GORAN LOGO 1999 Annual Report Corporate Profile Goran Capital Inc. owns subsidiaries engaged in a number of business activities. The most important of these is the property and casualty insurance business conducted in 46 U.S. states, Canada and Barbados, on both a direct and reinsurance basis through a number of subsidiaries collectively referred to in this report as Goran. Goran owns 68.0% of Symons International Group, Inc. ("SIG") trades on The NASDAQ Stock Market's National Market under the symbol "SIGC". SIG owns niche insurance companies principally in the crop and nonstandard automobile insurance markets, IGF Insurance Company of Des Moines, Iowa is the fifth largest crop insurer in the United States. SIG also owns Superior Insurance Company of Tampa, Florida and Pafco General Insurance Company of Indianapolis, Indiana, which provide nonstandard automobile insurance and combined are the twelfth largest writers of such insurance in the United States. Granite Reinsurance Company Ltd. underwrites finite (limited risk) reinsurance in Bermuda, the United States and Canada. The common stock of Goran Capital Inc. trades on The Toronto Stock Exchange under the symbol "GNC" and The NASDAQ Stock Market's National Market under the symbol "GNCNF". All dollar amounts shown in this report are in U.S. currency unless otherwise indicated. The conversion rates for 1999 and as of December 31, 1999 were $1.4871 and $1.4432, respectively. Table of Contents Page Financial Highlights 2 Chairman's Report 3 Selected Financial Data 5 Management's Discussion and Analysis of Financial condition and Results of Operations 6 Consolidated Financial Statements 23 Notes to Consolidated Financial Statements 27 Report of Independent Accountants 53 Stockholder Information 54 Board of Directors and Executive Officers 1BC Subsidiary and Brance Offices 1BC GRAPH 1995 1996 1997 1998 1999 $146,303 $299,376 $448,982 $546,771 $473,687 Gross Premiums Written By Year Financial Highlights (in thousands, except per share data) For the years ended December 31, 1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- Gross premiums written $473,687 $546,771 $448,982 $299,376 $146,303 Earnings (loss) from continuing operations $(62,373) $(9,139) $15,763 $14,128 $6.652 Earnings (loss) per share from continuing $(10.61) $(1.56) $2.82 $2.67 $1.33 Operations Stockholders' equity $(18,061) $49,524 $61,462 $47,258 $12,761 Book Value per share $(3.07) $8.48 $10.53 $8.74 $2.52 Market Value per share $2.00 $10.38 $29.41 $20.08 $8.57 1) 1995 figures have been restated to reflect accounting policy changes and adopted in 1998 (see Note 1(0) to the financial statements); 1996 and 1997 figures were not materially impacted by the changes. CORPORATE STRUCTURE [graphic omitted] Goran Capital, Inc. Toronto, Ontario | - -------------------------------------------------------------------------------- | 68% Owned 100% Owned 100% Owned 100% Owned Symons International Granite Reinsurance Granite Symons Group, Inc., Company, Ltd Insurance International Indianapolis, Indiana Barbados Company Group, Inc. Florida |------------------------| IGF Holdings, Inc. Superior Insurance Group Management, Inc. | | North American IGF Insurance Crop Underwriters Company Inc. --------------------------------------- | | Pafco General Superior Insurance Insurance Company Company || -------------------------------------- | | Superior Guaranty Superior American Insurance Company Insurance Company Chairman's Report to our Shareholders On this Millennium New Year, I gathered with my family for a New Year's repast, hopeful that it would see the beginning of a better business period for our companies and us. During the past two years we had concentrated money and time on extensive adjustments in our reporting and operational systems and in the past year accelerated our search for people who could add expertise and experience to the basic divisions of the Company nonstandard auto and crop insurance. Many of our problems stemmed from our active acquisition program, our premium income rising from $127 million in 1994 to $546 million in 1998. The integration of this business with its diverse data processing systems, has been an expensive and difficult experience, but I'm pleased to say we have made substantial improvements and I expect these modifications to show tangible benefits in the near future. These systems play an important role in the functionality of the Company and its subsidiaries but in addition can have a significant effect on the expense ratio of our insurance entities. I will not dwell further on this aspect of our operations, but those shareholders who have been active in business, know that it is impossible to survive without a compliant and functional EDP program. Our shareholders know that we had significant losses in our Crop Operations in 1998 and 1999, the most devastating losses coming from a relatively new program called AgPI. This is a form of business interruption insurance designed initially to fill a coverage requirement for processors of crops such as grain dealers and companies that purchase the products grown by the farms. This business produced in 1998 approximately $7 million of premium and we have paid losses or established loss reserves against liabilities totaling approximately $35 million. The reserves are established by our staff, then reviewed by professional actuaries. The business was issued on policies of a third-party insurance company licensed in California and elsewhere and reinsured to us. A portion of the losses incurred resulted from the actions of certain independent brokers who sold the policies to insured's who knew they had losses before they applied for the coverage. The issuing company settled certain losses over our objections, which calls into question whether we have an obligation to meet liabilities of this magnitude. All of this business and its resultant losses, whether reserved or paid arose in 1998. However, the major increase in reserves took place in 1999 when the magnitude of the loss could finally be estimated. The losses are excessive by any standard, but regardless of our feelings on the quantum of the losses and practices employed to write this business, we have to pay some losses and reserve for others. The company is pursuing all applicable recovery rights. Unlike many other forms of insurance, crop insurance is a year-by-year thing. As the coverage is against loss occurring in the growing season it has no "long tail" exposure and it is generally possible to determine the profit or loss to the insurers at the end of the term. We start with a clean sheet, so to speak, the exception being rare. There is cause for some optimism, concerning Crop Year 2000, for not only has there been upward movement in the price of the products we insure but farmers realize that the Federal Government program is the safety net to the farmer and bankers are demanding more coverage. These two factors will increase the premium volume and we have seen this in the number and value of the applications received to date. With the substance of our reinsurance program and our emphasis on increased fee income, we are optimistic about our results for the current year. Fee income is earned from such programs as our Geo Ag, which uses global positioning satellites to grid map the farm and match with soil sampling for precision farming. Our agronomy-trained staff is proving to farmers the benefits of no-till techniques, to increase yields and stop soil run-off and air blown run-off. These techniques create carbon credits from the stalks remaining in the ground over the winter and we assist the farmers by marketing these credits to the power companies. We maintain a large staff of agronomists whose services are sold to the farmers on such matters as to the types of seed to plant for better results, the best fertilizer to use in certain areas of the farm, such information coming as a product of the GPS information we obtain on a specific piece of land. In the past three years the nonstandard auto insurance market was overly competitive as the larger companies fought to increase their market share. The resultant poor underwriting results has led to a return to sounder underwriting principles in the past short while. Our problems in the auto division were two fold; excessive competition coupled with a rising expense ratio. One of our system providers went out of business and flaws in other systems inherited from acquisitions needed to be overhauled. At considerable expense this has been attended to and we look for a return to lower expense ratios which previously prevailed. Rates have been rising in most states as many companies have reduced their market share in an attempt to return to profitability, while other nonstandard companies have withdrawn from the business. We inaugurated a program to find the best man available to head up our nonstandard business. We believe Gene Yerant who had an impressive record building Leader National Insurance Company, a nonstandard provider, is the right man for the job, and in January he assumed the Presidency of Superior Insurance Group. The Board has been impressed with the progress he has made in the relatively short time since he joined us. He has effected changes in key positions of senior personnel and has achieved a major improvement in the flow of business. The agents, several of them returning to the Company with business, have been most complimentary to these changes. I believe we are returning to the position we maintained when results were profitable and that evidence of that should not be very distant. It has been a hard haul for our staff as changes were implemented and I would like to express my gratitude to those who have remained with us through these changing times. I specifically wish to thank the Board members for their support as we tussled with these problems, and while we are not out of the woods yet, there is realistic cause for optimism. SELECTED CONSOLIDATED HISTORICAL FINANCIAL DATA Years Ended December 31, SELECTED CONSOLIDATED HISTORICAL FINANCIAL DATA OF GORAN CAPITAL INC. The selected consolidated financial data presented below is derived from the consolidated financial statements of the Company and its Subsidiaries and should be read in conjunction with the consolidated financial statements of the Company and the notes thereto, included elsewhere in this Report. Consolidated Statement of Operations Data (1): (in thousands, except per share amounts and ratios) 1999 1998 1997 1996 1995 Gross Premiums Written $473,687 $546,771 $448,982 $299,376 $146,303 Net Premiums Earned 276,040 342,177 276,540 214,346 72,102 Fee Income 15,791 20,203 17,821 9,286 2,170 Net Investment Income 13,418 13,401 12,777 7,745 3,686 NET EARNINGS (LOSS) $(62,373) $(12,076) $12,218 $31,296 $6,666 ========= ========= ======= ======= ====== Per Common Share Data: Basic Earnings Per Share From Continuing Operations $(10.61) $(1.56) $2.82 $2.67 $1.33 Basic Earnings Per Share $(10.61) $(2.07) $2.19 $5.89 $1.33 GAAP Ratios: Loss and LAE Ratio 100.2% 82.1% 76.5% 68.3% 71.0% Expense Ratio 35.5% 30.4% 22.9% 22.7% 21.5% Combined Ratio 135.7% 112.5% 99.4% 91.0% 92.5% Consolidated Balance Sheet Data: Investments $220,740 $240,866 $236,797 $198,594 $44,174 Assets 512,111 571,204 564,471 381,972 160,032 Losses and LAE 219,918 207,432 154,636 128,306 88,982 Trust Preferred Securities 135,000 135,000 135,000 48,000 5,811 Equity (Deficit) $(18,061) $49,524 $61,462 $47,984 $11,977 Book Value $(3.07) $8.43 $10.73 $8.88 $2.37 (1) The financial statements of the Company have been prepared in conformance with U.S. GAAP. See Note 22 to the financial statements. (2) 1995 figures have been restated to reflect accounting policy changes adopted in 1998 (see Note 1(0) to the financial statements); 1996 and 1997 figures were not materially impacted by the changes. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS All statements, trend analyses, and other information herein contained relative to markets for the Company's products and/or trends in the Company's operations or financial results, as well as other statements including words such as "anticipate," "could," "feel(s)," "believe," "believes," "plan," "estimate," "expect," "should," "intend," "will," and other similar expressions, constitute forward-looking statements under the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to known and unknown risks; uncertainties and other factors which may cause actual results to be materially different from those contemplated by the forward-looking statements. Such factors include, among other things: (i) general economic conditions, including prevailing interest rate levels and stock market performance; (ii) factors affecting the Company's crop insurance operations such as weather-related events, final harvest results, commodity price levels, governmental program changes, new product acceptance and commission levels paid to agents; (iii) factors affecting the Company's nonstandard automobile operations such as premium volume; and (iv) the factors described in this section and elsewhere in this report. Overview Goran Capital Inc. (the "Company" or "Goran") owns insurance companies that underwrite and market nonstandard private passenger automobile insurance and crop insurance. The Company's principal insurance company subsidiaries are Pafco General Insurance Company ("Pafco"), Superior Insurance Company ("Superior") and IGF Insurance Company ("IGF"). The Company also provides finite risk, stop loss and quota share reinsurance through Granite Reinsurance Company Ltd. ("Granite Re"). Nonstandard Automobile Insurance Operations Pafco, Superior, Superior Guaranty Insurance Company ("Superior Guaranty"), and Superior American Insurance Company ("Superior American"), are engaged in the writing of insurance coverage for automobile physical damage and liability policies for nonstandard risks. Nonstandard risk insureds are those individuals who are unable to obtain insurance coverage through standard market carriers due to factors such as poor premium payment history, driving experience or violations, particular occupation or type of vehicle. The Company offers several different policies which are directed towards different classes of risk within the nonstandard market. Premium rates for nonstandard risks are higher than for standard risks. Since it can be viewed as a residual market, the size of the nonstandard private passenger automobile insurance market changes with the insurance environment and grows when the standard coverage becomes more restrictive. Nonstandard policies have relatively short policy periods and low limits of liability. Due to the low limits of coverage, the period of time that elapses between the occurrence and settlement of losses under nonstandard policies is shorter than many other types of insurance. Also, since the nonstandard automobile insurance business typically experiences lower rates of retention than standard automobile insurance, the number of new policyholders underwritten by nonstandard automobile insurance carriers each year is substantially greater than the number of new policyholders underwritten by standard carriers. Crop Insurance Operations General The two principal components of the Company's crop insurance business are multiple-peril crop insurance (MPCI) and private named peril crop insurance, primarily crop hail insurance. Crop insurance is purchased by farmers to reduce the risk of crop loss from adverse weather and other uncontrollable events. Farms are subject to drought, floods and other natural disasters that can cause widespread crop losses and, in severe cases, force farmers out of business. Historically, one out of every twelve acres planted by farmers has not been harvested because of adverse weather or other natural disasters. Because many farmers rely on credit to finance their purchases of such agricultural inputs as seed, fertilizer, machinery and fuel, the loss of a crop to a natural disaster can reduce their ability to repay these loans and to find sources of funding for the following year's operating expenses. The Company generates revenue like other private insurers participating in MPCI program in two ways. First, it markets, issues and administers policies, for which it receives administrative fees; and second, it participates in a profit-sharing arrangement with the federal government. However, the Company may also pay a portion of the aggregate loss, in respect of the business it writes, if the losses exceed certain levels. The Company writes MPCI and crop hail insurance through approximately 2,850 independent agencies in 46 states. In addition to MPCI, the Company offers stand alone crop hail insurance, which insures growing crops against damage resulting from hail storms and involves no federal participation. The Company also offers a proprietary product which combines the application and underwriting process for MPCI and hail coverages - HailPlus(TM). This product tends to produce less volatile loss ratios than the stand alone product since the combined product generally insures a greater number of acres, thereby spreading the risk of damage over a larger insured area. Approximately 37% of the Company's hail policies are written in combination with MPCI. Although both crop hail and MPCI provide coverage against hail damage, the private crop hail coverages allow farmers to receive payments for hail damage which would not be severe enough to require a payment under an MPCI policy. The Company believes that offering crop hail insurance enables it to sell more policies than it otherwise would. In addition to crop hail insurance, the Company also sells insurance against crop damage from other specific named perils. These products cover specific crops and are generally written on terms that are specific to the kind of crop and farming practice involved and the amount of actuarial data available. The Company plans to seek potential growth opportunities in this niche market by developing basic policies on a diverse number of named crops grown in a variety of geographic areas. The Company has started three new business initiatives related to agriculture risk management: agronomy services, price risk management, and carbon emission reduction credits. Each will provide the opportunity to increase fee revenue. Fee revenue provides the Company with limited risk and high profit margins from its same base of operations and thus contributes to capital and surplus growth. The Company, through its IGF subsidiary, has launched additional pilot programs - - IGF Agronomics, IGF Price Risk Management, and Carbon Credits - aimed at generating fee income in addition to continuing its GeoAgPLUS services. IGF Agronomics is a new program where farmer-clients work hand-in-hand with IGF employed professional agronomists to maximize the producer's return by helping lower costs and increase yields. This is accomplished through the employment of best management practices ranging from tillage techniques to seed selection to fertilizer and pesticide application programs. Research shows that every dollar spent by farmers on agronomy services yields a multiple positive return per acre. IGF Price Risk Management is then designed to help farmers market their crop so as to generate a return sufficient to at least cover costs of production, if not generate a profit. Finally, IGF is established as a solicitor and accumulator of Carbon Emission Reduction Credits (CERC1s). CERCs are a tradable commodity sought by power companies and other industries with operations resulting in a net addition of carbon dioxide (CO2) to the atmosphere due to upcoming restrictions on such emissions imposed by regulators under international treaties. Certain agricultural practices, many already employed by American farmers, result in a net "sink" or actual reduction of emissions by avoidance or substitution (removing CO2) thereby generating CERCs. IGF has already participated in one large sale of CERCs and is awaiting federal standards criteria for expanding this initiative. Geo AgPLUS(TM) Services ("Geo Ag") provides to the farmer measuring, gridding, and soil sampling services combined with fertility maps and the software that is necessary to run their precision farming program. Grid soil sampling, when combined with precision farming technology, allows the farmer to apply the right amount of fertilization, thus balancing soil nutrients for a maximum crop yield. Precision farming technology increases the yield to the farmer, reduces the cost of unnecessary fertilization, and enhances the environment by reducing overflows of fertilization into the ecosystem. Geo AgPLUS(TM) is an precision farming service operating through a division that is now marketing its fee based services to the farmer. Seasonality The crop insurance business is seasonal by geographic region; spring crops in northern and midwestern states, fall crops in southern states such as fruit and nuts, winter crops in coastal states such as California and summer cash crops grown in all states. The Company also insures long term crops such as timber and nurseries. While this seasonality is time specific for each crop, the associated tasks of sales and marketing primarily occur before each respective crop growing season. The customer support, applications and claims processing tasks are time and event driven within the mid to later part of the growing season; many times being finished after the growing season and harvest is completed. The bulk of the loss adjustment activities for the spring and fall crops occur between May and November. These same activities occur for winter crops, such as fruits, in January and February, and for cash crops throughout the year. Throughout the year the Company provides to its customers services such as education, agronomy training, soil sampling, grid mapping for precision farming, insurance advice and loss adjusting. Certain Accounting Policies for Crop Insurance Operations MPCI is a government-sponsored program with accounting treatment which differs in certain respects from the more traditional property and casualty insurance lines. For income statement purposes under generally accepted accounting principles ("GAAP"), gross premiums written consist of the aggregate amount of MPCI premiums paid by farmers for buy-up coverage (MPCI coverage in excess of catastrophic ("CAT") coverage - the minimum available level of MPCI coverage), and any related federal premium subsidies, but do not include MPCI imputed premiums on CAT coverage. By contrast, net premiums written do not include any MPCI premiums or subsidies, all of which are deemed to be ceded to the Federal Crop Insurance Corporation (FCIC) as a reinsurer. The Company's profit or loss from its MPCI business is determined after the crop season ends on the basis of a complex profit sharing formula established by law and the FCIC under a Standard Reinsurance Agreement (SRA). For income statement purposes, any such profit or loss sharing earned or payable by the Company is treated as an adjustment to commission expense and is included in policy acquisition and general and administrative expenses. The Company also receives from the FCIC (i) an expense reimbursement payment (made on the farmer's behalf) equal to a percentage of gross premiums written for each Buy-Up Coverage policy it writes and (ii) a loss adjustment expense ("LAE") reimbursement payment equal to a percentage of MPCI imputed premiums for each CAT coverage policy it writes. The Buy-Up Expense Reimbursement Payment was reduced in 1999 to 24.5%, from 27.0% in 1998 of the MPCI Premium on regular MPCI yield-based policies and 21.1% Crop Revenue Coverage (CRC) revenue-based policies. For GAAP principles income statement purposes, the Buy-Up Expense Reimbursement Payment is treated as a contribution to income and reflected as an offset against policy acquisition and general and administrative expenses. The CAT LAE Reimbursement Payment is, for income statement purposes, recorded as an offset against LAE, up to the actual amount of LAE incurred by the Company in respect of such policies. The remainder of the payment, if any, is recorded as Other Income. In June 1998, the United States Congress passed legislation which provided permanent funding for the crop insurance industry. However, it also contained the Expense Reimbursement reductions noted above that began in 1999. In addition the new law reduced the CAT LAE Reimbursement Payment from 14.1% to 11% of imputed premium and the $60 CAT administrative fee previously retained by private carriers must, beginning in 1999, be remitted in full to the FCIC. Although the Company had hoped to offset these reductions through growth in fee income from non-federally subsidized programs, it was not fully able to do so in 1999. In 1996, the Company instituted a policy of recognizing (i) 35% of its estimated MPCI gross premiums written for each of the first and second quarters, 20% for the third quarter and 10% for the fourth quarter, (ii) commission expense at the applicable rate of MPCI gross premiums written recognized, (iii) Buy-Up Expense Reimbursement at the applicable rate of MPCI gross premiums written recognized along with normal operating expenses incurred in connection with premium writings and (iv) an estimate of underwriting profit based on historic results. In the third quarter, if a sufficient volume of policyholder acreage reports have been received and processed by the Company, the Company's policy is to recognize MPCI gross premiums written for the first nine months based on a re-estimate which takes into account actual gross premiums processed and growing conditions. If an insufficient volume of policies has been processed, the Company's policy is to recognize in the third quarter 20% of its full year estimate of MPCI gross premiums written, unless other circumstances require a different approach. The remaining amount of gross premiums written is recognized in the fourth quarter, when all amounts are reconciled. The Company also recognizes the MPCI underwriting gain or loss during each quarter, reflecting the Company's best estimate of the amount of such gain or loss to be recognized for the full year, based on, among other things, historical results, plus a provision for adverse development. In the third and fourth quarters, a reconciliation amount is recognized for the underwriting gain or loss based on final premium and latest available loss information. The growing seasons vary by region and crop. The determination of amounts of risk and volume of premium often is arrived at after the attachment of risk. For these reasons, management believes that the best method to arrive at an allocation of premium, expense and estimate of profit and loss is as stated above. Currently, the National Association of Insurance Commissioners ("NAIC") does not provide guidelines for the reporting of underwriting gains/losses. The Company's position is embedded in the understanding that these amounts more closely relate to ceding commission rather than normal revenues. Underwriting gain is a function of premiums less loss, which in non-MPCI insurance would result in commissions, which are returned to the Company from the reinsurer. Amounts are a function of the ceding commission related to the MPCI business and have been reported as such (included with the other commission expense items). These amounts are reported as a reduction to commission expense (gain) from a statutory basis. The Company's position has been to maintain consistency. The Company is currently involved with an industry taskforce working with the NAIC and the FCIC to develop standard accounting and reporting procedures for this line of business. The taskforce's goal is to provide to the NAIC the standard methodology, which can be incorporated no earlier than the year 2000 codification. Currently there are seventeen companies writing this line of business with varying reporting formats. Selected Segment Data of the Company The following table presents historical segment data for the Company's nonstandard automobile and crop insurance operations. This data does not reflect results of operations attributable to corporate overhead, interest costs and amortization of intangibles. Year Ended December 31, Nonstandard - Automobile Insurance Operations: (in thousands, except ratios) 1999 1998 1997 ---- ---- ---- Gross premiums written $235,773 $303,737 $323,915 -------- -------- -------- Net premiums written $244,826 $269,741 $256,745 -------- -------- -------- Net premiums earned $249,094 $264,022 $251,020 Fee income 15,185 16,431 15,515 Net investment income 12,339 11,958 10,969 Net realized capital gain (loss) (281) 4,124 9,462 ----- ----- ----- Total Revenues 276,337 296,535 286,966 ------- ------- ------- Losses and loss adjustment expenses 230,973 217,916 195,900 Policy acquisition and general administrative expenses 91,859 73,346 72,463 ------ ------ ------ Total Expenses 322,832 291,262 268,363 ------- ------- ------- Earnings before income taxes $(46,495) $5,273 $18,603 --------- ------ ------- GAAP RATIOS (Nonstandard Automobile Only) Loss and LAE ratio (1) 92.7% 82.5% 78.0% Expense ratio, net of billing fees (2) 30.8% 21.6% 22.7% ----- ----- ----- Combined ratio (3) 123.5% 104.1% 100.7% Crop Insurance Operations: Gross premiums written $237,286 $243,026 $126,401 -------- -------- -------- Net premiums written $12,737 $62,467 $20,796 ------- ------- ------- Net premiums earned $14,240 $60,901 $20,794 Fee income 456 3,772 2,276 Net investment income 293 275 191 Net realized capital gain (loss) 21 217 (18) -- --- ---- Total Revenues 15,010 65,165 23,243 ------ ------ ------ Losses and loss adjustment expenses 34,225 52,550 16,550 Policy acquisition and general and administrative expenses (4) 215 21,906 (14,404) Interest and amortization of intangibles 1,113 502 235 ----- --- --- Total Expenses 35,553 74,958 2,381 ------ ------ ----- Earnings (loss) before income taxes $(20,543) $(9,793) $20,862 ========= ======== ======= (1) Loss and LAE ratio: The ratio of losses incurred during the financial reporting year plus the cost to settle losses during the same period as a percentage of premiums earned. (2) Expense ratio: The ratio of policy acquisition, general administrative expenses, as percentage of premiums earned. (3) Combined ratio: The sum of the loss, plus LAE, plus the expense ratio as a percentage of premiums earned. Loss is the claims incurred on policies written. LAE is loss adjusting expense on claims for which policies have been written. (4) Negative crop expenses are caused by inclusion of MPCI expense reimbursements and underwriting gain as a set off to expense. See certain accounting policies for crop insurance operations. [photograph of automobiles and crop field down left side] Results of Operations Overview 1999 Compared To 1998 The Company recorded a net loss of $(62,373,000) or $(10.61) per share (basic and diluted) compared to a net loss of $(12,076,000) or $(2.07) per share (basic and diluted) in 1998. The loss in 1999 was due to reduced earnings in both crop and nonstandard automobile operations. Results for 1999 for the crop operations were significantly impacted by an increase in claims settlements and reserves for an agricultural business interruption product that was offered in 1998 and has since been discontinued ("AgPI"). The MPCI produced a profit while the named perils and hail programs had combined loss and expense ratios of 117.5% and 84.6%, respectively. Results for 1999 for the nonstandard automobile operations were impacted by a higher loss ratio and lower premium volume. These were the result of problems encountered with untimely rate filings, implementation of the Company's new operating system and competitive pressure. The Company also increased loss reserves for prior accident years by approximately $16.4 million in 1999 due to adverse loss development. 1998 Compared To 1997 The Company recorded a net loss of $(12,076,000) or $(2.07) per share (basic and fully diluted) compared to net earnings of $12,218,000 or $2.19 per share (basic) and $2.08 (fully diluted) in 1997. The loss in 1998 was due to reduced earnings in both crop and nonstandard automobile operations. Results for 1998 for the crop operations were significantly impacted by catastrophic crop hail losses primarily from Hurricane Bonnie and other weather related events of approximately $14 million pre-tax. Contributing to the lower results were higher than expected commission and integration costs related to the alliance with Continental Casualty Company ("CNA") for its crop insurance business (the "CNA Transaction") of approximately $3.0 million pre-tax and a lower underwriting gain on MPCI (11.2% in 1998 versus 25.0% in 1997) due primarily to severe drought conditions in certain parts of the country, overly wet conditions in other parts of the country and higher frequency of CRC claims due to extremely low commodity prices. Results for 1998 for the nonstandard automobile operations were impacted by a higher loss ratio and lower premium volume. These were the result of problems encountered with timely rate filings, implementation of the Company's new operating system and competitive pressure. The Company also increased loss reserves for prior accident years by approximately $13.0 million in 1998 due to adverse loss development. Years Ended December 31, 1999 and 1998 Gross Premiums Written Consolidated Gross Premiums Written decreased 13.4% in 1999 due to a withdrawal from certain areas of hail sales, a reduction in the price of crops leading to less insurable values upon which to price insurance, a reduction in nonstandard auto sales due to increased competition, rate increases and withdrawal from certain small volume states. The following shows gross premiums written for crop insurance products: (in thousands) 1999 1998 ---- ---- CAT imputed $39,727 $50,127 MPCI 179,727 157,225 Crop Hail 53,647 76,198 Named perils 3,816 2,074 AgPI 96 7,529 -- ----- $277,013 $293,153 Less CAT imputed (39,727) (50,127) -------- -------- Total $237,286 $243,026 Net Premiums Written Net premiums written decreased 29.2% in 1999 as compared to 1998 due to a larger quota share reinsurance cover for hail, from 25.0% in 1998 to 69.0% in 1999, along with lower written premiums in the auto segment. Net Premiums Earned Net premiums earned decreased 19.3% in 1999 as compared to the prior year, reflecting reduction in gross and net premiums written. The ratio of net premiums earned to net premiums written for the nonstandard automobile segment was 101.7% in 1999 due to lower written premium in the auto segment. Fee Income Fee income decreased 21.8% in 1999 compared to 1998. Fee income on nonstandard automobile operations decreased as a result of lower gross premiums written. Crop fees primarily include CAT fees and service fees such as GeoAg which totaled $456,000 in 1999 compared to $3,772,000 in 1998, a decline of 87.9%. The primary reason for the decline is due to the law change prohibiting company retention of the CAT fee. Net Investment Income Net investment income increased .1% in 1999 compared to 1998, such increase was due to higher yields. Net Realized Capital Gains (Losses) In 1999, the investment portfolio realized a small gain of $65,000 compared to a realized gain in 1998 of $4,104,000 which emanated from a high level of activity in the equity portfolio in 1998. Losses and LAE The loss and LAE ratio (the ratio of claims and loss adjusting expense as a percentage of earned premiums) ("Loss and LAE Ratio") for the nonstandard automobile segment was 92.7% for 1999 as compared to 82.5% for 1998. The crop hail Loss and LAE Ratio was 240.6% in 1999 compared to 79.4% in 1998. The increase in the Loss and LAE Ratio for the nonstandard automobile segment reflects adverse development on prior years of approximately 6.6%. The Company estimates its nonstandard automobile 1999 accident year loss ratio was 86.2% as compared to its current estimate of 81.1% in accident year 1998. The increase in the accident year loss ratio results from product and pricing decisions and increases in claim frequency. The increase in the crop hail Loss and LAE Ratio primarily reflects the adverse reserve development on 1998 AgPI losses. In addition, the pricing for crop insurance was inadequate and crop experience in the whole market was poor. The reinsurance program helped reduce the net effect to the Company as detailed in the reinsurance section. During 1998, premiums of $7.5 million were recognized from AgPI; however, the Company suffered losses during 1999 from this program. Adverse development, almost exclusively associated with AgPI, on 1998 crop Loss and LAE reserves affected 1999 by $14.1 million. Policy Acquisition and General and Administrative Expenses Policy acquisition and general and administrative expenses have increased as a result of the following: As previously reported, the Company had problems with its policy administration systems which resulted in higher expenses being incurred in 1999. The crop operation wrote approximately the same number of policies but at a lower average premium than in 1998 due to depressed commodity prices. Thus, as a percentage, the Company experienced an increase in its expense ratio in 1999. Policy acquisition and general and administrative expenses reduced to $97,950,000 or 35.5% of net premiums earned in 1999 compared to $103,926,000 or 30.4% of net premiums earned for 1998. The following represents the breakdown of crop policy acquisition and general and administrative expenses: (in thousands) 1999 1998 MPCI expense reimbursements $(38,580) $(37,982) MPCI underwriting gain, net of stop loss and CNA reinsurance in 1998 (18,404) (14,902) Commissions 44,797 50,089 Ceding commission income (12,266) (6,899) Operating expenses 24,668 31,600 ------ ------ Total $215 $21,906 ==== ======= MPCI expense reimbursements declined to 21.5% of MPCI premiums for 1999 as compared to 24.2% in 1998 due to federally mandated reductions. Commission expense as a percentage of gross written premiums were, in 1999, 16.2% of gross written premiums compared to 17.1% in 1998. Operating expenses as a percentage of gross written premiums were 9.3% in 1999 compared to 10.8% in 1998. Nonstandard automobile expenses net of fee income were 30.8% of earned premiums in 1999 compared to 21.6% in 1998. In 1998 the Company reserved for uncollectable items as a result of issues with the operating system acquired as part of the CNA Transaction. Amortization of Intangibles Amortization of intangibles includes goodwill from the acquisition of Superior, additional goodwill from the acquisition of the minority interest portion of Superior Insurance Group Management, Inc. ("Superior Group Management", formerly, GGS Management Holdings, Inc. ("GGSH")), the acquisition of North American Crop Underwriters, Inc. ("NACU") and debt or preferred security issuance costs. Amortization expense in 1999 of $2,297,000 is a decrease of 3.4 % over 1998. Interest Expense Interest expense in 1999 represents the crop segment's borrowings on its seasonal line of credit at weighted average rate of 7.02% and from the FCIC, at 15% interest. Due to the payments of approximately $21.9 million for gross losses in 1999 on AgPI, the cash reserves of IGF were lower than in 1998. Therefore, IGF deferred remittance to the FCIC of uncollected premiums in accordance with the SRA. Income Tax Expense (Benefit) The variance in the rate from the U.S. federal statutory rate of 35% is primarily due to tax exempt income, nondeductible goodwill amortization, alternative minimum taxes, tax versus book basis in capital assets and securities disposed. At December 31, 1999 the Company's net deferred tax assets are fully offset by a valuation allowance. The Company will continue to assess the valuation allowance and to the extent it is determine that such allowance is no longer required, the tax benefit of the remaining net deferred tax assets will be recognized in the future. Approximately $21.4 million of the 1999 net operating loss ("NOL") was carried back to the 1997 tax year which resulted in a refund claim. The ability of the Company to utilize the 1999 NOL is dependent upon future taxable income generated by the Company. Years Ended December 31, 1998 and 1997 Gross Premiums Written Consolidated gross premiums written increased 21.8% in 1998 due to growth in the crop operations from the integration of business from the CNA Transaction, internal growth and AgPI revenue. Crop gross premiums written increased 92.3% in 1998 from 1997. Nonstandard automobile gross premiums written decreased 6.2% in 1998 as compared to 1997 due primarily to reduced volume in the states of Florida and California for the reasons previously disclosed. Remaining gross premiums written represent reinsurance business. Net Premiums Written Net premiums written increased in 1998 as compared to 1997 due to the growth in gross premiums written offset by quota share reinsurance. In 1998, the Company ceded 10% of its nonstandard automobile premiums as part of a quota share treaty. This treaty and all previous quota share treaties for 1997 and 1998 were commuted effective October 1, 1998 and the Company received a return of unearned premiums and loss reserves from such treaties as of that date. For the first three quarters of 1997, the Company ceded 20% of nonstandard automobile premiums and ceded 25% of such premiums in the fourth quarter of 1997. In 1998, the Company ceded 25% of its crop hail premiums as part of a quota share treaty as compared to 40% in 1997. Named peril premiums were ceded at a 50% rate in both 1998 and 1997 under a quota share treaty. Net Premiums Earned Net premiums earned increased in 1998 as compared to 1997 reflecting growth in gross and net premiums written. The ratio of net premiums earned to net premiums written for the nonstandard automobile segment was 97.9% in 1998 as compared to 97.8% in 1997. Fee Income Fee income increased 13.4% in 1998 compared to 1997. Fee income on nonstandard automobile operations increased as a result of higher fees as a percentage of gross premiums written, 5.41% in 1998 and 4.79% in 1997, offset by lower premium volume. Crop fees primarily included CAT fees. CAT fees increased in 1998 as compared to 1997 due to growth in premium volume. Fees in 1998 also increased due to the introduction of Geo Ag Plus and other processing fees. Net Investment Income Net investment income increased 4.9% in 1998 compared to 1997. Such increase was due to greater invested assets offset somewhat by declining yields due to market conditions. Net Realized Capital Gains Capital transaction activity primarily reflects activity in the Company's equity portfolio. The higher level of gains in 1997 reflects the strong market conditions during that year. Gains decreased in 1998 as a result of market conditions. In the fourth quarter of 1998, the Company significantly reduced its exposure to equities reflecting the Company's concern with the market and its desire to increase investment income. Losses and LAE The Loss and LAE Ratio for the nonstandard automobile segment was 82.5% for 1998 as compared to 78.0% for 1997. The crop hail Loss and LAE Ratio was 79.4% in 1998 compared to 75.1% in 1997. The increase in the Loss and LAE Ratio for the nonstandard automobile segment reflects adverse development on prior years of approximately 5.0%. The Company estimates its nonstandard automobile 1998 accident year loss ratio was 77.5% as compared to 76.1% in accident year 1997. The increase in the accident year loss ratio results from product and pricing decisions and increases in frequency in certain product lines. The increase in the crop hail loss and LAE Ratio includes $10.7 million for the effects of catastrophic events net of reinsurance recoveries. The crop hail Loss and LAE Ratio prior to reinsurance recoveries was 100.6%. The named perils loss ratio was 100% and the AgPI loss ratio was 100% in 1998 due to losses on certain coverages due to unusual weather related events estimated to be $3.3 million. Policy Acquisition and General and Administrative Expenses Policy acquisition and general and administrative expenses increased in 1998 over 1997 as a result of the increased volume of business produced by the Company. Policy acquisition and general and administrative expenses rose to $103,926,000 or 30.4% of net premiums earned in 1998 compared to $63,344,000 or 22.9% of net premiums earned for 1997. MPCI expense reimbursements declined to 24.2% of MPCI premiums for 1998 as compared to 28.2% in 1997 due to federally mandated reductions. The MPCI underwriting gain, net of stop loss costs, decreased to 9.5% of CAT and MPCI premiums in 1998 (after adding $4,861,000 in 1998 as a result of the CNA Transaction) compared to 21.9% in 1997 due to severe drought in certain sections of the country and overly wet conditions in other sections of the country. The Company considers the 1998 underwriting gain to be well below average while the 1997 gain was well above average. Commission expense as a percentage of gross written premiums (including CAT) increased in 1998 to 17.1% of gross written premiums compared to 16.1% in 1997 due to the integration of business from the CNA Transaction and competitive industry pressure. Ceding commission income increased in 1998 compared to 1997 due to a increase in ceded premiums. Operating expenses as a percentage of gross written premiums (including CAT) increased in 1998 to 10.8% compared to 10.2% 1997. Operating expenses in 1998 include $3 million, or 1.0% of gross written premiums (including CAT), of one time costs primarily related to the integration of business from the CNA Transaction. These additional one-time expenses, due to a reduction of offices, severances and write down of assets, were recorded as normal operating expenses and were deducted in 1998 as incurred in accordance with APB16. Operating expenses in 1998 also include a $3.2 million reserve, or 1.1% of gross written premiums (including CAT), for potential processing errors during 1998 on assumed premiums from business from the CNA Transaction. This increase in reserve was due to the integration of a processing system acquired in the CNA Transaction that did not reconcile properly. The Company reserved for this unreconciled amount as at December 31, 1998. The Company has determined that the amount is not recoverable, therefore it was properly reserved as at December 31, 1998. Nonstandard automobile expenses net of fee income were 21.6% of earned premiums in 1998 compared to 22.7% in 1997. Amortization of Intangibles Amortization of intangibles includes goodwill from the acquisition of Superior, additional goodwill from the acquisition of the minority interest portion of Superior Group Management and the acquisition of NACU and debt or preferred security issuance costs. The increase in 1998 over 1997 reflected a full year's impact of amortization of goodwill associated with the purchase of the minority interest position in Superior Group Management and a full year's amortization of deferred issuance costs on the Company's manditorily redeemable preferred securities issued by SIG's trust subsidiary ("Preferred Securities"). Interest Expense Interest expense in 1998 represents the crop segment's borrowings on its seasonal line of credit. Interest expense for 1997 includes both interest for the crop segment and interest on the Superior Insurance Group, Inc. ("Superior Group" formerly GGS Management, Inc. ("GGS")) Senior Credit Facility which was repaid in 1997 from the proceeds of the offering of the Preferred Securities. Income Tax Expense (Benefit) The variance in the rate from the U.S. statutory rate of 35% is primarily due to nondeductible goodwill amortization. Distributions on Preferred Securities Distributions on the Preferred Securities are calculated at 9.5% net of U.S. federal income taxes from the offering date of August 12, 1997. Symons International Group, Inc. - Florida Goran's wholly-owned subsidiary, Symons International Group, Inc. - Florida ("SIGF") is a specialized surplus lines underwriting unit. SIGF's operations no longer fit the Company's strategic operating plan of concentrating on the business segments of nonstandard automobile, crop and reinsurance. Accordingly, the majority of the book of business was sold effective January 1, 1999. A small amount of premium remained after the sale. In 1999, the premium volume from this operation reduced to $526,000 from $6,427,000 in 1998 and $9,560,000 in 1997. In 1999, SIGF recognized a loss of $861,000 primarily as a result of closing expenses and the write down of capitalized software, compared to operating losses of $2,937,000 in 1998 and $3,545,000 in 1997. Non-U.S. Operations Granite Insurance Company Granite Insurance Company ("Granite") is a Canadian federally licensed insurance company which is presently servicing its investment portfolio and a very few outstanding claims. Granite stopped writing business on December 31, 1989 and sold its book of Canadian business in June 1990. The outstanding claims continue to be settled in accordance with actuarial estimates with moderate redundancies appeared in the most recent year. Granite's invested assets increased to $3.0 million from $2.6 million in 1998. This is the result of realized profits for the year. Total net outstanding claims decreased to $368,000 in 1999 from $400,000 in 1998. It is expected that the run-off of outstanding claims will continue at least through 2000. Granite recorded a net profit of $179,000 in 1999, compared to a $403,000 net loss in 1998 and $261,000 net loss in 1997. This is a reflective of the realization of gains and losses in the investment portfolio. Granite Reinsurance Company Ltd. Granite Reinsurance Company Ltd. ("Granite Re") is managed by Atlantic Security Ltd. of Bermuda and a corporate services management company in Barbados. Granite Re underwrites finite risk, stop loss and quota share reinsurance, through various programs in Bermuda, the United States and Canada. During 1999, 1998 and 1997, Granite Re participated in certain quota share and stop loss programs for Goran's crop insurance subsidiary, IGF. These covers were in accordance with third party placements whereby Granite Re assumed a portion of these treaties as third party reinsurers. In 1998 and 1997, Granite Re participated in Goran's nonstandard automobile subsidiaries through a quota share treaty. On January 1, 1999, the nonstandard automobile treaty was commuted resulting in a return premium of $11.2 million. There was no other assumed automobile reinsurance in 1999. 1999 gross premiums written relating to crop were effectively offset by the automobile commutation disclosed above. However, net premiums earned in 1999 of $12.7 million compared to $21.8 million in 1998 and $12.7 million in 1997. A break even year in 1999 resulted in a $.2 million loss compared to a loss of $1.1 million in 1998 and a profit of $2.1 million in 1997. Granite Re's capital and surplus reduced by approximately $10 million from $16.2 million as reported in 1998 to $6.6 million as at December 31, 1999, primarily as a result of a deemed dividend to Goran relating to prior years activities. Liquidity and Capital Resources The primary source of funds for Goran is through dividend and other funding from Granite Re, its offshore subsidiary. The primary source of funds available to SIG are fees from policy holders, management fees and dividends from its subsidiaries. SIG also receives $150,000 quarterly pursuant to an administration agreement with IGF to cover the costs of executive management, accounting, investing, marketing, data processing and reinsurance. Superior Group collects billing fees charged to policyholders of Pafco and Superior who elect to make their premium payments in installments. Superior Group also receives management fees under its management agreement with Pafco and Superior. When the Florida Department of Insurance ("Florida Department") approved the acquisition of Superior by Superior Group Management, it prohibited Superior from paying any dividends (whether extraordinary or not) for four years from the date of acquisition (May 1, 1996) without the prior written approval of the Florida Department. Extraordinary dividends, within the meaning of the Indiana Insurance Code, cannot be paid by Pafco without the prior approval of the Indiana Insurance Commissioner. The management fees charged to Pafco and Superior by Superior Group are subject to review by the Indiana Department of Insurance ("Indiana Department") and Florida Department. The nonstandard automobile insurance subsidiaries' primary source of funds are premiums, investment income and proceeds from the maturity or sale of invested assets. Such funds are used principally for the payment of claims, payment of claims settlement costs, operating expenses (primarily management fees), commissions to independent agents, dividends and the purchase of investments. There is variability to cash outflows because of uncertainties regarding settlement dates for liabilities for unpaid losses. Accordingly, the Company maintains investment programs intended to provide adequate funds to pay claims. During 1999, due to a slow down in premium volume, the Company began liquidating investments to pay claims. The Company historically has tried to maintain duration averages of 3.5 years. However, the reduction in new funds due to lower premium has and will cause the Company to shorten duration. The Company may incur a cost of selling longer bonds to pay claims. Claim payments tend to lag premium receipts. Due to the decline in premium volume, the Company has experienced a reduction in its investment portfolio but to date has not experienced any problems meeting its obligations for claims payments. Cash flows in the Company's MPCI business differ from cash flows from certain more traditional lines. The Company pays insured losses to farmers as they are incurred during the growing season, with the full amount of such payments being reimbursed to the Company by the federal government within three business days. MPCI premiums are not received from farmers until covered crops are harvested. Collected and uncollected premiums are required to be paid in full to the FCIC by the Company, with interest at 15%, if not paid by a specified date during the crop year. During 1999, IGF borrowed funds under its revolving line of credit to finance payables to the FCIC for collected and uncollected premiums (the "IGF Revolver"). In 1999, the maximum borrowing amount under the IGF Revolver was $15,000,000. The IGF Revolver carried a weighted average interest rate of 8.75%, 6.96% and 7.02% in 1997, 1998 and 1999, respectively. Payables to the FCIC accrue interest at a rate of 15%, as do the receivables from farmers. By utilizing the IGF Revolver, which bears interest at a floating rate equal to the prime rate minus .75% in 1999 (prime rate plus 1.00% in 1998), IGF avoids the higher interest expense to the FCIC while continuing to earn 15% interest on the receivables due from the farmer. The IGF Revolver contains certain covenants which (i) restricts IGF's ability to accumulate common stock, (ii) sets minimum standards for investments and policyholder surplus and (iii) limits the ratio of net written premiums to surplus. The IGF Revolver also contains other customary covenants which, among other things, restricts IGF's ability to participate in mergers, acquire another enterprise or participate in the organization or creation of any other business entity. At December 31, 1999, IGF had borrowed the full amount available. This line of credit has been extended through December 15, 2000; however, the authorized line of credit has been reduced to $8,000,000 as of March 17, 2000, all of which was available April 1, 2000. At December 31, 1999, IGF was not in compliance with a minimum statutory surplus covenant; however, IGF received a waiver of such covenant for December 31, 1999. IGF does expect to meet the minimum statutory surplus covenant for 2000. During 1999 IGF deferred remittance of uncollected premium amounts to the FCIC and therefore incurred interest of 15% on such amounts. The Company expects to continue this practice in 2000. On August 12, 1997, the SIG's trust subsidiary issued $135 million in Preferred Securities at a rate of 9.5% paid semi-annually. The Preferred Securities are backed by Senior Subordinated Notes to the trust from the Company. The proceeds of the Preferred Securities offering were used to repurchase the remaining minority interest in Superior Insurance Group Management, Inc. (formerly GGS Management Holdings, Inc.) ("GGSH") for $61 million, repay the balance of the Superior Group Senior Credit Facility of $44.9 million and contribute $10.5 million to the nonstandard automobile insurers with the balance held for general corporate purposes. Expenses of the issue aggregated $5.1 million and are amortized over the term of the Preferred Securities (30 years). In the third quarter of 1997, the Company wrote off the remaining unamortized costs of the Superior Group Senior Credit Facility of approximately $1.1 million pre-tax or approximately $0.07 per share (basic) as an extraordinary item. The Preferred Securities have a term of 30 years with semi-annual interest payments which commenced February 15, 1998. The Preferred Securities may be redeemed in whole or in part after 10 years. The Preferred Security interest obligation of approximately $13 million was funded from SIG's nonstandard automobile management company and surplus funds available in SIG in 1999. During 1999 SIG paid the two Preferred Securities interest payments. Semi-annual interest payments of $6,412,500 were made in February and August 1999. In February 2000, the Company deferred the interest payment in accordance with the terms of the Trust Indenture. SIG may defer payment of any or all interest payments for up to five years. The unpaid interest installment amounts accrue interest at 9.5%. SIG presently intends to defer interest payments in the year 2000; however, it will reconsider this intention depending upon cash flow and profitability. The Trust Indenture contains certain restrictive covenants. These covenants are based upon the SIG's Consolidated Coverage Ratio of earnings before interest, taxes, depreciation and amortization (EBITDA) whereby if the SIG's EBITDA falls below 2.5 times consolidated interest expense (including Preferred Security distributions) for the most recent four quarters, the following restrictions become effective: o SIG may not incur additional indebtedness or guarantee additional indebtedness. o SIG may not make certain restricted payments including loans or advances to affiliates, stock repurchases and a limitation on the amount of dividends is in force. o SIG may not increase its level of non-investment grade securities defined as equities, mortgage loans, real estate, real estate loans and non-investment grade fixed income securities. These restrictions currently apply as SIG's consolidated coverage ratio was (4.9) in 1999, and will continue to apply until SIG's consolidated coverage ratio is in compliance with the terms of the Trust Indenture. SIG is in compliance with these additional restrictions and, therefore, this does not represent a default by the SIG on the Preferred Securities. Net cash provided/(used) by operating activities in 1999 aggregated $(20,619,000) compared to $11,716,000 in 1998 due to reduced cash provided by operations as a result of the net loss. The Company believes cash flows in the nonstandard automobile segment from premiums, investment income and billing fees are sufficient to meet that segment's obligations to policyholders and operating expenses for the foreseeable future. This is due primarily to the lag time between receipt of premiums and claims payments. Therefore, the Company does not anticipate borrowings for this segment. The Company also believes cash flows in the crop segment from premiums and expense reimbursements are sufficient to meet the segment's obligations for the foreseeable future. Due to the more seasonal nature of the crop segment's operations, it may be necessary to obtain short term funding at times during a calendar year by drawing on the IGF Revolver or deferring remittance of premiums to the FCIC. Except for this short term funding and normal increases therein resulting from an increase in the business in force, the Company does not anticipate any significant short or long term additional borrowing needs for crop business. Accordingly, while there can be no assurance as to the sufficiency of the Company's cash flow in future periods, the Company believes that its cash flow will be sufficient to meet all of the Company's operating expenses and operating debt service (not including the Preferred Securities) for the foreseeable future and, therefore, does not anticipate additional borrowings. While GAAP shareholders' equity reflected a deficit of $18 million at December 31, 1999, it does not reflect the statutory equity upon which the company conducts its various insurance operations. Its insurance subsidiaries had statutory surplus of approximately $50 million at December 31, 1999. Effects of Inflation Due to the short term that claims are outstanding in the two product lines the Company underwrites, inflation does not pose a significant risk to the Company. Primary Differences Between GAAP and SAP The financial statements contained herein have been prepared in conformity with GAAP which differ from Statutory Accounting Practices ("SAP") prescribed or permitted for insurance companies by regulatory authorities in the following respects: (i) certain assets are excluded as "Nonadmitted Assets" under statutory accounting; (ii) costs incurred by the Company relating to the acquisition of new business are expensed for statutory purposes; (iii) the investment in wholly- owned subsidiaries is consolidated for GAAP rather than valued on the statutory equity method. The net income or loss and changes in unassigned surplus of the subsidiaries is reflected in net income for the period rather than recorded directly to unassigned surplus; (iv) fixed maturity investments are reported at amortized cost or market value based on their NAIC rating; (v) the liability for losses and loss adjustment expenses and unearned premium reserves are recorded net of their reinsured amounts for statutory accounting purposes; (vi) deferred income taxes are not recognized on a statutory basis; and (vii) credits for reinsurance are recorded only to the extent considered realizable. New Accounting Standards On March 4, 1998, the AICPA Accounting Standards Executive Committee issued Statement of Position No. 98-1 (SOP 98-1), "Accounting for the Cost of Computer Software Developed or Obtained for Internal Use." SOP 98-1 was issued to address diversity in practice regarding whether and under what conditions the costs of internal-use software should be capitalized. SOP 98-1 is effective for financial statements for years beginning after December 15, 1998. The Company has adopted the new requirements of the SOP in 1999. There is no material impact on the net earnings in 1999. The NAIC is considering the adoption of a recommended statutory accounting standard for crop insurers, the impact of which is uncertain since several methodologies are currently being examined. Although the Indiana Department has permitted the Company to continue, for its statutory financial statements through December 31, 1999, its practice of recording its MPCI business as 100% ceded to the FCIC with net underwriting results recognized in ceding commissions, the Indiana Department has indicated that in the future it will require the Company to adopt the MPCI accounting practices recommended by the NAIC or any similar practice adopted by the Indiana Department. Since such a standard would be adopted industry wide for crop insurers, the Company would also be required to conform its future GAAP financial statements to reflect the new MPCI statutory accounting methodology and to restate all historical GAAP financial statements consistent with this methodology for comparability. The Company cannot predict the accounting methodology that will eventually be implemented or when the Company will be required to adopt such methodology. The Company anticipates that any such new crop accounting methodology will not affect GAAP net income. In 1998, the NAIC adopted the Codification of Statutory Accounting Principles guidance, which replaced the current Accounting Practices and Procedures manual as the NAIC's primary guidance on statutory accounting. The NAIC is now considering amendments to the Codification guidance that would also be effective upon implementation. The NAIC has recommended an effective date of January 1, 2001. The Codification provides guidance for areas where statutory accounting has been silent and changes current statutory accounting in some areas. It is not known whether the Indiana Department and the Florida Department will adopt the Codification or make any changes to the guidance. The Company has not estimated the potential effect of the Codification guidance if adopted by the departments of insurance. However, the actual effect of adoption could differ as changes are made to the Codification guidance, prior to its recommended effective date of January 1, 2001. In June 1998 SFAS No. 133, as amended, "Accounting for Derivative Instruments and Hedging Activities" was issued, to be effective for fiscal quarters and fiscal years beginning after June 15, 2000. The Company does not have any derivative instruments or hedging activities, therefore, the Company believes that SFAS No. 133 will have no material impact on the Company's financial statements or notes thereto. Quantitative And Qualitative Disclosures About Market Risk Insurance company investments must comply with applicable laws and regulations which prescribe the kind, quality and concentration of investments. In general, these laws and regulations permit investments, within specified limits and subject to certain qualifications, in federal, state and municipal obligations, corporate bonds, preferred and common securities, real estate mortgages and real estate. The Company's investments in real estate and mortgage loans represent .9% of the Company's aggregate investments. The investment portfolios of the Company at December 31, 1999, consisted of the following: Cost or Type of Investment (in thousands) Amortized Cost Market Value -------------- ------------ Fixed maturities: United States Treasury securities and obligations of United States government corporation and agencies $63,857 $61,187 Obligations of states and political subdivisions 42 38 Corporate securities 113,272 110,391 ------- ------- Total Fixed Maturities 177,171 171,616 Equity Securities: Common Stocks 15,511 13,555 Short-Term investments 32,634 32,634 Mortgage loans 1,990 1,990 Other invested assets 945 945 --- --- Total Investments $228,251 $220,740 ======== ======== The following table sets forth composition of the fixed maturity securities portfolio of the Company by time to maturity as of December 31: (in thousands) 1998 1999 Percent Total Percent Total Time to Maturity Market Value Market Value Market Value Market Value ---------------- 1 year or less 7,937 4.0% 4,268 2.5 More than 1 year through 5 years 53,327 27.0% 89,901 52.4 More than 5 years through 10 years 38,236 19.4% 38,566 22.5 More than 10 years 23,034 11.7% 35,641 20.7 ------ ----- ------ ---- 122,534 62.1% 168,376 98.1 Mortgage-backed securities 74,717 37.9% 3,420 1.9 ------ ----- ----- --- Total 197,251 100.0% 171,616 100.00 ======= ====== ======= ====== The following table sets forth the ratings assigned to the fixed maturity securities of the Company as of December 31: (in thousands) 1998 1999 Percent Total Percent Total Rating (1) Market Value Market Value Market Value Market Value ---------- ------------ ------------ ------------ ------------ Aaa or AAA 76,484 38.8% 106,547 62.1 Aa or AA 2,256 1.1% 3,381 2.0 A 81,271 41.2% 25,718 15.0 Baa or BBB 23,504 11.9% 21,576 12.5 Ba or BB 13,736 7.0% 13,691 8.0 Other below investment grade ---- 0.0% 702 .4 ---- ---- --- -- Total 197,251 100.0% 171,616 100.0 ======= ====== ======= ===== (1) Ratings are assigned by Moody's Investors Service, Inc., and when not available, are based on ratings assigned by Standard & Poor's Corporation. The investment results of the Company for the periods indicated are set forth below: (in thousands) Years Ended December 31, 1997 1998 1999 Net investment income (1) 13,418 13,401 12,777 Average investment portfolio (2) 215,894 236,197 233,423 Pre-tax return on average investment portfolio 5.7% 5.7% 5.9% Net realized gains (losses) 9,393 4,104 65 (1) Includes dividend income received in respect of holdings of common stock. (2) Average investment portfolio represents the average (based on amortized cost) of the beginning and ending investment portfolio. The Company has the ability to hold its fixed maturity securities to maturity. If interest rates were to increase 10% from the December 31, 1999 levels, the decline in fair value of the fixed maturity securities would not significantly affect the Company's ability to meet its obligations to policyholders and debtors. Market-Sensitive Instruments and Risk Management The Company's investment strategy is to invest available funds in a manner that will maximize the after-tax yield of the portfolio while emphasizing the stability and preservation of the capital base. The Company seeks to maximize the total return on investment through active investment management utilizing third-party professional administrators, in accordance with pre-established investment policy guidelines established and reviewed regularly by the Board of Directors of the Company. Accordingly, the entire portfolio of fixed maturity securities is available to be sold in response to changes in market interest rate; changes in relative values of individual securities and asset sectors; changes in prepayment risks; changes in credit quality; and liquidity needs, as well as other factors. The portfolio is invested in types of securities and in an aggregate duration which reflect the nature of the Company's liabilities and expected liquidity needs diversified among industries, issuers and geographic locations. The Company's fixed maturity and common equity investments are substantially all in public companies. The following table provides information about the Company's financial instruments that are sensitive to changes in interest rates. For investment securities and debt obligations, the table presents principal cash flows and related weighted-average interest rates by expected maturity date. Additionally, the Company has assumed its available for sale securities are similar enough to aggregate those securities for presentation purposes. Interest Rate Sensitivity Principal Amount by Expected Maturity Average Interest Rate (dollars in thousands) Fair Value There-after 12/31/99 ----------- -------- 2000 2001 2002 2003 2004 Total ---- ---- ---- ---- ---- ----- Assets Available for sale 4,278 22,056 20,268 24,072 27,113 87,189 184,976 171,616 Average interest rate 6.5% 7.1% 7.3% 6.0% 6.3% 6.4% 6.5% 7.0% Liabilities IGF line of credit $15,000 $ -- $ -- $ -- $ -- $ -- $15,000 $15,000 Preferred securities $ -- $ -- $ -- $ -- $ -- $135,000 $135,000 $135,000 Average interest rate 8.5% --% --% --% --% 9.5% 9.4% 9.4% Impact of the Year 2000 Issue The Company successfully completed the appropriate assessment, remediation and testing processes necessary in all of its primary locations, Des Moines, Atlanta, Indianapolis and Tampa, to resolve the year 2000 issue. No significant issues were identified by management, and there was no interruption to the Company's business processing system as a result of the year 2000 issue. Total costs associated with the year 2000 issue were $9.4 million, of which $7.7 million was capitalized. The Company had already made the decision to transition off all of its nonstandard auto legacy systems and this process had been in progress since 1996. These new systems are Y2K compliant and were completed prior to December 31,1999. The majority of costs capitalized are hardware and software costs. CONSOLIDATED FINANCIAL STATEMENTS as of December 31, 1999 and 1998 (in thousands, except share data) CONSOLIDATED BALANCE SHEETS 1999 1998 ---- ---- ASSETS: Investments: Available for sale: Fixed maturities, at market $171,616 $197,251 Equity securities, at market 13,555 12,988 Short-term investments, at amortized cost, which approximates market 32,634 27,637 Mortgage loans, at cost 1,990 2,100 Other invested assets 945 890 --- --- TOTAL INVESTMENTS 220,740 240,866 Investments in and advances to related parties 1,346 2,118 Reinsurance recoverable on paid and unpaid losses, net 88,293 67,885 Cash and cash equivalents 3,173 15,123 Receivables, Net of allowances 92,446 123,690 Prepaid reinsurance premiums 10,259 17,486 Federal income taxes recoverable 6,820 12,711 Deferred policy acquisition costs 13,920 16,332 Deferred income taxes 0 5,146 Property and equipment, net of accumulated depreciation 21,967 19,350 Intangible assets 43,812 46,300 Other assets 9,335 4,197 ----- ----- TOTAL ASSETS $512,111 $571,204 ======== ======== LIABILITIES LIABILITIES: Losses and loss adjustment expenses $219,918 $207,432 Unearned premiums 90,007 110,665 Reinsurance payables 37,603 12,353 Notes payable 16,929 13,744 Distributions payable on preferred securities 4,809 4,809 Other 25,906 17,474 ------ ------ TOTAL LIABILITIES $395,172 $366,477 -------- -------- Minority interest: Equity in net assets of subsidiaries -- 20,203 Company obligated mandatorily redeemable preferred stock of trust subsidiary holding solely parent debentures 135,000 135,000 SHAREHOLDERS EQUITY (DEFICIT) Common Stock 19,017 17,940 Additional paid in capital 2,775 2,775 Unrealized gain (loss), net of deferred tax (4,874) 1,176 Cumulative translation adj. 13 252 Retained earnings (accumulated deficit) (34,992) 27,381 -------- ------ TOTAL SHAREHOLDERS' EQUITY (DEFICIT) (18,061) 49,524 -------- ------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) $512,111 $571,204 ========= ======== The accompanying notes are an integral part of the consolidated financial statements. CONSOLIDATED FINANCIAL STATEMENTS for the years ended December 31, 1999, 1998, and 1997 (in thousands, except per share data) CONSOLIDATED STATEMENTS OF EARNINGS (LOSS) 1999 1998 1997 ---- ---- ---- Gross premiums written $473,687 $546,771 $448,982 Less ceded premiums $(217,188) $(184,665) $(167,086) ---------- ---------- ---------- NET PREMIUMS WRITTEN $256,499 $362,106 $281,896 ======== ======== ======== NET PREMIUMS EARNED $276,040 $342,177 $276,540 Fee income 15,791 20,203 17,821 Net investment income 13,418 13,401 12,777 Net realized capital gain -- ----- ----- TOTAL REVENUES 305,314 379,885 316,531 ------- ------- ------- Expenses: Losses and loss adjustment expenses 276,633 279,127 211,503 Policy acquisition and general and administrative expenses 97,950 103,926 63,344 Interest expense 620 163 3,087 Amortization of intangibles 2,687 2,379 1,197 ----- ----- ----- TOTAL EXPENSES 377,890 385,595 279,131 ------- ------- ------- EARNINGS (LOSS) BEFORE INCOME TAXES, MINORITY INTEREST AND UNDERNOTED ITEMS (72,576) (5,710) 37,400 -------- ------- ------ ITEM Income taxes: Current (6,617) (1,706) 12,720 Deferred 7,865 1,643 (1,301) ----- ----- ------- TOTAL INCOME TAXES 1,248 (63) 11,419 ----- ---- ------ NET EARNINGS (LOSS) BEFORE MINORITY INTEREST UNDERNOTED ITEMS (73,824) (5,647) 25,981 Minority Interest (19,787) (4,919) 7,098 Distributions on preferred securities, net of tax 8,336 8,411 3,120 ----- ----- ----- NET EARNINGS (LOSS) FROM CONTINUING OPERATIONS (62,373) (9,139) 15,763 Net earnings (loss) from discontinued operations ---- (2,937) (3,545) NET EARNINGS (LOSS) $(62,373) $(12,076) $12,218 ========= ========= ======= Weighted average shares outstanding - Basic 5,876,398 5,841,329 5,590,576 ========= ========= ========= Earnings (loss) per share from continuing operations $(10.61) $(1.56) $2.82 ======== ======= ===== Earnings (loss) per share from continuing operations - diluted $(10.61) $(1.56) $2.68 ======== ======= ===== Net earnings (loss) per share $(10.61) $(2.07) $2.19 ======== ======= ===== Net earnings (loss) per share -diluted $(10.61) $(2.07) $2.08 ======== ======= ===== The accompanying notes are an integral part of the consolidated financial statements. CONSOLIDATED FINANCIAL STATEMENTS for the years ended December 31, 1999, 1998, and 1997 (in thousands, except number of shares) CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY Additional Unrealized Cumulative Total Common Stock Paid Retained Gain/(Loss) Transulation Stockholders' Adjustment Shares Amount In Capital Earnings On Equity Investments BALANCE AT JANUARY 1, 1997 (1) (1) 5,405,820 $16,821 $2,775 $27,761 $820 $(334) $47,843 Comprehensive Income: Net earnings 12,218 12,218 Change in unrealized gains (losses) on securities and Cumulative Translation Adjustments 516 42 558 Comprehensive income 12,218 516 42 12,776 Adjustments of offering costs Issuance of shares 324,456 594 594 Change in loans to acquire shares 249 249 BALANCE AT DECEMBER 31, 1997 5,730,276 17,664 2,775 39,979 1,336 (292) 61,462 Comprehensive Income: Net loss (12,076) (12,076) Change in unrealized gains (losses) on securities and Cumulative Translation Adjustments (160) 544 384 Comprehensive income (loss) (12,076) (160) 544 11,692 Exercise of stock options 215,922 1,533 1,533 Shares acquired (69,800) (226) (522) (748) Change in loans to acquire shares (1,031) 1,031 BALANCE AT DECEMBER 31, 1998 5,876,398 17,940 2,775 27,381 1,176 252 49,524 Comprehensive Income: Net earnings (loss) (62,373) (62,373) Change in unrealized gains (losses) on securities (6,050) (239) (6,289) Comprehensive loss (62,373) (6,050) (239) (68,662) Change in loans to acquire shares 1,077 1,077 BALANCE AT DECEMBER 31, 1999 5,876,398 $19,017 $2,775 $(34,992) $(4,874) $13 $(18,061) (1) Capital stock and retained earnings have been restated by $(595) and $(360) respectively, to reflect the adoption of U.S. GAAP. (See Note 22) The accompanying notes are an integral part of the consolidated financial statements. CONSOLIDATED FINANCIAL STATEMENTS for the years ended December 31, 1999, 1998, and 1997 (in thousands) CONSOLIDATED STATEMENTS OF CASH FLOWS 1999 1998 1997 ---- ---- ---- Cash flows from operating activities Net earnings (loss) (62,373) (12,076) 12,218 Adjustments to reconcile net earnings (loss) to net cash provided from operations: Minority interest (19,787) (4,919) 7,098 Depreciation, amortization and other 7,722 6,032 5,258 Deferred income tax expense (benefit) 8,462 (1,752) (1,301) Net realized capital (gain) loss (65) (4,371) (9,393) Net changes in operating assets and liabilities (net of assets acquired): Receivables 40,354 (10,396) (6,644) Reinsurance recoverable on losses, net (32,552) 40,321 (61,311) Prepaid reinsurance premiums 7,227 19,121 (21,624) Federal income taxes recoverable 5,891 0 0 Deferred policy acquisition costs 2,412 (4,483) 2,011 Other assets and liabilities 5,012 (11,836) (4,083) Losses and loss adjustment expenses 12,486 52,796 26,330 Unearned premiums (20,658) (7,951) 27,409 Reinsurance payables 25,250 (48,770) 37,810 ------ -------- ------ NET CASH PROVIDED FROM (USED IN) OPERATIONS (20,619) 11,716 13,778 -------- ------ ------ Cash flow from investing activities net of assets acquired: Purchase of minority interest and subsidiaries 0 (1,208) (61,000) Net sales (purchases) of short-term investments (13,168) (8,807) 11,638 Proceeds from sales, calls and maturities of fixed maturities 206,208 129,951 227,604 Purchases of fixed maturities (182,453) (148,417) (268,542) Proceeds from sales of equity securities 11,215 69,379 36,101 Purchase of equity securities (9,850) (42,909) (35,558) Net proceeds from (purchase) sales of other investments (2,045) (390) 41 Purchase of property and equipment (7,278) (9,348) (5,803) Cash paid for NACU 0 (3,000) 0 Other, net (71) 0 1,130 ---- - ----- NET CASH PROVIDED FROM (USED IN) INVESTING ACTIVITIES 2,558 (14,749) (94,389) ----- -------- -------- Cash flow from financing activities net of assets acquired: Proceeds from issuance of preferred securities 0 0 129,877 Proceeds from (purchase) issue of share capital 1,077 (675) 843 Redemption of share capital 0 (748) 0 Proceeds from (payments made on) term debt 3,185 7,855 (43,818) Proceeds from consolidated subsidiary minority interest owner 0 0 2,354 Loans from and (repayments to) related parties 1,849 (1,600) 0 ----- ------- - NET CASH PROVIDED FROM (USED IN) FINANCING ACTIVITIES: 6,111 4,832 89,256 ----- ----- ------ Increase (decrease) in cash and cash equivalents (11,950) 1,799 8,645 Cash and cash equivalents, beginning of year 15,123 13,324 4,679 ------ ------ ----- Cash and cash equivalents, end of year 3,173 15,123 13,324 ===== ====== ====== The accompanying notes are an integral part of the consolidated financial statements. [HEADER] GORAN CAPITAL INC AND SUBSIDIARIES 1. Nature of Operations and Significant Accounting Policies: Goran Capital Inc. ("Goran" or the "Company") is the parent company of the Goran group of companies. The consolidated financial statements include the accounts of all subsidiary companies of Goran as follows: Symons International Group, Inc. ("SIG") is a 68% owned subsidiary of Goran Capital Inc. ("Goran"). The Company is primarily involved in the sale of nonstandard automobile insurance and crop insurance. The Company's products are marketed through independent agents and brokers. Its insurance subsidiaries are licensed in 35 states, primarily in the Midwest and Southern United States. The following is a description of the significant accounting policies and practices employed: a. Basis of Presentation: The consolidated financial statements include the accounts, after intercompany eliminations, of the Company and its wholly-owned subsidiaries as follows: Superior Insurance Group Management, Inc ("Superior Group Management") (formerly, GGS Management Holdings, Inc. ("GGSH")) -a holding company for the nonstandard automobile operations which includes: Superior Insurance Group, Inc. ("Superior Group") (formerly, GGS Management, Inc. ("GGS")) -a management company for the nonstandard automobile operations; Superior Insurance Company ("Superior")-an insurance company domiciled in Florida; Superior American Insurance Company ("Superior American")-an insurance company domiciled in Florida; Superior Guaranty Insurance Company ("Superior Guaranty")-an insurance company domiciled in Florida; Pafco General Insurance Company ("Pafco")-an insurance company domiciled in Indiana; IGF Holdings, Inc. ("IGFH")-a holding company for the crop operations which includes IGF and Hail Plus Corp.; IGF Insurance Company ("IGF")-an insurance company domiciled in Indiana; North American Crop Underwriters, Inc. ("NACU") - a managing general agency with exclusive focus on crop insurance. Granite Reinsurance Company Ltd. ("Granite Re") - a finite risk reinsurance company based in Barbados. Granite Insurance Company ("Granite") - a Canadian federally licensed insurance company which ceased writing new insurance policies on January 1, 1990. Symons International Group, Inc. of Ft. Lauderdale, Florida ("SIGF") - a Florida based surplus lines insurance agency. These operations have been discontinued effective January 1, 1999. On August 12, 1997, the Company acquired the remaining 48% minority interest in Superior Group Management from Goldman Funds through a purchase business combination. (See Note 2.) On July 8, 1998, the Company acquired NACU through a purchase business combination. The Company's Consolidated Statement of Earnings for the year ended December 31, 1998 includes the results of operations of NACU subsequent to July 8, 1998. (See Note 2.) b. Use of Estimates: The preparation of financial statements requires management to make estimates and assumptions that affect amounts reported in the financial statements and accompanying notes. Such estimates and assumptions could change in the future as more information becomes known which could impact the amounts reported and disclosed herein. c. Premiums: Premiums are recognized as income ratably over the life of the related policies and are stated net of ceded premiums. Unearned premiums are computed on the semimonthly pro rata basis. d. Investments: Investments are presented on the following basis: Fixed maturities and equity securities are classified as available for sale and are carried at market value with the unrealized gain or loss as a component of stockholders' equity, net of deferred tax, and accordingly, has no effect on net income. Real estate-at cost, less allowances for depreciation. Mortgage loans-at outstanding principal balance. Realized gains and losses on sales of investments are recorded on the trade date and are recognized in net income on the specific identification basis. Interest and dividend income are recognized as earned. e. Cash and Cash Equivalents: For purposes of the statement of cash flows, the Company includes in cash and cash equivalents all cash on hand and demand deposits with original maturities of three months or less. f. Deferred Policy Acquisition Costs: Deferred policy acquisition costs are comprised of agents' commissions, premium taxes, certain other costs and investment income (starting in 1999) which are related directly to the acquisition of new and renewal business, net of expense allowances received in connection with reinsurance ceded, which have been accounted for as a reduction of the related policy acquisition costs. These costs are deferred and amortized over the terms of the policies to which they relate. Acquisition costs that exceed estimated losses and loss adjustment expenses and maintenance costs are charged to expense in the period in which those excess costs are determined. g. Property and Equipment: Property and equipment are recorded at cost. Depreciation for buildings is based on the straight-line method over 31.5 years and the straight-line method for other property and equipment over their estimated useful lives ranging from five to seven years. Asset and accumulated depreciation accounts are relieved for dispositions, with resulting gains or losses reflected in net income. h. Intangible Assets: Intangible assets consists primarily of goodwill, and debt acquisition costs. Goodwill is amortized over a 25-year period on a straight-line basis based upon management's estimate of the expected benefit period. Deferred debt acquisition costs are amortized over the term of the debt. i. Losses and Loss Adjustment Expenses: Reserves for losses and loss adjustment expenses include estimates for reported unpaid losses and loss adjustment expenses and for estimated losses incurred but not reported. These reserves have not been discounted. The Company's loss and loss adjustment expense reserves include an aggregate stop-loss program. Reserves are established using individual case-basis valuations and statistical analysis as claims are reported. Those estimates are subject to the effects of trends in loss severity and frequency. While management believes the reserves are adequate, the provisions for losses and loss adjustment expenses are necessarily based on estimates and are subject to considerable variability. Changes in the estimated reserves are charged or credited to operations as additional information on the estimated amount of a claim becomes known during the course of its settlement. The reserves for losses and loss adjustment expenses are reported net of the receivables for salvage and subrogation of approximately $8,506 and $10,684 at December 31, 1999 and 1998, respectively. j. Preferred Securities: Preferred securities represent Company-obligated mandatorily redeemable securities of subsidiary holding solely parent debentures and are reported at their liquidation value under minority interest. Distributions on these securities are charged against consolidated earnings. k. Income Taxes: The Company utilizes the liability method of accounting for deferred income taxes. Under the liability method, companies will establish a deferred tax liability or asset for the future tax effects of temporary differences between book and taxable income. Changes in future tax rates will result in immediate adjustments to deferred taxes. (See Note 11.) Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense is the tax payable or refundable for the period plus or minus the change during the period in deferred tax assets and liabilities. l. Reinsurance: Reinsurance premiums, commissions, expense reimbursements, and reserves related to reinsured business are accounted for on basis consistent with those used in accounting for the original policies and the terms of the reinsurance contracts. Premiums ceded to other companies have been reported as a reduction of premium income. m. Asset Impairment Policy: The Company reviews the carrying values of its long-lived and identifiable intangible assets for possible impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. Any long-lived assets held for disposal are reported at the lower of their carrying amounts or fair value less cost to sell. n. Certain Accounting Policies for Crop Insurance Operations: In 1996, IGF instituted a policy of recognizing (i) 35% of its estimated multiple peril crop insurance (MPCI) gross premiums written for each of the first and second quarters, 20% for the third quarter and 10% for the fourth quarter; (ii) commission expense at the applicable rate of MPCI gross premiums written recognized; and (iii) Buy-up Expense Reimbursement at a rate of 25% in 1999, 27% in 1998, and 29% in 1997 of MPCI gross premiums written recognized along with normal operating expenses incurred in connection with premium writings. In the third quarter, if a sufficient volume of policyholder acreage reports have been received and processed by IGF, IGF's policy is to recognize MPCI gross premiums written for the first nine months based on a reestimate which takes into account actual gross premiums processed. If an insufficient volume of policies has been processed, IGF's policy is to recognize in the third quarter 20% of its full year estimate of MPCI gross premiums written, unless other circumstances require a different approach. The remaining amount of gross premiums written is recognized in the fourth quarter, when all amounts are reconciled. IGF recognizes MPCI underwriting gain or loss during the first and second quarters, as well as the third quarter, reflecting IGF's best estimate of the amount of such gain or loss to be recognized for the full year, based on, among other things, historical results, plus a provision for adverse developments. In the third and fourth quarters, a reconciliation amount is recognized for the underwriting gain or loss based on final premium and latest available loss information. o. Accounting Changes: In 1998, the Company adopted the provisions of SFAS No. 130, "Reporting Comprehensive Income" and SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information." SFAS 130 requires companies to disclose comprehensive income in their financial statements. In addition to items included in net income, comprehensive income includes items currently charged or credited directly to stockholders' equity, such as the change in unrealized appreciation (depreciation) of securities. SFAS 131 established new standards for reporting operating segments, products and services, geographic areas and major customers. Segments are defined consistent with the basis management used internally to assess performance and allocate resources. On March 4, 1998, the AICPA Accounting Standards Executive Committee issued Statement of Position No. 98-1 (SOP 98-1), "Accounting for the Cost of Computer Software Developed or Obtained for Internal Use." SOP 98-1 was issued to address diversity in practice regarding whether and under what conditions the costs of internal-use software should be capitalized. SOP 98-1 is effective for financial statements for years beginning after December 15, 1998. In 1999, the Company adopted the new requirements of the SOP which did not have significant effect on net earnings during 1999. In June 1998 SFAS No. 133, as amended, "Accounting for Derivative Instruments and Hedging Activities" was issued, to be effective for fiscal quarters and fiscal years beginning after June 15, 2000. The Company does not have any derivative instruments or hedging activities therefore, the Company believes that SFAS No. 133 will have no material impact on the Company's financial statements or notes thereto. The Company's accounting policy prior to 1998 was to discount the reserves for direct claims for the time value of money. Effective January 1, 1998, the Company adopted its current policy which does not take into account the impact of discounting. The new policy is consistent with United States generally accepted accounting principles ("GAAP"). p. Earnings Per Share: The Company's basic earnings per share calculations are based upon the weighted average number of shares of common stock outstanding during each period. Due to the net loss in 1998 and 1999, fully diluted earnings per share is the same as basic earnings per share. 2. Corporate Reorganization and Acquisitions: On August 12, 1997, the Company purchased the remaining minority interest in Superior Group Management for $61 million in cash. The excess of the acquisition price over the minority interest liability aggregated approximately $36,045 and was assigned to goodwill as the fair market value of assets and liabilities approximated their carrying value. In July 1998, IGFH acquired all of the outstanding shares of common stock of NACU, a Henning, Minnesota based managing general agency which focuses exclusively on crop insurance. The acquisition price for NACU was $4,000 of which $3,000 was paid in cash and the remaining $1,000 payable July 1, 2001 without interest. The acquisition of NACU was accounted for as a purchase and recorded as follows (in thousands): Assets acquired $21,035 Liabilities assumed 19,705 ------ Net assets acquired 1,330 Purchase price 4,000 ----- Excess purchase price (goodwill) $2,670 ====== The Company's results from operations for the year ended December 31, 1998 include the results of NACU subsequent to July 8, 1998. 3. Investments: Investments are summarized as follows: Cost or Estimated Amortized Unrealized Market December 31, 1999 (in thousands) Cost Gain Loss Value Fixed Maturities: U.S. Treasury securities and obligations of U.S. government corporations and agencies $63,857 $103 $(2,773) $61,187 Foreign governments ---- ----- ---- ---- Obligations of states and political subdivisions 42 ----- (4) 38 Corporate securities 113,272 14 (2,895) 110,391 ------- -- ------- ------- TOTAL FIXED MATURITIES 177,171 117 (5,672) 171,616 Equity securities 15,511 884 (2,840) 13,555 Short-term investments 32,634 ---- ---- 32,634 Mortgage loans 1,990 ---- ---- 1,990 Other invested assets 945 --------- --------- 945 --- --------- --------- --- TOTAL INVESTMENTS $228,251 $1,001 $(8,512) $220,740 ======== ====== ======== ======== Cost or Estimated Amortized Unrealized Market December 31, 1998 (in thousands) Cost Gain Loss Value Fixed Maturities: U.S. Treasury securities and obligations of U.S. government corporations and agencies $74,060 $2,193 $(174) $76,079 Foreign governments ---- ---- ---- ---- Obligations of states and political subdivisions 7,080 3 (115) 6,968 Corporate securities 113,137 1,766 (699) 114,204 ------- ----- ----- ------- TOTAL FIXED MATURITIES 194,277 3,962 (988) 197,251 ------- ----- ----- ------- Equity securities 13,691 755 (1,458) 12,988 Short-term investments 27,637 ---- ---- 27,637 Mortgage loans 2,100 ---- ---- 2,100 Other invested assets 890 ---- ---- 890 --- ---- ---- --- TOTAL INVESTMENTS $238,595 $4,717 $(2,446) $240,866 ======== ====== ======== ======== At December 31, 1999, 91.4% of the Company's fixed maturities were considered investment grade by The Standard & Poors Corporation or Moody's Investor Services, Inc. Securities with quality ratings Baa and above are considered investment grade securities. In addition, the Company's investments in fixed maturities did not contain any significant geographic or industry concentration of credit risk. The amortized cost and estimated market value of fixed maturities at December 31, 1999, by contractual maturity, are shown in the table which follows. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalty: Estimated Market Amortized Cost Value (in thousands) Maturity: Due in one year or less $4,276 $4,268 Due after one year through five years 91,708 89,901 Due after five years through ten years 40,779 38,566 Due after ten years 37,099 35,641 Mortgage-backed securities 3,309 3,240 ----- ----- TOTAL $177,171 $171,616 ======== ======== Gains and losses realized on sales of investments are as follows: (in thousands) 1999 1998 1997 ---- ---- ---- Proceeds from sales $206,208 $129,951 $227,604 Gross gains realized $3,375 $10,901 $10,639 Gross losses realized $(3,310) $ (6,797) $(1,246) Net investment income for the years ended December 31 are as follows (in thousands): 1999 1998 1997 ---- ---- ---- Fixed maturities $12,301 $11,931 $11,213 Equity securities 401 596 340 Cash and short-term investments 1,475 1,346 1,544 Mortgage loans 152 173 182 Other (173) 32 (40) ----- -- ---- Total investment income 14,156 14,078 13,239 Investment expenses (738) (677) (462) ----- ----- ----- Net investment income $13,418 $13,401 $12,777 ======= ======= ======= Investments with a market value of $12,728 and $14,950 (amortized cost of $12,760 and $14,726) as of December 31, 1999 and 1998, respectively, were on deposit in the United States and Canada. The deposits are required by various insurance departments and others to support licensing requirements and certain reinsurance contracts, respectively. 4. Deferred Policy Acquisition Costs: Policy acquisition costs are capitalized and amortized over the life of the policies. Policy acquisition costs are those costs directly related to the issuance of insurance policies including commissions, premium taxes, and underwriting expenses net of reinsurance commission income on such policies. During 1999 the Company changed its method of calculating deferred policy acquisition costs by including investment income in the computation. Prior period calculations did not consider investment income. The effect of the change was to increase policy acquisition costs by approximately $4,071 in 1999. Policy acquisition costs both acquired and deferred, and the related amortization charged to income were as follows: (in thousands) 1999 1998 1997 ---- ---- ---- Balance, beginning of year $16,332 $11,849 $13,860 Costs deferred during year 43,714 56,041 17,345 Amortization during year (46,126) (51,558) (19,356) -------- -------- -------- Balance, end of year $13,920 $16,332 $11,849 ======= ======= ======= 5. Property and Equipment: Property and equipment at December 31 are summarized as follows (in thousands): Accumulated 1999 Cost Depreciation 1999 Net 1998 Net --------- ------------ -------- -------- Land $260 $---- $260 $260 Buildings 7,412 1,232 6,180 6,348 Office furniture and equipment 7,626 4,853 2,773 3,182 Automobiles 160 57 103 70 Computer equipment 20,889 8,238 12,651 9,490 ------ ----- ------ ----- Total $36,347 $14,380 $21,967 $19,350 ======= ======= ======= ======= Accumulated depreciation at December 31, 1998 was $9,719. Depreciation expense related to property and equipment for the years ended December 31, 1999, 1998 and 1997 were $4,887, $3,151 and $1,754, respectively. 6. Intangible Assets: Intangible assets at December 31 are as follows (in thousands): Accumulated 1999 Cost Depreciation 1999 Net 1998 Net --------- ------------ -------- -------- Goodwill $43,376 $4,641 $38,735 $39,851 Deferred debt costs 5,131 413 4,718 4,889 Other 1,299 940 359 1,560 ----- --- --- ----- $49,806 $5,994 $43,812 $46,300 ======= ====== ======= ======= Accumulated amortization at December 31, 1998 was $3,697. Amortization expense related to intangible assets for the years ended December 31, 1999, 1998 and 1997 was $2,297, $2,379 and $1,197 respectively. 7. Unpaid Losses and Loss Adjustment Expenses (in thousands): Activity in the liability for unpaid losses and loss adjustment expenses is summarized as follows: 1999 1998 1997 ---- ---- ---- Balance at January 1 $207,432 $154,636 $128,306 Less reinsurance recoverables 67,885 108,206 33,113 ------ ------- ------ NET BALANCE AT JANUARY 1 139,547 46,430 95,193 ------- ------ ------ Incurred related to: Current year 237,817 267,395 200,566 Prior years 38,816 11,732 10,937 ------ ------ ------ TOTAL INCURRED 276,633 279,127 211,503 ------- ------- ------- Paid related to: Current year 167,262 165,336 180,925 Prior years 117,293 61,677 79,341 ------- ------ ------ TOTAL PAID 284,555 227,013 260,266 ------- ------- ------- NET BALANCE AT DECEMBER 31 131,625 139,547 46,430 Plus reinsurance recoverables 88,293 67,885 108,206 ------ ------ ------- BALANCE AT DECEMBER 31 $219,918 $207,432 $154,636 ======== ======== ======== Reserve estimates are regularly adjusted in subsequent reporting periods, consistent with sound insurance reserving practices, as new facts and circumstances emerge which indicate a modification of the prior estimate is necessary. The adjustment, referred to as "reserve development," is inevitable given the complexities of the reserving process and is recorded in the statements of earnings in the period the need for the adjustments becomes apparent. The foregoing reconciliation indicates that deficient reserve developments of $30,461, $12,996 and $10,967 in the December 31, 1999, 1998, and 1997 loss and loss adjustment expense reserves, respectively, emerged in the following year. The 1997 and 1998 deficient reserve development occurred primarily due to volatility in the historical trends for the nonstandard automobile business as a result of significant growth during 1996 and 1997. The deficient reserve development during 1999 resulted from a higher than expected frequency and severity on nonstandard automobile claims and from higher than expected losses on 1998 AgPI policies (see Note 17). The anticipated effect of inflation is implicitly considered when estimating liabilities for losses and loss adjustment expenses. While anticipated price increases due to inflation are considered in estimating the ultimate claim costs, the increase in average severities of claims is caused by a number of factors that vary with the individual type of policy written. Future average severities are projected based on historical trends adjusted for implemented changes in underwriting standards, policy provisions, and general economic trends. Those anticipated trends are monitored based on actual development and are modified if necessary. Liabilities for loss and loss adjustment expenses have been established when sufficient information has been developed to indicate the involvement of a specific insurance policy. In addition, a liability has been established to cover additional exposure on both known and unasserted claims. The effects of changes in settlement costs, inflation, growth and other factors have all been considered in establishing the current year reserve for unpaid losses and loss adjustment expenses. 8. Notes Payable: At December 31, 1999, IGF maintained a revolving bank line of credit in the amount of $15,000 (the "IGF Revolver"). At December 31, 1999 and 1998, the outstanding balance was $15,000 and $12,000 respectively. Interest on this line of credit was at the New York prime rate (8.50% at December 31, 1999) minus .75% adjusted daily. This line is collateralized by the crop-related uncollected premiums, reinsurance recoverable on paid losses, Federal Crop Insurance Corporation (FCIC) annual settlement, and a first lien on the real estate owned by IGF. The IGF Revolver contains certain covenants which (i) restricts IGF's ability to accumulate common stock; (ii) sets minimum standards for investments and policyholder surplus; and (iii) limits the ratio of net written premiums to surplus. At December 31, 1999, IGF was not in compliance with the minimum statutory surplus covenant. However, IGF has received a waiver from the bank for December 31, 1999. The weighted average interest rate on the line of credit was 7.02%, 6.96%, and 8.75% during 1999, 1998 and 1997, respectively. Notes payable at December 31, 1999 also includes a $1,000 note due 2001 on the purchase of NACU at no interest. The balance of notes payable at December 31, 1999 includes three smaller notes (less than $300 each) assumed in the acquisition of NACU due 2002-2006 with periodic payments at interest rates ranging from 7% to 9.09%. 9. Company-Obligated Mandatorily Redeemable Preferred Stock of Trust Subsidiary Holding On August 12, 1997, SIG's wholly owned trust subsidiary issued $135 million in preferred securities ("Preferred Securities") at a rate of 9.5% paid semi-annually. The principal asset of the wholly owned trust subsidiary are Senior Subordinated Notes of SIG in the principal amount of $135 million with an interest rate and maturity date substantially identical to those of the Preferred Securities. The Preferred Securities were offered under Rule 144A of the SEC ("Preferred Securities Offering") and, pursuant to the Registration Rights Agreement executed at closing, SIG filed a Form S-4 Registration Statement with the SEC on September 16, 1997 to effect the Exchange Offer. The S-4 Registration Statement was declared effective on September 30, 1997 and the Exchange Offer successfully closed on October 31, 1997. The proceeds of the Preferred Securities Offering were used to repurchase the remaining minority interest in Superior Group Management for $61 million, repay the balance of the term debt of $44.9 million the balance, after expenses, of approximately $24 million was contributed to the nonstandard automobile insurers of which $10.5 million was contributed in 1997. Expenses of the issue aggregated $5.1 million and are amortized over the term of the Preferred Securities (30 years). In the third quarter of 1997, the Company wrote off the remaining unamortized costs of the term debt of approximately $1.1 million pre-tax or approximately $0.09 per share which was recorded as an extraordinary item. The Preferred Securities represent company-obligated mandatorily redeemable securities of a subsidiary holding solely its parent debentures and have a term of 30 years with semi-annual interest payments commencing February 15, 1998. The Preferred Securities may be redeemed in whole or in part after 10 years. The Preferred Security obligations of approximately $13 million per year is funded from the Company's nonstandard automobile management company and dividend capacity from the crop operations. The nonstandard auto funds are the result of management and billing fees in excess of operating costs. The Trust Indenture for the Preferred Securities contains certain restrictive covenants. These covenants are based upon SIG's consolidated coverage ratio of earnings before interest, taxes, depreciation and amortization (EBITDA) whereby if SIG's EBITDA falls below 2.5 times consolidated interest expense (including Preferred Security distributions) for the most recent four quarters the following restrictions become effective: o SIG may not incur additional indebtedness or guarantee additional indebtedness. o SIG may not make certain restricted payments including loans or advances to affiliates, stock repurchases and a limitation on the amount of dividends is inforce. o SIG may not increase its level of non-investment grade securities defined as equities, mortgage loans, real estate, real estate loans and non-investment grade fixed income securities. These restrictions currently apply as the SIG's consolidated coverage ratio was (4.89) in 1999, and will continue to apply until the SIG's Consolidated Coverage Ratio is in compliance with the terms of the Trust Indenture. SIG is in compliance with these additional restrictions and therefore, this does not represent a default by the Company on the Preferred Securities. Assuming the Preferred Securities Offering took place at January 1, 1997, the proforma effect of this offering on the Company's consolidated statement of earnings from continuing operations for the year ended December 31, 1997 is as follows: Unaudited (In thousands) Revenues $319,019 Net earnings from continuing operations $11,163 Net earnings from continuing operations per common $1.99 share (fully diluted) The pro forma results are not necessarily indicative of what actually would have occurred if these transactions had been in effect for the entire periods presented. In addition, they are not intended to be a projection of future results. 10. Capital Stock The Company's authorized share capital consists of: (a) First Preferred shares An unlimited number of first preferred shares of which none are outstanding at December 31, 1999 (1998-nil) (b) Common Shares An unlimited number of common shares of which 5,876,398 are outstanding as at December 31, 1999 (1998 - 5,876,398). During the year, pursuant to the exercise of warrants and options, the Company issued nil (1998 - 215,992) common shares for aggregate consideration in the amount nil (1998 - $1,533) of which $1,177 of the consideration was in the form of a loan. During 1998, the Company purchased 69,800 of its common shares for an aggregate consideration of $748. 11. Income Taxes: The Company and its subsidiaries have net operating loss carryovers of $66,152. Of that amount, $43,325 is attributable to SIG, $15,983 is attributable to Goran and its non U.S. subsidiaries, and $6,844 is attributable to SIGF a U.S. subsidiary which does not qualify for filing consolidated tax returns with SIG. These losses are usable only against future income in these respective operating units. As of December 31, 1999, the Company has unused net operating loss carryovers available as follows (in thousands): Years ending not later than December 31: Goran & ------- Canadian Total SIG Subsidiaries SIGF --- ------------ ---- 2000 541 1,571 2,112 2001 1,537 1,537 2002 126 865 991 2003 1,120 1,120 2004 511 511 2005 1,659 1,659 2006 1,113 1,113 2017 4,688 4,688 2018 1,295 1,295 2019 42,658 -- 861 43,519 Capital Losses -- 7,607 -- 7,607 -- ----- -- ----- TOTAL 43,325 15,983 6,844 66,152 ====== ====== ===== ====== SIG files a consolidated U.S. federal income tax return with its wholly-owned subsidiaries. Intercompany tax sharing agreements between SIG and its wholly-owned subsidiaries provide that income taxes will be allocated based upon separate return calculations in accordance with the Internal Revenue Code of 1986, as amended. Intercompany tax payments are remitted at such times as estimated taxes would be required to be made to the Internal Revenue Service ("IRS"). Refunds received from the IRS are distributed in a timely manner to the appropriate subsidiaries. A reconciliation of the differences between federal tax computed by applying the federal statutory rate of 35% to income before income taxes and the income tax provision is as follows (in thousands): 1999 1998 1997 ---- ---- ---- Computed income taxes (benefit) at statutory rate $(25,509) (2,953) $13,266 Alternative minimum taxes 1,203 55 ---- Dividends received deduction (92) (130) (78) Goodwill and acquisition costs 793 621 179 Other (1,649) (1,243) (346) Tax Exempt (Income) Loss 88 689 (134) Application of Operating Loss Carry Forward (82) ---- (1,291) (25,248) (2,961) 11,596 Valuation allowance change 23,859 923 ---- ------ --- ---- Income Tax Expense (Benefit) $(1,389) $(2,038) $11,596 ======== ======== ======= The net deferred tax asset at December 31, 1999 and 1998 is comprised of the following (in thousands): 1999 1998 Deferred tax assets: Unpaid losses and loss adjustment expenses $4,271 $3,548 Unearned premiums and prepaid insurance 5,568 5,972 Allowance for doubtful accounts 1,022 1,118 Unrealized losses on investments 2,637 ---- Net operating loss carryforwards 23,779 8,129 Other 303 1,468 --- ----- DEFERRED TAX ASSET $37,580 $20,235 ------- ------- Deferred tax liabilities: Deferred policy acquisition costs $(4,872) $(5,716) Unrealized gains on investments ---- (680) Other (799) (602) ----- ----- DEFERRED TAX LIABILITY $(5,671) $(6,998) -------- -------- 31,909 13,237 VALUATION ALLOWANCE $31,909 (8,090) ------- ------- NET DEFERRED TAX ASSET $---- $5,147 ===== ====== At December 31, 1999 the Company's net deferred tax assets are fully offset by a valuation allowance. The company will continue to assess the valuation allowance and to the extent it is determined that such allowance is no longer required, the tax benefit of the remaining net deferred tax assets will be recognized in the future. 12. Leases: The Company leases buildings, furniture, cars and equipment under operating leases. Operating leases generally include renewal options for periods ranging from two to seven years and require the Company to pay utilities, taxes, insurance and maintenance expenses. The following is a schedule of future minimum lease payments under cancelable and non-cancelable operating leases for each of the five years succeeding December 31, 1999 and thereafter, excluding renewal options (in thousands): Year Ending December 31: 2000 $4,316 2001 2,529 2002 2,270 2003 1,411 2004 and Thereafter $2,586 Rental expense charged to operations in 1999, 1998 and 1997 amounted to $3,607, $2,939 and $1,176, respectively, including amounts paid under short-term cancelable leases. 13. Reinsurance: The Company limits the maximum net loss that can arise from a large risk, or risks in concentrated areas of exposure, by reinsuring (ceding) certain levels of risks with other insurers or reinsurers, either on an automatic basis under general reinsurance contracts known as "treaties" or by negotiation on substantial individual risks. Such reinsurance includes quota share, excess of loss, stop-loss and other forms of reinsurance on essentially all property and casualty lines of insurance. In addition, the Company assumes reinsurance on certain risks. The Company remains contingently liable with respect to reinsurance, which would become an ultimate liability of the Company in the event that such reinsuring companies might be unable, at some later date, to meet their obligations under the reinsurance agreements. On March 2, 1998, the Company announced that it had signed an agreement with Continental Casualty Company ("CNA") to assume its multi-peril and crop hail operations. CNA wrote approximately $80 million of multi-peril and crop hail insurance business in 1997. The Company reinsures a small portion of the Company's total crop book of business (approximately 22% MPCI and 15% crop hail) with CNA. Starting in the year 2000, assuming no event of change in control as defined in the agreement, the Company can purchase the reinsurance from CNA through a call provision or CNA can require the Company to buy the premiums reinsured with CNA. Regardless of the method of takeout of CNA, CNA must not compete in MPCI or crop hail for a period of time. There was no purchase price. The formula for the buyout in the year 2000 is based on a multiple of average pre-tax earnings that CNA received from reinsuring the Company's book of business. Reinsurance activity for 1999, 1998 and 1997, which includes reinsurance with related parties, is summarized as follows (in thousands): 1999 Gross Ceded Net ---- ----- ----- --- Premiums Written $473,687 $(217,188) $256,499 Premiums Earned 495,019 (218,979) 276,040 Incurred losses and loss adjustment expenses 494,725 (218,092) 276,633 Commission expenses (income) $76,679 $(73,088) $3,591 1998 Premiums Written 546,771 (184,665) 362,106 Premiums Earned 554,722 (212,545) 342,177 Incurred losses and loss adjustment expenses 519,711 (240,584) 279,127 Commission expenses (income) 94,818 (80,272) 14,546 1997 Premiums Written 448,982 (167,086) 281,896 Premiums Earned 422,200 (145,660) 276,540 Incurred losses and loss adjustment expenses 312,583 (101,080) 211,503 Commission expenses (income) 65,529 (77,279) (11,750) Amounts recoverable from reinsurers relating to unpaid losses and loss adjustment expenses were $88,293 and $67,885, as of December 31, 1999 and 1998, respectively. These amounts are reported as assets and are not netted against the liability for loss and loss adjustment expenses in the accompanying Consolidated Balance Sheets. 14. Related Party Transactions The 1989, the Company wrote off a loan of $5,135 owed by a subsidiary of Symons International Group Ltd. ("SIGL"). SIGL the majority shareholder of Goran, guaranteed this loan and pledged 1.2 million escrowed common shares of Goran (the "escrowed shares") as security for the loan. During 1994, SIGL entered into agreements with Goran whereby as consideration for the release of 766,600 of the escrowed shares, SIGL repaid $1,465 of the loan. During 1997, SIGL entered into an agreement with Goran whereby as consideration for release of 333,400 of the escrowed shares, SIGL repaid $1,444 of the loan, The balance due to Goran of $2,226 continues to be guaranteed by SIGL and is secured by the 100,000 remaining escrowed shares. Included in investments and advances to related parties are $300 (1998 - $1,377) due from certain shareholders and directors which relate to the purchase of common shares of the company. Approximately $300 of the amounts due bear interest and are subject to principal repayment schedules. Other receivables at December 31, 1999, also includes $1,046 due from certain shareholders unrelated to stock purchases, the majority of which bear interest and are subject to principal repayment terms. SIG paid $3,112, $2,832 and $1,034 in 1999, 1998 and 1997, respectively, for consulting and other services relative to the conversion to the company's new non-standard automobile operating system. The Company has capitalized these costs as part of its new non-standard automobile operating system. Approximately 90% of these payments are for services provided by consultants and vendors unrelated to the Company. Stargate Solutions ("Stargate") manages the work of each unrelated consultants and vendors and, as compensation for such work, has retained approximately 10% of the payments referred to above in return for management services provided. During 1999, Stargate was owned beneficially by certain directors of the Company and a relative of those directors. Also included in consulting fees to related parties is $520 and $270 in 1999 and 1998 respectively, for payments to Onex, Inc., an officer of which is on SIG's Board of Directors, for employment related matters. 15. Regulatory Matters: Pafco and IGF, domiciled in Indiana, prepare their statutory financial statements in accordance with accounting practices prescribed or permitted by the Indiana Department of Insurance (IDOI). Statutory requirements place limitations on the amount of funds which can be remitted to the Company from Pafco and IGF. The Indiana statute allows 10% of surplus as regard to policyholders or 100% of net income, whichever is greater, to be paid as dividends only from earned surplus. The Superior entities, domiciled in Florida, prepare their statutory financial statements in accordance with accounting practices prescribed or permitted by the Florida Department of Insurance (FDOI). In the consent order approving the Acquisition of Superior, the FDOI (the "Acquisition Consent Order") has prohibited Superior from paying any dividends for four years without the prior written approval of the FDOI which prohibition was in effect through the 1999 calendar year. Prescribed statutory accounting practices include a variety of publications of the National Association of Insurance Commissioners (NAIC), as well as state laws, regulations, and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed. IGF received written approval through December 31, 1999 from the IDOI to reflect its business transacted with the FCIC as a 100% cession with any net underwriting results recognized in ceding commissions for statutory accounting purposes, which differs from prescribed statutory accounting practices. As of December 31, 1999, that permitted transaction had no effect on statutory surplus or net income. The underwriting profit results of the FCIC business, net of reinsurance of $18,206, $18,405 and $31,595, are netted with policy acquisition and general and administrative expenses for the years ended December 31, 1999, 1998 and 1997, respectively, in the accompanying Consolidated Statements of Earnings. The NAIC is considering the adoption of a recommended statutory accounting standard for crop insurers, the impact of which is uncertain since several methodologies are currently being examined. Although the IDOI has permitted the Company to continue for its statutory financial statements through December 31, 1999 its practice of recording its MPCI business as 100% ceded to the FCIC with net underwriting results recognized in ceding commissions, the IDOI has indicated that in the future it will require the Company to adopt the MPCI accounting practices recommended by the NAIC or any similar practice adopted by the IDOI. Since such a standard would be adopted industry-wide for crop insurers, the Company would also be required to conform its future GAAP financial statements to reflect the new MPCI statutory accounting methodology and to restate all historical GAAP financial statements consistently with this methodology for comparability. The Company cannot predict what accounting methodology will eventually be implemented, but believe the Company will be required to adopt such methodology. The Company anticipates that any such new crop accounting methodology will not affect GAAP net earnings. Net income (loss) of the U.S. insurance subsidiaries, as determined in accordance with statutory accounting practices (SAP), was $(20.5) million, $(21.5) million and $7.7 million, for 1999, 1998 and 1997, respectively. Consolidated statutory capital and surplus was approximately $50 million and $105 million at December 31, 1999 and 1998, respectively. As of December 31, 1999, the risk-based capital of IGF was in excess of the company action level. Superior's risk-based capital ratio was at 199% or $151,000 below the company action level and Pafco's risk-based ratio was at 72% or $10.5 million below the company action level using the NAIC guidelines. To address IDOI concerns relating to Pafco, on February 17, 2000, Pafco agreed to an order under which the IDOI may monitor more closely the ongoing operations of Pafco. Among other matters, Pafco must: o Refrain from doing any of the following without the IDOI's prior written consent: selling assets or business in force or transferring property, except in the ordinary course of business; disbursing funds, other than for specified purposes or for normal operating expenses and in the ordinary course of business (which does not include payments to affiliates, other than under written contracts previously approved by the IDOI, and does not include payments in excess of $10,000); lending funds; making investments, except in specified types of investments; incurring debt, except in the ordinary course of business and to unaffiliated parties; merging or consolidating with another company, or entering into new, or modifying existing, reinsurance contracts. o Reduce its monthly auto premium writings, or obtain additional statutory capital or surplus, such that the year 2000 ratio of gross written premium to surplus and net written premium to surplus does not exceed 4.0 and 2.4, respectively; and provide the IDOI with regular reports demonstrating compliance with these monthly writings limitations. Further restrictions in premium writings would result in lower premium volume. Management fees payable to Superior Group are based on gross written premium therefore lower premium volume would result in reduced management fees paid by Pafco. o Provide a summary of affiliate transactions to the IDOI. o Continue to comply with prior IDOI agreements and orders to correct business practices, under which (as previously disclosed) Pafco must provide monthly financial statements to the IDOI, obtain prior IDOI approval of reinsurance arrangements and of affiliated party transactions, submit business plans to the IDOI that address levels of surplus and net premiums written, and consult with the IDOI on a monthly basis. Pafco's inability or failure to comply with any of the above could result in the IDOI requiring further reductions in Pafco's permitted premium writings or in the IDOI instituting future proceedings against Pafco. No report has yet been issued by the IDOI on its previously disclosed target examination of Pafco, covering loss reserves, pricing and reinsurance. Pafco has also agreed with the Iowa Department of Insurance (IADOI) to (i) limit its policy counts on automobile business in Iowa and (ii) provide the IADOI with policy count information on a monthly basis until June 30, 2000 and thereafter on a quarterly basis. In addition Pafco has agreed to provide monthly financial information to other departments of insurance in states in which it writes business. As previously disclosed, with regard to IGF and as a result of the losses experienced by IGF in the crop insurance operations, IGF has agreed with the IDOI to provide monthly financial statements and consult monthly with the IDOI, and to obtain prior approval for affiliated party transactions. IGF currently is in compliance with its agreement to provide monthly financial statements to IDOI; however, IGF is working with the IDOI to provide this information on a timely basis. IGF has agreed with the IADOI that it will not write any nonstandard business, other than that which it is currently writing until such time as IGF has: (i) increased surplus; (ii) a net written premium to surplus ratios less than three to one; and (iii) surplus reasonable to its risk. The FDOI has initiated examinations covering Superior. The scope of these examinations has covered or will cover market conduct, data processing systems, Year 2000 readiness and financial examinations as of June 30, 1999 and December 31, 1999. Although no report has been issued or other action taken by the FDOI, Superior expects to maintain ongoing discussions with the FDOI to address these and other issues, including reserve levels and financial review and reporting. The Company's operating subsidiaries, their business operations, and their transactions with affiliates, including the Company, are subject to regulation and oversight by the IDOI, the FDOI, and the insurance regulators of other states in which the subsidiaries write business. The Company is a holding company and all of its operations are conducted by its subsidiaries. Regulation and oversight of insurance companies and their transactions with affiliates is conducted by state insurance regulators primarily for the protection of policyholders and not for the protection of other creditors or of shareholders. Failure to resolve issues with the IDOI and the FDOI in a manner satisfactory to the Company could result in future regulatory actions or proceedings that materially and adversely affect the Company. In 1998, the NAIC adopted the Codification of Statutory Accounting Principles guidance, which will replace the current Accounting Practices and Procedures manual as the NAIC's primary guidance on statutory accounting. The NAIC is now considering amendments to the Codification guidance that would also be effective upon implementation. The NAIC has recommended an effective date of July 1, 2001. The Codification provides guidance for areas where statutory accounting has been silent and changes current statutory accounting in some areas. It is not known whether the IDOI or the FDOI will adopt the Codification, and whether the Departments will make any changes to the guidance. The Company has not estimated the potential effect of the Codification guidance if adopted by the departments of insurance. However, the actual effect of adoption could differ as changes are made to the Codification guidance, prior to its recommended effective date of July 1, 2001. 16. Commitments and Contingencies: On February 23, 2000, a complaint for a class action alleging violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 was filed against the Company, SIG, certain officers, and certain directors in the United States District Court for the Southern District of Indiana. The complaint alleges, among other things, that the defendants rendered false and misleading statements and/or omissions concerning financial condition and business prospects of the Company, as well as the financial benefits that would inure to the Company and its shareholders. The Company intends to vigorously defend the claims brought against it. The California Department of Insurance (CDOI) has advised the Company that it is reviewing a possible assessment which could total $3 million. This possible assessment relates to the charging of brokers fees charged to policyholders by independent agents who placed business with Superior. The CDOI has indicated that such broker fees charged by the independent agent to the policyholder were improper and has requested reimbursement to the policyholders by Superior. The Company did not receive any of these broker fees. As the ultimate outcome of this potential assessment is not deemed probable, the Company has not accrued any amount in its consolidated financial statements. Although the assessment has not been formally made by the CDOI at this time, the Company will vigorously defend any potential assessment and believes it will prevail. In 1998, IGF sold a total of 157 policies for agricultural business interruption insurance called AgPI that were intended to protect businesses that depend upon a steady flow of crop (or crops) to stay in business. This product was sold to a variety of businesses involved in agribusiness, including farmers, as well as grain elevator operators, produce shippers, custom harvesters, cotton gins, agriculture chemical dealers and other processing businesses whose income is heavily dependent on a stable supply of raw product (i.e., cotton), or whose product sales are negatively affected if crop yields fall (i.e., chemical dealers). Most of the policies were sold to California policyholders. The policy form required that the county in which crops reside must suffer a minimum level of crop loss before a loss recovery by a policyholder is possible. After the county loss test was met, then the policyholder must demonstrate an insurable economic loss on an individual basis under the policy. The Company recognized approximately $7.6 million in written premium in 1998, of which $6 million was earned in 1998 and $1.6 million earned in the first quarter of 1999. Adverse weather conditions and resultant crop damage in parts of the country where the policies were sold, led the Company to begin establishing reserves for its possible exposure. However, the lack of National Agricultural Statistical Service ("NASS") and policyholder loss data adversely affected the Company's ability to establish the amount of their exposure. At December 31, 1998, the Company set its reserves at an amount equal to 100% of the earned premium. County loss data, as well as policyholder loss data, gradually became known starting in late April 1999. As of May 28, 1999, the Company recognized that it was experiencing unexpected adverse loss development on these policies and increased its incurred losses related to 1998 policies to $15 million. When the Company published second quarter results, NASS data was complete, and the Company had received policyholder data on nearly all policies to determine its exposure. The Company's estimated gross ultimate incurred loss and loss adjustment expense ("LAE") related to these policies was $25 million (gross loss before reinsurance recoveries). As the Company continued to investigate and reevaluate these claims, it increased its estimated ultimate gross incurred loss and loss adjustment expense related to these policies to $34.5 million. IGF is a party to a number of pending legal proceedings relating to AgPI. IGF remains a defendant in six lawsuits pending in California state court (King and Fresno counties) having settled four other suits including two declaratory judgment actions that were brought by IGF in Federal District Court in California. In addition, IGF has settled 13 arbitration proceedings involving policyholders of AgPI and has no outstanding arbitrations relating to this product. The first of these proceedings was commenced in July 1999. All discovery in the remaining proceedings has been stayed pending a June 2000 hearing on IGF's appeal of an order denying a dismissal of the cases and a remanding of these disputes to arbitration as called for in the policy provisions. The policyholders involved in the open proceedings have asserted that IGF is liable to them for the face amount of their policies, an aggregate of approximately $14.7 million, plus an unspecified amount of punitive damages and attorney's fees. As of December 31, 1999, IGF had paid an aggregate of approximately $7 million to the policyholders involved in these legal proceedings. The Company increased its reserves by $9.5 million in the fourth quarter of 1999 and reserved a total of $34.5 million in 1999 of which $22.3 million was paid through December 31, 1999. Less than $0.1 million of 1999 gross written AgPI premiums have been written and assumed by the Company in 1999; in addition the policy language was revised materially. Based on the information presently available, the Company believes that it has recognized, through loss and LAE payments and reserves, its ultimate loss exposure related to the AgPI product. The Company feels its financial reserves for the lawsuits and arbitrations are sufficient to cover the resulting liability, if any, that may arise from these matters. However, there can be no assurance that the Company's ultimate liability for AgPI related claims will not be materially greater than the $34.5 million in gross losses already recorded in the consolidated financial statements related to this product and will not have a material adverse effect on the Company's results of operations or financial condition. Of the $34.5 million AgPI losses reserved approximately $21 million has been paid to date. During the first quarter of 1999, the Company entered into reinsurance arrangements covering a portion of the AgPI business. Under those arrangements, during the first quarter the Company recorded $4.7 million of ceded gross premium and a $9.4 million reinsurance recovery, deferring the resulting net gain of $4.7 million. The $4.7 million deferred gain was recognized as income in the second quarter. The Company subsequently negotiated a change to the reinsurance in the fourth quarter which resulted in approximately $4.2 million additional gain being recorded as of December 31, 1999. The Company is not entitled to any further recoveries under these reinsurance arrangements. The Company is a joint and several guarantor in a $7.25 million debt collateralized by operating assets held in an entity in which the company is a 50% owner. The estimated fair market value of the assets approximates the debt. At December 31, 1998, the Company provided an allowance of $3.2 million associated with discrepancies identified in connection with the processing of premiums from the assumption of the CNA business and the related premiums receivable balance. In 1999, the Company resolved the discrepancy and reduced the allowance to $0. Two assertions have been made in Florida alleging that service charges or finance charges are in violation of Florida law. The plaintiffs are attempting to obtain class certification in these actions. The Company believes that it has substantially complied with the premium financing statute and intends to vigorously defend any potential loss. The Company, and its subsidiaries, are named as defendants in various lawsuits relating to their business. Legal actions arise from claims made under insurance policies issued by the subsidiaries. These actions were considered by the Company in establishing its loss reserves. The Company believes that the ultimate disposition of these lawsuits will not materially affect the Company's operations or financial position. 17. Supplemental Cash Flow Information: Cash paid for interest and income taxes are summarized as follows: (in thousands) 1999 1998 1997 ---- ---- ---- Cash paid for interest $515 $260 $3,467 Cash paid/(received) for federal income taxes, net of refunds $(17,910) $5,351 $11,670 refunds 18. Disclosures About Fair Values of Financial Instruments: The following discussion outlines the methodologies and assumptions used to determine the estimated fair value of the Company's financial instruments. Considerable judgment is required to develop these fair values and, accordingly, the estimates shown are not necessarily indicative of the amounts that would be realized in a one-time, current market exchange of all of the Company's financial instruments. a) Fixed Maturity, Equity Securities, and Other Investments: Fair values for fixed maturity and equity securities are based on quoted market prices. b) Short-term Investments, and Cash and Cash Equivalents: The carrying value for assets classified as short-term investments, and cash and cash equivalents in the accompanying Consolidated Balance Sheets approximates their fair value. c) Short-term Debt: The carrying value for short-term debt approximates fair value. d) Preferred Securities: The December 31, 1999 estimated market value of the Preferred Securities was $40,500 based on quoted market prices. 19. Segment Information: The Company has two reportable segments based on products: nonstandard automobile insurance and crop insurance. The nonstandard automobile segment offers personal nonstandard automobile insurance coverages through a network of independent general agencies. The crop segment writes MPCI and crop hail insurance through independent agencies with its primary concentration in the Midwest. The accounting policies of the segments are the same as those described in "Nature of Operations and Significant Accounting Policies." There are no significant intersegment transactions. The Company evaluates performance and allocates resources to the segments based on profit or loss from operations before income taxes. The following is a summary of the Company's segment data and a reconciliation of the segment data to the Consolidated Financial Statements. The "Corporate and Other" includes operations not directly related to the reportable business segments and unallocated corporate items (i.e., corporate investment income, interest expense on corporate debt and unallocated overhead expenses). Segment assets are those assets in the Company's operations in each segment. "Corporate and Other" assets are principally cash, short-term investments, related-party assets, intangible assets, and property and equipment. Nonstandard Segment Corporate Consolidated ------------ -------- ---------- ------------ Auto Crop Totals & Other Totals ---- ---- ------ ------- ------ (in thousands) Year Ended December 31, 1999 Premiums earned $249,094 $14,240 $263,334 $12,706 $276,040 Fee income 15,185 456 15,641 150 15,791 Net investment income 12,339 293 12,632 786 13,418 Net realized capital gain (loss) (281) 21 (260) 325 65 ----- -- ----- --- -- Total Revenue 276,337 15,010 291,347 13,967 305,314 ------- ------ ------- ------ ------- Loss and loss adjustment expenses 230,973 34,225 265,198 11,435 276,633 Operating expenses 91,859 215 92,074 5,876 97,950 Amortization of intangibles -- 493 493 2,194 2,687 Interest expense -- 620 620 -- 620 -- --- --- -- --- Total expenses 322,832 35,553 358,385 19,505 377,890 ------- ------ ------- ------ ------- Loss before income taxes, minority interest and other items $(46,495) $(20,543) $(67,038) $(5,538) $(72,576) ========= ========= ========= ======== ========= Segment assets $229,640 $145,622 $375,262 $136,849 $512,111 ======== ======== ======== ======== ======== Year Ended December 31, 1998 Premiums earned $264,022 $60,901 $324,923 $17,254 $342,177 Fee income 16,431 3,772 20,203 -- 20,203 Net investment income 11,958 275 12,233 1,168 13,401 Net realized capital gain (loss) 4,124 217 4,341 (237) 4,104 ----- --- ----- ----- ----- Total revenue $296,535 65,165 361,700 18,185 379,885 -------- ------ ------- ------ ------- Loss and loss adjustment expenses (recovery) 217,916 52,550 270,466 8,661 279,127 Operating Expenses 73,346 21,906 95,252 8,674 103,926 Amortization of intangibles -- 339 339 2,040 2,379 Interest expense -- 163 163 -- 163 -- --- --- -- --- Total expenses 291,262 74,958 366,220 19,375 385,595 ------- ------ ------- ------ ------- Earnings (loss) before income taxes, minority interest and other items $5,273 $(9,793) $(4,520) $(1,190) $(5,710) ====== ======== ======== ======== ======== Segment assets $376,831 $143,434 $520,265 $50,939 $571,204 ======== ======== ======== ======= ======== Year Ended December 31, 1997 Premiums earned $251,020 $20,794 $271,814 4,726 $276,540 Fee income 15,515 2,276 17,791 30 17,821 Net investment income 10,969 191 11,160 1,617 12,777 Net realized capital gain (loss) 9,462 (18) 9,444 (51) 9,393 ----- ---- ----- ---- ----- Total revenue $286,966 $23,243 $310,209 $6,322 $316,531 -------- ------- -------- ------ -------- Loss and loss adjustment expenses (recovery) 195,900 16,550 212,450 (947) 211,503 Operating Expenses 72,463 (14,404) 58,059 5,285 63,344 Amortization of intangibles -- 2 2 1,195 1,197 Interest expense -- 233 233 2,854 3,087 -- --- --- ----- ----- Total expenses 268,363 2,381 270,744 8,387 279,131 ------- ----- ------- ----- ------- Earnings (loss) before income taxes, minority interest and other items $18,603 $20,862 $39,465 $(2,065) $37,400 ======= ======= ======= ======== ======= Segment assets $363,864 $119,660 $483,524 $80,947 $564,471 ======== ======== ======== ======= ======== 20. Stock Option Plans: Information regarding the Goran Stock Option Plan is summarized below (in Canadian dollars): 1999 1998 1997 Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price ------ ----- ------ ----- ------ ----- Outstanding at the beginning of the 695,572 $29.92 546,856 $17.86 526,899 $8.76 year Granted -- -- 363,970 $36.57 188,355 $29.57 Exercised -- -- (215,254) $10.53 (166,831) $2.26 Forfeited/Surrendered (34,864) $14.69 -- -- (1,567) $25.45 -------- ------ -- -- ------- ------ Outstanding at the end of the year 660,708 $14.17 695,572 $29.92 546,856 $17.86 ======= ====== ======= ====== ======= ====== Options exercisable at year end 619,035 -- 569,126 -- 349,141 -- Available for future grant 251,865 -- 175,428 -- 40,062 -- On November 1, 1996, SIG adopted the Symons International Group, Inc. 1996 Stock Option Plan (the "SIG Stock Option Plan"). The SIG Stock Option Plan provides SIG the authority to grant nonqualified stock options and incentive stock options to officers and key employees of SIG and its subsidiaries and nonqualified stock options to nonemployee directors of SIG and Goran. Options have been granted at an exercise price equal to the fair market value of the SIG's stock at date of grant. All of the outstanding stock options vest and become exercisable in three equal installments on the first, second and third anniversaries of the date of grant. On October 14, 1998, all SIG options were repriced to $6.3125 per share. In November 1999, certain officers and non employee directors of SIG surrendered a total of 1,153,600 stock options. Information regarding the SIG Stock Option Plan is summarized below: 1999 1998 1997 Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price ------ ----- ------ ----- ------ ----- Outstanding at the beginning of the 1,457,833 $6.3125 1,000,000 $6.3125 830,000 $12.50 year Granted -- $6.3125 478,000 6.3125 185,267 15.35 Exercised (1,667) $6.3125 (4,332) 6.3125 (1,667) 12.50 Forfeited/Surrendered (1,243,133) $6.3125 (15,835) 6.3125 (13,600) 12.50 ----------- ------- -------- ------ -------- ----- Outstanding at the end of the year 213,033 $6.3125 1,457,833 $6.3125 1,000,000 $13.03 ======= ======= ========= ======= ========= ====== Options exercisable at year end 120,366 $6.3125 760,289 $6.3125 521,578 $12.50 Available for future grant 1,286,967 42,167 -- The weighted average remaining life of the SIG options as of December 31, 1999 is 7.9 years. The Board of Directors of Superior Group Management adopted the GGS Management Holdings, Inc. Stock Option Plan (the "Superior Group Management Stock Option Plan"), effective April 30, 1996. The Superior Group Management Stock Option Plan authorizes the granting of nonqualified and incentive stock options to such officers and other key employees as may be designated by the Board of Directors of Superior Group Management. Options granted under the Superior Group Management Stock Option Plan have a term of ten years and vest at a rate of 20% per year for the five years after the date of the grant. The exercise price of any options granted under the Superior Group Management Stock Option Plan is subject to the following formula: 50% of each grant of options having an exercise price determined by the Board of Directors of Superior Group Management at its discretion, with the remaining 50% of each grant of options subject to a compound annual increase in the exercise price of 10%, with a limitation on the exercise price escalation as such options vest. Information regarding the Superior Group Management Stock Option Plan is summarized below: 1999 1998 1997 Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Shares Price Shares(1) Price Shares(1) Price ------ ----- --------- ----- --------- ----- Outstanding at the beginning of the year 94,732 $51.75 95,282 $51.75 27,777 $51.75 Granted -- -- -- -- 68,855 -- Forfeited (2,500) $51.75 (550) 51.75 (1,350) 51.75 ------- ------ ----- ----- ------- ----- Outstanding at the end of the year 92,232 $51.75 94,732 $51.75 95,282 $51.75 ====== ====== ====== ====== ====== ====== Options exercisable at year end 42,448 24,601 5,555 Available for future grant 18,879 16,379 15,829 (1) Prior years outstanding share options have been restated to properly reflect outstanding options as at those respective dates. Options Options Outstanding Exercisable Weighted weighted Weighted Average Average Average Number Remaining Life Exercise Price Number Exercise Price ----- ----- ----- Range of Exercise Prices Outstanding (in years) Exercisable - ------------------------ ----------- ---------- ----------- $44.17 - $53.45 64,561 6.8 $46.13 39,668 $47.35 $58.79-$71.14 27,671 6.8 64.87 2,777 $58.79 ------ --- ----- ----- ------ 92,232 42,445 ====== ====== The Company applies Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretation in accounting for its stock option plans. Accordingly, no compensation cost has been recognized for such plans. Had compensation cost been determined, based on fair value at the grant dates for options granted under the Company stock option plan as well under both the SIG Stock Option Plan and the GGS Stock Option Plan during 1998, 1997 and 1996 consistent with the method of SFAS No. 123, "Accounting for Stock-Based Compensation", the Company's pro-forma net earnings and pro-forma earnings per share for the years ended December 31, 1998, 1997 and 1996 would have been as follows: 1999 1999 1998 1998 1997 1997 As Pro- As Pro- As Pro- Reported Forma Reported Forma Reported Forma Earnings (loss) from continuing operations $(62,373) (65,969) $(9,139) $(12,109) $15,763 $13,592 Basic EPS from continuing operations $(10.61) $(11.23) $(1.56) $(2.07) $2.82 $2.43 Fully diluted EPS continuing operations $(10.61) $(11.23) $(1.56) $(2.07) $2.68 $2.31 Net earnings (loss) (62,373) $(65,969) $(12,076) $(15,046) $12,218 $10,047 Basic EPS $(10.61) $(11.23) $(2.07) $(2.58) $2.19 $1.80 Fully diluted EPS $(10.61) $(11.23) $(2.07) $(2.58) $2.08 $1.71 The fair value of each option grant used for purposes of estimating the pro-forma amounts summarized above is estimated on the grant date using the Black-Scholes option-pricing model with the weighted average assumptions for 1998, 1997 and 1996 shown on the following table: SIG Goran SIG SIG 1998 1998 1997 1997 Grants Grants Grants Grants Risk-free interest rates 5.53% 5.40% 6.03% 6.40% Dividend yields --- --- --- --- Volatility factors 0.41 0.41 0.40 0.39 Weighted average expected life 2.5 years 3.2 years 2.0 years 3.3 years Weighted average fair value per share $7.20 $5.73 $5.28 $5.54 The Goran stock options are granted and denominated in Canadian dollars. The pro-forma stock based compensation for these options are translated at the average rate for the year. The weighted average fair value per share is translated at the year end rate. 21. Quarterly Financial Information (unaudited): Quarterly financial information is as follows: (in thousands) First Second Third Fourth Total ----- ------ ----- ------ ----- 1999 Gross written premiums $152,022 $173,870 $67,685 $80,110 $473,687 Net premiums written 67,271 79,150 55,228 54,850 256,499 Net premiums earned 67,124 76,527 68,164 64,225 276,040 Total revenues 73,774 83,553 74,272 73,715 305,314 Net earnings (loss) $123 $(5,882) $(13,907) $(42,707) $(62,373) Net earnings (loss) per share - basic $.02 $(1.00) $(2.37) $(7.26) $(10.61) Net earnings (loss) per share - fully diluted $.02 $(1.00) $(2.37) $(7.26) $(10.61) 1998 Gross premiums written $177,196 $170,505 $95,887 $103,183 $546,771 Net premiums written 98,361 109,729 72,469 81,547 362,106 Net premiums earned 71,885 99,618 94,168 76,506 342,177 Total revenues 82,149 109,085 102,407 86,244 379,885 Net earnings $3,517 $4,775 $( 10,233) $(10,135) $(12,076) Net earnings (loss) per share - basic $0.61 $0.82 $(1.76) $(5.23) $(2.07) Net earnings (loss) per share - fully diluted $0.59 $0.78 $(1.76) $(5.19) $(2.07) In the fourth quarter of 1999, the Company provided for a valuation allowance on its net deferred tax assets of $23.1 million. In the fourth quarter of 1999, the Company provided for additional AgPI loss reserves of $5.3 million, net of reinsurance. During the fourth quarters of 1999 and 1998, the Company increased reserves on its nonstandard automobile business by $6.9 million and $3.0 million respectively for both current and prior accident years. In the fourth quarter of 1998, the Company provided a $3.2 million reserve for potential processing errors in the crop business assumed from CNA. The Company also increased its reserves on AgPI exposures by approximately $1.8 million. As is customary in the crop insurance industry, insurance company participants in the FCIC program receive more precise financial results from the FCIC in the fourth quarter based upon business written on spring-planted crops. On the basis of FCIC-supplied financial results, IGF recorded, in the fourth quarter, an additional underwriting gain (loss), net of reinsurance, on its FCIC business of $791, $(3,506) and $6,979 during 1999, 1998 and 1997, respectively. 22. Reconciliation Of Canadian And United States Generally Accepted Accounting Principles ("GAAP") And Additional Information The consolidated financial statements are prepared in accordance with U.S. GAAP Material differences between Canadian and U.S. GAAP are described below. (a) Earnings per share Earnings per share, as determined in accordance with Canadian GAAP are set out below. The following average number of shares were used for the compilation of basic and fully diluted earnings per share: 1999 1998 1997 Basic 5,876,398 5,841,329 5,590,576 Fully Diluted 5,876,398 5,841,329 5,886,211 Earnings per share, as determined in accordance with U.S. GAAP, are as follows: Basic earnings per share from continuing operations $(10.61) $(1.56) $2.82 Fully diluted earnings per share from continuing operations $(10.61) $(1.56) $2.68 Basic earnings per share $(10.61) $(2.07) $2.19 Fully diluted earnings per share $(10.61) $(2.07) $2.08 (b) Receivables from sale of capital stock The SEC Staff Accounting Bulletins require that accounts or notes receivable arising from transactions involving capital stock should be presented as deductions from shareholders' equity and not as assets. Accordingly, in order to comply with U.S. GAAP shareholders' equity has been reduced by $300 and $1,377 at December 31, 1999 and December 31, 1998, respectively to reflect the loans due from certain shareholders which relate to the purchase of common shares of the Company. (c) Unrealized gain (loss) on investments U.S. GAAP requires that unrealized gains and losses on investment portfolios be included as a component in determining shareholders' equity. In addition, SFAS No. 115 permits prospective recognition of unrealized gains (losses) on investment portfolio for year-ends commencing after December 15, 1993. As a result, shareholders' equity was increased by $(4,874) and by $1,176, which is net of deferred tax of $2,637 and $679 and related minority interest of $416 and $658, as at December 31, 1999 and 1998, respectively. (d) Changes in shareholders's equity A reconciliation of shareholders' equity from US GAAP to Canadian GAAP is as follows: 1999 1998 1997 Shareholders equity in accordance with U.S. GAAP $(18,061) $49,524 $61,462 Add (deduct) effect of difference in account for: Receivables from sale of capital stock (see note (f)) 300 1,377 346 Unrealized gain on investments (see note (g)) 4,874 (1,176) (1,336) ----- ------- ------- Shareholder's equity in accordance with Canadian GAAP $(12,887) $49,725 $60,472 ========= ======= ======= 23. Subsequent Events On March 23, 2000, the FDOI notified SIG that Superior is required to not exceed a written premiums to surplus ratio of 4 to 1 as computed on an annualized basis and to file on a monthly basis a schedule that verifies its compliance with the net writing limitation of 4 to 1. On February 29, 2000, SIG contributed $2.0 million in capital to Pafco. 24. Management's Plans The Company reported net losses of $62.4 million and $12.1 million for the years 1999 and 1998 respectively. While the stockholders equity at December 31, 1999 is a deficit of approximately $18.1 million, SIG has a thirty year mandatorily redeemable preferred stock outstanding of $135 million at an interest rate of 9.5%. This Trust Preferred is not due for redemption until 2027. The insurance subsidiaries have statutory surplus of approximately $57 million upon which the Company conducts its insurance operations. The management has initiated substantial changes in operational procedures and business in an effort to return the Company to profitable levels and to improve its financial condition. The nonstandard auto insurance segment hired a new President, a new Chief Information Officer, and pricing and claims management since the year end. The Company has and is continuing to raise its rates in a market environment where increasing rates and withdrawal from the market by other companies shows positive trends for an improving profitability of the nonstandard auto division. The crop insurance company has experienced a substantial increase in gross sales in its major product lines and strong demand for its new innovative products. Management believes that despite the recent losses and the deterioration in stockholders equity and statutory surplus, it has developed a business plan that if successfully implemented, can substantially improve operating results and its financial condition. MANAGEMENT RESPONSIBILITY Management recognizes its responsibility for conducting the Company's affairs in the best interests of all its shareholders. The consolidated financial statements and related information in this Annual Report are the responsibility of management. The consolidated financial statements have been prepared in accordance with generally accepted accounting principles which involve the use of judgement and estimates in applying the accounting principles selected. Other financial information in this Annual Report is consistent with that in the consolidated financial statements. The Company maintains systems of internal controls which are designed to provide reasonable assurance that accounting records are reliable and to safe-guard the Company's assets. The independent accounting firm of Schwartz Levitsky Feldman LLP has audited and reported on the Company's consolidated financial statements. Their opinion is based upon audits conducted by them in accordance with generally accepted auditing standards to obtain assurance that the consolidated financial statements are free of material misstatements. The Audit Committee of the Board of Directors, the members of which include outside directors, meets with the independent external auditors and management representatives to review the internal accounting controls, the consolidated financial statements and other financial reporting matters. In addition to having unrestricted access to the books and records of the Company, the independent external auditors also have unrestricted access to the Audit Committee. The Audit Committee reports its findings and makes recommendations to the Board of Directors. /s/ Alan G. Symons Chief Executive Officer April 14, 2000 Board of Directors And Stockholders of Goran Capital Inc. REPORT OF INDEPENDENT AUDITOR"S We have audited the accompanying consolidated balance sheets of Goran Capital Inc. (incorporated in Canada) as of December 31, 1999 and 1998, and the related consolidated statements of income (loss), changes in stockholders' equity, and cash flows for each of the years ended December 31, 1999, 1998 and 1997. These consolidated financial statements are the responsibility of the company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the financial statements of Symons International Group, Inc., a 68% owned subsidiary, which statements reflect total assets of $499,811 as of December 31, 1999, and total revenues of $291,207 for the year then ended. Those 1999 statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for Symons International Group, Inc., is based solely on the report of the other auditors. We conducted our audits in accordance with generally accepted auditing standards in the United States of America. Those standards require that we plan and perform our audits to obtain reasonable assuranco about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits and the report of other auditors provide a reasonable basis for our opinion. In our opinion, based on our audits and the report of other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Goran Capital Inc. as of December 31, 1999 and 1998, and the results of their operations and their cash flows for the years ended, December 31, 1999 and 1998 and 1997 in conformity with general accepted accounting principles in the United States of America. Since the accompanying consolidated financial statements have been prepared and audited in accordance with generally accepted accounting principles and auditing standards in the United States of America, they may not satisfy the reporting requirements of Canadian statutes and regulations. Significant differences between the accounting principles applied in the accompanying consolidated financial statements and those under Canadian generally accepted accounting principles are quantified and explained in note 22 to the consolidated financial statements. /s/ Schwartz Levitsky Feldman, LLP Chartered Accountants Toronto, Ontario, Canada M6A 2X1 March 14, 2000, except for Note 23, which is as of March 23, 2000 Stockholder Information Registrar and Transfer Agent CIBC Mellon Trust Company Toronto, Ontario Independent Public Accountants Schwartz Levitsky Feldman LLP Toronto, Ontario Annual Meeting of Stockholders May 30, 2000 10:00 a.m. Location to be announced Annual Report on Form 10-K A copy of the Annual Report on Form 10-K for Goran Capital Inc. for the year ended December 31, 1999, filed with the Securities and Exchange Commission, may be obtained, without charge, upon request to the individual and address noted under Shareholder Inquiries. Market and Dividend Information The Company's common shares began trading on the Toronto Stock Exchange under the symbol "GNC" in 1986. The Company's common shares began trading on The NASDAQ National Market under the symbol "GNCNF" on November 8, 1994. As of December 31, 1999 there were approximately 100 Common shareholders of record, including many brokers holding shares for the individual clients. The number of individual shareholders on the same date is estimated at 1,000. The number of common shares outstanding on December 31, 1999 totaled 5,876,398. Information relating to the common shares is available through The NASDAQ National Market system and the Toronto Stock Exchange. The following table sets forth the high and low closing sale prices for the common shares for each quarter of 1999, 1998 and 1997. TORONTO STOCK EXCHANGE 1999 1998 1997 High Low High Low High Low Quarter Ended March 31 $12.37 $7.73 $31.93 $25.84 $29.15 $18.98 June 30 $9.75 $7.06 $29.61 $23.89 $26.05 $19.31 September 30 $12.78 $7.40 $28.10 $20.38 $39.35 $24.27 December 30 $8.74 $1.95 $21.40 $8.04 $39.32 $27.75 NASDAQ 1999 1998 1997 High Low High Low High Low Quarter Ended March 31 $10.73 $8.38 $31.50 $25.25 $29.25 $18.75 June 30 $10.19 $7.31 $30.50 $23.50 $26.25 $19.75 September 30 $13.25 $7.75 $28.50 $19.75 $40.00 $24.50 December 30 $8.38 $2.00 $21.06 $8.00 $39.50 $27.75 On March 22, 2000, SIG received notice from Nasdaq - Amex that the Listing Qualifications Panel has determined that SIG was not in compliance with certain listing qualifications. On or before June 30, 2000, SIG must make a filing with the SEC and Nasdaq - Amex evidencing complete compliance with the required qualifications including net tangible assets excluding Preferred Securities, of at least $15,000,000, market value of public float of at least $5,000,000 for a period of ten consecutive days immediately thereafter, and a minimum $1.00 per share bid price requirement. In the event that SIG fails to comply with any of the terms of these requirements, SIG securities will be delisted from The Nasdaq National Market. There can be no assurance that SIG will be able to comply with such requirements. In that event, SIG expects that its common stock may then be traded on the OTC Bulletin Board. The Company intends to appeal the decision of the Listing Qualifications Panel. The Company was scheduled to appear before the Nasdaq-Amex Listing Qualifications Panel on April 6, 2000. Nasdaq advised the Company that it no longer met the minimum $15 million market value of public float and $5.00 bid price requirements pursuant to certain Nasdaq listing requirements. On April 4, 2000, the Company received a communication from Nasdaq that it was recommending to the Listing Qualifications Panel that Goran be granted a similar period to correct its listing deficiencies, as had previously been granted to the Company's 68% owned subsidiary, SIG. To date, the Company has not received any further communication from Nasdaq regarding this issue and therefore cannot evaluate its ability to comply with any current or future listing requirements that may be established by Nasdaq. Should Goran's common shares be delisted from the Nasdaq National Market, the Company expects that its shares may then be traded on the OTC Bulletin Board. Regardless of the outcome of the Nasdaq Listing Qualifications Panel, the Company expects to continue the listing of the commons shares on the Toronto Stock Exchange. Shareholder Inquiries Inquiries should be directed to: Alan G. Symons Chief Executive Officer Goran Capital Inc. Tel: (317) 259-6302 E-mail: asymons@sigins.com Board of Directors G. Gordon Symons Chairman of the Board Goran Capital Inc. Symons International Group, Inc. Alan G. Symons President, Chief Executive Officer Goran Capital Inc. Douglas H. Symons Vice President, Chief Operating Officer Goran Capital Inc. President, Chief Executive Officer and Secretary Symons International Group, Inc. J. Ross Schofield President Schofield Insurance Brokers David B. Shapira President Medbers Limited John K. McKeating Former Partner Vision 2120, Inc. Executive Officers Alan G. Symons President, Chief Executive Officer Goran Capital Inc. Douglas H. Symons Vice President, Chief Operating Officer Goran Capital Inc. President, Chief Executive Officer and Secretary Symons International Group, Inc. Bruce K. Dwyer Vice President, Chief Financial Officer and Treasurer Goran Capital Inc. Symons International Group, Inc. Gene Yerant Executive Vice President Goran Capital Inc. Symons International Group, Inc. Chief Operating Officer and President Superior Insurance Group, Inc. Mary E. DeLaat Vice President, Chief Accounting Officer Goran Capital Inc. Symons International Group, Inc. Company, Subsidiaries and Branch Offices HEAD OFFICE - CANADA Goran Capital Inc. 2 Eva Road, Suite 200 Etobicoke, Ontario Canada M9C 2A8 Tel: 416-622-0660 Fax: 416-622-8809 HEAD OFFICE - US Goran Capital Inc. 4720 Kingsway Drive Indianapolis, Indiana 46205 Tel: 317-259-6400 Fax: 317-259-6395 Website: www.sigins.com SUBSIDIARIES AND BRANCHES Symons International Group, Inc. 4720 Kingsway Drive Indianapolis, Indiana 46205 Tel: 317-259-6300 Fax: 317-259-6395 IGF Southwest Pafco General Insurance Company 7914 Abbeville Avenue 4720 Kingsway Drive Lubbock, Texas 79424 Indianapolis, Indiana 46205 Tel: 806-783-3010 Tel: 317-259-6300 Fax: 806-783-3017 Fax: 317-259-6395 IGF South Superior Insurance Company 101 Business Park Drive, 280 Interstate North Circle, N.W., Suite 500 Ridgeland, Mississippi 39157 Atlanta, Georgia 30339 Tel: 601-957-9780 Tel: 770-952-4885 Fax: 601-957-9793 Fax: 770-988-8583 IGF West Superior Insurance Company 1700 Bullard Avenue, Suite106 5483 W. Waters Avenue Fresno, California 93710 Suite 1200, Building P Tel: 559-432-0196 Tampa, Florida 33634 Fax: 559-432-0294 Tel: 813-887-4878 Fax: 813-287-8362 IGF North 116 South Main, Box 1090 Superior Insurance Company Stanley, North Dakota 58784 1745 West Orangewood Road, Suite 210 Tel: 701-628-3536 Orange, California 92826 Fax: 701-628-3537 Tel: 714-978-6811 Fax: 714-978-0353 IGF - NACU Highway 210 West, Box 375 IGF Insurance Company Henning, Minnesota 56551 Corporate Office Tel: 218-583-4800 6000 Grand Avenue Fax: 218-583-4852 Des Moines, Iowa 50312 Tel: 515-633-1000 Fax: 515-633-1010 IGF Mid East 3921 Pintail Drive Springfield, Illinois 62707 Tel: 217-726-2450 Fax: 217-726-2451