FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
(x) QUARTERLY REPORT UNDER SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For Quarter Ended March 31, 1999
( ) TRANSITION REPORT, PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 1-7801
ORION CAPITAL CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 95-6069054
(State of 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
Former name, former address and former fiscal year if changed since last report.
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 ( )
Approximately 27.2 million shares of Common Stock, $1.00 par value, of the
registrant were outstanding on May 1, 1999.
Page 1 of 33
Exhibit Index Appears at Page 33
1
ORION CAPITAL CORPORATION
FORM 10-Q INDEX
For the Quarter Ended March 31, 1999
Page
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements:
Consolidated Balance Sheet at March 31, 1999 (Unaudited)
and December 31, 1998 3 - 4
Consolidated Statement of Operations for the three months
ended March 31, 1999 and 1998 (Unaudited) 5
Consolidated Statement of Stockholders' Equity for the three
months ended March 31, 1999 and 1998 (Unaudited),
and for the year-ended December 31, 1998 6
Consolidated Statement of Cash Flows for the three months
ended March 31, 1999 and 1998 (Unaudited) 7 - 8
Notes to Consolidated Financial Statements (Unaudited) 9 - 14
Independent Accountants' Review Report 15
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 16 - 31
PART II. OTHER INFORMATION 31
2
PART I. FINANCIAL INFORMATION
ORION CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
ASSETS
March 31, 1999 December 31,
(In millions) (Unaudited) 1998
- --------------------------------------------------------------------------------
Assets:
Investments: -
Fixed maturities, at amortized cost
(market $270.3 - 1999 and $272.7 - 1998) .......... $ 260.2 $ 260.6
Fixed maturities, at market (amortized cost
$1,391.7 - 1999 and $1,305.5 - 1998) .............. 1,429.8 1,349.9
Common stocks, at market (cost $164.0 -
1999 and $200.3 - 1998) ........................... 189.6 242.4
Non-redeemable preferred stocks, at market
(cost $248.1 - 1999 and $269.1 - 1998) ............ 245.5 268.5
Other long-term investments .......................... 95.7 116.2
Short-term investments ............................... 198.7 248.7
---------- ----------
Total investments .............................. 2,419.5 2,486.3
Cash ................................................. 35.4 18.0
Accrued investment income ............................ 26.8 27.0
Investment in affiliate .............................. 22.8 22.8
Accounts and notes receivable ........................ 154.8 217.2
Reinsurance recoverables and prepaid reinsurance ..... 910.4 801.5
Deferred policy acquisition costs .................... 147.4 155.6
Property and equipment ............................... 100.7 95.4
Excess of cost over fair value of net assets acquired 166.1 167.7
Federal income taxes receivable ...................... 49.8 22.4
Deferred federal income taxes ........................ 53.7 26.7
Other assets ......................................... 118.5 123.8
---------- ----------
Total assets ................................... $ 4,205.9 $ 4,164.4
========== ==========
[FN]
See Notes to Consolidated Financial Statements (Unaudited)
</FN>
3
ORION CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
LIABILITIES AND STOCKHOLDERS' EQUITY
March 31, 1999 December 31,
(In millions, except for share data) (Unaudited) 1998
- ------------------------------------------------------------------------------------
Liabilities:
Policy liabilities: -
Losses ................................................ $ 1,680.1 $ 1,602.1
Loss adjustment expenses .............................. 472.4 415.6
Unearned premiums ..................................... 560.3 564.0
Policyholders' dividends .............................. 18.1 17.9
---------- ----------
Total policy liabilities ................................ 2,730.9 2,599.6
Notes payable ........................................... 209.4 217.4
Other liabilities ....................................... 400.0 370.1
---------- ----------
Total liabilities ....................................... 3,340.3 3,187.1
---------- ----------
Contingencies (Note 6)
Company-obligated mandatorily redeemable preferred
capital securities of subsidiary trusts holding solely
the junior subordinated debentures of the Company .... 250.0 250.0
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 ......................................... 147.7 149.6
Retained earnings ....................................... 455.8 553.2
Accumulated other comprehensive income .................. 42.4 58.5
Treasury stock, at cost (3,396,817 shares -
1999 and 3,505,091 shares - 1998)..................... (53.7) (57.8)
Deferred compensation on restricted stock ............... (7.3) (6.9)
---------- ----------
Total stockholders' equity .......................... 615.6 727.3
---------- ----------
Total liabilities and stockholders' equity .......... $ 4,205.9 $ 4,164.4
========== ==========
[FN]
See Notes to Consolidated Financial Statements (Unaudited)
</FN>
4
ORION CAPITAL CORPORATON AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)
Three Months Ended March 31,
----------------------------
(In millions, except for per share data) 1999 1998
- -------------------------------------------------------------------------------
Revenues:
Premiums earned ....................................... $ 299.1 $ 348.8
Net investment income ................................. 34.4 41.4
Realized investment gains ............................. 1.7 29.0
Other income .......................................... 1.1 5.6
--------- ---------
Total revenues ....................................... 336.3 424.8
--------- ---------
Expenses:
Losses incurred and loss adjustment expenses .......... 365.6 232.3
Amortization of deferred policy acquisition costs ..... 87.7 100.8
Other insurance expenses .............................. 1.8 6.9
Dividends to policyholders ............................ 6.0 6.4
Interest expense ...................................... 4.6 5.8
Other expenses ........................................ 7.3 11.1
--------- ---------
Total expenses ....................................... 473.0 363.3
--------- ---------
Earnings (loss) before equity in earnings (loss) of
affiliate, federal income
taxes, minority interest expense and cumulative
effect of adoption of new accounting principle ..... (136.7) 61.5
Equity in earnings (loss) of affiliate ................ -- (0.6)
--------- ---------
Earnings (loss) before federal income taxes, minority
interest expense and cumulative effect of
adoption of new accounting principle ................ (136.7) 60.9
Federal income tax expense (benefit) .................. (52.1) 16.0
Minority interest expense of subsidiary trust
preferred securities, net of federal income taxes .. 3.4 2.7
--------- ---------
Earnings (loss) before cumulative effect of adoption of
new accounting principle ........................... (88.0) 42.2
Cumulative effect of adoption of new accounting
principle, net of tax............................... (4.6) --
--------- ---------
Net earnings (loss) .................................. $ (92.6) $ 42.2
========= =========
Net earnings (loss) per common share:
Earnings (loss) before cumulative effect of adoption of
new accounting principle ........................... $ (3.26) $ 1.54
Cumulative effect of adoption of new accounting
principle .......................................... (0.17) --
--------- ---------
Basic ................................................ $ (3.43) $ 1.54
========= =========
Earnings (loss) before cumulative effect of adoption of
new accounting principle ........................... $ (3.26) $ 1.50
Cumulative effect of adoption of new accounting
principle .......................................... (0.17) --
--------- ---------
Diluted .............................................. $ (3.43) $ 1.50
========= =========
[FN]
See Notes to Consolidated Financial Statements (Unaudited)
</FN>
5
ORION CAPITAL CORPORATON AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
Three Months Ended Three Months Ended Year Ended
March 31, 1999 March 31, 1998 December 31, 1998
(In millions) (Unaudited) (Unaudited)
- -------------------------------------------------------------------------------------------------------------
Common Stock $ 30.7 $ 30.7 $ 30.7
======= ======= =======
Capital Surplus:
Balance, beginning of period $ 149.6 $ 152.1 $ 152.1
Exercise of stock options and net
issuance of restricted stock (1.9) 0.7 (2.5)
------- ------- -------
Balance, end of period $ 147.7 $ 152.8 $ 149.6
======= ======= =======
Retained Earnings:
Balance, beginning of period $ 553.2 $ 469.5 $ 469.5
Net earnings (loss) (92.6) $ (92.6) 42.2 $ 42.2 102.8 $ 102.8
------- ------- -------
Dividends declared (4.8) (4.4) (19.1)
------- ------- -------
Balance, end of period $ 455.8 $ 507.3 $ 553.2
======= ======= =======
Accumulated Other
Comprehensive Income:
Balance, beginning of period $ 58.5 $ 109.2 $ 109.2
Unrealized investment
gains (losses), net of taxes (16.5) 5.5 (52.4)
Unrealized foreign exchange
translation gains, net of taxes 0.4 - 1.7
------- ------- -------
Other comprehensive income (loss) (16.1) (16.1) 5.5 5.5 (50.7) (50.7)
------- ------- ------- ------- ------- -------
Comprehensive income (loss) $(108.7) $ 47.7 $ 52.1
======= ======= =======
Balance, end of period $ 42.4 $ 114.7 $ 58.5
======= ======= =======
Treasury Stock:
Balance, beginning of period $ (57.8) $ (34.3) $ (34.3)
Exercise of stock options and net
issuance of restricted stock 4.1 1.6 13.4
Common stock issued pursuant to
employee stock purchase plan - - 1.1
Acquisition of treasury stock - (6.7) (38.0)
------- ------- -------
Balance, end of period $ (53.7) $ (39.4) $ (57.8)
======= ======= =======
Deferred Compensation on
Restricted Stock:
Balance, beginning of period $ (6.9) $ (4.1) $ (4.1)
Net issuance of restricted stock (1.0) (1.6) (4.3)
Amortization of deferred
compensation on restricted stock 0.6 0.4 1.5
------- ------- -------
Balance, end of period $ (7.3) $ (5.3) $ (6.9)
======= ======= =======
[FN]
See Notes to Consolidated Financial Statements (Unaudited)
</FN>
6
ORION CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
Three Months Ended March 31,
----------------------------
(In millions) 1999 1998
- --------------------------------------------------------------------------------
Cash flows from operating activities:
Premiums collected $ 357.5 $ 386.1
Net investment income collected 31.0 40.1
Losses and loss adjustment expenses paid (288.9) (241.5)
Policy acquisition costs paid (90.5) (115.6)
Dividends paid to policyholders (5.8) (7.2)
Interest paid (8.7) (9.7)
Payments on trust preferred securities (5.5) (5.5)
Federal income tax refunds (payments) 20.0 (8.5)
Other payments (7.2) (15.4)
------- -------
Net cash provided by operating activities 1.9 22.8
------- -------
Cash flows from investing activities:
Maturities of fixed maturity investments 31.4 54.9
Sales of fixed maturity investments 156.8 198.8
Sales of equity securities 165.2 108.0
Investments in fixed maturities (292.1) (240.5)
Investments in equity securities (98.1) (104.1)
Net sales (purchases) of short-term investments 55.5 (39.0)
Acquisition and divestiture activities (4.3) (2.9)
Purchase of property and equipment, net (9.2) (4.5)
Other receipts (payments) 21.9 (12.7)
------- -------
Net cash provided by (used in) investing activities 27.1 (42.0)
------- -------
Cash flows from financing activities:
Net proceeds from issuance of trust preferred securities - 121.9
Proceeds from exercise of stock options 1.2 0.7
Repayment of notes payable (8.0) (100.2)
Dividends paid to stockholders (4.8) (4.4)
Purchases of common stock - (6.6)
Other payments - (0.4)
------- -------
Net cash (used in) provided by financing activities (11.6) 11.0
------- -------
Net increase (decrease) in cash 17.4 (8.2)
Cash balance, beginning of period 18.0 9.3
------- -------
Cash balance, end of period $ 35.4 $ 1.1
======= =======
[FN]
See Notes to Consolidated Financial Statements (Unaudited)
</FN>
7
ORION CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS - (Continued)
(UNAUDITED)
Three Months Ended March 31,
----------------------------
(In millions) 1999 1998
- --------------------------------------------------------------------------------
Reconciliation of net earnings (loss) to net cash
provided by operating activities:
Net earnings (loss) $ (92.6) $ 42.2
------- -------
Adjustments:
Cumulative effect of adoption of new
accounting principle 4.6 -
Depreciation and amortization 4.7 3.6
Amortization of excess of cost over fair
value of net assets acquired 1.5 1.3
Deferred federal income taxes (15.6) (0.9)
Amortization of fixed maturity investments 1.0 (0.6)
Non-cash investment income (2.2) (5.4)
Realized investment gains (1.7) (29.0)
Equity in loss of affiliate - 0.6
Changes in assets and liabilities, net of acquisition
and divestiture activities:
Decrease in accrued investment income 0.2 2.3
Decrease in accounts and notes receivable 15.4 4.1
Increase in reinsurance recoverable
and prepaid reinsurance (116.1) (76.9)
Increase in deferred policy acquisition costs (4.4) (6.3)
Decrease (increase) in federal income
taxes receivable (29.3) 8.5
Increase in other assets (9.5) (0.8)
Increase in losses and loss adjustment expenses 171.4 5.0
Increase in unearned premiums 36.3 14.1
Increase in policyholders' dividends 0.2 0.2
Increase in other liabilities 38.0 60.8
------- -------
Total adjustments and changes 94.5 (19.4)
------- -------
Net cash provided by operating activities $ 1.9 $ 22.8
======= =======
[FN]
See Notes to Consolidated Financial Statements (Unaudited)
</FN>
8
ORION CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Three Months Ended March 31, 1999 and 1998
Note 1 - Basis of Financial Statement Presentation
The consolidated financial statements and notes thereto are prepared in
accordance with generally accepted accounting principles for property and
casualty insurance companies. The consolidated financial statements include
Orion Capital Corporation ("Orion") and its wholly-owned subsidiaries
(collectively the "Company"). All material intercompany balances and
transactions have been eliminated.
As of January 1, 1999, the Company adopted Statement of Position ("SOP")
98-1, Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use, issued by the American Institute of Certified Public Accountants
("AICPA"). This Statement requires that certain costs incurred in developing
internal-use computer software be capitalized, and provides guidance for
determining whether computer software is considered to be for internal use. The
Company will amortize these costs over the software's useful life, which is
generally a period of 3 to 6 years. Previously, the Company expensed internal
cost of computer software as incurred. The adoption of this statement resulted
in an after-tax benefit of $0.9 million, or $0.03 per common share, for the
three months ended March 31, 1999.
On January 1, 1999, the Company adopted SOP 97-3, Accounting by Insurance
and Other Enterprises for Insurance-Related Assessments, which provides guidance
for determining when an insurance or other enterprise should recognize a
liability for guaranty-fund and other insurance-related assessments and guidance
for measuring the liability. This Statement requires recognition of a liability
when it is probable that an assessment will be imposed, the amount of the
assessment can be reasonably estimated, and the event obligating a company to
pay has occurred. Previously, the Company expensed guaranty-fund and other
insurance-related assessments as reported to the Company. The cumulative effect
recorded at January 1, 1999, as if this new accounting standard was applied
retroactively for all periods, resulted in an after-tax charge of $4.6 million,
or $0.17 per common share.
In the opinion of management, the accompanying consolidated financial
statements reflect all adjustments (consisting solely of normal recurring
adjustments) necessary to present fairly the Company's results of operations,
financial position and cash flows for all periods presented. Although these
consolidated financial statements are unaudited, they have been reviewed by the
Company's independent accountants, Deloitte & Touche LLP, for conformity with
accounting requirements for interim financial reporting. Their report on such
review is included herein. These consolidated financial statements should be
read in conjunction with the consolidated financial statements and notes thereto
included in the Company's 1998 Annual Report on Form 10-K.
Note 2 - Realignment Events
As part of the final steps in a two-year reshaping of Orion Capital, the
Company recently completed a detailed study of its loss and loss adjustment
expense reserve position as of March 31, 1999. The loss reserve study, performed
with the assistance of independent actuarial advisors, focused on the businesses
that the Company has exited or plans to exit. As a result of this study, the
Company recorded a net pre-tax charge of $164.5 million in the first quarter of
1999 primarily
9
ORION CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
related to the Specialty Commercial and Workers Compensation segments. The net
charge primarily comprised a provision for loss and loss adjustment expenses of
$139.0 million relating to 1998 and prior accident years, which was net of
reinsurance, and included a $25.5 million net ceded premium adjustment based
upon the Company's loss experience. Approximately $123.4 million of the loss
reserve provision is attributed to exited businesses. The study also reviewed
the reserve position for the Company's ongoing business in light of current
industry conditions. The Company recorded loss reserve strengthening of
approximately $15.6 million relating to its ongoing businesses including $8.4
million for EBI, $4.2 million for DPIC and $3.0 million for OrionAuto. Further,
the Company has adjusted loss ratios for the 1999 accident year in consideration
of the reserve study findings.
As part of the Company's reshaping to focus its resources on more
profitable business, on April 9, 1999 the Company sold Wm. H. McGee & Co. for
$59.4 million in cash resulting in a pre-tax gain of $40.2 million and an
after-tax gain of $26.3 million, which will be reported in the second quarter of
1999. In connection with the sale, the Company entered into reinsurance
agreements with the buyer transferring the Company's participation in McGee's
United States and Canadian pools effective as of January 1, 1999, resulting in
negative net premiums written of $40.0 million in the first quarter of 1999.
These transfers have resulted in a $23.5 million cash payment to the buyer on
the sale date for the transfer of the Company's net liabilities and assets of
the McGee pools. Additionally, the buyer was designated as the clearing company
for McGee pools effective January 1, 1999 under McGee's Inter-Office Reinsurance
Agreements. At December 31, 1998 and for the year then ended, the Company
reflected net premiums written and total revenue of approximately $104.4 million
and $100.2 million, respectively, and total assets of approximately $112.0
million related to sold business of McGee.
In the third quarter of 1998, the Company established a restructuring
reserve in connection with a realignment of Orion Specialty resulting in exiting
of approximately $100 million of unprofitable commodity business, primarily
commercial automobile and transportation. This restructuring included the
reduction of approximately 90 employees related to exited business. Activity for
the three months ended March 31, 1999 within this restructuring reserve was as
follows:
(In millions)
- -----------------------------------------------------------
Balance at December 31, 1998 $ 5.1
Actions taken:
Severance and program termination costs (0.9)
--------
Balance at March 31, 1999 $ 4.2
========
The Company is performing a strategic review of the $150 million book of
specialty commercial program and binding authority business of Orion Specialty.
See "Recent Activities" on page 17.
Note 3 - Investment in Affiliate
As of March 31, 1999, the carrying value of the Company's 26% investment in
Intercargo Corporation ("Intercargo") was $22.8 million, representing the amount
that the Company agreed to
10
ORION CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
sell Intercargo in cash pursuant to Intercargo's merger with a subsidiary of XL
Capital, Ltd. See note 9 "Subsequent Event."
In 1998, the Company recorded its share of Intercargo's operating
results on a quarterly lag basis, after Intercargo has reported its financial
results. For the three months ended March 31, 1998, Intercargo reported $18.8
million of revenues and $2.1 million of net loss. The Company's proportionate
share of Intercargo net loss including goodwill amortization was $0.6 million
for the first quarter of 1998.
Note 4 - Reinsurance
In the normal course of business, the Company's insurance subsidiaries
reinsure certain risks, generally on an excess-of-loss or pro rata basis, with
other companies to limit its exposure to losses. Reinsurance does not discharge
the primary liability of the original insurer. The table below summarizes
certain reinsurance information for the three months ended March 31:
(In millions) 1999 1998
- --------------------------------------------------------------------------
Direct premiums written ............................$ 480.8 $ 441.7
Reinsurance assumed ................................ 32.6 14.1
------ ------
Gross premiums written ............................. 513.4 455.8
Reinsurance ceded .................................. (238.5) (86.8)
------ ------
Net premiums written ...............................$ 274.9 $ 369.0
====== ======
Direct premiums earned .............................$ 494.4 $ 435.6
Reinsurance assumed ................................ 15.4 10.9
------ ------
Gross premiums earned .............................. 509.8 446.5
Reinsurance ceded .................................. (210.7) (97.7)
------ ------
Net premiums earned ................................$ 299.1 $ 348.8
====== ======
Loss and loss adjustment expenses incurred
recoverable from reinsurers .....................$ 158.5 $ 70.4
====== ======
Note 5 - Stockholders' Equity and Earnings Per Common Share
During the first quarter of 1999, the Company repurchased 6,414 shares at
an aggregate cost of $0.2 million related to its employee benefit plans. During
the first quarter of 1998, the Company repurchased 132,000 shares of its common
stock at an aggregate cost of $6.6 million under the stock repurchase program
authorized by the Board of Directors and repurchased 2,377 shares at an
aggregate cost of $0.1 million related to its employee benefit plans. The
remaining authorization from the Company's Board of Directors for the purchase
of common stock was $42.5 million as of March 31, 1999.
Orion declared dividends on its common stock of $4.8 million and $4.4
million or $0.18 and $0.16 per common share for the three months ended March 31,
1999 and 1998, respectively.
11
ORION CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
A reconciliation of basic and diluted earnings (loss) per share ("EPS") for
the three months ended March 31, 1999 and 1998 was as follows:
Net
Earnings Average Per Share
(In millions, except for per share amounts) (loss) shares Amount
- ----------------------------------------------------------------------------------
1999 -
Basic EPS:
Net earnings (loss) available to
common stockholders .................... $ (92.6) 27.0 $ (3.43)
========
Stock options and awards .................. -- --
-------- --------
Diluted EPS:
Net earnings (loss) available to common
stockholders with assumed exercises .... $ (92.6 27.0 $ (3.43)
======== ======== ========
1998 -
Basic EPS:
Net earnings available to
common stockholders .................... $ 42.2 27.4 $ 1.54
========
Stock options and awards .................. -- 0.7
-------- --------
Diluted EPS:
Net earnings available to common
stockholders with assumed exercises .... $ 42.2 28.1 $ 1.50
======== ======== ========
The average shares for 1999 excludes equivalent shares of 279,000 in the
computation of diluted earnings per common share because to include them would
have been antidilutive.
Note 6 - 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.
12
ORION CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Note 7 - Accumulated Other Comprehensive Income
Accumulated other comprehensive income balances, net of taxes, are as
follows:
Unrealized Unrealized Foreign Accumulated Other
Investment Gains Translation Comprehensive
(In millions) (Losses) Gains (Losses) Income (Loss)
- -------------------------------------------------------------------------------------
Quarter ended March 31, 1999:
Balance, beginning of period ..... $ 61.2 $ (2.7) $ 58.5
Current period change ..... (16.5) 0.4 (16.1)
--------- --------- ---------
Balance, end of period ..... $ 44.7 $ (2.3) $ 42.4
========= ========= =========
Quarter ended March 31, 1998:
Balance, beginning of period ..... $ 113.6 $ (4.4) $ 109.2
Current period change ..... 5.5 -- 5.5
--------- ---------- ---------
Balance, end of period ..... $ 119.1 $ (4.4) $ 114.7
========= ========= =========
Year ended December 31, 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
========= ========= =========
The pretax unrealized investment gains (losses) arising during the period
were $(25.4) million and $8.6 million for the three months ended March 31, 1999
and 1998, respectively, and $(80.4) million for the year ended December 31,
1998. The pretax unrealized foreign exchange translation gains arising during
the period were $0.6 million for the three months ended March 31, 1999 and $2.6
million for the year ended December 31, 1998.
Note 8 - Segment Information
The Company reports its insurance operations in three segments at March 31,
1999. These reportable segments comprise operating units of the Company that
have different insurance products and services, market focus and operational
structure. The Company's reportable segments comprise:
Workers Compensation - this segment provides workers compensation insurance
products and services sold by the EBI Companies ("EBI")and includes package
commercial insurance policies that are no longer written by the Company.
Nonstandard Automobile - this segment specializes in nonstandard personal
automobile insurance sold by OrionAuto (formerly known as Guaranty National
Corporation).
13
ORION CAPITAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Specialty Commercial - this segment markets various specialty commercial
products and services, primarily professional liability insurance through DPIC
Companies and client-focused specialty insurance programs through Orion
Specialty; and also includes the run-off operations of the Company's assumed
reinsurance business, SecurityRe, which was sold in late 1996. The Company
exited the marine business by selling its 26% interest in Intercargo (see Notes
3 and 9) and Wm. H. McGee (see Note 2).
Financial information for the Company's segments for the three months
ended March 31 is shown below and discussed in detail in "Results of Operations"
on page 18:
(In millions) 1999 1998
- ----------------------------------------------------------------------------
Revenues:
Workers Compensation ................................ $ 93.7 $ 119.8
Nonstandard Automobile .............................. 121.4 99.8
Specialty Commercial ................................ 118.4 203.1
Other ............................................... 2.8 2.1
-------- --------
Consolidated ..................................... $ 336.3 $ 424.8
======== ========
Pre-tax Earnings (Loss) before Minority Interest (a):
Workers Compensation ................................ $ (39.1) $ 28.4
Nonstandard Automobile .............................. 5.8 7.9
Specialty Commercial ................................ (98.9) 29.7
Other ............................................... (4.5) (5.1)
-------- --------
Consolidated ..................................... $ (136.7) $ 60.9
======== ========
(a) Excludes cumulative effect of adoption of new accounting principle in 1999
(see note 1).
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.
Note 9 - Subsequent Event
In December 1998, the Company agreed to sell its 26% interest in Intercargo
in cash pursuant to Intercargo's merger with a subsidiary of XL Capital, Ltd.
Intercargo announced that its merger was consummated on May 7, 1999. The Company
will receive $22.8 million in cash from the sale in the near future. Also see
Note 2 regarding the sale of McGee.
14
INDEPENDENT ACCOUNTANT'S REVIEW REPORT
Board of Directors and Stockholders
Orion Capital Corporation
Farmington, Connecticut
We have reviewed the accompanying consolidated balance sheet of Orion
Capital Corporation and subsidiaries (the "Company") as of March 31, 1999, and
the related consolidated statements of operations, stockholders' equity, and
cash flows for the three-month periods ended March 31, 1999 and 1998. These
financial statements are the responsibility of the Company's management.
We conducted our review in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data and of making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with generally accepted auditing standards, the objective of which is
the expression of an opinion regarding the financial statements taken as a
whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that
should be made to such consolidated financial statements for them to be in
conformity with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of Orion Capital Corporation and
subsidiaries as of December 31, 1998, and the related consolidated statements of
earnings, stockholders' equity and cash flows for the year then ended; and in
our report dated February 22, 1999 (except for Note 20, as to which the date is
March 11, 1999), we expressed an unqualified opinion on those consolidated
financial statements. The consolidated statements of earnings and cash flows for
the year ended December 31, 1998 are not presented herein. In our opinion, the
information set forth in the accompanying consolidated balance sheet as of
December 31, 1998 and related consolidated statement of stockholders' equity for
the year then ended is fairly stated, in all material respects, in relation to
the consolidated financial statements from which it has been derived.
DELOITTE & TOUCHE LLP
Hartford, Connecticut
May 7, 1999
15
ORION CAPITAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OPERATIONS
THREE MONTHS ENDED MARCH 31, 1999 AND 1998
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 March 31, 1999 as follows:
Workers Compensation - this segment markets the workers compensation insurance
products and services sold by the EBI Companies ("EBI")and includes package
commercial insurance policies that are no longer written by the Company.
Nonstandard Automobile - this segment specializes in nonstandard personal
automobile insurance sold by OrionAuto, formerly known as Guaranty National
Corporation.
Specialty Commercial - this segment presently markets various specialty
commercial products and services, primarily professional liability insurance
through DPIC Companies ("DPIC") and client-focused specialty insurance programs
through Orion Specialty; and also includes the run-off operations of the
Company's assumed reinsurance business, SecurityRe, which was sold in late 1996.
Over the past two years, Orion has been reshaping its business to focus its
resources on high potential lines of business. Business in Orion's workers
compensation segment is conducted through EBI, 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 100% in
December 1997 and then transformed Guaranty National (OrionAuto) into a focused
personal nonstandard automobile company. The commercial lines business of
Guaranty National was shifted to a newly-formed unit, Orion Specialty Group,
Inc. and integrated with Connecticut Specialty Insurance Group, Inc. Guaranty
National was recently renamed OrionAuto, Inc. The Company added scale to its
nonstandard automobile operation by acquiring two businesses, Unisun Insurance
Company in December 1997 and portions of Strickland Insurance Group in April
1998 expanding its geographic market to 35 states.
The Company continued the reshaping in its specialty commercial segment. As of
March 31, 1999, this segment included DPIC, 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, the Company added a specialty insurance company serving the
independent grocery industry with the purchase of Grocers Insurance Group. The
Company sold a unit of Orion Specialty, Colorado Casualty Insurance Company, in
September 1998. Additionally, during the third quarter of 1998, the Company took
steps to exit a block of commercial automobile and transportation business,
representing approximately $100 million in net written premiums, that was highly
price-driven and was performing below our levels of expectations.
16
In November 1996, the Company exited the assumed reinsurance business when it
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.
RECENT ACTIVITIES
As part of its final reshaping initiatives, the Company in early May completed a
reserve study focused on business that has been or is in the process of being
exited. The reserve study was performed with the assistance of independent
actuarial advisors. In the first quarter of 1999, the Company strengthened its
loss and loss adjustment reserves by recording a net charge of $164.5 million on
a pre-tax basis and $106.9 million on an after-tax basis, or $3.96 per diluted
common share, in connection with the reserve study. The net charge is
substantially related to exited business. See section "Expense and Other -
Operating Ratios" on page 24.
Orion continues its reshaping of the specialty commercial segment to focus
resources on more profitable lines of business. As part of that effort, the
Company exited the marine business by selling our 26% interest in Intercargo
Corporation and Wm. H. McGee & Co., Inc. On April 9, 1999 the Company sold Wm.
H. McGee & Co. for $59.4 million in cash resulting in a pre-tax gain of $40.2
million and an after-tax gain of $26.3 million, which will be recorded in the
second quarter of 1999. In connection with the sale, the Company entered into
reinsurance agreements with the buyer transferring the Company's participation
in McGee's United States and Canadian pools effective January 1, 1999 resulting
in negative net premiums written of $40.0 million in the first quarter of 1999.
Additionally, the buyer was designated as the clearing company of the McGee
pools effective as of January 1, 1999 under McGee's Inter-Office Reinsurance
Agreements. The Company reflected net premiums written and total revenue of
approximately $104.4 million and $100.2 million, respectively, for the year
ended December 31, 1998 and total assets of approximately $112.0 million at
December 31, 1998 related to sold business of McGee.
In December 1998, the Company agreed to sell its investment in Intercargo for
$22.8 million (its current carrying value), or $12 per share, in cash pursuant
to the terms of Intercargo's merger with a subsidiary of XL Capital, Ltd.
Intercargo announced that its merger was consummated on May 7, 1999. The Company
will receive $22.8 million in cash from the sale in the near future.
In April 1999, the Company announced that it is working with financial advisors
on the final initiatives in its reshaping process, which includes a review of
strategic alternatives for the $150 million book of specialty commercial program
and binding authority business of Orion Specialty. The Company believes that the
specialty commercial program and binding authority business is the last piece of
Orion's operation that lacks market leadership or competitive advantage and will
explore a full range of options for it. Announcement of the results of that
review is anticipated during the third quarter of 1999.
Excluding the Orion Specialty business under strategic review, after all these
steps have been completed, the Specialty Commercial segment will include DPIC,
Orion Financial, Grocers Insurance, and ARTIS, and will have approximately $420
million of gross written premiums and approximately $298 million of net written
premiums based on 1998 volume.
17
RESULTS OF OPERATIONS
OVERVIEW
Earnings (loss) by segment before federal income taxes, minority interest
expense and cumulative effect of adoption of new accounting principle for the
three months ended March 31 are summarized as follows:
(In millions) 1999 1998
- --------------------------------------------------------------
Workers Compensation $ (39.1) $ 28.4
Nonstandard Automobile 5.8 7.9
Specialty Commercial (98.9) 29.7
Other (4.5) (5.1)
----------- ------------
$ (136.7) $ 60.9
=========== ============
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 (loss), after-tax realized investment gains, net earnings
(loss) and per diluted common share amounts for the three months ended March 31
are summarized as follows:
(In millions, except for per share amounts and %) 1999 1998
- --------------------------------------------------------------------------------
Operating earnings (loss) .................. $ (89.1) $ 23.4
After-tax investment gains ................. 1.1 18.8
Cumulative effect of adoption of
new accounting principle ................ (4.6) --
------------ -----------
Net earnings (loss) ..................... $ (92.6) $ 42.2
============ ===========
Per diluted common share:
Operating earnings (loss) .................. $ (3.30) $ 0.83
After-tax investment gains ................. 0.04 0.67
Cumulative effect of adoption of
new accounting principle ................ (0.17) --
------------ -----------
Net earnings (loss) ..................... $ (3.43) $ 1.50
============ ===========
Operating earnings (loss) represents earnings (loss) after taxes, excluding net
realized investment gains and the cumulative effect of an accounting change. For
the first quarter of 1999, operating earnings were adversely effected by a
$106.9 million after-tax charge, or $3.96 per diluted share, related to an
increase in loss reserves in connection with a recently completed loss reserve
study. Excluding this charge, the Company's after-tax operating earnings would
be $17.8 million, or $0.66 per share.
The Company's results of operations for 1999 reflects a $4.6 million after-tax
charge, or $0.17 per diluted common share, for the cumulative effect of adoption
of a new accounting principle, AICPA Statement of Position 97-3 "Accounting by
Insurance and Other Enterprises for Insurance Related Assessments." See note 1
to the Company's condensed financial statements for discussion of new accounting
principles adopted by the Company in 1999.
18
Weighted average common shares and diluted equivalents outstanding were
26,993,000 and 28,130,000 for the three months ended March 31, 1999 and 1998,
respectively. The average share for 1999 excludes equivalent shares of 279,000
in the computation of diluted earnings per common share because to include them
would have been antidilutive.
REVENUES
Revenues for the three months ended March 31 are summarized as follows:
Percentage
(In millions) 1999 1998 Change
- -----------------------------------------------------------------------------
Net Premiums written ........... $ 274.9 $ 369.0 (25.5)%
========= ========= =====
Premiums earned ................ $ 299.1 $ 348.8 (14.2)%
Net investment income .......... 34.4 41.4 (16.8)
Realized investment gains ...... 1.7 29.0 (94.0)
Other .......................... 1.1 5.6 (82.3)
--------- --------- -----
Total revenues .............. $ 336.3 $ 424.8 (20.8)%
========= ========= =====
PREMIUMS
The Company's gross premiums written by segment for the three months ended March
31 are as follows:
Percentage
(In millions) 1999 1998 Change
- ---------------------------------------------------------------------------
Workers Compensation $ 147.1 $ 115.6 27.2%
Nonstandard Automobile 152.4 127.6 19.4
Specialty Commercial 213.9 212.6 0.6
--------- --------- ----
Consolidated $ 513.4 $ 455.8 12.6%
========= ========= ====
The Company's net premiums written by segment for the three months ended March
31 are as follows:
Percentage
(In millions) 1999 1998 Change
- ---------------------------------------------------------------------------
Workers Compensation ..................$ 94.7 $ 110.7 (14.5)%
Nonstandard Automobile ................ 124.8 96.0 29.9
Specialty Commercial .................. 55.4 162.3 (65.8)
--------- --------- -----
Consolidated ....................$ 274.9 $ 369.0 (25.5)%
========= ========= =====
Consolidated, excluding McGee ...$ 314.9 $ 352.4 (10.7)%
========= ========= =====
In connection with the sale of McGee in April 1999, the Company transferred its
participation in McGee's United States and Canadian pools effective January 1,
19
1999, resulting in a $40.0 million reduction to net written premiums and no
effect on premiums earned in the first quarter of 1999. In the first quarter of
1999, based on the Company's loss experience, the Company also ceded an
additional $35.2 million of premiums under a corporate-wide aggregate stop loss
reinsurance agreement entered into in 1998 related to the 1998 accident year.
The Company does not expect to use corporate-wide aggregate stop loss agreements
for the 1999 accident year.
Workers Compensation
Net premiums written for Workers Compensation decreased by 14.5% in the first
quarter of 1999 compared to the same 1998 period reflecting lower premium
retention of $46.7 million primarily from a change in EBI's reinsurance programs
effective October 1998. The effect of this change was partly offset by gross
premium growth of $30.7 million from new business written through EBI's
multi-state accounts program and continued geographic expansion and penetration.
In order to improve profitability, EBI has instituted rate increases, which is
expected to reduce the growth of EBI's gross premiums written for the remainder
of 1999.
NONSTANDARD AUTOMOBILE
Net premiums written for Nonstandard Automobile increased by 29.9% in the first
quarter of 1999 compared to the same 1998 period primarily due to increased
premiums of $12.1 million from the acquisition of Strickland in April 1998 and
higher net premiums in South Carolina of $9.0 million from transitioning to a
voluntary market environment in that state on March 1, 1999. OrionAuto generated
net premium growth in 25 of the 35 states where it writes business in the first
quarter of 1999 compared to the same 1998 period. Excluding the acquisitions of
Strickland and Unisun, Nonstandard Automobile's gross premiums written and net
premiums written growth was 5.6% and 7.6% in the first quarter of 1999 compared
to the same 1998 period.
SPECIALTY COMMERCIAL
Gross premiums written, excluding McGee, for the three months ended March 31 are
as follows:
Percentage
(In millions) 1999 1998 Change
- ---------------------------------------------------------------------------
Orion Specialty ......................... $ 135.1 $ 115.0 17.5%
DPIC .................................... 52.0 49.9 4.1
Assumed reinsurance and eliminations .... (1.5) (0.8)
------- ------- ----
$ 185.6 $ 164.1 13.1%
======= ======= ====
20
Net premiums written for the three months ended March 31 are as follows:
Percentage
(In millions) 1999 1998 Change
- ---------------------------------------------------------------------------
Orion Specialty ........................ $ 57.0 $ 103.5 (44.9)%
DPIC ................................... 38.4 42.3 (9.1)
McGee .................................. (40.0) 16.6
-------- ------- -----
55.4 162.4 (65.9)
Assumed reinsurance .................... -- (0.1)
-------- ------- -----
Specialty Commercial ................ $ 55.4 $ 162.3 (65.8)%
======== ======= =====
Specialty Commercial, excluding McGee $ 95.4 $ 145.7 (34.5)%
======== ======= =====
Net premiums written by DPIC for professional liability insurance, the largest
special program, decreased 9.1% in the first quarter of 1999 compared to the
same 1998 period primarily as a result of increased use of reinsurance in its
lawyers and accountants programs, offset in part by continued high levels of
policy renewals.
Net premiums written by Orion Specialty decreased by 44.9% in the first quarter
of 1999 compared to the same 1998 period primarily due to the effect of exiting
unprofitable commodity business in connection with the third quarter 1998
realignment of this unit, $23.9 million of ceded premiums in 1999 under the
corporate-wide reinsurance agreement previously mentioned and lower premiums of
$13.6 million from the sale of Colorado Casualty Insurance Company in September
1998. The decreases were partly offset by increased net written premiums of
$13.7 million from the acquisition of Grocers Insurance Group in July 1998.
Orion Specialty's Financial Services Division, which primarily writes collateral
protection insurance, had gross premiums written of $31.7 million and $25.2
million for the three months ended March 31, 1999 and 1998, respectively, and
corresponding net premiums written of $20.4 million in 1999 and $21.4 million in
1998. ARTIS, our alternative risk business formed in June 1997, had gross and
net premiums written of $26.7 million and $0.7 million in the first quarter of
1999, respectively, as compared to $5.7 million of gross and no net premiums
written for the same 1998 period.
In the first quarter of 1999, McGee recorded negative net premiums written of
$40.0 million reflecting the unearned premium portfolio transferred as of
January 1, 1999 in connection with the sale of McGee.
PREMIUMS EARNED
The Company's premiums earned decreased 14.2% to $299.1 million in the first
quarter of 1999 from $348.8 million ($334.6 million excluding McGee) in the
corresponding 1998 period. Premiums earned reflect the recognition of income
from the changing levels of net premium writings.
OTHER INCOME
Other income is $1.1 million and $5.6 million for the first quarters of 1999 and
1998, respectively. The decrease is due to lower commission income resulting
from the sale of McGee. As part of the McGee sale, the buyer was designated as
the clearing company of the pools managed by McGee effective January 1, 1999.
21
INVESTMENT PERFORMANCE
The Company manages its investment portfolio on a total return basis which
emphasizes both current net investment income and realized investment gains as
well as unrealized investment results. The pre-tax performance of the Company's
investments, including net investment income, net realized gains (losses) and
net unrealized appreciation (depreciation) for the three months ended March 31
is as follows:
(In millions, except for %) 1999 1998
- ------------------------------------------------------------------------------
Net investment income ............................$ 34.4 $ 41.4
Realized investment gains ........................ 1.7 29.0
Unrealized appreciation (depreciation) ........... (27.4) 8.1
------------ -----------
$ 8.7 $ 78.5
============ ===========
Investment yields on average portfolio:
Pre-tax ....................................... 5.7% 7.0%
After-tax ..................................... 4.5% 5.5%
Carrying value: ................................March 31, 1999 December 31, 1998
--------------------------------
Fixed maturities and short-term investments .$ 1,888.7 $ 1,859.2
Equity securities ........................... 435.1 510.9
Other long-term investments ................. 95.7 116.2
------------ -----------
$ 2,419.5 $ 2,486.3
============ ===========
NET INVESTMENT INCOME
Pre-tax net investment income decreased by $7.0 million in the first quarter of
1999 compared to the same 1998 period primarily due to lower earnings on limited
partnership investments accounted for on an equity basis, a continued shift in
the fixed income portfolio from taxable to tax-advantaged securities and the
impact of lower reinvestment rates in 1998 and in the first quarter of 1999
resulting in reduced investment yields of the Company's fixed income portfolio.
Net investment income includes equity earnings in limited partnership
investments of $2.0 million in the first quarter of 1999 and $5.2 million for
the same 1998 period, partially the result of planned reductions in these
investments. Earnings from limited partnership investments can vary considerably
from year-to-year. Although, the Company's long-term experience with limited
partnership investments has been quite favorable; they represent 3.8% and 4.5%
of total investments at March 31, 1999 and December 31, 1998, respectively.
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. The carrying
value of fixed maturity and short-term investments is $1,888.7 million at March
31, 1999 and $1,859.2 million at December 31, 1998, or approximately 76.9% and
74.2% of the Company's cash and investments, respectively.
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
22
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. The Company invests primarily in investment grade
securities and additionally invests a portion of its portfolio in a diversified
group of non-investment grade fixed maturity securities or securities that are
not rated to increase the portfolio average return. 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 March 31, 1999 and December 31, 1998, the
Company's investment in non-investment grade and non-rated fixed maturity
securities were as follows:
(In millions, except for %) March 31, 1999 December 31, 1998
- --------------------------------------------------------------------------------
Non-investment grade and
non-rated fixed maturity securities $ 156.9 $ 208.7
As percentage of total cash and investments 6.4% 8.3%
As percentage of total assets 3.7% 5.0%
REALIZED AND UNREALIZED INVESTMENT RESULTS
Net realized investment gains are $1.7 million and $29.0 million for the three
months ended March 31, 1999 and 1998, respectively. Approximately one-half of
the first quarter 1998 net realized investment gains resulted from the sale of
two investments in entities which were acquired or taken public during that
quarter. Realized investment gains may be reduced by provisions for losses on
securities deemed to be other-than-temporarily impaired. 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. 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.
The Company has a new outside investment manager that is repositioning part of
the Company's investment portfolio and expects the repositioning to be complete
by June 30, 1999.
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, and included as a component of other comprehensive
income (see note 7 to condensed financial statements). Unrealized investment
appreciation (depreciation) can vary significantly depending upon fluctuations
in interest rates, changes in credit spreads and in equity prices.
23
EXPENSES AND OTHER
OPERATING RATIOS
The following table sets forth certain ratios of insurance operating expenses to
premiums earned for the three months ended March 31:
1999 1998
- -------------------------------------------------------------------------------
Loss and loss adjustment expenses 122.2% 66.5%
Policy acquisition costs and other insurance expenses 29.9 31.0
-------- --------
Total before policyholders' dividends 152.1 97.5
Policyholders' dividends 2.0 1.8
-------- --------
Combined ratio 154.1% 99.3%
======== ========
Loss and loss adjustment expenses ratio by segment:
Workers Compensation 115.6% 56.6%
Nonstandard Automobile 72.9 72.0
Specialty Commercial 185.3 69.6
In the third quarter of 1998, the Company announced a realignment of Orion
Specialty to address lines of business that had not met growth and profitability
expectations. The realignment continued Orion Specialty's shift away from
commodity business. The Company's recent trends in the loss development of the
previously cancelled program business at Orion Specialty indicated a
deterioration of claims experience and prompted the recently completed loss
reserve study.
In the first quarter of 1999, the ratio of loss and loss adjustment expenses to
premiums earned (the "loss ratio") of 122.2% reflects significant strengthening
of the Company's reserve position as of March 31, 1999 based upon a recently
completed loss reserve study.
Excluding the provision for loss and loss adjustment expenses recorded in
connection with the loss reserve study, the loss and loss adjustment expenses
ratio by segment for the three months ended March 31, 1999 would have been 62.3%
for Workers Compensation, 70.3% for Nonstandard Automobile, and 69.6% for
Specialty Commercial.
The Company made the decision to conduct a review of its loss reserves for
exited business and to review strategic alternatives for Orion Specialty's
remaining program and binding authority business in the first quarter of 1999 as
part of the final steps in an aggressive two-year reshaping of the Company's
business. The Company expanded the analysis to a full-scale review of all
reserves and elected to add the perspective of an independent actuarial review.
As a result of this study, in the first quarter of 1999, the Company recorded a
provision for loss and loss adjustment expenses of $139.0 million related to the
1998 and prior accident years, which was net of reinsurance, and included a
$25.5 million net ceded premium adjustment based upon the Company's loss
experience. The loss reserve study focused on the business that the Company has
exited or plans to exit and the provision included costs of settling outstanding
claims for exited business. Approximately 89% of the net provision were
attributed to businesses that the Company has exited and will be exiting.
The loss reserve study also reviewed the reserve positions for the Company's
ongoing business in light of current market conditions and industry trends.
Approximately 11% of the loss reserve strengthening is related to ongoing
business, including $8.4 million for EBI, $4.2 million for DPIC and $3.0 million
for OrionAuto. Further, the Company has adjusted loss ratios for the 1999
accident year in consideration of the reserve study findings.
24
The 1999 first-quarter loss ratio for Workers Compensation reflects $31.9
million of reserve strengthening related to non-workers compensation lines that
originated in this segment, but are no longer written by the Company.
Additionally, EBI strengthened its net reserves in the first quarter 1999 by
recording a loss and loss adjustment expense provision of $8.4 million primarily
relating to the 1998 accident year as a result of the loss reserve study. The
benefit of EBI's service-oriented approach, working with its customers to
prevent losses and reduce claim costs, has allowed EBI to report better than
industry results.
The 1999 loss ratio for Nonstandard Automobile reflects an increase in loss
costs resulting from the loss reserve study substantially offset by a decrease
in loss adjustment expenses from continued improvements in efficiencies.
In connection with the loss reserve study, in the first quarter of 1999,
Specialty Commercial strengthened its loss reserve positions by recording a net
provision for loss and loss adjustment expenses of $95.7 million related to 1998
and prior accident years. Approximately $47.1 million of this net charge is
related to the assumed reinsurance business that the Company exited in late
1996, $44.4 million is related to the exited program and binding authority
business at Orion Specialty, and $4.2 million is related to the ongoing business
at DPIC.
The ratio of policy acquisition costs and other insurance expenses to premiums
earned (the "expense ratio") improved to 29.9% from 31.0% for the three months
ended March 31, 1999 and 1998, respectively. The lower expense ratio is
primarily due to a favorable change in the Company's total business mix with an
increasing percentage of business in Nonstandard Automobile and a declining
percentage in Specialty Commercial, as well as the Company's actions to decrease
operating expenses. Policy acquisition costs include direct costs, such as
commissions, premium taxes, and salaries that relate to and vary with the
production of new business. These costs are deferred and amortized as the
related premiums are earned, subject to a periodic test for recoverability.
The Company regularly evaluates its reserves for loss and loss adjustment
expenses. Loss reserve amounts are based on management's informed estimates and
judgements, using data currently available. As part of the evaluation of its
first quarter loss reserve position, the Company took the additional action of
having an independent actuarial review of its loss reserves. The results of
which were considered in the increases in loss reserves during the first quarter
of 1999. 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. Although there can be no assurance that
changes in loss trends will not result in additional development of prior years'
reserves in the future, the Company believes that the current and prospective
loss reserving reflects an increased level of conservatism. 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 variability or development will generally be at low levels,
considering actions that have been taken to increase loss reserving levels,
improve underwriting standards and emphasize loss prevention and control.
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.
25
INTEREST EXPENSE
Interest expense is $4.6 million and $5.8 million for the first quarters of 1999
and 1998, respectively. Interest expense declined 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 are $7.3 million and $11.1 million for the first quarters of 1999
and 1998, respectively. The decrease is primarily due to the elimination of
McGee agency expense resulting from the sale of this unit.
EQUITY IN EARNINGS (LOSS) OF AFFILIATE
Equity in loss of affiliate consists of a loss of $0.6 million in the first
quarter of 1998 from the Company's 26% investment in Intercargo. In December
1998, the Company has agreed to sell its investment in Intercargo pursuant to
the terms of a merger agreement between Intercargo and a subsidiary of XL
Capital, Ltd., and reduced its carrying value of Intercargo to the sale price of
$22.8 million. The Company continued to carry its investment in Intercargo at
$22.8 million in the first quarter of 1999. Intercargo announced that its merger
was consummated on May 7, 1999. The Company will receive $22.8 million in cash
from the sale in the near future.
FEDERAL INCOME TAXES (BENEFITS)
Federal income taxes (benefits), including tax benefits from trust preferred
securities and excluding tax benefits from an accounting change, and the related
effective tax rates are $(53.9) million (-38.0%) and $14.5 million (25.6%) for
the first quarters of 1999 and 1998, respectively. The Company's effective tax
rates for 1999 and 1998 are different than the statutory tax rate of 35%
primarily because of income derived from tax-advantaged securities. The 1999
first quarter effective tax rate has been calculated on a discrete period basis
giving effect of expected tax benefits to be realized during the year.
MINORITY INTEREST EXPENSE
Minority interest expense in subsidiary trust preferred securities of $3.4
million and $2.7 million for the first quarters of 1999 and 1998, respectively,
represents the financing cost, after the federal income tax deduction, on
Orion's 8.73% and 7.701% trust preferred securities. The increase in 1999
reflects minority interest expense associated with the issuance of $125 million
7.701% trust preferred securities in February 1998.
26
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash flows for the three months ended March 31 is as follows:
(In millions) 1999 1998
- --------------------------------------------------------------
Cash flows:
Operating activities $ 1.9 $ 22.8
Investing activities 27.1 (42.0)
Financing activities (11.6) 11.0
----------- -----------
$ 17.4 $ (8.2)
=========== ===========
Cash provided by operating activities decreased by $20.9 million to $1.9 million
in the first quarter of 1999 from $22.8 million in the first quarter of 1998.
The decrease in operating cash flow in 1999 is primarily the result of higher
payments for losses and loss adjustment expenses, largely influenced by the
runoff of exited business, and reductions in premium and investment income
collections as well as certain timing differences related to reinsurance.
Partially offsetting these cash flow changes were declines in policy acquisition
costs and federal income tax payments, as well as a $20.0 million federal tax
refund received by the Company. The sale of McGee did not result in a
significant change to operating cash flow in the first quarter of 1999 as
compared to the same 1998 period. However, McGee generated $15.6 million of
operating cash for the 1998 year. Due to the anticipated level of claim payments
from exited business, operating cash flow for 1999 is expected to be less than
1998. The Company's existing cash and expected investment maturities are
anticipated to be adequate to cover any additional operating cash flow needs in
1999.
Cash provided by investment activities increased by $69.1 million in the first
quarter of 1999 to $27.1 million from cash used in investment activities of
$42.0 million in the first quarter of 1998. Cash is used in or provided by
investment activities primarily for purchases or sales and maturities of
investments, and for acquisition and from divestiture 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. In April
1999, the Company received approximately $33.9 million of net cash in connection
with the sale of McGee. Additionally, the Company will receive $22.8 million of
cash related to the sale of Intercargo in the second quarter of 1999.
Cash (used in) provided by financing activities were $(11.6) million and $11.0
million for the three months ended March 31, 1999 and 1998, respectively. The
Company repaid the outstanding balance of $8.0 million under its bank credit
agreement in the first quarter of 1999. The issuance of 7.701% trust preferred
securities by the Company provided $121.9 million of cash in the first quarter
of 1998. Net proceeds from that issuance were used to repay the $100 million
bank indebtedness of Guaranty National in February 1998.
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. Payments of
dividends by Orion's insurance subsidiaries must comply with insurance
regulatory limitations concerning stockholder 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.
27
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 $204.2 million
and $242.4 million at March 31, 1999 and December 31, 1998, respectively. The
consolidated policyholders' surplus of Orion's insurance subsidiaries is $637.7
million and $732.1 million at March 31, 1999 and December 31, 1998,
respectively. The Company's statutory operating leverage ratios of trailing
twelve months net premiums written to policyholders' surplus is 2.2:1 and 2.1:1
at March 31, 1999 and December 31, 1998, respectively.
In July 1998, the Company entered into a five year credit agreement with a group
of banks which provides for unsecured borrowings up to $150 million. No
borrowings are outstanding at March 31, 1999. 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, as amended, requires the Company to maintain certain defined
financial covenants and may limit the Company's ability to incur secured
indebtedness or certain contingent obligations. 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.
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 the Company's ability to incur secured
indebtedness without equally and ratably securing the senior notes. 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 March 31, 1999 the
Company is in compliance with the terms of its senior note indentures.
In February 1998, Orion issued $125 million of 7.701% Trust Preferred Securities
due April 15, 2028. In January 1997, Orion also issued $125 million of 8.73%
Trust Preferred Securities due January 1, 2037. 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 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.
Management believes that the Company continues to have substantial sources of
capital and liquidity from the capital markets and bank borrowings.
The Company has repurchased 132,000 shares of its common stock at an aggregate
cost of $6.6 million under the stock repurchase program in the first quarter of
1998. No repurchases under this program were made in 1999. At March 31, 1999 the
Company's remaining stock purchase authorization from its Board of Directors
amounted to $42.5 million.
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
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.
28
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 March 31, 1999, the
Company had completed approximately 97% 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
$20.0 million, of which $0.5 million has been expensed in the first quarter of
1999 and $15.8 million in 1998 and prior periods.
With a timely start on correcting the Year 2000 problem, the Company has been
able to address this potential exposure while continuing to replace 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 other operations in 1999. Those major technology improvement
projects, which were substantially completed in 1998, totaled approximately
$13.0 million and have been or will be capitalized as fixed assets. The Company
does not expect to incur any significant Year 2000 capital expenditures in 1999.
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 March 31, 1999, the Company had received responses from
approximately 89% of the third parties of whom it has inquired and 97% 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.
29
Evaluations of the most critical third parties have been initiated. These
evaluations will be followed by the development of contingency plans, which have
already been prepared for third parties having near term Year 2000 impact.
During the first quarter of 1999, contingency plans were finalized for all
critical production systems. Focus has been shifting to third parties and
non-technical functions. During the third quarter of 1999, appropriate
contingency plans will be completed for all critical third party relationships
and business functions. The Company believes that this aspect of its Year 2000
effort was on schedule at March 31, 1999.
A follow-up mailing to significant vendors and service providers that did not
initially respond, or whose responses were deemed unsatisfactory by the Company,
was completed by March 31,1999. The Company also expanded its survey to vendors
and service providers who do not directly interface with the Company's systems.
In the third quarter of 1999, the Company plans to re-survey all critical third
parties.
The Company presently believes that the Year 2000 problems will not pose
significant operational problems for the Company. However, if a Year 2000
problem is not properly identified so that assessment, remediation and testing
can be effected timely, 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 and will be prepared. 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."
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.
30
FORWARD-LOOKING STATEMENTS
All statements made in this quarterly 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.
PART II. OTHER INFORMATION
Items 1 - 5.
None.
Item 6. Exhibits and reports on Form 8-K
Exhibits
Exhibit 4(i): First Amendment to Credit Agreement, dated May
4, 1999 between Orion Capital Corporation and the lenders
named therein, First Union National Bank, as Administrative
Agent.
Exhibit 10(i) Stock Purchase Agreement by and between Fireman's
Fund Insurance Company, and Orion Capital Corporation
regarding the Sale of the Shares of Wm. H. McGee & Co.,
Inc. dated March 9, 1999.
Exhibit 15: Deloitte & Touche LLP Letter re: unaudited
interim financial information.
Exhibit 27: Financial Data Schedule.
(b) Report on Form 8-K
None.
31
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
ORION CAPITAL CORPORATION
Date: May 14, 1999 By: /s/ W. Marston Becker
-------------------------
Chairman of the Board and
Chief Executive Officer
Date: May 14, 1999 By: /s/ Michael L. Pautler
--------------------------
Senior Vice President and
Chief Financial Officer
32
EXHIBIT INDEX
Exhibit 4(i): First Amendment to Credit Agreement, dated May 4, 1999
between Orion Capital Corporation and the lenders named
therein, First Union National Bank, as Administrative Agent.
Exhibit 10(i) Stock Purchase Agreement by and between Fireman's
Fund Insurance Company, and Orion Capital Corporation
regarding the Sale of the Shares of Wm. H. McGee & Co.,
Inc. dated March 9, 1999.
Exhibit 15: Deloitte & Touche LLP Letter
Re: unaudited interim financial information
Exhibit 27: Financial Data Schedule
33