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 the fiscal year ended Commission file number
December 31, 1998 1-7801
ORION CAPITAL CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 95-6069054
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
9 Farm Springs Road, Farmington, Connecticut 06032
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 860-674-6600
Securities registered pursuant to Section 12(b)of the Act:
Name of each exchange
Title of each class on which registered
Common Stock, $1 par value New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
(Title of Class)
9.125% Senior Notes due September 1, 2002
7.25% Senior Notes due July 15, 2005
8.73% Trust Preferred Capital Securities due January 1, 2037
7.701% Trust Preferred Capital Securities due April 15, 2028
(issued by wholly-owned Trusts of the Registrant)
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 amendments to
this Form 10-K. [ ]
The aggregate market value of the voting stock of the registrant held by
non-affiliates was $910.5 million as of March 1, 1999.
As of March 1, 1999, 27,231,000 Shares of Common Stock, $1.00 par value, of
registrant were outstanding exclusive of shares held by registrant and its
subsidiaries.
1
DOCUMENTS INCORPORATED BY REFERENCE
The information required by Part III is incorporated by reference from
registrant's definitive proxy statement for its Annual Meeting to be held on May
25, 1999. Registrant intends to file the proxy material, which involves the
election of directors, not later than 120 days after the close of its fiscal
year.
Table of Contents Page
Part I
Item 1: Business 3
General 3
Workers Compensation 8
Nonstandard Automobile 9
Specialty Commercial 11
Insurance Industry Characteristics 15
Item 2: Properties 27
Item 3: Legal Proceedings 28
Item 4: Submission of Matters to a Vote of Security Holders 28
Information concerning Executive Officers of the Company 28
Part II
Item 5: Market for Registrant's Common Equity and Related
Stockholder Matters 30
Item 6: Selected Financial Data 31
Item 7: Management's Discussion and Analysis of Financial
Condition and Results of Operations 32
Item 7A: Quantitative and Qualitative Disclosures About Market Risk 49
Item 8: Financial Statements and Supplementary Data 50
Item 9: Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 85
Part III
Item 10: Directors and Executive Officers of the Company 85
Item 11: Executive Compensation 85
Item 12: Security Ownership of Certain Beneficial Owners
and Management 85
Item 13: Certain Relationships and Related Transactions 85
Part IV
Item 14: Exhibits, Financial Statement Schedules
and Reports on Form 8-K 85
Signatures 91
Exhibit Index 93
2
Forward-Looking Statements
All statements made in this Annual Report on Form 10-K that do not reflect
historical information are "forward-looking statements" within the meaning of
the Private Securities Litigation Reform Act of 1995. Such forward-looking
statements involve known and unknown risks, uncertainties and other factors that
may cause the actual results, performance or achievements of Orion Capital
Corporation and its consolidated subsidiaries to be materially different from
any future results, performance or achievements, expressed or implied by the
forward-looking statements. Such risks, uncertainties and other factors include,
among other things, (i) general economic and business conditions; (ii) interest
rate and financial market changes; (iii) competition and the regulatory
environment in which we operate; (iv) claims frequency; (v) claims severity;
(vi) medical cost inflation; (vii) increases in the cost of property repair;
(viii) the number of new and renewal policy applications submitted to us; (ix)
Year 2000 problems; and (x) other factors over which the Company has little or
no control. The Company's expectation is that its plan for Year 2000 Compliance
will be completed on schedule depends, in large part, on the Company's own
efforts and expenditures on hardware, software and systems, which is on schedule
as to those exposures which the Company has been able to identify. However, Year
2000 problems could also arise because of unanticipated non-compliance on the
part of vendors, agents, customers and other third parties including
governmental entities. Significant Year 2000 problems could materially and
adversely affect future performance and results of operations. The Company
disclaims any obligation to update or to publicly announce the impact of the
above risks, uncertainties and other factors or any revisions to any
forward-looking statements to reflect future events or developments.
PART I
ITEM 1. BUSINESS
GENERAL
Our Operations
Orion Capital Corporation ("Orion") is an insurance holding company. We
have the ability, through our nineteen wholly-owned insurance subsidiaries, to
write almost all types of property and casualty insurance nationwide and
throughout Canada. However, our operations are highly specialized. We currently
only underwrite and sell specialized insurance products and services through
three segments: Workers Compensation, Nonstandard Automobile and Specialty
Commercial.
Over the past two years, Orion has been reshaping its business to focus
resources in high potential lines of business. Business in Orion's workers
compensation segment is conducted through EBI Companies, Inc., a specialty
monoline workers compensation operation. Orion has been reshaping EBI from a
regional to a national monoline workers compensation specialist.
In Orion's nonstandard personal automobile segment, Orion increased its
ownership in Guaranty National Corporation ("Guaranty National") to 81% in July
1996 and to 100 % in December 1997. In January 1998, we transformed Guaranty
National into a focused personal nonstandard automobile company by shifting the
commercial lines business of Guaranty National to a newly-formed unit, Orion
Specialty Group, Inc. At that same time, we also shifted the Company's program
business from Connecticut Specialty Insurance Group, Inc., to the new Orion
Specialty unit and began integrating and refocusing the two operations. Guaranty
National was recently renamed OrionAuto, Inc. We added scale to our nonstandard
automobile operation by acquiring two businesses, Unisun Insurance Company in
December 1997 and portions of Strickland Insurance Group in April 1998 expanding
our geographic focus to 35 states.
During the third quarter of 1998, we accelerated the reshaping in our
specialty commercial segment. This segment includes DPIC Companies, Inc.,
Orion's professional liability business, Wm. H. McGee & Co., Inc., the marine
business, and Orion Specialty, which includes ARTIS, our alternative risk
business formed in June 1997, Orion Financial (formerly Intercon), our
collateral protection business and the commercial lines business from Guaranty
National and Connecticut Specialty. In July 1998, we added a specialty insurance
company serving the grocery and food services industry with the purchase of
Grocers Insurance Group. We sold a unit of Orion Specialty, Colorado Casualty
Insurance Company, in September 1998. Additionally, we took steps to exit a
block of commercial automobile and transportation business, representing
approximately $100 million in net written premiums, that is highly price-driven
and performing poorly. Orion will continue its reshaping of this segment in
1999. As part of that effort, we will exit the marine segment by selling our 26%
interest in Intercargo Corporation and Wm. H. McGee & Co., Inc.
3
In November 1996, we exited the assumed reinsurance business when we sold
the ongoing operations of our subsidiary, SecurityRe Companies, Inc. As a result
of the sale, SecurityRe ceased actively writing business and became an inactive
company. The capacity we have developed to handle the run-off of SecurityRe will
support our administration of run-off business which results from the reshaping
of our specialty commercial segment.
We own insurance companies, as well as brokerage companies and insurance
management and service companies. Those companies have licenses to transact
business nationwide and in all Canadian provinces. In general we do not sell our
insurance products directly to our policyholders. We obtain substantially all
our business through independent insurance agents and brokers. We have
approximately 4,100 employees. Substantially all of our employees work in our
insurance or insurance-related operations. The Company is not a party to any
collective bargaining agreements and believes its relationship with its
employees is good.
Orion Capital Corporation was incorporated in the State of Delaware in
1960, and its wholly-owned insurance subsidiaries are incorporated in the States
of California, Connecticut, Colorado, North Carolina, Oklahoma, Oregon, South
Carolina, Texas and Wisconsin. Our principal executive offices are located at 9
Farm Springs Road, Farmington, Connecticut 06032 and the telephone numbers are
(860) 674-6600 and (800) 243-7060. Information about Orion is available on the
Internet at www.orioncapital.com.
In the following pages of this report, Orion Capital Corporation is
referred to as "Orion" or the "parent corporation," while Orion and its
consolidated subsidiaries are collectively referred to as the "Company."
ORION CAPITAL CORPORATION - CAPITAL STRUCTURE
In July 1997, to increase the trading liquidity and affordability of our
common stock, we declared a 2-for-1 stock split. At December 31, 1998 the
securities that Orion (or its wholly-owned Trusts) had outstanding were:
- 27,170,000 shares of Common Stock;
- $110 million face amount of 9.125% Senior Notes, due September 1, 2002;
- $100 million face amount of 7.25% Senior Notes, due July 15, 2005;
- $125 million of 8.73% Trust Preferred Capital Securities, due January 1,
2037; and
- $125 million of 7.701% Trust Preferred Capital Securities due April
15, 2028.
On January 13, 1997, Orion issued $125 million of 8.73% Junior Subordinated
Deferrable Interest Debentures, due January 1, 2037, to Orion Capital Trust I
("Trust I"), a Delaware statutory business trust we sponsored. Trust I then
simultaneously sold, in a private placement, $125 million of the Trust I's 8.73%
Preferred Capital Securities, which have substantially the same terms as the
8.73% Debentures. The proceeds from the sale of the securities were used, in
part, to purchase Guaranty National in December 1997. The securities were
registered with the Securities and Exchange Commission in April 1997.
4
On February 2, 1998, similar to the prior year's issuance of trust
preferred securities, Orion issued $125 million of 7.701% Junior Subordinated
Deferrable Interest Debentures, due April 15, 2028, to Orion Capital Trust II
("Trust II"), a Delaware statutory business trust we sponsored. Trust II then
simultaneously sold $125 million of the Trust II's 7.701% Preferred Capital
Securities, which have substantially the same terms as the 7.701% Debentures.
Approximately $100 million of the net proceeds from the sale were used to retire
the bank indebtedness of Guaranty National. The securities were registered with
the Securities and Exchange Commission in June 1998.
While the two trust preferred issues have complicated structures, they
offer us advantages of preferred stock with the tax deductibility feature of
debt. The securities provide a low after-tax cost of financing for our business
growth. See Note 9 to the Company's consolidated financial statements.
On July 8, 1998 Orion entered into a five year credit agreement with a
group of banks which provides for unsecured borrowings up to $150 million. We
intend to use the credit facility for general corporate purposes that may
include acquisitions. Borrowings outstanding under the credit agreement are $8
million at 1998 year end and accrue interest equal to LIBOR (London Interbank
Offered Rate) plus a margin based upon Orion's credit rating. The credit
agreement requires the Company to maintain certain covenants including financial
ratios.
SEGMENT REPORTING
The Securities and Exchange Commission requires registered companies to
report their results in segments by type of business, geographic distribution or
other meaningful breakdown. During the fourth quarter of 1998, we adopted a new
accounting standard on segment reporting. The standard requires that public
companies disclose segment information based on how management organizes the
segments of the enterprise to make operating decisions and assess performance.
Our insurance operations are divided into three segments. See Notes 1 and 17 to
the Company's consolidated financial statements. Our segments are as follows:
- Workers Compensation - this segment includes the workers compensation
insurance products and services sold by EBI Companies, Inc.
- Nonstandard Automobile - this segment specializes in personal nonstandard
automobile insurance sold by OrionAuto (formerly named Guaranty National).
- Specialty Commercial - as of 1998 year end, this segment markets various
specialty commercial products and services including professional liability
insurance through DPIC Companies, Inc.; client-focused specialty insurance
programs through Orion Specialty; underwriting management specializing in
ocean marine, inland marine and commercial property insurance through Wm.
H. McGee & Co, Inc.; insurance for international trade through the
Company's 26% interest in Intercargo Corporation; and also includes the
run-off operations of our assumed reinsurance business, SecurityRe, which
was sold in late 1996. The Company expects to close its sale of Wm. H.
McGee and its 26% interest in Intercargo Corporation ("Intercargo") in
1999.
5
For purposes herein, historical statements and transactions related to the
former Guaranty National (the commercial lines and personal lines company) will
be referred to as "Guaranty National" whereas the presently existing personal
lines only company will be referred to as "OrionAuto."
Net Earnings
Our net earnings and per share amounts for the past three years, were as
follows:
(In millions, except per share amounts) 1998 1997 1996
- --------------------------------------------------------------------
Net earnings $ 102.8 $ 115.8 $ 86.6
Net earnings per basic share $ 3.78 $ 4.24 $ 3.16
Net earning per diluted share $ 3.69 $ 4.15 $ 3.12
Weighted average shares outstanding 27.2 27.3 27.4
Weighted average shares and diluted
equivalent outstanding 27.8 27.9 27.8
Earnings per share has been calculated based upon a new accounting standard
adopted in 1997. Additionally, the 1996 shares and per share amounts have been
restated for the 2-for-1 stock split issued on July 7, 1997.
The following tables present condensed financial information showing
revenues, pre-tax earnings and other financial data and ratios of our segments
for each of the three years in the period ended December 31, 1998. Identifiable
assets, by segment, are included in Note 17 to the Company's consolidated
financial statements.
(In millions) 1998 1997 1996
- -----------------------------------------------------------------------------
REVENUES:
Workers Compensation .................... $ 484.7 $ 418.0 $ 402.0
Specialty Commercial .................... 782.9 812.1 804.8
Nonstandard Automobile .................. 441.5 349.7 283.5
Other ................................... 7.6 10.8 3.2
--------- --------- ---------
Consolidated ......................... $ 1,716.7 $ 1,590.6 $ 1,493.5
========= ========= =========
EARNINGS:
Workers Compensation .................... $ 86.2 $ 86.8 $ 68.4
Specialty Commercial .................... 54.2 65.3 56.5
Nonstandard Automobile .................. 37.1 40.7 23.3
--------- --------- ---------
Total property and casualty operations 177.5 192.8 148.2
Other ................................... (20.8) (16.6) (20.9)
--------- --------- ---------
156.7 176.2 127.3
Federal income taxes .................... (41.1) (46.5) (32.0)
Minority interest expense ............... (12.8) (13.9) (8.7)
--------- --------- ---------
Net earnings ............................... $ 102.8 $ 115.8 $ 86.6
========= ========= =========
6
The following table sets forth certain insurance ratios for the past three years
for the Company:
1998 1997 1996
- ----------------------------------------------------------------------
Loss and loss adjustment expenses
to premiums earned 67.9% 66.7% 67.9%
Policy acquisition and other insurance
expenses to premiums earned 31.0% 31.2% 30.1%
----- ----- -----
Total before policyholders' dividends 98.9% 97.9% 98.0%
Policyholders' dividends to premiums
earned 1.6% 1.8% 1.8%
----- ----- -----
Combined ratio 100.5% 99.7% 99.8%
===== ===== =====
One or more of Orion's insurance subsidiaries are licensed to transact
business in each of the 50 states of the United States, the District of
Columbia, Puerto Rico and all provinces of Canada. In 1998, approximately 13.9%
of the Company's consolidated direct premiums written was generated in
California, 6.7% in South Carolina, 6.4% in both Pennsylvania and Texas, 5.5% in
North Carolina and 5.4% in New York. California premiums are primarily generated
from nonstandard personal automobile coverages written by OrionAuto. Also
significant in California is architects and engineers professional liability
insurance issued by DPIC Companies. The increases in South Carolina and North
Carolina premiums are from the acquisitions in December 1997 and April 1998 of
two nonstandard personal automobile businesses. The primary line of business in
Pennsylvania and Texas is workers compensation. New York's primary line in 1998
was the ocean and inland marine business written by Wm. H. McGee.
The following table shows the geographical distribution of direct premiums
written by the Company for the years ended December 31:
Geographical distribution of Direct Premiums Written
--------------------------------------------------------------
(In millions, except for %) 1998 % 1997 % 1996 %
- --------------------------------------------------------------------------------------------
States
California ... $ 259.1 13.9% $ 226.0 14.8% $ 172.0 12.0%
South Carolina 125.6 6.7% 13.5 0.9% 12.7 0.9%
Pennsylvania . 119.3 6.4% 116.7 7.7% 130.8 9.1%
Texas ........ 118.4 6.4% 85.3 5.6% 84.9 5.9%
North Carolina 102.0 5.5% 25.7 1.7% 21.7 1.5%
New York ..... 101.0 5.4% 96.8 6.4% 106.1 7.4%
All Others (1) 1,036.6 55.7% 957.3 62.9% 903.2 63.2%
---------- ----- ---------- ----- ---------- -----
$ 1,862.0 100.0% $ 1,521.3 100.0% $ 1,431.4 100.0%
========== ===== ========== ===== ========== =====
(1) In 1998, no other single state or country, other than the United States,
accounted for more than 5% of total direct premiums written.
For 1998, 29.5% of the Company's net premiums written was derived from
nonstandard personal automobile insurance; 28.9% came from workers compensation
insurance; 16.5% related to liability insurance other than automobile, primarily
professional liability insurance; 9.2% came from commercial automobile
insurance, 6.9% was from marine insurance coverages and 5.1% for commercial
multiple peril insurance. No other line of business contributed in excess of
5.0% to the 1998 net premiums written.
7
The following table shows the Company's net premiums written, by major
statutory lines of business, for the years ended December 31:
Net Premiums Written
-----------------------------------------------------------
(In millions, except for %) 1998 % 1997 % 1996 %
- -------------------------------------------------------------------------------------------------
Nonstandard personal automobile $ 452.4 29.5% $ 373.1 27.3% $ 307.5 23.0%
Workers compensation .......... 444.3 28.9% 380.8 27.8% 383.6 28.8%
Liability other than automobile 252.4 16.5% 250.0 18.3% 249.4 18.7%
Commercial automobile ......... 140.7 9.2% 155.7 11.4% 147.3 11.0%
Marine ........................ 105.3 6.9% 69.1 5.1% 67.6 5.1%
Commercial multiple peril ..... 78.8 5.1% 65.8 4.8% 46.4 3.5%
All Others .................... 59.7 3.9% 72.6 5.3% 132.3 9.9%
---------- ----- ---------- ----- ---------- -----
$ 1,533.6 100.0% $ 1,367.1 100.0% $ 1,334.1 100.0%
========== ===== ========== ===== ========== =====
WORKERS COMPENSATION
The Workers Compensation segment is comprised of the EBI Companies ("EBI"),
which provides workers compensation insurance, and accident prevention and cost
containment services.
A specialist in workers compensation on a regional and national basis, EBI
continues to expand its market presence by bringing its distinctive value-added
approach to new states and through a new customer focus in multi-state accounts.
EBI operates on a nationwide basis through 46 offices located in 27 states.
Through the addition of alternative products and pricing approaches, entry into
new states and continued emphasis on its value-added services, EBI expects
further to expand its presence in the workers compensation market. It ranks
among the 15 largest writers of workers compensation insurance in the United
States based on net premiums written and has one of the lowest three year
average loss ratios within this group. Its headquarters are in Itasca, Illinois,
a suburb of Chicago. Information about EBI is available on the Internet at
http://www.ebico.com.
EBI's competitive edge stems from its service-oriented approach. EBI
offices are staffed with underwriters, marketing representatives, claim
representatives, accident prevention consultants, lawyers, medical and
rehabilitation experts and other technical and administrative personnel who work
in a multidisciplinary team environment. The team approach starts with the
underwriting process. EBI's method of underwriting is not merely to evaluate the
risk, but also to assess the likelihood of reducing injury through accident
prevention services. Accident prevention and claims management personnel, as
well as underwriters, have direct responsibility for account selection,
underwriting and servicing each client.
EBI teams work directly with the client and its employees to identify the
factors that affect their insurance costs, and to provide services designed to
reduce the frequency and severity of injuries. EBI's approach to accident
prevention requires insureds to establish and maintain a Zero Accident
Culture(R) (ZAC(R)), designed to keep the work environment free of accidents.
EBI manages worker injuries through claims personnel and rehabilitation nurses
to minimize the employee's disability and related medical costs.
With a desire to influence the work place environment to reduce losses and
long-term insurance costs, EBI's marketing targets businesses where its
ZAC(R)philosophy and service-oriented approach can have the greatest impact. EBI
concentrates its efforts on businesses in selected industries, including
manufacturing, healthcare, hospitality, school districts and service industries.
EBI's geographic expansion and growth in recent years has given it a much
broader base of operations. Today, EBI is recognized as a national workers
compensation niche insurance carrier.
8
As EBI has continued to grow, it has refined its agency force by
strengthening relationships with large, regional and national insurance agents
and brokers. Approximately 1,100 independent agents and brokers produced all of
the direct business written in 1998 by EBI. These agents and brokers receive
commissions on the sale of insurance. No single independent agent or broker
contributed more than 10% of this segment's net written premiums.
EBI has recorded profitable underwriting results for the past five years
which has led it to continue its plan of geographic expansion. In 1998, it
expanded into three new states. Expansion opportunities now also include
multi-state clients. EBI has been able to gain a strong reputation for service.
Among the alternative products EBI offers is workers compensation excess
coverage and an accompanying self-insured administration program and an
integrated employee benefit program. These products and services are designed to
capitalize on EBI's expertise in traditional workers compensation. EBI applies
those skills to writing workers compensation for larger accounts and clients
desiring large deductibles.
Description of Workers Compensation Insurance: A workers compensation
policy obligates an insurance company to pay all disability, medical and other
benefits for injured workers as may be required by applicable state laws. The
insurance policies currently written by EBI provide workers compensation
coverage with limits of liability set by the provisions of state workers
compensation laws. The benefits provided by these laws vary with the nature and
severity of the injury or disease, as well as with the wage level, occupation,
and age of the employee. Employers' liability coverage is also provided to
employers who may be subject to claims for damages (other than workers
compensation benefits) due to an injury to a worker.
The amount of workers compensation premiums earned is directly dependent
upon wage levels, the number of employees on the payroll of each policyholder
and the job classifications of those employees. Premium rates are revised
annually in most states in which EBI does business. EBI uses the rates and
rating plans filed in the states where it does business. See "Industry
Characteristics - Rates."
NONSTANDARD AUTOMOBILE
The nonstandard automobile segment consists of OrionAuto, which is one of
the leading national writers of nonstandard personal automobile insurance. In
December 1997, the Company purchased the remaining interest in Guaranty National
that it did not already own, in part to provide a more appropriate ownership
structure to continue the Company's expansion in the nonstandard personal
automobile insurance business. Immediately following the purchase of Guaranty
National, in January 1998, the Company consolidated Guaranty National's
commercial insurance operations to its newly-formed unit, Orion Specialty. This
action transformed Guaranty National into a focused nonstandard personal
automobile insurance company. Guaranty National was recently renamed OrionAuto,
Inc.
9
In December 1997, the Company purchased Unisun Insurance Company ("Unisun")
from Michigan Mutual Insurance Company for $26.2 million in cash including
acquisition expenses. Unisun is the largest servicing carrier for the state
automobile insurance facility in South Carolina and also writes personal
automobile insurance in the States of Alabama, Georgia and North Carolina. Total
net premiums written by Unisun for 1997 were approximately $20 million.
Effective March 1, 1999 the State of South Carolina will transition to a
voluntary market environment that will provide OrionAuto with further business
opportunities in this market.
In April 1998, the Company acquired the nonstandard personal automobile
insurance business of North Carolina-based Strickland Insurance Group
("Strickland") for $44.1 million in cash including acquisition expenses.
Strickland is the second largest automobile insurance writer in North Carolina
and also writes personal automobile insurance in Florida. In 1997, Strickland
reported approximately $99 million of personal automobile gross premiums written
and $46 million of net premiums written.
OrionAuto focuses its operations on the nonstandard markets. Nonstandard
personal automobile insurance represents insurance (i) for drivers usually
unacceptable to other insurers for, among other reasons, adverse driving or
accident history, age or vehicle type, or (ii) for customers who can only afford
a low down payment or are transitioning from an uninsured to an insured status.
Nonstandard risks generally involve a potential for poor claims experience
because of increased risk exposure and require specialized underwriting, claims
management and other skills and experience. OrionAuto's loss exposure is limited
by the fact that its insureds 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. This insurance coverage is sold
primarily in the State of California, the Rocky Mountain and Pacific Northwest
regions, and the Southeastern United States. OrionAuto sells its insurance
through approximately 12,000 independent agents located in 35 states.
Overall, OrionAuto seeks to distinguish itself from its competitors by
providing a superior, highly automated and responsive level of service to its
agents and insureds. In addition to high quality service, OrionAuto provides
ease of payment for insureds through low monthly installments.
In underwriting nonstandard automobile risks, OrionAuto sets premium rates
which are substantially higher than standard rates. Policy coverage periods are
generally one or six months on personal automobile policies. The business of
OrionAuto is not materially dependent upon any single customer, group of
customers, or group of agents.
Customer service and policy processing operations are a critical part of
OrionAuto. Offices are currently located in Phoenix Arizona; Irvine, California;
Pleasant Hill, California; Englewood, Colorado; Freeport, Illinois; Goldsboro,
North Carolina; High Point, North Carolina; Salem, Oregon; Charleston, South
Carolina; Salt Lake City; Utah and Madison, Wisconsin. Multiple locations in
multiple time zones contribute to efficient volume routing. In the customer
service area, use of the Interactive Voice Response system permits efficient,
automated answering of routine agent and customer questions.
10
SPECIALTY COMMERCIAL
The Company's Specialty Commercial segment concentrates in highly
specialized, client-focused lines of business in the property and casualty
insurance field. As of 1998 year end, the Specialty Commercial segment marketed
various specialty commercial products and services including professional
liability insurance through DPIC Companies; client-focused specialty insurance
programs through Orion Specialty; underwriting management specializing in ocean
marine, inland marine and commercial property insurance through Wm. H. McGee;
insurance for international trade through the Company's 26% interest in
Intercargo Corporation; and also includes the run-off operations of the
Company's assumed reinsurance business, SecurityRe, which was sold in late 1996.
In December 1998, Intercargo announced an agreement of merger pursuant to which,
when consummated, the Company would receive $22.8 million in cash for its
interest in Intercargo. On March 11, 1999 the Company announced the signing of a
definitive agreement to sell Wm. H. McGee & Co., Inc. Both the sale of our
interest in Intercargo and of McGee are a part of Orion's continued sharpening
of the Company's focus on profitable lines of business.
11
DPIC
DPIC Companies, Inc. ("DPIC" or the "DPIC Companies"), through the
Company's insurance company affiliates, writes professional liability insurance
for its niche markets: architects, engineers, environmental consultants,
accountants and lawyers. It is the largest underwriter of architect, engineer
and environmental consultants in North America. DPIC operates in offices
throughout the United States and Canada. It is headquartered in Monterey,
California. Information about DPIC can be found on the Internet at
http://www.dpic.com.
DPIC's operations are organized to be directly aligned with its various
client markets, both geographically and by profession. Since its inception,
DPIC's claims operations have been set up in strategic geographical locations.
In July 1997, DPIC's underwriting operations were decentralized, linking up with
its major regional claims offices to serve clients and agency representatives
more efficiently and effectively. DPIC underwriting/claims offices are in
Newport Beach, California; San Francisco, California; Englewood, Colorado;
Norcross, Georgia; Itasca, Illinois; Clifton, New Jersey; New York, New York;
and Toronto, Ontario; DPIC claims offices can also be found in and Montreal,
Quebec. Satellite claims offices are located in Calgary, Alberta and Dallas,
Texas.
Professional liability insurance covers liability arising out of alleged
negligent performance of professional services. Underwriting and claims
management require a high level of knowledge and expertise. To limit risk
exposure, DPIC's specialized underwriters evaluate a great number of factors,
including the experience of an applicant firm's professional personnel, the loss
history of the firm, the employees covered, the type of work performed and the
firm's utilization of loss prevention measures. DPIC actively rewards firms that
participate in loss prevention education, risk management and business practice
improvement programs. It offers a series of client-focused professional
liability education programs and provides financial incentives for resolving
disputes through mediation.
The professional liability coverage offered by DPIC is on a "claims-made"
policy form, a form that generally insures only those claims reported by the
insured during the policy term. With some exceptions in Canada, DPIC's policies
cap defense costs, primarily legal fees, within the insureds stated policy
limits. This has resulted in a favorable impact in controlling legal costs.
DPIC's specialized claims staff stresses early intervention in disputes to
avoid litigation. DPIC has pioneered the use of alternative dispute resolution
("ADR"), mediation in particular, to resolve disputes promptly. Because of
mediation's proven success in reducing the costs of claims in terms of time,
money, and relationships - over 25% of DPIC's claim files are resolved through
this technique. These initiatives have had a favorable impact on DPIC's
operating results.
DPIC markets its products through 65 specialized agencies, each highly
knowledgeable about loss prevention and risk management for the professions
served. The agents are active in continuing education programs, sponsored by
DPIC, and in their professional association, Professional Liability Agents
Network, and participate extensively in their clients' professional societies.
Exclusive territory assignments and extensive support from DPIC lead to a
focused commitment to meet the insurance and loss prevention needs of the
professions served.
Orion Specialty
Upon completion of the December 1997 merger of Guaranty National into a
wholly-owned subsidiary of the Company, the Company formed a new business unit
in January 1998, Orion Specialty Group, Inc. Orion Specialty consolidates
Connecticut Specialty Insurance Group, Inc., the Company's program business
unit, and the commercial lines business of Guaranty National. With this
consolidation, Orion Specialty began refocusing its business mix to fewer,
narrower customer segments targeting distinct client groups in the commercial
service, trade and financial services industries, as well in the alternative
risk sector. Orion Specialty uses three underwriting and distribution models
that enable it to deliver a spectrum of insurance products and services to meet
the particular needs of these targeted groups.
12
Segments of the business initially combined under the Orion Specialty
umbrella were heavily exposed to commodity pricing pressures, especially the
commercial automobile and transportation area. Orion Specialty had been writing
nearly 30 classes of such business and, as a part of its refocusing efforts,
actively worked to reduce the amount of this business. In the third quarter of
1998, the Company accelerated this realignment, resulting in the decision to
exit unprofitable business totaling approximately $100 million in annualized net
written premiums. The third quarter action also included a reduction of
approximately 90 employees whose duties were related to the business being
exited. At the same time, the Company sold Colorado Casualty Insurance Company,
which while profitable wrote approximately $55 million in annual net premium
consisting largely of standard commercial business that did not fit the
Company's specialization strategy. The Company will continue in 1999 to assess
Orion Specialty's remaining programs.
The three underwriting and distribution models used by Orion Specialty to
deliver a spectrum of insurance products are as follows:
- Property & Casualty Division ("P&C Division") with offices located in
Farmington, Connecticut, Englewood, Colorado and Portland, Oregon;
-Alternative Risk Transfer Insurance Strategies ("ARTIS") located in
Windsor, Connecticut; and
- Financial Services Division located in Dallas, Texas.
P&C DIVISION
Orion Specialty's P&C Division tailors coverage packages to the needs of
specific classes of insureds. By structuring programs to group insureds with
common exposures (e.g., hairdressers, travel agents, etc.), Orion Specialty
delivers effective and efficient risk transfer and management to its targeted
client groups. It operates through general agents and program administrators.
The Division administers the operation of approximately 15 specialized programs
with emphasis in professional services and trade industries.
In addition, the P&C Division provides agents with binding authority in
selected "Premier Product" lines. These products appeal to a broader base of
customers and are generally offered on a mono-line basis. These lines of
business include general liability, property, professional liability, commercial
auto, and umbrella coverages.
A key aspect to the business of the P&C Division is the strategic alliances
it has formed with what it believes are knowledgeable and well respected agents
in the specialty insurance field. Each of its general agents has superior
knowledge of its markets and has earned customer loyalty by providing quality
services and support.
In July 1998, the Company purchased Grocers Insurance Group ("Grocers") an
Oregon-based specialty insurance holding company serving the grocery and food
service industry. The purchase price was $36.7 million in cash including
acquisition expenses. In 1997, Grocers reported approximately $23 million of net
premiums written, principally general liability, property and workers
compensation with the majority of its volume concentrated in the Northwestern
states. Grocers is headquartered in Portland, Oregon and operates offices in
Woodland, California; Medford, Oregon; Brentwood, Tennessee; and North Richland
Hills, Texas. Approximately 14 independent agents and 17 contract agents
produced the direct business written by Grocers in 1998.
13
ARTIS
ARTIS, offers an unbundled alternative market approach to allow insureds,
producers and sponsoring associations and groups to participate in the
underwriting and risk assumption of their insurance programs. ARTIS custom
designs its alternative risk programs for groups and individual clients
utilizing traditional captives, agency-owned-captives, member-owned-captives,
rent-a-captives, joint-owned-captives, self-insured retentions, large
deductibles, portfolio transfers and finite reinsurance. While workers
compensation is the largest component of its business, ARTIS also offers
coverage in general liability, automobile liability, property, inland marine,
surety and professional liability lines of business.
FINANCIAL SERVICES DIVISION
Orion Specialty's Financial Services Division offers products and coverages
to credit unions, banks, leasing companies, finance companies, and automobile
and equipment dealerships strictly through general agents. Insurance programs
offered by the Financial Services Division are collateral protection, mortgage
security, lenders' comprehensive single interest, creditors' installment sales,
inland marine, credit fire, guaranteed auto protection and flood. The largest of
the products offered, collateral protection insurance, 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. The
Financial Services Division currently markets its products in 50 states, the
District of Columbia and Commonwealth of Puerto Rico through 60 general and
retail agents.
McGee
Wm. H. McGee & Co., Inc. ("McGee") is a leading ocean cargo, inland marine
and related commercial property insurance underwriter and has been in business
for over 110 years. Security Insurance Company of Hartford ("Security"), a
subsidiary of the Company, has been represented by McGee since 1894. McGee
provides all related services in connection with this business, including policy
issuance, claim settlement, accounting and placement of reinsurance. McGee's
operations are conducted in the United States, through its headquarters in New
York City and 20 branch offices throughout the country. Activities in Canada,
Bermuda and Puerto Rico are managed by McGee's subsidiaries located in those
jurisdictions and they each perform substantially similar services.
In the United States, McGee ranks among the top 10 writers of ocean cargo
insurance and among the 20 largest writers of inland marine insurance. Ocean
cargo insurance covers cargo against the perils of the sea and is usually
broadened to include loss or damage to the goods while in transit until they
arrive at the destination specified in the policy. Inland marine insurance
covers property while being transported, property of a movable nature and
property instrumental to transportation or communication. Some common examples
of property covered by inland marine insurance are cargo being shipped by train,
truck or airplane; mobile equipment; bridges and tunnels; radio and television
transmitting equipment; personal jewelry and furs; art collections; livestock
and medical equipment.
Each insurer represented by McGee participates in either the United States
or Canadian Inter-Office Reinsurance Agreement (the "McGee Pools"). It is
through these underwriting pooling agreements that premiums and risk are
allocated among the various participating insurers. The insurers participating
in the McGee Pools and the percentage allocated to each insurer is reviewed and
revised annually. Security is a member and clearing company in both the United
States and Canadian pools. For 1998, McGee underwrote approximately $198 million
of gross premiums on behalf of the insurers participating in the McGee Pools.
The Company's participation in the United States pool was 71.5% in 1998, 52% in
1997, and 37% in 1996. Participation in the Canadian pool was 72% in 1998, 61%
in 1997, and 49% in 1996.
14
McGee, as an underwriting manager, does not directly solicit business from
insureds but instead relies on a production force consisting of insurance
brokers and agents appointed to represent the portion of the insurers' business
which McGee manages. McGee is compensated for its services by the insurers it
represents based upon a combination of factors, including a percentage of the
premiums written, the profitability of the business written and the management
services provided.
On March 11, 1999, the Company announced the signing of a definitive
agreement to sell McGee. The transaction is expected to be complete by April
1999, subject to regulatory approvals and other closing conditions.
INTERCARGO CORPORATION
The Specialty Commercial segment also includes the Company's 26% interest
in Intercargo, a publicly traded insurance holding company whose subsidiaries
specialize in international trade and transportation coverages. Its principal
product lines are United States customs bonds and marine cargo insurance sold to
importers and exporters through customs brokers and other service firms engaged
in the international shipment of goods. Intercargo operates as an independent
entity and a pro rata share of any profit or loss is reflected in the Company's
consolidated financial statements, based on the Company's equity interest in
Intercargo. In December 1998, the Company agreed to sell its investment in
Intercargo for $22.8 million in cash pursuant to terms of a merger between
Intercargo and X. L. America, Inc., a subsidiary of EXEL Limited. The sale is
expected to be complete late in the first quarter or early in the second quarter
of 1999, subject to regulatory approval.
SECURITYRE
In November 1996, the Company exited the assumed reinsurance business and
sold for cash the ongoing business of its subsidiary, SecurityRe. SecurityRe
primarily underwrote a diverse book of casualty business, using reinsurance
intermediaries, with exposures largely concentrated in the domestic market.
SecurityRe's premiums had been principally concentrated in the treaty segment
reinsuring small-to-medium-sized regional and specialty companies in various
lines of business (primarily automobile and commercial coverages). Facultative
coverage was provided on an excess of loss basis for casualty and property
exposures. Generally, the largest net amount insured by SecurityRe was
approximately $1 million. As a result of the sale, SecurityRe discontinued
writing business. The Company kept the reserves with respect to the outstanding
business and will continue to manage the settlement of claims arising out of
that business.
INSURANCE INDUSTRY CHARACTERISTICS
LOSS RESERVES
The Company establishes reserve liabilities for reported losses, incurred
but not reported ("IBNR") losses, and claim settlement and administration
expenses. Reserves for reported losses and loss adjustment expenses are
estimates of the ultimate costs of claims reported to the Company but not
settled. IBNR loss reserves are estimates for both unreported claims and
additional development of previously reported claims. Reserves are based on the
circumstances surrounding each claim, the Company's historical experience with
losses arising from claims both reported and not yet reported and the particular
experience associated with the line of business and type of risk involved.
Consideration is also given to expected changes in costs for property, repairs
to property, benefit changes for injured workers, medical care, and litigation
and other legal costs. Reserve estimates are regularly reviewed and adjusted to
consider all pertinent information, as it becomes available. Such reevaluation
is a normal, recurring activity that is inherent in the process of loss reserve
estimation.
Several methods are used for reviewing loss reserves, including paid and
incurred loss development, and incurred claim counts and average claim costs.
These methods can be subject to variability in loss reserve estimation for a
number of reasons, including improved claims department operating procedures,
accelerated claims settlement due to the use of alternate dispute resolution,
and expedited resolution of civil suits in litigation. Other factors that are
analyzed and are considered in the determination of loss reserves include: (i)
claim emergence and settlement patterns and changes in these patterns from year
to year, (ii) trends in the frequency and severity of paid and incurred losses,
(iii) changes in policy limits and changes in reinsurance coverages, (iv)
changes in the mix and classes of business, and (v) changes in claims handling
procedures.
Management revises its loss reserve estimates as appropriate and believes
that the loss and loss adjustment expense reserves of the Company's insurance
subsidiaries make reasonable and sufficient provision for the ultimate cost of
all losses and claims incurred. However, no assurances can be given that adverse
reserve development will not occur in the future.
ACCIDENT YEAR LOSS AND LOSS ADJUSTMENT EXPENSE ANALYSIS
Accident year is a period of exposure. It is used to accumulate loss and
loss adjustment experience by the year in which an incident giving rise to a
claim occurs. Accident year information is used for loss reserving and in
establishing premium rates. Each accident year loss experience is updated in
subsequent years until all losses and loss adjustment expenses related to that
given accident year have been settled. Accident year loss ratio relates losses
associated with incidents giving rise to claims occuring during a given calendar
year to the premiums earned during the same calendar year. Presented below are
loss reserve development tables for the five years ended December 31, 1998
prepared in an accident year format.
15
For each accident year, the following table presents premiums earned, and
the provision for loss and loss adjustment expenses as a percentage of premiums
earned (the "loss ratios") as established in the initial accident year and the
cumulative figures as of December 31, 1998:
Loss and Loss Adjustment
Accident Premiums Expense Development
---------------------------
(In millions, except for %) Year Earned Initial Cumulative
- --------------------------------------------------------------------------
1994 $ 691.2 69.6 % 69.0%
1995 749.0 66.8 % 66.8%
1996 1,300.8 67.2 % 68.1%
1997 1,357.7 66.0 % 67.9%
1998 1,503.0 65.6 % -
The table set forth below indicates premiums earned, the cumulative loss
ratio for each accident year, the ratio of policy acquisition costs and other
insurance expenses to premiums earned (the "expense ratio"), the ratio of
policyholders' dividends to premiums earned (the "policyholders' dividend
ratio") and the total of the ratios (the "combined ratio") at December 31, 1998:
Accident Premiums Loss Expense Policyholders' Combined
Year Earned Ratio Ratio Dividend Ratio Ratio
- --------------------------------------------------------------------------
(In millions, except for %)
1994 $ 691.2 69.0% 27.0% 2.1% 98.1%
1995 749.0 66.8% 29.0% 2.9% 98.7%
1996 1,300.8 68.1% 30.1% 1.8% 100.0%
1997 1,357.7 67.9% 31.2% 1.8% 100.9%
1998 1,503.0 65.6% 31.0% 1.6% 98.2%
16
Calendar Year Loss Reserve Analysis
An analysis of the Company's calendar year loss and loss adjustment expense
reserves, net of reinsurance, for the most recent three years ended December 31
is presented in the following table. The 1996 current year provision includes
favorable loss development for Guaranty National of $1.0 million and 1996
current year payments include $144.8 million attributable to periods prior to
the consolidation of Guaranty National's results in the Company's financial
statements. The 1998 provision - prior year and payments - prior year includes
amounts related to Colorado Casualty Insurance Company, which was sold in 1998,
of $1.1 million and $ 6.9 million, respectivley.
(In millions) 1998 1997 1996
- ----------------------------------------------------------------------------
Beginning of year .............. $ 1,390.7 $ 1,368.4 $ 994.0
Effect of acquisitions and other 16.9 8.9 286.3
---------- ---------- ----------
1,407.6 1,377.3 1,280.3
---------- ---------- ----------
Provision:
Current year ................ 986.6 896.3 874.1
Prior year .................. 33.9 9.2 8.9
---------- ---------- ----------
1,020.5 905.5 883.0
---------- ---------- ----------
Payments:
Current year ................ 450.3 370.9 499.2
Prior year .................. 559.4 521.2 295.7
---------- ---------- ----------
1,009.7 892.1 794.9
---------- ---------- ----------
End of year .................... $ 1,418.4 $ 1,390.7 $ 1,368.4
========== ========== ==========
Cumulative reserve development for the Company's wholly-owned insurance
subsidiaries (including acquisitions from date of purchase and excluding amounts
related to a divestiture for all periods presented) as of December 31, 1998 for
the calendar years then ended from 1992 through 1998 is shown in the table that
follows:
(In millions) 1992 1993 1994 1995 1996 1997 1998
- ----------------------------------------------------------------------------------------------------------
Gross liability .. $ 1,081.4 $ 1,140.4 $ 1,181.3 $ 1,275.0 $ 1,772.9 $ 1,864.8 $ 2,017.7
Reinsurance
recoverable ... 335.1 309.6 289.8 281.0 415.2 491.0 599.3
--------- --------- --------- ---------- ---------- ---------- ----------
Net liability .... $ 746.3 $ 830.8 $ 891.5 $ 994.0 $ 1,357.7 $ 1,373.8 $ 1,418.4
========= ========= ========= ========== ========== ========== ==========
Gross re-estimated
liability ..... $ 1,177.1 $ 1,171.5 $ 1,219.5 $ 1,302.0 $ 1,816.0 $ 1,905.9 $ -
Re-estimated
recoverable ... 346.1 308.6 309.7 295.7 444.5 499.3 -
--------- --------- --------- ---------- ---------- ---------- ----------
Net re-estimated
liability ..... $ 831.0 $ 862.9 $ 909.8 $ 1,006.3 $ 1,371.5 $ 1,406.6 -
========= ========= ========= ========== ========== ========== ==========
Gross (deficiency) $ (95.7) $ (31.1) $ (38.2) $ (27.0) $ (43.1) $ (41.1) $ -
redundancy ========= ========= ========= ========== ========== ========== ==========
17
Cumulative reserve development, net of reinsurance, for the Company's
wholly-owned insurance subsidiaries (including acquisitions from date of
purchase and excluding amounts related to a divestiture for all periods
presented) as of December 31, 1998 for the calendar years 1988 through 1998 is
shown in the table that follows:
December 31,
--------------------------------------------------------------------------------------------------------
(In millions) 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
- -----------------------------------------------------------------------------------------------------------------------------------
Net liability for unpaid
loss and loss
adjustment expenses ... $ 520.3 $ 602.5 $ 595.5 $ 668.5 $ 746.3 $ 830.8 $ 891.5 $ 994.0 $ 1,357.7 $ 1,373.8 $ 1,418.4
Paid (cumulative) as of:
One year later ........ 236.7 281.2 261.5 240.3 249.6 303.3 263.3 295.7 516.7 552.5 --
Two years later ....... 403.1 438.3 408.6 378.5 429.5 445.4 434.7 495.6 800.9 -- --
Three years later ..... 488.4 526.2 493.2 484.3 514.2 543.7 553.4 607.7 -- -- --
Four years later ...... 544.4 581.9 567.1 540.3 577.5 625.7 622.2 -- -- -- --
Five years later ...... 582.5 633.4 605.0 580.1 634.2 668.5 -- -- -- -- --
Six years later ....... 624.4 660.6 629.7 625.0 663.2 -- -- -- -- -- --
Seven years later ..... 643.4 676.9 666.5 648.5 -- -- -- -- -- -- --
Eight years later ..... 653.8 706.7 690.9 -- -- -- -- -- -- -- --
Nine years later ...... 680.6 727.7 -- -- -- -- -- -- -- -- --
Ten years later ....... 698.6 -- -- -- -- -- -- -- -- -- --
Net liability re-estimated
as of:
One year later ........ 573.6 647.6 657.1 694.9 770.6 848.1 903.3 1,002.8 1,364.0 1,406.6 --
Two years later ....... 624.3 695.2 685.7 715.0 782.3 855.0 903.0 1,003.2 1,371.5 -- --
Three years later ..... 658.0 722.6 705.5 732.0 786.0 855.3 903.1 1,006.3 -- -- --
Four years later ...... 687.8 741.8 741.1 744.3 801.2 856.0 909.8 -- -- -- --
Five years later ...... 705.5 770.4 756.5 763.7 822.6 862.9 -- -- -- -- --
Six years later ....... 733.8 788.3 786.6 782.5 831.0 -- -- -- -- -- --
Seven years later ..... 747.5 812.4 802.7 793.4 -- -- -- -- -- -- --
Eight years later ..... 771.4 831.5 817.8 -- -- -- -- -- -- -- --
Nine years later ...... 794.7 843.5 -- -- -- -- -- -- -- -- --
Ten years later ....... 804.6 -- -- -- -- -- -- -- -- -- --
Net deficiency ........... (284.3) (241.0) (222.3) (124.9) (84.7) (32.1) (18.3) (12.3) (13.8) (32.8) --
18
The preceding loss reserve development tables indicate the aggregate
year-end liability for loss and loss adjustment expenses, net of reinsurance,
the cumulative amounts paid attributable to those reserves through December 31,
1998, the re-estimate of the aggregate liability as of December 31 of each
subsequent year and the cumulative development of prior years' reserves.
Information is also provided on a gross basis for 1992 through 1998. Consistent
with industry practice, certain claims for long- term disability workers
compensation benefits are carried at discounted values. At December 31, 1998 and
1997, long-term disability workers compensation loss reserves are carried in the
Company's consolidated financial statements at $46.0 million and $52.9 million,
respectively, at net present value using a statutory interest rate of 3.5%.
The Company's IBNR loss and loss adjustment expense reserves and other bulk
reserves for losses and loss adjustment expenses for which claim files have not
been established, net of reinsurance, were $616.2 million, $686.4 million and
$690.6 million as of December 31, 1998, 1997 and 1996, respectively.
During 1998 and 1997, the Company strengthened loss reserves and
experienced adverse development for prior years' business of $33.9 million and
$9.2 million, respectively. For 1998, adverse development for reserve
strengthening in connection with the Orion Specialty realignment of $17.0
million, various pools and associations of $6.9 million (other than from McGee),
the assumed reinsurance business of $3.1 million, and workers compensation of
$8.7 million was partly offset by favorable development from other lines of
business of $1.8 million. For 1997, adverse development for various pools and
associations (other than McGee) of $11.4 million, for the assumed reinsurance
exited in 1996 of $12.2 million and certain cancelled program business of $20.9
million was partly offset by favorable development from workers compensation of
$34.3 million and other lines of business of $0.8 million. In the third quarter
of 1998, the Company completed an actuarial study of the business being exited
in connection with Orion Specialty's realignment and strengthened reserves by
$27.8 million including $17.0 million related to 1997 and prior accident years.
Adverse development relating to the Company's pools and associations business is
based on their experience, which is generally recorded as the information is
reported to the Company and relates primarily to environmental reserves. The
adverse development from workers compensation in 1998 primarily reflects upward
adjustments to 1997 and prior year initial reserve estimates based upon higher
current case reserves. The adverse development from cancelled programs in 1997
is largely due to an ocean marine program cancelled in that year which
experienced high claim frequency and severity. The favorable development from
the workers compensation and other lines of business in 1997 was the result of
improvement from the application of loss prevention and loss control procedures.
Loss reserve estimates are based on forecasts of the ultimate settlement of
claims and are subject to uncertainty with respect to future events. Loss
reserve amounts are based on management's informed estimates and judgments,
using data currently available. Reserve amounts and the underlying actuarial
factors and assumptions are regularly analyzed and adjusted to reflect new
information. Current operations are more focused on underwriting risks where the
Company has specialized knowledge and can provide enhanced service to reduce
loss costs. This concentration, and the specialized knowledge and growing
experience in its selected lines of business arising from such concentration,
have enabled the Company to implement improvements in its claims administration
and underwriting procedures which have enhanced the Company's ability to analyze
data and project reserve trends.
19
The following table presents the differences between loss and loss
adjustment expense reserves reported in the consolidated financial statements in
accordance with generally accepted accounting principles ("GAAP"), and those
reported in the combined annual statement filed with state insurance departments
in accordance with statutory accounting practices ("SAP") for the years ended
December 31:
(In millions) 1998 1997
- -------------------------------------------------------------------------------
Liability on SAP basis $ 1,405.7 $ 1,380.6
Estimated salvage and subrogation
recoveries recorded on a cash basis for
SAP and on an accrual basis for
GAAP (related to acquisition of Unisun) - (1.2)
Foreign subsidiary reserves 12.7 11.3
------------ ------------
Liability on GAAP basis, net of reinsurance 1,418.4 1,390.7
Reinsurance recoverables on GAAP reserves 599.3 481.0
------------ ------------
Liability on GAAP basis $ 2,017.7 $ 1,871.7
============ ============
Investments
The Company derives a significant part of its income from its investments.
The investment portfolio of the Company's insurance subsidiaries must comply
with applicable insurance laws and regulations of the respective states in which
such companies are domiciled and other jurisdictions in which they conduct
business. Neither Orion nor any of its non-insurance subsidiaries is constrained
by investment restrictions set forth in state insurance laws.
The Company maintains a diversified portfolio representing a broad spectrum
of industries and types of securities. The Company manages its total
investments, so that at all times there are fixed income securities that are
adequate in amount and duration to meet the cash requirements of current
operations and longer term liabilities, as well as to meet insurance regulatory
requirements with respect to investments under specific state insurance laws. To
the extent that there are funds available for investment beyond these
requirements, the investment objective for such funds are to maximize total
return within a prudent level of risk, taking into account the potential impact
on the volatility of reported earnings and reserves. The Company adjusts
investment risk to offset or complement insurance risk based upon total
corporate risk tolerance. The Company has investment guidelines for fixed income
and equity portfolios covering portfolio characteristics, permitted investments,
diversification and performance benchmarks.
Approximately 59% of the Company's fixed maturity portfolio is invested in
tax-advantaged securities at December 31, 1998. Except for investments in
securities of the United States Government and its agencies, the Company had
investments in only one issuer (AAA rated fixed income securities totaling $26.7
million) that exceeded $25 million at December 31, 1998.
The Company has the ability to hold its fixed maturity investments to term
since its operating cash flow and its short-term investment portfolio provide
the Company with substantial liquidity. Fixed maturity investments that the
Company has the positive intent to hold to maturity are recorded at amortized
cost. Fixed maturity investments which may be sold in response to, among other
things, changes in interest rates, prepayment risk, income tax strategies, or
liquidity needs are classified as available-for-sale and are carried at market
value, with unrealized gains and losses reflected in stockholders' equity.
Equity securities are stated at market value. Both the fixed maturities and the
equity investments consist primarily of readily marketable securities. See
"Market Risk of Financial Instruments" on page 47.
20
The following table shows the composition of the investment portfolio of
the Company as of December 31, 1998 and 1997, and the quality ratings for the
Company's fixed maturity investments. The investments shown below are listed at
their amortized cost, market and financial statement (book) values.
1998: Market Book
(In millions, except for %) Cost % Value % Value %
- ----------------------------------------------------------------------------------------
Fixed Maturities:
AAA .................... $ 697.1 29.0% $ 724.4 29.0% $ 716.8 28.8%
AA ..................... 339.3 14.1% 361.1 14.5% 357.7 14.4%
A ...................... 215.6 9.0% 226.0 9.0% 224.1 9.0%
BBB .................... 100.5 4.2% 102.4 4.1% 103.1 4.2%
BB ..................... 59.3 2.5% 60.6 2.4% 60.6 2.4%
B and Below ............ 120.5 5.0% 108.7 4.3% 108.8 4.4%
Not Rated .............. 33.8 1.4% 39.4 1.6% 39.4 1.6%
---------- ----- ---------- ----- ------------ -----
Sub-total ........... 1,566.1 65.2% 1,622.6 64.9% 1,610.5 64.8%
Equity Securities ......... 469.4 19.6% 510.9 20.4% 510.9 20.5%
Other Long-Term Investments 116.2 4.8% 116.2 4.7% 116.2 4.7%
Short-Term Investments .... 248.7 10.4% 248.7 10.0% 248.7 10.0%
---------- ----- ---------- ----- ------------ -----
$ 2,400.4 100.0% $ 2,498.4 100.0% $ 2,486.3 100.0%
========== ===== ========== ===== ============ =====
1997: Market Book
(In millions, except for %) Cost % Value % Value %
- ----------------------------------------------------------------------------------------
Fixed Maturities:
AAA .................... $ 700.8 29.5% $ 730.6 28.7% $ 725.6 28.7%
AA ..................... 417.0 17.5% 441.2 17.3% 437.6 17.3%
A ...................... 198.9 8.4% 212.2 8.3% 211.8 8.3%
BBB .................... 147.4 6.2% 151.4 5.9% 150.9 5.9%
BB ..................... 73.4 3.1% 76.9 3.0% 76.8 3.0%
B and Below ............ 137.6 5.8% 145.7 5.7% 145.7 5.7%
Not Rated .............. 33.1 1.3% 34.2 1.3% 34.2 1.3%
---------- ----- ---------- ----- ------------ -----
Sub-total ........... 1,708.2 71.8% 1,792.2 70.2% 1,782.6 70.2%
Equity Securities ......... 346.6 14.6% 438.5 17.2% 438.5 17.2%
Other Long-Term Investments 94.3 4.0% 94.3 3.7% 94.3 3.7%
Short-Term Investments .... 228.3 9.6% 228.3 8.9% 228.3 8.9%
---------- ----- ---------- ----- ------------ -----
$ 2,377.4 100.0% $ 2,553.3 100.0% $ 2,543.7 100.0%
========== ===== ========== ===== ============ =====
Investment yields on the Company's average investment portfolio for the years
ended December 31 are as follows:
1998 1997
- -----------------------------------------------------------
Yields on average investments:
Pre-tax 6.0% 7.0%
=== ===
After-tax 4.7% 5.3%
=== ===
21
Included in Other Long-Term Investments at December 31, 1998 were
investments in limited partnerships carried at $111.1 million. The assets of
these partnerships are managed by outside entities. Individual partnerships may
invest in a variety of investment vehicles, including but not limited to U.S.
and foreign bonds and equities, both public and private, and real estate. The
Company accounts for its investments in limited partnership using the equity
method of accounting. Such partnerships are carried at the Company's interest in
the underlying net assets of the limited partnerships. Net investment income
from these partnerships was $2.6 million, $17.1 million and $16.0 million for
1998, 1997 and 1996, respectively.
The Company strives to enhance the average return of its portfolio by
investing a small percentage of the portfolio in a diversified group of
non-investment grade fixed maturity securities, or securities that are not
rated. In the non-investment grade segment of the investment portfolio, the
Company maintains a high degree of diversity, with an average investment per
issuer of approximately $1.7 million at December 31, 1998.
The Company closely monitors the financial stability of issuers of
securities that it owns. When conditions are deemed appropriate, the Company
ceases to accrete discount, or accrue interest and dividends. In cases where the
value of investments are deemed to be other than temporarily impaired, the
Company recognizes losses. During 1998, provisions for such losses were $1.1
million for equity securities and $3.2 million for fixed maturity investments.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations, Investment Performance."
REINSURANCE
In the ordinary course of business, the Company's insurance subsidiaries
enter into reinsurance contracts with other insurers which serve to provide
greater diversification of business and to limit the Company's maximum loss from
catastrophes, large risks or unusually hazardous risks. Ceding reinsurance
reduces an insurer's operating leverage ratio. Operating leverage is defined as
net premiums written as a multiple of policyholders' surplus.
A large portion of the Company's reinsurance protection is provided by
reinsurance contracts or treaties under which all risks meeting prescribed
criteria are automatically covered. In other instances, reinsurance is obtained
by negotiation for individual risks, or facultative reinsurance. The Company's
insurance subsidiaries have certain excess-of-loss and catastrophe treaties with
unaffiliated insurers or reinsurers which provide protection against a specified
part or all of certain types of losses over stipulated dollar amounts arising
from one or more occurrences. The amount of each risk retained by an insurer is
subject to maximum limits which vary by line of business and type of coverage.
Retention limits are periodically revised as the capacity of the Company's
insurance subsidiaries to retain risk varies and as reinsurance prices change.
Reinsurance contracts do not relieve the Company of its obligation to the
policyholders. The collectibility of reinsurance is subject to the solvency of
the reinsurers. The Company is very selective as to its reinsurers, placing
reinsurance with only those reinsurers considered to be in sound financial
condition and having satisfactory underwriting ability. Many of the Company's
reinsurance agreements are subject to annual renewal as to coverage, limits and
price. The Company continually monitors the financial strength of its
reinsurers. The Company's insurance subsidiaries, to their knowledge, have no
material exposure to potential unrecognized losses due to reinsurers that are in
known financial difficulties.
EBI has reinsurance protection for losses in excess of $1.5 million per
occurrence up to $200 million and for losses in excess of $5.0 million per
person up to $20 million subject to annual aggregate limitations. EBI's
reinsurance includes aggregate stop loss coverage providing loss ratio
protection with aggregate limits. EBI also has excess of loss protection and 15%
quota share reinsurance agreements covering lower layers of losses. The Company
is evaluating alternatives in response to a recent regulatory action taken
related to a reinsurance arrangement in which EBI participates. Although this
regulatory action is pending further clarification, the Company believes that
the resolution of this matter will not materially effect its results of
operations or financial position.
22
DPIC has a 50% quota share reinsurance agreement on the first $1.0 million
of coverage for the lawyers and accountants classes of business. DPIC has
reinsurance for losses in excess of $1.0 million up to $5.0 million. Policy
limits greater than $5.0 million up to $20 million for DPIC are reinsured by a
facultative agreement.
Guaranty National Insurance Company ("GNIC"), an affiliated company of
Guaranty National has reinsurance coverage in excess of $0.5 million up to $6.0
million for property and casualty losses, and in excess of $0.5 million up to
$25 million for excess and umbrella losses with an aggregate limit of $25
million. GNIC's reinsurance includes a $6.0 million annual aggregate deductible
for all coverages and protection for catastrophic losses for each occurrence
exceeding $1 million.
Orion Specialty (primarily program business) is protected by per event
coverage for losses in excess of $0.5 million up to $10 million with an annual
aggregate limit of $15 million except for property related losses which is $10
million. Grocers has reinsurance protection in excess of $0.2 million up to $20
million per occurrence for workers compensation, up to $4 million of treaty
protection with facultative above that amount for property losses, and up to $5
million of treaty protection for general/auto liability.
McGee's business is reinsured for losses in excess of $1.5 million up to
$150 million, with retention buydowns to excess of $0.5 million on Canadian,
cargo/hull and armored car classes of business.
The Company has corporate-wide aggregate stop loss reinsurance that
protects it from extraordinary losses.
GOVERNMENT REGULATION
Similar to other insurance companies, the Company's insurance subsidiaries
are subject to comprehensive regulation by insurance authorities. In particular,
the Company is subject to regulation by the insurance departments of the states
of incorporation of all of the Company's insurance subsidiaries. These states
include California, Connecticut, Colorado, North Carolina, Oklahoma, Oregon,
South Carolina, Texas, and Wisconsin. All insurance companies must file annual
statements and other reports with state regulatory agencies and are subject to
regular and special examinations by those agencies. Regular periodic
examinations of the Company's insurance subsidiaries, covering their operations
and statutory financial statements are conducted on a regular basis by the state
of domicile of each insurance company and may include other states, insurance
departments in which they are licensed. The last periodic examinations of the
Company's insurance subsidiaries were completed for periods ending from December
31, 1993 to December 31, 1996. No significant adjustments resulted from the
examinations of any of the Company's insurance subsidiaries. The State of
Connecticut recently commenced their periodic examination of insurance
subsidiaries domiciled in Connecticut for periods from January 1, 1995 to
December 31, 1998.
Each of the Company's insurance subsidiaries is also subject to regulation
by other jurisdictions in which it sells insurance, including Puerto Rico,
certain Canadian provinces and Bermuda. States regulate the insurance business
through supervisory agencies that have broad administrative powers, including
powers relating to, among other things:
23
- the standards of solvency which must be met and maintained;
- the licensing of insurers and their agents;
- restrictions on the amount of risk which may be insured under a single
policy;
- the approval of premium rates;
- the form and content of the insurance policy and sales literature;
- the form and content of financial statements;
- reserve requirements;
- the imposition of monetary penalties for rules violation; and
- the nature of and limitations on permitted investments.
In general, such regulations are for the protection of policyholders rather than
stockholders.
In some instances, particularly in connection with workers compensation
insurance, various states routinely require deposits of assets for the
protection of policyholders and their employee claimants located in those
states. As of December 31, 1998 and 1997, securities representing approximately
10% and 9%, respectively, of the book value of the Company's investment
portfolio were on deposit with various state treasurers or custodians for such
purpose. These deposits consist of securities of the types that comply with
standards established by each state.
The Company is also subject to state laws regulating insurance holding
company systems. Most states have enacted legislation and adopted administrative
regulations affecting insurance holding companies and the acquisition of control
of insurance companies, as well as transactions between insurance companies and
their affiliates. The nature and extent of such legislation and regulations
currently in effect vary from state to state. Most states currently require
administrative approval of the acquisition of 10% or more of the outstanding
shares of an insurance company incorporated in the state or the acquisition of
10% or more of an insurance holding company whose insurance subsidiary is
incorporated in the state. The acquisition of 10% of such shares is deemed to be
the acquisition of "control" for the purpose of most holding company statutes
and requires the filing of detailed information concerning the acquiring parties
and the plan of acquisition and administrative approval prior to such
acquisition. Material transactions between insurance companies and affiliated
members of the holding company system are generally required to be "fair and
reasonable" and in some cases are subject to administrative approval.
Other states, in addition to an insurance company's state of domicile, may
regulate affiliated transactions and the acquisition of control of licensed
insurers. The State of California, for example, presently treats certain
insurance subsidiaries of the Company, which are not domiciled in California as
though they were domestic insurers for insurance holding company purposes. Such
subsidiaries are required to comply with the holding company provisions of the
California Insurance Code, certain of which provisions may be more restrictive
than the comparable laws of the insurance company's state of domicile.
All state jurisdictions in which the Company is authorized to transact
business require participation in guaranty funds. Insurers authorized to
transact business in those jurisdictions can be assessed by a state guaranty
fund a percentage (usually from 1% to 2%) of direct premiums written in that
jurisdiction each year to pay claims on behalf of insolvent insurers. The
likelihood and amount of any future assessment cannot be estimated until after
an insolvency has occurred. For the years ended December 31, 1998 and 1997 the
Company's insurance subsidiaries were assessed approximately $1.5 million and
$0.7 million, respectively (net of estimated future recoveries) as a result of
known insolvencies. Insurance companies are required by certain states in which
they do business to participate in automobile insurance plans and workers
compensation plans. These plans provide insurance on risks that are not written
in the voluntary market. Participation in these plans has usually been
unprofitable for the Company.
24
A number of state legislatures and the United States Congress have for
years been considering, or have now enacted, some type of legislative proposals
which alter the rules for tort claims and increase the states' authority to
regulate insurance companies. These initiatives have expanded, in some
instances, the states' regulation over rates (see "Rates" below) and also have
increased data reporting requirements. In recent years the state insurance
regulatory framework has come under federal scrutiny, and certain state
legislatures have considered or enacted laws that alter, and in many cases
increase, state authority to regulate insurance companies and insurance holding
company systems.
The National Association of Insurance Commissioners ("NAIC") and state
regulators are re-examining existing laws and regulations relating to the
solvency of insurers. The NAIC has adopted Risk Based Capital ("RBC")
requirements for property and casualty insurers. RBC refers to the determination
of the amount of statutory capital required for an insurer based on the risks
assumed by the insurer (including, for example, investment risks, credit risks
relating to reinsurance recoverables and underwriting risks) rather than just
the amount of net premiums written by the insurer. A formula that applies
prescribed factors to the various risk elements in an insurer's business is used
to determine the minimum statutory capital requirement for the insurer. The
statutory capital of each of the Company's active insurance subsidiaries at
December 31, 1998 exceeds the RBC requirements.
In March 1998, the NAIC adopted the Codification of Statutory Accounting
Principles ("Codification"). Codification, which is intended to standardize
regulatory accounting and reporting for the insurance industry, is proposed to
be effective January 1, 2001. However, statutory accounting principles will
continue to be established by individual state laws and permitted practices and
it is uncertain when, or if, the Company's domiciling states will require
adoption of Codification for the preparation of statutory based financial
statements. The Company has not finalized the quantification of the effects of
Codification on its statutory based financial statements.
Although the federal government generally does not directly regulate the
business of insurance, federal initiatives often have an impact on the business
in a variety of ways. There are various current, proposed and tabled federal
measures that may significantly affect the Company's insurance business,
including, among other proposals:
- Superfund reform;
- tort liability reform, including limitation on punitive damages and
"loser pays" litigation expense costs; - regulatory reform concerning
financial services modernization;
- revocation of the antitrust exemption provided by the McCarran-Ferguson
Act and the ensuing federal regulation of the business of insurance; and
- suggested changes of the nation's health care system that, if enacted,
might negatively affect the Company's workers compensation and automobile
liability businesses.
The economic and competitive effects of any such proposals upon the Company
would depend upon the final form such legislation might take. The Company is
unable to predict what regulatory proposals may be adopted in the future or the
effect any such proposals might have on the Company's businesses if adopted.
25
LIMITATIONS ON PAYMENTS FROM INSURANCE SUBSIDIARIES
The principal sources of cash available to Orion are dividends,
reimbursement of various administrative charges, repayment of principal and
interest on loans due from its subsidiaries; and tax payments from its
subsidiaries. The payment of dividends to Orion by its insurance subsidiaries is
subject to state regulation. No state restricts dividend payments by the Company
to its stockholders.
The ability of the Company's insurance subsidiaries to declare dividends is
governed primarily by the insurance laws of such subsidiaries' state of
domicile. Generally, such laws currently provide that, unless prior approval is
obtained, dividends of a property and casualty insurance company in any
consecutive 12-month period shall not exceed the greater of its net income, as
adjusted for individual state regulations, for the preceding calendar year or
10% of its policyholders' surplus as of the preceding December 31, determined on
a statutory accounting basis. Dividends and distributions by the Company's
insurance subsidiaries are also subject to a requirement that statutory
policyholders' surplus be reasonable in relation to outstanding liabilities and
adequate to meet the companies' financial needs following the declaration of any
dividends or distributions. State insurance regulators, however, have broad
discretionary authority with respect to approving the payment of dividends by
insurance companies. Under current regulations, the maximum dividends permitted
at December 31, 1998 for the ensuing twelve months, without prior approval,
aggregated $135.5 million. Orion received $55.2 million in the aggregate in
dividends from its subsidiaries in 1998. Since it is difficult to predict future
levels of statutory policyholders' surplus or earnings, the amount of dividends
that could be paid in the future without prior approval cannot be determined at
this time.
RATES
The Company's insurance subsidiaries are generally subject to regulation as
to rates. Most states have insurance laws requiring that rate schedules and
other information be filed with or made available to the state's regulatory
authority, either directly or through a rating organization with which the
insurer is affiliated. The regulatory authority may, in most states, disapprove
of a rate filing if it finds that the rates are inadequate, excessive or
unfairly discriminatory. Rates, which are not necessarily uniform for all
insurers, vary by class of business, hazard assumed and size of risk. Subject to
regulatory requirements, the Company's management determines the prices charged
for its policies based on a variety of factors including recent historical
claims experience, inflation, competition, tax law and anticipated changes in
the legal environment, both judicial and legislative. Methods for arriving at
rates vary by type of business, exposure assumed and size of risk. Underwriting
profitability is affected by the accuracy of these assumptions, by the
willingness of insurance regulators to approve changes in those rates which they
control and by such other matters as underwriting selectivity and expense
control.
Some states have adopted open rating systems for workers compensation,
which permit insurers to set premium rates independently without the prior
approval of the insurance commissioners. A number of other states permit
insurers to deviate from standard rates for workers compensation insurance after
receiving prior approval. In insuring professional liability risks, DPIC is
generally not limited to the standard rates of a rating organization but
establishes its own rates because of the unique nature of the risks being
underwritten. Nonstandard and special risks, including nonstandard automobile
insurance rates, are generally not limited to the standard rates of national
rating bureaus. Nonstandard automobile insurance rates 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 to cancel, reduce or not renew coverage
with respect to existing policies, particularly personal auto insurance.
26
COMPETITION
The insurance industry is highly competitive. Over 3,000 property and
casualty insurance companies write business in the United States, but about 900
companies write most of the business. No single company or group has more than
10% of the overall market. The Company's insurance subsidiaries are in
competition with numerous stock and mutual property and casualty insurance
companies, as well as state-run workers compensation insurance funds, many of
which are substantially larger and have significantly greater resources than the
Company. Competition might also come from service organizations, which
administer self-insured workers compensation programs.
The impact of competition may take the form of lower premiums, specialized
products, more complete and complex product lines, greater pricing flexibility,
superior service, different marketing methods, higher policyholder dividend
rates or higher agent compensation. Superior service and marketing methods are
of particular importance in workers compensation.
The Company relies on multiple distribution channels to market its
insurance products. The Company's insurance subsidiaries sell their insurance
principally through independent agents, brokers and general agents, who
typically also represent one or more competing insurance companies. They are
paid commissions based on premiums collected from insureds. Commission rates
vary according to the type and amount of insurance sold. Some competitors in
certain lines obtain their business at a lower direct cost through the use of
salaried personnel rather than independent agents and brokers.
RATING
A.M. Best Company rates the Company's insurance subsidiaries "A
(Excellent)," excluding Viking Insurance Company of Wisconsin and its affiliate
and Grocers Insurance Company which are rated "A- (Excellent)." In general, A.M.
Best Company's ratings are based on an analysis of the financial condition and
operation of an insurance company as it relates to the industry. These ratings
are not primarily designed for investors and do not constitute recommendations
to buy, sell or hold any security
Management believes that a significant change in its A.M. Best ratings
could affect the business of the subsidiary where ratings were altered,
including its relationship with its independent agents, positive in the case of
an upgrade or negative in the case of a downgrade.
ITEM 2. PROPERTIES
The Company's executive office is located at 9 Farm Springs Road,
Farmington, Connecticut, 06032. The Company's executive office facility consists
of approximately 140,000 square feet and is leased at an annual rental of
approximately $3.2 million. DPIC owns its office building, which consists of
approximately 42,000 square feet, in Monterey, California. OrionAuto owns
facilities in Englewood, Colorado; Salem, Oregon; Freeport, Illinois; and
Goldsboro, North Carolina. Those facilities consist, in the aggregate, of
approximately 254,000 square feet. Grocers owns its office building, which
consists of 43,500 square feet, in Portland, Oregon.
All of the other insurance operations of the Company are conducted from
leased premises in or adjacent to major urban centers throughout the United
States, Puerto Rico, Canada and Bermuda. These operations, in the aggregate,
occupy approximately 1,070,000 square feet, at an annual rental of approximately
$12.0 million. The Company believes that its current facilities are suitable and
adequate for their present use and anticipated requirements.
27
ITEM 3. LEGAL PROCEEDINGS
The Company is routinely engaged in litigation incidental to its
businesses. In the judgment of the Company's management, there are no
significant legal proceedings pending against the Company which, net of reserves
established therefor, are likely to result in judgments for amounts that are
material to the financial condition, liquidity or results of operations of Orion
and its consolidated subsidiaries, taken as a whole.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
INFORMATION CONCERNING EXECUTIVE OFFICERS OF THE COMPANY
The following is a summary of certain information regarding the current
executive officers of Orion. All officers of Orion and its subsidiaries serve at
the pleasure of their respective Boards of Directors.
W. Marston Becker, Chairman of the Board and Chief Executive Officer of
Orion since January 1997; Vice Chairman of the Board from March 1996 to December
1996; President and Chief Executive Officer of the DPIC from July 1994 to June
1996; and Senior Vice President of Orion and the Orion Capital Companies, Inc.
("OC Companies") from July 1994 to March 1996; President and Chief Executive
Officer of McDonough Caperton Insurance Group, an insurance brokerage firm, from
March 1987 to July 1994; age 47.
Raymond W. Jacobsen, Executive Vice President of Orion since December 1997;
Senior Vice President of Orion from July 1994 to December 1997; Vice President
of Orion from March 1990 to July 1994; Chairman of EBI since July 1996;
President and Chief Executive Officer of EBI from June 1993 to July 1996; Acting
President and Chief Executive Officer of Connecticut Specialty from October 1995
to November 1996; Executive Vice President of EBI from December 1989 to May
1993; Senior Vice President of the OC Companies since March 1990; age 46.
John J. McCann, Executive Vice President and Secretary of Orion since May
1998; Partner of Donovan Leisure Newton & Irvine from September 1995 to May
1998; and Partner of Hall, Dicklery, Kent, Friedman & Wood from January 1994 to
September 1995; age 62.
James R. Pouliot, Executive Vice President of Orion since December 1997;
President and Chief Executive Officer of Guaranty National Corporation since
December 1996; President and Chief Executive Officer of Viking Insurance Company
from October 1992 to December 1996; age 45.
Claudia F. Lindsey, Senior Vice President of Orion since December 1997;
Vice President of Orion from January 1997 to December 1997; Vice President -
Business Development of the OC Companies since September 1996; President of
Strategic Marketing & Research, Inc. and Vice President of Anthem Financial from
1994 to 1996; Director, Managing Partner and Chief Financial Officer of
McDonough Caperton Insurance Group from 1985 to 1994; age 43.
William G. McGovern, Senior Vice President and Chief Actuary of Orion since
December 1997; Vice President and Chief Actuary of Orion from March 1990 to
December 1997; Senior Vice President and Chief Actuary of OC Companies since
October 1989; age 46.
28
Stephen M. Mulready, Senior Vice President of Orion since December 1997;
Vice President of Orion from January 1997 to December 1997; President of Orion
Specialty, previously known as Connecticut Specialty, since November 1996;
Senior Vice President - Strategic Underwriting and Product Development of
Travelers/Aetna Property Casualty Corporation from January 1996 to November
1996; Senior Vice President - National Commercial Accounts of Aetna Life &
Casualty from 1994 to 1996; Vice President, Field Operations - National
Commercial Accounts of Aetna Life & Casualty from 1991 to 1994; age 49.
Thomas M. Okarma, Senior Vice President of Orion since December 1997; Vice
President of Orion from January 1997 to December 1997; President and Chief
Executive Officer of DPIC since July 1996; Chief Claims Officer of DPIC from
December 1995 to June 1996; President of Professional Concepts Insurance Agency
and Executive Vice President of AVA Insurance Agency Inc. from February 1989 to
September 1994; age 49.
Michael L. Pautler, Senior Vice President and Chief Financial Officer of
Orion since January 1999; Vice President of Corporate Development of Orion from
December 1997 to December 1998; Senior Vice President-Finance and Treasurer of
Guaranty National Corporation from September 1988 to February 1998; age 44.
David B. Semeraro, Senior Vice President of Orion since December 1997; Vice
President of Orion from January 1997 to December 1997; Vice President and Chief
Information Officer of OC Companies since April 1996; Vice President - Business
& Technology Solutions of Connecticut Mutual Life Insurance Company from
November 1990 to April 1996; age 51.
Susan B. Sweeney, Senior Vice President-Finance and Chief Investment
Officer of Orion since January 1999; Vice President - Finance of Orion from
March 1998 to December 1998; Independent Consultant from October 1997 to
February 1998; Vice President Planning and Analysis of Travelers Property and
Casualty Corporation, from April 1996 to September 1997; Managing Director,
Strategic Planning Property/Casualty Finance of Aetna Life & Casualty Company
from 1994 to April 1996; Director of Corporate Finance of Aetna Life & Casualty
Company from 1991 to 1994; age 46.
Jeanne S. Hotchkiss, Vice President-Investors Relations since March 1999;
Assistant Vice President, Corporate Communications from May 1994 to March 1999;
Director, Corporate Communications from 1983 to May 1994; age 46.
Craig A. Nyman, Vice President and Treasurer of Orion since January 1997;
Assistant Vice President and Assistant Treasurer from June 1988 to December
1996; Treasurer of OC Companies since March 1996; Vice President of OC Companies
since January 1991; Assistant Vice President of OC Companies since March 1987
and; Assistant Treasurer since March 1985; age 43.
Peter M. Vinci, Vice President, Chief Accounting Officer and Controller of
Orion since December 1997; Vice President and Controller of OC Companies since
January 1997; Vice President of OC Companies from July 1988 to January 1997; age
46.
29
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
(a) Principal Market. The principal market on which Orion'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 Orion's Common Stock for 1998 and
1997.
Cash
Stock Prices Dividends
High Low Declared
1998:
Quarter Ended December 31 $ 39.813 $ 28.000 $ 0.18
Quarter Ended September 30 59.250 34.563 0.18
Quarter Ended June 30 57.750 52.000 0.18
Quarter Ended March 31 55.688 43.063 0.16
-----------
Total $ 0.70
===========
1997:
Quarter Ended December 31 $ 51.000 $ 42.375 $ 0.16
Quarter Ended September 30 45.750 36.720 0.16
Quarter Ended June 30 37.625 30.813 0.16
Quarter Ended March 31 33.875 30.000 0.14
----------
Total $ 0.62
==========
Stock prices and cash dividends declared are restated for the 2-for-1 stock
split of the Company's common stock issued on July 7, 1997. Cash dividends have
been paid on Orion's Common stock in every quarter since the fourth quarter of
1978, when dividends were first commenced.
(c) Approximate Number of Holders of Common Stock. The number of holders of
record of Orion's Common Stock as of March 1, 1999 was approximately 2,000.
30
ITEM 6. SELECTED FINANCIAL DATA
The following table summarizes information with respect to the operations
and financial condition of Orion and its subsidiaries. Common stock and per
common share data have been restated to give effect to the 2-for-1 stock split
issued on July 7, 1997. The Company owned slightly less than 50% of Guaranty
National Corporation until the Company increased its ownership to 81% in July
1996 and 100% in December 1997. Guaranty National Corporation is included in the
financial statements of the Company on a consolidated basis beginning on January
1, 1996 with recognition of minority interest expense for the portion of
Guaranty National Corporation's earnings attributable to shares not owned by the
Company until it became a wholly-owned subsidiary. For 1994 and 1995, the
Company's investment in Guaranty National Corporation was accounted for using
the equity method. The Company's acquisitions have been included in its
financial statements from date of purchase and up to the date of sale for
divestitures.
(In millions, except for % and per share amounts) 1998 1997 1996 1995 1994
- --------------------------------------------------------------------------------------------------------
Year Ended December 31:
Total revenues ..................... $ 1,716.7 $ 1,590.6 $ 1,493.5 $ 874.3 $ 780.9
========= ========= ========= ========= =========
Operating earnings ................. $ 68.6 $ 85.7 $ 72.9 $ 59.9 $ 52.8
After-tax investment gains ......... 34.2 30.1 13.7 7.7 2.4
--------- --------- --------- --------- ---------
Net earnings ....................... $ 102.8 $ 115.8 $ 86.6 $ 67.6 $ 55.2
========= ========= ========= ========= =========
Combined ratios (GAAP) ............. 100.5% 99.7% 99.8% 100.3% 101.2%
========= ========= ========= ========= =========
Per basic common share:
Operating earnings .............. $ 2.52 $ 3.14 $ 2.66 $ 2.13 $ 1.85
After-tax investment gains ...... 1.26 1.10 0.50 0.28 0.09
--------- --------- --------- --------- ---------
Net earnings ................. $ 3.78 $ 4.24 $ 3.16 $ 2.41 $ 1.94
========= ========= ========= ========= =========
Per diluted common share:
Operating earnings .............. $ 2.46 $ 3.07 $ 2.63 $ 2.11 $ 1.84
After-tax investment gains ...... 1.23 1.08 0.49 0.27 0.09
--------- --------- --------- --------- ---------
Net earnings ................. $ 3.69 $ 4.15 $ 3.12 $ 2.38 $ 1.93
========= ========= ========= ========= =========
Dividends declared per common share $ 0.70 $ 0.62 $ 0.51 $ 0.43 $ 0.38
========= ========= ========= ========= =========
Weighted average shares outstanding:
Basic ........................... 27.2 27.3 27.4 28.1 28.5
Diluted ......................... 27.8 27.9 27.8 28.4 28.7
At December 31:
Total cash and investments ......... $ 2,504.3 $ 2,553.0 $ 2,321.4 $ 1,606.4 $ 1,325.2
Total assets ....................... 4,164.4 3,884.1 3,464.4 2,473.6 2,112.8
Total policy liabilities ........... 2,599.6 2,443.8 2,304.4 1,596.0 1,450.8
Notes payable ...................... 217.4 310.2 310.9 209.1 152.4
Minority interest .................. -- -- 45.2 -- --
Trust preferred securities ......... 250.0 125.0 -- -- --
Stockholders' equity ............... 727.3 723.1 576.7 490.9 365.1
Common shares outstanding .......... 27.2 27.6 27.5 27.9 28.1
Book value per common share ........ $ 26.77 $ 26.19 $ 20.94 $ 17.59 $ 13.0
Statutory policyholders' surplus ... 732.1 789.0 670.6 521.5 458.7
31
ITEM 7. ORION CAPITAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
Orion Capital Corporation ("Orion") and its wholly-owned subsidiaries
(collectively the "Company") operate principally in the property and casualty
insurance business. The Company reports its insurance operations in three
segments as of December 31, 1998 as follows:
Workers Compensation - this segment includes the workers compensation insurance
products and services sold by the EBI Companies ("EBI").
Specialty Commercial - as of 1998 year end, this segment markets various
specialty commercial products and services and includes professional
liability insurance through DPIC Companies ("DPIC"); client-focused
specialty insurance programs through Orion Specialty; underwriting
management specializing in ocean marine, inland marine and commercial
property insurance through Wm. H. McGee & Co., Inc. ("McGee");
insurance for international trade through the Company's 26% interest in
Intercargo Corporation (" Intercargo"); and also includes the run-off
operations of the Company's assumed reinsurance business, SecurityRe,
which was sold in late 1996. McGee and Intercargo are expected to be
sold in 1999 (see below).
Nonstandard Automobile - this segment specializes in nonstandard personal
automobile insurance sold by OrionAuto, formerly known as Guaranty
National Corporation.
RECENT ACTIVITIES
The Company increased its ownership of Guaranty National Corporation ("Guaranty
National") to 100% in December 1997. Beginning in 1998, the commercial insurance
operations of Guaranty National were consolidated with Connecticut Specialty to
form a new company named Orion Specialty. Since the formation of Orion
Specialty, OrionAuto's only business is nonstandard personal automobile
insurance.
On December 16, 1997 the Company purchased Unisun Insurance Company ("Unisun")
from Michigan Mutual Insurance Company for $26.2 million in cash including
acquisition expenses. Unisun is the largest automobile insurance facility
carrier in South Carolina and also writes personal automobile insurance in the
States of Alabama, Georgia and North Carolina. Unisun has been included in the
Company's consolidated financial statements from the date of acquisition. Total
net premiums written by Unisun for 1997 are approximately $20 million. The total
consideration exceeded the fair value of the acquired net assets by
approximately $5.3 million and is being amortized over 25 years.
On April 30, 1998 the Company acquired the nonstandard personal automobile
insurance business of North Carolina-based Strickland Insurance Group, Inc.
("Strickland"). The acquisition included two insurance companies, a premium
finance company, a claim adjusting company and a general agency in Florida. In
1997, Strickland reported approximately $99 million of personal automobile gross
premiums written and $46 million of net premiums written. The purchase price was
$44.1 million including acquisition expenses. The acquisition was accounted for
as a purchase and accordingly, the acquired business has been included in the
Company's consolidated financial statements from the date of acquisition. The
total consideration exceeded the fair value of the acquired net assets by
approximately $28.7 million and is being amortized over 25 years.
32
On July 9, 1998 the Company completed the acquisition of Grocers Insurance Group
("Grocers") from United Grocers, Inc. for $36.7 million in cash including
acquisition expenses. Grocers, an Oregon-based specialty insurance holding
company, is a recognized leader in providing specialized insurance programs to
the grocery and food service industry. In 1997, Grocers wrote approximately $23
million of net premiums, principally general liability, property and workers
compensation with the majority of its volume concentrated in the Northwestern
states. The acquisition was accounted for as a purchase and, accordingly,
Grocers has been included in the Company's consolidated financial statements
from the date of acquisition. The total consideration exceeded the fair value of
the net assets acquired by approximately $8.1 million and is being amortized
over 25 years.
In the third quarter of 1998, the Company announced an accelerated realignment
of its Orion Specialty unit to address lines that had not met the Company's
growth and profitability expectations. The realignment continued Orion
Specialty's shift away from commodity business, primarily commercial auto and
transportation, to a smaller number of more client-focused programs and
specialty niches. The realignment involved exiting approximately $100 million in
annualized net written premiums of unprofitable commodity and marginal lines of
business, the reduction of approximately 90 employees related to the exited
business, and the sale of its Colorado Casualty unit. Colorado Casualty produced
approximately $55 million in annual net premiums, which consisted largely of
business that did not fit the Company's specialization strategy.
On September 29, 1998, the Company sold Colorado Casualty resulting in a pre-tax
gain of approximately $24.2 million. The Company recorded severance and program
termination expenses of $7.0 million and asset write downs of $1.9 million
related to the exited business in the third quarter of 1998. Subsequently, the
Company recorded $1.9 million of charges against the severance and program
termination liability for incurred costs during 1998.
In connection with the third quarter realignment, the Company performed an
actuarial analysis for the business to be exited resulting in a provision for
losses and loss adjustment expenses of $27.8 million in the third quarter of
1998, including reserve strengthening of $10.8 million related to the 1998
accident year. The Company will continue in 1999 to assess Orion Specialty's
remaining programs.
In December 1998, the Company agreed to sell its investment in Intercargo for
$22.8 million or $12 per share, in cash pursuant to the terms of Intercargo's
merger with X. L. America, Inc, a subsidiary of EXEL Limited. The Company
reduced the carrying value of its investment in Intercargo to $22.8 million
resulting in $7.0 million pre-tax realized investment loss during December 1998.
The sale of Intercargo is expected to be complete late in the first quarter or
early in the second quarter of 1999, subject to regulatory approval.
Also a part of the Company's reshaping to focus resources on high potential
lines of business, on March 11, 1999 the Company announced the signing of a
definitive agreement to sell McGee. The transaction is expected to be complete
by April 1999, subject to regulatory approvals and other closing conditions.
33
RESULTS OF OPERATIONS
OVERVIEW
Earnings by segment before federal income taxes and minority interest expense
are summarized as follows:
% Change
--------------
(In millions, except for %) 1998 1997 1996 98/97 97/96
- ---------------------------------------------------------------------
Workers Compensation . $ 86.2 $ 86.8 $ 68.4 -0.8% 27.0%
Specialty Commercial . 54.2 65.3 56.5 -16.9% 15.5%
Nonstandard Automobile 37.1 40.7 23.3 -8.7% 74.8%
-------- -------- -------- --- ----
177.5 192.8 148.2 -7.9% 30.1%
Other ................ (20.8) (16.6) (20.9) -25.6% 20.3%
-------- -------- -------- --- ----
$ 156.7 $ 176.2 $ 127.3 -11.1% 38.3%
======== ======== ======== ==== ====
During the fourth quarter of 1998, the Company adopted FAS No.131, "Disclosure
about Segments of an Enterprise and Related Information." FAS 131 establishes
new standards for reporting information about operating segments and requires
that the segments be based on the internal structure and reporting of the
Company's operations. See footnote 17 to the consolidated financial statements
for the Company's segment disclosure.
Miscellaneous income and expenses (primarily interest, general and
administrative expenses and other consolidating elimination entries) of the
parent company are reported as "Other" in the above table.
Operating earnings, after-tax realized investment gains, net earnings and per
diluted common share amounts for the years ended December 31 are summarized as
follows:
% Change
--------------
(In millions, except for per share amounts and %) 1998 1997 1996 98/97 97/96
- -------------------------------------------------------------------------------------------
Operating earnings ....... $ 68.6 $ 85.7 $ 72.9 -19.9% 17.5%
After-tax investment gains 34.2 30.1 13.7 13.5% 120.0%
--------- --------- -------- ---- ----
Net earnings .......... $ 102.8 $ 115.8 $ 86.6 -11.2% 33.7%
========= ========= ======== ==== ====
Per diluted common share:
Operating earnings ....... $ 2.46 $ 3.07 $ 2.63 -19.8% 16.7%
After-tax investment gains 1.23 1.08 0.49 13.7% 120.4%
--------- --------- -------- ---- ----
Net earnings .......... $ 3.69 $ 4.15 $ 3.12 -11.0% 33.0%
========= ========= ======== ==== ====
Operating earnings represents earnings after taxes, excluding net realized
investment gains. For 1998, operating earnings of $68.6 million reflects a
realignment of Orion Specialty and third-quarter losses from the Company's
limited partnership investments. In the third quarter of 1998, the Company
recorded $12.5 million of net pre-tax charges, or $0.35 per diluted share on an
after-tax basis, in connection with a realignment of Orion Specialty and related
reserve strengthening for exited business. In the third quarter of 1998, the
Company reported pre-tax investment losses of $14.1 million, or $0.33 per
diluted share on an after-tax basis, related to declines in the value of the
Company's limited partnership investments which are accounted for on an equity
basis. These charges and losses have obscured continued strong operating
performance from the Company's insurance operations, in particular EBI, DPIC and
OrionAuto. That performance is combined with an increase in after-tax
investment gains to arrive at net earnings. For the five year period ended
December 31, 1998, the Company's return on equity from net earnings and
operating earnings has averaged 15.7% and 12.9% per year, respectively.
34
Weighted average common shares and diluted equivalents outstanding were
27,842,000, 27,900,000 and 27,788,000 for 1998, 1997 and 1996, respectively. The
1996 common stock and per common share data presented in this document has been
restated to give effect to the 2-for-1 split of the Company's common stock
issued on July 7, 1997.
REVENUES
Revenues for the years ended December 31 are summarized as follows:
% Change
-----------------
(In millions, except for %) 1998 1997 1996 98/97 97/96
- --------------------------------------------------------------------------------
Net premiums written .... $ 1,533.6 $ 1,367.1 $ 1,334.1 12.2% 2.5%
========= ========= ========= ===== =====
Net premiums earned ..... $ 1,503.0 $ 1,357.7 $ 1,300.8 10.7% 4.4%
Net investment income ... 143.2 164.9 145.4 -13.1% 13.4%
Realized investment gains 52.5 47.8 24.2 9.9% 97.6%
Other income ............ 18.0 20.2 23.1 -11.0% -12.8%
--------- --------- --------- ----- -----
Total revenues ....... $ 1,716.7 $ 1,590.6 $ 1,493.5 7.9% 6.5%
========= ========= ========= ===== =====
PREMIUMS WRITTEN
The Company's net premiums written by segment for the years ended December 31
are as follows:
% Change
------------------
(In millions, except for %) 1998 1997 1996 98/97 97/96
- ----------------------------------------------------------------------------------
Workers Compensation . $ 439.5 $ 365.1 $ 353.0 20.4% 3.4%
Specialty Commercial . 665.1 669.2 725.8 -0.6% -7.8%
Nonstandard Automobile 429.0 332.8 255.3 28.9% 30.3%
---------- ---------- ---------- ---- ----
$ 1,533.6 $ 1,367.1 $ 1,334.1 12.2% 2.5%
========== ========== ========== ==== ====
In November 1996, the Company sold the renewal book of business of its assumed
reinsurance operation to concentrate on businesses where the Company could
better service its specialized niche markets. Excluding premiums from this
operation, the Company's net premiums written increased by 13.1% in 1998 and
8.1% in 1997 compared to prior year periods.
WORKERS COMPENSATION
Net premiums written for Workers Compensation increased by 20.4% in 1998 and
3.4% in 1997 compared to prior year periods largely due to new business written
through EBI's multi-state accounts program established in 1997 and continued
geographic expansion and penetration. The increases in net premiums written are
mitigated, in part, by the effects of legislative reforms in certain states that
have led to an increasingly competitive workers compensation marketplace with
lower premium rates as well as a reduction in losses. Additionally, 1998
reflects lower premium retention from a change in EBI's reinsurance programs
effective October 1998.
35
SPECIALTY COMMERCIAL
Net premiums written from Specialty Commercial for the years ended December 31
are as follows:
% Change
------------------
(In millions, except for %) 1998 1997 1996 98/97 97/96
- ------------------------------------------------------------------------------
Orion Specialty ... $ 376.2 $ 402.8 $ 409.6 -6.6% -1.7%
DPIC .............. 185.0 198.7 195.6 -6.9% 1.7%
McGee ............. 104.4 57.1 41.6 82.8% 37.4%
-------- -------- -------- ---- ----
665.6 658.6 646.8 1.1% 1.8%
Assumed reinsurance (0.5) 10.6 79.0 (a) (a)
-------- -------- -------- ---- ----
$ 665.1 $ 669.2 $ 725.8 -0.6% -7.8%
======== ======== ======== ==== ====
(a) - not meaningful
Net premiums written by DPIC for professional liability insurance decreased by
6.9% in 1998 compared to 1997 primarily due to rate reductions resulting from
the competitive professional liability insurance market and growth in its more
heavily reinsured products areas, partly offset by continual high levels of
policy renewals and growth in project policies. The 1.7% increase in 1997
compared to 1996 is primarily attributable to the DPIC's continued high levels
of policy renewals and new business offset in part by rate reductions in a
competitive professional liability insurance market.
Orion Specialty's net premiums written decreased by 6.6% in 1998 compared to
1997 primarily due to its exit of unprofitable commodity program business and
marginal lines of business related to a realignment of this unit. Exited
programs during the past two years with the largest year-over-year impact on net
premiums written were truck liability, marine, coal mine and nonstandard
automobile personal injury protection. Net premiums written also reflect lower
premiums from Orion Specialty's collateral protection business and from Colorado
Casualty, which was sold on September 29, 1998 as part of realigning Orion
Specialty. These decreases were partly offset by higher premiums from the
acquisition of Grocers on July 9, 1998.
In 1997 compared to 1996, Orion Specialty's net premiums written decreased by
1.7% primarily due to the cancellation of marine programs and lower premiums of
the commercial nonstandard business of Guaranty National resulting from agent
and program cancellations, increased competition and lower production. These
decreases were partly offset by higher premiums written by the former
Connecticut Specialty unit from transportation programs and low exposure
professional liability programs, higher retentions after a change in reinsurance
effective May 1996, and premium volume growth for Orion Specialty's collateral
protection business.
McGee's net premiums written increased by 82.8% in 1998 compared to 1997 due to
the Company's greater participation in the underwriting pools managed by McGee
and increased premium retention reflecting a change in McGee's reinsurance
programs effective July 1998. The Company's participation in McGee's United
States pool was 71.5% in 1998, 52% in 1997 and 37% in 1996. Participation in
McGee's Canadian pool was 72% in 1998, 61% in 1997 and 49% in 1996.
The assumed reinsurance business was sold in late 1996 resulting in the
continued decline in net premiums written.
36
NONSTANDARD AUTOMOBILE
The net premiums written growth of 28.9% for Nonstandard Automobile in 1998
compared to 1997 is primarily due to the acquisitions of Strickland and Unisun,
premium growth in the monthly product business in California and the
northwestern United States , offset in part by rate reductions due to a
competitive market. Premium growth in California is primarily attributed to
enacted legislation requiring all drivers to maintain minimum liability
insurance.
The net premiums written growth of 30.3% for Nonstandard Automobile in 1997
compared to 1996 is due to newly-enacted legislation in the state of California
which requires all drivers to maintain minimum liability insurance effective
January 1997. This change in California law resulted in a 75% increase in the
Nonstandard Automobile's one-month product business to approximately $155
million in 1997.
PREMIUMS EARNED
The Company's premiums earned increased 10.7%, or $145.3 million, to $1,503.0
million in 1998 and increased 4.4%, or $56.9 million, to $1,357.7 million in
1997 from $1,300.8 million in 1996. Premiums earned reflect the recognition of
income from the changing levels of net premium writings.
INVESTMENT PERFORMANCE
The pre-tax performance of the Company's investments, including net investment
income, net realized gains (losses) and net unrealized appreciation
(depreciation) is as follows:
(In millions, except for %) 1998 1997 1996
- --------------------------------------------------------------------------------------------
Year ended December 31:
Net investment income ................................. $ 143.2 $ 164.9 $ 145.4
---------- ---------- ----------
Net realized gains:
Fixed maturities ................................... 12.5 4.0 2.1
Equity securities .................................. 40.0 43.8 22.1
---------- ---------- ----------
Total realized gains ............................ 52.5 47.8 24.2
---------- ---------- ----------
Net unrealized appreciation (depreciation) recorded in
stockholders' equity:
Fixed maturities - available for sale .............. (30.0) 38.9 (11.1)
Equity securities .................................. (50.4) 18.4 18.4
Net unrealized appreciation (depreciation) for
fixed maturities - held to maturity ................ 2.5 1.7 (5.3)
---------- ---------- ----------
Total unrealized appreciation (depreciation) .... (77.9) 59.0 2.0
---------- ---------- ----------
$ 117.8 $ 271.7 $ 171.6
========== ========== ==========
Investment yields on average portfolio:
Pre-tax ............................................ 6.0% 7.0% 6.9%
========== ========== ==========
After-tax .......................................... 4.7% 5.3% 5.4%
========== ========== ==========
Carrying value at December 31:
Fixed maturities and short-term investments ........ $ 1,859.2 $ 2,010.9 $ 1,858.0
Equity securities .................................. 510.9 438.5 361.7
Other long-term investments ........................ 116.2 94.3 90.1
---------- ---------- ----------
$ 2,486.3 $ 2,543.7 $ 2,309.8
========== ========== ==========
37
NET INVESTMENT INCOME
Pre-tax net investment income decreased by $21.7 million in 1998 compared to
1997 primarily due to lower earnings on limited partnership investments
accounted for on an equity basis, the continued shift in the fixed income
portfolio from taxable to tax-advantaged securities, which generally provide
lower income yields than taxable fixed income securities, and lower investment
yields. Additionally, investment yields declined from the reinvestment of the
proceeds of matured and called securities at declining rates during the year.
Net investment income was favorably affected by positive operating cash flow.
Net investment income increased by $19.5 million in 1997 compared to 1996
primarily due to a higher investment base and a slight increase in pre-tax
investment yields. The higher investment base for 1997 reflects the proceeds
from the issuance of $125 million of trust preferred securities in January 1997
and the effects of positive operating cash flow. These increases have been
offset in part by the July 1996 cash outlay of approximately $88.2 million for
the purchase of Guaranty National common shares.
Net investment income reflects limited partnership investment equity earnings of
$2.6 million in 1998, $17.1 million in 1997 and $16.0 million in 1996. The
decrease in limited partnership earnings in 1998 as compared to 1997 is due
primarily to a $14.1 million pre-tax investment loss recorded in the third
quarter of 1998. This loss was attributed to volatility and declines in the
financial markets during the third quarter of 1998 resulting in significant
declines in value of three of the Company's larger limited partnership
investments. The increase in limited partnership earnings for 1997 as compared
to 1996 is primarily attributable to favorable performance for a majority of the
limited partnership investments. Earnings (losses) from limited partnership
investments can vary considerably from year-to-year. The Company's long-term
experience with limited partnership investments has been quite favorable;
however, they represented only 4.5% and 3.6% of total investments at December
31, 1998 and 1997, respectively. The Company currently plans to modestly reduce
its limited partnership investments in 1999.
Fixed maturity investments, which the Company has both the positive intent and
the ability to hold-to-maturity, are recorded at amortized cost. Fixed maturity
investments, which may be sold in response to, among other things, changes in
interest rates, prepayment risk, income tax strategies or liquidity needs are
classified as available-for-sale and are carried at market value. At December
31, 1998 and 1997 fixed maturities and short-term investments comprised 74.2%
and 78.8%, respectively, of the Company's cash and investments. The effective
duration of the Company's fixed income investment portfolio was 5.0 years at
December 31, 1998.
The Company invests primarily in investment grade securities and strives to
enhance the average return of its portfolio through limited investment in a
diversified group of non-investment grade fixed maturity securities or
securities that are not rated. The risk of loss due to default is generally
considered greater for non-investment grade securities than for investment grade
securities because the former, among other things, are often subordinated to
other indebtedness of the issuer and are often issued by highly leveraged
companies. At December 31, 1998 and 1997, the Company's investment in
non-investment grade and non-rated fixed maturity securities were carried at
$208.7 million and $256.7 million, respectively. These investments represented a
total of 8.3% and 10.1% of cash and investments and 5.0% and 6.6% of total
assets at December 31, 1998 and 1997, respectively.
38
The Company monitors the financial condition of the issuers of securities that
it owns. When conditions are deemed appropriate, the Company ceases to accrete
discounts, or accrue interest and dividends and, in cases where the value of
such investments is deemed to be other than temporarily impaired, recognizes
losses. The Company's non-investment grade securities are highly diversified,
with an average investment per issuer of approximately $1.7 million at December
31, 1998. The largest non-investment grade security had a carrying value of
$12.0 million at December 31, 1998.
REALIZED AND UNREALIZED INVESTMENT RESULTS
Net realized investment gains are $52.5 million, $47.8 million and $24.2 million
for 1998, 1997 and 1996, respectively. Realized investment gains (losses) vary
from period to period, depending on market conditions relative to the Company's
investment holdings, the timing of investment sales generating gains and losses,
the occurrence of events which give rise to other-than-temporary impairment of
investments, and other factors. Approximately 25% of the 1998 net realized
investment gains resulted from the sale of two investments in entities which
were acquired or taken public during the first quarter. In the fourth quarter of
1998, the Company recorded a $7.0 million realized loss in connection with the
pending sale of its investment in Intercargo. Excluding provisions for
other-than-temporary impairment, sales of equity securities have resulted in net
gains of $41.1 million, $44.2 million and $22.4 million and sales of fixed
maturity investments have resulted in net gains of $15.7 million, $6.0 million
and $3.2 million in 1998, 1997 and 1996, respectively. Realized investment gains
may be reduced by provisions for losses on securities deemed to be
other-than-temporarily impaired. Impairment provisions of $1.1 million, $0.4
million and $0.3 million for equity securities and $3.2 million, $2.0 million
and $1.1 million for fixed maturity investments were recognized in 1998, 1997
and 1996, respectively. Any such provision is based on available information at
the time and is made in consideration of the decline in the financial condition
of the issuers of such securities.
Net unrealized investment appreciation (depreciation) for equity securities and
fixed maturities classified as available-for-sale are recorded in stockholders'
equity, net of federal taxes. Unrealized investment appreciation (depreciation)
can vary significantly depending upon fluctuations in interest rates, changes in
credit spreads and in equity prices. For 1998, equity securities and fixed
maturities recorded in stockholders' equity had unrealized depreciation of $50.4
million and $30.0 million, respectively, after taking $52.5 million of realized
net gains. For 1997, equity securities and fixed maturities recorded in
stockholders' equity had unrealized appreciation of $18.4 million and $38.9
million, respectively, after taking $47.8 million of realized net gains. See
section titled "Market Risk of Financial Instruments" on pages 47-48.
39
EXPENSES AND OTHER
OPERATING RATIOS
The following table sets forth certain ratios of insurance operating expenses to
premiums earned for the years ended December 31:
1998 1997 1996
----- ----- -----
Loss and loss adjustment expenses 67.9% 66.7% 67.9%
Policy acquisition costs and other
insurance expenses 31.0% 31.2% 30.1%
----- ---- ----
Total before policyholders' dividends 98.9% 97.9% 98.0%
Policyholders' dividends 1.6% 1.8% 1.8%
----- ---- ----
Combined ratio 100.5% 99.7% 99.8%
===== ==== ====
Loss and loss adjustment expenses ratio by segment:
Workers Compensation 57.5% 53.7% 58.8%
Specialty Commercial 74.0% 72.1% 71.3%
Nonstandard Automobile 69.1% 70.0% 71.3%
The loss ratio for Workers Compensation increased in 1998 compared to 1997 due
to the effects of competitive pricing pressure and a change in loss development
reflecting upward adjustments to initial reserve estimates for the 1997 and
prior accidents years. The benefit of EBI's service-oriented approach, working
with its customers to prevent losses and reduce claim costs, has partially
offset this impact. The loss ratio for Workers Compensation decreased in 1997
compared to 1996 due to favorable loss development and loss experience achieved
by EBI through its service-oriented approach.
The loss ratio for Specialty Commercial increased in 1998 compared to 1997
primarily due to $27.8 million of loss reserve strengthening recorded in 1998
related to business being exited in connection with an Orion Specialty
realignment. Excluding these charges, the loss ratio for Specialty Commercial
would have been 69.7% in 1998. Additionally, the loss ratio for Specialty
Commercial reflects reserve strengthening for the Company's pools and
associations, and for the assumed reinsurance business exited in late 1996.
These increases were partly offset by an improvement in DPIC's and McGee's loss
ratios in 1998 as compared to 1997.
The loss ratio for Specialty Commercial increased in 1997 compared to 1996
primarily due to losses from certain programs cancelled by Orion Specialty,
reserve strengthening for the Company's pools and associations and reinsurance
business, and higher estimates for losses and loss adjustment expenses for the
commercial automobile line of business written by Guaranty National. The 1997
loss ratio increase has been partly offset by the favorable effect of a change
in this segment's mix of business, particularly the lower premiums and losses
from the assumed reinsurance business that the Company exited in November 1996.
The loss ratio for Nonstandard Automobile improved in 1998 compared to 1997
primarily due to a decline in claims frequency and claims severity partly offset
by higher loss expenses. The improvement in the Nonstandard Automobile loss
ratio for 1997 compared to 1996 is primarily due to lower claims frequency. This
improvement has been partly offset by costs incurred to improve claim handling
and reduce insurance fraud.
40
The ratios of policy acquisition costs and other insurance expenses to premiums
earned (the "expense ratio") are 31.0% in 1998, 31.2% in 1997, and 30.1% in
1996. Policy acquisition costs include direct costs, such as commissions,
premium taxes, and salaries that relate to and vary with the production of new
and renewal business. These costs are deferred and amortized as the related
premiums are earned, subject to a periodic test for recoverability. The increase
in the expense ratio in 1997 as compared to 1996 is attributable to the
Company's continued investment in building its loss prevention competencies and
the costs of expanding in new territories and changing the EBI office
operations. Additionally, the 1997 increase is the result of higher commissions
at EBI and Orion Specialty including a change in reinsurance in 1996, which
provides for lower ceding commissions. The ratio of policyholders' dividends to
premiums earned (the "dividend ratio") was 1.6% in 1998 and 1.8% in both 1997
and 1996. The decrease in the dividend ratio for 1998 as compared to 1997 was
due to a change in business mix at Orion Specialty resulting in a lower
percentage of policies paying dividends to policyholders.
Provisions for losses and loss adjustment expenses include development of loss
and loss adjustment expense reserves relating to prior accident years, which
increased the calendar year combined ratio by 2.3 percentage points in 1998 and
0.7 percentage points in both 1997 and 1996. During 1998, the Company's loss
ratio was unfavorably affected by loss development in exited programs at Orion
Specialty, the assumed reinsurance business discontinued in 1996, pools and
associations (other than from McGee), and workers compensation line of business.
In the third quarter of 1998, the Company recorded $17.0 million of loss
reserves pertaining to prior accident years for business being exited in
connection with the Orion Specialty realignment. Excluding this charge, adverse
development of prior accident years increased the calendar year combined ratio
by 1.1 percentage points in 1998. During 1997, the Company's loss ratio was
unfavorably affected by loss development in the pools and associations, assumed
reinsurance business discontinued in 1996 and cancelled program business, partly
reduced by favorable development in the workers compensation insurance line of
business.
The Company's environmental claims principally relate to asbestos and hazardous
waste, arising from certain liability business written prior to the mid 1980's,
which business was never a major element of the Company's operations.
Environmental claims are also received from certain pools and associations where
reserves are established based on information reported to the Company by the
managers of those pools and associations. The Company discontinued its
participation in these reinsurance pools and associations in the mid 1980's.
Establishing reserve liabilities for environmental claims is subject to
significant uncertainties that make reserve estimation difficult. Judicial
decisions have tended to expand insurance coverage beyond the intent of the
policies. The disposition of such claims often requires lengthy and costly
litigation. Uncertainties as to required clean-up remedies and difficulties in
identifying the responsible parties add further to the complexity of reserve
estimation for these claims. In recent years, the Company has intensified its
efforts to settle and close environmental claims. In recognition of these
efforts, reserves have also been increased to provide for the costs related to
settling claims. To help minimize the cost of losses and claims, the Company
maintains a dedicated environmental claims staff, which administers and
continually evaluates each claim and its defense and settlement possibilities.
In 1998, 1997 and 1996, the Company paid $7.5 million, $6.8 million and $4.8
million, respectively, for the costs of defending and settling such claims.
Claim counts have been aggregated by year of coverage for each occurrence for
which policyholders are being defended, and often include numerous claimants.
As of December 31, 1998 and 1997, the Company has environmental claims-related
loss and loss adjustment expense reserves, net of reinsurance recoverables, of
$65.7 million and $67.9 million, respectively. Claim counts are 515 and 551 at
December 31, 1998 and 1997, respectively, for direct business written by the
Company that excludes pools and associations. Following industry practice,
counts for asbestos claims are generally established for each insured for each
policy. Counts for environmental claims are based upon each site. In estimating
liabilities for environmental-related claims, the Company considers all
pertinent information, as it becomes available. The net reserve for
environmental claims and IBNR increased $10.9 million in 1997 primarily due to
higher claims reported to the Company by certain reinsurance pools and
associations, which is the basis of establishing such reserve, and higher loss
reserve estimates.
41
Management believes that the Company's reserves for loss and loss adjustment
expenses make reasonable and sufficient provision for the ultimate cost of all
losses on claims incurred. However, there can be no assurance that changes in
loss trends will not result in additional development of prior years' reserves
in the future. Variability in claim emergence and settlement patterns and other
trends in loss experience can result in future development patterns different
than expected. The Company believes that any such development will continue at
the low levels experienced in recent years, considering actions that have been
taken to increase reserving levels, improve underwriting standards and emphasize
loss prevention and control. The Company's loss ratios in recent years,
including development of prior years' losses, have compared favorably with loss
ratios experienced by the industry.
The Company limits both current losses and future development of losses by
ceding business to reinsurers. The Company continually monitors the financial
strength of its reinsurers and, to the Company's knowledge, has no material
exposure with regard to potential unrecognized losses due to reinsurers having
known financial difficulties.
INTEREST EXPENSE
Interest expense was $19.4 million in 1998 and $24.7 million for both 1997 and
1996, decreasing 21.6% in 1998 compared to 1997. Interest expense declined in
1998 as a result of the repayment of the $100 million bank indebtedness of
Guaranty National in February 1998 with proceeds from the issuance of the
Company's 7.701% Trust Preferred Securities.
OTHER EXPENSES
Other expenses were $44.0 million, $45.0 million and $43.0 million in 1998, 1997
and 1996, respectively. During the fourth quarter of 1998, the Company closed
its corporate office in New York City and integrated the investment function
into the corporate office located in Farmington, Connecticut. These actions
resulted in a $2.3 million pre-tax charge for severance and office closure
expenses.
EQUITY IN EARNINGS (LOSSES) OF AFFILIATE
Equity in earnings (losses) of affiliate represents earnings (losses) from the
Company's 26% investment in Intercargo and was $(0.7) million in 1998, $8.6
million in 1997 and $(0.4) million in 1996. The Company has agreed to sell its
investment in Intercargo, which is expected to close late in the first quarter
or early in the second quarter of 1999 pursuant to Intercargo's merger with X.
L. America, Inc., a subsidiary of EXEL Limited. The Company recorded its share
of Intercargo's results in the subsequent quarter as Intercargo reports its
quarterly earnings after the Company reports its earnings. In 1997, equity in
earnings of affiliates reflected a pre-tax gain of $7.0 million from
Intercargo's sale of Kingsway Financial Services.
FEDERAL INCOME TAXES
Federal income taxes, including tax benefits from trust preferred securities,
and the related effective tax rates are $34.3 million (25.0%) for 1998, $42.8
million (25.8%) for 1997 and $32.0 million (25.2%) for 1996. The Company's
effective tax rates are less than the statutory tax rate of 35% primarily
because of income derived from tax-advantaged securities.
42
In October 1996 the Internal Revenue Service ("IRS") completed an examination of
the Company's federal income tax returns through 1992. Certain tax benefits from
tax attributes existing at the date of the Company's reorganization in 1976 were
not recognized pending completion of the IRS examination. Accordingly, the
Company recorded a credit to capital surplus in 1996 for tax benefits of $11.9
million with respect to the 1976 reorganization. The recording of this credit
had no impact on the Company's earnings.
MINORITY INTEREST EXPENSE
Minority interest expense in trust preferred securities was $12.8 million for
1998 and $6.9 million for 1997. Minority interest expense in trust preferred
securities represents the financing cost, after the federal income tax benefit,
on Orion's 8.73% and 7.701% Trust Preferred Securities. The increase in 1998 and
1997 reflects minority interest expense associated with the issuance of the
7.701% and 8.73% Trust Preferred Securities in February 1998 and January 1997,
respectively.
Minority interest expense in subsidiary net earnings of $7.0 million in 1997 and
$8.7 million in 1996 was recorded for the after-tax portion of Guaranty
National's earnings attributable to stockholders of Guaranty National other than
the Company. Guaranty National became a wholly-owned subsidiary of the Company
in December 1997.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash flows for the years ended December 31 was as follows:
(In millions) 1998 1997 1996
- -----------------------------------------------------------------
Cash flows:
Operating activities ....... $ 29.9 $ 100.0 $ 167.7
Investing activities ....... 11.3 (207.4) (132.4)
Financing activities ....... (32.5) 105.1 (27.3)
-------- -------- --------
$ 8.7 $ (2.3) $ 8.0
======== ======== ========
The decrease in operating cash flow for 1998 and 1997 is primarily the result of
higher payments for losses, policy acquisition costs, federal income taxes (in
1998) and minority interest from trust preferred securities. The higher loss
payments reflect both an acceleration of claims settlement in two of our
operations during 1998 and loss payments related to the assumed reinsurance
business exited by the Company. Higher payments for policy acquisition costs,
are related to the Company's current rate of growth. Federal income tax payments
for 1998 include $8.5 million of federal tax payments related to 1997 and a
$20.0 million federal tax refund that was received by the Company in the first
quarter of 1999. Partially offsetting these increased cash outflows are higher
premiums collected, reflective of the Company's current rate of growth, as well
as higher investment income collected.
Cash is used in or provided by investment activities primarily for purchases or
from sales and maturities of investments, for acquisition activities, and for
purchases of property and equipment. Investment purchases are funded by
maturities and sales of investments, as well as by the net cash from operating
cash flows after cash provided by or used in financing activities. Cash used for
acquisitions totaled $80.1 million in 1998 and $132.6 million in 1997 (excluding
acquired cash of $17.5 million in 1998 and $1.7 million in 1997). Cash used in
acquisition activities (excluding cash acquired) in 1998 included $39.7 million
for purchase of Strickland's nonstandard personal automobile insurance business,
$32.4 million for purchase of Grocers, $5.1 million related to settlement of
purchase price contingency for Guaranty National's acquisition of Viking
Insurance Company of Wisconsin in 1995, and $2.9 million to tender the remaining
shares of Guaranty National related to the December 1997 purchase. In September
1998, the Company sold Colorado Casualty providing cash proceeds of $13.1
million (net of cash sold with Colorado Casualty and before taxes). Cash used in
acquisition activities (excluding cash acquired) in 1997 included $104.4 million
for the purchase of Guaranty National common stock, $26.2 million for the
purchase of Unisun, and a $2.0 million purchase price deposit for the
acquisition of Strickland.
43
Cash used in financing activities included repayment of $100 million bank
indebtedness of Guaranty National from net proceeds of the 7.701% Trust
Preferred Securities issued in February 1998. The issuance of trust preferred
securities by the Company provided $121.9 million and $123.0 million of cash in
1998 and 1997, respectively. During 1998, the Company used $8.0 million from
unsecured borrowings under its bank credit facility to fund uses of cash and
repaid $9.4 million of assumed bank debt related to the acquisition of
Strickland. Cash used in financing activities also includes dividend payments,
scheduled debt repayments and payments related to the Company's common stock
repurchase program. Orion increased the quarterly dividend rate on its common
stock by 12.5% and 14.3% in the second quarters of 1998 and 1997, respectively.
Orion's uses of cash consist of debt service, dividends to stockholders and
overhead expenses. These cash uses are funded from existing available cash,
financing transactions and receipt of dividends, reimbursement of overhead
expenses, debt service costs from loans due from subsidiaries, and amounts in
lieu of federal income taxes from Orion's insurance subsidiaries. Orion has
received $55.2 million, $42.8 million and $35.3 million in dividends, $8.3
million, $8.1 million and $7.4 million for overhead expenses and federal tax
payments of $20.8 million, $9.5 million and $7.5 million from its insurance
subsidiaries in 1998, 1997 and 1996, respectively. Payments of dividends by
Orion's insurance subsidiaries must comply with insurance regulatory limitations
concerning stockholders' dividends and capital adequacy. State insurance
regulators have broad discretionary authority with respect to limitations on the
payment of dividends by insurance companies. Limitations under current
regulations are well in excess of Orion's cash requirements.
Orion's insurance subsidiaries maintain liquidity in their investment portfolios
substantially in excess of that required to pay claims and expenses. The
insurance subsidiaries held cash and short-term investments of $242.4 million
and $160.4 million at December 31, 1998 and 1997, respectively. The consolidated
policyholders' surplus of Orion's insurance subsidiaries was $732.1 million and
$789.0 million at December 31, 1998 and 1997, respectively. The Company's
statutory operating leverage ratios of trailing twelve months net premiums
written to policyholders' surplus was 2.1:1 at December 31, 1998 and 1.8:1 at
December 31, 1997.
On July 8, 1998 the Company entered into a five year credit agreement with a
group of banks which provides for unsecured borrowings up to $150 million, of
which $8.0 million was outstanding at December 31, 1998. The Company intends to
use the credit facility for general corporate purposes, which may include
acquisitions. Borrowings under the credit agreement bear interest at LIBOR
(London Interbank Offered Rate) plus a margin based upon the Company's credit
ratings. The credit agreement requires the Company to maintain certain defined
financial covenants including a maximum debt to total capitalization ratio and a
minimum combined statutory surplus. Also, the credit agreement limits the
Company's ability to incur secured indebtedness or certain contingent
obligations except for indebtedness secured by liens specifically permitted by
the credit agreement and additional secured indebtedness with a principal amount
not exceeding a defined percentage of the Company's consolidated net worth. The
Company is in compliance with the terms of this credit agreement. Management
does not believe that the credit agreement's covenants or limitations unduly
restrict the Company's operations or limit Orion's ability to acquire additional
indebtedness.
44
The terms of Orion's indentures for its $100 million of 7.25% Senior Notes due
2005 and its $110 million of 9.125% Senior Notes due 2002 limit the amount of
liens and guarantees by the Company and its ability to incur secured
indebtedness without equally and ratably securing the senior notes. The senior
notes are non-callable to maturity. Management does not believe that these
limitations unduly restrict the Company's operations or limit Orion's ability to
pay dividends on its stock. At December 31, 1998 the Company is in compliance
with the terms of its senior note indentures. Management believes that the
Company continues to have substantial sources of capital and liquidity from the
capital markets and bank borrowings.
On January 13, 1997 Orion issued $125 million of 8.73% Junior Subordinated
Deferrable Interest Debentures due January 1, 2037 (the "8.73% Debentures") to
Orion Capital Trust I ("Trust I"), a Delaware statutory business trust sponsored
by Orion. Trust I simultaneously sold $125 million of 8.73% capital securities
(the "8.73% Trust Preferred Securities") which have substantially the same terms
as the 8.73% Debentures. The net proceeds from the sale of the 8.73% Trust
Preferred Securities were used in part for the acquisition of Guaranty National
common stock in December 1997. The 8.73% Trust Preferred Securities may be
redeemed without premium on or after January 1, 2007.
On February 2, 1998 Orion issued $125 million of 7.701% Junior Subordinated
Deferrable Interest Debentures due April 15, 2028 (the "7.701% Debentures") to
Orion Capital Trust II ("Trust II"), a Delaware statutory business trust
sponsored by Orion. Trust II then sold $125 million of 7.701% capital securities
(the "7.701% Trust Preferred Securities"), which have substantially the same
terms as the 7.701% Debentures. Approximately $100 million of net proceeds from
the sale of the 7.701% Trust Preferred Securities were used to repay bank
indebtedness of Guaranty National in February 1998. The 7.701% Trust Preferred
Securities are non-callable to maturity.
The 8.73% and 7.701% Trust Preferred Securities are subordinated to all
liabilities of the Company. The Company may defer interest distributions on
these capital securities; however, during any period when such cumulative
distributions have been deferred, Orion may not declare or pay any dividends or
distributions on its common stock.
The Company issued a 2-for-1 split of its common stock on July 7, 1997 to
shareholders of record on June 23, 1997. The Company has repurchased 836,100
shares, 42,916 shares and 482,228 shares of its common stock at an aggregate
cost of $35.6 million, $1.5 million and $11.2 million under the Company's stock
repurchase program in 1998, 1997 and 1996, respectively. The Company's Board of
Directors increased authorization for purchases of its common stock by an
additional $75 million in 1998. The remaining stock purchase authorization was
$42.5 million at March 1, 1999.
LEGAL PROCEEDINGS
Orion and its subsidiaries are routinely engaged in litigation incidental to
their businesses. Management believes that there are no significant legal
proceedings pending against the Company which, net of reserves established
therefore, are likely to result in judgments for amounts that are material to
the financial condition, liquidity or results of operations of Orion and its
consolidated subsidiaries, taken as a whole.
45
YEAR 2000 COMPLIANCE
The "Year 2000 problem" exists because many computer programs which companies
use rely on only the last two digits to refer to a particular year. As a result,
these computer programs may interpret the Year 2000 as 1900. If not corrected,
computer software may fail or create erroneous results. The potential impact of
the Year 2000 problem on business, financial and governmental entities
throughout the world is not known and, if not timely corrected, may broadly
affect the national economy in which we operate.
The Company concluded that as an extensive user of technology, it has a material
exposure to the Year 2000 problem and has taken steps to assess and address that
exposure. In response to this issue, the Company has inventoried and assessed,
for all its operations and locations, its insurance policy issuance, billing and
collection, claims paying, and other operational systems, along with the
hardware and software used in its computing facilities, embedded chips used in
its physical structures, third party data-exchanges, and reliance on external
business relations. This work has been carried out by the Company through
central coordination supported by dedicated teams working at each Company site.
Progress has been reviewed regularly by senior management. The process by which
the Company is managing its Year 2000 efforts has also been reviewed by
independent consultants.
The Company began addressing its computer programs in 1996 at the locations
where its most significant technology concentration exists. Similar work
commenced shortly thereafter at other locations.
As of December 31, 1998, the Company had completed approximately 95% of its
scheduled remediation of critical production systems for processing Year 2000
dates. This places the Company on or ahead of its plan for meeting Year 2000
processing needs. Non-critical systems will be tested and critical systems will
be re-tested during 1999. The total costs to test or modify these existing
systems, which include both internal and external costs of programming and
testing, is estimated to be approximately $19.4 million, of which $15.8 million
has been expensed ($2.4 million through 1997 and $13.4 million in 1998).
With a timely start on correcting the Year 2000 problem, the Company has been
able to address this potential exposure. This has allowed the Company to
continue replacement of outdated systems with newer versions offering greater
functionality and cost efficiencies. The Company completed replacing its
financial, personnel, and payroll systems in 1998 and began phasing in new
integrated processing systems for certain of its operations in 1999. The total
cost for these major technology improvement projects are estimated at
approximately $13.1 million of which $11.7 million had been capitalized through
December 31, 1998. Additional technology projects are planned for 1999 as Year
2000 projects wind down. All costs are being funded through operating cash
flows.
In addition to addressing its own hardware, software and processing exposure,
the Company has been engaged since 1996 in a process of identifying and
prioritizing critical suppliers and customers at the direct interface level, and
communicating with them about their plans and progress in addressing the Year
2000 problem.
The Company has mailed letters to significant vendors and service providers and
has verbally communicated with many strategic customers to determine the extent
to which interfaces with such entities are vulnerable to Year 2000 problems and
whether the products and services purchased from or by such entities are Year
2000 compliant. As of December 31, 1998, the Company had received responses from
approximately 65% of the third parties of whom it has inquired and 90% of the
companies that have responded have provided written assurances that they expect
to address all their significant Year 2000 problems on a timely basis.
46
Evaluations of the most critical third parties have been initiated. These
evaluations will be followed by the development of contingency plans, which have
been prepared for third parties having near term Year 2000 impact or are being
developed for other third parties, with completion during the first quarter of
1999. The Company believes that this aspect of its Year 2000 effort was on
schedule at December 31, 1998.
A follow-up mailing to significant vendors and service providers that did not
initially respond, or whose responses were deemed unsatisfactory by the Company,
is expected to be completed by March 31, 1999. The Company will also expand its
survey to vendors and service providers who do not directly interface with the
Company's systems.
The Company presently believes that the Year 2000 problems will not pose
significant operational problems for the Company. However, if all Year 2000
problems are not properly identified, or assessment, remediation and testing are
not effected timely with respect to Year 2000 problems that are identified,
there can be no assurance that the Year 2000 issue will not materially adversely
impact the Company's results of operations or adversely affect the Company's
relationships with customers, vendors, or others.
The Company is unable to determine at this time whether the consequences of
counter-parties Year 2000 failures will have a material impact on the Company's
results of operations, liquidity or financial condition. The possibility exists
that a portion of its third-party distribution channels may not be ready, that
communications with its agents could be disrupted, that underwriting data, such
as motor vehicle reports, could be unobtainable, that the claim settling process
could be delayed or that the frequency and severity of losses may increase due
to external factors. Where concern appears justified about an aspect of
readiness, contingency plans have been prepared or are being developed. However,
there can be no assurance that unanticipated Year 2000 issues of other entities
will not have a material adverse impact on the Company's systems or results of
operations.
This is a Year 2000 Readiness Disclosure statement. Readers are cautioned that
forward-looking statements contained in "Year 2000 Compliance" should be read in
conjunction with the Company's disclosures under the heading: "Forward-Looking
Statements."
MARKET RISK OF FINANCIAL INSTRUMENTS
The Company is subject to market risk arising from the potential change in the
value of its various financial instruments. These changes may be due to
fluctuations in interest rates, and changes in credit spreads and in equity
prices. The level of market risk is influenced by many factors, such as
volatility, correlation and liquidity. Potential gains or losses from changes in
market conditions can be estimated through statistical models that attempt to
predict within a specified confidence level the " value at risk" based on
historical price and volatility movements. For example, if historical
probabilities indicate that the change in the value of a fixed income security
would not be expected to exceed $1 million with a 95 percent probability within
a given time period, then the security's value at risk at a 95 percent
confidence level for that period is $1 million.
The major components of market risk affecting the Company are interest rate and
equity risk. The Company has a fixed income investment portfolio, which includes
non-redeemable preferred stocks and short term investments, with a market value
of $2,139.8 million at December 31, 1998 that is subject to changes in value due
to changes in market interest rates. Within the fixed income portfolio, certain
mortgage-backed and asset-backed securities ($145.0 million of value at December
31, 1998) are exposed to accelerated prepayment risk generally caused by
interest rate movements. Should interest rates decline, mortgage holders are
more likely to refinance existing mortgages at lower rates. Acceleration of
repayments could unfavorably affect future investment income, if reinvestment of
the cash received from repayments is in lower yielding securities.
Statistically, the Company's estimated prepayment risk was not significant at
December 31, 1998.
47
In addition to interest rate risk, the Company's common equity portfolio of
$242.4 million at December 31, 1998 is subject to changes in value based on
changes in equity prices in United States markets. The Company's common equity
portfolio is highly correlated with the S&P 500 and Russell 2000 indices in
equal amounts.
The Company's portfolio includes investments in limited partnerships ($111.1
million at December 31, 1998) that generally provide higher investment returns,
but also carries higher volatility and market risk compared to the Company's
other investments. Changes in the market value of limited partnership
investments can vary considerably from year-to-year. However, the long-term
performance of the Company's limited partnership investments has been favorable.
The effect of limited partnership investments is not included in the value at
risk disclosure shown below.
The Company's exposure to foreign exchange risk arising from the possibility
that changes in foreign currency exchange rate will impact the value of
financial instruments is not significant.
The Company manages its total investments, so that at all times, there are fixed
income securities that are adequate in amount and duration to meet the cash
requirements of current operations and longer term liabilities, as well as to
meet insurance regulatory requirements with respect to investments under
specific state insurance laws. To the extent that there are funds available for
investment beyond these requirements, the investment objective for such funds is
to maximize total return within a prudent level of risk, taking into account the
potential impact on the volatility of reported earnings and reserves. The
Company shall adjust investment risk to offset or complement insurance risk
based upon total corporate risk tolerance. The Company has investment guidelines
for fixed income and equity portfolios covering portfolio characteristics,
permitted investments, diversification and performance benchmarks.
Value at risk estimates are presented in the table below and represent the
potential after-tax change in value of the Company's invested assets, which, to
the extent unrealized, would generally be included directly in stockholders'
equity. Caution should be used in evaluating the Company's overall market risk
from the information below, since actual results could differ materially because
the information was developed using estimates and assumptions as described in
this section. These estimates exclude any potentially offsetting effect
resulting from movements in the economic value of the Company's liabilities,
most importantly, loss reserves and reinsurance recoverables on unpaid losses.
The estimates shown in the table were calculated using Monte Carlo simulation
involving 5,000 stochastic paths with a 95 percent confidence level based on
weekly correlation's and volatilities based upon observed values for 1991 -
1998. Mean assumptions included no change in weekly interest rates and an 8.0%
annual appreciation for the common equity portfolio. The Company's total value
at risk includes a diversification benefit since interest rate and equity risks
are only partially correlated.
The overall after-tax value at risk for the Company at December 31,
1998 was as follows:
(In millions)
- ---------------------------------------------
Interest rate risk $ 19.5
Equity risk 6.0
Diversification benefit (9.8)
---------
Total $ 15.7
=========
48
ACCOUNTING PRONOUNCEMENTS TO BE ADOPTED
In June 1998, the Financial Accounting Standards Board issued FAS No. 133,
Accounting for Derivative Instruments and Hedging Activities. This standard
requires companies to record all derivatives on the balance sheet as either
assets or liabilities and measure those instruments at fair value. The manner in
which companies are to record gains or losses resulting from changes in the
values of those derivatives depends on the use of the derivative and whether it
qualifies for hedge accounting. This standard is effective for the Company's
financial statements beginning January 1, 2000, with early adoption permitted.
The Company is currently evaluating the impact of the adoption of this statement
and the potential effect on its financial position or results of operations.
In March 1998, the AICPA issued SOP 98-1, Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use. This statement provides
guidance on accounting for costs of computer software developed or obtained for
internal use including when incurred costs are and are not eligible for
capitalization. This statement is effective for 1999 financial statements with
early adoption permitted. The Company is currently evaluating the impact of the
adoption of this statement and the potential effect on its financial position
and result of operations.
FORWARD-LOOKING STATEMENTS
All statements made in this annual report that do not reflect historical
information are forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995. 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) medical cost
inflation; (vii) increases in the cost of property repair; (viii) the number of
new and renewal policy applications submitted to the Company; (ix) Year 2000
problems and (x) other factors over which the Company has little or no control.
The Company's expectation that its plan for Year 2000 Compliance will be
completed on schedule depends, in large part, on the Company's own efforts and
expenditures on hardware, software and systems, which is on schedule as to those
exposures which the Company has been able to identify. However, Year 2000
problems could also arise because of unanticipated non-compliance on the part of
vendors, agents, customers and other third parties including governmental
entities. Significant Year 2000 problems could materially and adversely affect
future performance and results of operations. The Company disclaims any
obligation to update or to publicly announce the impact of any such factors or
any revisions to any forward-looking statements to reflect future events or
developments.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See section "Market Risk of Financial Instruments" on pages 47- 48.
49
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF MANAGEMENT
The management of Orion Capital 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 appropriate in the
circumstances, and, where necessary, include amounts based on management's
informed estimates and judgments.
The Company has a system of internal control which it believes provides
reasonable assurance that assets are safeguarded from loss or unauthorized use,
that transactions are recorded in accordance with management's policies and that
the financial records are reliable for preparing financial statements. The
system of internal control includes written policies and procedures that are
communicated to all appropriate personnel and updated as necessary.
Compliance with the system of internal control 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,
perform an evaluation of the system of internal control to the extent they
consider necessary to express an opinion on the consolidated financial
statements. Both the internal auditors and Deloitte & Touche LLP provide
recommendations concerning the system of internal control, and management takes
actions, which are believed to be appropriate responses to these
recommendations.
The Audit and Information Services 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 and Information Services 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
and results of the audits. Both internal and independent auditors have free
access to the Audit and Information Services Committee, without members of
management present, to discuss the adequacy of the system of internal control
and any other matters which they believe should be brought to the attention of
the Committee.
W. Marston Becker Michael L. Pautler
Chairman & Chief Executive Officer Senior Vice President &
Chief Financial Officer
50
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders
Orion Capital Corporation
Farmington, Connecticut
We have audited the accompanying consolidated balance sheets of Orion
Capital Corporation and subsidiaries as of December 31, 1998 and 1997, and the
related consolidated statements of earnings, stockholders' equity, and cash
flows for each of the three years in the period ended December 31, 1998. Our
audits also included the financial statement schedules listed in the Index at
Item 14(a)2. These financial statements and financial statement schedules are
the responsibility of the Company's management. Our responsibility is to express
an opinion on the financial statements and financial statement schedules 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 Orion Capital Corporation and
subsidiaries as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998 in conformity with generally accepted accounting principles.
Also, 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.
DELOITTE & TOUCHE LLP
Hartford, Connecticut
February 22, 1999
(except for Note 20, as to
which the date is March 11, 1999)
51
ORION CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
ASSETS
December 31,
----------------------
(In millions) 1998 1997
- -------------------------------------------------------------------------------
Assets:
Investments: -
Fixed maturities, at amortized cost
(market $272.7 - 1998 and $322.4 - 1997) .......... $ 260.6 $ 312.8
Fixed maturities, at market (amortized cost
$1,305.5 - 1998 and $1,395.4 - 1997) .............. 1,349.9 1,469.8
Common stocks, at market (cost $200.3 -
1998 and $163.0 - 1997) ........................... 242.4 245.4
Non-redeemable preferred stocks, at market
(cost $269.1 - 1998 and $183.6 - 1997) ............ 268.5 193.1
Other long-term investments .......................... 116.2 94.3
Short-term investments ............................... 248.7 228.3
---------- ----------
Total investments .............................. 2,486.3 2,543.7
Cash ................................................. 18.0 9.3
Accrued investment income ............................ 27.0 29.6
Investment in affiliate .............................. 22.8 31.3
Accounts and notes receivable ( less allowance for
doubtful accounts $3.4 - 1998 and $4.1 - 1997) .... 217.2 189.3
Reinsurance recoverables and prepaid reinsurance ..... 801.5 622.2
Deferred policy acquisition costs .................... 155.6 147.1
Property and equipment ( less accumulated depreciation
$49.0 - 1998 and $35.9 - 1997) .................... 95.4 70.8
Excess of cost over fair value of net assets acquired
( less accumulated amortization $33.6 - 1998
$27.4 - 1997) ..................................... 167.7 140.0
Deferred federal income taxes ........................ 26.7 1.0
Other assets ......................................... 146.2 99.8
---------- ----------
Total assets ................................... $ 4,164.4 $ 3,884.1
========== ==========
[FN]
See Notes to Consolidated Financial Statements
</FN>
52
ORION CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
LIABILITIES AND STOCKHOLDERS' EQUITY
December 31,
----------------------
(In millions, except for share amounts) 1998 1997
- -------------------------------------------------------------------------------
Liabilities:
Policy liabilities: -
Losses ................................................$ 1,602.1 $ 1,476.4
Loss adjustment expenses .............................. 415.6 395.3
Unearned premiums ..................................... 564.0 551.6
Policyholders' dividends .............................. 17.9 20.5
--------- ---------
Total policy liabilities ................................ 2,599.6 2,443.8
Notes payable ........................................... 217.4 310.2
Other liabilities ....................................... 370.1 282.0
--------- ---------
Total liabilities ....................................... 3,187.1 3,036.0
--------- ---------
Commitments and Contingencies (Notes 13 and 14)
Company-obligated mandatorily redeemable preferred
capital securities of subsidiary trusts holding solely
the junior subordinated debentures of the Company .... 250.0 125.0
Stockholders' equity:
Preferred stock, authorized 5,000,000 shares; issued
and outstanding - none
Common stock, $1 par value; authorized 50,000,000
shares; issued 30,675,300 shares ..................... 30.7 30.7
Capital surplus ......................................... 149.6 152.1
Retained earnings ....................................... 553.2 469.5
Accumulated other comprehensive income .................. 58.5 109.2
Treasury stock, at cost (3,505,091 shares -
1998 and 3,069,756 shares - 1997)...................... (57.8) (34.3)
Deferred compensation on restricted stock ............... (6.9) (4.1)
--------- ---------
Total stockholders' equity .......................... 727.3 723.1
--------- ---------
Total liabilities and stockholders' equity ..........$ 4,164.4 $ 3,884.1
========= =========
[FN]
See Notes to Consolidated Financial Statements
</FN>
53
ORION CAPITAL CORPORATON AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF EARNINGS
Year Ended December 31,
---------------------------
(In millions, except for per share amounts) 1998 1997 1996
- ----------------------------------------------------------------------------------
Revenues:
Premiums earned ................................. $ 1,503.0 $ 1,357.7 $ 1,300.8
Net investment income ........................... 143.2 164.9 145.4
Realized investment gains ....................... 52.5 47.8 24.2
Other income .................................... 18.0 20.2 23.1
--------- --------- ---------
Total revenues ................................. 1,716.7 1,590.6 1,493.5
--------- --------- ---------
Expenses:
Losses incurred ................................. 800.6 701.3 694.5
Loss adjustment expenses ........................ 219.9 204.2 188.5
Amortization of deferred policy acquisition costs 417.9 387.2 363.6
Other insurance expenses ........................ 48.0 36.6 27.9
Dividends to policyholders ...................... 24.8 24.0 23.6
Interest expense ................................ 19.4 24.7 24.7
Other expenses .................................. 44.0 45.0 43.0
Restructuring expenses and other (Note 3) ....... (15.3) -- --
--------- --------- ---------
Total expenses ................................. 1,559.3 1,423.0 1,365.8
--------- --------- ---------
Earnings before equity in earnings (loss) of
affiliate, federal income taxes and minority
interest expense .............................. 157.4 167.6 127.7
Equity in earnings (loss) of affiliate .......... (0.7) 8.6 (0.4)
Earnings before federal income taxes and --------- --------- ---------
minority interest expense ..................... 156.7 176.2 127.3
Federal income taxes ............................ 41.1 46.5 32.0
Minority interest expense:
Subsidiary trust preferred securities, net
of federal income taxes ..................... 12.8 6.9 --
Subsidiary net earnings ....................... -- 7.0 8.7
--------- --------- ---------
Net earnings ................................... $ 102.8 $ 115.8 $ 86.6
========= ========= =========
Net earnings per common share:
Basic ....................................... $ 3.78 $ 4.24 $ 3.16
========= ========= =========
Diluted ..................................... $ 3.69 $ 4.15 $ 3.12
========= ========= =========
[FN]
See Notes to Consolidated Financial Statements
</FN>
54
ORION CAPITAL CORPORATON AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
Year Ended December 31,
--------------------------------------------------------------
(In millions) 1998 1997 1996
- ------------------------------------------------------------------------------------------------------
Common Stock:
Balance, beginning of period $ 30.7 $ 15.3 $ 15.3
Stock issued in 2-for-1
common stock split - 15.4 -
------- ------- -------
Balance, end of period $ 30.7 $ 30.7 $ 15.3
======= ======= =======
Capital Surplus:
Balance, beginning of period $ 152.1 $ 158.6 $ 146.7
Exercise of stock options and net
issuance of restricted stock (2.5) 0.5 -
Acquisition of Guaranty National - 8.4 -
Recognition of pre-reorganization
federal income tax benefits - - 11.9
Stock issued in 2-for-1
common stock split - (15.4) -
------- ------- -------
Balance, end of period $ 149.6 $ 152.1 $ 158.6
======= ======= =======
Retained Earnings:
Balance, beginning of period $ 469.5 $ 370.8 $ 298.5
Net earnings 102.8 $ 102.8 115.8 $ 115.8 86.6 $ 86.6
------- ------- -------
Dividends declared (19.1) (17.1) (14.3)
------- ------- -------
Balance, end of period $ 553.2 $ 469.5 $ 370.8
======= ======= =======
Accumulated Other
Comprehensive Income:
Balance, beginning of period $ 109.2 $ 70.1 $ 59.3
Unrealized investment
gains (losses), net of taxes (52.4) 41.3 9.0
Unrealized foreign exchange
translation gains (losses), net of taxes 1.7 (2.2) 1.8
------- ------- -------
Other comprehensive income (loss) (50.7) (50.7) 39.1 39.1 10.8 10.8
------- ------- ------- ------- ------- -------
Comprehensive income $ 52.1 $ 154.9 $ 97.4
======= ======= =======
Balance, end of period $ 58.5 $ 109.2 $ 70.1
======= ======= =======
Treasury Stock:
Balance, beginning of period $ (34.3) $ (35.0) $ (26.5)
Exercise of stock options and net
issuance of restricted stock 13.4 3.2 2.7
Common stock issued pursuant to
employee stock purchase plan 1.1 - -
Acquisition of treasury stock (38.0) (2.5) (11.2)
------- ------- -------
Balance, end of period $ (57.8) $ (34.3) $ (35.0)
======= ======= =======
Deferred Compensation on
Restricted Stock:
Balance, beginning of period $ (4.1) $ (3.1) $ (2.3)
Net issuance of restricted stock (4.3) (1.9) (1.8)
Amortization of deferred
compensation on restricted stock 1.5 0.9 1.0
------- ------- -------
Balance, end of period $ (6.9) $ (4.1) $ (3.1)
======= ======= =======
[FN]
See Notes to Consolidated Financial Statements
</FN>
55
ORION CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
Year Ended December 31,
-----------------------------------
(In millions) 1998 1997 1996
- --------------------------------------------------------------------------------------------
Cash flows from operating activities:
Premiums collected ..................................... $ 1,521.9 $ 1,364.5 $ 1,330.3
Net investment income collected ........................ 145.7 140.1 127.1
Losses and loss adjustment expenses paid ............... (1,009.7) (892.1) (794.9)
Policy acquisition costs paid .......................... (456.5) (401.1) (387.7)
Federal income tax payments ............................ (57.1) (28.4) (30.3)
Dividends paid to policyholders ........................ (27.5) (26.0) (20.1)
Interest paid .......................................... (20.5) (23.8) (24.1)
Payments on trust preferred securities ................. (17.6) (5.1) --
Other payments ......................................... (48.8) (28.1) (32.6)
---------- ---------- ----------
Net cash provided by operating activities .............. 29.9 100.0 167.7
---------- ---------- ----------
Cash flows from investing activities:
Sales of fixed maturities available-for-sale ........... 1,014.5 308.3 250.9
Sales of equity securities ............................. 447.9 199.7 153.2
Maturities of fixed maturity investments
available-for-sale .................................. 144.5 100.4 144.2
Maturities of fixed maturity investments
held-to-maturity .................................... 60.5 20.1 34.6
Investments in fixed maturities
available-for-sale .................................. (1,005.0) (595.9) (449.5)
Investments in equity securities ....................... (533.1) (204.1) (83.4)
Investments in fixed maturities
held-to-maturity .................................... -- (14.3) (8.6)
Net sales (purchases) of short-term investments ........ (18.5) 108.5 (78.1)
Acquisition of businesses, net of cash acquired ........ (62.6) (130.9) (81.8)
Sale of business, net of cash sold ..................... 13.1 -- --
Purchases of property and equipment, net ............... (30.5) (18.5) (14.9)
Other receipts (payments) .............................. (19.5) 19.3 1.0
---------- ---------- ----------
Net cash provided by (used in) investing activities .... 11.3 (207.4) (132.4)
---------- ---------- ----------
Cash flows from financing activities:
Net proceeds from issuance of trust preferred securities 121.9 123.0 --
Proceeds from stock issued under employee benefit plans 2.3 0.6 --
Repayment of notes payable, net ........................ (102.0) (0.8) (1.3)
Purchases of common stock .............................. (35.6) (1.5) (10.7)
Dividends paid to stockholders ......................... (18.5) (18.0) (15.3)
Other receipts (payments) .............................. (0.6) 1.8 --
---------- ---------- ----------
Net cash (used in) provided by financing activities .... (32.5) 105.1 (27.3)
---------- ---------- ----------
Net increase (decrease) in cash ........................ 8.7 (2.3) 8.0
Cash balance, beginning of period ...................... 9.3 11.6 3.6
---------- ---------- ----------
Cash balance, end of period ............................ $ 18.0 $ 9.3 $ 11.6
========== ========== ==========
[FN]
See Notes to Consolidated Financial Statements
</FN>
56
ORION CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS - (Continued)
Year Ended December 31,
----------------------------------
(In millions) 1998 1997 1996
- -------------------------------------------------------------------------------------------
Reconciliation of net earnings to net cash
provided by operating activities:
Net earnings .......................................... $ 102.8 $ 115.8 $ 86.6
---------- ---------- ----------
Adjustments:
Depreciation and amortization ......................... 15.9 13.4 12.1
Amortization of excess of cost over fair
value of net assets acquired ....................... 6.7 3.2 3.1
Deferred federal income taxes ......................... 3.6 4.5 10.0
Equity in (earnings) loss of affiliates,
net of dividends received .......................... 1.0 (8.2) 0.7
Realized investment gains ............................. (52.5) (47.8) (24.2)
Non-cash investment income ............................ (1.6) (19.0) (17.8)
Amortization (accretion) of fixed maturity investments (1.5) (2.5) 1.4
Restructuring expenses and other (Note 3) ............. (15.3) -- --
Minority interest expense in subsidiary net earnings .. -- 7.0 8.7
Other ................................................. 0.6 1.5 2.1
Changes in assets and liabilities, net of acquisitions,
divestiture and restructuring:
Decrease (increase) in accrued investment income ...... 2.0 (2.3) 1.2
(Increase) decrease in accounts and notes receivable .. (28.8) 1.4 7.5
Increase in reinsurance recoverables
and prepaid reinsurance ............................ (123.0) (91.0) (78.0)
Increase in deferred policy acquisition costs ......... (11.9) (8.1) (20.9)
Increase in other assets .............................. (16.0) (10.8) (34.3)
Increase in losses .................................... 60.5 47.4 115.2
Increase in loss adjustment expenses .................. 20.0 29.6 32.4
Increase in unearned premiums ......................... 38.4 45.6 58.9
Increase (decrease) in policyholders' dividends ....... (2.7) (2.0) 3.5
Increase (decrease) in other liabilities .............. 31.7 22.3 (0.5)
---------- ---------- ----------
Total adjustments and changes ........................ (72.9) (15.8) 81.1
---------- ---------- ----------
Net cash provided by operating activities ............. $ 29.9 $ 100.0 $ 167.7
========== ========== ==========
[FN]
See Notes to Consolidated Financial Statements
</FN>
57
ORION CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 1998, 1997 and 1996
Note 1 - Significant Accounting Policies
Basis of Financial Statement Presentation - Orion Capital Corporation
("Orion") and its wholly-owned subsidiaries (collectively the "Company") operate
principally in the property and casualty insurance business. The consolidated
financial statements and notes thereto are presented in accordance with
generally accepted accounting principles ("GAAP") for property and casualty
insurance companies and include the accounts of Orion and its wholly-owned
subsidiaries. The Company's investment in its unconsolidated affiliate is
accounted for using the equity method (See Note 4). All material intercompany
balances and transactions have been eliminated. The preparation of the Company's
consolidated financial statements in conformity with GAAP requires the Company's
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.
Regulation - The Company's insurance subsidiaries are subject to
comprehensive regulation by various state insurance departments including
regulations limiting dividend payments to Orion and intercompany transactions.
Under these regulations, the maximum dividends permitted at December 31, 1998
for the ensuing twelve months, without prior approval, aggregated $135.5
million. However, state insurance regulators have broad discretionary authority
with respect to approving the payment of dividends by insurance companies.
Policyholders' surplus of Orion's insurance subsidiaries determined in
accordance with prescribed statutory accounting practices amounted to $732.1
million and $789.0 million at December 31, 1998 and 1997, respectively.
Statutory net income amounted to $151.5 million, $146.1 million and $107.9
million for 1998, 1997 and 1996, respectively.
Cash - For purposes of the consolidated statement of cash flows, the
Company considers only demand deposit accounts to be cash.
Investments - Fixed maturity investments include bonds, preferred stocks
with mandatory redemption features, and certificates of deposit that mature more
than one year after the balance sheet date. Fixed maturity investments that the
Company has both the positive intent and the ability to hold to maturity are
recorded at amortized cost. Fixed maturity investments, which may be sold in
response to, among other things, changes in interest rates, prepayment risk,
income tax strategies or liquidity needs are classified as available-for-sale
and are carried at market value. Common stocks and non-redeemable preferred
stocks are also carried at market value. Fluctuations in the market value of
these available-for-sale securities are recorded as unrealized investment gains
or losses and credited or charged to stockholders' equity. Other long-term
investments principally include equity ownership interests in limited
partnerships, which are recorded using the equity method of accounting.
Short-term investments include certificates of deposit and commercial paper that
mature within one year of the balance sheet date, money market accounts and
United States Treasury Bills. Short-term investments are recorded at market
value, which approximates cost. Market values are generally based on quoted
market prices or dealer quotes. Realized investment gains and losses, including
provision for other than temporary impairment of investment securities, are
recognized on the specific identification method.
Deferred Policy Acquisition Costs - Costs that vary with, and are directly
related to, the production of new and renewal business are deferred and
amortized as the related premiums are earned. These costs primarily comprise
commissions, premium taxes and salaries. The test for recoverability of such
deferred
58
ORION CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
costs includes the consideration of net investment income.
Excess of Cost Over Fair Value of Net Assets Acquired - The excess of the
cost of acquiring subsidiaries over the fair value of their net assets
("goodwill") is amortized on a straight-line basis over periods of 25 to 40
years. The Company evaluates the recoverability of goodwill from expected future
cash flows, and impairments would be recognized in operating results if a
permanent diminution in value were to occur.
Revenue Recognition - Premiums are earned on a daily pro rata basis over
the policy period. A provision is made for anticipated retrospective premium
adjustments and audit premiums. Direct and assumed premiums are reduced for
reinsurance ceded to other insurers.
Policy Liabilities and Reinsurance - Loss and loss adjustment expense
liabilities are established in consideration of individual cases for reported
losses and past experience for incurred but not yet reported losses ("IBNR").
Estimated reinsurance receivables are recognized in a manner consistent with the
liabilities relating to the underlying reinsured contracts. At December 31, 1998
and 1997, long-term disability workers compensation loss reserves are carried at
$46.0 million and $52.9 million, respectively, in the consolidated financial
statements at net present value using a statutory interest rate of 3.5%.
Policyholders' dividends on participating policies are accrued at estimated
payment rates as the related premiums are earned. Participating business
represented 19% and 18% of premiums in-force at December 31, 1998 and 1997,
respectively. As a percent of premiums earned, participating business amounted
to 19% in 1998, 18% in 1997 and 16% in 1996.
Federal Income Taxes - The Company recognizes taxes payable or refundable
for the current year, and deferred taxes for the future tax consequences of
differences between the financial reporting and tax basis of assets and
liabilities. Deferred tax assets and liabilities are measured using enacted tax
rates expected to apply to taxable income in the years the temporary differences
are expected to reverse.
Earnings Per Common Share - In the fourth quarter of 1997, the Company
adopted Statement of Financial Accounting Standards ("FAS") No. 128, "Earnings
per Share," for all periods presented. Basic earnings per share computations are
based on the average number of shares of common stock outstanding during the
year. Diluted earnings per share reflect the assumed exercise and conversion of
all securities, including stock options. All common stock and per share common
stock data presented has been restated to give effect to the 2-for-1 stock split
of the Company's common stock issued on July 7, 1997.
Comprehensive Income - As of January 1, 1998 the Company adopted FAS No.
130, "Reporting Comprehensive Income". This statement establishes standards for
the reporting and presentation of comprehensive income and its components in
financial statements. Comprehensive income encompasses all changes in
shareholders' equity (except those arising from transactions with shareholders)
and includes net income, net unrealized capital gains or losses on
available-for-sale securities and foreign currency translation adjustments. This
standard requires additional disclosures and does not affect the Company's
financial position or results of operations.
Segment disclosures - During the fourth quarter of 1998, the Company
adopted FAS No. 131, "Disclosure about Segments of an Enterprise and Related
Information." FAS 131 establishes new standards for reporting information about
operating segments and related disclosures about products and services,
geographic areas and major customers. It requires that the segments be based on
the
59
ORION CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
internal structure and reporting of the Company's operations. The adoption of
FAS 131 did not materially effect the Company's primary financial statements,
but did affect the disclosure of segment information contained in Note 17 to the
consolidated financial statement. The segment disclosures for prior years have
been restated to conform to the current year presentation.
Reclassifications - The 1997 and 1996 consolidated financial statements
have been reclassified to conform to the 1998 presentation.
Note 2 - Acquisitions
Grocers - On July 9, 1998 the Company completed the acquisition of Grocers
Insurance Group ("Grocers") from United Grocers, Inc ("United"). Grocers is an
Oregon-based specialty insurance holding company serving the grocery and food
service industry. In 1997, Grocers reported approximately $23 million of net
premiums written, principally general liability, property and workers
compensation with the majority of its volume concentrated in the Northwestern
states. The purchase price was $36.7 million in cash including acquisition
expenses of $ 0.4 million. The Company made cash payments of $32.4 million in
1998 related to the purchase of Grocers. At December 31, 1998 the Company
retained $4.0 million of the purchase price due to United to secure obligations
of United and Grocers. The Company used cash and short-term investments to fund
the purchase. The acquisition was accounted for as a purchase and accordingly,
Grocers has been included in the Company's consolidated financial statements
from the date of acquisition. The total consideration exceeded the fair value of
the net assets acquired by approximately $8.1 million and is being amortized
over 25 years. The pro forma consolidated results of the Company's operations,
as if the Grocers purchase had been made as of the beginning of the year, would
not be materially different than reported herein.
Strickland - On April 30, 1998 the Company completed the acquisition of the
nonstandard personal automobile insurance business of North Carolina - based
Strickland Insurance Group, Inc. ("Strickland"). The acquisition included two
insurance companies, a premium finance company, a claims adjusting company and a
general agency in Florida. In 1997, Strickland reported approximately $99
million of personal automobile gross premiums written and $46 million of net
premiums written. The purchase price was $44.1 million in cash including
acquisition expenses of $0.2 million. The Company made cash payments of $39.7
million in 1998 and $2.0 million in 1997 related to the Strickland acquisition
with $2.4 million of the purchase price including interest retained by the
Company in part to secure obligations of Strickland. Simultaneous with the
acquisition, the Company repaid $9.4 million of Strickland bank debt. The
acquisition includes a purchase price contingency for loss development incurred
by the acquired business during the period from the acquisition date to December
31, 2000 relating to accident years prior to the acquisition date. The Company
used cash and short-term investments to fund the acquisition. The acquisition
was accounted for as a purchase and accordingly, the acquired business has been
included in the Company's consolidated financial statements from the date of
acquisition. The total consideration exceeded the fair value of the net assets
acquired by approximately $28.7 million and is being amortized over 25 years.
The pro forma consolidated results of the Company's operations, as if the
Strickland purchase had been made as of the beginning of the year, would not be
materially different than reported herein.
Unisun - On December 16, 1997, the Company purchased Unisun Insurance
Company ("Unisun") from Michigan Mutual Insurance Company for $26.2 million in
cash including acquisition expenses of $0.2 million. Unisun is the largest
automobile insurance facility carrier in South
60
ORION CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Carolina and also writes personal automobile insurance in the States of Alabama,
Georgia and North Carolina. Total net premiums written by Unisun for 1997 were
approximately $20.0 million. The acquisition includes a purchase price
contingency for loss development incurred by Unisun during the period from the
acquisition date to December 31, 2002 relating to accident years prior to the
acquisition date. The acquisition of Unisun was accounted for as a purchase, and
accordingly, Unisun has been included in the Company's financial statements from
the date of acquisition. The total consideration exceeded the estimated fair
value of net assets of Unisun by $5.3 million, which is being amortized over 25
years. The pro forma consolidated results of the Company's operations, as if the
Unisun purchase had been made as of the beginning of the year, would not be
materially different than reported herein.
Guaranty National Corporation 1997 purchase - The Company completed a
tender offer that increased its ownership of Guaranty National Corporation
("Guaranty National") from approximately 81% to 100% on December 10, 1997. The
Company purchased the remaining or 2,970,000 shares of Guaranty National common
stock in 1997 that were held by minority interest shareholders for $36 per share
in cash ("1997 GNC Purchase"). Immediately following the 1997 GNC Purchase,
Guaranty National was merged into a wholly owned subsidiary of the Company and
delisted as a publicly traded company on the New York Stock Exchange. As part of
the merger, 450,238 outstanding stock options granted by Guaranty National were
converted into 358,090 stock options of the Company, with equivalent terms as
the Guaranty National options except for the exercise price, which was adjusted
to reflect the difference between the then current stock prices.
The 1997 GNC Purchase was recorded as a step acquisition using the purchase
method of accounting. The aggregate purchase price was $116.1 million, including
stock options converted of $8.4 million and acquisition expenses of $0.8
million. The Company recorded the excess of the cost over the estimated fair
value of the 19.7% interest in Guaranty National's net assets acquired during
1997 of $59.5 million and eliminated the related minority interest. The excess
of the cost over fair value will be amortized over 27 years, which is the
remaining amortization period for goodwill recorded upon the Company's initial
investment in Guaranty National.
Guaranty National Corporation 1996 purchase - On July 2, 1996, the Company
completed a tender offer for 4,600,000 shares of Guaranty National common stock
("1996 GNC Purchase"). Together with the open-market purchase of 120,000
additional shares on July 17, 1996, the Company increased its ownership of
Guaranty National from 49.5% to approximately 81%. The aggregate purchase price
of approximately $88.2 million, including expenses, was paid in cash.
The 1996 GNC Purchase was recorded as a step acquisition using the purchase
method of accounting as of June 30, 1996. The assets and liabilities of Guaranty
National were consolidated in the Company's financial statements and minority
interest for approximately 19% of Guaranty National's shareholders equity was
recorded. Beginning in 1996, all revenues and expenses of Guaranty National have
been consolidated with those of the Company, and minority interest expense has
been recorded for the portion of Guaranty National's earnings that was
attributable to the shares not owned by the Company until it became a
wholly-owned subsidiary.
The increase in the Company's ownership in 1996 to over 80% of Guaranty
National allowed the inclusion of Guaranty National in Orion's consolidated
federal income tax return, as well as the reversal of a deferred tax liability
previously established by the Company for its share of the undistributed
earnings
61
ORION CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
of Guaranty National. The excess of cost over the estimated fair value of the
31.5% interest in Guaranty National's net assets acquired during 1996 was $9.1
million, after the reversal of $21.5 million of deferred taxes, and will be
amortized over 28 years, which was the remaining amortization period for
goodwill recorded upon Orion's initial investment in Guaranty National.
Pro forma information, as if Guaranty National was 100% owned as of the
beginning of 1996, is as follows for the year ended December, 31:
(In millions, except for per share amounts) 1997 1996
- --------------------------------------------------------------------------
Total revenues $ 1,590.5 $ 1,491.2
=========== ===========
Net earnings $ 116.9 $ 93.8
=========== ===========
Net earnings per diluted share $ 4.16 $ 3.35
=========== ===========
Note 3 - Orion Specialty Realignment
In the third quarter of 1998, the Company announced an accelerated
realignment of its Orion Specialty unit to address lines that had not met the
Company's growth and profitability expectations. The realignment continued Orion
Specialty's shift away from commodity business, primarily commercial auto and
transportation, to a smaller number of more client-focused programs and
specialty niches. The 1998 realignment has included the discontinuation of
approximately $100 million in annualized net written premiums of unprofitable
commodity and marginal lines of business, the reduction of approximately 90
employees related to the exited business, and the sale of Colorado Casualty.
Colorado Casualty produced approximately $55 million in annual net premiums,
which consisted largely of business that did not fit the Company's
specialization strategy.
The Company recorded severance and program termination expenses of $7.0
million and asset write downs of $1.9 million related to the exited business in
the third quarter of 1998. On September 29, 1998, the Company sold Colorado
Casualty resulting in a pre-tax gain of approximately $24.2 million. Charges for
severance and program termination expenses and asset write-offs, and the gain
from the sale of Colorado Casualty, representing a net pre-tax gain of $15.3
million, are reflected as "Restructuring expenses and other" in the Company's
Consolidated Statement of Earnings.
The restructuring liability activity for the year ended December 31, 1998 is as
follows:
(In millions)
- -------------------------------------------------------------------
Balance at December 31, 1997 $ -
Restructuring expenses 8.9
Actions taken:
Asset write-downs (1.9)
Severance and program termination costs (1.9)
----------
Balance at December 31, 1998 $ 5.1
==========
62
ORION CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
In connection with the third quarter realignment, the Company completed an
actuarial analysis for the business to be exited resulting in a provision for
losses and loss adjustment expenses of $27.8 million in the third quarter of
1998. The Company will continue in 1999 to assess Orion Specialty's remaining
programs.
Note 4 - Investment in Affiliate
As of December 31, 1998, the Company owned 26% of the common stock of
Intercargo Corporation ("Intercargo"), a publicly held company. The Company
records its share of Intercago's operating results on a quarterly lag basis,
after Intercargo has reported its financial results. In December 1998, the
Company agreed to sell its investment in Intercargo for $22.8 million or $12 per
share in cash pursuant to Intercargo's merger with X. L. America, Inc., a
subsidiary of EXEL Limited. The Company reduced the carrying value of its
investment in Intercargo to $22.8 million resulting in $7.0 million pre-tax
realized investment loss during December 1998. The sale of Intercargo is
expected to be complete in the late first quarter or early second quarter of
1999, subject to regulatory approval.
The carrying values of the Company's investment in affiliates were $22.8
million at December 31, 1998 and $31.3 million at December 31, 1997. The
carrying value included $3.0 million and $10.5 million of goodwill at December
31, 1998 and 1997, respectively. In August 1997, Intercargo recognized a gain
before taxes of $49.4 million from the sale of substantially all of its
interest in Kingsway Financial Services. The Company reflected its portion of
the Kingsway sale by recording a gain before taxes of $7.0 million in the fourth
quarter of 1997.
Summarized financial information for the Company's affiliate is set forth
below:
(In millions) 1998 1997 1996
- ---------------------------------------------------------------------
Year Ended December 31:
Revenues ............................. $ 63.7 $ 117.8 $ 74.5
Expenses ............................. 62.6 65.2 74.8
------- ------- -------
1.1 52.6 (0.3)
Federal income (taxes) benefit ....... (2.3) (15.9) 0.2
------- ------- -------
Net earnings (loss) .................. $ (1.2) $ 36.7 $ (0.1)
======= ======= =======
Company's proportionate share,
including goodwill amortization (a) $ (0.7) $ 8.6 $ (0.4)
======= ======= =======
(In millions) 1998 1997
- ----------------------------------------------------------------------
At December 31:
Cash and investments $ 109.6 $ 131.8
Other assets 55.6 54.0
------- -------
165.2 185.8
Policy liabilities (70.3) (72.7)
Other liabilities (13.8) (29.2)
------- -------
Stockholders' equity $ 81.1 $ 83.9
======= =======
(a) 1998 excludes $7.0 million pre-tax realized investment loss.
63
ORION CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Note 5 - Investments
The amortized cost and estimated market values of investments in fixed
maturities, equity securities and short-term investments at December 31 are as
follows:
Gross Gross Estimated
Amortized Unrealized Unrealized Market
(In millions) Cost Gains Losses Value
- -----------------------------------------------------------------------------------------
1998:
Held-to-maturity securities:
United States Government and
government agencies and authorities $ 81.4 $ 3.2 $ - $ 84.6
States, municipalities and
political subdivisions 156.1 8.4 - 164.5
Corporate securities 23.1 0.5 - 23.6
--------- --------- --------- ---------
$ 260.6 $ 12.1 $ - $ 272.7
========= ========= ========= =========
Available-for-sale securities:
United States Government and
Government agencies and authorities $ 69.0 $ 1.9 $ (0.3) $ 70.6
States, municipalities and
political subdivisions 684.1 41.1 (1.4) 723.8
Foreign governments 4.1 0.6 - 4.7
Corporate securities 447.6 20.7 (19.3) 449.0
Mortgage-backed securities
(exclusive of government agencies) 100.7 2.5 (1.4) 101.8
Equity securities 469.4 78.9 (37.4) 510.9
Short-term investments 248.7 - - 248.7
--------- --------- --------- ---------
$ 2,023.6 $ 145.7 $ (59.8) $ 2,109.5
========= ========= ========= =========
1997:
Held-to-maturity securities:
United States Government and
government agencies and authorities $ 122.7 $ 1.8 $ (0.5) 124.0
States, municipalities and
political subdivisions 166.9 7.6 - 174.5
Corporate securities 23.2 0.7 - 23.9
--------- --------- --------- ---------
$ 312.8 $ 10.1 $ (0.5) $ 322.4
========= ========= ========= =========
Available-for-sale securities:
United States Government and
government agencies and authorities $ 381.7 $ 22.5 $ (2.9) $ 401.3
States, municipalities and
political subdivisions 439.5 30.6 (0.2) 469.9
Foreign governments 4.6 0.5 - 5.1
Corporate securities 526.5 27.4 (4.5) 549.4
Mortgage-backed securities
(exclusive of government agencies) 43.1 1.0 - 44.1
Equity securities 346.6 101.4 (9.5) 438.5
Short-term investments 228.3 - - 228.3
--------- --------- --------- ---------
$ 1,970.3 $ 183.4 $ (17.1) $ 2,136.6
========= ========= ========= =========
64
ORION CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Net investment income for the years ended December 31 is as follows:
(In millions) 1998 1997 1996
- ------------------------------------------------------------------------
Net investment income:
Fixed maturities ............ $ 109.2 $ 115.8 $ 98.2
Equity securities ........... 19.4 18.4 19.9
Other long-term investments . 2.6 17.4 16.1
Short-term investments ...... 10.8 16.3 13.2
Accounts and notes receivable 0.7 0.5 0.3
Other ....................... 3.2 0.1 0.3
-------- -------- --------
Total investment income ..... 145.9 168.5 148.0
Less investment expenses .... 2.7 3.6 2.6
-------- -------- --------
Net investment income $ 143.2 $ 164.9 $ 145.4
======== ======== ========
Certain information concerning realized and unrealized gains (losses) for fixed
maturities and equity securities during the years ended December 31 is set forth
below:
(In millions) 1998 1997 1996
- ------------------------------------------------------------------------
Fixed maturities available-for-sale:
Gross realized gains ....................$ 31.1 $ 12.0 $ 10.3
Gross realized losses ................... (15.4) (7.4) (7.1)
Provision for other than temporary
Impairment ........................... (3.2) (2.0) (1.1)
-------- -------- --------
$ 12.5 $ 2.6 $ 2.1
======== ======== ========
Change in unrealized gains (losses)
Recorded in stockholders' equity .....$ (30.0) $ 38.9 $ (11.1)
======== ======== ========
Equity securities:
Gross realized gains ....................$ 80.9 $ 51.5 $ 29.0
Gross realized losses (a) ............... (39.8) (7.3) (6.6)
Provision for other than temporary
Impairment ........................... (1.1) (0.4) (0.3)
-------- -------- --------
$ 40.0 $ 43.8 $ 22.1
======== ======== ========
Change in unrealized gains (losses)
Recorded in stockholders' equity .....$ (50.4) $ 18.4 $ 18.4
======== ======== ========
(a) 1998 includes $7.0 million realized loss related to the planned sale of
Intercargo.
65
ORION CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The amortized cost and estimated market values of fixed maturity and
short-term investments at December 31, 1998, by contractual fiscal maturity, are
shown below. Expected maturities will differ from contractual maturities because
issuers of securities may have the right to call or prepay obligations with or
without call or prepayment penalties.
Fixed Maturities Fixed Maturities
Held-to-Maturity Available-for-Sale
--------------------------- -----------------------
Estimated Estimated
Amortized Market Amortized Market
(In millions) Cost Value Cost Value
- -------------------------------------------------------------------------------------------
Due in one year or less .............. $ 8.7 $ 8.8 $ 264.7 $ 264.9
Due after one year through five years 173.4 179.4 256.9 252.1
Due after five years through ten years 34.7 37.1 266.0 278.1
Due after ten years .................. 43.8 47.4 655.6 691.3
-------- ---------- ---------- ----------
260.6 272.7 1,443.2 1,486.4
Mortgage-backed securities ........... -- -- 111.0 112.2
-------- ---------- ---------- ----------
$ 260.6 $ 272.7 $ 1,554.2 $ 1,598.6
======== ========== ========== ==========
Other long-term investments had aggregate carrying values of $116.2 million
at December 31, 1998 and $94.3 million at December 31, 1997 including mortgage
loans on real estate of $2.2 million and $2.3 million, respectively. Estimated
market values of mortgage loans and other long-term investments approximate
their carrying values. The carrying value of the Company's investments in
principal-only securities and interest-only securities totaled approximately
$1.5 million at December 31, 1998.
The carrying value of securities on deposit with state regulatory
authorities in accordance with statutory requirements totaled $242.4 million and
$223.4 million at December 31, 1998 and 1997, respectively. Excluding
investments in securities of the United States Government and its agencies, the
Company had investments in only one issuer (AAA rated fixed income securities
totaling $26.7 million) that exceeded $25.0 million. The Company had $0.2
million of fixed maturity investments for which it was not accruing income for
both 1998 and 1997.
Note 6 - Reinsurance
In the normal course of business, the Company's insurance subsidiaries
reinsure certain risks, generally on an excess-of-loss or pro rata basis, with
other companies to limit exposure to losses. Reinsurance does not discharge the
primary liability of the original insurer. As of December 31, 1998 and 1997,
recoverables for reinsurance ceded to the Company's two largest reinsurers were
an aggregate of $71.7 million and $132.8 million, respectively. As of December
31, recoverables for reinsurance ceded to the two largest McGee pool members
other than the Company aggregated $50.6 million for 1998, and $54.7 million for
1997, and the Company had ceded balances payable to these pool members of $6.3
million and $21.0 million, respectively.
66
ORION CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The table below illustrates the effect of reinsurance on premiums written
and premiums earned for the years ended December 31:
(In millions, except for %) 1998 1997 1996
- -------------------------------------------------------------------------------
Direct premiums written ............... $ 1,862.0 $ 1,521.3 $ 1,431.4
Reinsurance assumed ................... 117.8 72.0 174.7
---------- ---------- ----------
Gross premiums written ................ 1,979.8 1,593.3 1,606.1
Reinsurance ceded ..................... (446.2) (226.2) (272.0)
---------- ---------- ----------
Net premiums written .................. $ 1,533.6 $ 1,367.1 $ 1,334.1
========== ========== ==========
Percentage of amount assumed to net ... 7.7% 5.3% 13.1%
========== ========== ==========
Direct premiums earned ................ $ 1,810.6 $ 1,500.8 $ 1,388.9
Reinsurance assumed ................... 116.8 106.1 182.5
---------- ---------- ----------
Gross premiums earned ................. 1,927.4 1,606.9 1,571.4
Reinsurance ceded ..................... (424.4) (249.2) (270.6)
---------- ---------- ----------
Net premiums earned ................... $ 1,503.0 $ 1,357.7 $ 1,300.8
========== ========== ==========
Loss and loss adjustment expenses
incurred recoverable from reinsurers $ 457.2 $ 165.4 $ 174.3
========== ========== ==========
Reinsurance recoverables and prepaid reinsurance includes prepaid
reinsurance of $129.8 million at December 31, 1998 and $125.5 million at
December 31, 1997.
67
ORION CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Note 7- Loss and Loss Adjustment Expense Reserves
An analysis of the Company's calendar year net loss and loss adjustment
expense reserves for the three years ended December 31, 1998 is summarized in
the following table. The 1996 current year provision and payments include
favorable loss development for Guaranty National of $1.0 million and payments of
$144.8 million attributable to periods prior to the consolidation of Guaranty
National's results in the Company's financial statements.
(In millions) 1998 1997 1996
- --------------------------------------------------------------------------
Net balance, beginning of year . $ 1,390.7 $ 1,368.4 $ 994.0
Effect of acquisitions and other 16.9 8.9 286.3
---------- ---------- ----------
1,407.6 1,377.3 1,280.3
---------- ---------- ----------
Provision:
Current year ................ 986.6 896.3 874.1
Prior years ................. 33.9 9.2 8.9
---------- ---------- ----------
1,020.5 905.5 883.0
---------- ---------- ----------
Payments:
Current year ................ 450.3 370.9 499.2
Prior years ................. 559.4 521.2 295.7
---------- ---------- ----------
1,009.7 892.1 794.9
---------- ---------- ----------
Net balance, end of year ....... 1,418.4 1,390.7 1,368.4
Add reinsurance recoverables 599.3 481.0 417.3
---------- ---------- ----------
Balance, end of year ........... $ 2,017.7 $ 1,871.7 $ 1,785.7
========== ========== ==========
Loss reserve estimates are based on forecasts of the ultimate settlement of
claims and are subject to uncertainty with respect to future events. Loss
reserve amounts are based on management's informed estimates and judgments,
using data currently available. Reserve amounts and the underlying actuarial
factors and assumptions are regularly analyzed and adjusted to reflect new
information. Such re-evaluation is a normal, recurring activity that is inherent
in the process of loss reserve estimation and therefore, no assurances can be
given that reserve development will not occur in the future. During the three
years ended December 31, 1998 a substantial portion of the loss development
experienced by the Company resulted from pools and associations, assumed
reinsurance, and certain discontinued lines and program business (including
$17.0 million in 1998 related to Orion Specialty realignment), partly reduced by
favorable development in workers compensation.
68
ORION CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
An analysis of the Company's loss and loss adjustment expense environmental
reserves and claim counts for the three years ended December 31, 1998 is
presented below. Claim counts (excluding pools and associations) have been
aggregated by year of coverage for each occurrence for which policyholders are
being defended, and often include numerous claimants.
1998 1997 1996
------------------ ---------------- ---------------
Claim Claim Claim
(In millions, except for claims count) Amount Counts Amount Counts Amount Counts
- ----------------------------------------------------------- ---------------- ---------------
Net balance, beginning of year $ 67.9 551 $ 57.0 632 $ 34.6 474
Provision .................. 5.3 17.7 24.4
Payments ................... (7.5) (6.8) (4.8)
Acquisitions ............... -- -- 2.8 70
------- ------- -------
Net balance, end of year ...... 65.7 515 67.9 551 57.0 632
Add reinsurance recoverables 13.0 12.3 12.5
------- ------- -------
Balance, end of year .......... $ 78.7 $ 80.2 $ 69.5
======= ======= =======
The Company's environmental claims principally relate to asbestos and
hazardous waste, arising from certain liability business written prior to the
mid 1980's, which business was never a major element of the Company's
operations. Environmental claims are also received from certain pools and
associations where reserves are established based on information reported to the
Company by the managers of those pools and associations. In view of the lines of
insurance that the Company has traditionally written, environmental claims have
not represented, and are not expected to represent in the future, a material
portion of the Company's total claims.
Establishing reserve liabilities for environmental claims is subject to
significant uncertainties that make reserve estimation difficult. Legal
decisions have tended to expand insurance coverage beyond the intent of the
policies. The Company does not use discounting in determining its reserves for
environmental claims. IBNR of $45.6 million and $51.0 million is included in net
reserves for environmental claims at December 31, 1998 and 1997, respectively.
The net reserve for environmental claims and IBNR increased in 1997 primarily
due to higher claims reported to the Company by certain pools and associations,
which is the basis of establishing such reserve, and higher loss reserve
estimates.
69
ORION CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Note 8 - Notes Payable
Notes payable are recorded at face value less unamortized discount. The
carrying value and estimated market value of notes payable at December 31
consist of the following:
Estimated
Carrying Value Market Value
------------------ -------------------
(In millions) 1998 1997 1998 1997
- ----------------------------------------------------------- -------------------
$110.0 face amount, 9.125% Senior
Notes, due September 1, 2002 . $ 109.9 $ 109.9 $ 118.9 $ 121.2
$100.0 face amount, 7.25% Senior
Notes, due July 15, 2005 ..... 99.5 99.4 102.9 103.2
Bank credit facility ............ 8.0 -- 8.0 --
Loan agreement with banks ....... -- 100.0 -- 100.0
Collateralized term loan ........ -- 0.9 -- 0.9
-------- -------- -------- --------
$ 217.4 $ 310.2 $ 229.8 $ 325.3
======== ======== ======== ========
On July 8, 1998 the Company entered into a credit agreement with a group of
banks ("Bank Credit Facility") which provides for unsecured borrowings up to
$150 million. The Bank Credit Facility expires on July 8, 2003 and provides for
two one-year extension periods. The Company intends to use the Bank Credit
Facility for general corporate purposes, which may include acquisitions. The
Bank Credit Facility carries an annual facility fee on the unused amounts of the
credit facility. Borrowings under the Bank Credit Facility bear interest at
LIBOR (London Interbank Offered Rate) plus a margin based upon the Company's
credit ratings. The Bank Credit Facility requires the Company to maintain
certain financial covenants including a maximum debt to total capitalization
ratio of 0.4 to 1.0, as defined, and a minimum combined statutory surplus of
$650 million plus 30% of the Company's aggregate combined annual statutory net
income. The Bank Credit Facility limits the Company's ability to incur secured
indebtedness or certain contingent obligations except for indebtedness secured
by liens specifically permitted by the Bank Credit Facility and additional
secured indebtedness with a principal amount not exceeding 10% of the Company's
consolidated net worth, as defined.
The indentures for the 7.25% Senior Notes and the 9.125% Senior Notes limit
the amount of liens and guarantees by the Company, and the Company's ability to
incur secured indebtedness without equally and ratably securing the senior
notes.
The $100 million borrowings under the loan agreement between Guaranty
National and several banks outstanding at December 31, 1997 was fully repaid by
the Company in February 1998 from proceeds of the sale of the 7.701% Trust
Preferred Securities (See Note 9).
As of December 31, 1998 maturities of the Company's notes payable are as
follows: 2002 - $110.0 million, 2003 - $8.0 million, and 2005 - $100.0 million.
70
ORION CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Note 9 - Trust Preferred Securities
Company-Obligated Mandatorily Redeemable Preferred Capital Securities
of Subsidiary Trusts Holding Solely the Junior Subordinated Debentures of the
Company ("Trust Preferred Securities") at December 31 comprise the following:
Estimated
Carrying Value Market Value
----------------- ----------------
(In millions) 1998 1997 1998 1997
- ---------------------------------------------------------------------------
8.73% Trust Preferred Securities
due January 1, 2037 $ 125.0 $ 125.0 $ 119.0 $ 137.5
7.701% Trust Preferred Securities
due April 15, 2028 125.0 - 112.0 -
------- ------- ------- -------
$ 250.0 $ 125.0 $ 231.0 $ 137.5
======= ======= ======= =======
On January 13, 1997 Orion issued $125 million of 8.73% Junior Subordinated
Deferrable Interest Debentures due January 1, 2037 (the "8.73% Debentures") to
Orion Capital Trust I ("Trust I"), a Delaware statutory business trust sponsored
by Orion. Trust I simultaneously sold $125 million of 8.73% capital securities
(the "8.73% Trust Preferred Securities") which have substantially the same terms
as the 8.73% Debentures. The net proceeds from the sale of the 8.73% Trust
Preferred Securities were used in part for the acquisition of Guaranty National
common stock in December 1997. The 8.73% Trust Preferred Securities may be
redeemed without premium on or after January 1, 2007.
On February 2, 1998 Orion issued $125 million of 7.701% Junior Subordinated
Deferrable Interest Debentures due April 15, 2028 (the "7.701% Debentures") to
Orion Capital Trust II ("Trust II"), a Delaware statutory business trust
sponsored by Orion. Trust II then sold $125 million of 7.701% capital securities
(the "7.701% Trust Preferred Securities"), which have substantially the same
terms as the 7.701% Debentures. Approximately $100 million of net proceeds from
the sale of the 7.701% Trust Preferred Securities were used to repay bank
indebtedness of Guaranty National in February 1998.
The 8.73% and 7.701% Trust Preferred Securities are subordinate to all
liabilities of the Company. The Company may defer interest distributions on
these Trust Preferred Securities; however, during any period when such
cumulative distributions have been deferred, Orion may not declare or pay any
dividends or distributions on its common stock. The Company registered the Trust
Preferred Securities under the Securities Act of 1933. The Trusts are
consolidated in the Company's financial statements because they are wholly-owned
by the Company. The sole assets of the Trusts are the Debentures issued by
Orion. Orion has given its partial guarantee, which when taken together with the
Company's obligations under the declaration of the Trust, the Debentures, and
the indenture pursuant to which the Trust Preferred Securities are issued
including its obligations to pay costs, expenses, debts and liabilities of the
Trusts (other than with respect to the Trust Preferred Securities), provides a
full and unconditional guarantee of amounts due on the Trust Preferred
Securities.
71
ORION CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Note 10 - Federal Income Taxes
Orion and its wholly-owned subsidiaries file a consolidated federal income
tax return, including Guaranty National from July 2, 1996. Substantially all
federal income taxes incurred by Orion and its subsidiaries relate to domestic
operations.
In October 1996 the Internal Revenue Service ("IRS") completed an
examination of the Company's federal income tax returns through 1992. Certain
tax benefits from tax attributes existing at the date of the Company's
reorganization in 1976 were not recognized pending completion of the IRS
examination. Accordingly, the Company recorded a credit to capital surplus in
1996 for tax benefits of $11.9 million with respect to the 1976 reorganization.
The recording of this credit had no impact on the Company's earnings.
The components of the provision (benefit) for federal income taxes on
income from operations and allocations of taxes (benefits) to other items for
the years ended December 31 are as follows:
(In millions) 1998 1997 1996
- ---------------------------------------------------------------------------------------
Taxes on income from operations before minority interest:
Current .................................................$ 37.5 $ 42.0 $ 22.0
Deferred ................................................ 3.6 4.5 10.0
------ ------ ------
41.1 46.5 32.0
Tax benefit from trust preferred securities ................ (6.8) (3.7) --
------ ------ ------
Total tax expense ....................................... 34.3 42.8 32.0
Taxes allocated to stockholders' equity for:
Unrealized appreciation (depreciation) of securities .... (28.0) 22.8 2.0
Pre-reorganization income tax benefits .................. -- -- (11.9)
Other ................................................... (1.5) (2.0) 0.6
------ ------ ------
$ 4.8 $ 63.6 $ 22.7
====== ====== ======
72
ORION CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The tax effects of the temporary differences comprising the Company's net
deferred tax asset at December 31 are as follows:
(In millions) 1998 1997
- -----------------------------------------------------------
Deferred tax assets:
Loss reserve discounting ........ $ 71.8 $ 72.2
Unearned premium reserves ....... 32.6 30.1
Policyholders' dividends ........ 6.3 7.1
Retiree medical benefits ........ 5.4 4.6
Deferred compensation ........... 5.0 7.8
Other ........................... 20.9 19.8
------- -------
142.0 141.6
------- -------
Deferred tax liabilities:
Deferred policy acquisition costs 54.7 51.5
Unrealized investment gains ..... 30.2 58.4
Investment income ............... 18.3 16.5
Other ........................... 12.1 14.2
------- -------
115.3 140.6
------- -------
Net deferred tax asset ....... $ 26.7 $ 1.0
======= =======
A reconciliation of expected federal income tax expense on pre-tax earnings
at regular corporate rates to actual tax expense for the years ended December 31
is as follows:
(In millions, except for %) 1998 1997 1996
- ----------------------------------------------------------------------------------------
Amount Rate Amount Rate Amount Rate
Expected income tax expense $ 48.0 35.0% $ 58.0 35.0% $ 44.6 35.0%
Tax-exempt interest ........ (13.1) -9.6% (11.5) -6.9% (10.2) -8.0%
Dividends-received deduction (5.7) -4.2% (5.6) -3.3% (6.5) -5.1%
Amortization of goodwill ... 4.2 3.1% 1.1 0.6% 1.0 0.8%
Other ...................... 0.9 0.7% 0.8 0.4% 3.1 2.5%
------- ---- ------- ---- ------- ----
Actual income tax expense .. $ 34.3 25.0% $ 42.8 25.8% $ 32.0 25.2%
======= ==== ======= ==== ======= ====
Note 11 - Employee Benefit Plans
The Company maintains 401(k) and Profit Sharing Plan(s) ("Plans"),
qualified under the Internal Revenue Code Section 401(a) for eligible employees
of the Company. (These Plans include the Orion Capital 401(k) and Profit Sharing
Plan, Orion Capital Corporation Retirement Savings Plan for the Employees of
Guaranty National Insurance Company and Wm. H. McGee & Co., Inc. Profit Sharing
Plan.) Employee and employer matched contributions to the Plans are limited to
the extent allowable under the Plans and in accordance with Internal Revenue
Code limits. The Plans also provide a provision that allows the Company to make
annual profit sharing contributions to the Plans based on percentage of
employee's compensation. The profit sharing contribution is determined annually
by the Company. Employees vest in the Company's contributions on a graduated
scale over a six-year or seven-year period. In addition to the active plans,
Strickland, acquired in April 1998, froze its 401(k) defined contribution plan
for all its eligible employees. The Company has adopted supplemental benefit
plans to provide
73
ORION CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
accrual of benefits for those eligible employees who receive less than the full
employer contributions to the Company's qualified plans as a result of the
Internal Revenue Code limitations.
During 1998, the Company's shareholders approved the Employees' Stock
Purchase Plan to allow eligible employees of the Company and its subsidiaries to
purchase, through payroll deductions, shares of the Company's common stock at 90
percent of the fair market value at specified dates. In May 1998, the Company
reserved 300,000 shares of its common stock for issuance under the Employees'
Stock Purchase Plan. The initial purchase period began on July 1, 1998 and ended
December 31, 1998, resulting in 29,851 shares issued at an aggregate purchase
price of $1.1 million. At December 31, 1998 approximately 24% of eligible
employees participated in the plan and 270,149 shares are reserved for future
issuance under the plan.
The Company maintains incentive plans for key employees, including the 1982
Long-Term Performance Incentive Plan and the Equity Incentive Plan (together the
"Incentive Plans"). Orion has awarded both stock options and restricted stock to
members of the Company's management under the Incentive Plans. All stock options
are granted by Orion with exercise prices at fair market value at date of grant,
and are intended to qualify to the maximum extent possible as incentive stock
options. Stock options become exercisable from the first through fourth
anniversaries of the date of grant, and expire ten years after the date of
grant. Restricted stock is considered issued and outstanding when awarded. There
are restrictions as to its transferability, which restrictions generally lapse
in 25% increments over four or five year periods from the date of grant. For
certain employees, the restrictions fully lapse after three years from the date
of grant if the participant remains employed with the Company. As of December
31, 1998, the number of shares of stock reserved under the Incentive Plans is
1,693,152, of which 1,611,442 are for outstanding stock options and 81,710 are
available for future awards under the Incentive Plans. Included in 1997 granted
options of 696,600 were 358,090 of stock options relating to the 1997
acquisition of Guaranty National.
74
ORION CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
A summary of the status of Orion's stock option plans at December 31, 1998
and for the three years then ended is presented below:
(Shares in thousands) 1998 1997 1996
- --------------------------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
Beginning of year ........ 1,452.4 $ 25.16 893.7 $ 18.07 588.3 $ 12.40
Granted ............... 538.9 37.39 696.6 32.39 374.1 25.68
Cancelled ............. (75.8) 31.37 (33.1) 29.42 (13.9) 17.14
Exercised ............. (304.1) 13.47 (104.8) 11.41 (54.8) 9.47
------- ------- -----
End of year .............. 1,611.4 31.10 1,452.4 25.16 893.7 18.07
======= ======= ======= ======= ===== =======
Exercisable at end of year 594.4 $ 23.59 646.1 $ 16.95 402.0 $ 11.48
======= ======= ======= ======= ===== =======
(Shares in thousands) December 31, 1998
- -------------------------------------------------------------------------------
Weighted Weighted Weighted
Range of Average Average Average
Exercise Options Exercise Remaining Options Exercise
Prices Outstanding Price Years Exercisable Price
$ 10.01 - $ 17.50 167.3 $ 15.12 5.1 167.3 $ 15.12
17.51 - 25.00 310.5 21.48 6.9 210.3 21.44
25.01 - 40.00 791.2 32.32 9.0 140.4 25.89
40.01 - 46.00 305.4 43.87 8.8 76.4 43.87
46.01 - 57.00 37.0 52.95 9.3 - -
------- ---------
10.01 - 57.00 1,611.4 31.10 8.1 594.4 23.59
======= ======== === ========= =========
The Company applies Accounting Principles Board Opinion No. 25 and related
interpretations in accounting for stock options granted under the Incentive
Plans and the Employees' Stock Purchase Plan. Accordingly, no compensation cost
has been recognized for activities related to these plans. Had compensation cost
for these plans been recognized pursuant to FAS 123 "Accounting for Stock-Based
Compensation," the Company's net earnings and earnings per diluted share on a
proforma basis for the years ended December 31, 1998, 1997 and 1996 would have
been approximately $100.8 million or $3.62 per diluted share, $114.9 million or
$4.12 per diluted share, and $86.5 million or $3.11 per diluted share,
respectively.
The weighted average fair value of options granted was $10.62 per share for
1998, $14.08 per share for 1997 and $14.58 per share for 1996. The fair value of
options granted was estimated on the date of grant using the binomial
option-pricing model with the following weighted-average assumptions: dividend
yield of 1.9% - 1998 and 1996, and 1.5% - 1997; expected volatility of 22% -
1998, 23% - 1997 and 19% - 1996; risk free interest rate of 5.4% - 1998, 5.5% -
1997 and 6.0% - 1996; and expected life 7.0 years - both 1998 and 1997 and 7.1
years in 1996.
75
ORION CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
During 1998 and 1997 Orion granted 26,000 and 69,000 stock options,
respectively, to directors at fair market value, which become exercisable one
year from the date of grant and expire in ten years.
Orion granted 130,263 shares of restricted stock at a weighted average fair
value of $40.91 per share during 1998, 57,202 shares at $43.95 per share during
1997 and 92,636 shares at $25.61 per share for 1996. As of December 31, 1998,
the restrictions have not lapsed on 224,013 shares of restricted stock. The fair
market value of restricted stock on the date of issuance is amortized over the
vesting period during which the restrictions lapse.
The total expense for 1998, 1997 and 1996 for the above savings, retirement
and employee benefit plans, excluding amortization of deferred compensation on
restricted stock, was $10.1 million, $10.9 million and $9.5 million,
respectively.
Note 12 - Postretirement Medical Benefits and Defined Benefit Pension Plans
During the fourth quarter of 1998, the Company adopted FAS 132 "Employers'
Disclosures about Pensions and Other Postretirement Benefits," which modifies
the Company's disclosure of such benefits.
The Company and subsidiaries provide postretirement benefits to eligible
employees, who have attained age 55 and have 10 years of consecutive service
immediately prior to retirement. The Company premium subsidy provided to
eligible participants electing continuation of medical Plan benefits coverage is
a service formula based on years of service up to a maximum of 25 years.
McGee has a noncontributory defined benefit retirement plan covering all
eligible employees. Unisun, which was acquired in December 1997, froze its
defined benefit pension plan for all of its eligible employees.
76
ORION CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The Company's benefit obligation, plan assets and recorded balances for the
years ended December 31 are as follows:
Postretirement
Pension Benefits Benefits
-------------------- -------------------
(In millions, except for %) 1998 1997 1998 1997
- -------------------------------------------------------------------------- -------------------
Change in benefit obligation:
Benefit obligation, beginning of year .............. $ 30.6 $ 23.0 $ 6.2 $ 9.8
Service cost .................................... 0.9 0.8 0.5 1.0
Interest cost ................................... 2.1 1.6 0.5 0.7
Actuarial losses (gains) and amendments ......... 1.7 1.1 0.7 (4.9)
Acquisitions .................................... -- 5.8 0.5 --
Benefit paid, net of participants' contributions (2.1) (1.7) (0.5) (0.4)
------- ------- ------- ------
Benefit obligation, end of year .................... 33.2 30.6 7.9 6.2
------- ------- ------- ------
Change in plan assets:
Fair value of plan assets, beginning of year ....... 27.9 19.4 -- --
Return on plan assets ........................... 4.0 2.6
Acquisitions .................................... -- 7.1 -- --
Employer contributions .......................... 0.9 0.5 0.5 0.4
Benefits paid, net of participants' contributions (2.1) (1.7) (0.5) (0.4)
------- ------- ------- ------
Fair value of plan assets, end of year ............. 30.7 27.9 -- --
------- ------- ------- ------
Funded status ...................................... (2.5) (2.7) (7.9) (6.2)
Unrecognized net gains ............................. (1.4) (1.2) (7.1) (8.9)
------- ------- ------- ------
Accrued benefit cost ............................ $ (3.9) $ (3.9) $ (15.0) $(15.1)
======= ======= ======= ======
Weighted-average assumptions as
of December 31:
Discount rate ...................................... 6.75% 7.0% 6.75% 7.0%
Rate of compensation increase ...................... 5.0% 5.0%
Expected return on plan assets ..................... 8.0%-9.0% 8.0%-9.0%
The components of net periodic benefit costs for the years ended December
31 are as follows:
Postretirement
Pension Benefits Benefits
--------------------------------- ----------------------------------
(In millions) 1998 1997 1996 1998 1997 1996
- -------------------------------------------------------------------------- ----------------------------------
Components of net periodic benefit cost:
Service cost $ 0.9 $ 0.8 $ 0.8 $ 0.5 $ 1.0 $ 1.1
Interest cost 2.1 1.6 1.6 0.5 0.7 0.7
Return on plan assets (2.1) (1.5) (1.5) - - -
Recognized net gains - - - (1.2) (0.5) (0.5)
--------- --------- --------- --------- --------- ---------
Net periodic benefit cost $ 0.9 $ 0.9 $ 0.9 $ (0.2) $ 1.2 $ 1.3
========= ========= ========= ========= ========= =========
77
ORION CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The expected health care cost trend rates used to calculate the
postretirement benefits obligation were 15.0% for 1998 and 8.5% for 1999,
decreasing linearly each year until it reaches 5% for 2006 and future years.
Assumed health care cost trend rates have a significant effect on the amounts
reported for the postretirement medical benefit plans. A one percentage-point
change in assumed health care cost trend rates would have the following effects:
(In millions) 1-Percentage Point Change
- ---------------------------------------------------------------------
1998 1997
-------- --------
Effect on total of service and interest
cost components $ 0.1 $ 0.3
Effect on postretirement benefit obligation $ 0.8 $ 0.6
Orion maintained a non-qualified defined benefit retirement plan for
members of the Board of Directors who are not employees. On December 31, 1997,
the Company terminated this plan resulting in $0.3 million of benefits payments
in January 1998 with the remaining accrued benefits of $0.4 million to be paid
with interest in future periods. Benefits were based on years of service and
director fee levels at retirement or termination date of the plan.
Note 13 - Commitments
Minimum lease commitments at December 31, 1998, with the majority having
initial lease periods from one to twenty-five years, are as follows:
(In millions)
- ------------------------------------------
1999 $ 22.6
2000 20.2
2001 15.7
2002 12.5
2003 10.0
2004 and thereafter 37.8
-----------
Minimum lease commitments $ 118.8
===========
Rent expense amounted to $20.2 million, $23.1 million and $19.8 million for
1998, 1997 and 1996, respectively. Substantially all leases are for office space
and equipment. A number of lease commitments contain renewal options ranging
from one to thirty years.
Note 14 - Contingencies
Orion and its subsidiaries are routinely engaged in litigation incidental
to their businesses. Management believes that there are no significant legal
proceedings pending against the Company which, net of reserves established
therefore, are likely to result in judgments for amounts that are material to
the financial condition, liquidity or results of operations of Orion and its
consolidated subsidiaries, taken as a whole.
78
ORION CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Note 15 - Stockholders' Equity and Earnings Per Common Share
During 1998, the Company repurchased 836,100 shares of its common stock at
an aggregate cost of $35.6 million under the stock repurchase program authorized
by the Board of Directors and repurchased 45,615 shares at an aggregate cost of
$2.4 million related to its employee benefit plans. The Company repurchased
42,916 shares for $1.5 million in 1997 and 482,228 shares for $11.2 million in
1996 under the stock repurchase program.
Orion declared dividends on its common stock of $19.1 million, $17.1
million and $14.3 million, or $0.70, $0.62 and $0.51 per share in 1998, 1997 and
1996, respectively.
A reconciliation of basic and diluted earnings per share ("EPS") for the
years ended December 31 is as follows:
Net Average Per Share
(In millions, except for per share amounts) Earnings Shares Amount
- -------------------------------------------------------------------------------
1998 -
Basic EPS:
Net earnings available to
common stockholders $ 102.8 27.2 $ 3.78
==========
Stock options and awards - 0.6
--------- ---------
Diluted EPS:
Net earnings available to common
stockholders with assumed exercises $ 102.8 27.8 $ 3.69
========= ========= ==========
1997 -
Basic EPS:
Net earnings available to
common stockholders $ 115.8 27.3 $ 4.24
==========
Stock options and awards - 0.6
--------- ---------
Diluted EPS:
Net earnings available to common
stockholders with assumed exercises $ 115.8 27.9 $ 4.15
========= ========= ==========
1996 -
Basic EPS:
Net earnings available to
common stockholders $ 86.6 27.4 $ 3.16
==========
Stock options and awards - 0.4
--------- ---------
Diluted EPS:
Net earnings available to common
stockholders with assumed exercises $ 86.6 27.8 $ 3.12
========= ========= =========
Effective as of September 11, 1996, Orion redeemed its old stockholder
rights plan and adopted a new Stockholder Rights Plan ("Rights Plan"). Under the
Rights Plan each outstanding share of common stock includes one preferred stock
purchase right ("Right"). The Rights Plan is designed to assure
79
ORION CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
stockholders that they will receive equitable treatment in the event of a
proposed takeover. Under the Rights Plan, each holder of a Right is entitled to
buy two-hundredth of a share of Series B Junior Participating Preferred Stock.
The Rights become exercisable (i) if an acquiror gains a 15% or greater
beneficial ownership interest in Orion's outstanding common stock, on other than
fair and favorable terms to all stockholders or (ii) following the commencement
of a tender offer or exchange offer that would result in an acquiror owning 15%
or more of Orion's outstanding common stock. Each Right not owned by such
acquiror will enable the holder to purchase, at an initial purchase price of
$100, common stock having a value of twice the Right's purchase price. In
addition, under certain circumstances if Orion is involved in a merger each
Right will entitle its holder to purchase, at the Right's then current purchase
price, common shares of such other company having a value of twice the Right's
purchase price. Until 1998, the Rights Plan provided that, in the event of a
change in control for a period of 180 days, Rights could be redeemed only by
action of the continuing Directors. That restriction was removed in 1998.
Note 16 - Accumulated Other Comprehensive Income
Accumulated other comprehensive income balances, net of taxes, for the years
ended December 31 are as follows:
Unrealized Unrealized Foreign Accumulated
Unrealized Exchange Accumulated Other
Investment Gains Translation Comprehensive
(In millions) (Losses) Gains (Losses) Income (Loss)
- --------------------------------------------------------------------------------
1998:
Balance, beginning of year $ 113.6 $ (4.4) $ 109.2
Current year change (52.4) 1.7 (50.7)
-------- -------- --------
Balance, end of year $ 61.2 $ (2.7) $ 58.5
======== ======== ========
1997:
Balance, beginning of year $ 72.3 $ (2.2) $ 70.1
Current year change 41.3 (2.2) 39.1
-------- -------- --------
Balance, end of year $ 113.6 $ (4.4) $ 109.2
======== ======== ========
1996:
Balance, beginning of year $ 63.3 $ (4.0) $ 59.3
Current year change 9.0 1.8 10.8
-------- -------- --------
Balance, end of year $ 72.3 $ (2.2) $ 70.1
======== ======== ========
The pre-tax unrealized investment gains (losses) were $(80.4) million,
$62.9 million and $14.0 million for the year ended December 31, 1998, 1997 and
1996, respectively. The pre-tax unrealized foreign exchange translation gains
(losses) were $2.6 million, $(3.4) million and $2.8 million for the year ended
December 31, 1998, 1997 and 1996, respectively.
80
ORION CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The components of change in accumulated other comprehensive income related
to changes in unrealized investment gains (losses) for 1998 are as follows:
(In millions)
- --------------------------------------------------------------
Unrealized investment holding gains (losses)
arising during the period, net of taxes $ 2.6
Reclassification adjustment for gains (losses)
Included in net earnings, net of taxes (55.0)
Net investment gains (losses) recognized in ----------
other comprehensive income $ (52.4)
==========
Pre-tax unrealized investment holding gains (losses) arising during 1998
was $4.4 million. Pre-tax reclassification adjustment for gains included in net
earnings was $84.7 million.
Note 17 - Segment Information
The Company reports its insurance operations in three segments at December 31,
1998. These reportable segments comprise operating units of the Company that
have different insurance products and services, market focus and operational
structure. The Company reportable segments comprise:
Workers Compensation - this segment provides workers compensation insurance
products and services sold by the EBI Companies.
Specialty Commercial - this segment markets various specialty commercial
products and services and includes professional liability insurance through
DPIC Companies; client-focused specialty insurance programs through Orion
Specialty; underwriting management specializing in ocean marine, inland
marine and commercial property insurance through Wm. H. McGee; insurance
for international trade through the Company's 26% interest in Intercargo
Corporation; and also includes the run-off operations of the Company'
assumed reinsurance business, SecurityRe, which was sold in late 1996.
McGee and Intercargo are expected to be sold in 1999 as discussed in Notes
20 and 4.
Nonstandard Automobile - specializes in nonstandard personal automobile
insurance sold by OrionAuto.
81
ORION CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Financial information for the Company's segments for the years ended
December 31 is shown below:
(In millions) 1998 1997 1996
- -------------------------------------------------------------------------------
Net Premiums Written:
Workers Compensation .................. $ 439.5 $ 365.1 $ 353.0
Specialty Commercial .................. 665.1 669.2 725.8
Nonstandard Automobile ................ 429.0 332.8 255.3
---------- ---------- ----------
Consolidated ....................... $ 1,533.6 $ 1,367.1 $ 1,334.1
========== ========== ==========
Revenues:
Workers Compensation -
Premiums earned ....................... $ 429.8 $ 362.1 $ 356.8
Net investment income ................. 35.2 41.8 38.2
Realized investment gains ............. 19.1 13.8 6.8
Other income .......................... 0.6 0.3 0.2
---------- ---------- ----------
Total Workers Compensation ......... 484.7 418.0 402.0
---------- ---------- ----------
Specialty Commercial -
Premiums earned ....................... 656.0 673.2 686.5
Net investment income ................. 82.9 90.5 82.4
Realized investment gains ............. 30.0 28.7 13.2
Other income .......................... 14.0 19.7 22.7
---------- ---------- ----------
Total Specialty Commercial ......... 782.9 812.1 804.8
---------- ---------- ----------
Nonstandard Automobile -
Premiums earned ....................... 417.2 322.4 257.5
Net investment income ................. 21.2 21.8 19.7
Realized investment gains ............. 3.1 5.5 6.3
---------- ---------- ----------
Total Nonstandard Automobile ....... 441.5 349.7 283.5
---------- ---------- ----------
Other .................................... 7.6 10.8 3.2
---------- ---------- ----------
Consolidated ....................... $ 1,716.7 $ 1,590.6 $ 1,493.5
========== ========== ==========
Pre-tax Earnings before Minority Interest:
Workers Compensation .................. $ 86.2 $ 86.8 $ 68.4
Specialty Commercial .................. 54.2 65.3 56.5
Nonstandard Automobile ................ 37.1 40.7 23.3
Other ................................. (20.8) (16.6) (20.9)
---------- ---------- ----------
Consolidated ....................... $ 156.7 $ 176.2 $ 127.3
========== ========== ==========
Identifiable Assets at December 31:
Workers Compensation .................. $ 989.7 $ 936.2
Specialty Commercial .................. 2,240.5 2,066.2
Nonstandard Automobile ................ 883.3 811.4
Other ................................. 50.9 70.3
---------- ----------
Consolidated ....................... $ 4,164.4 $ 3,884.1
========== ==========
82
ORION CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The miscellaneous income and expenses (primarily interest, general and
administrative expenses and other consolidating elimination entries) of the
parent company are reported as "Other" in the above table.
The accounting policies of the segments are the same as those described in
Note 1 to the consolidated financial statements included herein. Investments,
net investment income and realized investment gains are allocated to each
segment based on the cash flows of these segments. Earnings for the segments
represents earnings (loss) before federal income taxes and minority interest
expense, and includes an allocation of payroll, office and other expenses
incurred by the parent company to support the operations of the Company's
segments. Earnings for Specialty Commercial include equity earnings (loss) of
affiliate of $(0.7) million in 1998, $8.6 million in 1997 and $(0.4) million in
1996. Additionally, identifiable assets for Specialty Commercial include
investment in affiliate, Intercargo, of $22.8 million and $31.3 million at
December 31, 1998 and 1997, respectively.
Less than 2% of the Company's premiums are derived from operating units
located outside the United States. Substantially all of the Company's long-lived
assets are located in the United States. No one single customer represents 10%
or more of the Company's revenue for 1998, 1997 and 1996.
Note 18 - Selected Quarterly Financial Data (Unaudited)
Quarterly results of operations and earnings per common share for 1998 and
1997 are summarized as follows:
First Second Third Fourth
(In millions, except for per share amounts) Quarter Quarter Quarter Quarter
- -------------------------------------------------------------------------------------------
Premiums earned ..................... $ 348.8 $ 370.4 $ 396.5 $ 387.3
Net investment income ............... 41.4 42.5 22.3 37.0
Realized investment gains ........... 29.0 22.7 0.4 0.4
Other income ........................ 5.6 7.0 2.1 3.3
-------- -------- -------- ---------
Total revenues ................... $ 424.8 $ 442.6 $ 421.3 $ 428.0
======== ======== ======== =========
Net earnings ..................... $ 42.2 $ 38.2 $ 2.3 $ 20.1
======== ======== ======== =========
Net earnings per basic common share . $ 1.54 $ 1.39 $ 0.08 $ 0.75
======== ======== ======== =========
Net earnings per diluted common share $ 1.50 $ 1.36 $ 0.08 $ 0.74
======== ======== ======== =========
1997:
Premiums earned ..................... $ 324.0 $ 335.2 $ 347.4 $ 351.0
Net investment income ............... 40.2 41.3 40.8 42.6
Realized investment gains ........... 15.8 8.4 5.2 18.5
Other income ........................ 4.9 5.2 5.0 5.1
-------- -------- -------- ---------
Total revenues ................... $ 384.9 $ 390.1 $ 398.4 $ 417.2
======== ======== ======== =========
Net earnings ..................... $ 29.5 $ 25.4 $ 24.5 $ 36.4
======== ======== ======== =========
Net earnings per basic common share . $ 1.08 $ 0.93 $ 0.90 $ 1.33
======== ======== ======== =========
Net earnings per diluted common share $ 1.06 $ 0.91 $ 0.88 $ 1.30
======== ======== ======== =========
Earnings per share are computed independently for the quarters presented.
Therefore, the sum of the quarterly earnings per share may not equal the total
computed for the year.
83
ORION CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Note 19 - Accounting Standards Not Yet Adopted
In June 1998, the Financial Accounting Standards Board issued FAS No. 133,
Accounting for Derivative Instruments and Hedging Activities. This Standard
requires companies to record all derivatives on the balance sheet as either
assets or liabilities and measure those instruments at fair value. The manner in
which companies are to record gains or losses resulting from changes in the
values of those derivatives depends on the use of the derivative and whether it
qualifies for hedge accounting. This Standard is effective for the Company's
financial statements beginning January 1, 2000, with early adoption permitted.
The Company is currently evaluating the impact of the adoption of this statement
and the potential effect on its financial position or results of operations.
In March 1998, the AICPA issued SOP 98-1, Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use. This Statement
provides guidance on accounting for costs of computer software developed or
obtained for internal use including when incurred costs are and are not eligible
for capitalization. This Statement is effective for 1999 financial statements
with early adoption permitted. The Company is currently evaluating the impact of
the adoption of this Statement and the potential effect on its financial
position and results of operations.
Note 20 - Subsequent Event
As a part of the Company's reshaping to focus resources on high potential
lines of business, on March 11, 1999, the Company announced the signing of a
definitive agreement to sell McGee. The transaction is expected to be complete
by April 1999, subject to regulatory approvals and other closing conditions.
84
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 25, 1999. 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 Financial Statements:
The following financial statements are included in Part II, Item 8.
Page
Report of Management 50
Independent Auditors' Report 51
Orion Capital Corporation and Subsidiaries:
December 31, 1998 and 1997 Consolidated Balance Sheet 52-53
For the years ended December 31, 1998, 1997 and 1996:-
Consolidated Statement of Earnings 54
Consolidated Statement of Stockholders' Equity 55
Consolidated Statement of Cash Flows 56-57
Notes to the Consolidated Financial Statements 58-84
(a)2. Financial Statement Schedules:
Selected Quarterly Financial Data - for the years ended
December 31, 1998, and 1997 - Included in Part II, Item 8.
Schedule I Consolidated Summary of Investments - Other than
Investments in Related Parties - December 31, 1998. S-1
II Condensed Financial Information of Registrant -
December 31, 1998, 1997 and 1996 S-2 through S-8
III Supplementary Insurance Information -
December 31, 1998, 1997 and 1996 S-9
85
V Valuation and Qualifying Accounts -
December 31, 1998, 1997 and 1996 S-10
VI Supplemental Information For Property - Casualty Insurance
Underwriters - December 31, 1998, 1997 and 1996 S-11
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 Financial Statements or notes thereto.
(a)3. Exhibits:
Exhibit 2(i) Agreement and Plan of Merger dated as of October 31, 1997, between
Guaranty National Corporation and Orion; filed as Exhibit (c)(1) to the
Company's Tender Offer Statement on Schedule 14D-1; filed on November 5, 1997.
Exhibit 3(i) Restated Certificate of Incorporation of Orion, as amended on June
5, 1997; filed as Exhibit 3(i) to the Company's Annual Report on Form 10-K for
1997.
Exhibit 3(ii) By-Laws of Orion, as amended on September 11, 1996; filed as
Exhibit 3(ii) to the Company's Annual Report on Form 10-K for 1996.
Exhibit 4(i) Certificate of Designation, Preferences and Rights of Series B
Junior Participating Preferred Stock of Orion, dated September 17, 1996; filed
as Exhibit 4(i) to the Company's Annual Report on Form 10-K for 1996.
Exhibit 4(ii) Specimen certificate representing shares of Orion's Common Stock
(proof of March 27, 1989); filed as Exhibit 4(xii) to the Company's Annual
Report on Form 10-K for 1988.
Exhibit 4(iii) Indenture, dated as of September 8, 1992, between Orion and the
Connecticut National Bank (now known as Fleet Bank Connecticut, National
Association), as Trustee of Orion's 9 1/8% Senior Notes due September 1, 2002;
filed as Exhibit 4(v) to the Company's Annual Report on Form 10-K for 1992.
Exhibit 4(iv) Specimen certificate representing Orion's 9 1/8% Senior Notes;
filed as Exhibit 4(vi) to the Company's Annual Report on Form 10-K for 1992.
Exhibit 4(v) Senior Debt Indenture, dated as of July 17, 1995, between Orion and
the State Street Bank and Trust Company of Connecticut, National Association, as
Trustee of Orion's 7 1/4% Senior Notes due July 15, 2005; filed as Exhibit 4.9
to the Company's Current Report on Form 8-K, filed on July 14, 1995.
Exhibit 4(vi) First Supplemental Indenture to the Senior Debt Indenture; filed
as Exhibit 4.9(a) to the Company's Current Report on Form 8-K, filed on July 14,
1995.
Exhibit 4(vii) Specimen Certificate representing Orion's 7 1/4% Senior Notes;
filed as Exhibit 4.9(b) to the Company's Current Report on Form 8-K, filed on
July 14, 1995.
86
Exhibit 4(viii) Indenture, dated as of February 5, 1998, between Orion and the
Bank of New York, as Trustee of Orion's 7.701% Junior Subordinated Deferrable
Interest Debentures; filed as Exhibit 4(viii) to the Company's Annual Report on
Form 10-K for 1997.
Exhibit 4(ix) Indenture, dated as of January 13, 1997, between Orion and the
Bank of New York, as Trustee of Orion's 8.73% Junior Subordinated Deferrable
Interest Debentures; filed as Exhibit 4.1 to the Company's Registration
Statement on Form 4 (No. 333- 21205).
Exhibit 4(x) Form of Exchange Debenture Certificate representing Orion's 8.73%
Junior Subordinated Deferrable Interest Debentures; filed as Exhibit 4.2 to the
Company's Registration Statement on Form S-4 (No. 333-21205), filed on February
5, 1997.
Exhibit 4(xi) Certificate of Trust of Orion Capital Trust II, dated as of
February 2, 1998; filed as Exhibit 4(xi) to the Company's Annual Report on Form
10-K for 1997.
Exhibit 4(xii) Certificate of Trust of Orion Capital Trust I, dated as of
January 3, 1997; filed as Exhibit 4.3 to the Company's Registration Statement on
Form S-4 (No. 333- 21205), filed on February 5, 1997.
Exhibit 4(xiii) Declaration of Trust of Orion Capital Trust II, dated as of
February 2, 1998; filed as Exhibit 4(xiii) to the Company's Annual Report on
Form 10-K for 1997.
Exhibit 4(xiv) Declaration of Trust of Orion Capital Trust I, dated as of
January 3, 1997; filed as Exhibit 4.4 to the Company's Registration Statement on
Form S-4 (No. 333-21205), filed on February 5, 1997.
Exhibit 4(xv) Amended and Restated Declaration of Trust of Orion Capital Trust
II, dated as of February 5, 1998; filed as Exhibit 4(xv) to the Company's Annual
Report on Form 10-K for 1997.
Exhibit 4(xvi) Amended and Restated Declaration of Trust of Orion Capital Trust
I, dated as of January 13, 1997; filed as Exhibit 4.5 to the Company's
Registration Statement on Form S-4 (No. 333-21205), filed on February 5, 1997.
Exhibit 4(xvii) Form of Certificate evidencing 8.73% Exchange Capital Securities
of Orion Capital Trust I; filed as Exhibit 4.6 to the Company's Registration
Statement on Form S-4 (No. 333-21205).
Exhibit 4(xviii) Capital Securities Guarantee Agreement, dated as of January 13,
1997, delivered by Orion as Guarantor and relating to the 8.73% Exchange Capital
Securities; filed as Exhibit 4.7 to the Company's Registration Statement on Form
S-4 (No. 333-21205).
Exhibit 4(xix) Capital Securities Guarantee Agreement, dated as of February 5,
1998, delivered by Orion as Guarantor, and relating to the 7.701% Capital
Securities of Orion Capital Trust II; filed as Exhibit 4(xix) to the Company's
Annual Report on Form 10-K for 1997.
87
Exhibit 4(xx) Form of Certificate evidencing 7.701% Capital Securities of Orion
Capital Trust II included as part of Exhibit 4(xv); filed as Exhibit 4(xx) to
the Company's Annual Report on Form 10-K for 1997.
Exhibit 4(xxi) Form of Certificate representing Orion's 7.701% Junior
Subordinated Deferrable Interest Debentures (filed as Exhibit A to Exhibit
4(viii).
Exhibit 4(xxii) Credit Agreement, dated as of July 8, 1998, between the Company,
the lenders named therein, First Union National Bank, as Administrative Agent,
Bank if America National Trust and Savings Association, as Documentation Agent,
and Fleet National Bank, as Syndication Agent; filed as Exhibit 4 to the
Company's Quarterly Report on Form 10-Q for June 30, 1998.
Exhibit 10(xx) Amendment, dated February 14, 1995, to the Letter Agreement by
and between Orion Capital Corporation and Intercargo Corporation; filed as
Exhibit 10(xxiii) to the Company's Annual Report on Form 10-K for 1994.
Exhibit 10(xxi) Second Amendment, dated August 12, 1997, to the Letter Agreement
by and between Orion Capital Corporation and Intercargo Corporation); filed as
Exhibit 10(xxi) to the Company's Annual Report on Form 10-K for 1997.
Exhibit 10(i)* Orion's Deferred Compensation Plan, as amended; filed as Exhibit
10(i) to the Company's Annual Report on Form 10-K for 1991.
Exhibit 10(ii)* Orion's 1982 Long-Term Performance Incentive Plan, as amended;
filed as Exhibit 10(ii) to the Company's Annual Report on Form 10-K for 1996.
Exhibit 10(iii)* Orion's 1994 Stock Option Plan for Non-Employee Directors;
filed as Exhibit 10(iii) to the Company's Annual Report on Form 10-K for 1994.
Exhibit 10(iv)* Employment Agreement between Raymond W. Jacobsen and Orion, as
amended and restated as of December 6 1995; filed as Exhibit 10(vii) to the
Company's Annual Report on Form 10-K for 1995.
Exhibit 10(v)* Employment Agreement between W. Marston Becker and Orion, dated
as of October 31, 1995; filed as Exhibit 10(viii) to the Company's Annual Report
on Form 10-K for 1995.
Exhibit 10(vi)* Amendment to Employment Agreement between W. Marston Becker and
Orion, dated as of January 1, 1997; filed as Exhibit 10(x) to the Company's
Annual Report on Form 10-K for 1996.
Exhibit 10(vii) Lease Agreement between Connecticut UTF, Inc., as lessor, and
Security Insurance Company of Hartford ("Security"), as lessee, dated as of
December 19, 1984; filed as Exhibit 10(xxxiii) to the Company's Annual Report on
Form 10-K for l984.
*Management contract or compensatory plan or arrangement.
88
Exhibit 10(viii) Second Assignment of Lease and Agreement from Connecticut UTF,
Inc. to Security, dated as of December 19, 1984; filed as Exhibit 10(xxxiv) to
the Company's Annual Report on Form 10-K for 1984.
Exhibit 10(ix) Purchase Money Second Mortgage from Connecticut UTF, Inc., as
mortgagor, to Security, as mortgagee, dated as of December 19, 1984; filed as
Exhibit 10(xxxvi) to the Company's Annual Report on Form 10-K for 1984.
Exhibit 10(x) Purchase Money Note, in the face amount of $2,800,000, from
Connecticut UTF, Inc. to Security, dated December 19, 1984; filed as Exhibit
10(xxxvi) to the Company's Annual Report on Form 10-K for l984.
Exhibit 10(xi) Guarantee from Orion to Connecticut UTF, Inc., dated as of
December 19, 1984, guaranteeing the performance of Security under its lease with
Connecticut UTF, Inc.; filed as Exhibit 10(xxxvii) to the Company's Annual
Report on Form 10-K for 1984.
Exhibit 10(xii) Form of Indemnification Agreement, dated as of June 3, 1987,
between Orion and each of its Directors and Executive Officers; filed as Exhibit
10(xi) to the Company's Annual Report on Form 10-K for 1987.
Exhibit 10(xiii) Rights Agreement, dated as of September 11, 1996, between Orion
and First Chicago Trust Company of New York, as Successor Rights Agent to Chase
Mellon; filed as Exhibit 10(v) to the Company's Annual Report on Form 10-K for
1998.
Exhibit 10(xiv)* Orion Supplemental Benefits Plan, filed as Exhibit 10(xxv) to
the Company's Annual Report on Form 10-K for 1991.
Exhibit 10(xv) Orion's Equity Incentive Plan, dated September 11, 1996; filed as
Exhibit 10(xx) to the Company's Annual Report on Form 10-K for 1996.
Exhibit 10(xvi) Letter Agreement, dated September 13, 1993, by and between Orion
and Intercargo Corporation; filed as Exhibit 10(xxii) to the Company's Annual
Report on Form 10-K for 1993.
Exhibit 10(xvii) Purchase Agreement by and between Sun Alliance USA, Inc. and
Orion, dated as of June 30, 1995; filed as Exhibit 10(xxv) to the Company's
Annual Report on Form 10-K for 1995.
Exhibit 10(xviii)* Amended and Restated Employment Agreement between W. Marston
Becker and Orion, dated July, 1998; filed as Exhibit 10(i) to the Company's
Annual Report on Form 10-K for 1998.
Exhibit 10(xix)* Amended and Restated Employment Agreement between W. Marston
Becker and Orion, dated as of January 30, 1999; filed as Exhibit 10(ii) to the
Company's Annual Report on Form 10-K for 1998.
*Management contract or compensatory plan or arrangement.
89
Exhibit 10(xx)* Form of Employment Agreement between Orion and each of its
Senior Executive Officers dated February 1999; filed as Exhibit 10(iii) to the
Company's Annual Report on Form 10-K for 1998.
Exhibit 10(xxi) Letter Agreement dated December 1, 1998, between Orion Capital
Corporation and XL America, Inc., a Delaware Corporation; filed as Exhibit
10(iv) to the Company's Annual Report on Form 10-K for 1998.
*Management contract or compensatory plan or arrangement
Copies of exhibits may be obtained upon payment of a $0.50 per page fee.
Such requests should be made in writing to: Corporate Secretary, Orion Capital
Corporation, 9 Farm Springs Road, Farmington, CT 06032.
(b) Reports on Form 8-K:
None.
(c) Filed exhibits:
See Exhibit Index.
90
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
ORION CAPITAL CORPORATION
By: /s/ W. Marston Becker March 25, 1999
- -------------------------
W. Marston Becker
Chairman of the Board
and Chief Executive Officer
By: /s/ Michael L. Pautler March 25, 1999
- --------------------------
Michael L. Pautler
Senior Vice President and
Chief Financial Officer
91
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 dates indicated:
Signature and Title Date
/s/ W. Marston Becker March 25, 1999
- ---------------------
W. Marston Becker
Chairman of the Board
/s/ Gordon F. Cheesbrough March 25, 1999
- -------------------------
Gordon F. Cheesbrough
Director
/s/ John C. Colman March 25, 1999
- ------------------
John C. Colman
Director
/s/ David H. Elliott March 25, 1999
- --------------------
David H. Elliott
Director
/s/ Victoria R. Fash March 25, 1999
- --------------------
Victoria R. Fash
Director
/s/ Robert H. Jeffrey March 25, 1999
- --------------------
Robert H. Jeffrey
Director
/s/ Gordon W. Kreh March 25, 1999
- ------------------
Gordon W. Kreh
Director
/s/ Warren R. Lyons March 25, 1999
- -------------------
Warren R. Lyons
Director
/s/ James K. McWilliams March 25, 1999
- -----------------------
James K. McWilliams
Director
/s/ Ronald W. Moore March 25, 1999
- -------------------
Ronald W. Moore
Director
/s/ William B. Weaver March 25, 1999
- ---------------------
William B. Weaver
Director
92
EXHIBIT INDEX
Exhibit 10(i) Amended and Restated Employment Agreement between W. Marston
Becker and Orion, dated July 1998.
Exhibit 10(ii) Amended and Restated Employment Agreement between W. Marston
Becker and Orion, dated as of January 30, 1999.
Exhibit 10(iii) Form of Employment Agreement between Orion and each of its
Senior Executive Officers dated February 1999.
Exhibit 10(iv) Letter Agreement dated December 1, 1998, between Orion Capital
Corporation and XL America, Inc., a Delaware Corporation.
Exhibit 10(v) Rights Agreement, dated as of September 11, 1996, between Orion
Capital Corporation and First Chicago Trust Company of New York, as Successor
Rights Agent to Chase Mellon.
Exhibit 11 Statement re: computation of earnings per common share.
Exhibit 21 Subsidiaries of Orion.
Exhibit 23 Consent of Deloitte & Touche, LLP.
Exhibit 27 Financial Data Schedules.
93
SCHEDULE I
ORION CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED SUMMARY OF INVESTMENTS-OTHER THAN
INVESTMENTS IN RELATED PARTIES
December 31, 1998
(In millions)
- -------------------------------------------------------------------------------
Column A Column B Column C Column D
Amount Shown
Market on Balance
Type of Investment Cost Value Sheet
- -------------------------------------------------------------------------------
Fixed maturities held-to-maturity:
Bonds -
United States Government and
government agencies and
Authorities ............... $ 81.4 $ 84.6 $ 81.4
States, municipalities and
political subdivisions .... 156.1 164.5 156.1
All other corporate bonds .... 23.1 23.6 23.1
---------- --------- ---------
260.6 272.7 260.6
---------- --------- ---------
Fixed maturities available-for-sale:
Bonds -
United States Government and
government agencies and
authorities ............... 69.0 70.6 70.6
States, municipalities and
political subdivisions .... 684.1 723.8 723.8
Foreign governments .......... 4.1 4.7 4.7
All other corporate bonds .... 447.6 449.0 449.0
Redeemable preferred stocks ..... 100.7 101.8 101.8
---------- --------- ---------
1,305.5 1,349.9 1,349.9
---------- --------- ---------
Equity securities:
Common stocks -
Public utilities ............. 1.6 1.7 1.7
Banks, trusts and insurance
Companies ................. 15.1 39.2 39.2
Industrial, miscellaneous and
all other ................. 183.6 201.5 201.5
Non-redeemable preferred stocks . 269.1 268.5 268.5
---------- --------- ---------
469.4 510.9 510.9
---------- --------- ---------
Mortgage loans on real estate ...... 2.2 2.2 2.2
Other long-term investments ........ 114.0 114.0 114.0
Short-term investments ............. 248.7 248.7 248.7
---------- --------- ---------
Total investments ......... $ 2,400.4 $ 2,498.4 $ 2,486.3
========== ========= =========
S-1
SCHEDULE II
ORION CAPITAL CORPORATION AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
ORION CAPITAL CORPORATION
BALANCE SHEET
ASSETS
December 31,
--------------------
(In millions) 1998 1997
- -------------------------------------------------------------------------------
Fixed maturities, at market (cost $0.3) ................... $ 0.2 $ 0.2
Non-redeemable preferred stocks, at market (cost $27.8) ... 27.8 --
Short-term investments .................................... 4.3 68.7
Cash ...................................................... 0.2 0.4
Notes receivable and other assets ......................... 8.6 5.3
Deferred federal income taxes ............................. 27.4 9.4
Investment in subsidiaries ................................ 1,035.5 947.1
Loans receivable due from affiliates ...................... 99.0 --
Due from affiliates ....................................... 3.5 --
Excess of cost over fair value of net assets acquired ..... 43.4 98.9
-------- --------
Total assets ........................................... $1,249.9 $1,130.0
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Other liabilities ......................................... $ 55.2 $ 55.8
Due to affiliates ......................................... -- 16.8
Notes payable ............................................. 217.4 209.3
-------- --------
Total liabilities ...................................... 272.6 281.9
Company-obligated mandatorily redeemable preferred
capital securities of subsidiary trusts holding solely
the junior subordinated debentures of the Company ...... 250.0 125.0
Stockholders' equity ...................................... 727.3 723.1
-------- --------
Total liabilities and stockholders' equity ............. $1,249.9 $1,130.0
======== ========
[FN]
See Notes to Condensed Financial Statements of Registrant
</FN>
S-2
SCHEDULE II
ORION CAPITAL CORPORATION AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
ORION CAPITAL CORPORATION
STATEMENT OF EARNINGS
Year Ended December 31,
-----------------------------
(In millions) 1998 1997 1996
- ------------------------------------------------------------------------------
Revenues:
Net investment income ..................... $ 1.7 $ 8.4 $ 1.9
Interest income on affiliate loans ........ 6.1 -- --
Other income .............................. 0.8 0.6 0.4
-------- -------- ---------
8.6 9.0 2.3
-------- -------- ---------
Expenses:
Interest .................................. 18.4 18.4 17.8
General and administrative ................ 10.0 6.2 3.7
Amortization of excess of cost over fair
value of net assets acquired ........... 1.9 2.0 1.9
-------- -------- ---------
30.3 26.6 23.4
-------- -------- ---------
Loss before federal income taxes, equity in
net earnings of subsidiaries and minority
interest expense .......................... (21.7) (17.6) (21.1)
Federal income taxes ......................... 41.1 45.0 30.1
-------- -------- ---------
Loss before equity in net earnings of
subsidiaries and minority interest expense (62.8) (62.6) (51.2)
Equity in net earnings of subsidiaries ....... 178.4 185.3 137.8
Minority interest expense in subsidiary trusts
preferred securities, net of federal income
taxes ..................................... 12.8 6.9 --
-------- -------- ---------
Net earnings ........................... 102.8 115.8 86.6
Other comprehensive income, net of tax: -------- -------- ---------
Unrealized investment gains (losses) ...... (52.4) 41.3 9.0
Unrealized foreign exchange translation
gains (losses) ......................... 1.7 (2.2) 1.8
-------- -------- ---------
Other comprehensive income ............. (50.7) 39.1 10.8
-------- -------- ---------
Comprehensive income ................ $ 52.1 $ 154.9 $ 97.4
======== ======== =========
[FN]
See Notes to Condensed Financial Statements of Registrant
</FN>
S-3
SCHEDULE II
ORION CAPITAL CORPORATION AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
ORION CAPITAL CORPORATION
STATEMENT OF CASH FLOWS
Year Ended December 31,
---------------------------
(In millions) 1998 1997 1996
- -------------------------------------------------------------------------------
Cash flows from operating activities:
Dividends received from subsidiaries .......... $ 55.2 $ 42.8 $ 35.3
Net investment income collected ............... 4.6 8.0 1.9
Interest income received from affiliates ...... 7.0 -- --
Interest paid ................................. (20.4) (17.3) (17.3)
Payments on trust preferred securities ........ (17.6) (5.1) --
Other receipts (payments) ..................... (11.6) 7.9 6.4
------ ------- ------
Net cash provided by operating activities .. 17.2 36.3 26.3
------ ------- ------
Cash flows from investing activities:
Sales (purchases) of equity securities ........ (27.0) 0.2 --
Net sales (purchases) of short-term investments 64.4 (36.0) 22.8
Purchases of Guaranty National common stock ... (2.9) (104.4) (20.7)
Issuance of loans to affiliates, net .......... (99.0) -- --
Purchase of Grocers Insurance Group ........... (32.4) -- --
Other payments ................................ 1.4 (0.2) (2.6)
------ ------- ------
Net cash used in investing activities ...... (95.5) (140.4) (0.5)
------ ------- ------
Cash flows from financing activities:
Net proceeds from issuance of trust preferred
securities ................................. 121.9 123.0 --
Proceeds from loan with banks, net ............ 8.0 -- --
Proceeds from exercise of stock options ....... 2.3 0.6 --
Dividends paid to stockholders ................ (18.5) (18.0) (14.9)
Purchases of common stock ..................... (35.6) (1.5) (10.5)
Other receipts (payments) ..................... -- 0.1 --
------ ------- ------
Net cash provided by (used in) financing
activities .............................. 78.1 104.2 (25.4)
------ ------- ------
Net (decrease) increase in cash ............ (0.2) 0.1 0.3
Cash balance, beginning of year ............... 0.4 0.3 --
------ ------- ------
Cash balance, end of year ..................... $ 0.2 $ 0.4 $ 0.3
====== ======= ======
[FN]
See Notes to Condensed Financial Statements of Registrant
</FN>
S-4
SCHEDULE II
ORION CAPITAL CORPORATION AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
ORION CAPITAL CORPORATION
STATEMENT OF CASH FLOWS - (Continued)
Year Ended December 31,
---------------------------
(In millions) 1998 1997 1996
- ---------------------------------------------------------------------------
Reconciliation of net earnings to net cash
provided by operating activities:
Net earnings ................................. $ 102.8 $ 115.8 $ 86.6
------- ------- -------
Adjustments:
Equity in net earnings of subsidiaries .... (178.4) (185.3) (137.8)
Consolidating elimination of subsidiaries
income taxes ........................... 51.1 40.1 35.5
Dividends received from subsidiaries ...... 55.2 42.8 35.3
Depreciation and amortization ............. 3.8 3.0 3.0
Deferred federal income taxes ............. 3.6 3.1 10.0
Other ..................................... -- 0.1 0.4
Change in assets and liabilities, net:
Decrease (increase) in notes receivable and
other .................................. (1.3) 1.1 (2.2)
Increase (decrease) in other liabilities .. 0.7 11.6 (3.7)
Change in amounts due to/from affiliates .. (20.3) 4.0 (0.8)
------- ------- -------
Total adjustments and changes .......... (85.6) (79.5) (60.3)
------- ------- -------
Net cash provided by operating activities . $ 17.2 $ 36.3 $ 26.3
======= ======= =======
[FN]
See Notes to Condensed Financial Statements of Registrant
</FN>
S-5
SCHEDULE II
ORION CAPITAL CORPORATION AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
Years Ended December 31, 1998, 1997, and 1996
Note 1 - Expense Reimbursement, Management Fees and Dividends from Subsidiaries
During 1996 through 1998 the Registrant was reimbursed for payroll, office
rental and other expenses incurred by it to support the operations of its
insurance subsidiaries. This reimbursement of $8.3 million, $8.1 million and
$7.4 million in 1998, 1997 and 1996, respectively, is accounted for as a
reduction of general and administrative expenses. The Registrant also received
an annual investment management fee from Guaranty National Corporation of $0.6
million in 1998, 1997 and 1996. The Registrant was reimbursed for federal tax
expenses pursuant to tax sharing agreements with its subsidiaries.
The Registrant has received $55.2 million, $42.8 million and $35.3 million
in dividends from its insurance subsidiaries in 1998, 1997 and 1996,
respectively. Payments of dividends by the Registrant's insurance subsidiaries
must comply with insurance regulatory limitations concerning stockholders'
dividends and capital adequacy. State insurance regulators have broad
discretionary authority with respect to limitations on the payment of dividends
by insurance companies. Under current regulation, the maximum dividends
permitted from the Registrant's insurance subsidiaries at December 31, 1998 for
the ensuing twelve months, without prior approval, aggregated $135.5 million.
Note 2 - Notes Payable
Notes payable at December 31 consist of the following:
(In millions) 1998 1997
- -----------------------------------------------------------------
$110,000,000 face amount, 9.125% Senior
Notes, due September 1, 2002 $ 109.9 $ 109.9
$100,000,000 face amount, 7.25% Senior
Notes, due July 15, 2005 99.5 99.4
Loan agreement with banks 8.0 -
--------- ---------
$ 217.4 $ 209.3
========= =========
On July 8, 1998 the Company entered into a credit agreement with a group of
banks ("Bank Credit Facility") which provides for unsecured borrowings up to
$150.0 million. The Bank Credit Facility expires on July 8, 2003 and provides
for two one-year extension periods. The Company intends to use the Bank Credit
Facility for general corporate purposes, which may include acquisitions. The
Bank Credit Facility carries an annual facility fee on the unused amounts of the
credit facility. Borrowings under the Bank Credit Facility bear interest at
LIBOR (London Interbank Offered Rate) plus a margin based upon the Company's
credit ratings. The Bank Credit Facility requires the Company to maintain
certain financial covenants including a maximum debt to total capitalization
ratio of 0.4 to 1.0, as defined, and a minimum combined statutory surplus of
$650.0 million plus 30% of the Company's aggregate combined annual statutory net
income. The Bank Credit Facility limits the Company's ability to incur secured
indebtedness or certain contingent obligations except for indebtedness secured
by liens specifically
S-6
SCHEDULE II
ORION CAPITAL CORPORATION AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
Years Ended December 31, 1998, 1997, and 1996
permitted by the Bank Credit Facility and additional secured indebtedness with a
principal amount not exceeding 10% of the Company's consolidated net worth, as
defined.
The indentures for the 7.25% Senior Notes and for Orion's 9.125% Senior
Notes limit the amount of liens and guarantees by the Company, and the Company's
ability to incur secured indebtedness without equally and ratably securing the
senior notes.
As of December 31, 1998 maturities of the Company's notes payable are as
follows: 2002 - $110.0 million; 2003 - $8.0 million; and 2005 - $100.0 million.
Note 3 - Trust Preferred Securities
Company-Obligated Mandatorily Redeemable Preferred Capital Securities of
Subsidiary Trusts Holding Solely the Junior Subordinated Debentures of the
Company ("Trust Preferred Securities") comprise the following at December 31:
(In millions) 1998 1997
- ------------------------------------------------------------
8.73% Trust Preferred Securities
due January 1, 2037 $ 125.0 $ 125.0
7.701% Trust Preferred Securities
due April 15, 2028 125.0 -
--------- ---------
$ 250.0 $ 125.0
========= =========
On January 13, 1997 the Registrant issued $125 million of 8.73% Junior
Subordinated Deferrable Interest Debentures due January 1, 2037 (the "8.73%
Debentures") to Orion Capital Trust I ("Trust I"), a Delaware statutory business
trust sponsored by the Registrant. Trust I simultaneously sold $125 million of
8.73% capital securities (the "8.73% Trust Preferred Securities") which have
substantially the same terms as the 8.73% Debentures. The 8.73% Trust Preferred
Securities may be redeemed without premium on or after January 1, 2007.
On February 2, 1998 the Registrant issued $125 million of 7.701% Junior
Subordinated Deferrable Interest Debentures due April 15, 2028 (the "7.701%
Debentures") to Orion Capital Trust II ("Trust II"), a Delaware statutory
business trust sponsored by the Registrant. Trust II then sold $125 million of
7.701% capital securities (the "7.701% Trust Preferred Securities"), which have
substantially the same terms as the 7.701% Debentures.
The 8.73% and 7.701% Trust Preferred Securities are subordinate to all
liabilities of the Company. The Company may defer interest distributions on
these Trust Preferred Securities; however, during any period when such
cumulative distributions have been deferred, the Registrant may not declare or
pay any dividends or distributions on its common stock. The sole assets of the
Trusts are the Debentures issued by the Registrant.
S-7
SCHEDULE II
ORION CAPITAL CORPORATION AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
Years Ended December 31, 1998, 1997, and 1996
The Registrant has given its partial guarantee, which when taken together
with the Company's obligations under the declaration of the Trust, the
Debentures, and the indenture pursuant to which the Trust Preferred Securities
are issued including its obligations to pay costs, expenses, debts and
liabilities of the Trusts (other than with respect to the Trust Preferred
Securities), provides a full and unconditional guarantee of amounts due on the
Trust Preferred Securities.
Note 4 - Loan Receivable Due from Affiliates
In February 1998, the Registrant entered into a ten-year $100.0 million
senior unsecured revolving loan with Guaranty National Corporation of which
$89.6 million was outstanding at December 31, 1998. Interest accrues at 6.5% per
annum for the first two-year period of this loan and then will reprice over the
remaining loan period. This loan was funded from the proceeds of the sale of the
7.701% Trust Preferred Securities (see Note 3). Guaranty National Corporation
used the loan proceeds to repay its bank indebtedness.
In April 1998, the Registrant entered into a $10.0 million revolving credit
loan with a subsidiary acquired in the Strickland purchase. The outstanding
balance under this loan ($9.4 million at December 31, 1998) is secured by
eligible receivables of the subsidiary borrower and accrues interest at prime
rate plus a margin (8.5% at December 31, 1998).
Note 5 - Comprehensive Income
As of January 1, 1998 the Registrant adopted FAS No. 130, "Reporting
Comprehensive Income". This statement establishes standards for the reporting
and presentation of comprehensive income and its components in financial
statements. Comprehensive income encompasses all changes in shareholders' equity
(except those arising from transaction with shareholders) and includes net
income, net unrealized investment gains or losses and foreign currency
translation adjustments. This standard requires additional disclosures and does
not affect the Registrant's financial position or results of operations. For
Registrant financial statements only, comprehensive income is displayed on the
Statements of Earnings.
Stockholders' equity includes accumulated other comprehensive income of
$58.5 million and $109.2 million at December 31, 1998 and 1997, respectively,
primarily comprising unrealized investment gains.
Note 6 - Subsequent Event
As a part of the Company's reshaping to focus resources on high potential
lines of business, on March 11, 1999, the Registrant announced the signing of a
definitive agreement to sell McGee. The transaction is expected to be complete
by April 1999, subject to regulatory approvals and other closing conditions.
S-8
SCHEDULE III
ORION CAPITAL CORPORATION AND SUBSIDIARIES
SUPPLEMENTARY INSURANCE INFORMATION
(In millions)
- ----------------------------------------------------------------------------------------------------------------------------------
Column A Column B Column C Column D Column E Column F Column G Column H Column I Column J Column K Column L
Reserve
For Unpaid Dividends Amortization
Deferred Losses Payable Losses of Deferred Policy-
Policy and Loss to Net and Loss Policy Other holders'
Acquisition Adjustment Unearned Policy- Premiums Investment Adjustment Acquisition Insurance Dividend Premiums
Segment Costs Expenses Premiums Holders Earned Income Expenses Costs Expenses Expenses Written
(a)
- --------------------------------------------------------------------------------------------------------------------------------
1998:
Workers
Compensation... $ 48.5 $ 440.3 $ 95.7 $ 17.4 $ 429.8 $ 35.2 $ 247.1 $ 110.9 $ 15.1 $ 24.7 $ 439.5
Specialty
Commercial .... 89.2 1,326.7 390.7 0.5 656.0 82.9 485.1 210.9 23.2 0.1 665.1
Nonstandard
Automobile .... 17.9 250.7 77.6 -- 417.2 21.2 288.3 96.1 9.7 -- 429.0
Other ........... -- -- -- -- -- 3.9 -- -- -- -- --
------- --------- -------- ------- -------- -------- -------- -------- ------- ------- --------
$ 155.6 $ 2,017.7 $ 564.0 $ 17.9 $1,503.0 $ 143.2 $1,020.5 $ 417.9 $ 48.0 $ 24.8 $1,533.6
======= ========= ======== ======= ======== ======== ======== ======== ======= ======= ========
1997 (b):
Workers
Compensation... $ 41.4 $ 447.7 $ 86.0 $ 19.9 $ 362.1 $ 41.8 $ 194.4 $ 101.8 $ 13.2 $ 20.6 $ 365.1
Specialty
Commercial .... 91.7 1,212.6 405.0 0.6 673.2 90.5 485.5 217.4 14.8 3.4 669.2
Nonstandard
Automobile .... 14.0 211.4 60.6 -- 322.4 21.8 225.6 68.0 8.6 -- 332.8
Other ........... -- -- -- -- -- 10.8 -- -- -- -- --
------- --------- -------- ------- -------- -------- -------- -------- -------- -------
$ 147.1 $ 1,871.7 $ 551.6 $ 20.5 $1,357.7 $ 164.9 $ 905.5 $ 387.2 $ 36.6 $ 24.0 $1,367.1
======= ========= ======== ======= ======== ======== ======== ======== ======= ======= ========
1996 (c):
Regional
Operations.... $ 33.2 $ 466.0 $ 83.9 $ 20.5 $ 356.8 $ 38.2 $ 209.7 $ 92.0 $ 11.2 $ 18.5 $ 353.0
Special
Programs ..... 58.6 955.7 258.1 2.0 462.3 62.7 335.5 137.6 6.3 5.1 489.9
Guaranty
National ..... 44.4 364.0 154.2 -- 481.7 39.4 337.8 134.0 10.4 -- 491.2
Other ........... -- -- -- -- -- 5.1 -- -- -- -- --
------- --------- -------- ------- -------- -------- -------- -------- ------- ------- --------
$ 136.2 $ 1,785.7 $ 496.2 $ 22.5 $1,300.8 $ 145.4 $ 883.0 $ 363.6 $ 27.9 $ 23.6 $1,334.1
======= ========= ======== ======= ======== ======== ======== ======== ======= ======= ========
(a) Net investment income is generally allocated on the basis of cash flow.
(b) 1997 restated to conform with 1998 basis of presentation.
(c) 1996 represents FAS 14 Segment Presentation including Guaranty National
Corporation, which comprises both commercial and personal lines of business.
S-9
SCHEDULE V
ORION CAPITAL CORPORATION AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
(In millions)
- ------------------------------------------------------------------------------------------------
Column A Column B Column C Column D Column E
--------
Additions
(1) (2)
Balance at Charged to Charged to Balance at
Beginning of Costs and Other Deductions End of
Description Year Expenses Accounts (a) Year
- ------------------------------------------------------------------------------------------------
1998:
Allowance for doubtful accounts-
Accounts and notes receivable ...$ 4.1
Effects of acquisition .......... 0.7
------ ------- ---- ------ ------
$ 4.8 $ 3.0 $ -- $ 4.4 $ 3.4
====== ======= ==== ====== ======
1997:
Allowance for doubtful accounts-
Accounts and notes receivable ...$ 3.7
Effects of acquisition .......... 0.3
------ ------- ---- ------ ------
$ 4.0 $ 1.3 $ -- $ 1.2 $ 4.1
====== ======= ==== ====== ======
1996:
Allowance for doubtful accounts-
Accounts and notes receivable ...$ 3.2
Effects of acquisition .......... 0.4
------ ------- ---- ------ ------
$ 3.6 $ 1.5 $ -- $ 1.4 $ 3.7
====== ======= ==== ====== ======
(a) Accounts written off
S-10
SCHEDULE VI
ORION CAPITAL CORPORATION AND SUBSIDIARIES
SUPPLEMENTAL INFORMATION FOR PROPERTY-CASUALTY INSURANCE UNDERWRITES
(In millions)
- ------------------------------------------------------------------------------------------------------------------------------------
Column A Column B Column C Column D Column E Column F Column G Column H Column I Column J Column K
Reserve Losses and
For Loss Adjustment
Unpaid Expenses Incurred Amortization Paid
Affiliation Deferred Losses Discount Related to of Deferred Losses
With Policy And loss Deducted Net (1) (2) Policy and Loss
Registrant Acquisition Adjustment in column Unearned Premiums Investment Currrent Prior Acquisition Adjustment Premiums
(a) Costs Expenses (b) Premiums Earned Income Year Year Costs Expenses Written
- --------------------------------------------------------------------------------------------------------------------------------
1998 $ 155.6 $ 2,017.7 $ 10.1 $ 564.0 $ 1,503.0 $ 139.3 $ 986.6 $ 33.9 $ 417.9 $1,009.7 $1,533.6
====================================================================================================================
1997 $ 147.1 $ 1,871.7 $ 4.1 $ 551.6 $ 1,357.7 $ 154.1 $ 896.2 $ 9.2 $ 387.2 $ 892.1 $1,367.1
====================================================================================================================
1996 $ 136.2 $ 1,785.7 $ 4.1 $ 496.2 $ 1,300.8 $ 140.3 $ 874.1 $ 8.9 $ 363.6 $ 794.9 $1,334.1
====================================================================================================================
(a) Consolidated Property and Casualty entities.
(b) Discount deducted in Column C is computed using a statutory interest
rate of 3.5% for certain workers compensation losses.
S-11