Fund American Companies
1995 Annual Report
TABLE OF CONTENTS
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Letter from Jack Byrne, Chairman 2
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Letter from Tom Kemp, CEO of White Mountains 4
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The White Mountains Family 6
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Source One 16
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Selected Consolidated Financial Data 18
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Management's Discussion and Analysis 19
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Consolidated Financial Statements 32
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Notes to Consolidated Financial Statements 36
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Report on Management's Responsibilities 64
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Report of Independent Auditors 65
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Selected Quarterly Financial Data 66
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Investments 67
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Directors and Committees 68
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Chairmen and Officers 70
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Corporate Information 72
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caption: "On the cover" It took a bit of a search, but we found the "WM" of our
White Mountains logo in the hills surrounding Mount Washington, New Hampshire.
(c) William H. Johnson.
CHAIRMAN'S LETTER
Dear Shareholder,
1995 financial results for your enterprise were satisfactory. We ended the year
with a GAAP book value per share of $83.28, up 21%.
1995 was a year we applied a box of Crayolas to the pencil outline of Fund
American. We are pleased with the emerging portrait. As planned, we liquidated
over $200 million of our passive investments this year and redeployed them into
operating businesses. Our insurance operations, headed by Tom Kemp and Morgan
Davis, are taking shape nicely. White Mountains Holdings, a start-up only a year
ago, has become the parent to a nice cluster of successful insurance companies:
Financial Security Assurance, Main Street America, White Mountains Insurance,
and new acquisitions Valley and Charter. In 1996 we will add one more
significant holding, Folksamerica Reinsurance, to this family.
Financial Security Assurance (FSA), which joined us in 1994, exceeded its
challenging new business goal for 1995 while achieving a growth in adjusted book
value per share of 20%. Bob Cochran and his team capped a fine year by
completing the acquisition of municipal bond insurer Capital Guaranty, creating
a $1.5 billion combined enterprise. This places FSA solidly in the top rank of
AAA rated financial-guaranty insurers.
Main Street America turned in a GAAP aftertax ROE of 34% for 1995. CEO Phil
Koerner modestly allows that, "1995 was a good year." $131 million in written
premiums and a 1995 combined ratio of 100.2% increased Main Street America's
value to us in our first year of affiliation.
Morgan Davis has our home state White Mountains Insurance off to a solid start.
The company was licensed in March 1995, appointed 24 independent agents in
September, wrote its first policy in October, and finished the year with
$250,000 in written premiums. The enthusiasm of the agents and the gratifying
response from the New Hampshire marketplace have delighted us.
The fourth quarter acquisition of the Valley Group, which writes $73 million in
property and casualty premiums annually in Washington, Oregon and California,
adds Dan Post to
[PHOTO OF CHAIRMAN APPEARS HERE]
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caption: John J. Byrne, Chairman
2
our family of experienced insurance managers. As part of the purchase we also
acquired Charter, which writes $64 million of non-standard automobile premiums
in Texas annually, which Dan Post also manages.
White Mountains Holdings now has total assets of $360 million, with a group of
affiliated insurers focused on careful underwriting in good regional or niche
markets, writing over $300 million in annual premiums. I see a long steady
future for our insurance operations under this team of seasoned insurance
professionals - three yards and a cloud of dust.
While Source One achieved above-plan net income of $26 million, they fell short
on originations in a brutally competitive mortgage market, and seriously lagged
on our touchstone measure -- growth in intrinsic business value. For the second
time in two years, we have not completed a sale of Source One after an
expression of interest from a competitor. We believe the time will come when
values return to this industry.
Finally, this is the year Fund American completed a lengthy transformation. In
July we paid off the last portion of preferred stock held by our former parent,
American Express. We had a little ceremony up here in rural New England to
celebrate. We've completed a ten-year journey from initial public offering,
through the fine operations of Fireman's Fund, to the Allianz sale, to a
liquidation period where we returned almost $4 billion to our stakeholders, to
re-emerge as a smaller, more sharply focused regional insurance company and
mortgage company. We appreciate those of you who have made the entire journey
with us, and welcome those who joined along the way.
Thank you for your patience.
Respectfully submitted,
/s/ John J. Byrne
John J. Byrne
Chairman
March 17, 1996
3
White Mountains Holdings
Tom Kemp, CEO
Dear Shareholder,
We applied a variety of colors to our portrait in the last year in White
Mountains. A new idea fifteen months ago, White Mountains has blossomed into a
$360 million company, a major planning and operating unit of Fund American.
Jack reviewed the companies making up White Mountains Holdings in his letter.
In 1996, we plan to add a 50% interest in Folksamerica Reinsurance, acquired for
$79 million.
White Mountains' mission is to become a premier group of regional or niche
property and casualty underwriters which, with prudent operating and financial
leverage, produces for their owners a long-term return equal to 700 basis points
over ten year treasuries (currently 13%, for ease of conversation) after
corporate tax. We wish each member of our group to be well managed in its own
right, and each underwriting-driven using its own strategy. We will function as
intelligent owner and capital provider/allocator.
My years of association with Jack Byrne have inculcated a set of insurance
business traditions and operating principles which you will recognize if you
follow our companies. These principles guide our acquisitions and unify our
affiliates. For White Mountains I state them as follows:
1. Underwriting comes first. An insurance enterprise must respect the
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fundamentals of insurance. There must be a realistic expectation of
underwriting profit on all business written, and demonstrated fulfillment of
that expectation over time, with focused attention to loss ratios and to all of
the professional insurance disciplines.
2. Invest for total return. Historical insurance accounting has tended to hide
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unrealized gains and losses in the investment portfolio and to over-reward
reported investment income (interest and dividends). Regardless of the
accounting, we must invest for the best growth in value over time. In addition
to investing our bond portfolios for total after tax return, that will mean
prudent investment in equities consistent with leverage and insurance risk
considerations. (Over the long-term equities are not necessarily any more risky
than the true risks in bonds or other fixed income investments.)
3. Maintain a disciplined balance sheet. The first concern here is that
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insurance liabilities must always be fully recognized. Loss reserves and,
increasingly, expense reserves must be solid before any other aspect of the
business can be solid. Pricing, marketing, and underwriting all depend on
informed judgement of ultimate loss costs.
4. Be the low cost operator. This principle seems to wax and wane in management
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attention, and in the quality of its management. Spending more money to provide
a better product or service may confuse or seem to rebut the "low cost"
argument. Investments in better systems can be expensive (and worse,
ineffective). However, the business that can produce its product/service at a
lower cost than competitors has an embedded advantage (a moat around its
franchise).
5. Think like owners. Each of the first four principles are "thinking like
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owners", so, to some degree, this is a catchall, but it has a value all its own.
Yes, there are other "stakeholders" in a business enterprise, and yes, doing
good work (as a business or an individual) requires more than this quarter's
profit. But thinking like an owner embraces all that without losing the
touchstone of a capitalist economic enterprise. We should be students of
capital and business (and much else, but business is what this organization is
about). The short version, in my view, is that the original Adam Smith had it
right...capital will flow according to its own nature; the "invisible hand." If
we do not earn and deserve our owners' capital, we will not long have it.
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[PHOTO OF TOM KEMP APPEARS HERE]
caption: Tom Kemp, CEO
4
In the coming year, many of us at White Mountains will be playing new or
expanded roles, and all of us will be working with new colleagues. For Dan
Post, Stu Olson, Phil Koerner, Bob Cochran, Roger Taylor, Morgan Davis and Carey
Benson some of the associations are new but the current role is clear: be the
hands-on general manager of Valley, NGM/MSA, FSA, White Mountains Insurance and
Charter. In the pages which follow, our managers will briefly explore some
unique features of our affiliated companies. I am proud to have assembled them;
I think you will be proud to own them. We look forward to sharing our futures
with you.
Respectfully submitted,
/s/ K.T. Kemp
K.T. Kemp
In the next few pages, each of our general managers talk about their companies.
Some have been part of the Fund American family for years (Source One), some
were introduced to you last year (FSA, White Mountains Insurance and Main Street
America), and some are new to you this year (Valley and Charter). While Valley
and Charter are both part of the "Valley Group", we present them separately here
because the businesses are distinct. Independent as our companies are, you will
discover in their comments a common commitment to service, value and financial
discipline.
5
Financial Security Assurance (FSA)
Bob Cochran, President & CEO
Roger Taylor, Managing Director & COO
Founded in 1985, FSA is one of the four major bond insurers that provide
guarantees of principal and interest in the municipal bond and asset-backed
securities markets. In 1995 we became a bigger, better, stronger company.
Through strong origination activity, growth in the value of our investment
portfolio and our merger with Capital Guaranty Corporation, we increased our
assets to almost $1.5 billion, shareholders' equity to $778 million and total
claims-paying resources to more than $1 billion.
Financial guaranty insurance bridges differences between the needs of investors
and issuers in the municipal bond and asset-backed securities markets.
Investors in FSA-guaranteed securities rely on the guaranty not only for default
protection but also to enhance liquidity, to mitigate the risk of issuer
downgrade and to simplify the investment decision concerning complex securities.
For issuers, FSA's Aaa/AAA guaranty lowers interest costs and broadens the
distribution of securities. We add additional value through the knowledge and
skill of our underwriters. Our job is not to only raise a bond issue's rating
to Triple-A. We also work with issuers and their advisors to find the structure
and execution that best meets the issuer's needs.
INCREASED MUNICIPAL PRESENCE THROUGH THE CAPITAL GUARANTY MERGER
The merger with Capital Guaranty was greeted enthusiastically in the municipal
bond market. It brings important benefits to FSA, including increased capital
and claims-paying resources, expanded service capabilities, and improved
liquidity for FSA-insured municipal bonds.
FSA began providing municipal bond insurance in 1990, and our municipal business
has grown substantially since then. The merger accelerates this growth. FSA
and Capital Guaranty together captured about 9% of the insured municipal new-
issue market in 1995, and we will build on this base over time. We are
committed to being a major participant in this market, providing high-quality,
responsive service to all our customers, including issuers, their advisors and
purchasers of FSA-insured municipal bonds.
Conditions in the municipal bond market were mixed in 1995. The U.S. municipal
new-issue volume of $156 billion was essentially flat with the previous year,
although volume did improve over the course of the year. The insured portion of
the market actually grew 11% in dollar volume, and insurance penetration rose to
44%, partly as a result of price competition that reduced the cost of insurance.
Industry pricing firmed somewhat toward the end of 1995, a development we
applaud. Higher prices, even with lower penetration, would improve insurers'
overall returns. And lower penetration would be healthy for the market as a
whole, creating a wider choice of ratings and yields for institutional
investors.
We are pleased with our results given this environment. FSA insured more than
twice as many primary-market municipal transactions than in the previous year.
We increased the municipal par amount we originated by 22% to $5.4 billion,
wrote $65.3 million of present value premiums and maintained average returns on
equity in our target range.
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[PHOTO OF BOB COCHRAN APPEARS HERE]
caption 1: Bob Cochran, President & CEO
[PHOTO OF ROGER TAYLOR APPEARS HERE]
caption 2: Roger Taylor, Managing Director & COO
6
A RECORD YEAR IN THE ASSET-BACKED MARKET
To a greater extent than any other bond insurer, FSA balances its involvement in
the municipal and asset-backed businesses. In 1995 the value of this approach
was obvious, as our asset-backed business led FSA's overall performance. In
this market, we turned in our finest performance ever, guaranteeing $9.8 billion
of asset-backed obligations to produce $73.9 million of present value premiums,
an 88% increase.
While the U.S. municipal bond market is mature, the asset-backed market still
has significant growth potential. New U.S. public issues on non-mortgage asset-
backed securities soared to $108 billion in 1995 from only $51 billion as
recently as 1992. There are also other substantial market sectors, including
residential mortgage-backed securities, asset-backed private placements and
commercial paper, as well as international markets. With insured penetration of
this market currently at less than 15%, we are optimistic about our asset-backed
business.
GLOBAL PERSPECTIVE
We continue to position FSA to benefit from the expansion of international
financial markets. To support this effort, we opened representative offices in
Madrid and Paris in 1995. During the year, we guaranteed a number of
international transactions, including financings in Australia, France and the
United Kingdom.
LOOKING AHEAD
We enter 1996 in a very strong position. We are the most experienced and
broadly based guarantor in the expanding asset-backed market. We have a greatly
enhanced profile in the municipal bond market and are positioned for growth
there. Because of our balanced strategy across these two markets, we have the
most diversified insured portfolio and the broadest opportunities in the
industry.
Just as important, we have the capital resources to take advantage of these
opportunities. Of the major bond insurers, FSA has the lowest ratio of risk to
capital and, according to Standard & Poor's Ratings Services, the highest margin
of safety for capital adequacy. As a result, we provide exceptional value for
policyholders and have capital to support further growth.
The guiding principles at FSA are financial strength, stringent underwriting and
customer service. We will stay focused on these principles as we continue to
build value for all our stakeholders.
7
White Mountains Insurance Company
Tom Kemp, Chairman
Morgan Davis, President & CEO
It has been a whirlwind first year for White Mountains Insurance.
Conceptualized, organized, capitalized, licensed, and writing new business all
in a matter of months.
We began by letting our customers teach us how to meet their needs. As a newly
emerging insurance company we knew it would be important to offer the agents and
their commercial customers a market that could respond to the business that is
indigenous to the territory. To do this we had to listen intently to what was
needed and rely on our past experiences with the New Hampshire marketplace.
We met with more than 75 agents in the state to determine their needs as well as
the needs of their commercial clients. We were told that to be successful we
must be a generalist, have local knowledge of the territory, operate as a
regional company, avoid class underwriting and make it easy for the agent to do
business. The agents also stressed the importance of developing a good working
relationship between the company and the agency. While these strategies might
seem obvious, it quickly became clear that in New Hampshire our competitors
often overlooked these concerns. Fortunately, it presents us with opportunities
we can capitalize upon.
Using the information we gained from our personal visits, we were able to start
building our company "brick by brick". We are acutely aware that every "brick"
is a small business, somebody else's dream. Protecting those dreams is our
mission. Our initial accounts consisted of manufacturers and contractors,
historical societies, restaurants, repair garages and other valuable services
based here in New Hampshire.
Having established a foothold in New Hampshire, plans are to expand our
operation into the adjoining states to reach our goal of being recognized as a
premier commercial middle market property and casualty insurance company in New
England. We believe that the same market opportunities that were discovered in
New Hampshire exist in the surrounding states and we are poised to take
advantage of them. By the year 2000 we expect to be an important and
significant competitor with a profitable book of business. White Mountains
Insurance prides itself in living up to its slogan, "Go to the White Mountains,
the 'go-to' company."
AN AGENTS PERSPECTIVE:
"To sum up White Mountains: fresh approach, modern ideas, strong
capitalization."
[TWO PHOTOS APPEAR HERE]
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caption 1: New Hampshire Governor Steve Merrill (center) joined Tom Kemp and
Morgan Davis at the opening of the White Mountains' principal field office in
Manchester.
caption 2: Sharon G. Bush, Vice President, Tender Corporation describes a
product's packaging to Jim Keck and Jim Wickman, White Mountains Insurance
Company, and Terrence Abbott, President & CEO, A.D. Davis, Inc. Insurance
Agency. Tender Corporation worked with White Mountains Insurance
representatives to configure its warehouse inventory to maximize the
effectiveness of their sprinkler system.
8
AN AGENTS PERSPECTIVE:
"White Mountains combines big company experience with small company enthusiasm."
9
Main Street America
Phil Koerner, President & CEO
It is always a pleasure to talk about strong results, so I'm happy to share that
we experienced a good year in 1995. Our written premiums increased by 6%, our
policyholders' surplus grew by more than 18% and our combined ratio beat
estimated industry averages by over six percentage points.
We also created opportunities to fortify our foundation for future growth. We
appointed over 100 new agency partners throughout our operating territories. At
the beginning of the year we began to do business in the state of North
Carolina, and by December we had 13 agency partners and nearly $600,000 in
written premiums. Throughout 1995 we prepared for a merger with The Mutual
Assurance Company (MACO) of Philadelphia, finalized in January of 1996. Through
MACO subsidiaries, we are preparing to enter new territories, particularly in
the Southeast, an area of targeted growth for our organization. As the second-
oldest property insurer in the nation, MACO adds a rich insurance tradition to
our group of companies.
Clearly, we are pleased with what we have achieved this year. Yet, we prefer to
view our growth in a broader perspective: To take stock of what we have become
over time, and what we accomplished along the way.
At the Main Street America group, we develop five-year Scenarios. These
Scenarios are checkpoints for us, as we travel on our journey into the future.
Along the route, we make opportunities to pause and reflect upon our journey
thus far; to re-examine our chosen route; and to always seek more efficient
means of travel. For us, this year brought the culmination of our 1995
Scenario, and allowed us to take a look at where we are in our progress toward
the new millennium.
We have realized many goals in the past five years, becoming the kind of
organization we wanted to be when we were spinning our dreams in the 1980's.
Our premium writings increased by over 60%, while our policyholders' surplus
doubled. Our average premium per agency rose $150,000. Information System &
Services Corporation, our policy processing subsidiary, now provides services to
35 insurance companies.
We purchased Guilderland Reinsurance Company and are establishing an assumed
reinsurance operation as well. One of the most meaningful events of the past
five years was the mutually-profitable relationship we entered into with Fund
American. Altogether we met, and in many cases exceeded, our expectations.
This was possible because we preserved those characteristics most important to
us. For example, we develop relationships carefully and then look for ways to
enrich them. Recognizing that business will always be personal, we emphasize
relationships as a means to accomplish our goals. We continue to focus on those
customers around whom we've built our organization - Main Street Americans - and
the independent agents who serve them.
While acquiring more customers, we have retained our emphasis on personal
service. "We take you personally", developed ten years ago as a service slogan,
has evolved into a description of the way we behave toward co-workers and
customers alike. And through significant production growth, we continued to
focus on the quality of our underwriting - which is one of the best ways to
ensure that today's production translates into tomorrow's prosperity. Together,
these attributes brought us success by any set of standards.
[PHOTO OF PHIL KOERNER APPEARS HERE]
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caption 1: Phil Koerner, President & CEO
10
As Irving Berlin once said, "The toughest thing about success is that you've got
to keep on being a success." We are proud we have had cumulatively successful
results throughout the decade, yet we must avoid wrapping ourselves in a cloak
of false security based upon our past success. This is particularly important
as we look down the road toward a very challenging remainder of the century.
The next few years will test our mettle as other companies enter our market,
technology evens the playing field among insurers and regulators continue to
exert their influence over the parameters within which we can operate. Yet, our
2000 Scenario - our next checkpoint - calls for us to have doubled our premium
volume while keeping our manpower steady. That is a very ambitious plan.
Ambitious plans require a talent for envisioning the future, the ability to
evaluate the shifting sands of the environment, and the clarity to describe
where you want to go to all of the people who will take you there. Most
importantly, ambitious plans require execution.
We have a consistent record of executing our plans - which has been the key to
our success thus far. We are well aware that the next several years will
challenge us. Throughout those years, we will focus on our market and the needs
of our customers, value our relationships, and provide outstanding service.
Furthermore, we are committed to doing our work more intelligently, and engaging
all of the people, resources and tools at our disposal in our quest to become
more productive. As we do these things well, we will continue to execute our
plans, and move into the next century as a strong, focused and prosperous
insurer.
[PHOTO APPEARS HERE]
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caption: Main Street America headquarters in Keene, NH
11
Valley Insurance Group
Dan Post, President & CEO
Stu Olson, Executive Vice President & COO
We are pleased to introduce you to the Valley Group which also includes Charter,
described separately. In 1985 the Valley Insurance Company opened its first
office in Albany, Oregon, with a clear vision in mind: to provide quality
insurance products and services to families and family owned businesses through
independent agencies. The customers receive the best attributes of size -
financial strength and security - and the best elements of service - speed and
innovation - allowing us to underwrite uniformly and operate efficiently.
We feel we do a great job here, because of our belief in our employees. We have
many Valley employees who have moved and grown throughout our history. The
experience of Sherri Vandecoevering, an underwriter at Valley, typifies this:
"Valley gave me the support and training to move from a data entry position to a
professional underwriter." In return, the company has benefited from her many
"million-dollar-months." In all, seventy Valley employees participated in
accredited accounting and insurance classes this past fall. Fulfilled employees
lead to satisfied customers.
Excellence in customer service is the cornerstone of Valley's foundation for
success. One area where Valley's reputation is particularly strong is claims.
Our claims philosophy is to pay all claims promptly and fairly. Every attempt is
made to contact claimants and insureds immediately and to make them aware of our
concern and intention to handle their claims properly. We tell our claims
staff, "People buy insurance to protect themselves in case of a loss, and its
our job to prove to insureds that their agents placed them with the best
company." The value of a caring attitude can never be overstated.
Unfortunately 1995 was a year in which we were to be tested in our claims area.
With three unprecedented catastrophes ("cats" to insurance folks) our people
worked around the clock to make our insureds whole. Our strong relationships
and "pre-cat" agreements with independent adjusters and contractors enabled us
to quickly and effectively serve the needs of our customers.
Here is what one agent wrote us about our performance:
"During the second and third weeks of January we followed up with all of our
clients that had claims as a result of the December windstorm. Our intent
was to make sure that our clients were properly taken care of and that
nothing had fallen through the cracks. We were extremely pleased that there
were no negative comments and, in many cases, clients expressed appreciation
for the speedy response and understanding exhibited by Valley. The claims
department, and the entire company, deserve a heartfelt 'Well Done' for their
efforts."
[TWO PHOTOS APPEAR HERE]
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caption 1: Dan Post, President & CEO
caption 2: Valley employees strengthen their community by supporting local
charities such as the United Way and the YMCA. Forty-five Valley employees from
our Albany, Oregon headquarters participated in December's blood drive for the
American Red Cross.
12
Good service works; actually, its the key to our success. Valley is rewarded
for its efforts with high customer retention rates. Over the past two years
Valley has retained 88% of its personal lines customers on a yearly basis. High
retentions over the long-term lead to lower than average policy acquisition
expense rates and better underwriting results. Our customers are pleased, and
we are pleased.
In 1995 we found the right partner in White Mountains and Fund American,
consolidated certain functions with Charter, became a service provider to White
Mountains Insurance, and wrote $66.8 million in net premiums. Unfortunately, we
had painful loss experience. Rather than make excuses for catastrophes which
are an integral cost of our product, we look forward to 1996 with renewed effort
on underwriting and pricing. We know that over time our patient, disciplined
strategy is working.
For 1996 we have many things to do. Although we plan to write 15% more
premiums, losses and expense control will remain our priorities; we will not
sacrifice profit for growth. In January 1996, we completed the acquisition of
Valley National Insurance Company which is licensed in forty-nine states,
effectively bringing us a national franchise. Valley National Insurance Company
expands our canvas in this and future years (Fund American, keep those crayons
handy!).
We are proud to join the White Mountains and Fund American family. The
financial strength and insurance expertise of our new parent is a tremendous
resource. We are pleased that our focus on personal service and careful
underwriting matches so well with our parent's philosophy.
[PHOTO APPEARS HERE]
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caption: Julie Hansen, Processing Center Manager, gives the "gift of life" at a
quarterly, Valley-sponsored blood drive.
13
The Charter Group
Dan Post, President & CEO
Carey Benson, Senior VP & COO
Charter joined the Valley Group in 1995. Charter was founded in Dallas, Texas,
in 1971, to provide a brokerage and servicing outlet for non-standard automobile
business written by the Allstate Insurance Company. Over the years, Charter
broadened its market to include independent agents who also needed access to a
non-standard automobile program. Today the company writes policies through 750
independent agents across Texas. As a regional specialist company, Charter has
built its reputation distributing competitive, quality insurance products and
exceptional service to its customers.
At Charter we focus on the automobile insurance needs of drivers with poor
driving records or other characteristics which may lead to higher losses.
Although many insurance companies focus on the standard and preferred risk
markets, there are opportunities available in the non-standard market as well.
One of our operating tenets is to maintain low expenses relative to our
competitors. The keys for achieving low expenses are: (1) concentration in the
personal automobile line itself, specifically non-standard automobile, thereby
enjoying the unique service capabilities, efficiencies and operating advantages
that such specialization creates; (2) maintaining a low cost operating
structure; and (3) encouraging our employees to work efficiently, through
emphasis on automated systems and technology. Although our expense ratio
improved dramatically from 54.7% for 1994, to 25.5% for 1995, we will continue
to focus on improvement (the low in the industry is 22%). Achieving a low
expense ratio puts us in a favorable competitive position in a price sensitive
market.
An equally important component is our underwriting philosophy and execution.
Charter's underwriting philosophy involves disciplined risk selection and
sophisticated pricing structures. Classes of risks are defined with clear
underwriting guidelines and pricing methodologies. Spread of risk is achieved
by a mix of agents, geographic and economic diversity, and concentration
avoidance. Low loss ratios help us compete profitably on price.
We strive to deliver on the Insurance Promise by providing service beyond our
customers' expectations. Charter's service standards and service response times
are monitored continuously. With the implementation of underwriting service
units (self-directed work groups) which began in January 1996, we will more
effectively target agreed-upon goals for customer service, premium production
and underwriting results by individual agencies.
After a difficult 1994, we accomplished a great deal of change and progress this
past year. We began consolidating functions with Valley where it will be
beneficial, yet strengthened the internal capabilities of our company. We
reduced our expense ratio to a level that is close to the lowest in the
industry. We studied and implemented a new rating system and more effective
pricing and commission structures. We completed significant systems
enhancements. As a result of these changes our written premium grew by 38% in
1995. We believe that the long-term opportunities for our non-standard program
are exceptional.
[PHOTO APPEARS HERE]
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caption: Carey Benson, Senior Vice President & COO
14
In 1996 we will focus on our business fundamentals. If we can continue lowering
the cost of our product, and if we price it properly, we will deliver above
average service and generate above average returns on the capital our
shareholder has entrusted to us.
[TWO PHOTOS APPEAR HERE]
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Caption 1: Charter Group Facility in Dallas, Texas
Caption 2: Reginald Bibb, Casualty Claims Supervisor and Elsa Kemp, Claims
Adjuster use new technology, implemented in August 1995, to print "on-the-scene"
damage appraisals for customers."
15
Source One Mortgage Services Corporation
Jim Conrad, President & CEO
Bob Richards, Chairman
We ended the year with $26 million in net income, but our intrinsic value
dropped with the 200 plus basis point decline in long-term interest rates. 1995
proved to be a volatile operating environment for Source One and the mortgage
banking industry. It was the second consecutive year we originated fewer loans.
Originations fell from $4.6 billion to $2.9 billion, a decline of 37%.
With significant industry overcapacity and extended irrational pricing, many of
our competitors have elected to exit the mortgage banking business, while others
have opted for scale. Consolidation is occurring in the industry on the
servicing side very quickly. As evidence, two years ago there were no $100
billion servicers. Today there are five.
Production seems to be a mixed bag with consolidation and fragmentation
occurring simultaneously. This is because the big servicers are building large
production networks to replenish run-off in their portfolios. The availability
of a large number of wholesalers offering attractively priced products led to
the growth of the independent broker segment of the business. Brokers tend to
be small and operate in local markets.
To be competitive and profitable in this type environment, Source One is:
1. Centralizing as many of the production operation functions as possible.
2. Utilizing technology to improve the quality, competitiveness, and speed
of delivery of our product offerings.
3. Committing to continue to lower the per unit cost associated with
producing and servicing loans.
4. Developing a hedging strategy to protect the value of our capitalized
servicing asset.
[TWO PHOTOS APPEAR HERE]
- ------------------------
caption 1: Bob Richards, Chairman and Jim Conrad, President & CEO
caption 2: Source One maintains a commitment not only to customer service, but
also to community service. Here, two Source One employees, John Heflin (left)
and John Clancey (right) participate in "Paint the Town," a charitable event
where people from local companies volunteer to fix up homes in need of repair
around the Detroit area.
16
While interest rates continue to take us on a roller-coaster ride, originations
have started the new year on an up-beat.
Source One will be celebrating its 50th Anniversary in 1996. During this time,
Source One has fulfilled its mission of "Financing the Future of America's
Homeowners" for millions of people around the country. Dalbar Inc., a Boston
based research company, recently conducted a nationwide survey which found
Source One to be the mortgage industry's top company in the area of customer
service. We earned this recognition because of our commitment to customer
satisfaction. The company is proud of its commitment to equal opportunity
lending, ensuring that every person who has the desire and means to own a home
can qualify for a mortgage. In 1996 and beyond, Source One will continue to
make the dream of home ownership a reality.
[PHOTO APPEARS HERE]
- ------------------------
caption: Source One's home office in Farmington Hills, Michigan
17
Fund American
SELECTED CONSOLIDATED FINANCIAL DATA
- ------------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31,
--------------------------------------------------------------------
Millions, except per share amounts 1995 1994 1993 1992 1991
- ------------------------------------------------------------------------------------------------------------------------------------
Income Statement Data:
Revenues $ 222 $ 229 $ 251 $ 214 $ 234
Expenses 226 226 234 191 162
--------------------------------------------------------------------
Pretax operating earnings (loss) (4) 3 17 23 72
Net investment gains 39 39 124 65 112
--------------------------------------------------------------------
Pretax earnings 35 42 141 88 184
Income tax provision 17 21 71 34 64
--------------------------------------------------------------------
After tax earnings 18 21 70 54 120
Gain from sale of discontinued operations, after tax 66 (a) -- -- 1 (c) 1,306 (c)
Loss on early extinguishment of debt, after tax -- -- -- -- (29)(f)
Cumulative effect of accounting changes:
Purchased mortgage servicing, after tax -- (44)(b) -- -- --
Postretirement benefits, after tax -- -- -- (2)(d) --
Income taxes -- -- -- (24)(e) --
Cumulative effect of transition adjustment for prior
period net unrealized investment losses, after tax -- -- -- -- (84)(g)
--------------------------------------------------------------------
Net income (loss) $ 84 $ (23) $ 70 $ 29 $1,313
====================================================================================================================================
Primary earnings per share:
After tax earnings $ 1.71 $ 1.20 $ 5.68 $ 2.71 $ 4.87
Net income (loss) 9.36 (3.51) 5.68 .74 67.14
Fully diluted earnings per share:
After tax earnings 2.02 1.20 5.68 2.70 4.85
Net income (loss) 9.16 (3.51) 5.68 .73 53.14
Cash dividends paid per share of common stock .20 -- -- -- .68
Ending Balance Sheet Data:
Total assets $1,872 $1,807 $3,305 $3,129 $2,964
Short-term debt 445 254 1,537 1,513 1,013
Long-term debt 407 547 601 423 324
Minority interest-- preferred stock of subsidiary 44 100 -- -- --
Shareholders' equity 700 (h) 661 (h) 905 (h)(i) 988 (h) 1,496
Book value per common and equivalent share 83.28 68.95 77.27 (i) 80.65 75.49
====================================================================================================================================
(a) Reflects the settlement of certain tax liabilities relating to the sale of
Fireman's Fund Insurance Company ("Fireman's Fund") for less than the
previously accrued amount. See Note 3 of the Notes to Consolidated
Financial Statements.
(b) Reflects the prior years' cumulative effect of a change in Source One's
methodology used to measure impairment of its purchased mortgage servicing
rights asset. See Note 6 of the Notes to Consolidated Financial
Statements.
(c) Reflects the sale of Fireman's Fund. See Note 3 of the Notes to
Consolidated Financial Statements.
(d) Reflects the prior years' cumulative effect of the adoption of Statement of
Financial Accounting Standards ("SFAS") No. 106, "Employers' Accounting for
Postretirement Benefits Other Than Pensions."
(e) Reflects the prior years' cumulative effect of the adoption of SFAS No.
109, "Accounting for Income Taxes."
(f) Reflects the repayment during the first quarter of 1991 of all the parent
company's debt outstanding at December 31, 1990.
(g) Prior to 1991 such unrealized investment losses were recorded as a direct
adjustment to shareholders' equity, with no corresponding charge to
earnings.
(h) Reflects redemptions of the Company's Voting Preferred Stock Series D, par
value $1.00 per share (the "Series D Preferred Stock") and repurchases of
shares of the Company's Common Stock, par value $1.00 per share ("Shares").
See Note 13 of the Notes to Consolidated Financial Statements.
(i) Reflects the distribution of approximately 74% of the outstanding shares of
Common Stock of White River Corporation ("White River") to shareholders on
December 22, 1993.
18
Fund American
MANAGEMENT'S DISCUSSION AND ANALYSIS
RESULTS OF OPERATIONS
Years Ended
December 31,
1995, 1994 and
1993
Consolidated Results
Fund American reported net income of $84.1 million for the year ended December
31, 1995, which compares to a net loss of $23.2 million for 1994 and net income
of $70.4 million for 1993. The 1995 income statement includes four non-recurring
items: (i) the adoption of SFAS No. 122 as of January 1, 1995 by Source One;
(ii) a $46.2 million pretax charge to compensation expense related to
outstanding employee stock warrants; (iii) a $66.0 million favorable tax
development relating to the sale of a former subsidiary; and (iv) the receipt of
a $9.7 million pretax breakup fee, plus related expenses, from Home Holdings,
Inc. The 1994 net loss includes a $44.3 million after tax charge related to a
change in accounting methodology adopted by Source One.
Book value per common and common equivalent share was $83.28 at December 31,
1995, which compares to $68.95 at December 31, 1994. The 1995 favorable tax
development and strong investment portfolio results combined to produce most of
the increase in book value per share from 1994 to 1995.
After tax earnings for 1995 were $18.5 million versus $21.1 million and $70.4
million for 1994 and 1993, respectively. The decrease from 1993 to 1994 is
primarily due to $73.4 million of pretax unrealized gains recorded in earnings
for 1993. Under a new accounting standard adopted as of December 31, 1993, Fund
American now records changes in unrealized gains and losses related to its
investment portfolio as a direct adjustment to shareholders' equity with no
credit or charge to net income.
Insurance Operations
As is further described under "Liquidity and Capital Resources," White Mountains
is acquiring and developing various insurance operating interests. WMIC began
operations in the third quarter of 1995, and White Mountains completed the
acquisitions of Valley and Charter on December 1, 1995.
Insurance operating results for the year ended December 31, 1995 included $5.8
million of net earned premiums and $8.2 million of losses and loss adjustment
expenses. Losses and loss adjustment expenses included $3.0 million of reserve
strengthening at Valley for losses incurred prior to the date of acquisition.
Losses and loss adjustment expenses are charged against income as incurred.
Unpaid losses and loss adjustment expenses are based on estimates by claims
adjusters, legal counsel and actuarial staff of the ultimate costs of settling
claims, including the effects of inflation and other societal and economic
factors. Unpaid loss and loss adjustment expense reserves represent management's
best estimate of ultimate losses and loss adjustment expenses net of estimated
salvage and subrogation recoveries. Such estimates are regularly reviewed and
updated and any adjustments resulting therefrom are reflected in current
operations. The process of estimating loss and loss adjustment expenses involves
a considerable degree of judgement by management and the ultimate amount of
expense to be incurred could be considerably greater than or less than the
amounts currently reflected in the financial statements.
19
In the normal course of business, White Mountains' insurance subsidiaries seek
to reduce the loss that may arise from catastrophes or other events that may
cause unfavorable underwriting results by reinsuring certain levels of risk in
various areas of exposure with other insurance enterprises or reinsurers. White
Mountains' insurance subsidiaries remain contingently liable for risks reinsured
with third parties to the extent that the reinsurer is unable to honor its
obligations under reinsurance contracts at the time of loss.
Management expects that White Mountains' insurance operations will have a
significantly larger impact on Fund American's reported financial results in
1996 and future years. See "Liquidity and Capital Resources - White Mountains."
Mortgage Origination and Servicing Operations
Source One adopted SFAS No. 122, "Accounting for Mortgage Servicing Rights," an
amendment to SFAS No. 65, as of January 1, 1995. SFAS No. 122 requires the
total cost of acquiring mortgage loans, either through loan origination
activities or purchase transactions, to be allocated to the mortgage servicing
rights and the loans based on their relative fair values. The statement
requires entities to measure impairment on a disaggregated basis by stratifying
the capitalized servicing asset based on one or more predominant risk
characteristics of the underlying loans. Impairment is recognized through a
valuation allowance for each individual stratum. The adoption of SFAS No. 122
as it relates to the capitalization of originated mortgage servicing rights
resulted in the recognition of an additional pretax gain on sales of mortgages
of $27.2 million for the year ended December 31, 1995. The impairment
provisions of SFAS No. 122 resulted in a pretax charge of $28.0 million for the
year.
In 1994 Source One changed the methodology used to measure impairment of its
purchased mortgage servicing rights asset. The new accounting methodology
measured the asset's impairment on a disaggregated basis and discounted the
asset's estimated future cash flows using a current market rate. Prior to 1994
Source One measured the asset's impairment on a disaggregated basis including a
cost of capital charge for estimating the asset's future cash flows. The
adoption of the new accounting methodology, recorded as a cumulative adjustment
as of January 1, 1994, resulted in a $68.1 million pretax, $44.3 million after
tax, charge to income for 1994.
Net mortgage servicing revenue was $60.5 million for the year ended December
31, 1995 which compares to $82.4 million in 1994 and $53.5 million in 1993. The
decrease in net servicing revenue for 1995 compared to 1994 reflects the sale of
$11.0 billion of servicing rights to third parties during 1995, partially offset
by slower amortization of the capitalized mortgage servicing asset due to lower
actual and anticipated mortgage loan prepayments in 1995 compared to 1994. The
increase in net servicing revenue in 1994 compared to 1993 reflects slower
amortization of the capitalized servicing asset due to the reduced pace of
mortgage loan payoffs in the servicing portfolio during 1994 compared to 1993,
partially offset by lower weighted average net servicing fee rates on newly
originated loans. A summary of the mortgage loan servicing portfolio activity
follows:
20
- --------------------------------------------------------------------------------
Year Ended December 31,
--------------------------------------
Billions 1995 1994 1993
- --------------------------------------------------------------------------------
Beginning balance $ 39.6 $ 38.4 $ 37.3
Mortgage loan production 2.9 4.6 11.5
Servicing acquisitions 4.7 3.7 6.4
Servicing sales (11.0) -- --
Mortgage loan payoffs (2.3) (4.7) (13.6)
Servicing released, principal
amortization and foreclosures (2.1) (2.4) (3.2)
--------------------------------------
Ending balance $ 31.8 $ 39.6 $ 38.4
================================================================================
During 1995 Source One sold the rights to service a total of $11.0 billion of
mortgage loans for net cash proceeds of $181.1 million, resulting in a pretax
gain of $40.0 million. During 1994 Source One sold the rights to service $3.9
billion of mortgage loans for cash proceeds of $70.2 million and continues to
service these loans pursuant to a subservicing agreement. A gain of $19.9
million was deferred in 1994 and is being recognized in income over the five-
year life of the subservicing agreement. For the years ended December 31, 1995
and 1994, the Company recognized $4.2 million and $2.7 million, respectively, of
the deferred gain which is included in net mortgage servicing revenue. The
mortgage servicing portfolio as of December 31, 1995 and 1994 includes loans
subserviced for others having a principal balance totalling $4.0 billion and
$4.3 billion, respectively.
Management's intent regarding the 1995 servicing sale was to take advantage
of the substantial increase in the value of servicing rights that was created by
the rise in interest rates during 1994 and to bring servicing and origination
activities into better balance. Additional sales transactions may occur in the
future when management deems it to be economically advantageous. However, a
strategy of Source One is to continue to increase the size of the servicing
portfolio in order to take advantage of its low cost servicing operation.
Consistent with that strategy, Source One purchased the rights to service $4.7
billion of mortgage loans in the fourth quarter of 1995.
Source One estimates the fair values of its mortgage servicing rights by
calculating the present value of the expected future cash flows associated with
such rights. In making those estimates, Source One incorporates assumptions
that market participants would use in their estimates of future servicing income
and expense and discounts those cash flows using current estimated market rates.
As of December 31, 1995 such discount rates were 10.5% for conventional loans
and 12.0% for insured loans.
To measure impairment of the mortgage servicing rights, Source One stratifies
its mortgage loan servicing portfolio based on the portfolio's predominant risk
characteristics which have been determined to be prepayment, default and
operational risks. This results in stratification by interest rate, loan type
(investor) and original term to maturity. The prepayment assumptions used in
the estimation of fair values are based on market prepayment predictions. The
fair value of each stratum is computed and compared to its recorded book value
to determine if a valuation allowance, or recovery of a previously established
valuation allowance, is required.
21
The discount rate and prepayment assumptions are significant factors used in
estimating the fair value of Source One's mortgage servicing rights and could be
significantly impacted by changes in interest rates. Accordingly, it is likely
that management's estimate of the fair value of the capitalized servicing asset
will change from time to time due to changes in interest rates.
Total mortgage loan production decreased to $2.9 billion for the year ended
December 31, 1995 from $4.6 billion and $11.5 billion in 1994 and 1993,
respectively. Production related to refinance activity represented
approximately 23%, 50% and 67% of total mortgage loan production for the years
ended December 31, 1995, 1994 and 1993, respectively. Mortgage loan payoffs
decreased to $2.3 billion and $4.7 billion for the years ended December 31, 1995
and 1994 from $13.6 billion in 1993. The decreases in mortgage loan production
and payoffs in 1995 and 1994 reflect increases in market interest rates during
1994 and into the first quarter of 1995, and a corresponding reduction in
industry-wide mortgage loan refinancing activity from 1993 levels. However,
declining market interest rates for mortgage loans during 1995, particularly
during the third and fourth quarters, and a flattening of the yield curve
resulted in increased fixed rate loan production volumes during the second half
of 1995 as compared to the first half of the year.
The net gain on sales of mortgages decreased to $24.0 million for the year
ended December 31, 1995 from $29.5 million in 1994 and $34.8 million in 1993.
The 1995 net gain amount includes $27.2 million of gains related to the adoption
of SFAS No. 122. Intensive price competition during 1995 led to increased
pricing subsidies on originated loans which suppressed gains on sales of
mortgages into the secondary market. The decrease in 1994 compared to 1993
reflects lower mortgage loan sales volumes due to the reduction in mortgage loan
production and increased pricing subsidies on newly originated loans during the
second half of 1994.
Investment Operations
The total return from Fund American's investment activities is shown below:
- ------------------------------------------------------------------------------------------------------------------------
Year Ended December 31,
--------------------------------------------------------
Millions 1995 1994 1993
- ------------------------------------------------------------------------------------------------------------------------
Net investment income:
Source One $ 37.7 $ 71.5 $ 117.0
Other 17.7 18.7 16.5
--------------------------------------------------------
Total net investment income 55.4 90.2 133.5
--------------------------------------------------------
Net realized investment gains 38.8 38.8 50.6
Change in net unrealized investment gains and losses:
Included in net income -- -- 73.4
Recorded directly to shareholders' equity 28.0 (84.3) 69.9
--------------------------------------------------------
Total net investment gains (losses), before tax 66.8 (45.5) 193.9
--------------------------------------------------------
Total net investment return, before tax $ 122.2 $ 44.7 $ 327.4
========================================================================================================================
22
Fund American's net investment income is comprised primarily of interest income
earned on mortgage loans originated by Source One. The decrease in Source One's
net investment income from 1994 to 1995 is mainly attributable to decreased
interest income from mortgage loans held for sale related to lower mortgage loan
production combined with lower mortgage interest rates experienced during 1995.
The decrease in Source One's net investment income from 1993 to 1994 is due
primarily to decreased interest income from mortgage loans held for sale related
to lower mortgage production experienced during 1994. The decrease in other net
investment income from 1994 to 1995 resulted from net sales of investment
securities during 1995. The increase in other net investment income from 1993 to
1994 resulted from a second quarter 1994 transfer of $112.0 million of common
equity securities from Source One to its parent, Fund American Enterprises, Inc.
("FAE", a subsidiary of the Company), in exchange for shares of Source One's
common stock held by FAE. Prior to such transfer, the net investment income
relating to the securities transferred was included in net investment income of
Source One. The effects of the securities transfer on other investment income
were partially offset by the Company's 1994 investment sales. Cash basis sales
and maturities of investments, net of purchases and excluding short-term
investments, totalled $154.1 million, $151.9 million and $115.0 million for the
years ended December 31, 1995, 1994 and 1993, respectively.
Net realized investment gains during 1995, before tax, included $23.9 million
of gains from the sale of American Express Company common stock. Net realized
investment gains during 1994, before tax, included $22.6 million of gains from
the sale of The Louisiana Land and Exploration Company common stock and $21.7
million of gains from the sale of American Express Company common stock. Net
realized gains during 1993, before tax, included $14.0 million of gains from the
sale of A. H. Belo common stock and $13.2 million of gains from the sale of San
Juan Basin Royalty Trust units.
Total investment gains and losses during the three years ended December 31,
1995 have been substantially affected by changes in market prices for crude oil
and natural gas. At December 31, 1995, 77% of Fund American's portfolio of
common equity securities was invested in the energy, natural resources and
related industries sector. Fund American believes that the oil and natural gas
industries are highly cyclical and, therefore, anticipates continued volatility
in the value of its investment portfolio in the future.
Prior to December 31, 1993 unrealized gains and losses from investments held
by Fund American, other than securities held by Source One, were included in net
income. As of December 31, 1993 Fund American adopted SFAS No. 115, "Accounting
for Certain Investments in Debt and Equity Securities." Under the provisions of
SFAS No. 115, substantially all of Fund American's portfolio of common equity
securities, fixed maturity investments and other investments are classified as
securities available for sale and are reported at fair value as of the balance
sheet date, with related unrealized gains and losses excluded from earnings and
reported as a net amount in a separate component of shareholders' equity.
Therefore, for periods beginning after December 31, 1993, all of Fund American's
net unrealized gains and losses are reported as a direct adjustment to
shareholders' equity with no credit or charge to net income.
A review of certain significant holdings in Fund American's portfolio of
common equity securities at December 31, 1995 follows. Share or unit and dollar
amounts refer to the aggregate number of shares or units and the aggregate fair
value at December 31, 1995 of Fund American's holdings of each security
discussed.
23
Energy, Natural Resources and Related Industries. The energy and natural
------------------------------------------------
resources industries, particularly the crude oil and natural gas industries, are
highly competitive, require significant capital expenditures and are subject to
extensive regulation at both the national and local levels. Fund American
believes that the market prices of securities of companies engaged in those
businesses are relatively volatile due to fluctuations in the prices of crude
oil, natural gas and other natural resources. Fund American's holdings within
the energy, natural resources and related industries sector consist in great
part of large blocks of securities of a small number of issuers. This
concentration may make the value of Fund American's portfolio more volatile than
the value of a more diversified portfolio.
The Louisiana Land & Exploration Company ("LLX"; 2,928,100 shares; $125.5
million). LLX is one of the largest independent exploration and production
companies in the nation. LLX explores for, produces and markets crude oil and
natural gas in the United States and certain foreign countries. Fund American
believes that LLX's operations are affected by, among other things, changes in
the prices of crude oil and natural gas, general economic conditions and LLX's
ability to successfully produce and replace crude oil and natural gas reserves.
Between January 31, 1996 and March 21, 1996 Fund American sold all 2,928,100
shares of LLX for net cash proceeds of $125.1 million.
San Juan Basin Royalty Trust ("SJT"; 10,994,876 units; $68.7 million). SJT
units receive a 75% net overriding royalty interest from certain of Southland
Royalty Company's leasehold and royalty interests in the San Juan Basin of
Northwestern New Mexico. Fund American believes that changes in crude oil and
natural gas prices and in the level of development and production expenditures
by the operator of SJT may affect the distributions to unitholders of SJT and,
therefore, the market prices of the units of SJT. In addition, Fund American
believes that the tax and accounting issues involved in owning units in SJT may
make such units unappealing to many investors
Other Significant Holdings.
--------------------------
Zurich Reinsurance Centre Holdings, Inc. ("ZRC"; 2,042,572 shares; $62.0
million). ZRC is one of the largest writers of broker-market property and
casualty reinsurance products in North America. On January 10, 1996 Fund
American sold all 2,042,572 shares of ZRC for net cash proceeds of $61.8
million.
Expenses
Compensation and benefits expense increased to $111.6 million in 1995 from $69.2
million in 1994 and $63.5 million in 1993. Compensation expense for 1995
includes a $46.2 million pretax charge related to an extension of the expiration
date of outstanding employee stock warrants. Additionally, Source One nets
mortgage loan origination fees, less certain direct costs, against compensation
and benefits expense. The high amount of originations experienced by Source One
during 1993 resulted in significantly more origination fees offsetting
compensation and benefits expense for those years than in 1994 and 1995.
Excluding the effects of the 1995 warrant extension and mortgage loan
origination fees, compensation and benefits expense was $82.9 million, $98.8
million and $137.8 million for each of the years ended December 31, 1995, 1994
and 1993, respectively. The declines in compensation and benefits expense
reflect significant reductions in production-related personnel at Source One
since 1993.
24
General expenses of $60.3 million for 1995 compare to 1994 and 1993 amounts
of $77.7 million and $67.5 million, respectively. The increase in general
expenses from 1993 to 1994 is due to the expansion of Source One's mortgage loan
production network throughout 1993 and early 1994. Efforts to reduce Source
One's operating expenses in response to the contraction in mortgage originations
began to take effect in late 1994 and continued through 1995.
Interest expense decreased to $45.8 million in 1995 which compares to $78.8
million for 1994 and $103.1 million for 1993. The decreases are primarily the
result of a decrease in total average indebtedness outstanding at Source One.
Source One's average inventory of mortgage loans held for sale, which decreased
from 1993 through 1995 as a result of lower mortgage loan production, is funded
mainly with debt.
Source One's provision for mortgage loan losses, included in general
expenses, was $7.0 million in 1995 which compares to $8.2 million for 1994 and
$3.7 million for 1993. The increase from 1993 to 1994 is primarily due to
charge-offs of certain commercial real estate owned properties and higher
average loss volumes relating to certain California residential mortgage loans.
Income Taxes
The income tax provision related to pretax earnings for 1995, 1994 and 1993
represents an effective tax rate of 47.3%, 49.3% and 50.1%, respectively. The
tax provision for 1993 includes $13.0 million of current income tax relating to
taxable capital gains triggered by the distribution of approximately 74% of the
shares of common stock of White River ("White River Shares") to shareholders on
December 22, 1993. Such gains were not recognized for financial reporting
purposes pursuant to generally accepted accounting principles ("GAAP"). The
1993 provision also includes $4.7 million of deferred income tax reflecting a
tax reserve established on White River's books of record as of December 22,
1993, the date of the distribution. Such reserve offset White River's deferred
tax asset calculated on a stand-alone basis as of that date.
Fund American has recorded a net deferred Federal income tax asset of $24.8
million as of December 31, 1995. The deferred tax asset includes a $38.2
million net asset related to various operating items partially offset by a $13.4
million net liability related to net unrealized gains on investment securities.
On January 2, 1991 the Company sold Fireman's Fund to Allianz of America,
Inc. The $1.3 billion gain from the sale as reported in 1991 included a $75.0
million tax benefit related to the Company's estimated tax loss from the sale.
Since 1991 the Company has carried an estimated reserve related to tax matters
affecting the amount of the deductible tax loss from the sale and other tax
matters. The conclusion in 1995 of Internal Revenue Service ("IRS") audits of
Fund American's Federal income tax returns for all taxable periods ending on or
prior to October 23, 1985 (the date of Fund American's initial public offering
of Shares) resolved certain of the tax matters affecting the amount of the
Company's deductible tax loss from the sale of Fireman's Fund and the Company
has, therefore, re-estimated its tax reserve. As a result of the reserve re-
estimation, the Company included in its 1995 income statement an additional
$66.0 million income tax benefit from the sale. The amount of tax benefit from
the sale of Fireman's Fund ultimately realized by the Company may be
significantly more or less than the Company's current estimate due to possible
changes in or new interpretations of tax rules, possible amendments to Fund
American's 1990 or prior years' Federal income tax returns, the results of
further IRS audits and other matters affecting the amount of the deductible tax
loss from the sale.
25
LIQUIDITY AND CAPITAL RESOURCES
Since the sale of Fireman's Fund, Fund American has been gradually liquidating
its portfolio of passive investment securities. Management's primary strategic
goal is to either: (i) reinvest Fund American's passive investments, together
with other resources available to Fund American, into operating businesses in
which management has knowledge and experience (if appropriate opportunities can
be found); or (ii) return excess capital to shareholders through additional
repurchases of Shares. Management believes that this strategy will, over time,
further enhance shareholder value. As is further described below, the formation
and capitalization White Mountains embodies this strategy.
Parent Company
The primary sources of cash inflows for the Company are investment income, sales
of investment securities and dividends received from its operating subsidiaries.
In June 1994 the Company entered into a revolving credit agreement with a
syndicate of banks. Under the agreement, through August 9, 1996 the Company and
certain of its subsidiaries may borrow up to $75.0 million at short-term market
interest rates. The credit agreement contains certain customary covenants,
including a $475.0 million minimum tangible net worth requirement and a minimum
financial asset coverage requirement. At December 31, 1995 and 1994 the Company
had no borrowings outstanding under the agreement.
During 1993 the Company issued $150.0 million in principal amount of
medium-term notes for net cash proceeds of $148.0 million after related costs.
Proceeds from the issuance of the notes were used to repay an existing revolving
credit facility and for general corporate purposes. During 1995 and 1994 the
Company repurchased $8.8 million and $25.0 million, respectively, in principal
amount of the notes due February 2003. At December 31, 1995 the remaining
outstanding notes had an average maturity of 7.41 years and an average yield to
maturity of 7.82%.
In August 1994 the Company redeemed 22,778 shares of the Series D Preferred
Stock for $82.0 million. In July 1995 the Company redeemed the remaining 20,833
shares of the Series D Preferred Stock outstanding for $75.0 million. The
redemption price for the shares of Series D Preferred Stock redeemed was equal
to the stock's liquidation preference. The annual dividend rate on the Series D
Preferred Stock was 7.75% through July 1994 and 8.75% from August 1994 through
July 1995.
During 1995, 1994 and 1993 the Company repurchased 877,868 Shares,
1,128,057 Shares and 536,247 Shares, respectively, for $65.5 million, $78.8
million and $41.8 million, respectively. All such repurchased Shares have been
retired. The repurchases of Shares represent a return of excess capital to the
Company's shareholders.
During 1993 and 1994 the Company did not pay regular cash dividends to
holders of Shares. In the fourth quarter 1995 the Board reinstated regular
periodic dividends on Shares of $.20 per quarter. The Board currently intends to
reconsider from time to time the declaration of regular periodic dividends on
Shares with due consideration given to the financial characteristics of Fund
American's remaining invested assets and operations and the amount and
regularity of its cash flows at the time. There can be no assurance, therefore,
as to whether or when the Board will declare additional dividends on Shares.
26
On December 22, 1993 the Company distributed approximately 74% of the
outstanding shares of Common Stock of White River to its shareholders. White
River commenced operations on September 24, 1993, concurrent with the purchase
and transfer of selected assets and the assumption of certain liabilities from
Fund American. The assets sold or otherwise transferred by Fund American to
White River included primarily $84.0 million of common equity securities, $147.1
million of securities classified as other investments and $25.8 million of
short-term investments. White River's initial capitalization consisted of a
$50.0 million demand note payable to Fund American, $7.0 million of redeemable
preferred stock and $200.0 million of common shareholder's equity. Of the
1,014,750 White River Shares retained by Fund American, 295,932 have been
reserved by Fund American for delivery upon exercise of existing employee stock
options and warrants.
Pursuant to the terms of a December 1993 credit agreement among the Company
and White River, the Company provided White River with a $50.0 million term note
(the "Term Note") and a $40.0 million revolving credit facility (the
"Revolver"). The credit agreement granted White River the right to use certain
of its investment securities to repay its borrowings under the Term Note and the
Revolver.
On June 29, 1995 White River repaid $35.1 million in principal amount on
the Revolver with (i) 930,000 shares of common stock of Mid Ocean Limited ("Mid
Ocean Shares") and (ii) options to acquire an additional 388,140 Mid Ocean
Shares through November 2002. On July 3, 1995, White River repaid the remaining
$4.9 million principal balance on the Revolver and $5.0 million in principal
amount on the Term Note in exchange for certain common equity securities. On
August 31, 1995, White River repaid the remaining $45.0 million principal
balance on the Term Note with 1,525,424 shares of common stock of Zurich
Reinsurance Centre Holdings, Inc.
On March 11, 1996 Fund American entered into a definitive agreement to
purchase for $50.0 million 3,144,827 shares of Common Stock of Travelers-Aetna
Property Casualty Corp ("TAPCC"). Fund American's investment will initially
represent a .87% interest in TAPCC. Fund American expects the transaction to
close near the end of the first quarter of 1996. Upon the closing John J. Byrne,
Fund American's Chairman and Chief Executive Officer, will become a director of
TAPCC. Fund American intends to fund the investment in TAPCC using proceeds from
sales of short-term investments.
White Mountains
In 1995 the Company capitalized White Mountains with $250.0 million of
assets. White Mountains was formed to be the holding company for all of Fund
American's insurance operating interests. As of December 31, 1995 White
Mountains' principal holdings included: 100% ownership of Valley, Charter and
WMIC; a 21.0% interest in FSA; and a 33.1% interest in MSA.
Under the insurance laws of the various states under which White Mountains'
insurance subsidiaries are incorporated or licensed to write business, an
insurer is restricted with respect to the amount of dividends it may pay without
prior approval by state regulatory authorities. Accordingly, there is no
assurance that dividends may be paid by White Mountains' insurance operating
subsidiaries in the future.
27
FSA. In May 1994 the Company purchased 2,000,000 shares of FSA Common Stock
from U S WEST Capital Corp., a wholly-owned subsidiary of U S WEST, Inc. The
purchase was part of an initial public offering of 8,082,385 shares of FSA's
Common Stock at the initial offering price of $20.00 per share. At that time the
Company's Chairman, John J. Byrne, also became Chairman of FSA. FSA conducts
operations principally through Financial Security Assurance Inc., a wholly-owned
monoline financial guarantee insurance subsidiary with Aaa/AAA claims-paying
ratings. FSA is principally engaged in guaranteeing municipal bonds and
residential mortgage and other asset-backed securities.
Following receipt of regulatory approvals, in September 1994 the Company
acquired various fixed price options and shares of convertible preferred stock
which, in total, give Fund American the right to acquire up to 4,560,607
additional shares of FSA Common Stock for aggregate consideration of $125.7
million. All shares of and rights to FSA Common Stock owned or acquired by the
Company as described above are subject to certain restrictions on transfer,
voting provisions and other limitations and requirements set forth in a
Shareholders' Agreement, a Registration Rights Agreement and a Voting Trust
Agreement. In 1995 the Company purchased an additional 460,200 shares of FSA
Common Stock on the open market for $8.8 million. As of December 31, 1995 Fund
American's economic and voting interests in FSA were 21.0% and 19.0%,
respectively. In December 1995 and January 1996 the Company transferred all of
its interests in FSA to White Mountains.
MSA. In December 1994 the Company purchased a 33.2% interest in MSA for
$25.0 million in cash. MSA shares in 40% of National Grange Mutual Insurance
Company's business through a reinsurance agreement. In December 1995 the Company
transferred all of its interest in MSA to White Mountains.
Valley and Charter. On December 1, 1995 White Mountains acquired Valley and
Charter for $41.7 million in cash less $3.0 million of purchase price
adjustments. Valley's wholly owned subsidiary, Valley Insurance Company, is an
"A" rated, Northwest-based property and casualty company which writes personal
and commercial lines through independent agents. In 1995 Valley Insurance
Company wrote $73.1 million of gross premiums in Oregon, Washington and
California. Charter's wholly owned subsidiary, Charter Indemnity Company, wrote
$64.4 million of gross non-standard automobile insurance premiums in Texas
during 1995.
In November 1995 Charter issued two notes totalling $20.2 million with
interest rates of 6.5%. The notes are due in 1996 and are collateralized by
certain assets of Charter.
WMIC. WMIC is a New Hampshire licensed commercial property and casualty
insurance company which commenced its operations in September 1995 and wrote
$250,000 in premiums during the year. WMIC is expected to expand its operations
to other states as additional state approvals are obtained.
28
Folksamerica. On March 11, 1996 Fund American announced that it had reached
definitive agreement to purchase for $79.4 million a 50% interest in
Folksamerica Holding Company, Inc. ("Folksamerica"), parent company of
Folksamerica Reinsurance Company. The proceeds from Fund American's investment
will be used by Folksamerica to complete its previously announced acquisition of
Christiania General Insurance Corporation of New York ("Christiania") for $88.0
million. Consummation of both transactions is subject to state insurance
regulatory and Federal antitrust approvals. Fund American believes that it will
receive the requisite approvals to proceed with the Folksamerica transaction,
however, there is no assurance that such approvals will be ultimately be
obtained.
Folksamerica is a multi-line broker-market reinsurance company which in 1995 had
net written premiums of $159.7 million. At December 31, 1995, Folksamerica had
$75.5 million of shareholders' equity and total capitalization of $151.0
million. Christiania had net written premiums in 1995 of $123.2 million and
shareholders' equity of $128.0 million at December 31, 1995. On a pro forma
basis giving effect to the investment by Fund American and the acquisition of
Christiania, Folksamerica will have approximately $220.0 million of statutory
policyholders' surplus, making it the nation's 16th largest broker-market
reinsurer.
Fund American's investment in Folksamerica will include (i) 6,920,000 shares of
ten-year 6.5% voting preferred stock having a liquidation preference of $79.4
million and (ii) ten-year warrants to purchase up to 6,920,000 shares of
Folksamerica Common Stock for $11.47 per share. Folksamerica's book value per
share at December 31, 1995 was $10.91.
Fund American expects to assign the purchase of the Folksamerica investment to
White Mountains. White Mountains intends to fund the Folksamerica investment
using proceeds from sales of investment securities and an additional $25.0
million capital contribution from the Company.
Upon consummation of the investment, Fund American expects to include
Folksamerica's financial results in Fund American's consolidated financial
statements. This will have a material effect on Fund American's financial
statements. Folksamerica's consolidated financial statements, pro forma for the
completion of Fund American's investment and the acquisition of Christiania,
include total assets of $1,024.4 million as of December 31, 1995 and total
revenues of $324.9 million for the year then ended.
Source One
Source One's investments, mortgage loans held for sale and mortgage loan
servicing portfolio provide a liquidity reserve since they may be sold to meet
liquidity needs.
In 1995 Source One sold the rights to service $11.0 billion of mortgage loans to
third parties for net cash proceeds of $181.1 million. The proceeds were used by
Source One to retire debt and to repurchase shares of its common stock from FAE.
In March 1995 Source One consolidated its three then existing credit facilities
into a single credit facility in the amount of $500.0 million. The new facility
can be increased at Source One's option with bank concurrence up to $1.0
billion. Borrowings under the new facility, which matures in March 1998, are
secured primarily by Source One's mortgage loans receivable and mortgage loan
servicing portfolio. As of December 31, 1995 no borrowings were outstanding
under the new facility. As of December 31, 1994 there was $195.0 million
outstanding under the previous three credit facilities.
29
Source One's secured credit agreements contain covenants which limit its
ability to pay dividends or make distributions on its capital in excess of
existing preferred stock dividend requirements. These covenants also require
Source One to maintain a certain level of total tangible net worth and a certain
ratio of debt to total tangible net worth. Source One is currently in compliance
with all such covenants.
In August 1995 Source One entered into a $60.0 million unsecured revolving
credit facility which expires in July 1996.
Source One also has a revolving credit agreement under which it can borrow
up to $10.0 million. As of December 31, 1995 and 1994 there was $4.5 million and
$3.8 million outstanding under this agreement, respectively.
Source One has a $650.0 million domestic and Euro commercial paper program.
The weighted average number of days to maturity of commercial paper outstanding
at December 31, 1995 was 19 days. As of December 31, 1995 and 1994 Source One
had $256.6 million and $26.1 million of commercial paper outstanding,
respectively.
In 1986 Source One issued $125.0 million of 8.25% debentures due November
1, 1996. During 1995 Source One repurchased and retired $50.4 million in
principal amount of these debentures.
In 1989 Source One issued $40.0 million of medium-term notes due in 1996
and having a total weighted average interest rate of 9.65%. In 1991 Source One
issued $160.0 million of 8.875% medium-term notes due in 2001. INFLATION During
1995 Source One repurchased and retired in principal amount $10.3 million
medium-term notes that were due in 1996 and $21.6 million of medium-term notes
that were due in 2001.
In 1992 Source One issued $100.0 million of 9% debentures due in 2012 under
terms of a $250.0 million shelf registration statement. The proceeds from
issuance were used for general corporate purposes.
In March 1994 Source One issued 4,000,000 shares of 8.42% perpetual
Cumulative Preferred Stock, Series A ("Source One Preferred Stock"), having a
liquidation preference of $25.00 per share, for net cash proceeds of $96.9
million. The Source One Preferred Stock is not redeemable prior to May 1, 1999.
On December 8, 1995 Source One exchanged and retired 2,239,061 shares of
Source One Preferred Stock for $56.0 million in principal amount of 9.375%
subordinated interest deferrable debentures (the "Subordinated Debentures"). The
Subordinated Debentures are due on December 31, 2025. The Subordinated
Debentures are redeemable at the option of Source One, in whole or part, at any
time on or after May 1, 1999.
FAE announced on December 26, 1995 that it had entered into a letter of
intent with Mellon Mortgage Company ("Mellon") contemplating the sale of Source
One for an aggregate price equal to Source One's adjusted book value as of the
closing date plus a premium of $65.0 million, and the assumption of all Source
One's existing debt and preferred stock. On March 6, 1996 FAE announced that its
discussions with Mellon were proceeding more slowly that had been anticipated
and that Mellon had subsequently revised the scope and other terms of the
originally announced Source One transaction. FAE is continuing discussions with
Mellon and other parties. There can be no assurance that any transaction will be
negotiated or consummated.
30
INFLATION
Inflation can have significant effects on White Mountains' insurance operations.
Inflation increases the costs of settling insurance claims over time. Increases
in market interest rates, which often occur during periods of high inflation,
reduce the market value of the insurance operations' fixed-income investments.
Conversely, reductions in market interest rates increase the market value of
White Mountains' fixed-income investments.
Inflation affects Source One most significantly in the area of loan
originations. As noted above, interest rates normally increase during periods of
high inflation and decrease during periods of low inflation. Historically,
Source One's loan originations have increased in response to falling interest
rates and have decreased during periods of rising interest rates. However,
higher interest rate environments typically enhance the value of Source One's
mortgage loan servicing portfolio due to related declines in refinancing
activity. Lower interest rates generally result in higher payoffs and,
therefore, typically reduce the value of the mortgage loan servicing portfolio.
31
Fund American
CONSOLIDATED BALANCE SHEETS
- -----------------------------------------------------------------------------------------------------------------------------------
December 31,
------------------------------------------------
Dollars in millions 1995 1994
- -----------------------------------------------------------------------------------------------------------------------------------
Assets
Common equity securities, at fair value (cost $232.1 and $294.2) $ 274.5 $ 332.4
Fixed maturity investments, at fair value (cost $109.8 and $102.2) 110.7 102.2
Other investments (cost $86.7 and $61.4) 95.9 55.1
Short-term investments, at amortized cost (which approximated fair value) 103.6 119.2
------------------------------------------------
Total investments 584.7 608.9
Cash 2.7 1.5
Capitalized mortgage servicing, net of accumulated amortization 397.1 530.5
Mortgage loans held for sale 381.0 210.5
Pool loan purchases 119.0 163.9
Mortgage claims receivable and real estate acquired,
less allowance for mortgage loan losses of $13.5 and $13.4 45.4 49.8
Insurance premiums receivable 45.3 --
Investments in unconsolidated affiliates 96.2 69.7
Goodwill 24.6 28.0
Other assets 175.9 144.5
------------------------------------------------
Total assets $ 1,871.9 $ 1,807.3
===================================================================================================================================
Liabilities
Short-term debt $ 445.4 $ 254.1
Long-term debt 407.3 547.0
Loss and loss adjustment expense reserves 44.1 --
Unearned insurance premiums 35.0 --
Accounts payable and other liabilities 196.4 245.1
------------------------------------------------
Total liabilities 1,128.2 1,046.2
- -----------------------------------------------------------------------------------------------------------------------------------
Minority interest -- preferred stock of subsidiary 44.0 100.0
- -----------------------------------------------------------------------------------------------------------------------------------
Shareholders' equity
Preferred stock -- authorized 10,000,000 shares,
Series D voting preferred stock, issued 0 and 20,833 shares -- 75.0
Common stock -- authorized 125,000,000 shares,
issued 32,719,279 and 33,597,147 shares 32.7 33.6
Common paid-in surplus 375.5 338.1
Retained earnings 1,124.6 1,098.2
Common stock in treasury, at cost: 25,034,939 and 25,187,210 shares (871.0) (878.5)
Net unrealized investment gains 37.9 19.7
Loan for common stock issued -- (25.0)
------------------------------------------------
Total shareholders' equity 699.7 661.1
- -----------------------------------------------------------------------------------------------------------------------------------
Total liabilities, minority interest and shareholders' equity $ 1,871.9 $ 1,807.3
===================================================================================================================================
See Notes to Consolidated Financial Statements.
32
Fund American
CONSOLIDATED INCOME STATEMENTS
- ---------------------------------------------------------------------------------------------------------------------
Year Ended December 31,
----------------------------------------
Millions, except per share amounts 1995 1994 1993
- ---------------------------------------------------------------------------------------------------------------------
Revenues:
Mortgage servicing revenue $ 141.9 $ 169.3 $ 187.1
Amortization of mortgage servicing 81.4 86.9 133.6
----------------------------------------
Net mortgage servicing revenue 60.5 82.4 53.5
Gain on sales of mortgage servicing 40.0 -- --
Net gain on sales of mortgages 24.0 29.5 34.8
Other mortgage operations revenue 16.4 23.9 29.2
Insurance premiums earned 5.8 -- --
Net investment income 55.4 90.2 133.5
Equity in earnings of unconsolidated affiliates 9.4 2.5 --
Other revenue 10.8 -- --
----------------------------------------
Total revenues 222.3 228.5 251.0
- ---------------------------------------------------------------------------------------------------------------------
Expenses:
Compensation and benefits 111.6 69.2 63.5
General expenses 60.3 77.7 67.5
Interest expense 45.8 78.8 103.1
Insurance losses and loss adjustment expenses 8.2 -- --
----------------------------------------
Total expenses 225.9 225.7 234.1
- ---------------------------------------------------------------------------------------------------------------------
Pretax operating earnings (loss) (3.6) 2.8 16.9
----------------------------------------
Net realized investment gains 38.8 38.8 50.6
Change in net unrealized investment gains and losses -- -- 73.4
----------------------------------------
Net investment gains 38.8 38.8 124.0
----------------------------------------
Pretax earnings 35.2 41.6 140.9
Income tax provision 16.7 20.5 70.5
----------------------------------------
After tax earnings 18.5 21.1 70.4
Tax benefit from sale of discontinued operations 66.0 -- --
Loss on early extinguishment of debt, after tax (.4) -- --
Cumulative effect of accounting change -
purchased mortgage servicing, after tax -- (44.3) --
----------------------------------------
Net income (loss) 84.1 (23.2) 70.4
Less dividends on preferred stock 3.8 9.9 12.2
----------------------------------------
Net income (loss) applicable to common stock $ 80.3 $ (33.1) $ 58.2
- -----------------------------------------------------------------------------========================================
Primary earnings per share:
After tax earnings $ 1.71 $ 1.20 $ 5.68
Tax benefit from sale of discontinued operations 7.69 -- --
Loss on early extinguishment of debt, after tax (.04) -- --
Cumulative effect of accounting change -- (4.71) --
----------------------------------------
Net income (loss) $ 9.36 $ (3.51) $ 5.68
- -----------------------------------------------------------------------------========================================
Fully diluted earnings per share:
After tax earnings $ 2.02 $ 1.20 $ 5.68
Tax benefit from sale of discontinued operations 7.18 -- --
Loss on early extinguishment of debt, after tax (.04) -- --
Cumulative effect of accounting change -- (4.71) --
----------------------------------------
Net income (loss) $ 9.16 $ (3.51) $ 5.68
=====================================================================================================================
See Notes to Consolidated Financial Statements.
33
Fund American
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
- -----------------------------------------------------------------------------------------------------------------------------------
Net
Common unrealized Loan for
stock and Common investment common
Preferred paid-in Retained stock in gains stock
Millions Total stock surplus earnings treasury (losses) issued
- -----------------------------------------------------------------------------------------------------------------------------------
Balances at January 1, 1993 $988.3 $157.0 $390.1 $1,375.2 $(886.2) $(24.0)) $(23.8)
Net income 70.4 -- -- 70.4 -- -- --
Dividends to preferred stockholders (12.2) -- -- (12.2) -- -- --
Distribution of subsidiary to common
stockholders (146.9) -- -- (146.9)
Purchases of common stock retired (41.8) -- (5.9) (35.9) -- -- --
Stock options exercised and
performance shares awarded 2.0 -- -- .7 1.3 -- --
Change in net unrealized investment
gains and losses, after tax 23.7 -- -- -- -- 23.7 --
Cumulative effect of change in
accounting for investment
securities, after tax 22.1 -- -- (52.7) -- 74.8 --
Other (.6) -- -- -- -- -- (.6)
--------------------------------------------------------------------------------------------
Balances at December 31, 1993 905.0 157.0 384.2 1,198.6 (884.9) 74.5 (24.4)
Net loss (23.2) -- -- (23.2) -- -- --
Dividends to preferred stockholders (9.4) -- -- (9.4) -- -- --
Redemption of preferred stock (82.0) (82.0) -- -- -- -- --
Purchases of common stock retired (78.8) -- (12.5) (66.3) -- -- --
Stock warrants exercised 4.9 -- -- (1.5) 6.4 -- --
Change in net unrealized investment
gains and losses, after tax (54.8) -- -- -- -- (54.8) --
Other (.6) -- -- -- -- -- (.6)
--------------------------------------------------------------------------------------------
Balances at December 31, 1994 661.1 75.0 371.7 1,098.2 (878.5) 19.7 (25.0)
Net income 84.1 -- -- 84.1 -- -- --
Dividends to stockholders (4.8) -- -- (4.8) -- -- --
Redemption of preferred stock (75.0) (75.0) -- -- -- -- --
Purchases of common stock retired (65.4) -- (9.7) (55.7) -- -- --
Stock options and warrants exercised 10.3 -- -- 2.8 7.5 -- --
Extension of outstanding stock warrants 46.2 -- 46.2 -- -- -- --
Change in net unrealized investment
gains and losses, after tax 18.2 -- -- -- -- 18.2 --
Repayment of loan for common stock
issued 25.0 -- -- -- -- -- 25.0
--------------------------------------------------------------------------------------------
Balances at December 31, 1995 $699.7 $ -- $408.2 $1,124.6 $(871.0) $ 37.9 $ --
===================================================================================================================================
See Notes to Consolidated Financial Statements.
34
Fund American
CONSOLIDATED STATEMENTS OF CASH FLOWS
-----------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31,
-------------------------------------------------
Millions 1995 1994 1993
- ------------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 84.1 $ (23.2) $ 70.4
Charges (credits) to reconcile net income (loss) to cash flows from operations:
Tax benefit from saleof discontinued operations (66.0) -- --
Loss on early extinguishment of debt, after tax .4 -- --
Cumulative effect of accounting change - purchased mortgage
servicing, after tax -- 44.3 --
Equity in earnings of unconsolidated affiliates (9.4) (2.5) --
Compensation expense resulting from warrant extension 46.2 -- --
Net investment gains (38.8) (38.8) (124.0)
(Increase) decrease in mortgage loans held for sale (170.5) 1,088.0 (182.4)
Gain on sales of mortgage servicing (40.0) -- --
Depreciation and amortization 86.4 99.2 142.3
Capitalized excess mortgage servicing income (7.4) (16.7) (58.1)
Change in current income taxes receivable and payable 24.4 22.6 21.2
Deferred income tax (benefit) provision (9.5) (1.4) 37.2
Change in other assets (4.9) 24.8 (26.9)
Change in accounts payable and other liabilities 35.9 (7.3) (26.1)
Other, net 7.3 4.9 9.7
-------------------------------------------------
Net cash (used for) provided from operating activities (61.8) 1,193.9 (136.7)
- -----------------------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Net decrease (increase) in short-term investments 15.6 133.3 (10.2)
Sales and maturities common stocks and other investments 204.5 338.2 360.4
Sales and maturities of fixed maturity investments 62.1 -- --
Purchases of common stocks and other investments (63.7) (137.8) (241.8)
Purchases of fixed maturity investments (48.8) (48.5) (3.6)
Purchase of Valley and Charter (42.2) -- --
Investments in unconsolidated affiliates (33.0) (44.0) --
Collections on mortgage origination and servicing 192.7 232.3 213.3
Additions to purchased mortgage servicing (82.1) (90.1) (72.2
Originated mortgage servicing (31.2) -- --
Proceeds from sales of mortgage servicing 181.1 70.2 --
Additions to other mortgage origination and servicing assets (150.4) (242.8) (255.9)
Sales (purchases) of fixed assets, net .4 (3.6) (11.2)
-------------------------------------------------
Net cash provided from (used for) investing activities 205.0 207.2 (21.2)
- -----------------------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Net issuances (repayments) of short-term debt 96.5 (1,314.5) 21.5
Repayments of long-term debt (93.7) (23.9) --
Proceeds from issuances of long-term debt -- -- 178.0
Proceeds from issuances of preferred stock by subsidiary -- 96.9 --
Redemptions of preferred stock (75.0) (82.0) --
Purchases of common stock retired (65.5) (78.8) (41.8)
Cash dividends paid to shareholders (6.4) (10.8) (12.7)
Other 2.1 2.8 2.1
-------------------------------------------------
Net cash (used for) provided from financing activities 142.0) (1,410.3) 147.1)
- -----------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash during year 1.2 (9.2) (10.8
Cash balance at beginning of year 1.5 10.7 21.5
-------------------------------------------------
Cash balance at end of year $ 2.7 $ 1.5 $ 10.7
===================================================================================================================================
See Notes to Consolidated Financial Statements.
35
Fund American
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying consolidated financial statements include the accounts of the
Company and its subsidiaries. Fund American's principal businesses are conducted
through White Mountains and Source One. White Mountains is an insurance holding
company principally engaged through its affiliates in the businesses of property
and casualty insurance and financial guaranty insurance. Source One is one of
the largest mortgage banking companies in the United States.
The financial statements have been prepared in accordance with GAAP. All
significant intercompany transactions have been eliminated in consolidation. The
financial statements include all adjustments considered necessary by management
to fairly present the financial position, results of operations and cash flows
of Fund American. The preparation of financial statements in conformity with
GAAP requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities as of the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. Certain
amounts in the prior year financial statements have been reclassified to conform
with the current year presentation.
Investment securities
As of December 31, 1993 Fund American adopted SFAS No. 115, "Accounting for
Certain Investments in Debt and Equity Securities." Under the provisions of SFAS
No. 115, substantially all of Fund American's portfolio of common equity
securities, fixed maturity investments and other investments are classified as
securities available for sale and are reported at fair value as of the balance
sheet date, with related unrealized gains and losses excluded from earnings and
reported as a net amount in a separate component of shareholders' equity. Prior
to December 31, 1993 unrealized gains and losses from investments held by Fund
American, other than securities held by Source One, were included in net income.
Other investments may include: non-redeemable preferred and common equity
securities having no established public market value and carried at internally
appraised fair value; securities which, due to restrictions regarding resale,
are carried at a discount to the quoted market value for similar unrestricted
securities; investment partnership interests accounted for using the equity
method; mortgage loans held for investment; residual interests in real estate
mortgage investment conduits ("REMICs") and interest rate principal contracts.
Mortgage loans held for investment are stated at the lower of cost or fair
value, determined on an individual loan basis at the time the permanent
investment decisions were made. REMICs are classified as held to maturity and
are carried at amortized cost using a method which approximates the effective
yield method of amortization. Interest rate floor contracts are considered held
for purposes other than trading and are carried at fair value with unrealized
gains and losses reported in other income.
Short-term investments are carried at amortized cost which approximated
fair value as of December 31, 1995 and 1994. Short-term mortgage-backed
securities are classified as trading securities and are stated at fair value
with unrealized gains and losses, if any, reported in income.
36
Related discounts, if any, are accreted to income over the anticipated life
of the investment.
Realized gains and losses resulting from sales of investment securities or
from other than temporary impairments of value are accounted for using the
specific identification method.
Insurance operations
Premiums are taken into income as earned on a daily pro rata basis over the
terms of the policies. Unearned premiums represent the portion of premiums
applicable to future insurance coverage provided by policies in force. White
Mountains' insurance subsidiaries insure property and liability risks in Oregon,
California, Washington, Texas and New Hampshire.
Policy acquisition costs include commissions and other costs which vary with
and are primarily related to the acquisition of new and renewal insurance
policies. Policy acquisition costs are deferred and amortized over the terms of
the applicable policies.
Losses and loss adjustment expenses are charged against income as incurred.
Unpaid losses and loss adjustment expenses are based on estimates by claims
adjusters, legal counsel and actuarial staff of the ultimate costs of settling
claims, including the effects of inflation and other societal and economic
factors. Unpaid loss and loss adjustment expense reserves represent
management's best estimate of ultimate losses and loss adjustment expenses net
of estimated salvage and subrogation recoveries. Such estimates are regularly
reviewed and updated and any adjustments resulting therefrom are reflected in
current operations. The process of estimating loss and loss adjustment expenses
involves a considerable degree of judgement by management and the ultimate
amount of expense to be incurred could be considerably greater than or less than
the amounts currently reflected in the financial statements.
In the normal course of business, White Mountains' insurance subsidiaries
seek to reduce the loss that may arise from catastrophes or other events that
may cause unfavorable underwriting results by reinsuring certain levels of risk
in various areas of exposure with other insurance enterprises or reinsurers.
White Mountains' insurance subsidiaries remain contingently liable for risks
reinsured with third parties to the extent that the reinsurer is unable to honor
its obligations under reinsurance contracts at the time of loss.
Amounts recoverable from reinsurers are estimated in a manner consistent with
the claim liability associated with the reinsured policy. Reinsurance premiums,
commissions, expense reimbursements and reserves related to reinsured business
are accounted for on a basis consistent with those used in accounting for the
original policies issued and the terms of the reinsurance contracts. Premiums
ceded to other companies have been reported as a reduction of premiums written.
Amounts applicable to reinsurance ceded for unearned premium reserves, and loss
and loss adjustment expense reserves, (i.e., prepaid reinsurance premiums and
reinsurance recoverable on unpaid losses, respectively) are not material and
have been included as a component of other assets. Expense allowances received
in connection with reinsurance ceded have been accounted for as a reduction of
the related policy acquisition costs and are deferred and amortized accordingly.
37
Mortgage origination and servicing
Fund American acquired Source One in 1986. The purchase price in excess of the
estimated fair value of the net assets acquired was allocated to goodwill and is
being amortized over 20 years.
Mortgage loans held for sale are stated at the lower of aggregate cost or
fair value.
Conventional mortgage loans are placed on a non-accrual basis when delinquent
90 days or more as to interest or principal. Interest on delinquent Federal
Housing Administration ("FHA") insured loans is accrued at the insured rate
beginning on the sixty-first day of delinquency. Interest on delinquent
Veterans Administration ("VA") guaranteed loans is accrued at the loan rate
during the period of delinquency.
Gains and losses from sales of mortgage loans are recognized when the
proceeds are received. Loan origination fees, net of certain direct costs, have
been deferred and are recognized as income when the related mortgage loans are
sold. Discounts from the origination of mortgage loans held for sale are
deferred and recognized as adjustments to gains or losses on sales.
Capitalized mortgage servicing includes certain costs incurred in the
origination and acquisition of mortgage servicing rights which are deferred and
amortized over the expected life of the loan. The total cost of acquiring
mortgage loans, either through origination activities or purchase transactions,
is allocated between the mortgage servicing rights and the loans based on their
relative fair values. The fair values of mortgage servicing rights are
estimated by calculating the present value of the expected future cash flows
associated with such rights, incorporating assumptions that market participants
would use in their estimates of future servicing income and expense. A current
market rate is used to discount estimated future cash flows. Impairment of
mortgage servicing rights is measured on a disaggregated basis by stratifying
the mortgage servicing rights based on one or more predominant risk
characteristics of the underlying loans. Impairment is recognized through a
valuation allowance for each individual stratum.
Capitalized mortgage servicing also includes the present value of future
servicing revenue in excess of normal servicing revenue on loans sold with
servicing retained. Such "excess servicing" is deferred and amortized using a
method that relates the anticipated net servicing revenue to total projected net
servicing revenue to be received over the expected life of the loan. Impairment
tests for excess servicing are performed on a disaggregated basis. The original
discount rate is used to discount excess servicing future cash flows.
Pool loan purchases, which are carried at cost, represent FHA insured, VA
guaranteed and conventional loans which were either delinquent or in the process
of foreclosure at the time they were purchased from Government National Mortgage
Association ("GNMA"), Federal National Mortgage Association ("FNMA") or Federal
Home Loan Mortgage Corporation ("FHLMC) mortgage-backed security pools which
Source One services or, to a lesser degree, from private investors. Interest is
accrued on these purchased loans at a rate based on expected recoveries.
Mortgage claims receivable represent claims filed primarily with FHA and VA.
These receivables are carried at cost less an estimated allowance for amounts
which are not fully recoverable from the claims filed with the underlying
mortgage insuring agencies.
38
Real estate acquired is stated at the lower of net realizable value or the
recorded balance satisfied at the date of acquisition, as determined on an
individual property basis. Costs related to holding the properties are charged
to expense as incurred.
The allowance for mortgage loan losses is based on an analysis of the
mortgage loan servicing portfolio and, in management's judgment, is adequate to
provide for estimated losses.
Mortgage servicing revenue represents fees earned for servicing real estate
mortgage loans owned by investors and late charge income. The servicing fees
are calculated based on the outstanding principal balances of the loans serviced
and are recognized together with late charge income when received.
Source One adopted the provisions of SFAS No. 122, "Accounting for Mortgage
Servicing Rights," an amendment to SFAS No. 65, as of January 1, 1995. SFAS No.
122 requires the total cost of acquiring mortgage loans, either through loan
origination activities or purchase transactions, to be allocated to the mortgage
servicing rights and the loans based on their relative fair values. The
statement requires entities to measure impairment on a disaggregated basis by
stratifying the mortgage servicing rights based on one or more predominant risk
characteristics of the underlying loans. Impairment is recognized through a
valuation allowance for each individual stratum. In accordance with SFAS No.
122, prior year financial statements have not been restated.
Earnings per share
For purposes of earnings per share, common stock equivalents include stock
options, warrants and non-cash performance shares. The Series D Preferred Stock
is not a common stock equivalent.
Primary earnings per share amounts are based on the weighted average number
of common shares and dilutive common stock equivalents outstanding. In the
calculation, income is adjusted for preferred stock dividends. The weighted
average shares used in the primary computation were 8,581,456; 9,405,093 and
10,247,746 for the years ended December 31, 1995, 1994 and 1993, respectively.
Fully diluted earnings per share amounts are based on the weighted average
number of common shares outstanding, assuming full dilution. Income is adjusted
for preferred stock dividends when the preferred shares are anti-dilutive. The
weighted average shares used in the fully diluted computation were 9,189,054;
9,408,785 and 10,247,746 for the years ended December 31, 1995, 1994 and 1993,
respectively.
Future application of accounting standard
SFAS No. 123, "Accounting for Stock Based Compensation," was issued in October
1995. That standard requires significantly more disclosure regarding all
employee stock options and encourages companies to recognize compensation
expense for stock-based awards based on the fair value of such awards on the
date of grant. Alternatively, companies may continue following existing
accounting standards provided that disclosures are made regarding the net income
and earnings per share impact as if the value recognition and measurement
criteria of SFAS No. 123 had been adopted. The disclosure requirements of the
standard are effective for fiscal years beginning after December 15, 1995. Fund
American does not expect to adopt the recognition and measurement criteria of
SFAS No. 123 and expects to provide the requisite pro forma information and
additional disclosures in 1996 as permitted by the new standard.
39
Fund American accounts for its stock options outstanding in accordance with
Accounting Principles Board Opinion ("APB") No. 25 , "Accounting for Stock
Issued to Employees, and accordingly, recognizes compensation and benefits
expense for stock option grants to the extent that the fair value of the stock
exceeds the exercise price of the option at the measurement date.
2. Insurance Operations
Insurance operations acquired and formed in 1995
On December 1, 1995 White Mountains acquired Valley and Charter for $41.7
million in cash less $3.0 million of purchase price adjustments. Valley's wholly
owned subsidiary, Valley Insurance Company, is an "A" rated, Northwest-based
property and casualty company which writes personal and commercial lines through
independent agents. In 1995 Valley Insurance Company wrote $73.1 million of
gross premiums in Oregon, Washington and California. Charter's wholly owned
subsidiary, Charter Indemnity Company, wrote $64.4 million of gross non-standard
automobile insurance premiums in Texas during 1995. The purchase price paid for
Valley and Charter was $.9 million less than the aggregate book value and
estimated fair value of the net assets of the companies on the date of
acquisition. The resulting negative goodwill is being amortized to income on a
straight-line basis over five years.
WMIC, a New Hampshire licensed commercial property and casualty insurance
company, commenced its operations in September 1995 and wrote $250,000 in direct
premiums during the year. WMIC is expected to expand its operations to other
states as additional state approvals are obtained.
Loss and loss adjustment expense reserve activity
The following table summarizes White Mountains' insurance subsidiaries' loss and
loss adjustment expense reserve activity for the year ended December 31, 1995:
- --------------------------------------------------------------------------------
Loss and loss
adjustment expense
Millions reserves
- --------------------------------------------------------------------------------
Balance as of December 31, 1994 $ --
Reserves acquired through the purchase of Valley and Charter 39.9
Estimated losses and loss adjustment expenses incurred 5.2
Reserve strengthening for periods' losses and loss adjustment expenses 3.0
Losses and loss adjustment expenses paid (4.0)
--------
Balance as of December 31, 1995 $44.1
================================================================================
Additional insurance operations information
Under the insurance laws of the various states under which White Mountains'
insurance subsidiaries are incorporated or licensed to write business, an
insurer is restricted with respect to the amount of dividends it may pay without
prior approval by state regulatory authorities. Accordingly, there is no
assurance that dividends may be paid by White Mountains' insurance operating
subsidiaries in the future.
Total policyholders surplus of White Mountains' insurance operating
subsidiaries as of December 31, 1995 was $58.5 million.
40
3. Tax Benefit From Sale of Subsidiary
On January 2, 1991 the Company sold Fireman's Fund to Allianz of America, Inc.
The $1.3 billion gain from the sale as reported in 1991 included a $75.0 million
tax benefit related to the Company's estimated tax loss from the sale. Since
1991 the Company has carried an estimated reserve related to tax matters
affecting the amount of the deductible tax loss from the sale and other tax
matters.
The conclusion in 1995 of IRS audits of Fund American's Federal income tax
returns for all taxable periods ending on or prior to October 23, 1985 (the date
of Fund American's initial public offering of Shares) resolved certain of the
tax matters affecting the amount of the Company's deductible tax loss from the
sale of Fireman's Fund and the Company has, therefore, re-estimated its tax
reserve. As a result of the reserve re-estimation, the Company included in its
1995 income statement an additional $66.0 million income tax benefit from the
sale.
The amount of tax benefit from the sale of Fireman's Fund ultimately realized
by the Company may be significantly more or less than the Company's current
estimate due to possible changes in or new interpretations of tax rules,
possible amendments to Fund American's 1990 or prior years' Federal income tax
returns, the results of further IRS audits and other matters affecting the
amount of the deductible tax loss from the sale.
4. Investment Securities
Net investment income consisted of the following:
- --------------------------------------------------------------------------------
Year Ended December 31,
------------------------------
Millions 1995 1994 1993
- --------------------------------------------------------------------------------
Interest income:
Mortgage loans held for sale $ 35.9 $ 66.6 $ 88.0
Short-term investments 6.6 7.8 6.4
Other 5.7 5.3 24.3
------------------------------
Total interest income 48.2 79.7 118.7
Dividend and royalty trust income 7.5 11.1 15.2
Less investment expenses and other (.3) (.6) (.4)
------------------------------
Net investment income, before tax $ 55.4 $ 90.2 $ 133.5
================================================================================
Net realized investment gains and changes in net unrealized investment losses
were as follows:
- --------------------------------------------------------------------------------
Year Ended December 31,
------------------------------
Millions 1995 1994 1993
- --------------------------------------------------------------------------------
Gross realized investment gains $ 46.3 $ 67.0 $ 63.0
Gross realized investment losses (7.5) (28.2) (12.4)
------------------------------
Net realized investment gains 38.8 38.8 50.6
Net unrealized investment gains (losses)
Included in net income -- -- 73.4
Recorded directly to shareholders' equity 28.0 (84.3) 69.9
------------------------------
Total net investment gains (losses),
before tax $ 66.8 $ (45.5) $ 193.9
================================================================================
41
Proceeds from sales of investments, excluding short-term investments, totalled
$252.1 million, $340.3 million and $356.3 million for the years ended December
31, 1995, 1994 and 1993, respectively.
The components of ending net unrealized investment gains and losses were as
follows:
- --------------------------------------------------------------
December 31,
-----------------
Millions 1995 1994
- --------------------------------------------------------------
Unrealized gains $ 60.6 $ 47.3
Unrealized losses (2.3) (17.0)
-----------------
Total net unrealized investment gains,
before tax $ 58.3 $ 30.3
==============================================================
The cost or amortized cost, gross unrealized investment gains and losses, and
carrying values of fixed maturity investments as of December 31, 1995 and 1994
were as follows:
- ---------------------------------------------------------------------------------------------------------------------
December 31, 1995
----------------------------------------------------------------------
Cost or Gross Gross
amortized unrealized unrealized Carrying
Millions cost gains losses value
- ---------------------------------------------------------------------------------------------------------------------
U S West, Inc. redeemable preferred stock $ 48.8 -- -- $ 48.8
State and municipal obligations 33.3 .1 (.1) 33.3
U. S. Government and agency obligations 23.5 .7 -- 24.2
Aggregate of holdings less than $10 million 4.2 .2 -- 4.4
----------------------------------------------------------------------
Total fixed maturity investments $109.8 1.0 (.1) $110.7
- -----------------------------------------------======================================================================
- ---------------------------------------------------------------------------------------------------------------------
December 31, 1995
----------------------------------------------------------------------
Cost or Gross Gross
amortized unrealized unrealized Carrying
Millions cost gains losses value
- ---------------------------------------------------------------------------------------------------------------------
White River Corporation term note $ 50.0 -- -- $ 50.0
U S West, Inc. redeemable preferred stock 48.6 -- -- 48.6
Aggregate of holdings less than $10 million 3.6 -- -- 3.6
----------------------------------------------------------------------
Total fixed maturity investments $102.2 -- -- $102.2
=====================================================================================================================
The cost or amortized cost and carrying value of fixed maturity investments at
December 31, 1995 and 1994 are shown below by contractual maturity. Actual
maturities could differ from contractual maturities because borrowers have the
right to call or prepay certain obligations with or without call or prepayment
penalties.
42
- --------------------------------------------------------------------------------
December 31,
--------------------------------------------------
1995 1994
--------------------- --------------------
Cost or Cost or
amortized Carrying amortized Carrying
Millions cost value cost value
- -------------------------------------------------------------------------------
Due in one year or less $ 3.0 $ 3.0 $ 50.0 $ 50.0
Due after one year through
five years 16.7 17.2 -- --
Due after five years
through ten years 60.0 60.1 52.2 52.2
Due after ten years 30.1 30.4 -- --
--------------------- --------------------
Total $109.8 $110.7 $102.2 $102.2
===============================================================================
Non-cash exchanges of investment securities totalling $90.4 million and $.3
million during 1995 and 1994, respectively, are not reflected in the
Consolidated Statements of Cash Flows.
5. Mortgage Origination and Servicing
Source One services loans throughout the United States. Source One's portfolio
of mortgage loans serviced, including loans subserviced, interim servicing
contracts and those under contract to acquire and excluding loans sold but not
transferred, totalled $31.8 billion and $39.6 billion as of December 31, 1995
and 1994, respectively. The servicing portfolio included GNMA guaranteed
mortgage-backed securities of $10.7 billion and $11.9 billion as of December 31,
1995 and 1994, respectively. The following table summarizes the mortgage loan
servicing portfolio:
- ----------------------------------------------------------------------------------------------------------------------------------
Weighted average
----------------------------------------------------------------------------------
Outstanding Remaining
principal Loan Net contractual
balance balance Interest servicing life
(millions) (thousands) rate fee rate (months)
- ----------------------------------------------------------------------------------------------------------------------------------
Loan Type:
Residential:
Conventional $16,291 $ 73 8.37% .411% 229
FHA 7,606 49 8.67 .433 271
VA 3,814 49 8.43 .432 256
Commercial 81 709 7.51 .155 171
-----------
27,792 61 8.46 .419 245
Subservicing 4,039
-----------
Total servicing portfolio $31,831
==================================================================================================================================
The servicing fee rates in the preceding table are shown after deducting
applicable guarantee fees. Guarantee fees, when applicable, range from six
basis points for governmental loans to approximately 30 basis points for certain
conventional loans. Certain loans sold to private investors have no guarantee
fees.
43
The following tables summarize Source One's mortgage loan servicing portfolio
by interest rate range and by location of property:
- ---------------------------------------------------------------------------------------------------------------------
December 31, 1995 December 31, 1994
------------------------------------------ ------------------------------------
Aggregate Weighted Aggregate Weighted
Number principal average Number principal average
Interest rate of balance interest of balance interest
range loans (millions) rate loans (millions) rate
- ----------------- ------------------------------------------ ------------------------------------
5.99% and lower 2,674 $ 114 5.51% 6,597 $ 318 5.37%
6.00% - 6.49% 8,208 434 6.19 11,887 800 6.21
6.50% - 6.99% 25,192 2,077 6.69 37,415 3,339 6.71
7.00% - 7.49% 64,052 4,573 7.16 89,649 7,316 7.16
7.50% - 7.99% 84,899 6,745 7.63 93,328 7,748 7.61
8.00% - 8.49% 60,843 4,315 8.10 57,323 4,220 8.09
8.50% - 8.99% 80,936 4,217 8.60 78,998 4,465 8.60
9.00% - 9.49% 38,939 2,234 9.08 36,115 2,168 9.08
9.50% - 9.99% 57,131 3,185 9.60 59,174 3,383 9.60
10% and above 71,177 3,937 10.55 72,942 4,160 10.52
------------------------- ---------------------
Total 494,051 $31,831 8.33% 543,428 $37,917 8.14%
=====================================================================================================================
- ---------------------------------------------------------------------------------------------------------------------
December 31, 1995 December 31, 1994
------------------------------------------ ------------------------------------
Aggregate Weighted Aggregate Weighted
Number principal average Number principal average
Interest rate of balance interest of balance interest
range loans (millions) rate loans (millions) rate
- ----------------- ------------------------------------------ ------------------------------------
California 73,865 $ 6,668 20.9% 79,621 $ 7,195 19.0%
New York 45,830 2,803 8.8 35,214 2,611 6.9
Washington 30,064 2,386 7.5 42,584 3,502 9.2
Texas 28,841 1,705 5.4 26,411 1,863 4.9
Florida 28,123 1,502 4.7 29,955 1,842 4.9
Michigan 30,235 1,308 4.1 33,174 1,865 4.9
Illinois 18,486 1,291 4.1 20,984 1,580 4.2
New Jersey 15,201 1,056 3.3 18,075 1,331 3.5
Arizona 15,751 949 3.0 17,570 1,104 2.9
Massachusetts 12,822 875 2.7 14,416 1,005 2.6
Other 194,833 11,288 35.5 225,424 14,019 37.0
------------------------------------------ ------------------------------------
Total 494,051 $31,831 100.0% 543,428 $37,917 100.0%
=====================================================================================================================
The tables above include $4,039 million and $4,294 million outstanding principal
balance of loans subserviced for others as of December 31, 1995 and 1994,
respectively. The tables exclude $1,651 million outstanding principal balance
of interim servicing as of December 31, 1994.
Escrow funds of approximately $236.0 million and $277.9 million as of
December 31, 1995 and 1994, respectively, relating to mortgages serviced and
subserviced, were held in non-interest bearing accounts at non-affiliated banks
and are not included in the consolidated financial statements.
44
Source One has in force an errors and omissions policy in the amount of $20.0
million. Primary fidelity coverage up to a limit of $35.0 million is provided
under a Fund American master policy for which Source One pays a portion of the
premium.
6. Capitalized Servicing
Source One estimates the fair values of its mortgage servicing rights by
calculating the present value of the expected future cash flows associated with
such rights. In making those estimates, Source One incorporates assumptions that
market participants would use in their estimates of future servicing income and
expense and discounts those cash flows using current estimated market rates. As
of December 31, 1995 such discount rates were 10.5% for conventional loans and
12.0% for insured loans.
To measure impairment of the mortgage servicing rights, Source One stratifies
its mortgage loan servicing portfolio based on the portfolio's predominant risk
characteristics which have been determined to be prepayment, default and
operational risks. This results in stratification by interest rate, loan type
(investor) and original term to maturity. The prepayment assumptions used in the
estimation of fair values are based on market prepayment predictions. The fair
value of each stratum is computed and compared to its recorded book value to
determine if a valuation allowance, or recovery of a previously established
valuation allowance, is required.
The discount rate and prepayment assumptions are significant factors used in
estimating the fair value of Source One's mortgage servicing rights and could be
significantly impacted by changes in interest rates. Accordingly, it is likely
that management's estimate of the fair value of the capitalized servicing asset
will change from time to time due to changes in interest rates.
The following table summarizes the fair value of mortgage servicing rights
and certain characteristics of Source One's servicing portfolio related to such
mortgage servicing rights as of December 31, 1995:
- ----------------------------------------------------------------------------------------------------
Fair value
of mortgage Principal Weighted Weighted Weighted
servicing balance average average average
rights serviced (a) interest maturity service
Loan type (millions) (millions) rate (months) fee
- ----------------------------------------------------------------------------------------------------
Insured $172.0 $ 8,872 8.77% 259 44%
Conventional 193.4 13,354 8.45 231 .34
Adjustable Rate 21.6 1,297 8.06 309 .43
-----------------------------
Total $387.0 $23,523 8.55% 246 .38%
====================================================================================================
(a) Excludes $4,039 million of related to originations not subservicing and
$4,269 million capitalized prior to the of mortgage servicing rights
adoption of SFAS No. 122.
The adoption of SFAS No. 122 as it relates to the capitalization of originated
mortgage servicing rights resulted in the recognition of an additional pretax
gain on sales of mortgages of $27.2 million for the year ended December 31,
1995. The impairment provisions of SFAS No. 122 resulted in a pretax charge of
$28.0 million for the year.
45
In 1994 Source One adopted an accounting methodology that measured impairment
of the purchased mortgage servicing rights asset on a disaggregated basis by
discounting estimated future cash flows using a current market rate. Prior to
1994 Source One measured impairment of the purchased mortgage servicing rights
asset on a disaggregated basis including a cost of capital charge for estimating
future cash flows. The adoption of the new accounting methodology, recorded as
a cumulative adjustment as of January 1, 1994, resulted in a $68.1 million
pretax, $44.3 million after tax, charge to income for 1994.
Source One estimates the fair value of its capitalized excess servicing asset
by discounting the anticipated future cash flows over the estimated life of the
related loans. Source One uses interest only ("I/O") strip interest rates as
quoted by market participants to determine the appropriate discount rates and
prepayment speed assumption rates that are based on interest rates, loan types
and original term to maturity. The discount rate used to capitalize excess
servicing for 1995 was 12.0%; ranged from 8.0% to 10.0% for the year ended
December 31, 1994; and was 8.0% for the year ended December 31, 1993. For the
years ended December 31, 1995, 1994 and 1993, the weighted average discount
rates inherent in the carrying amount of the capitalized excess servicing asset
were 10.03%, 9.12% and 9.03%, respectively.
The following table summarizes changes in Source One's capitalized servicing
asset:
- ------------------------------------------------------------------------------------------------------------------
Deferred
gain on Total
Purchased Originated Excess Valuation sale of capitalized
Millions servicing servicing servicing allowance servicing servicing
- ------------------------------------------------------------------------------------------------------------------
Balances at
January 1, 1993 $ 551.3 $ -- $ 73.4 $ -- $ -- $ 624.7
Additions 117.5 -- 58.1 -- -- 175.6
Scheduled amortization (90.1) -- (11.5) -- -- (101.6)
Impairment and
unscheduled amortization (8.5) -- (23.5) -- -- (32.0)
- ------------------------------------------------------------------------------------------------------------------
Balances at
December 31, 1993 570.2 -- 96.5 -- -- 666.7
Cumulative effect of
accounting change (68.1) -- -- -- -- (68.1)
Additions 69.7 -- 16.7 -- (19.9) 66.5
Scheduled amortization (61.7) -- (12.1) -- 2.7 (71.1)
Impairment and
unscheduled amortization (12.8) -- (.4) -- -- (13.2)
Sales (21.7) -- (28.6) -- -- (50.3)
- ------------------------------------------------------------------------------------------------------------------
Balances at
December 31, 1994 475.6 -- 72.1 -- (17.2) 530.5
Additions 64.2 31.2 7.4 -- -- 102.8
Scheduled amortization (43.9) (1.4) (7.5) -- 4.2 (48.6)
Impairment and unscheduled
amortization -- -- (.5) (28.0) -- (28.5)
Sales (132.4) -- (26.7) -- -- (159.1)
- ------------------------------------------------------------------------------------------------------------------
Balances at
December 31, 1995 $ 363.5 $29.8 $ 44.8 $(28.0) $(13.0) $ 397.1
==================================================================================================================
46
During 1995 Source One sold the rights to service $10,973 million of mortgage
loans for net proceeds of $199.1 million, resulting in a pretax gain of $40.0
million. During 1994 Source One sold the rights to service $3,868 million of
mortgage loans for net proceeds of $70.2 million and continues to service these
loans pursuant to a subservicing agreement. A gain of $19.9 million was
deferred in 1994 and is being recognized in income over the five-year life of
the subservicing agreement.
7. Mortgage Loans Held For Sale and Pool Loan Purchases
The following tables summarize Source One's mortgage loans held for sale and
pool loan purchases:
- -------------------------------------------------------------------------
December 31,
--------------------------
Millions 1995 1994
- -------------------------------------------------------------------------
Adjustable rate mortgage
loans, weighted average
interest rates of 6.55%
and 7.66% $ 17.6 $ 46.4
Fixed rate 5 year through
20 year mortgage loans,
weighted average
interest rates of 7.47%
and 8.81% 59.5 34.0
Fixed rate 30 year
mortgage loans, weighted
average
interest rates of 7.89%
and 9.27% 303.0 131.3
--------------------------
Total principal amount 380.1 211.7
Net premiums (discounts) .9 (1.2)
--------------------------
Total mortgage loans held
for sale $ 381.0 $ 210.5
=========================================================================
- ----------------------------------------------------------------------------
Principal balance
(millions) Number of loans
------------------- ---------------
December 31, 1995 1994 1995 1994
- ----------------------------------------------------------------------------
Loan type: FHA $ 77.6 $102.8 1,433 1,850
VA 32.5 41.9 545 719
Conventional 8.9 19.2 106 224
----------------------------------------
Total pool loan purchases $119.0 $163.9 2,084 2,793
============================================================================
8. Debt
Short-term debt
Short-term debt outstanding consisted of the following:
- -------------------------------------------------------------------------------
December 31,
-------------------------
Millions 1995 1994
- -------------------------------------------------------------------------------
Parent Company:
Loan guarantee $ -- $ 30.0
--------------------------
Charter:
Notes payable and obligations under capital leases 20.8 --
--------------------------
Source One:
Commercial paper 256.6 26.1
Credit agreement borrowings 64.5 198.8
Debentures due in 1996 74.6 --
Medium term notes due in 1996 29.7 --
Less net discounts (.8) (.8)
--------------------------
Total Source One 424.6 224.1
--------------------------
Total short-term debt 445.4 254.1
===============================================================================
47
The weighted average interest rates of short-term debt outstanding during 1995
and 1994 were as follows:
- --------------------------------------------------------------------------------
Year Ended December 31,
-----------------------
1995 1994
- --------------------------------------------------------------------------------
Parent Company:
Revolving credit facility 6.57% 5.11%
Loan guarantee 5.36% 5.36%
Charter:
Notes payable 6.50% --
Source One:
Commercial paper 6.04% 3.92%
Credit agreements and bid loans 6.91% 5.03%
================================================================================
In June 1994 the Company entered into a revolving credit agreement with a
syndicate of banks. Under the agreement, through August 9, 1996 the Company and
certain of its subsidiaries may borrow up to $75.0 million at short-term market
interest rates. The credit agreement contains certain customary covenants,
including a $475.0 million minimum tangible net worth requirement and a minimum
financial asset coverage requirement. At December 31, 1995 and 1994 the Company
had no borrowings outstanding under the agreement.
In August 1993 the Company sold a $30.0 million principal amount secured loan
receivable from the Company's Chairman to a third party. The Company had
guaranteed repayment of the loan and, therefore, in accordance with GAAP, had
reflected the guarantee of the loan as indebtedness on the balance sheet. The
loan matured and was repaid on October 23, 1995.
In November 1995 Charter issued two notes totalling $20.2 million. The notes
are due in 1996 and are collateralized by certain assets of Charter.
Source One has a $650.0 million domestic and Euro commercial paper program.
The weighted average number of days to maturity of commercial paper outstanding
at December 31, 1995 was 19 days.
In March 1995 Source One consolidated its three then existing credit
facilities into a single credit facility in the amount of $500.0 million. The
new facility can be increased at Source One's option with bank concurrence up to
$1.0 billion. Borrowings under the new facility, which matures in March 1998,
are secured primarily by Source One's mortgage loans receivable and mortgage
loan servicing portfolio. As of December 31, 1995 no borrowings were
outstanding under the new facility. As of December 31, 1994 there was $195.0
million outstanding under the previous three credit facilities.
Source One's secured credit agreements contain covenants which limit its
ability to pay dividends or make distributions on its capital in excess of
existing preferred stock dividend requirements. These covenants also require
Source One to maintain a certain level of total tangible net worth and a certain
ratio of debt to total tangible net worth. Source One is currently in
compliance with all such covenants.
In August 1995 Source One entered into a $60.0 million unsecured revolving
credit facility which expires in July 1996.
Under the credit agreements described above, Source One receives interest
expense credits as a result of holding escrow and custodial funds in trust
accounts at non-affiliated banks.
48
Source One also has a revolving credit agreement under which it can borrow up
to $10.0 million. As of December 31, 1995 and 1994 there was $4.5 million and
$3.8 million outstanding under this agreement, respectively.
Long-Term Debt
Long-term debt outstanding consisted of the following:
- --------------------------------------------------------------------------------
December 31,
------------------
Millions 1995 1994
- --------------------------------------------------------------------------------
Parent Company:
Medium-term notes $116.2 $125.0
Less net discounts (.9) (1.2)
------------------
Total Parent Company 115.3 123.8
------------------
Source One:
Debentures, 8.25% due in 1996 -- 125.0
Medium-term notes, 9.65% due in 1996 -- 40.0
Medium-term notes, 8.875% due in 2001 138.4 160.0
Debentures, 9% due in 2012 100.0 100.0
Subordinate debentures, 9.375% due 2025 56.0 --
Less net discounts (2.4) (1.8)
-------------------
Total Source One 292.0 423.2
------------------
Total long-term debt $407.3 $547.0
================================================================================
During 1993 the Company issued $150.0 million in principal amount of medium-term
notes for net cash proceeds of $148.0 million after related costs. Proceeds
from the issuance of the notes were used to repay an existing revolving credit
facility and for general corporate purposes. During 1995 and 1994 the Company
repurchased $8.8 million and $25.0 million, respectively, in principal amount of
the notes due February 2003. At December 31, 1995 the remaining outstanding
notes had an average maturity of 7.41 years and an average yield to maturity of
7.82%.
In 1986 Source One issued $125.0 million of 8.25% debentures due November 1,
1996. During 1995 Source One repurchased and retired $50.4 million in principal
amount of these debentures.
In 1989 Source One issued $40.0 million of medium-term notes due in 1996 and
having a total weighted average interest rate of 9.65%. In 1991 Source One
issued $160.0 million of 8.875% medium-term notes due in 2001. During 1995
Source One repurchased and retired in principal amount $10.3 million of medium-
term notes that were due in 1996 and $21.6 million of medium-term notes that
were due in 2001.
In 1992 Source One issued $100.0 million of 9% debentures due in 2012 under
terms of a $250.0 million shelf registration statement. The proceeds from
issuance were used for general corporate purposes.
On December 8, 1995 Source One exchanged and retired 2,239,061 shares of
Source One Preferred Stock for $56.0 million in principal amount of 9.375%
Subordinated Debentures. The Subordinated Debentures are due on December 31,
2025. The Subordinated Debentures are redeemable at the option of Source One,
in whole or part, at any time on or after May 1, 1999. The non-cash portion of
the exchange of Subordinated Debentures for Source One Preferred Stock is not
reflected in the Consolidated Statements of Cash Flows.
49
Total interest paid by Fund American for both short-term and long-term debt
was $47.9 million, $80.1 million and $98.1 million in 1995, 1994 and 1993,
respectively.
9. Income Taxes
The Company and its qualifying subsidiaries file a consolidated Federal income
tax return. The Federal income tax provision is computed on the consolidated
taxable income of the Company and those subsidiaries.
The total income tax provision (benefit) consisted of the following:
- --------------------------------------------------------------------------------
Year Ended December 31,
------------------------------
Millions 1995 1994 1993
- --------------------------------------------------------------------------------
Tax on pretax earnings:
Federal $ 16.6 $ 20.2 $ 67.8
State and local .1 .3 2.7
------------------------------
Income tax provision on pretax earnings 16.7 20.5 70.5
Tax benefit from sale of discontinued operations (66.0) -- --
Tax benefit from loss on early extinguishment
of debt (.2) -- --
Tax on cumulative effect of accounting change -
purchased mortgage servicing -- (23.8) --
------------------------------
Total income tax provision (benefit) $(49.5) $ (3.3) $ 70.5
- --------------------------------------------------==============================
Net income tax payments (recoveries) $ 2.6 $ (.7) $ 12.0
- --------------------------------------------------==============================
Tax provision (benefit) recorded directly to
shareholders' equity related to:
Exercises of employee stock options
and warrants $ .2 $ (2.0) $ (4.7)
Changes in net unrealized
investment gains and losses $ 9.8 $(29.5) $ 24.1
================================================================================
The components of the income tax provision on pretax earnings follow:
- --------------------------------------------------------------------------------
Year Ended December 31,
------------------------------
Millions 1995 1994 1993
- --------------------------------------------------------------------------------
Current provision $ 26.4 $ 21.9 $ 33.3
Deferred provision (benefit) (9.7) (1.4) 37.2
Total income tax provision on pretax earnings $ 16.7 $ 20.5 $ 70.5
================================================================================
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax return purposes. Significant
components of Fund American's net deferred Federal income tax asset follow:
50
- --------------------------------------------------------------------------------
December 31,
-----------------------
Millions 1995 1994
- --------------------------------------------------------------------------------
Deferred tax assets related to:
Capitalized mortgage servicing $ 13.7 $ 18.7
Employee compensation and benefit accruals 30.3 12.2
Allowance for mortgage loan losses 4.8 4.7
Other items 12.5 6.1
-----------------------
Total deferred tax assets 61.3 41.7
- --------------------------------------------------------------------------------
Deferred tax liabilities related to:
Purchase accounting adjustments 10.2 11.2
Net unrealized investment gains 13.4 2.5
Equity in earnings of affiliates 4.0 .8
Other items 8.9 5.8
-----------------------
Total deferred tax liabilities 36.5 20.3
- --------------------------------------------------------------------------------
Net deferred Federal income tax asset $ 24.8 $ 21.4
================================================================================
A reconciliation of taxes calculated using the 35% Federal statutory rate to the
income tax provision on pretax earnings follows:
- --------------------------------------------------------------------------------
Year Ended December 31,
-----------------------------
Millions 1995 1994 1993
- --------------------------------------------------------------------------------
Tax provision at Federal statutory rate $ 12.3 $ 14.6 $ 49.3
Differences in taxes resulting from:
Minority interest dividends 2.7 2.3 --
Purchase accounting adjustments .7 .7 .8
State and local income taxes -- .2 1.8
White River Distribution -- -- 17.7
Dividends received deduction (1.9) (2.2) (2.7)
Tax reserve adjustments 2.3 4.6 2.4
Other .6 .3 1.2
-----------------------------
Total income tax provision on pretax earnings $ 16.7 $ 20.5 $ 70.5
================================================================================
In December 1993 the Company distributed to its shareholders approximately 74%
of the outstanding shares of Common Stock of White River. The $17.7 million
income tax provision resulting from the distribution includes $13.0 million of
current tax related to taxable capital gains triggered by the distribution which
were not recognized for financial reporting purposes pursuant to GAAP. The
provision also includes a $4.7 million tax reserve established on White River's
books of record as of December 22, 1993, the date of the distribution. Such
reserve offsets White River's deferred tax asset calculated on a stand-alone
basis as of that date.
51
Sections 382 and 383 of the Internal Revenue Code of 1986, as amended
(the "IRC"), impose limitations on the use of certain tax benefits by a
corporation that undergoes a more than 50% ownership change. The tax benefits
which may be limited include loss carryforwards and built-in losses and
deductions existing on the date of ownership change. The annual limitation for
the utilization of such benefits during a five-year post-change period is
generally calculated by multiplying the value of the corporation (as defined by
the IRC) at the time of the ownership change by an interest rate (a long-term
tax-exempt bond rate defined by the IRC). While regulatory guidance on the
subject is not complete, the Company believes that it had an ownership change
during 1992 so as to make the Section 382 and 383 limitations applicable to Fund
American. Fund American believes that the imposition of such limitations will
not have a material adverse effect on its financial position or results of
operations.
10. Retirement and Post-Retirement Plans
In 1993 the Company established the Fund American Deferred Benefit Plan (the
"Deferred Benefit Plan"), a nonqualified defined contribution plan for a select
group of management employees for the purpose of providing retirement and
postretirement benefits. The amount of annual contributions to the Deferred
Benefit Plan are determined using actuarial assumptions; however, participants
in the Deferred Benefit Plan may choose between various investment options for
their plan balances. At December 31, 1995 the Company's liability to
participants pursuant to the Deferred Benefit Plan was $1.9 million.
In 1993 the Company also established the Fund American Voluntary Deferred
Compensation Plan (the "Deferred Compensation Plan"), a nonqualified plan for a
select group of management employees for the purpose of deferring current
compensation. Pursuant to the Deferred Compensation Plan, participants may defer
all or a portion of qualifying remuneration payable by Fund American.
Participants in the Deferred Compensation Plan may choose between various
investment options for their plan balances. At December 31, 1995 the Company's
liability to participants pursuant to the Deferred Compensation Plan was $16.5
million.
Source One established its defined benefit pension plan as of July 1,
1986 for the benefit of its employees. Benefits under the Source One plan are
based on years of service and each employee's highest average eligible
compensation over five consecutive years in his or her last ten years of
employment. Funding of retirement costs complies with the minimum funding
requirements specified by the Employee Retirement Income Security Act. Cash
contributions made by Source One to the plan for the years ended December 31,
1995, 1994 and 1993 totalled $1.7 million, $1.1 million and $1.9 million,
respectively.
Source One also has a supplemental pension plan which is a
nonqualified, unfunded benefit plan designed to provide supplementary retirement
benefits for employees whose pensionable compensation exceeds statutory limits.
52
The following table sets forth the pension cost and actuarial assumptions
used in determining the funded status of Source One's qualified defined benefit
pension plan:
- --------------------------------------------------------------------------------
Year Ended December 31,
--------------------------------
Dollars in millions 1995 1994 1993
- --------------------------------------------------------------------------------
Pension cost for period:
Service cost for period $ 1.4 $ 1.6 $ 1.4
Interest cost on projected benefit obligation 1.4 1.3 1.2
Actual return on plan assets (3.8) 1.0 (1.3)
Net amortization and deferral 2.6 (1.5) .9
--------------------------------
Total pension cost $ 1.6 $ 2.4 $ 2.2
- ------------------------------------------------================================
Funded status at end of period:
Actuarial present value of benefit obligation:
Accumulated benefit obligation, including
vested benefits of $15.1, $11.0 and $11.3 $17.2 $12.6 $13.0
Effect of projected future salary increases 6.8 5.1 5.3
--------------------------------
Total projected benefit obligation 24.0 17.7 18.3
Plan assets at fair value 18.1 13.1 13.3
--------------------------------
Projected benefit obligation in excess of
plan assets 5.9 4.6 5.0
Aggregate of items not yet charged
to earnings (4.2) (2.7) (4.4)
--------------------------------
Pension cost accrued at end of period $ 1.7 $ 1.9 $ .6
- -----------------------------------------------=================================
Actuarial assumptions:
Discount rate 7.0% 8.0% 7.0%
Rate of increase in future compensation levels 6.0% 6.0% 6.0%
Expected long-term rate of return on plan assets 8.0% 8.0% 8.0%
================================================================================
Total accrued postretirement benefit costs included in accounts payable and
other liabilities for Source One employees was $3.3 million and $3.2 million at
December 31, 1995 and 1994, respectively.
Through December 1, 1995 substantially all the employees of Valley and
Charter were covered under a defined benefit pension plan sponsored for the
former parent of Valley and Charter. Coverage for employees under that plan was
terminated as of December 31, 1995. Valley established a new defined
contribution plan for the benefit of substantially all Valley and Charter
employees as of January 1, 1996. The new plan provides Valley and Charter
employees with full credit for prior service.
11. Employee Stock Plans
At the Company's 1995 Annual Meeting shareholders approved certain amendments to
the Fund American Long-Term Incentive Plan (the "Incentive Plan"). The Incentive
Plan provides for granting to executive officers and other key employees of the
Company (and certain of its subsidiaries) various types of stock-based incentive
awards including stock options and performance shares. At December 31, 1995,
500,000 Shares remained available for grants under the Incentive Plan.
Stock options are rights to purchase a specified number of Shares at or
above the fair market value of Shares at the time an option is granted. Stock
options generally vest over a four-year period and expire no later than ten
years after the date on which they are granted.
53
Performance shares are conditional grants of a specified maximum number of
Shares or an equivalent amount of cash. The grants are generally payable,
subject to the attainment of a specified return on equity, at the end of three-
to five-year periods or as otherwise determined by the Human Resources Committee
(the "Committee") of the Company's Board of Directors (the "Board"). The
Committee consists solely of non-management directors.
The following table details the transactions applicable to non-qualified
stock options to acquire Shares:
- --------------------------------------------------------------------------------
Number Exercise price
- --------------------------------------------------------------------------------
Balance at January 1, 1993 114,125 $25.75-$56.41
Exercised during 1993 107,000 $25.75-$59.87
--------------------------------
Balance at December 31, 1993 and 1994 7,125 $24.82-$32.60
Exercised during 1995 4,125 $24.82
--------------------------------
Balance at December 31, 1995 3,000 $27.13-$32.60
================================================================================
All Fund American stock options outstanding at December 31, 1995 were fully
vested and exercisable.
Pursuant to the Incentive Plan 57,428 and 56,000 performance shares were
granted in 1995 and 1993, respectively. No performance shares were granted in
1994. During 1993, 75,375 performance shares were cancelled and 205,375
performance shares were paid, of which 27,672 were paid in the form of Shares
and the remainder in cash. No performance shares were cancelled or paid during
1994 and 1995. At December 31, 1995, 181,678 performance shares were
outstanding. Of the performance shares outstanding at December 31, 1995, 68,250
are valued as being equivalent to one Fund American Share plus one-half share of
Common Stock of White River. The remaining 113,428 performance shares
outstanding at December 31, 1995 are valued as being equivalent to one Fund
American Share. The financial goal for full payment of the performance shares is
the achievement of a 13% to 15% annual return on equity measured over the
applicable performance periods.
In 1985 the Company's Chairman purchased warrants from American Express
Company ("American Express") entitling him to buy 1,700,000 Shares for $25.75
per Share. Warrants to purchase 420,000 Shares, 130,000 Shares and 150,000
Shares were exercised by the Chairman during 1992, 1994 and 1995, respectively,
leaving warrants to purchase 1,000,000 Shares outstanding at December 31, 1995.
Pursuant to a proposal approved by shareholders at the Company's 1995 Annual
Meeting, the expiration date with respect to the warrants outstanding at
December 31, 1995 was extended from January 2, 1996 to January 2, 2002. In
accordance with APB No. 25, the warrant extension resulted in a $46.2 million
pretax charge to compensation expense which was recorded in the second quarter
of 1995.
Pursuant to certain anti-dilution adjustments related to the distribution of
White River Shares to the Company's shareholders, the Chairman received in 1993
warrants entitling him to purchase 640,000 White River Shares for $8.18 per
share, and the exercise price for the Chairman's warrants to purchase Shares was
reduced to $21.66 per Share. The Chairman exercised all the White River warrants
on November 19, 1993.
54
Source One has various long-term incentive plans which provide for the
granting, to key senior management employees of Source One, stock-based and cash
incentive awards. Awards made pursuant to the plans are payable upon the
achievement of specified financial goals over multi-year periods.
Source One also has a qualified employee stock plan. Contributions to
this plan are determined at the discretion of Source One's Board of Directors.
12. Minority Interest -Preferred Stock of Subsidiary
In March 1994 Source One issued 4,000,000 shares of 8.42% Source One Preferred
Stock, having a liquidation preference of $25.00 per share, for net cash
proceeds of $96.9 million. On December 8, 1995 Source One exchanged and retired
2,239,061 shares of Source One Preferred Stock for $56.0 million in principal
amount of Subordinated Debentures. The Source One Preferred Stock is not
redeemable prior to May 1, 1999. In consolidation, dividends on the Source One
Preferred Stock are included as a component of interest expense.
13. Shareholders' Equity
Series D and E Preferred Stock
Through July 31, 1994 the Series D Preferred Stock had an annual dividend rate
of 7.75% and was initially redeemable for cash or, at the Company's option, for
Shares (based on the then current market value of Shares) on July 31, 1994. On
August 1, 1994, the Company redeemed 22,778 shares of the Series D Preferred
Stock for $82.0 million, an amount equal to the stock's liquidation preference.
In accordance with the terms of the Series D Preferred Stock, the annual
dividend rate for the remaining 20,833 shares of the Series D Preferred Stock
outstanding was increased to 8.75% and the stock's term was extended to July 31,
1995. On July 31, 1995 the Company redeemed all 20,833 remaining shares of the
Series D Preferred Stock for $75.0 million of cash, an amount equal to the
stock's liquidation preference.
Common Share Repurchases
During 1995, 1994 and 1993 the Company repurchased 877,868 Shares, 1,128,057
Shares and 536,247 Shares, respectively, for $65.5 million, $78.8 million and
$41.8 million, respectively. All such repurchased Shares have been retired. At
December 31, 1995 the Company had outstanding authorization to purchase an
additional 372,132 Shares.
Loan for Common Stock Issued
On December 30, 1992, pursuant to a request from the Board, the Company's
Chairman agreed to an early exercise of stock options and warrants to purchase
1,000,000 Shares. The Board's request reflected concerns regarding proposed tax
legislation which could have limited or eliminated the Company's tax benefits
from certain employee stock options and warrants exercised in 1993 and
thereafter. To encourage exercise of the stock options and warrants, the Company
provided a $30.0 million 4% secured loan to the Chairman. The loan was reported
on the December 31, 1994 balance sheet in other assets, ($4.3million), and
shareholders' equity ($25.0 million). The non-recourse loan was fully repaid on
its maturity date, October 23, 1995.
55
As approved by shareholders at the 1995 Annual Meeting, the Company entered
into a five-year employment contract (the "Agreement") with the Company's
Chairman, John J. Byrne. The Agreement provided the Chairman with the right to
receive from the Company a guarantee of a loan obtained from a third party, in
an amount up to $15.0 million, upon the maturity of his existing loan with the
Company. In accordance with the Agreement, in October 1995 the Company
guaranteed a $15.0 million loan from a third party to the Chairman. The new loan
is recourse to the Chairman's net worth and has a term ending December 31, 1999,
a market interest rate and otherwise standard commercial terms. The Company was
not required to provide collateral protection for its guarantee of the loan and,
accordingly, the loan guarantee is not recorded on the balance sheet.
Common stock dividends
During 1993 and 1994 the Company did not pay regular cash dividends to
holders of Shares. In the fourth quarter 1995 the Board reinstated regular
periodic dividends on Shares of $.20 per quarter. The Board currently intends to
reconsider from time to time the declaration of regular periodic dividends on
Shares with due consideration given to the financial characteristics of Fund
American's remaining invested assets and operations and the amount and
regularity of its cash flows at the time.
14. Shareholders' Rights Plan
The Board adopted in 1987, and in 1988 and 1993 amended, a Shareholders' Rights
Plan under which rights to purchase preferred stock were distributed to
shareholders at the rate of one right for each Share (the "Rights"). Each Right
entitles the holder to purchase one one-thousandth of a share of the Company's
Series A Cumulative Participating Preferred Stock ("Series A Preferred").
The Rights enable the holders to acquire additional equity in either the
Company or an "Acquiring Person," and are exercisable if an unrelated person or
group (other than American Express or a wholly-owned subsidiary thereof, any
subsidiary of the Company, any employee benefit plan of the Company or its
subsidiaries or certain affiliates of the Company and certain persons who
inadvertently and temporarily cross the 25% threshold) acquires beneficial
ownership of 25% or more of the outstanding Shares (such a 25% or more
beneficial owner is deemed an "Acquiring Person"). Thereafter, the Rights would
trade separately from Shares and separate certificates representing the Rights
would be issued. The terms of the Series A Preferred are such that each one one-
thousandth of a share would be entitled to participate in dividends and to vote
on an equivalent basis with one whole Share, along with other preferential
dividend rights and preferential distribution rights in liquidation.
Upon the existence of an Acquiring Person, the Rights would entitle each
holder of a Right to purchase, at the exercise price, that number of one one-
thousandth of a share of Series A Preferred equivalent to the number of Shares
which, at the time of the transaction, would have a market value of twice the
exercise price. If certain acquisitions of the Company occur, a similar right to
purchase securities of the Company or the entity acquiring the Company at a
discount would arise.
Any Rights that are beneficially owned by an Acquiring Person (or any
affiliate or associate of an Acquiring Person) are null and void and any holder
of any such Right (including any subsequent holder) will be unable to exercise
or transfer any such Right. At any time after a person becomes an Acquiring
Person, the Board may mandatorily exchange all or some of the Rights for
consideration per Right equal to one-half of the
56
securities issuable upon the exercise of one Right pursuant to the terms of the
Rights Agreement (or the common share equivalent) and without payment of the
exercise price. The Rights, which do not have the right to vote or receive
dividends, expire November 25, 1997 and may be redeemed by the Company at a
price of $.01 per Right at any time prior to the earlier of (i) such time as a
person becomes an Acquiring Person or (ii) the expiration date. Under certain
circumstances, the Board may redeem the Rights only if a majority of the
disinterested directors (as defined in the Shareholders' Rights Plan) agrees
that the redemption is in the best interests of the Company and its
shareholders.
In 1987 the Company reserved 600,000 of its authorized preferred shares as
Series A Preferred for issuance pursuant to the Shareholders' Rights Plan.
15. Industry Segments
Revenues, pretax earnings and ending identifiable assets for Fund American's
industry segments are shown below:
- ------------------------------------------------------------------------------------------------
Year Ended December 31,
-------------------------------------------------------
Millions 1995 1994 1993
- ------------------------------------------------------------------------------------------------
Revenues:
Mortgage operations $ 178.6 $ 207.2 $ 234.5
Insurance operations 8.6 -- --
Other 35.1 21.3 16.5
-------------------------------------------------------
Total $ 222.3 $ 228.5 $ 251.0
- -----------------------------------------=======================================================
Pretax earnings:
Mortgage operations $ 43.3 $ 5.3 $ 62.2
Insurance operations (4.8) -- --
Other (3.3) 36.3 78.7
Total $ 35.2 $ 41.6 $ 140.9
- -----------------------------------------=======================================================
Ending assets:
Mortgage operations $1,135.0 $1,210.0 $2,647.2
Insurance operations 363.1 -- --
Other 373.8 597.3 657.8
-------------------------------------------------------
Total $1,871.9 $1,807.3 $3,305.0
================================================================================================
16. Investments in Unconsolidated Affiliates
Investment in FSA
Fund American owned 2,460,200 and 2,000,000 shares of FSA Common Stock at
December 31, 1995 and 1994, respectively. This represented approximately 7.8%
and 7.7%, respectively, of the total FSA shares outstanding at those times. Fund
American had voting rights to an additional 3,893,940 FSA shares at December 31,
1995 and 1994, raising Fund American's voting control of FSA to approximately
19.0% and 21.0%, respectively. At December 31, 1995 and 1994 Fund American also
owned various fixed price options and shares of convertible preferred stock
which, in total, give Fund American the right to acquire up to 4,560,607
additional shares of FSA Common Stock for aggregate consideration of $125.7
million. As of December 31, 1995 and 1994, Fund American's economic interest in
FSA was 21.0% and 23.4.%, respectively.
Fund American's investment in FSA is accounted for using the equity method.
The following table summarizes financial information for FSA:
57
- ----------------------------------------------------------------------------------------------------------------
Millions 1995 1994
- ----------------------------------------------------------------------------------------------------------------
Balance sheet data:
Total investments $1,110.7 $ 747.2
Total assets 1,490.3 1,074.3
Unearned premium reserve, net 330.3 212.9
Loss and loss adjustment expense reserve, net 50.2 35.6
Preferred shareholder's equity 0.7 0.7
Common shareholders' equity 777.2 544.7
Income statement data:
Gross premiums written $ 110.7 $ 106.4
Net premiums written 77.6 77.8
Net premiums earned 69.3 65.8
Net investment income 49.0 46.6
Net income 55.0 60.4
Amounts recorded by Fund American:
Investment in FSA $ 62.5 $ 44.4
Equity in earnings of FSA (a) 5.4 2.5
Equity in net unrealized investment gains (losses)
of FSA, before tax (b) 4.8 (1.9)
=================================================================================================================
(a) Recorded net of related amortization of goodwill
(b) Recorded directly to shareholders' equity
At December 31, 1995 and 1994 Fund American's consolidated retained earnings
included $4.6 million and $2.3 million, respectively, of undistributed earnings
of FSA.
Investment in MSA
At December 31, 1995 and 1994 Fund American owned 90,606 shares of MSA Common
Stock. This represented approximately 33.1% and 33.2%, respectively, of the
total MSA shares outstanding at those times. Fund American's investment in MSA
is accounted for using the equity method. The following table summarizes
financial information for MSA:
- ----------------------------------------------------------------------------------------------------------------
Millions 1995 1994
- ----------------------------------------------------------------------------------------------------------------
Balance sheet data:
Total investments $ 240.8 $ 189.6
Total assets 309.6 258.1
Unearned premium reserve, net 58.4 55.2
Loss and loss adjustment expense reserves, net 116.2 115.0
Shareholders' equity 92.0 69.8
Income statement data:
Net premiums written $ 130.9 $ 97.2
Net premiums earned 127.7 73.4
Net investment income 15.0 8.3
Net income 12.4 3.5
Amounts recorded by Fund American:
Investment in MSA $ 33.7 $ 25.3
Equity in earnings of MSA (a) 4.0 --
Equity in net unrealized investment gains of MSA,
before tax (b) 3.2 --
=================================================================================================================
(a) Recorded net of related amortization of goodwill
(b) Recorded directly to shareholders' equity
58
At December 31, 1995 Fund American's consolidated retained earnings included
$4.6 million of undistributed earnings of MSA.
17. Financial Instruments With Off-Balance Sheet Risk
Fund American has only limited involvement with derivative financial instruments
and does not use derivative financial instruments for trading purposes. Fund
American's use of derivative financial instruments is primarily limited to (i)
commitments to extend credit, (ii) mandatory forward commitments, (iii) interest
rate floors and (iv) to achieve a fixed interest rate on existing variable rate
obligations.
Source One is a party to financial instruments with off-balance-sheet risk
in the normal course of business to meet the financing needs of its customers
and to reduce its exposure to fluctuations in interest rates. These financial
instruments primarily include commitments to extend credit and mandatory forward
commitments. Those instruments involve, to varying degrees, elements of credit
and market interest rate risk in excess of the amounts recognized in the
consolidated balance sheets. The contract or notional amounts of those
instruments reflect the extent of risk Source One has related to the
instruments.
Source One's exposure to credit loss in the event of nonperformance by the
other party for commitments to extend credit (mortgage loan pipeline) is
represented by the contractual notional amount of those commitments. Source
One's mortgage loan pipeline for locked commitments totalled $221.9 million and
$147.5 million at December 31, 1995 and 1994, respectively. Fixed rate
commitments result in Source One having market interest rate risk as well as
credit risk. Variable rate commitments result in only credit risk. The amount of
collateral required upon extension of credit is based on management's credit
evaluation of the mortgagor and consists of the mortgagor's residential
property. Source One obtains mandatory forward commitments of up to 120 days to
sell mortgage-backed securities to hedge the market interest rate risk
associated with the portion of the mortgage loan pipeline that is expected to
close and all mortgage loans receivable. At December 31, 1995 and 1994 Source
One had $561.0 million and $351.2 million, respectively, of mandatory forward
commitments outstanding. If secondary market interest rates decline after Source
One commits to an interest rate for a loan, the loan may not close and Source
One may incur a loss from the cost of covering its obligations under a related
mandatory forward commitment. If secondary market interest rates increase after
Source One commits to an interest rate for a loan and Source One has not
obtained a forward commitment, Source One may incur a loss when the loan is
subsequently sold.
Source One's risk management function closely monitors the mortgage loan
pipeline and mortgage loans receivable balance to determine appropriate forward
commitment coverage on a daily basis in order to manage the risk inherent in
these off-balance-sheet financial instruments. In addition, the risk management
area seeks to reduce counterparty risk by committing to sell mortgage loans only
to approved dealers with no dealer having in excess of 20% of current
commitments. Source One currently transacts business with seven approved
dealers.
59
Source One sells loans through mortgage-backed securities issued pursuant
to programs of GNMA, FNMA and FHLMC or through institutional investors. Most
loans are aggregated in pools of $1.0 million or more which are purchased by
institutional investors after having been guaranteed by GNMA, FNMA or FHLMC.
Substantially all GNMA securities are sold by Source One without recourse for
loss of principal in the event of a subsequent default by the mortgagor due to
the FHA and VA insurance underlying such securities. Prior to December 1992,
substantially all conventional securities were sold with recourse to Source One,
to the extent of insufficient proceeds from private mortgage insurance,
foreclosure and other recoveries. Since December 1992 all conventional loans
have been sold without recourse to Source One.
Servicing agreements relating to mortgage-backed securities issued pursuant
to programs of GNMA, FNMA or FHLMC require Source One to advance funds to make
the required payments in the event of a delinquency by the borrower. Source One
expects that it would recover most funds advanced upon cure of default by the
borrower or foreclosure. However, funds advanced in connection with VA partially
guaranteed loans and certain conventional loans (which are at most partially
insured by private mortgage insurers) may not be fully recovered due to
potential declines in collateral value. In addition, most of Source One's
servicing agreements for mortgage-backed securities typically require the
payment to investors of a full month's interest on each loan although the loan
may be paid off (by optional prepayment or foreclosure) other than on a month-
end basis. In this instance, Source One is obligated to pay the investor
interest at the note rate from the date of loan payoff through the end of the
calendar month without reimbursement.
As of December 31, 1995 and 1994 Source One serviced approximately $10.7
billion and $11.9 billion of GNMA loans (without substantial recourse),
respectively, and $3.5 billion and $3.7 billion of conventional loans (with
recourse), respectively.
To cover loan losses that may result from these servicing arrangements and
other losses, Source One has provided an allowance for loan losses of $13.5
million and $13.4 million on the consolidated balance sheets at December 31,
1995 and 1994, respectively. Source One's management believes the allowance for
loan losses is adequate to cover unreimbursed foreclosure advances and principal
losses. During 1995 Source One modified the methodology used to estimate the
allowance for loan losses to more accurately reflect Source One's loss
experience. This change reduced the amount that would have been computed under
the prior methodology.
Source One enters into interest rate floor contracts to reduce the
sensitivity of its earnings to changes in market interest rates. The interest
rate floor contracts derive their value from the ten-year constant maturity
treasury yield index. The floor yields range from 5.47% to 5.85%. To the extent
that market interest rates increase, the value of the floors declines. However,
Source One is not exposed to losses in excess of its initial investment in the
floors. The interest rate floor contracts are carried at fair value with
unrealized gains and losses recorded in other mortgage operations revenue on the
consolidated income statements. As of December 31, 1995 the carrying value of
Source One's open interest rate floor contracts totaled $3.5 million with a
total notional principal amount of $500.0 million. The floors have terms ranging
from one to five years.
60
White Mountains' insurance subsidiaries extend credit to their
policyholders in the normal course of business, perform credit evaluations and
maintain allowances for potential credit losses. Concentration of credit risk
with respect to receivables is limited due to the large number of policyholders
and their dispersion across a multi-state area.
18. Fair Value of Financial Instruments
The estimated fair values for Fund American's financial instruments have been
determined by using appropriate market information and valuation methodologies.
Considerable judgement is required to develop the estimates of fair value.
Therefore, the estimates provided herein are not necessarily indicative of the
amounts that could be realized in a current market exchange. Carrying value
approximates fair value for common equity securities, fixed maturity
investments, short-term investments, cash, other financial assets and other
financial liabilities. For each other class of financial instrument for which
it is practicable to estimate fair value, the following methods and assumptions
were used to estimate such value:
Other Investments. The fair values of mortgage loans held for
investment are estimated using quoted market prices for securities backed by
similar loans, adjusting for differences in loan characteristics. Fair values
of REMICs are estimated using discounted cash flow analyses reflecting I/O strip
and LIBOR interest rates, and Prepayment Speed Assumption ("PSA") rates, taking
into consideration the characteristics of the related collateral. For interest
rate floor contracts, fair value is estimated based on quoted market prices for
those or similar investments and equals carrying value. For all other
securities classified as other investments fair values have been determined
using quoted market values or internal appraisal techniques.
Capitalized Excess Mortgage Servicing. Fair value is estimated by
discounting the annual anticipated net revenue to be received over the life of
the related loans, discounted using quoted I/O strip interest rates and PSA
rates.
Mortgage Loans Held for Sale. Fair values are estimated using quoted
market prices for securities backed by similar loans and adjusting for
differences in loan characteristics.
Pool Loan Purchases. Fair values are estimated using (i) discounted
cash flow analyses reflecting Source One's short-term incremental borrowing rate
or (ii) quoted market prices for securities backed by similar loans.
Loans in Foreclosure and Mortgage Claims Receivable. Fair values are
estimated by discounting anticipated future cash flows using Source One's short-
term incremental borrowing rate.
Loan For Common Stock Issued. Fair value is estimated by discounting
future cash flows using market interest rates for similar types of borrowing
arrangements.
Debt. Fair value is estimated by discounting future cash flows using
incremental borrowing rates for similar types of borrowing arrangements. For
subordinated debentures, fair value is based on quoted market prices.
61
Off-Balance-Sheet Financial Instruments. Fair value for commitments
to sell mortgage loans is based on current settlement values for those
commitments. Fair value for commitments to extend credit is based on current
quoted market prices for securities backed by similar loans, adjusting for loan
characteristics.
The carrying amounts and estimated fair values of Fund American's financial
instruments were as follows:
- --------------------------------------------------------------------------------
December 31, 1995 December 31, 1994
-------------------- ------------------
Carrying Fair Carrying Fair
Millions amount value amount value
- --------------------------------------------------------------------------------
Financial assets:
Common equity securities $274.5 $274.5 $332.4 $332.4
Fixed maturity investments 110.7 110.7 102.2 102.2
Other investments 95.9 96.5 55.1 54.1
Short-term investments 103.6 103.6 119.2 119.2
Cash 2.7 2.7 1.5 1.5
Capitalized excess mortgage servicing 44.7 46.0 72.1 98.3
Mortgage loans held for sale 381.0 391.5 210.5 211.4
Pool loan purchases 119.0 122.3 163.9 164.9
Loans in foreclosure and
mortgage claims receivable, net (a) 29.6 29.0 33.3 32.4
Employee loan receivable -- -- 29.3 28.9
Other 25.7 25.7 27.5 27.5
- --------------------------------------------------------------------------------
Financial liabilities:
Short-term debt 445.4 449.0 254.1 254.1
Long-term debt 407.3 450.8 547.0 528.8
Other 12.4 12.4 38.4 38.4
- --------------------------------------------------------------------------------
Off-balance-sheet financial instruments:
Mandatory forward commitments -- 562.4 -- 349.0
Commitments to extend credit expected
to close -- 226.6 -- 147.8
================================================================================
(a) Excludes $15.8 million and $16.5 million of real estate owned in 1995 and
1994, respectively.
Other financial assets includes investment income receivable, accounts
receivable from securities sales and White River Shares held for delivery upon
exercise of existing employee stock options. Other financial liabilities
includes accrued interest payable, accounts payable on securities purchases,
dividends payable to shareholders and liability for existing employee stock
options to purchase White River Shares.
The estimated fair value amounts for Fund American's financial
instruments have been determined using available market information and
valuation methodologies. Such estimates provided herein are not necessarily
indicative of the amounts that would be potentially realized in a current market
exchange.
It is not practicable without incurring excessive costs to estimate
the fair value of conventional loans sold with recourse, which is an off-
balance-sheet financial instrument representing Source One's obligation to
repurchase loans sold that subsequently default.
62
19. Related Party Transactions
In December 1993 BYRNE & sons, l.p. ("BYRNE & sons"), a partnership in which the
Company's Chairman, John J. Byrne, is the sole general partner, made its initial
investment in the Merastar Partners Limited Partnership and the Southern
Heritage Limited Partnership (the "Partnerships"). The Partnerships are involved
in various property and casualty insurance ventures. Shortly after making its
initial investment, BYRNE & sons offered one-third of its interest in the
Partnerships to Fund American on equal terms and conditions. In May 1994 Fund
American accepted the offer and paid BYRNE & sons an amount equal to one-third
of BYRNE & sons' cost for the Partnerships plus interest at a 6.0% annual rate.
For corporate travel purposes Fund American leases aircraft owned by
Haverford Transportation Inc. ("HTI"). Mr. Byrne and K. Thomas Kemp, Executive
Vice President of the Company, are the sole shareholders of HTI. Fund American
believes that its arrangement with HTI is on terms that are more favorable to
Fund American than would generally be available if secured through an
arrangement with an unaffiliated third party.
Through December 22, 1993 White River was a wholly-owned subsidiary of the
Company. The Company currently owns 1,014,750 White River Shares, or
approximately 20.7% of the outstanding White River Shares of which 295,932
shares, or 6.0% of the outstanding White River Shares have been reserved by Fund
American for delivery upon exercise of existing employee stock options and
warrants. White River had outstanding a $50 million term note and a $40 million
revolving loan payable to the Company which were repaid on various dates during
1995. Gordon S. Macklin, a director of the Company, is the non-executive
Chairman of White River.
American Express and its former affiliate Lehman Brothers Inc. have from time
to time provided various services to Fund American including investment banking
services, brokerage services, underwriting of debt and equity securities and
financial consulting services. In addition, Source One has from time to time
sold certain mortgage loans to subsidiaries of American Express. American
Express formerly owned all outstanding shares of the Series D Preferred Stock.
Howard L. Clark, a director of the Company, was formerly Chairman of American
Express and Howard L. Clark, Jr., a director of the Company, is Vice Chairman of
Lehman Brothers Inc.
George J. Gillespie, III, a director of the Company, is a Partner of Cravath,
Swaine & Moore, which has been retained by Fund American from time to time to
perform legal services.
Arthur Zankel, a director of the Company, is a General Partner of First
Manhattan Co., which has been retained by Fund American from time to time to
perform discretionary investment management services, non-discretionary
investment advisory services and brokerage services.
Fund American believes that all the above transactions were on terms that
were reasonable and competitive. Additional transactions of this nature may be
expected to take place in the ordinary course of business in the future.
63
Fund American
REPORT ON MANAGEMENT'S RESPONSIBILITIES
The financial information included in this annual report, including the
audited consolidated financial statements, has been prepared by the management
of Fund American. The consolidated financial statements have been prepared in
accordance with generally accepted accounting principles and, where necessary,
include amounts based on informed estimates and judgments. In those instances
where there is no single specified accounting principle or standard, management
makes a choice from reasonable, accepted alternatives which are believed to be
most appropriate under the circumstances. Financial information presented
elsewhere in this annual report is consistent with that shown in the financial
statements.
Fund American maintains internal financial and accounting controls designed to
provide reasonable and cost effective assurance that assets are safeguarded from
loss or unauthorized use, that transactions are recorded in accordance with
management's policies and that financial records are reliable for preparing
financial statements. The internal controls structure is documented by written
policies and procedures which are communicated to all appropriate personnel and
is updated as necessary. Fund American's business ethics policies require
adherence to the highest ethical standards in the conduct of its business.
Compliance with these controls, policies and procedures is continuously
maintained and monitored by management.
Ernst & Young LLP provides an objective, independent review and evaluation of
the structure of internal controls to the extent they consider necessary in
their audit of Fund American's consolidated financial statements. Ernst & Young
also evaluates and reports on the adequacy of and adherence to these internal
controls, policies and procedures. In addition, Management reviews all
recommendations of the independent auditors concerning the structure of internal
controls and responds to such recommendations with corrective actions, as
appropriate.
The Audit Committee of the Board is comprised of all non-management directors
and has general responsibility for the oversight and surveillance of the
accounting, reporting and financial control practices of Fund American. The
Audit Committee, which reports to the full Board, annually reviews the
effectiveness of the independent auditors, Fund American's internal auditors and
management with respect to the financial reporting process and the adequacy of
internal controls. Both the internal auditors and the independent auditors
have, at all times, free access to the Audit Committee, without members of
management present, to discuss the results of their audits, the adequacy of
internal controls and any other matter that they believe should be brought to
the attention of the Audit Committee.
John J. Byrne Allan L. Waters Michael S. Paquette
Chairman of the Board, President Senior Vice President Vice President and
and Chief Executive Officer and Chief Financial Officer Controller
64
Fund American
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Shareholders
Fund American Enterprises Holdings, Inc.
We have audited the accompanying consolidated balance sheets of Fund American
Enterprises Holdings, Inc., as of December 31, 1995 and 1994, and the related
consolidated income statements and statements of shareholders' equity and cash
flows for each of the three years in the period ended December 31, 1995. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Fund American
Enterprises Holdings, Inc. at December 31, 1995 and 1994, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended December 31, 1995, in conformity with generally accepted accounting
principles.
As discussed in the Notes to Consolidated Financial Statements, in 1995 the
Company changed its method of accounting for originated mortgage servicing
rights, in 1994 the Company changed its methodology used to measure impairment
of purchased mortgage servicing rights and in 1993 the Company changed its
method of accounting for certain investment securities.
New York, New York
February 13, 1996
65
Fund American
SELECTED QUARTERLY FINANCIAL DATA
(Unaudited)
Selected quarterly financial data for 1995 and 1994 is shown in the following
table. The quarterly financial data includes, in the opinion of management, all
recurring adjustments necessary for a fair presentation of the results of
operations for the interim periods.
- ------------------------------------------------------------------------------------------------------------------------------------
1995 Three Months Ended (a) 1994 Three Months Ended
------------------------------------------ --------------------------------------------
Millions, except per share amounts Dec. 31 Sept. 30 June 30 Mar. 31 Dec. 31 Sept. 30 June 30 Mar. 31
- ------------------------------------------------------------------------------------------------------------------------------------
Revenues $ 53.6 $ 48.6 $ 43.3 $ 76.8 $ 41.4 $ 44.4 $ 71.7 $ 71.0
Expenses 52.8 42.9 86.8 43.4 52.0 56.4 59.7 57.6
----------------------------------------------------------------------------------------------
Pretax operating earnings (loss) .8 5.7 (43.5) 33.4 (10.6) (12.0) 12.0 13.4
Net investment gains (losses) 7.0 4.4 10.4 17.0 (4.2) 20.6 20.9 1.5
----------------------------------------------------------------------------------------------
Pretax earnings (loss) 7.8 10.1 (33.1) 50.4 (14.8) 8.6 32.9 14.9
Income tax provision (benefit) 5.4 3.5 (10.6) 18.4 (2.7) 4.3 13.0 5.9
----------------------------------------------------------------------------------------------
After tax earnings (loss) 2.4 6.6 (22.5) 32.0 (12.1) 4.3 19.9 9.0
Tax benefit from sale of
discontinued operations - - 66.0 - - - - -
Loss on early extinguishment
of debt, after tax - - (.2) (.2) - - - -
Cumulative effect of accounting
change-purchased mortgage
servicing, after tax - - - - - - - (44.3)
----------------------------------------------------------------------------------------------
Net income (loss) $ 2.4 $ 6.6 $ 43.3 $ 31.8 $(12.1) $ 4.3 $ 19.9 $(35.3)
- --------------------------------------==============================================================================================
Primary earnings per share:
After tax earnings (loss) $ .29 $ .75 $(2.95) $ 3.43 $(1.64) $ .24 $ 1.72 $ .60
Net income (loss) .29 .75 5.08 3.41 (1.64) .24 1.72 (3.86)
Fully diluted earnings per share:
After tax earnings (loss) .29 .75 (2.44) 3.23 (1.64) .24 1.62 .60
Net income (loss) .29 .75 4.68 3.22 (1.64) .24 1.62 (3.86)
====================================================================================================================================
(a) The quarterly amounts for the three month periods ended June 30 and March
31, 1995, have been restated to reflect the adoption as of January 1, 1995,
of SFAS No. 122. Prior to restatement, net income for the three month
periods ended June 30 and March 31, 1995, was $48.2 million and $26.9
million, respectively.
The quarterly trading range for Shares of common stock during 1995 and 1994 is
presented below:
- -----------------------------------------------------------------------------------------------------------------------------------
1995 1994
------------------------- --------------------------
High Low High Low
- -----------------------------------------------------------------------------------------------------------------------------------
Quarter ended:
December 31 $ 75 $ 66 1/4 $ 79 1/4 $ 70 1/2
September 30 76 68 1/4 78 3/8 69 3/4
June 30 72 5/8 68 3/8 70 3/8 60 1/2
March 31 76 71 3/4 77 64 3/4
===================================================================================================================================
66
Fund American
INVESTMENTS
(Unaudited)
Common Equity Securities
- -----------------------------------------------------------------------------------------------------------------------------
December 31, 1995
--------------------------------------------------------
Percent
of total
Shares Fair fair
Shares and units in thousands, dollars in millions or units Cost value value
- -----------------------------------------------------------------------------------------------------------------------------
Energy, natural resources and related industries:
The Louisiana Land and Exploration Company 2,928 $ 97.9 $125.5 45.7%
San Juan Basin Royalty Trust 10,995 56.7 68.7 25.0
Aggregate of holdings less than $10.0 million 14.1 16.1 5.9
--------------------------------------------------------
Total energy, natural resources and related industries 168.7 210.3 76.6
All other:
Zurich Reinsurance Centre Holdings, Inc. 2,043 60.4 62.0 22.6
Aggregate of holdings less than $10.0 million 3.0 2.2 .8
--------------------------------------------------------
Total common equity securities $232.1 $274.5 100.0%
=============================================================================================================================
Fixed Maturity Investments
- -----------------------------------------------------------------------------------------------------------------------------
December 31, 1995
---------------------------------
Cost or
amortized Fair
Millions cost value
- ----------------------------------------------------------------------------------------------------------------------------
U S West, Inc. redeemable preferred stock $ 48.8 $ 48.8
State and municipal obligations 33.3 33.3
U. S. Government and agency obligations 23.5 24.2
Aggregate of holdings less than $10.0 million 4.2 4.4
---------------------------------
Total fixed maturity investments $ 109.8 $ 110.7
- -----------------------------------------------------------------------------------------------------------------------------
Other Investments
- -----------------------------------------------------------------------------------------------------------------------------
December 31, 1995
---------------------------------
Cost or
amortized Carrying
Millions cost value
- ----------------------------------------------------------------------------------------------------------------------------
Mid Ocean Limited restricted common shares and options $ 24.7 $ 30.5
White River Corporation restricted common shares 21.1 25.6
Mortgage loans held for investment 24.3 24.3
Aggregate of holdings less than $10.0 million 16.6 15.5
---------------------------------
Total other investments $ 86.7 $ 95.9
=============================================================================================================================
67
Fund American
BOARD OF DIRECTORS
Class I (terms ending in 1998):
Howard L. Clark Former Chairman - American Express Company
K. Thomas Kemp Executive Vice President
Gordon S. Macklin Chairman - White River Corporation
Class II (terms ending in 1996):
George J. Gillespie, III Partner - Cravath, Swaine & Moore
John J. Byrne Chairman, President and CEO
Class III (terms ending in 1997):
Howard L. Clark, Jr. Vice Chairman - Lehman Brothers Inc.
Robert P. Cochran President and CEO - Financial Security
Assurance Holdings Ltd.
Arthur Zankel Co-Managing Partner - First Manhattan Co.
68
Fund American
COMMITTEES OF THE BOARD
Audit Committee of the Board of Directors
The Audit Committee, consisting of all non-management directors, has general
responsibility for the oversight and surveillance of the accounting, reporting
and financial control practices of Fund American. The Audit Committee annually
reviews the qualifications of the independent auditors, makes recommendations to
the Board as to their selection, and reviews the plan, fees and results of their
audit.
Howard L. Clark, Jr., Chairman
Human Resources Committee of the Board of Directors
The Human Resources Committee, consisting of all non-management directors,
oversees Fund American's compensation and benefit policies and programs,
including administration of the Incentive Plan, the Deferred Compensation Plan
and the Deferred Benefit Plan. The Human Resources Committee also sets the
annual salaries and bonuses for elected officers and certain other key
employees.
Gordon S. Macklin, Chairman
69
Fund American
CHAIRMEN AND OFFICERS
- --------------------------------------------------------------------------------
CORPORATE
Fund American Enterprises Holdings, Inc. (Hanover, New Hampshire)
John J. Byrne Chairman, President and CEO K. Thomas Kemp Executive VP
Dennis P. Beaulieu VP and Secretary Michael S. Paquette VP and Controller
Reid T. Campbell Assistant Controller Allan L. Waters Senior VP and CFO
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
MORTGAGE ORIGINATION AND SERVICING OPERATIONS
Fund American Enterprises, Inc. (Norwich, Vermont)
John J. Byrne Chairman Terry L. Baxter President and Secretary
Source One Mortgage Services Corporation (Farmington Hills, Michigan)
Robert W. Richards Chairman James A. Conrad President and CEO
Michael C. Allemang Executive VP and CFO Robert R. Densmore Executive VP and Secretary
- --------------------------------------------------------------------------------
70
Fund American
CHAIRMEN AND OFFICERS
- ---------------------------------------------------------------------------------------------------
INSURANCE OPERATIONS
White Mountains Holdings, Inc. (Hanover, New Hampshire)
John J. Byrne Chairman K. Thomas Kemp President and CEO
Dennis P. Beaulieu VP and Secretary Michael S. Paquette VP and Controller
Reid T. Campbell Assistant Controller Allan L. Waters Senior VP and CFO
Morgan W. Davis Senior VP and COO
Valley Group, Inc. (Albany, Oregon)
K. Thomas Kemp Chairman Daniel A. Post President and CEO
Kenneth R. Hisel Senior VP Stuart E. Olson Executive VP, COO and CFO
Phillip L. Kloek Senior VP
Charter Group, Inc. (Dallas, Texas)
K. Thomas Kemp Chairman Daniel A. Post President and CEO
Carey D. Benson Senior VP and COO
White Mountains Insurance Company (Hanover, New Hampshire)
K. Thomas Kemp Chairman Morgan W. Davis President and CEO
Dennis P. Beaulieu Senior VP, CFO and Treasurer Michael S. Paquette VP and Controller
- ---------------------------------------------------------------------------------------------------
71
Fund American
CORPORATE INFORMATION
Principal Offices
Fund American Enterprises Holdings, Inc.
White Mountains Holdings, Inc.
80 South Main Street
Hanover, New Hampshire 03755-2053
(603) 643-1567
Fund American Enterprises, Inc.
The 1820 House, Main Street
Norwich, Vermont 05055-0850
(802) 649-3633
Form 10-K
The financial statements contained in this report, in the opinion of management,
substantially conform with or exceed the financial statement information
required in the "Form 10-K, Annual Report" to be filed with the Securities and
Exchange Commission no later than April 1, 1996. Certain supplemental
information appears in the Form 10-K which is not disclosed within this
document. Copies of the Form 10-K are available without charge upon written
request to the Corporate Secretary's office at the Hanover, New Hampshire
address.
Transfer Agent and Registrar for Common Stock
First Chicago Trust Company of New York
P.O. Box 2532
Mail Suite 4690
Jersey City, New Jersey 07303-2532
Shareholders may obtain information about transfer requirements, replacement
dividend checks, duplicate 1099 forms and changes of address by calling the
Transfer Agent's Telephone Response Center at (201) 324-1644. Please be prepared
to provide your tax identification or social security number, description of
securities and address of record. Other inquiries concerning your shareholder
account should be addressed in writing to the Transfer Agent and Registrar.
Stock Exchange Information
The Company's Common Stock (symbol FFC) is listed on the New York Stock
Exchange.
Annual Meeting
The 1996 Annual Meeting of shareholders will be held on Thursday, May 16, 1996,
at Byrne Hall, Amos Tuck School of Business at Dartmouth College, Hanover, New
Hampshire and will commence at 9:00 a.m.
Independent Auditors
Ernst & Young LLP
787 Seventh Avenue
New York, New York 10019-6018
Shareholder Inquiries
Written shareholder inquiries should be sent to the Corporate Secretary at the
Hanover, New Hampshire address. Written inquiries from the investment community
should be directed to the Investor Relations Department, c/o Fund American
Enterprises, Inc., at the Norwich, Vermont address.
Matching Gifts Program
Fund American encourages its employees and its Board to support higher education
and charitable organizations through the Fund American Matching Gifts Program.
Employee gifts to accredited, four-year institutions of higher education located
in the United States are matched on the basis of $2 for every dollar with an
annual maximum of $4,000 per employee. Community or charitable gifts are
matched on the basis of $1 for every dollar with an annual maximum of $4,000 per
individual.
Fund American's Social Responsibility Committee also sponsors employees who
contribute their time or expertise to organizations they believe in by
supplementing their devotion to the organization with a cash donation.
Supplemental endorsement requests are considered on a case by case basis.
72
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