143
======= ======= ======= =======
The carrying value and estimated fair value of other financial
instruments at December 31, 1996 and 1995 are as follows (in
thousands):
December 31, 1996 December 31, 1995
------------------------- -----------------------
Carrying Estimated Carrying Estimated
Value Fair Value Value Fair Value
-------- ---------- -------- ----------
Assets:
Equities $ 88,102 $ 88,102 $ 85,085 $ 85,085
Other long-term
investments 13,585 13,600 11,521 11,572
Short-term investments 94,993 94,993 52,257 52,257
Liabilities:
Notes payable 101,688 101,696 103,000 103,009
Estimated fair value of the term loan, included in notes
payable above, was calculated by discounting contractual cash flows
through maturity using quoted market rates for similar issues with
similar maturities. Estimated fair value of the Credit Agreement,
also included in notes payable above, approximates face value due
to the credit terms during the revolving period. See Note 6 for
further discussion of both the term loan and Credit Agreement.
The estimated fair value of financial hedge instruments,
both of which are held for other than trading purposes, is the
estimated amount the Company would pay to terminate the interest
rate swap agreements, taking into consideration current interest
rates and other relevant factors. The estimated amount at December
31, 1996 and 1995 was $214,000 and $678,000, respectively.
8. Income Taxes
Effective July 2, 1996, the Company will be included in Orion's
consolidated federal income tax return and is covered by income tax
sharing agreements under which the Company computes its current
federal income tax liability on a separate return basis and pays
Orion any taxes due on this basis.
Deferred income taxes result from temporary differences in the
basis of various assets and liabilities for financial statement
purposes and for tax purposes, and alternative minimum tax ("AMT")
credit carryforwards. The tax effects of
-47-
the temporary differences and AMT carryforwards comprising the net
deferred tax liability at December 31, 1996 and the net deferred
tax asset at December 31 1995, which are included in other
liabilities and other assets in the consolidated balance sheet, are
as follows (in thousands):
Year Ended December 31,
-------------------------
1996 1995
---- ----
Discounted loss reserves $10,406 $11,325
Unearned premiums 9,642 8,971
Deferred compensation arrangements 1,658 1,030
Realized investment losses 595 747
AMT credit carryforward 1,141 1,819
Accrued post retirement benefits
other than pensions 643 504
Accrued exit activity costs 574 1,464
Other 891 1,039
------ ------
Gross deferred tax assets 25,550 26,899
------ ------
Deferred policy acquisition costs 15,560 13,173
Net unrealized investment gain 9,212 8,357
Amortization of fixed maturities 461 489
Other 1,120 664
------ ------
Gross deferred tax liabilities 26,353 22,683
------ ------
Net deferred tax (liability) asset $ (803) $ 4,216
====== ======
Included in gross deferred tax assets at December 31, 1996 and 1995, is
$1,141,000 and $1,819,000 of AMT credit carryforward, respectively. The
credit is allowed for the amount of adjusted net minimum tax for all years
reduced by the minimum tax credit for all prior tax years. This
credit has no expiration date as a credit against the Company's
future regular tax liability. Included in other deferred tax
assets at December 31, 1996 and 1995, is the tax effect of a
$573,000 and $639,000, respectively, net operating loss
carryforward arising from the acquisition of CCIC, available to
offset future taxable income of CCIC. This carryforward
substantially expires in 1997, with final expiration in 2003. Also
included in other deferred tax assets at December 31, 1995, is the
tax effect of a $609,000 net operating loss carryforward, which was
utilized to reduce the Company's 1996 regular tax liability. This
carryforward expires in 2010. As of December 31, 1996, no
valuation allowance on deferred tax assets was necessary.
Total income taxes (benefits) are allocated as follows (in
thousands):
Year Ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
Income from continuing operations $ 9,375 $ (1,597) $ 7,036
Shareholders' equity, for unrealized
investment gains (losses) 855 12,160 (9,493)
Shareholders' equity, other 8 8
------ ------- ------
$10,230 $10,571 $(2,449)
====== ====== ======
The components of the provision (benefit) for income taxes on
continuing operations are as follows (in thousands):
Year Ended December 31,
--------------------------------------
1996 1995 1994
---- ---- ----
Current $5,211 $ 1,946 $7,012
Deferred 4,164 (3,543) 24
----- ------ -----
$9,375 $(1,597) $7,036
===== ====== =====
-48-
The following table reconciles the effective tax rate to the
federal statutory rate of 35 percent for pretax earnings from
continuing operations (in thousands):
Year Ended December 31,
------------------------------------
1996 1995 1994
---- ---- ----
Earnings before taxes $36,881 $ 7,332 $29,587
====== ====== ======
Expected income tax expense $12,908 $ 2,566 $10,355
Adjustments resulting from:
Dividends received deduction (1,234) (1,875) (1,528)
Nontaxable interest income (3,848) (3,451) (2,754)
Proration 762 799 642
Nonrecurring tender offer
charge (Note 17) 409
Other, net 378 364 321
------ ------- -------
$ 9,375 $ (1,597) $ 7,036
====== ======= =======
9. 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 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. For the first half of 1996, such
reinsurance arrangements limited 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.
Reinsurance contracts do not relieve the Company from its
obligations to policyholders. To the extent that any reinsuring
company is unable to meet its obligations, the Company would be
liable for such defaulted amounts; consequently, allowances are
established for amounts deemed uncollectible. The allowances
established for uncollectible amounts were $200,000 at both
December 31, 1996 and 1995. The Company generally does not require
collateral to support reinsurance recoverables, but continually
evaluates the financial condition of its reinsurers and monitors
concentrations of credit risk to minimize exposure to significant
losses from reinsurer insolvencies. At December 31, 1996 and 1995,
reinsurance recoverables of $80,249,000 and $68,938,000,
respectively, were associated with two reinsurers (both companies
are rated A+ or above by A.M. Best) under the Company's excess of
loss property and casualty treaties and certain facultative
reinsurance contracts. The Company's reinsurance treaties
generally provide that premiums are ceded on a written basis but
are paid to the reinsurers on an earned basis; consequently,
prepaid reinsurance premiums are primarily deposits required by
contract terms and amounts paid related to facultative reinsurance
contracts. Prepaid reinsurance premiums are amortized over the
contract period in proportion to the amount of reinsurance
protection provided.
The approximate prepaid and recoverable amounts of reinsurance
ceded to other companies, including subsidiaries of Orion under
100% reinsurance arrangements, are as follows (in thousands):
December 31, 1996 December 31, 1995
-------------------------- --------------------------
Non-Affiliates Affiliates Non-Affiliates Affiliates
-------------- ---------- -------------- ----------
Premiums prepaid $ 2,244 $ 30 $ 4,435 $ 79
Paid losses recoverable 4,780 9,016
Unpaid losses recoverable 66,633 2,197 51,491 3,438
Unpaid LAE recoverable 12,238 2,659 10,048 3,318
------ ------ ------ ------
$85,895 $ 4,886 $74,990 $ 6,835
====== ====== ====== ======
-49-
Premiums, losses and LAE, including the effect of reinsurance,
are comprised of (in thousands):
Year Ended December 31,
-------------------------------------------------------------
1996 1995 1994
---------------- ---------------- ----------------
Written Earned Written Earned Written Earned
------- ------ ------- ------ ------- ------
Premiums:
Direct $493,660 $492,077 $414,694 $393,886 $295,714 $284,918
Assumed 44,376 37,921 36,819 47,916 69,277 76,720
Ceded (46,804) (48,350) (53,614) (51,785) (42,066) (40,000)
------- ------- ------- ------- ------- -------
Net $491,232 $481,648 $397,899 $390,017 $322,925 $321,638
======= ======= ======= ======= ======= =======
% Assumed to Net 9.03% 9.25% 21.45%
==== ==== =====
Incurred Incurred Incurred
-------- -------- --------
Losses and LAE:
Direct $361,837 $309,298 $192,183
Assumed 20,268 32,281 54,892
Ceded (44,321) (48,066) (33,570)
------- ------- -------
Net $337,784 $293,513 $213,505
======= ======= =======
Included in direct premiums earned above, for the years ended
December 31, 1996, 1995 and 1994, were $97,000, $309,000 and
$1,152,000, respectively, of premiums earned under 100% reinsurance
agreements with subsidiaries of Orion. Also, included in direct
losses incurred above, for the years ended December 31, 1996, 1995
and 1994, were $67,000, $218,000 and $854,000, respectively, of
losses incurred under these same 100% reinsurance agreements with
subsidiaries of Orion.
The Company has entered into reinsurance agreements with
subsidiaries of Orion, whereby it assumes business written by the
affiliates. Included in premiums assumed above, for the years
ended December 31, 1996, 1995 and 1994, were $15,673,000,
$9,495,000 and $30,921,000 of premiums written, respectively, which
were assumed under these agreements. Assumed premiums and incurred
losses have changed, compared to the prior years, as a result of
the changes in the Company's business written in different states.
The Company paid fees and expenses to affiliates for assumed
business written as follows: 1996-$607,000; 1995-$338,000; 1994-
$1,440,000.
Since the acquisition of Viking, the Company is party to 100%
reinsurance agreements with VCM, whereby the Company assumes
business written, in the state of Texas, by this affiliate.
Included in 1996 and 1995 premiums assumed above were $29,623,000
and $5,525,000, respectively, of premiums written under these
agreements. The policy issue fee charged by VCM is offset by the
management fee charged by the Company to VCM. Therefore, the net
amount of policy issue fees and management fees is immaterial.
-50-
10. Reserves for Loss and Loss Adjustment Expenses
The Company's loss and LAE reserves are summarized below (in
thousands):
Year Ended December 31,
----------------------------------------
1996 1995 1994
---- ---- ----
Balance at beginning of year $354,634 $241,221 $220,965
Reserves acquired as a result of
a business combination 80,692
Less reinsurance recoverables 68,295 61,446 55,165
------- ------- -------
Net adjusted beginning balance 286,339 260,467 165,800
Provision for incurred losses
and LAE:
Current year 338,779 280,726 212,458
Prior years (995) 12,787 1,047
------- ------- -------
337,784 293,513 213,505
------- ------- -------
Payments for incurred losses
and LAE:
Current year 194,667 159,208 111,418
Prior years 144,775 108,433 88,112
------- ------- -------
339,442 267,641 199,530
------- ------- -------
Net balance at end of year 284,681 286,339 179,775
Plus reinsurance recoverables 83,727 68,295 61,446
------- ------- -------
Balance at end of year $368,408 $354,634 $241,221
======= ======= =======
As a result of changes in estimates of insured events in prior
years, the provision for prior year losses and LAE decreased by
$995,000 in 1996, a significant improvement compared to 1995.
The favorable development in 1996 was the result of $4,038,000
redundant development in the personal lines business unit. The
redundancy in this unit was due to estimated incurred but not
reported losses at the beginning of the year developing lower
than expected, as well as the successful implementation of claims
operational changes, which resulted in better than expected
development on 1995 personal lines acquired reserves. The
favorable development within the personal lines business unit
during 1996 was partially offset by adverse development within
the commercial and collateral protection units. The total
commercial lines adverse development in 1996 was $1,675,000,
which represented a significant improvement over 1995, and
resulted primarily from general liability losses and loss
adjustment expenses on reported claims costing more to settle
than expected. During 1996, the collateral protection unit
experienced $1,368,000 adverse development primarily due to an
under-estimation of unreported claims, as of December 31, 1995,
for the Blanket Vendor Single Interest and Puerto Rico business.
The 1995 adverse development in personal lines of $2,504,000
was a result of adverse trends in claim frequency which caused
higher than expected development of outstanding claims and
incurred but not reported losses. Development on personal lines
during 1994 was favorable. Total adverse development in
commercial lines during 1995 was $10,056,000, of which $7,266,000
was caused by commercial automobile liability higher claim
severity primarily in 1994 through 1992. The remaining
commercial lines 1995 adverse development was from general
liability and other lines. The adverse development in commercial
lines in 1994 was primarily due to loss development on
professional, general and commercial automobile liability claims
occurring prior to 1985. These accident years accounted for
$920,000 of commercial lines' adverse development in 1995 and
$1,300,000 in 1994. The remaining adverse development in 1995 of
$227,000 was attributable to the collateral protection business
unit.
The Company primarily writes automobile coverage, and
therefore has limited exposure for environmental claims. In
establishing the liability for unpaid losses and LAE related to
environmental claims, the Company considers facts currently
known, current state of the law, and coverage litigation.
Liabilities are recognized for known claims when sufficient
information has been developed to indicate the involvement of a
specific insurance policy, and its liability can be reasonably
estimated. In addition, liabilities have been established to
cover additional exposures on both known and unasserted claims.
Estimates of the liabilities are reviewed and updated
continually. Developed case law and adequate claim history do
not exist for such claims,
-51-
especially because significant uncertainty exists about the
outcome of coverage litigation and whether past claim
experience will be representative of future claim experience.
Environmental claims reported to the Company to date, such
as asbestos and pollution contamination, have primarily related
to policies written during the period 1984 to 1978. In 1985,
the Company added an absolute pollution exclusion clause to
general liability policies to significantly reduce exposure to
such claims. The Company's known exposure to environmental
losses is not considered to be material as they have amounted
to approximately three percent of cumulative payments on
general liability claims for the accident years 1984 to 1978,
and there are less than $600,000 in net outstanding claim
reserves, and approximately $2,000,000 in total loss and loss
adjustment expense reserves, at December 31, 1996. Based on
the claim activity to date and the nature of the business
written during this period and subsequent periods, the Company
does not believe that a material exposure to such risks exists
in the future.
11. Interest Rate Swap Agreements
At December 31, 1996, the Company had two interest rate swap
agreements outstanding, with participating commercial banks,
having a total notional principal amount of $80,000,000, or
$40,000,000 for each bank. These agreements effectively change
the Company's interest rate exposure on $80,000,000 of the
$100,000,000 million principal balance outstanding under the
Credit Agreement, which is discussed in Note 6, to a fixed
rate. The fixed rate interest percentage paid by the Company
on the total notional amounts is approximately 6.3%. Net cash
payments made or received under the swap agreements have been
included within interest expense.
The interest rate swap agreements terminate on March 16,
1998. The interest rate swap floating rate, which is paid by
the banks to the Company, resets every three months, beginning
December 20, 1995, which coincides with the LIBOR determination
dates available on the outstanding principal balance under the
Company's Credit Agreement. The floating interest rate under
the swap agreements is based upon the LIBOR rate at each
determination date.
The Company is exposed to credit loss in the event of
nonperformance by the other parties to the interest rate swap
agreements. However, the Company does not anticipate
nonperformance by the counterparties.
12. Commitments and Contingencies
The Company rents various buildings for its branch office
locations. Rent expense for operating leases was as follows: 1996-
$1,697,000; 1995-$1,262,000; 1994-$1,450,000. Future minimum lease
payments on building and equipment operating lease commitments are
as follows: 1997-$1,520,000; 1998-$1,221,000; 1999-$451,000; 2000-
$102,000; 2001-$16,000; 2002 and thereafter-$0.
In conjunction with the Viking acquisition there is additional
purchase price which may ultimately be paid to the seller depending
on Viking's future loss development. See Note 3 for further
discussion of this contingency payment.
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 consolidated financial statements as of December 31,
1996, as part of the nonrecurring charge discussed in Note 17.
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.
-52-
13. Restrictions On Shareholders' Equity
The amended and restated Credit Agreement, which is
discussed in Note 6, imposes no dividend restrictions on the
Company, but requires the Company to maintain consolidated net
worth of $190,000,000, plus 30% of the aggregate positive
consolidated net income for each fiscal quarter ending after
December 31, 1996, plus 100% of the aggregate amount of
increases in the stated capital and additional paid-in capital
accounts resulting from the issuance of equity securities or
other capital investments after December 31, 1996. According
to the definition outlined in the Credit Agreement,
consolidated net worth means the net worth of Guaranty and its
subsidiaries determined in accordance with GAAP, and without
regard to the requirements of Statement of Financial Accounting
Standards No. 115. As of December 31, 1996, the required net
worth under the bank loan agreement was $190,000,000 while the
Company's actual net worth, as defined in the Credit Agreement,
was $232,920,000.
Shareholders' equity of the Company is primarily represented by
the surplus, including undistributed earnings, of GNIC and VICW.
The Colorado dividend restriction law limits the annual dividend a
Colorado domiciled insurance company may pay to its parent holding
company during a twelve-month period to the greater of 10% of
GNIC's statutory surplus as reported at the end of the preceding
calendar year ($164,474,000 and $133,749,000 at December 31, 1996
and 1995, respectively), or GNIC's statutory net income, excluding
realized capital gains ($9,332,000 and ($442,490) for 1996 and
1995, respectively) as reported at the end of the preceding
calendar year. When a dividend is declared by GNIC to Guaranty,
the Colorado Insurance Department must be notified of such
declaration within five days thereafter, and at least ten business
days before the payment of the dividend. The Wisconsin dividend
restriction law limits the annual dividend that VICW may pay to
Guaranty to the lesser of 10% of VICW's statutory surplus as of the
end of the preceding calendar year ($88,597,000 and $86,872,000 at
December 31, 1996 and 1995, respectively) or the greater of either
the statutory net income of VICW for the preceding calendar year,
less realized capital gains, ($7,524,000 and $14,591,000 at
December 31, 1996 and 1995, respectively) or the aggregate of the
net income of VICW for the three calendar years preceding the date
of the dividend, less realized capital gains for those calendar
years minus dividends paid or credited and distributions made
within the first two of the preceding three calendar years
($10,642,000 and $17,521,000 at December 31, 1996 and 1995,
respectively). When a dividend is paid by VICW to Guaranty, the
Wisconsin Insurance Department must have been notified in writing
at least 30 days prior to the payment of the dividend. During
1996, GNIC paid no dividends to Guaranty, while VICW paid dividends
in the amount of $8,687,000 to Guaranty. In 1995, GNIC paid
dividends of $16,500,000 to Guaranty, while VICW paid no dividends
to Guaranty. The Company believes that GNIC and VICW will be in a
position to pay dividends to Guaranty in the future.
14. Related Party Transactions
During 1996, Orion increased its ownership in the Company by
approximately 31.5%, to 81%. See Notes 12 and 17 for further
discussion of this transaction
Orion manages a majority of the Company's investment portfolio.
The Company paid investment management fees to Orion as follows:
1996-$650,000; 1995-$595,000; 1994-$550,000.
The Company paid commissions to an Orion agency affiliate of
$85,000, $72,000 and $90,000 in 1996, 1995 and 1994, respectively,
for premiums written by the affiliate for the Company of $436,000,
$411,000 and $516,000 in 1996, 1995 and 1994, respectively.
In 1990, GNIC entered into a loan participation agreement with a
subsidiary of Orion, whereby they loaned money to another
affiliate. The loan was secured by a leasehold deed of trust and
matured in November 1995. GNIC's proportionate share of this loan
was $3,700,000, or 41.1%. GNIC received quarterly interest
payments at a rate of 11% of its proportionate share. Interest
earned was $355,000 in 1995 and $407,000 in 1994. In 1995, during
the assembly of the Viking acquisition financing, the Company
received a commitment for a $21,000,000 Bridge Loan from Orion, for
which the Company paid a $210,000 commitment fee. During 1995, the
Company converted the $20,896,000 Orion Notes into 1,326,128 shares
of common stock. See Note 6 for further discussion related to this
conversion. In 1995 and 1994, the interest expense paid to Orion
was $1,122,000 and $1,640,000, respectively.
Also, the Company has entered into certain reinsurance
agreements with subsidiaries of Orion (see Note 9).
In the opinion of management, the terms of the Company's
transactions with Orion are reasonable and representative of the
terms that would have been applicable in transactions with
unrelated parties.
-53-
The son of the Company's Chairman of the Board is a managing
director of Insurance Partners Advisors L.P., which manages
Insurance Partners L.P., a partnership formed to make equity
investments in the insurance industry. The Company has committed
initial capital in an aggregate amount not to exceed $1,500,000 of
the total $550,000,000 committed by all partners.
A member of the Board of Directors of the Company is the owner
of a general agency. Gross commissions paid by the Company to the
agency, under a standard agency contract, for business produced
were $731,000, $813,000 and $789,000 in 1996, 1995 and 1994,
respectively.
As a result of the Viking acquisition and the subsequent change
in control of VCM, VCM was required to increase its surplus to a
minimum of $2,000,000 as required by the Texas Insurance Code. The
increase was accomplished by the issuance of a surplus debenture to
Viking in the amount of $1,300,000 in exchange for cash. The
debenture pays interest annually at a rate of 8.5%. Interest
earned in 1996 and 1995 was $129,000 and $33,000, respectively.
Also, the Company provides management services to VCM. The fees
paid by VCM are offset by policy issue fees paid to VCM by the
Company under 100% reinsurance agreements (see Note 9).
15. Employee Benefit Plans
The Company provides incentive plans for key employees. These
plans include the Company's 1987 Performance Unit Plan (the "Unit
Plan") and the Equity Incentive Plan, which replaced the 1991 Long-
Term Performance Incentive Plan (the "Incentive Plan").
Under the Unit Plan, units granted increase in value in
relationship to the book value per share of the Company's common
stock with certain adjustments. As of December 31, 1996, 225,707
units are outstanding. No units were issued during 1996.
Under the Incentive Plan, shares of restricted stock as
well as stock options may be granted by the Company. The Incentive
Plan, as adopted September 12, 1991, reserved 800,000 common shares
for grant to key employees. During 1996, no restricted stock was
issued. In 1995, 12,000 shares of restricted stock was issued, a
portion of which was from treasury stock. Restricted stock is
considered issued and outstanding when awarded, and is recorded as
deferred compensation. As a result of the Orion tender offer,
which was completed in July 1996 and is discussed in Note 17, all
restrictions on the restricted stock lapsed in 1996. Therefore,
the Company included $587,000 of compensation expense, which
related to the restricted stock that became fully vested as a
result of the Orion tender offer, in the nonrecurring tender offer
charge, which is also discussed in Note 17. Prior to the Orion
tender offer, the Company had recorded $57,000 as compensation
expense on restricted stock during 1996. The compensation expense
recognized on restricted stock during 1995 and 1994 was $263,000
and $250,000, respectively.
All stock options under the Incentive Plan are granted at fair
market value at date of grant, become exercisable proportionately
from the first through the fourth anniversaries of the grant dates,
and expire ten years after the date of grant. In October 1996, the
Company's Board of Directors amended the Incentive Plan to be
consistent with the terms of the Equity Incentive Plan.
As a result of the Orion tender offer, all stock options granted
prior to the completion of the tender offer became fully vested and
became exercisable. At December 31, 1996, there were 400,500
options exercisable under the Incentive Plan and 39,986 common
shares available for grant under the Incentive Plan.
The Equity Incentive Plan was approved by the Board of
Directors on October 29, 1996, and reserved 700,000 shares to
grant to key employees. All stock options under this plan must be
granted at no less than fair market value at the date of grant.
The options granted under the Equity Incentive Plan are
exercisable proportionately from the first through fourth
anniversaries of the grant dates and expire ten years after the
date of the grant. At December 31, 1996, there were no options
exercisable under the Equity Incentive Plan. The 162,747 stock
options granted under this plan in 1996 are pending shareholder
approval at the May 13, 1997 Annual Meeting of Shareholders. If
approved, there would be 537,253 common shares available for grant
under the Equity Incentive Plan at December 31, 1996.
Additionally, the Equity Incentive Plan provides for performance
unit awards, which allow for cash and common stock payments to be
made, contingent on the future cumulative increases in book value
of the Company's common stock. The awards allow for annual
payments to be earned up to four years from the date of grant.
-54-
As discussed in Note 1, the Company follows APB. No. 25 for
stock options issued to employees, rather than following Statement
of Financial Accounting Standards ("SFAS") No. 123, "Accounting
for Stock-Based Compensation." SFAS No. 123, among other things,
requires estimating the fair value of stock options using an
option pricing model that considers factors specified by this
SFAS, and recording compensation cost based on the estimated fair
value of the stock options. Had compensation cost for the stock
options granted under the Company's Equity Incentive Plan and
Incentive Plan been determined consistent with SFAS No. 123, the
Company's net earnings and earnings per common share would have
been reduced to the pro forma amounts indicated below:
1996 1995
---- ----
Net Income (In thousands)
As Reported $27,506 $8,929
Pro Forma 27,093 (a) 8,727
Earnings Per Common Share:
As Reported $ 1.84 $ 0.67
Pro Forma 1.81 (a) 0.65
(a) As a result of the Orion tender offer, approximately
$361,000 of the compensation cost estimated under SFAS No. 123
would have been included in the 1996 nonrecurring charge.
The following is a summary of stock option transactions:
1996 1995
------------------------- --------------------------
Weighted Weighted
Average Exercise Average Exercise
Shares Price Shares Price
------ ---------------- ------ ----------------
Balance-January 1 471,500 $16.70 458,000 $16.44
Granted 302,749 16.50 90,000 17.25
Exercised (98,500) 14.28 (36,750) 14.98
Terminated (2,500) 17.50 (39,750) 16.64
------- ----- ------- -----
Balance - December 31 673,249 $16.96 471,500 $16.70
======= ===== ======= =====
Options exercisable at
year end with the
corresponding
weighted-average
exercise price 400,500 $17.05 237,625 $15.97
======= ===== ======= =====
Weighted-average
fair value
of options granted
during the year $ 4.16 $ 5.18
======= =======
Range of Exercise
Prices for Options
Outstanding at
December 31 $13.50-23.25 $14.50-23.25
============ ============
The Company utilized the Black-Scholes option pricing model to
estimate the fair value, on the date of grant, of stock options
granted. The following weighted-average assumptions were used for
1996 stock options issued: 3.0% dividend yield, expected
volatility of 24%, risk free interest rate of 6.1% and expected
term of 6.0 years. The following weighted-average assumptions
were used for 1995 stock options issued: 2.9% dividend yield,
expected volatility of 24%, risk free interest rate of 6.4% and
expected term of 8.7 years.
The Company had 272,749 and 233,875 nonexercisable options,
including those granted under the Equity Incentive Plan and the
Incentive Plan, at December 31, 1996 and 1995, respectively. All
of the December 31, 1996 and 1995 nonexercisable options were time-
based-exercisable options, based on the four year vesting period
discussed above.
-55-
The weighted-average remaining contractual lives for options
outstanding at December 31, 1996 and 1995 were 7.5 and 7.4 years,
respectively.
The Company has a defined contribution profit sharing plan,
which qualifies under Section 401(k) of the Internal Revenue Code,
for which substantially all employees are eligible after a specific
waiting period. The plan is contributory and the Company matches
employee contributions unless changed by the withBoard of
Directors. Prior to 1996, Viking had its own separate Individual
Retirement Plan which was pending qualification under Section
401(k) of the Internal Revenue Code. On April 1, 1996, the Company
received a favorable determination letter from the Internal Revenue
Service and rolled the Viking plan into its plan.
The Company has a non-qualified Supplemental Executive
Retirement Plan ("SERP") for employees whose compensation meets a
minimum requirement. This plan provides deferred benefits for
those employees who received less than the full employer
contribution of the Company's defined contribution profit sharing
plan as a result of federal tax limitations on participation in the
plan. Eligible employees are entitled to receive payment of funds
upon retirement or termination unless terminated for good cause as
defined in the SERP. Prior to 1996, Viking employees were not
eligible to participate in this plan.
The Company, excluding Viking, has a defined benefit health care
plan ("the Plan") that provides postretirement medical benefits to
full-time employees who have worked for ten years and attained age
55 while in service with the Company. Benefits generally are
provided under the Plan for retirees and their dependents until the
retirees attain age 65. The Plan is contributory and contains
other cost sharing features which may be adjusted annually for the
expected general inflation rate. The Company's policy is to fund
the cost of the Plan benefits in amounts determined at the
discretion of management. To date, no funding of the Plan has been
made.
As of December 31, 1995, Viking terminated its defined benefit
health care plan that provided for post-retirement medical benefits
to individuals who retired or became permanently disabled while in
service with Viking. Employees who were retired or disabled as of
December 31, 1995 continue to be eligible for post-retirement
medical benefits. Benefits generally are provided under this plan
for retirees and their dependents until the death of the retiree.
This plan is contributory and contains other cost sharing features
which may be adjusted annually. Viking's policy is to fund the
cost of plan benefits in amounts determined at the discretion of
management.
Total expense for the Company's employee benefit plans, discussed
above, is as follows: 1996-$2,692,000; 1995-$2,132,000; 1994-
$1,602,000.
16. Shareholder Rights Agreement
On November 20, 1991, the Board of Directors approved the
adoption of a Shareholder Rights Agreement and in connection
therewith declared a dividend distribution of one Right for each
outstanding share of Common Stock until such time that separate
Right certificates are distributed, or the Rights are redeemed or
expire. When exercisable, each Right will entitle a holder to
purchase from the Company a unit consisting of one one-hundredth of
a share of a new series of the Company's Preferred Stock at a
purchase price of $60 per share.
The Rights become exercisable ten days following a
public announcement that a person or group of acquires has acquired
or obtained the rights to acquire beneficial ownership of 20% or
more of the Company's Common Stock or ten business days following
announcement of a tender offer or exchange offer that could result
in beneficial ownership of 20% or more of the Company's Common
Stock. Prior to consummation of such a transaction, each holder of
a Right is entitled to purchase shares of the Company's Common
Stock having a value equal to two times the exercise price of the
Right. The Company has the right to redeem the Rights at $.01 per
Right prior to the time they become exercisable. The Rights will
expire on December 30, 2001.
17. Nonrecurring Charges
On May 8, 1996, Orion 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.
-56-
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.
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%.
The Company relocated its Colorado operations to a new home
office facility during the second quarter of 1994. New facility
expenditures totaled $16,208,000, which were primarily funded from
operating cash flow. Total nonrecurring relocation charges of
$838,000 were incurred in 1994.
18. Quarterly Financial Data (Unaudited)
Three Months Ended
----------------------------------------
March 31 June 30 Sept 30 Dec 31
-------- ------- ------- ------
(In thousands, except per share data)
1996:
Total revenue $126,704 $129,823 $134,125 $138,890
Earnings before income taxes 7,241 6,945 10,402 12,293
Net earnings 5,787 5,225 7,521 8,973
Earnings per share $ 0.39 $ 0.35 $ 0.50 $ 0.60
1995:
Total revenue $ 86,502 $ 88,306 $121,479 $127,997
Earnings (loss) before income taxes 7,535 6,575 (8,349) 1,571
Net earnings (loss) 5,768 4,851 (4,113) 2,423
Earnings (loss) per share $ 0.48 $ 0.40 $ (0.29) $ 0.16
During the third quarter of 1995, the Company completed the
Viking acquisition (see Note 3), which significantly increased
revenues in the third and fourth quarters of 1995. Also in the
third quarter of 1995, the Company strengthened its loss reserves
(losses and loss adjustment expenses) by $13,971,000, as a result
of adverse development within the personal and commercial lines
units (see Note 10).
-57-
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
Pursuant to General Instruction G(3) to this form, the
information required by Part III (Items 10, 11, 12 and 13) hereof
is incorporated by reference from the Company's definitive proxy
statement for its Annual Meeting to be held on May 13, 1997. The
Company intends to file the proxy material, which involves the
election of directors, not later than 120 days after the close of
the Company's fiscal year.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON
FORM 8-K
(a) 1. Consolidated Financial Statements:
The following financial statements filed as part of this Form
10-K appear on the pages indicated:
Page
----
Report of Management 33
Independent Auditors' Report 34
Guaranty National Corporation and subsidiaries:
December 31, 1996 and 1995
Consolidated Balance Sheets 35
Years ended December 31, 1996, 1995 and 1994
Consolidated Statements of Earnings 36
Consolidated Statements of Changes in
Shareholders' Equity 37
Consolidated Statements of Cash Flows 38
Notes to the Consolidated Financial Statements 40
(a) 2. Financial Statement Schedules:
Page
----
Independent Auditors' Report on Schedules S-1
Schedule I Summary of Investments - Other than
Investments in Related Parties-December
31, 1996 S-2
II Condensed Financial Information of
Registrant - December 31, 1996, 1995
and 1994 S-3
III Supplemental Information For Property and
Casualty Insurance Operations - December
31, 1996, 1995 and 1994 S-5
Schedules other than those listed above are omitted for the
reason that they are not required or are not applicable, or
the required information is shown in the Consolidated
Financial Statements or notes thereto.
-58-
(a) 3. EXHIBITS:
Exhibit
Number Exhibit
*3.1 Amended and Restated Articles of Incorporation of the
Registrant--filed as Exhibit 3.1 to the Company's
Registration Statement on Form S-1 (No. 33-42781)
*3.2 By-laws of the Registrant--filed as Exhibit 3.2 to the
Company's Registration Statement on Form S-1 (No. 33-42781)
*4.1 Form of Certificate for Common Stock--filed as Exhibit
4.1 to the Company's Registration Statement on Form S-1
(No. 33-42781)
*4.2 Form of Rights Agreement--filed as Exhibit 1 to the
Company's Registration Statement on Form 8-A, filed December
19, 1991
*10.1 Form of Indemnification Agreement--filed as Exhibit 10.1
to the Company's Registration Statement on Form S-1 (No.
33-42781)
*10.2 Guaranty National Insurance Company Retirement Savings
Plan and Trust Agreement, as amended and restated as of
January 1, 1989 (formerly Guaranty National Insurance
Company Profit Sharing Plan)--filed as Exhibit 28.7 to
the Company's Form 10-Q for September 30, 1993
*10.3 Guaranty National Corporation Performance Unit Plan,
adopted November 17, 1987, as amended July 29, 1993 by
form of Amendment No. 1--filed as Exhibit 10.5 to the
Company's Form 10-K for 1993 (#)
*10.4 Employment Agreement between Guaranty National
Corporation and Roger B. Ware, dated September 1, 1986--
filed as Exhibit 10.7 to the Company's Registration
Statement on Form S-1 (No. 33-42781) (#)
*10.5 Casualty Excess of Loss Reinsurance Agreement between
Guaranty National Insurance Company and Landmark American
Insurance Company and National Reinsurance Corporation,
dated March 27, 1985--filed as Exhibit 10.10 to the
Company's Registration Statement on Form S-1 (No. 33-
42781)
*10.6 Umbrella and Following Form Excess of Loss Reinsurance
Agreement between Guaranty National Insurance Company and
Landmark American Insurance Company and National
Reinsurance Corporation, dated April 20, 1990--filed as
Exhibit 10.14 to the Company's Registration Statement on
Form S-1 (No. 33-42781)
*10.7 First Property Per Risk Excess of Loss Reinsurance
Agreement between Guaranty National Insurance Company and
Landmark American Insurance Company and National
Reinsurance Corporation, dated March 4, 1985--filed as
Exhibit 10.16 to the Company's Registration Statement on
Form S-1 (No. 33-42781)
*10.8 American Re-Insurance Company Reinsurance Agreement with
Guaranty National Insurance Company, dated November 15,
1982--filed as Exhibit 10.17 to the Company's
Registration Statement on Form S-1 (No. 33-42781)
*10.9 Casualty Quota Share Reinsurance Contract between
Landmark American Insurance Company/Guaranty National
Insurance Company and Design Professionals Insurance
Company/The Connecticut Indemnity Company/Security
Insurance Company of Hartford, dated September 1, 1989--
filed as Exhibit 10.18 to the Company's Registration
Statement on Form S-1 (No. 33-42781)
10.10 Guaranty National Corporation 1991 Long-Term Performance
Incentive Plan, adopted September 12, 1991, as amended
October 29, 1996 (#)
*10.11 Form of Officer's Severance Pay Agreement--filed as
Exhibit 10.21 to the Company's Registration Statement on
Form S-1 (No. 33-42781) (#)
- -------------------------------------------
*Incorporated by reference
(#)Management compensation agreement
-59-
*10.12 Participation Agreement Regarding Design Professionals
Insurance Company Loan between Security Reinsurance
Company and Guaranty National Insurance Company, dated
December 20, 1990--filed as Exhibit 10.22 to the
Company's Registration Statement on Form S-1 (No. 33-
42781)
*10.13 Commercial Automobile Physical Damage and Liability Quota
Share Reinsurance Agreement between Williamsburg National
Insurance Company and Guaranty National Insurance
Company, dated January 1, 1991--filed as Exhibit 10.25 to
the Company's Registration Statement on Form S-1 (No. 33-
42781)
*10.14 Special Risk Division Casualty Reinsurance Contract
issued to Guaranty National Insurance Company and
Landmark American Insurance Company by E. W. Blanche Co.,
dated January 1, 1990--filed as Exhibit 10.26 to the
Company's Registration Statement on Form S-1 (No. 33-
42781)
*10.15 Note Issuance Agreement, as amended, effective August 1,
1993 by and among Guaranty National Corporation, Orion
Capital Corporation and certain subsidiaries of Orion
Capital Corporation--filed as Exhibit 10.22 to the
Company's Form 10-K for 1993
*10.16 Specimen of 7.85% Subordinated Promissory note due
July 1, 2003 of Guaranty National Corporation--included
as Exhibit "A" to Exhibit 10.15 above
*10.17 Investment Management Agreement by and among Orion
Capital Corporation, Guaranty National Corporation and
Certain Subsidiaries of Guaranty National Corporation--
filed as Exhibit 10.29 to the Company's Form 10-K for 1991
*10.18 Shareholder Agreement by and among Orion Capital
Corporation, Guaranty National Corporation and certain
wholly owned subsidiaries of Orion Capital Corporation--
filed as Exhibit 10.30 to the Company's Form 10-K for 1991
*10.19 Trade Name Agreement by and among Guaranty National
Corporation on behalf of itself and all subsidiaries and
affiliates and Orion Capital Corporation on behalf of
itself and all subsidiaries and affiliates--filed as
Exhibit 10.31 to the Company's Form 10-K for 1991
*10.20 Amendment to Guaranty National Corporation 1991 Long-Term
Performance Incentive Plan dated December 19, 1991--filed
as Exhibit 28.2 to the Company's Form S-8 filed December
19, 1991 (#)
*10.21 Property and Casualty Excess of Loss Agreement
Reinsurance Agreement (First, Second, Third and Fourth)
issued to Guaranty National Insurance Company and
Landmark American Insurance Company by E. W. Blanch Co.,
dated as of January 1, 1992--filed as Exhibit 28.2 to the
Company's Form 10-Q for June 30, 1992
*10.22 Stock Purchase Agreement for Colorado Casualty Insurance
Company by and between Guaranty National Insurance
Company and Providence Washington Insurance Company dated
September 30, 1992 (Exhibit 10.1), and related Services
Agreement (Exhibit 10.2), Reinsurance Agreement (Exhibit
10.3), Trust Agreement (Exhibit 10.4), Second Reinsurance
Agreement (Exhibit 10.5) and Asset Purchase Agreement
(Exhibit 10.6)--filed on Form 8-K on October 31, 1992
*10.23 Amended and Restated Credit Agreement by and between
Guaranty National Corporation and Norwest Bank Denver,
N.A. and Shawmut Bank Connecticut, N.A. dated
November 23, 1993--filed as Exhibit 10.30 to the
Company's Form 10-K for 1993
*10.24 Quota Share Reinsurance Agreement by and between Landmark
American Insurance Company and State and County Mutual
Fire Insurance Company, dated as of July 15, 1989 and
amended as of March 1, 1992--filed as Exhibit 10.36 to
the Company's Form 10-K for 1992
*10.25 Termination Addendum to the Special Risk Division
Casualty Reinsurance Contract issued to Guaranty National
Insurance Company and Landmark American Insurance Company
by E. W. Blanch Co., dated as of January 1, 1990--filed
as Exhibit 10.37 to the Company's Form 10-K for 1992
- ----------------------------------------
*Incorporated by reference
(#)Management compensation agreement
-60-
*10.26 Amendment to Investment Management Agreement by and Among
Orion Capital Corporation, Guaranty National Corporation
and Certain Subsidiaries of Guaranty National
Corporation, dated January 13, 1993--filed as Exhibit
10.40 to the Company's Form 10-K for 1992
*10.27 Investment Management Contract by and between Guaranty
National Insurance Company and Cambiar Investors, Inc.,
dated October 8, 1992--filed as Exhibit 10.41 to the
Company's Form 10-K for 1992
*10.28 Multiple Line Excess of Loss Agreement No. 3973-05
between National Reinsurance Corporation and Guaranty
National Insurance Company and its subsidiaries and
affiliates and Viking Insurance Company of Wisconsin and
its affiliate, which replaces and continues the previous
Multiple Line Excess of Loss Reinsurance Agreement No.
3973-05 which became effective January 1, 1993 and was
subsequently amended by Endorsements numbered 1 through
14--filed as Exhibit 10.2 to the Company's Form 10-Q for
June 30, 1996
*10.29 Stock Purchase Agreement for Peak Property and Casualty
Insurance Corporation between GE Capital Mortgage
Corporation and Guaranty National Insurance Company,
dated as of September 15, 1993--filed as Exhibit 10.42 to
the Company's 10-K for 1993
*10.30 Amendment to Guaranty National Corporation 1991 Long-Term
Performance Incentive Plan, effective May 11, 1993--filed
by the Company on Form S-8 dated July 22, 1993 (#)
*10.31 Non-revolving line of credit agreement by and between
Norwest Bank Denver, N. A. and Guaranty National
Corporation, dated December 30, 1993--filed as Exhibit
28.1 to the Company's Form 10-Q for March 31, 1994
*10.32 First Amendment of Credit Agreement by and between
Guaranty National Corporation and Norwest Bank Colorado,
N.A. and Shawmut Bank Connecticut, N.A., dated June 1,
1994--filed as Exhibit 28.2 to the Company's Form 10-Q
for June 30, 1994
*10.33 Stock Purchase Agreement for General Electric Mortgage
Insurance Corporation of California between GE Capital
Mortgage Corporation and Guaranty National Insurance
Company, effective August 26, 1994--filed as Exhibit 28.3
to the Company's Form 10-Q for September 30, 1994
*10.34 Guaranty National Insurance Company Supplemental
Executive Retirement Plan, dated December 30, 1994--filed
as Exhibit 10.48 to the Company's Form 10-K for 1994 (#)
*10.35 Amendment to Shareholder Agreement by and among Orion
Capital Corporation, Guaranty National Corporation and
certain wholly owned subsidiaries of Orion Capital
Corporation, dated February 2, 1994--filed as Exhibit
10.49 to the Company's Form 10-K for 1994
*10.36 Amendment to Shareholder Agreement by and among Orion
Capital Corporation, Guaranty National Corporation and certain
wholly owned subsidiaries of Orion Capital Corporation, dated March
2, 1995--filed as Exhibit 10.50 to the Company's Form 10-K for 1994
10.37 Credit Agreement among Guaranty National Corporation, as
Borrower, and First Union National Bank of North
Carolina, as Agent, dated as of June 2, 1995, amended and
restated as of December 16, 1996
*10.38 Stock Purchase Agreement for Viking Insurance Holding,
Inc., between Talegen Holdings, Inc. and Guaranty
National Corporation, signed April 26, 1995--filed as
Exhibit 10.1 to the Company's Form 10-Q for March 31,
1995
*10.39 Note Issuance Agreement, as amended and restated
effective June 14, 1995, by and among Guaranty National
Corporation, Orion Capital Corporation and Certain
Subsidiaries of Orion Capital Corporation--filed as
Exhibit 10.3 to the Company's Form 10-Q for June 30, 1995
*10.40 International Swap Dealers Association, Inc., (ISDA)
Master Agreement dated as of September 19, 1995, between
Norwest Bank Minnesota, N.A. and Guaranty National
Corporation--filed as Exhibit 10.6 to the Company's Form
10-Q for September 30, 1995
- ---------------------------------------------
*Incorporated by reference
(#)Management compensation agreement
-61-
*10.41 ISDA Master Agreement dated as of September 19, 1995,
between Guaranty National Corporation and Mellon Bank,
N.A.--filed as Exhibit 10.7 to the Company's Form 10-Q
for September 30, 1995
*10.42 Employment Agreement between Guaranty National
Corporation and James R. Pouliot, dated April 27, 1995--
filed as Exhibit 10.48 to the Company's Form 10-K for
1995 (#)
*10.43 Private Passenger Non-Standard Auto Quota Share
Reinsurance Agreement issued to Guaranty National
Insurance Company of California by Zurich Reinsurance
Centre, Inc., dated as of May 1, 1995--filed as Exhibit
10.49 to the Company's Form 10-K for 1995
*10.44 Property First Surplus, First Property Per Risk Excess of
Loss and Second Property Per Risk Excess of Loss
Reinsurance Contract issued to Colorado Casualty
Insurance Company, Guaranty National Insurance Company,
Peak Property and Casualty Insurance Corporation and
Landmark American Insurance Company by Towers Perrin
Reinsurance, dated as of January 1, 1995--filed as
Exhibit 10.50 to the Company's Form 10-K for 1995
10.45 Tax Allocation Agreement by and among Guaranty National
Corporation and each of its subsidiaries, dated as of
December 23, 1996
*10.46 Quota Share Reinsurance Agreement No. LIC-00I, by and
between Viking County Mutual Insurance Company and
Landmark American Insurance Company, dated November 15,
1995--filed as Exhibit 10.52 to the Company's Form 10-K
for 1995
*10.47 Managing General Agency Agreement No. 001-IGA by and
between Viking County Mutual Insurance Company and
Intercon General Agency, Inc., dated November 15, 1995--
filed as Exhibit 10.53 to the Company's Form 10-K for
1995
*10.48 Amendment to Employment Agreement of Roger B. Ware, dated
as of February 29, 1996--filed as Exhibit 10.54 to the
Company's Form 10-K for 1995 (#)
*10.49 100% Quota Share Reinsurance Treaty between Viking County
Mutual Insurance Company, Texas, and Landmark American
Insurance Company, Oklahoma--filed as Exhibit 10.1 to the
Company's Form 10-Q for June 30, 1996
*10.50 Endorsement No. 1, dated April 1, 1996, to the Multiple
Line Excess of Loss Agreement No. 3973-05--filed as
Exhibit 10.3 to the Company's Form 10-Q for June 30, 1996
*10.51 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--filed as Exhibit 10.4
to the Company's Form 10-Q for September 30, 1996
*10.52 Endorsement No. 2, dated July 1, 1996, to the Multiple
Line Excess of Loss Agreement No. 3973-05--filed as
Exhibit 10.5 to the Company's Form 10-Q for September 30,
1996
10.53 Property First Catastrophe Excess of Loss Contract,
effective January 1, 1996, issued to Guaranty National
Insurance Company, Colorado Casualty Insurance Company,
Peak Property and Casualty Insurance Corporation,
Guaranty National Insurance Company of California,
Landmark American Insurance Company, Viking Insurance
Company of Wisconsin, Viking County Mutual Insurance
Company by Towers Perrin Reinsurance
10.54 Property Second Catastrophe Excess of Loss Contract,
effective January 1, 1996, issued to Guaranty National
Insurance Company, Colorado Casualty Insurance Company,
Peak Property and Casualty Insurance Corporation,
Guaranty National Insurance Company of California,
Landmark American Insurance Company, Viking Insurance
Company of Wisconsin, Viking County Mutual Insurance
Company by Towers Perrin Reinsurance
- -----------------------------------------------
*Incorporated by reference
(#)Management compensation agreement
-62-
10.55 Tax Sharing Agreement, dated as of December 20, 1996, by
and between Orion Capital Corporation and Guaranty
National Corporation
10.56 Guaranty National Corporation Equity Incentive Plan,
approved by the Company's Board of Directors on October
29, 1996, and subject to Shareholder approval on May 13,
1997 (#)
21.1 Subsidiaries of Registrant
23.1 Consent of Deloitte & Touche LLP
- -----------------------------------------------
*Incorporated by reference
(#)Management compensation agreement
(b) REPORTS ON FORM 8-K:
No reports on Form 8-K have been filed by
the Registrant during the fourth quarter of
1996.
-63-
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/James R. Pouliot
------------------
James R. Pouliot, 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: February 28, 1997
-64-
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons
(including a majority of the members of the Board of Directors of
the Registrant) in the capacities and on the date indicated:
SIGNATURE & TITLE DATE
s/Alan R. Gruber February 28, 1997
- ----------------
Alan R. Gruber
Chairman of the Board
of Directors
s/James R. Pouliot February 28, 1997
- ------------------
James R. Pouliot
President and Chief Executive
Officer and Director
s/Tucker H. Adams February 28, 1997
- -----------------
Tucker H. Adams
Director
s/W. Marston Becker February 28, 1997
- -------------------
W. Marston Becker
Director
s/Dennis J. Lacey February 28, 1997
- -----------------
Dennis J. Lacey
Director
s/M. Ann Padilla February 28, 1997
- ----------------
M. Ann Padilla
Director
s/Vincent T. Papa February 28, 1997
- ------------------
Vincent T. Papa
Director
s/Robert B. Sanborn February 28, 1997
- -------------------
Robert B. Sanborn
Director
-65-
s/William J. Shepherd February 28, 1997
- ---------------------
William J. Shepherd
Director
s/Richard R. Thomas February 28, 1997
- -------------------
Richard R. Thomas
Director
s/Roger B. Ware February 28, 1997
- ---------------
Roger B. Ware
Director
-66-
INDEPENDENT AUDITORS' REPORT
Board of Directors and Shareholders
Guaranty National Corporation
We have audited the consolidated financial statements of
Guaranty National Corporation and subsidiaries as of December 31,
1996 and 1995, and for each of the three years in the period ended
December 31, 1996, and have issued our report thereon dated
February 14, 1997, (included elsewhere in this Form 10-K). Our
audits also included the financial statement schedules listed in
Item 14(a)2 of this Form 10-K. These financial statement schedules
are the responsibility of the Company's management. Our
responsibility is to express an opinion on the financial statement
schedules based on our audits. In our opinion, such financial
statement schedules, when considered in relation to the basic
consolidated financial statements taken as a whole, present fairly
in all material respects the information set forth therein.
s/Deloitte & Touche LLP
DELOITTE & TOUCHE LLP
Denver, Colorado
February 14, 1997
S-1
SCHEDULE I
GUARANTY NATIONAL CORPORATION
SUMMARY OF INVESTMENTS -
OTHER THAN INVESTMENTS IN RELATED PARTIES
DECEMBER 31, 1996
(In thousands)
COLUMN A COLUMN B COLUMN C COLUMN D
- ------------------------------------------------------------------------------
AMOUNT
SHOWN IN THE
TYPE OF INVESTMENT COST VALUE BALANCE SHEET
- -----------------------------------------------------------------------------
Fixed Maturities Held to Maturity:
Bonds:
United States Government and
agencies and authorities $ 30,674 $ 30,738 $ 30,674
States, municipalities and
political subdivisions 47,605 48,661 47,605
All other corporate 1,992 2,031 1,992
------- ------- ------
80,271 81,430 80,271
------- ------- ------
Fixed Maturities Available For Sale:
Bonds:
United States Government and
agencies and authorities 112,115 112,789 112,789
States, municipalities and
political subdivisions 156,439 162,424 162,424
Public utilities 5,810 5,559 5,559
All other corporate 78,220 79,868 79,868
Redeemable preferred stocks 29,831 29,650 29,650
------- ------- -------
382,415 390,290 390,290
------- ------- -------
Total fixed maturities 462,686 471,720 470,561
Equity Securities:
Common Stock:
Public utilities 1,471 1,994 1,994
Banks, trusts, insurance companies 3,306 6,833 6,833
Industrial, miscellaneous and
all other 37,912 50,588 50,588
Nonredeemable preferred stocks 26,969 28,687 28,687
------ ------ ------
Total equity securities 69,658 88,102 88,102
------ ------ ------
Other long-term investments 13,585 13,600 13,585
Short-term investments 94,993 94,993 94,993
------ ------ ------
Total investments $640,922 $668,415 $667,241
======= ======= =======
S-2
SCHEDULE II
GUARANTY NATIONAL CORPORATION
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(In thousands)
BALANCE SHEET
December 31,
--------------------
1996 1995
---- ----
Cash $ 9 $ 4
Investment in subsidiaries 341,158 310,539
Due from subsidiaries 3,108 4,601
Other assets 3,855 5,231
------- -------
Total assets $348,130 $320,375
======= =======
Other liabilities $ 8,403 $ 1,824
Notes payable 101,688 103,000
Shareholders' equity 238,039 215,551
------- -------
Total liabilities and
shareholders' equity $348,130 $320,375
======= =======
STATEMENT OF EARNINGS
Year Ended December 31,
-------------------------
1996 1995 1994
---- ---- ----
Miscellaneous income $ 2,639 $ 1,336 $ 947
Equity in earnings of subsidiaries 46,253 14,171 34,176
------ ------ ------
Total income 48,892 15,507 35,123
------ ------ ------
Interest expense 6,851 5,708 3,218
Nonrecurring charge 2,163
Other expenses 2,997 2,467 2,318
------ ------ -----
Total expenses 12,011 8,175 5,536
------ ----- -----
Earnings before income taxes 36,881 7,332 29,587
Income taxes 9,375 (1,597) 7,036
------ ------ ------
Net earnings $27,506 $8,929 $22,551
====== ===== ======
Note: The Parent only condensed financial information should be
read in conjunction with the consolidated financial
statements and accompanying notes of Guaranty National
Corporation and subsidiaries.
S-3
SCHEDULE II
GUARANTY NATIONAL CORPORATION
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(In thousands)
STATEMENT OF CASH FLOWS
Year Ended December 31,
------------------------------------
1996 1995 1994
---- ---- ----
OPERATING ACTIVITIES:
Dividends received from subsidiaries $ 8,687 $ 16,500 $ 4,000
Interest expense paid (6,817) (6,005) (3,043)
Miscellaneous income 2,639 1,337 947
Operating expenses (760) (834) (820)
Nonrecurring charge (1,302)
Advances from (to) subsidiaries,
net of income taxes paid 7,214 (3,189) 1,023
------ ------ ------
Net cash provided by
operating activities 9,661 7,809 2,107
------ ------ ------
INVESTING ACTIVITIES:
Sales of property and equipment 30 92 265
Purchases of property and equipment (1,145) (3,732)
Investment in subsidiary (950) (95,558)
----- ------ -----
Net cash used in
investing activities (920) (96,611) (3,467)
----- ------ -----
FINANCING ACTIVITIES:
Proceeds from issuance of
notes payable 130,654 14,000
Repayment of notes payable (1,313) (60,000)
Dividends paid (7,485) (6,655) (6,049)
Proceeds from issuance of common stock 24,220
Proceeds from exercise of stock options 62 550
Purchase of treasury stock (6,636)
------- ------- -----
Net cash provided by (used in)
financing activities (8,736) 88,769 1,315
------ ------- -----
NET INCREASE (DECREASE) IN CASH 5 (33) (45)
------ ------- -----
CASH, BEGINNING OF YEAR 4 37 82
------ ------ -----
CASH, END OF YEAR $ 9 $ 4 $ 37
====== ====== =====
Non-Cash Financing Transactions:
Conversion of affiliate debt $ $(20,896) $
Issuance of common stock in
conversion of affiliate debt 14,881
Conversion of affiliate debt
from treasury stock 6,015
Restricted stock forfeitures (126)
Note: The Parent only condensed financial information should be
read in conjunction with the consolidated financial
statements and accompanying notes of Guaranty National
Corporation and subsidiaries.
S-4
SCHEDULE III
GUARANTY NATIONAL CORPORATION
SUPPLEMENTAL INFORMATION FOR PROPERTY AND CASUALTY INSURANCE OPERATIONS
(In Thousands)
Column A Column B Column C Column E Column F Column G
- -------- -------- -------- -------- -------- --------
Deferred Unpaid
Policy Losses & Loss Net
Acquisition Adjustment Unearned Premiums Investment
Costs Expenses Premiums Earned Income
----------- ------------- -------- -------- ----------
Property/Liability
Insurance
Year ended
December 31, 1996 $ 44,456 $368,408 $154,242 $481,648 $ 39,439
======= ======= ======= ======= =======
Year ended
December 31, 1995 $ 37,637 $354,634 $146,205 $390,017 $ 30,976
======= ======= ======= ======= =======
Year ended
December 31, 1994 $ 31,623 $241,221 $123,092 $321,638 $ 23,576
======= ======= ======= ======= =======
SCHEDULE III (CONTINUED)
GUARANTY NATIONAL CORPORATION
SUPPLEMENTAL INFORMATION FOR PROPERTY AND CASUALTY INSURANCE OPERATIONS
(In Thousands)
Column A Column H Column I Column J Column K
- -------- -------- -------- -------- --------
Losses & Loss
Adjustment Expenses Amortization Paid
Incurred Related to of Deferred Losses
(1) (2) Policy & Loss Net
Current Prior Acquisition Adjustment Premiums
Year Year Costs Expenses Written
------- ----- ------------ ---------- --------
Property/Liability
Insurance
Year ended
December 31, 1996 $338,779 $ (995) $133,931 $339,442 $491,232
======= ===== ======= ======= =======
Year ended
December 31, 1995 $280,726 $12,787 $110,341 $267,641 $397,899
======= ====== ======= ======= =======
Year ended
December 31,1994 $212,458 $ 1,047 $ 93,103 $199,530 $322,925
======= ====== ======= ======= =======
S-5