1
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF MANAGEMENT
The management of Guaranty National Corporation is responsible
for the consolidated financial statements and the information included therein.
The consolidated financial statements are fairly presented and have been
prepared in accordance with generally accepted accounting principles and are
appropriate in the circumstances, and, where necessary, include amounts based
on management's informed estimates and judgments.
The Company has an internal control structure which it believes
provides reasonable assurance that assets are safeguarded from loss or
unauthorized use, transactions are recorded in accordance with management's
policies and that the financial records are reliable for preparing financial
statements. The internal control structure includes written policies and
procedures which are communicated to all appropriate personnel and updated as
necessary.
Compliance with the internal control structure is continuously
maintained and monitored by management. The internal audit staff of the Company
evaluates and reports on the adequacy of and adherence to these controls,
policies and procedures. In addition, as part of its audit of the consolidated
financial statements, Deloitte & Touche LLP, the independent auditors for the
Company, evaluate the Company's internal control structure to the extent they
consider necessary to express an opinion on the consolidated financial
statements. Recommendations concerning the internal control structure are
provided by both the internal auditors and Deloitte & Touche LLP, and management
takes actions which are believed to be appropriate responses to these
recommendations.
The Audit Committee of the Board of Directors is comprised of
independent directors, and has general responsibility for oversight of financial
controls and audit activities of the Company and its subsidiaries. The Audit
Committee, which reports to the Board, annually reviews the qualifications of
the independent auditors and meets periodically with them, the internal auditors
and management to review the plans for and results of the audits. Both internal
and independent auditors have free access to the Audit Committee, without
members of management present, to discuss the adequacy of the internal control
structure and any other matters which they believe should be brought to the
attention of the Audit Committee.
Roger B. Ware Michael L. Pautler
President and Chief Executive Officer Senior Vice President - Finance and
Treasurer
33
2
INDEPENDENT AUDITORS' REPORT
Board of Directors and Shareholders
Guaranty National Corporation
We have audited the accompanying consolidated balance sheets of
Guaranty National Corporation and subsidiaries ("the Company") as of December
31, 1995 and 1994, and the related consolidated statements of earnings, changes
in shareholders' equity, and cash flows for each of the three years in the
period ended December 31, 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, such consolidated financial statements present
fairly, in all material respects, the financial position of Guaranty National
Corporation and subsidiaries at December 31, 1995 and 1994 and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1995 in conformity with generally accepted accounting
principles.
DELOITTE & TOUCHE LLP
Denver, Colorado
February 20, 1996
34
3
GUARANTY NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
ASSETS
December 31,
----------------------
1995 1994
--------- ---------
Investments: (Notes 4 and 7)
Fixed maturities held to maturity, at cost $ 75,017 $ 118,695
Fixed maturities available for sale, at market 395,198 154,444
--------- ---------
470,215 273,139
Equity securities, at market 85,085 66,572
Other long-term investments 11,521 11,726
Short-term investments 52,257 26,896
--------- ---------
Total investments 619,078 378,333
Cash 6,794 9,609
Accrued investment income 7,603 5,056
Accounts receivable, (less allowance of
$374 - 1995; $171 - 1994) 51,638 45,972
Reinsurance recoverables and prepaids,
(less allowance of $200 - 1995; $200 - 1994) (Note 9) 81,825 74,874
Property and equipment, (less accumulated depreciation
of $9,326 - 1995; $6,212 - 1994) (Note 5) 31,573 25,851
Deferred policy acquisition costs 37,637 31,623
Goodwill, (less accumulated amortization
of $5,263 -1995; $4,380 - 1994) (Note 3) 33,133 23,404
Deferred income taxes (Note 8) 4,216 9,207
Other assets 1,676 1,159
--------- ---------
Total assets $ 875,173 $ 605,088
--------- ---------
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Unpaid losses (Note 10) $ 290,156 $ 195,861
Unpaid loss adjustment expenses (Note 10) 64,478 45,360
Unearned premiums 146,205 123,092
Notes payable (Notes 6, 7, and 14) 103,000 52,896
Reinsurance payables and deposits 8,290 9,111
Other liabilities 47,493 34,009
--------- ---------
Total liabilities 659,622 460,329
========= =========
Commitments and contingencies (Notes 9, 10, and 12)
Shareholders' equity: (Notes 2, 4, 8, and 13)
Preferred stock, $.10 par value;
authorized, 6,000,000 shares;
none issued and outstanding
Common stock, $1 par value;
authorized, 30,000,000 shares,
issued 14,961,354 shares - 1995;
12,479,612 shares - 1994 14,961 12,480
Capital in excess of par 121,050 84,073
Retained earnings 64,664 62,390
Deferred compensation on restricted stock (644) (781)
Net unrealized investment gains (losses) 15,520 (7,061)
--------- ---------
215,551 151,101
Less treasury stock, at cost
(438,200 shares - 1994) (6,342)
--------- ---------
Total shareholders' equity 215,551 144,759
========= =========
Total liabilities and shareholders' equity $ 875,173 $ 605,088
========= =========
See notes to consolidated financial statements
35
4
GUARANTY NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
(In thousands, except per share amounts)
Year Ended December 31,
---------------------------------
1995 1994 1993
--------- --------- ---------
Revenue:
Premiums earned (Note 9) $ 390,017 $ 321,638 $ 257,540
Net investment income (Note 4) 30,976 23,576 22,551
Realized investment gains (Note 4) 3,291 3,007 5,996
Other income 2 69
--------- --------- ---------
424,284 348,223 286,156
--------- --------- ---------
Expenses:
Losses incurred (Notes 9 and 10) 248,771 180,865 147,065
Loss adjustment expenses (Notes 9 and 10) 44,742 32,640 26,435
Policy acquisition costs 110,341 93,103 76,725
General and administrative 6,458 7,206 6,280
Interest 5,708 3,218 2,592
Settlement of litigation 1,750
Nonrecurring relocation charge (Note 5) 838
Other 932 766 683
--------- --------- ---------
416,952 318,636 261,530
--------- --------- ---------
Earnings before income taxes 7,332 29,587 24,626
Income taxes (Note 8) (1,597) 7,036 5,341
--------- --------- ---------
Earnings before cumulative effect of changes
in accounting principles 8,929 22,551 19,285
Cumulative effect of changes in accounting
principles:
Income taxes (Note 8) 1,502
Postretirement benefits, net of tax (Note 15) (396)
--------- --------- ---------
1,106
--------- --------- ---------
Net earnings $ 8,929 $ 22,551 $ 20,391
========= ========= =========
Earnings per share before
cumulative effect of accounting changes $ 0.67 $ 1.86 $ 1.54
Cumulative effect of accounting changes 0.09
--------- --------- ---------
Earnings per common share $ 0.67 $ 1.86 $ 1.63
========= ========= =========
See notes to consolidated financial statements
36
5
GUARANTY NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(In thousands)
Deferred Unrealized
Capital Compensation Investment
Common In Excess Retained on Restricted Gains Treasury
Stock Of Par Earnings Stock (Losses) Stock
-------- -------- -------- ------------- ---------- --------
Balance, January 1, 1993 $ 12,460 $ 83,546 $ 31,729 $ (578) $ 2,966 $
Net earnings 20,391
Change in unrealized
investment gains (losses),
less applicable deferred taxes 7,827
Issuance of restricted
stock, net of cancellation 20 387 (407)
Amortization of deferred
compensation on restricted
stock 58 322
Cash dividends declared and
paid (6,232)
-------- -------- -------- --------- --------- ---------
Balance, December 31, 1993 12,480 83,991 45,888 (663) 10,793
Net Earnings 22,551
Change in unrealized
investment gains (losses),
less applicable deferred taxes (17,854)
Purchase of treasury stock (6,636)
Issuance of restricted
stock, net of cancellation 74 (368) 294
Amoritization of deferred
compensation on restricted
stock 8 250
Cash dividends declared and
paid (6,049)
-------- -------- -------- --------- --------- ---------
Balance December 31, 1994 12,480 84,073 62,390 (781) (7,061) (6,342)
Net earnings 8,929
Change in unrealized
investment gains (losses),
less applicable deferred taxes 22,581
Issuance of restricted stock,
net of cancellation 20 329 (126) 327
Amortization of deferred
compensation on restricted
stock 8 263
Sale of common stock 1,550 22,670
Conversion of affiliate debt 911 13,970 6,015
Cash dividends declared and
paid (6,655)
-------- -------- -------- --------- --------- ---------
Balance, December 31, 1995 $ 14,961 $121,050 $ 64,664 $ (644) $ 15,520 $
======== ======== ======== ========= ========= =========
See notes to consolidated financial statements.
37
6
GUARANTY NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Year Ended December 31,
-----------------------------------
1995 1994 1993
--------- --------- ---------
Operating Activities:
Premiums collected $ 396,621 $ 321,000 $ 277,439
Net investment income collected 29,938 22,969 21,141
Losses and loss adjustment expenses paid (267,641) (199,530) (152,208)
Policy acquisition costs and general and
administrative expenses paid (119,821) (93,495) (87,166)
Interest paid (6,005) (3,043) (2,621)
Settlement of litigation (1,750)
Nonrecurring relocation charge (978)
Federal income taxes paid (5,359) (6,108) (5,924)
Other receipts (payments) 1,368 (1,337) 669
--------- --------- ---------
Net cash provided by operating activities 29,101 39,478 49,580
--------- --------- ---------
Investing Activities:
Maturities of fixed maturities 45,319
Maturities of fixed maturities held to
maturity 12,096 10,231
Maturities of fixed maturities available
for sale 20,219 8,281
Sales of fixed maturities 12,959
Sales of fixed maturities available for sale 40,158 37,147
Sales of equity securities 28,367 19,185 27,407
Net change in short-term investments (20,039) 7,535 1,935
Sales of property and equipment 590 274 289
Purchases of fixed maturities (79,192)
Purchases of fixed maturities held to
maturity (10,138) (16,570)
Purchases of fixed maturities available
for sale (74,652) (57,989)
Purchases of equity securities (21,480) (21,883) (38,385)
Net Change in other long-term investments 1,825 (1,376) (1,617)
Purchases of property and equipment (2,950) (13,643) (8,187)
Acquisition of subsidiaries,
net of cash acquired (94,681) (6,363) (8,301)
--------- --------- ---------
Net cash used in investing activities (120,685) (35,171) (47,773)
--------- --------- ---------
Financing Activities:
Proceeds from issuance of notes payable 130,654 14,000 18,000
Repayment of notes payable (60,000) (12,000)
Dividends paid to shareholders (6,655) (6,049) (6,232)
Purchase of treasury stock (6,636)
Proceeds from issuance of common stock 24,220
Proceeds from exercise of stock options 550
--------- --------- ---------
Net cash provided by (used in)
financing activities 88,769 1,315 (232)
--------- --------- ---------
Net Increase (Decrease) in Cash (2,815) 5,622 1,575
Cash, Beginning of Year 9,609 3,987 2,412
--------- --------- ---------
Cash, End Of Year $ 6,794 $ 9,609 $ 3,987
========= ========= =========
Non-Cash Financing Transactions:
Conversion of affiliate debt (Note 6) $ (20,896)
Issuance of common stock
in conversion of affiliate debt 14,881
Conversion of affiliate debt from
treasury stock 6,015
Restricted stock forfeitures (126)
(Continued)
38
7
GUARANTY NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Year Ended December 31,
--------------------------------
1995 1994 1993
-------- -------- --------
Reconciliation of Net Earnings to
Net Cash Provided By Operating Activities:
Net earnings $ 8,929 $ 22,551 $ 20,391
Adjustments:
Depreciation 3,490 2,692 2,078
Non-cash investment income (275) (401) (1,158)
Realized investment gains (3,291) (3,007) (5,996)
Amortization of goodwill 883 766 683
Deferred tax provision (3,543) 24 1,067
Other 979 774 1,122
Cumulative effect of changes in
accounting principles (1,106)
Changes in assets and liabilities:
Accrued investment income (763) (206) (252)
Accounts receivable (2,782) (2,248) (15,157)
Reinsurance recoverables and prepaids (6,679) (8,070) (10,008)
Deferred policy acquisition costs (3,775) 187 (7,560)
Other assets 250 (25) 187
Unpaid losses 26,620 15,778 24,905
Unpaid loss adjustment expenses 5,829 4,478 4,552
Unearned premiums 12,375 3,506 34,651
Reinsurance payables and deposits (821) (4,261) 1,669
Other liabilities (8,325) 6,940 (488)
-------- -------- --------
Total adjustments and changes 20,172 16,927 29,189
-------- -------- --------
Net Cash Provided by Operating Activities $ 29,101 $ 39,478 $ 49,580
======== ======== ========
See notes to consolidated financial statements
39
8
GUARANTY NATIONAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS - Guaranty National Corporation and its
subsidiaries (the "Company") is a corporation based in Englewood, Colorado which
principally underwrites and sells specialty property and casualty insurance
coverages that are generally not available in traditional insurance markets. The
Company manages its business under three operational areas based on function:
commercial lines, personal lines and collateral protection.
The Company's insurance subsidiaries are authorized as
multiple-line insurance carriers and may insure all types of property and
liability risks. The insurance coverages provided by these insurance carriers
are generally known as nonstandard risks due to the potential for poor
claims experience because of increased risk exposure. The insurance subsidiaries
market insurance coverage throughout the United States, and one or more of these
subsidiaries is admitted in all states except Michigan and New Hampshire.
BASIS OF PRESENTATION - The consolidated financial statements
and notes thereto are presented in accordance with generally accepted accounting
principals ("GAAP") for property and casualty insurance companies. The
preparation of the Company's consolidated financial statements in conformity
with generally accepted accounting principles requires Company management to
make estimates and assumptions that affect the amounts reported in these
financial statements and accompanying notes. Actual results could differ from
those estimates.
From November 1,1988, through November 19, 1991, Orion Capital
Corporation and its affiliates ("Orion") owned 100% of Guaranty National
Corporation and subsidiaries outstanding common stock. The assets and
liabilities of the Company were revalued at the time of purchase. The
accompanying financial statements reflect the recording of these acquisition
adjustments by Orion. Orion's current ownership is approximately 49%.
In 1995, the Company acquired control of, but not ownership of,
Viking County Mutual Company ("VCM"). VCM is a Texas mutual organization which
performs 100% reinsurance services for its affiliated companies. VCM is not
included in the consolidated financial statements.
As discussed in Notes 9 and 14, there are various transactions
with Orion and VCM which include certain expenses paid to Orion and VCM and
other transactions with Orion affiliates and VCM. In the opinion of management,
the transaction amounts with Orion are reasonable and representative of expenses
that would have been incurred in transactions with unrelated parties.
Certain reclassifications have been made to the 1994 financial
statements to conform with the presentation used in 1995.
PRINCIPLES OF CONSOLIDATION - The consolidated financial
statements include the accounts of Guaranty National Corporation ("Guaranty")
and its wholly-owned subsidiaries, Intercon General Agency, Inc. ("Intercon"),
Auto Insurance Centers, Inc. ("AIC"), Guaranty National Warranty Services
("GNWS"), Guaranty National Insurance Company ("GNIC") and Viking Insurance
Holdings, Inc. GNIC includes its wholly-owned subsidiaries, Landmark American
Insurance Company ("LAIC"), Colorado Casualty Insurance Company ("CCIC"), Peak
Property and Casualty Insurance Corporation ("PEAK"), and Guaranty National
Insurance Company of California ("GNICOC"). Viking Insurance Holdings, Inc.
includes its wholly-owned subsidiaries, Viking Insurance Company of Wisconsin
("VICW") and Viking General Agency, Inc. ("VGA"), collectively "Viking." All
significant intercompany accounts and transactions have been eliminated in
consolidation.
SIGNIFICANT ACCOUNTING POLICIES - This summary of significant
accounting policies is presented to assist in understanding the Company's
financial statements:
a. INVESTMENTS - Investments in bonds and redeemable preferred
stocks are carried in the accompanying consolidated balance sheets as fixed
maturities. Fixed maturities for which the Company has the positive intent and
ability to hold until maturity are recorded at amortized cost. Fixed maturities
classified as available for sale are recorded at fair value with any unrealized
gains or losses reflected in shareholders' equity, net of applicable deferred
taxes. Losses considered other than temporary are recorded in earnings as a
realized loss. The Company's criteria used to
40
9
identify fixed maturities held to maturity as of December 31, 1995, and 1994,
generally includes investment grade bonds with stated maturities less than 10
years. All other fixed securities are classified as available for sale and may
be sold in response to changes in interest rates, anticipated prepayments,
liquidity needs or other economic factors. Select issues with maturities beyond
10 years may be classified as held to maturity due to certain factors including
expected early call provisions.
Investments in common stocks and nonredeemable preferred stocks
are classified as available for sale and are carried at fair value, with any
unrealized gains or losses of securities reflected in shareholders' equity, net
of applicable deferred taxes. Losses considered other than temporary are
recorded in earnings as a realized loss.
Fair value for securities is generally based on last sales
prices, listed bid prices, bid quotations received from security dealers or,
when fair values are not readily available through market sources, fair value
estimates are based on quoted market prices of similar instruments. Mortgage
loans are carried at their unpaid balance and are classified as other long-term
investments. Estimated fair value for mortgage loans is calculated by
discounting scheduled cash flows through maturity using estimated market
discount rates. Other long-term investments, which are principally comprised of
interests in several investment limited partnerships, are generally carried at
equity value which approximates fair value. Short-term investments, which
include certificates of deposit, money market accounts, and commercial paper
maturing within one year of the balance sheet date, are carried at cost which
approximates fair value.
Realized investment gains and losses are recognized on the
specific identification method, and amortization of premiums and discounts is
determined using the interest method.
b. LOSSES AND LOSS ADJUSTMENT EXPENSES - Losses and loss
adjustment expenses ("LAE") are charged to operations as incurred. Losses and
loss adjustment expense liabilities are determined on the basis of claims
adjusters' evaluations and estimates based on historical experience including
estimates of incurred but not reported losses and salvage and subrogation
recoveries. Such liabilities are recorded gross of applicable reinsurance.
Management believes that the recorded liabilities are a reasonable provision for
all losses and loss adjustment expenses incurred. Notwithstanding the foregoing,
no assurances can be given that further reserve development may not occur in the
future as the process of establishing loss and LAE reserves is, by nature,
imprecise. The estimates are continually reviewed and as adjustments to these
estimates become necessary, such adjustments are reflected in current
operations.
c. REVENUE RECOGNITION - Unearned premiums are generally
computed on a daily pro-rata method over the term of the policies in-force and
are carried gross of related reinsurance. Historically, the Company has not
experienced significant losses related to receivables because of short payment
terms and the lack of concentrations of credit risk.
Thus, the carrying amount approximates estimated fair value.
d. DEFERRED POLICY ACQUISITION COSTS - Policy acquisition costs
are deferred and charged to operations over the periods in which the related
premiums are earned. The determination of recoverability of such deferred costs
includes anticipated investment income.
e. PROPERTY, EQUIPMENT AND DEPRECIATION - Property and
equipment are recorded at cost. Depreciation is computed using the
straight-line method over the estimated useful lives.
f. INCOME TAXES - Deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and
their respective tax basis. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled.
g. GOODWILL - The excess of Viking's cost over fair value of net
assets acquired is being amortized by the straight-line method over 40 years.
The excess of Orion's cost over fair value of net assets acquired and other
goodwill is being amortized by the straight-line method over 31 to 36 years.
Reflected in other expenses is amortization of goodwill of $883,000, $766,000,
and $683,000 for the years ended December 31, 1995, 1994, and 1993,
respectively.
h. STATEMENT OF CASH FLOWS - For purposes of the consolidated
statements of cash flows, the Company considers only demand deposit accounts to
be cash.
41
10
i. EARNINGS PER SHARE - Earnings per share for 1995, 1994, and
1993 has been computed by dividing net earnings by the number of weighted
average shares and equivalent shares outstanding of 13,324,200, 12,135,505 and
12,538,227 respectively. The common stock equivalents are stock options which
result in a dilutive effect from assumed exercise of the options.
j. EMPLOYEE STOCK COMPENSATION PLANS - The Company follows
Accounting Principles Board Opinion (APB) No.25, "Accounting for Stock Issued to
Employees." The grant price of stock options issued to employees equals the
market price of the stock on the measurement date, and therefore, the Company
does not record compensation expense on stock options granted to employees.
Restricted stock issued to employees is considered issued and outstanding when
awarded, and is recorded as deferred compensation.
2. STATUTORY ACCOUNTING PRACTICES
The accompanying consolidated financial statements are prepared
under GAAP which differs materially from practices prescribed by statutory
accounting rules and regulations. Under such practices, GNIC consolidated
policyholders' surplus reported to the state regulatory authorities as of
December 31, 1995, and 1994, was $133,749,000 and $133,229,000, respectively,
and VICW policyholders' surplus as of December 31, 1995 was $86,872,000.
Statutory net income, as reported to state insurance departments, is as follows
(in thousands):
GNIC VICW
---- ----
Year ended December 31, 1995 $ 7,875 $ 15,866
Year ended December 31, 1994 26,324
Year ended December 31, 1993 13,342
3. ACQUISITIONS
On July 18, 1995, the Company acquired Viking in a business
combination accounted for as a purchase. Viking is a property and casualty
insurance company writing nonstandard personal automobile insurance, primarily
in the state of California. The results of operations of Viking are included in
the accompanying financial statements since the date of acquisition.
The total cost of the acquisition was $97,225,000, with total
cash paid of approximately $94,681,000, including acquisition expenses and net
of $878,000 cash acquired. The total consideration exceeded the fair value of
the net assets of Viking by approximately $10,612,000. The total acquisition
cost differs from the announced total consideration paid of $103,000,000 due to
transaction expenses, the contingent purchase price adjustments, discussed
below, and a $12,000,000 extraordinary dividend taken by Talegen Holdings, Inc.
("Seller") from Viking just prior to the sale.
Included in the cost of the acquisition was $3,250,000 paid to
the Seller as additional purchase price, in anticipation of favorable
development of Viking's recorded 1994 and prior accident year loss and loss
adjustment expense reserves. The Company will also pay the Seller, as additional
purchase price, two-thirds of any favorable loss development up to $15,000,000,
and one-third of any favorable development between $15,000,000 and $20,000,000.
The amounts payable will be reduced by 35% to compensate for the applicable tax
rate. The Company and the Seller will initially settle any additional purchase
price as of December 31, 1998, and will finalize the settlement as of December
31, 2001. If adverse development results, the Seller will repay to the Company
an offsetting amount, after allowance for the tax adjustment, not to exceed the
initial $3,250,000 paid to the Seller at the time of acquisition.
Any payments to or receivables from the Seller, as a result of
the positive or negative loss development, will include accrued interest from
the acquisition closing date at an annual rate equal to 6.28%, for the initial
loss development settlement payment as of December 31, 1998. For the final loss
development settlement payment, as of December 31, 2001, the interest rate will
equal the mid-term Applicable Federal Rate (as defined in the Internal Revenue
Service Code) in effect as of January 1, 1999.
Management estimates that a payment in excess of the $3,250,000
already paid will ultimately be made to the Seller, and has included this
estimated amount of approximately $1,666,000, as well as the corresponding
interest payable, in the accompanying balance sheet. Loss and loss adjustment
expense reserves of Viking were
42
11
recorded at the date of acquisition at amounts consistent with the Company's
estimates of additional purchase price that will be paid.
The following summarized pro forma information (unaudited)
assumes the Viking acquisition had occurred on January 1, 1995 and 1994 (in
thousands, except per share amounts):
Twelve Months Ended
December 31,
1995 1994
-------- --------
Total Revenue $512,718 $509,657
======== ========
Net Income 7,765 30,014
======== ========
Earnings Per Share $ 0.53 $ 2.05
======== ========
The above amounts reflect adjustments used in recording the
purchase, such as adjustments for interest on notes payable issued as part of
the purchase price, amortization of goodwill, and fees eliminated as a result of
the acquisition.
On August 26, 1994, the Company acquired General Electric
Mortgage Insurance Corporation of California ("GEMIC") for $6,363,000 in cash
and received in exchange the common stock of GEMIC, with net assets valued at
$5,508,000. Goodwill of $954,000, including accrued expenses, was recorded by
the Company. The Company renamed GEMIC as Guaranty National Insurance Company of
California. The Company is utilizing GNICOC for its California commercial and
collateral protection business, reducing the need for 100% reinsurance services
from Orion. The Company assumed no liabilities from previously written business
or other operations of GNICOC.
On November 16, 1993, the Company acquired PEAK for $8,301,000
in cash and received in exchange the common stock of PEAK, with net assets
valued at $5,848,000. The remaining $2,453,000 was recorded by the Company as
goodwill. PEAK was a property and casualty insurance company "shell" and the
acquisition has increased the Company's marketing and licensing flexibility to
take advantage of opportunities to write more special program business. In
addition, the acquisition has expanded the Company's standard commercial
business to states outside of the Rocky Mountain region. The Company assumed no
liabilities from previously written business or other operations of PEAK.
43
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4. INVESTMENTS
The cost and fair values of investments in fixed maturity and
equity securities are as follows (in thousands):
December 31,
------------------------------------------
Gross Gross
Unrealized Unrealized Fair
1995 Cost Gains Losses Value
- ---- -------- -------- -------- --------
Fixed maturity securities held to maturity:
U.S. Treasury and U.S. Government agencies $ 17,943 $ 896 $ $ 18,839
State and municipal 53,907 1,564 400 55,071
Corporate 3,167 66 3,233
-------- -------- -------- --------
75,017 2,526 400 77,143
Fixed maturity securities available for sale:
U.S. Treasury and U.S. Government agencies 123,209 3,000 126,209
State and municipal 176,461 8,298 161 184,598
Corporate 83,465 2,884 1,958 84,391
-------- -------- -------- --------
383,135 14,182 2,119 395,198
-------- -------- -------- --------
Total fixed maturity securities $458,152 $ 16,708 $ 2,519 $472,341
======== ======== ======== ========
Equity securities:
Common stocks $ 41,994 $ 12,767 $ 2,622 $ 52,139
Nonredeemable preferred stocks 31,277 3,654 1,985 32,946
-------- -------- -------- --------
Total equity securities $ 73,271 $ 16,421 $ 4,607 $ 85,085
======== ======== ======== ========
1994
- ----
Fixed maturity securities held to maturity:
U.S. Treasury and U.S. Government agencies $ 25,031 $ 137 $ 528 $ 24,640
State and municipal 66,524 55 1,949 64,630
Corporate 27,140 297 885 26,552
-------- -------- -------- --------
118,695 489 3,362 115,822
Fixed maturity securities available
for sale:
U.S. Treasury and U.S. Government agencies 47,640 18 5,378 42,280
State and municipal 74,840 563 3,270 72,133
Corporate 43,945 622 4,536 40,031
-------- -------- -------- --------
166,425 1,203 13,184 154,444
-------- -------- -------- --------
Total fixed maturity securities $285,120 $ 1,692 $16,546 $270,266
======== ======== ======== ========
Equity securities:
Common stocks $ 33,718 $ 5,317 $ 2,794 $ 36,241
Nonredeemable preferred stocks 31,737 2,199 3,605 30,331
-------- -------- -------- --------
Total equity securities $ 65,455 $ 7,516 $ 6,399 $ 66,572
======== ======== ======== ========
Net investment income is summarized as follows (in thousands):
Year Ended December 31,
-------------------------------
1995 1994 1993
-------- -------- --------
Type of investment:
Fixed maturities $ $ $18,544
Fixed maturities held to maturity 7,531 7,653
Fixed maturities available for sale 15,886 10,999
Common stocks 1,420 1,147 1,044
Nonredeemable preferred stocks 2,432 2,557 1,606
Short-term investments 2,439 1,145 842
Other 2,397 1,166 1,553
-------- -------- --------
Total investment income 32,105 24,667 23,589
Less investment expenses 1,129 1,091 1,038
-------- -------- --------
Net investment income $30,976 $23,576 $22,551
-------- -------- --------
44
13
Realized investment gains and losses, which includes a
write-down for other than temporary impairments of $2,135,000 for the year ended
December 31, 1995, are as follows (in thousands):
Year Ended December 31,
-----------------------------
1995 1994 1993
------- ------- -------
Fixed maturities held to maturity:
Gains $ 360 $ 174 $
Losses (269) (21)
------- ------- -------
91 153
Fixed maturities available for sale:
Gains 1,566 2,374
Losses (2,869) (2,657)
------- ------- -------
(1,303) (283)
Fixed maturities:
Gains 1,866
Losses (269)
------- ------- -------
1,597
Equity securities:
Gains 6,227 3,192 4,836
Losses (1,724) (55) (437)
------- ------- -------
4,503 3,137 4,399
------- ------- -------
Total $ 3,291 $ 3,007 $ 5,996
======= ======= =======
Net change in unrealized gains (losses) in the fair value of
investments is as follows (in thousands):
Year Ended December 31,
------------------------------
1995 1994 1993
-------- -------- --------
Fixed maturities $ $ $ 6,462
Fixed maturities held to maturity 4,999 (7,819)
Fixed maturities available for sale 24,044 (20,675)
Equity securities 10,697 (6,672) 3,295
-------- -------- --------
Total $ 39,740 $(35,166) $ 9,757
======== ======== ========
To augment the average yield on its investment portfolio, the
Company invests a portion of its fixed maturity assets in "high yield" bonds
and preferred stocks, which are investments of a quality considered to be
noninvestment grade (rated "BB" or below). Such securities are generally
considered to have a higher potential of loss due to default because they are
unsecured, subordinated to other debt and/or issued by highly leveraged
companies. At December 31, 1995, and 1994, the Company had investments in "high
yield" securities of $36,641,000 and $30,933,000 with fair values of $36,356,000
and $27,904,000, respectively.
The Company closely monitors the financial condition of issuers
of securities that it owns, and if conditions are deemed appropriate, the
Company ceases to accrete discount, accrue interest or record "pay in-kind"
interest or dividends. The Company had $230,000 of fixed maturities at fair
value at December 31, 1995, which had been non-income producing for a portion of
the previous twelve months. All fixed maturities at December 31, 1994, had been
income producing during the year. During 1995, other-than-temporary investment
impairments amounting to $2,135,000 were recorded as a realized loss, while no
other-than-temporary investment impairments were recorded in 1994 or 1993. Also
in 1995, and as a result of the Statement of Financial Accounting Standards
(SFAS) No.115 "Implementation Guide" the Company transferred certain fixed
maturities from the held to maturity portfolio to the available for sale
portfolio. The amortized cost of this transfer was $41,643,000 and the
unrealized gain was $916,000. During 1994, the Company transferred fixed
maturity securities from the held to maturity portfolio to the available for
sale portfolio due to the decrease in credit ratings of three issuers. The
amortized cost of this transfer was $4,219,000 and the unrealized loss was
$450,000.
Concentrations of credit risk exist for groups of issuers when
they have similar economic characteristics that would cause their ability to
meet their obligations to be similarly affected by changes in economic or other
conditions. The Company holds $42,680,000 of fixed maturity and equity
securities of public utilities and $238,505,000 of fixed
45
14
maturities of state and local governments; these holdings are not
collateralized. The Company does not have a concentration of credit risk with
any one issuer of fixed income or equity securities.
5. PROPERTY AND EQUIPMENT
In conjunction with the Viking acquisition, in July 1995, the
Company acquired two Viking owned properties, as well as various Viking owned
equipment. The Viking owned properties consist of Viking's corporate office
building located in Madison, Wisconsin, and a regional claims office located in
Salem, Oregon. The estimated fair value of these two facilities, as well as the
equipment, totaled approximately $7,028,000 at July 18, 1995, the acquisition
closing date.
The Company relocated its Colorado operations to a new home
office facility during the second quarter of 1994. New facility expenditures
totaled $16,208,000, which were primarily funded from operating cash flow.
During 1994, the Company utilized a $3,000,000 term loan to purchase furniture
and fixtures for the new home office facility. Total nonrecurring relocation
charges of $838,000 were incurred in 1994.
6. NOTES PAYABLE
On June 2, 1995, the Company entered into a $110,000,000
agreement ("Agreement") with several participating banks. The Agreement provides
for an unsecured reducing revolving credit facility, used in part to fund the
Viking acquisition (See Note 3), to retire the outstanding balance of
$29,000,000 under the Company's previous revolving line of credit, and for
working capital and general corporate purposes. Principal payments are required
beginning April 15, 1997, until the loan is retired in 2002. The Company elected
to make an early principal payment during 1995 in the amount of $2,000,000, and
therefore, the next principal payment is due on April 15, 1998. Interest is
payable quarterly, and interest rates are based on the floating LIBOR (London
Interbank Offered Rate) rate, plus a margin of 0.5% to 1.0%. As of December 31,
1995, the outstanding loan amount under this Agreement was $100,000,000, with
an interest rate of 6.56% (see Note 11). Loan fees of approximately $393,000
will be amortized over the seven year life of the loan.
The Agreement contains covenants with respect to minimum net
worth and statutory surplus, the maximum ratio of net written premiums to
surplus, the maximum fixed charge coverage ratio, the minimum level of total
adjusted capital (within the meaning of the Risk-Based Capital for Insurers
Model Act as promulgated by the National Association of Insurance
Commissioners), and limitations on other items, such as permitted investments
and disposition of material assets. The Company is currently in compliance with
the affirmative, negative and financial covenants of the Agreement.
On June 14, 1995, the Company amended the $20,896,000
subordinated notes ("Orion Notes") held by Orion, to include a common stock
conversion feature. On June 22, 1995, the Company converted $8,667,000 of the
Orion Notes into 550,000 shares of common stock. On October 30, 1995, the
Shareholders of the Company approved the conversion of the remaining balance of
the Orion Notes into 776,128 shares of common stock.
As of December 31, 1995, the Company had a remaining principal
balance of $3,000,000 under its 6.5% term loan, which was entered into during
1994 in order to purchase furniture and fixtures for the new home office
facility. Monthly interest payments were due through 1995, and quarterly
principal and interest payments are due thereafter until April 1, 1999.
Maturities of notes payable are as follows: 1996-$1,125,000;
1997-$750,000; 1998-$15,750,000; 1999-$18,375,000; 2000-$20,000,000; 2001 and
thereafter-$47,000,000.
46
15
7. FAIR VALUE OF FINANCIAL INSTRUMENTS
The cost and fair value of fixed maturities at December 31,
1995, and 1994, by contractual maturity, are shown below (in thousands).
Expected maturities will differ from contractual maturities because issuers may
have the right to call or prepay obligations with or without call or prepayment
penalties.
December 31,
----------------------------------------
Available for Sale Held to Maturity
------------------- ------------------
Fair Fair
Cost Value Cost Value
-------- -------- -------- --------
1995
- ----
Due in one year or less $ 33,100 $ 33,342 $ 9,816 $ 9,861
Due after one year through five years 98,425 99,124 26,346 27,411
Due after five years through ten years 66,832 68,829 28,489 29,905
After ten years 132,220 139,818 10,366 9,966
Federal agency and other mortgage pools 52,558 54,085
-------- -------- -------- --------
$383,135 $395,198 $ 75,017 $ 77,143
======== ======== ======== ========
1994
- ----
Due in one year or less $ 163 $ 160 $ 4,546 $ 4,545
Due after one year through five years 6,338 6,493 39,616 39,288
Due after five years through ten years 27,320 25,028 43,777 42,615
After ten years 92,056 87,566 30,756 29,374
Federal agency and other mortgage pools 40,548 35,197
-------- -------- -------- --------
$166,425 $154,444 $118,695 $115,822
======== ======== ======== ========
The carrying value and estimated fair value of other financial instruments
at December 31, 1995, and 1994 are as follows (in thousands):
December 31, 1995 December 31, 1994
------------------- -------------------
Carrying Estimated Carrying Estimated
Value Fair Value Value Fair Value
-------- -------- -------- --------
Assets:
Equities $ 85,085 $ 85,085 $ 66,572 $ 66,572
Other long-term investments 11,521 11,572 11,726 12,108
Short-term investments 52,257 52,257 26,896 26,896
Liabilities:
Notes payable 103,000 103,009 52,896 51,474
Estimated fair value of the term loan and the Orion Notes,
included in notes payable above, was calculated by discounting contractual
cash flows through maturity using quoted market rates for similar issues with
similar maturities. Estimated fair value of the 1995 reducing, revolving
credit facility and the 1994 revolving line of credit, also included in notes
payable above, approximates face value due to the credit terms during the
revolving period.
The estimated fair value of financial hedge instruments, both of
which are held for other than trading purposes, is the estimated amount the
Company would pay to terminate the interest rate swap agreements, taking into
consideration current interest rates and other relevant factors. The estimated
amount at December 31, 1995 was $678,000.
47
16
8. Income Taxes
On January 1, 1993, the Company adopted, on a prospective basis, SFAS
No. 109, which among other things, revised the criteria for recognition and
measurement of deferred tax assets, including loss carryforwards, which were
more restrictive under the previous accounting standard. The cumulative effect
of adopting SFAS No. 109 included in the 1993 net earnings was a benefit,
primarily related to discounted loss reserves, of $1,502,000, or $.12 per common
share.
Deferred income taxes result from temporary differences in the basis of
various assets and liabilities for financial statement purposes and for tax
purposes, and alternative minimum tax ("AMT") credit carryforwards. The tax
effects of the temporary differences and AMT carryforwards comprising the net
deferred tax asset at December 31, 1995, and 1994, are as follows (in
thousands):
Year Ended December 31,
-----------------------
1995 1994
------- -------
Discounted loss reserves $11,325 $ 7,411
Unearned premiums 8,971 7,668
Deferred compensation arrangements 1,030 824
Net unrealized investment loss 3,803
Realized investment losses 747
AMT credit carryforward 1,819
Accrued post retirement benefits
other than pensions 504 334
Accrued exit activity costs 1,464
Other 1,039 1,147
------- -------
Gross deferred tax assets 26,899 21,187
------- -------
Deferred policy acquisition costs 13,173 11,068
Net unrealized investment gain 8,357
Amortization of fixed maturities 489 237
Other 664 675
------- -------
Gross deferred tax liabilities 22,683 11,980
------- -------
Net deferred tax asset $ 4,216 $ 9,207
======= =======
Included in net deferred tax assets at December 31, 1995, is $1,819,000
of AMT credit carryforward. The credit is allowed for the amount of adjusted net
minimum tax for all years reduced by the minimum tax credit for all prior tax
years. This credit has no expiration date as a credit against the Company's
future regular tax liability. Included in other deferred tax assets at December
31, 1995, and 1994, is the tax effect of a $639,000 and $882,000, respectively,
net operating loss carryforward arising from the acquisition of CCIC, available
to offset future taxable income of CCIC. This carryforward substantially expires
in 1997, with final expiration in 2003. Also included in other deferred tax
assets at December 31, 1995, is the tax effect of a $609,000 net operating loss
carryforward, which is available to offset the Company's future taxable income.
This carryforward expires in 2010. As of December 31, 1995, no valuation
allowance on deferred tax assets was necessary.
Total income taxes (benefit) are allocated as follows (in thousands):
Year Ended December 31
--------------------------------
1995 1994 1993
-------- -------- --------
Income from continuing operations $ (1,597) $ 7,036 $ 5,341
Cumulative effect of change in accounting
for postretirement benefits (204)
Shareholders' equity, for unrealized
investment gains (losses) 12,160 (9,493) 4,162
Shareholders' equity, other 8 8 58
-------- -------- --------
$ 10,571 $ (2,449) $ 9,357
======== ======== ========
48
17
The components of the provision (benefit) for income taxes on
continuing operations are as follows (in thousands):
Year Ended December 31,
--------------------------------
1995 1994 1993
-------- -------- --------
Current $ 1,946 $ 7,012 $ 4,274
Deferred (3,543) 24 1,067
-------- ------- -------
(1,597) $ 7,036 $ 5,341
======== ======= =======
The following table reconciles the effective tax rate to the
federal statutory rate of 35 percent for pretax earnings from continuing
operations (in thousands):
Year Ended December 31,
--------------------------------
1995 1994 1993
-------- -------- --------
Earnings before taxes $ 7,332 $29,587 $ 24,626
======== ======= =======
Expected income tax expense $ 2,566 $10,355 $ 8,619
Adjustments resulting from:
Dividends received deduction (1,875) (1,528) (1,232)
Nontaxable interest income (3,451) (2,754) (2,590)
Proration 799 642 573
Nondeductible goodwill 262 228 228
Other, net 102 93 (257)
-------- ------- -------
$ (1,597) $ 7,036 $ 5,341
======== ======= =======
9. REINSURANCE
In the ordinary course of business, the Company reinsures
certain risks, generally on an excess of loss basis with other insurance
companies. Such reinsurance arrangements serve to limit the Company's maximum
loss per occurrence from $150,000 to $300,000. Amounts recoverable from
reinsurers are recognized and estimated in a manner consistent with the claim
liabilities arising from the reinsured policies and incurred but not reported
losses.
Reinsurance contracts do not relieve the Company from its
obligations to policyholders. To the extent that any reinsuring company is
unable to meet its obligations, the Company would be liable for such defaulted
amounts; consequently, allowances are established for amounts deemed
uncollectible. The allowances established for uncollectible amounts were
$200,000 at December 31, 1995, and 1994. The Company generally does not require
collateral to support reinsurance recoverables, but continually evaluates the
financial condition of its reinsurers and monitors concentrations of credit risk
to minimize exposure to significant losses from reinsurer insolvencies. At
December 31, 1995, and 1994, reinsurance recoverables of $68,938,000 and
$41,143,000, respectively, were associated with two reinsurers (both companies
are rated A+ or above by A.M. Best) under the Company's excess of loss property
and casualty treaties and certain facultative reinsurance contracts. The
Company's reinsurance treaties generally provide that premiums are ceded on a
written basis but are paid to the reinsurers on an earned basis; consequently,
prepaid reinsurance premiums are primarily deposits required by contract terms
and amounts paid related to facultative reinsurance contracts. Prepaid
reinsurance premiums are amortized over the contract period in proportion to
the amount of reinsurance protection provided.
49
18
The approximate prepaid and recoverable amounts of reinsurance
ceded to other companies, including subsidiaries of Orion under 100% reinsurance
arrangements, are as follows (in thousands):
December 31, 1995 December 31, 1994
----------------------------- -----------------------------
Non-Affiliates Affiliates Non-Affiliates Affiliates
-------------- ---------- -------------- ----------
Premiums prepaid $ 4,435 $ 79 $ 5,191 $
Paid losses recoverable 9,016 8,237
Unpaid losses recoverable 51,491 3,438 45,127 4,691
Unpaid loss adjustment expenses
recoverable 10,048 3,318 8,134 3,494
------- ------- ------- -------
$74,990 $ 6,835 $66,689 $ 8,185
======= ======= ======= =======
Premiums, losses, and loss adjustment expenses, including the
effect of reinsurance, are comprised of (in thousands):
Year Ended December 31,
----------------------------------------------------------------------------------------
1995 1994 1993
------------------------ ------------------------ ------------------------
Written Earned Written Earned Written Earned
-------- -------- -------- -------- -------- --------
Premiums:
Direct $414,694 $393,886 $295,714 $284,918 $252,864 $232,900
Assumed 36,819 47,916 69,277 76,720 69,749 62,671
Ceded (53,614) (51,785) (42,066) (40,000) (38,573) (38,031)
-------- -------- -------- -------- -------- --------
Net $397,899 $390,017 $322,925 $321,638 $284,040 $257,540
======== ======== ======== ======== ======== ========
% Assumed to Net 9.25% 21.45% 24.56%
======== ======== ========
Incurred Incurred Incurred
-------- -------- --------
Losses and loss adjustment
expenses:
Direct $309,298 $192,183 $156,444
Assumed 32,281 54,892 43,058
Ceded (48,066) (33,570) (26,002)
-------- -------- --------
Net $293,513 $213,505 $173,500
======== ======== ========
Included in direct premiums earned above, for the years ended
December 31, 1995, 1994 and 1993, were $309,000, $1,152,000, and $3,099,000,
respectively, of premiums earned under 100% reinsurance agreements with
subsidiaries of Orion. Also, included in direct losses incurred above, for the
years ended December 31, 1995, 1994, and 1993, were $218,000, $854,000, and
$2,169,000, respectively, of losses incurred under these same 100% reinsurance
agreements with subsidiaries of Orion.
The Company has entered into reinsurance agreements with
subsidiaries of Orion, whereby it assumes business written by the affiliates.
Included in premiums assumed above, for the years ended December 31, 1995, 1994,
and 1993, were $9,495,000, $30,921,000, and $30,856,000 of premiums written,
respectively, which were assumed under these agreements. The decrease in assumed
premiums and incurred losses, compared to the prior years, is primarily due to
direct business written on GNICOC policies which was previously written by
subsidiaries of Orion and assumed by the Company. The Company paid fees and
expenses to affiliates for assumed business written as follows: 1995-$338,000;
1994-$1,440,000; 1993-$1,255,000.
Following the acquisition of Viking, the Company is party to
100% reinsurance agreements with VCM, whereby the Company assumes business
written by this affiliate. Included in 1995 premiums assumed above was
$5,525,000 of premiums written under these agreements. The policy issue fee
charged by VCM is offset by the management fee charged by the Company to VCM.
Therefore, the net amount of policy issue fees and management fees is
immaterial.
50
19
10. RESERVES FOR LOSS AND LOSS ADJUSTMENT EXPENSES
The Company's loss and LAE reserves are summarized below (in
thousands):
Year Ended December 31,
--------------------------------
1995 1994 1993
-------- -------- --------
Balance at beginning of year $241,221 $220,965 $191,508
Reserves acquired as a result of a
business combination 80,692
Less reinsurance recoverables 61,446 55,165 47,000
-------- -------- --------
Net adjusted beginning balance 260,467 165,800 144,508
Provision for incurred losses and LAE:
Current year 280,726 212,458 171,196
Prior years 12,787 1,047 2,304
-------- -------- --------
293,513 213,505 173,500
Payments for incurred losses and LAE:
Current year 159,208 111,418 81,022
Prior years 108,433 88,112 71,186
-------- -------- --------
267,641 199,530 152,208
-------- -------- --------
Net balance at end of year 286,339 179,775 165,800
Plus reinsurance recoverables 68,295 61,446 55,165
-------- -------- --------
Balance at end of year $354,634 $241,221 $220,965
======== ======== ========
As a result of changes in estimates of insured events in prior
years, the provision for prior year losses and LAE increased by $12,787,000 in
1995, a significant increase compared to 1994 and 1993. The adverse development
in 1995 is primarily a result of commercial automobile liability outstanding
claims and incurred but not reported losses developing higher than expected.
Total adverse development in commercial lines during 1995 was $10,056,000, of
which $7,266,000 was caused by commercial automobile liability higher claim
severity primarily in 1994 through 1992. The remaining commercial lines 1995
adverse development was from general liability and other lines. The adverse
development in commercial lines in 1994 and 1993 is primarily due to loss
development on professional, general and commercial automobile liability claims
occurring prior to 1985. These accident years accounted for $920,000 of
commercial lines' adverse development in 1995, $1,300,000 in 1994, and
$3,200,000 in 1993. The adverse development in personal lines totaled $2,504,000
is a result of adverse trends in claim frequency which caused higher than
expected development of outstanding claims and incurred but not reported losses.
Development on personal lines during 1994 and 1993 was favorable. The remaining
adverse development in 1995 of $227,000 is attributable to the collateral
protection business unit.
The Company primarily writes automobile coverage, and therefore
has limited exposure for environmental claims. In establishing the liability
for unpaid losses and LAE related to environmental claims, the Company
considers facts currently known, current state of the law, and coverage
litigation. Liabilities are recognized for known claims when sufficient
information has been developed to indicate the involvement of a specific
insurance policy, and its liability can be reasonably estimated. In addition,
liabilities have been established to cover additional exposures on both known
and unasserted claims. Estimates of the liabilities are reviewed and updated
continually. Developed case law and adequate claim history do not exist for
such claims, especially because significant uncertainty exists about the
outcome of coverage litigation and whether past claim experience will be
representative of future claim experience.
Environmental claims reported to the Company to date, such as
asbestos and pollution contamination, have primarily related to policies
written during the period 1984 to 1978. In 1985, the Company added an absolute
pollution exclusion clause to general liability policies to significantly
reduce exposure to such claims. The Company's known exposure to environmental
losses is not considered to be material as they have amounted to approximately
three percent of cumulative payments on general liability claims for the
accident years 1984 to 1978, and there are approximately $1,000,000 in net
outstanding claim reserves at December 31, 1995. Based on
51
20
the claim activity to date and the nature of the business written during this
period and subsequent periods, the Company does not believe that a material
exposure to such risks exists in the future.
11. INTEREST RATE SWAP AGREEMENTS
At December 31, 1995, the Company had two interest rate swap
agreements outstanding, with participating commercial banks, having a total
notional principal amount of $80,000,000, or $40,000,000 per bank. These
agreements effectively change the Company's interest rate exposure on
$80,000,000 of the $100,000,000 million principal balance outstanding under the
reducing, revolving credit facility, which is discussed in Note 6, to a fixed
rate. The fixed rate interest percentage paid by the Company on the total
notional amounts is approximately 6.5%. Net cash payments made or received under
the swap agreements will be included within interest expense.
The interest rate swap agreements terminate on March 16, 1998.
The interest rate swap floating rate, which is paid by the banks to the
Company, resets ever three months, beginning December 20, 1995, which coincides
with the LIBOR determination dates available on the outstanding principal
balance under the Company's reducing, revolving credit facility. The floating
interest rate under the swap agreements is based upon the LIBOR rate at each
determination date.
The Company is exposed to credit loss in the event of
nonperformance by the other parties to the interest rate swap agreements.
However, the Company does not anticipate nonperformance by the counterparties.
12. COMMITMENTS AND CONTINGENCIES
The Company rents various buildings for its branch office
locations. Rent expense for operating leases was as follows: 1995-$1,262,000;
1994-$1,450,000; 1993-$2,100,000. Future minimum lease payments on building and
equipment operating lease commitments are as follows: 1996-$1,417,000;
1997-$1,292,000; 1998-$1,136,000; 1999-$384,000; 2000-$47,000; 2001 and
thereafter-$0.
In conjunction with the Viking acquisition there is additional
purchase price which may ultimately be paid to the seller depending on Viking's
future loss development. See Note 3 for further discussion of this contingency
payment.
The Company is subject to litigation in the normal course of
operating its insurance business. The Company is not engaged in any litigation
which it believes would have a material impact on its financial condition.
13. RESTRICTIONS ON SHAREHOLDERS' EQUITY
The reducing revolving credit facility, which is discussed in
Note 6, imposes no dividend restrictions on the Company, but requires the
Company to maintain net worth of $135,000,000, plus 100% of the aggregate of all
increases in the stated capital and paid-in capital accounts resulting from the
issuance of equity securities or other capital investments after December 31,
1994. According to the definition outlined in the reducing, revolving credit
facility, consolidated net worth means the net worth of Guaranty and its
subsidiaries determined in accordance with GAAP, but excluding any preferred
stock or other class of equity securities that, by its stated terms, or upon the
occurrence of any event, matures or is manditorily redeemable, or is redeemable
at the option the holders thereof, in whole or in part, and without regard to
the requirements of Statement of Financial Accounting Standards No. 115. As of
December 31, 1995, the required net worth under the bank loan agreement was
$180,800,000, while the Company's actual net worth, as defined in the credit
agreement, was $207,710,000.
Shareholders' equity of the Company is primarily represented by
the surplus, including undistributed earnings, of GNIC and VICW. The Colorado
dividend restriction law limits the annual dividend a Colorado domiciled
insurance company may pay to its parent holding company during a twelve-month
period to the greater of 10% of GNIC's statutory surplus as reported at the end
of the preceding calendar year ($133,749,000 and $133,229,000 at December 31,
1995, and 1994, respectively), or GNIC's statutory net income, excluding
realized capital gains (($422,490) and $21,749,000 for 1995 and 1994,
respectively) as reported at the end of the preceding calendar year. When a
dividend is declared by GNIC to Guaranty, the Colorado Insurance Department
must be notified of such declaration within five days thereafter, and at least
ten business days before the payment of the dividend. The Wisconsin dividend
restriction law limits the annual dividend that VICW may pay to Guaranty to the
lesser of 10% of VICW's statutory surplus as of the end of the preceding
calendar year ($86,872,000 at December 31, 1995) or the greater of either the
statutory net income
52
21
of VICW for the preceding calendar year, less realized capital gains,
($14,591,000 at December 31, 1995) or the aggregate of the net income of VICW
for the three calendar years preceding the date of the dividend, less realized
capital gains for those calendar years minus dividends paid or credited and
distributions made within the first two of the preceding three calendar years
($17,521,000 at December 31, 1995). The Company believes that GNIC will be in a
position to pay dividends to Guaranty in the future, while VICW will also be in
a position to pay dividends to Guaranty in the future. Dividends of $16,500,000
and $4,000,000 were paid by GNIC to Guaranty during 1995 and 1994, respectively.
No dividends were paid by VICW to Guaranty during 1995.
14. RELATED PARTY TRANSACTIONS
Orion manages a majority of the Company's investment portfolio.
The Company paid investment management fees to Orion as follows: 1995-$595,000;
1994-$550,000; 1993-$550,000. However, in 1996, due to the higher investment
balances caused by the acquisition of Viking, the Company will pay $650,000 in
investment management fees to Orion.
The Company paid commissions to an Orion agency affiliate of
$72,000, $90,000 and $94,000 in 1995, 1994, and 1993, respectively, for premiums
written by the affiliate for the Company of $411,000, $516,000 and $537,000 in
1995, 1994, and 1993, respectively.
In 1990, GNIC entered into a loan participation agreement with a
subsidiary of Orion, whereby they loaned money to another affiliate. The loan
was secured by a leasehold deed of trust and matured in November 1995. GNIC's
proportionate share of this loan was $3,700,000, or 41.1%. GNIC received
quarterly interest payments at a rate of 11% of its proportionate share.
Interest earned was $355,000 in 1995 and $407,000 in 1994.
In 1995, during the assembly of the Viking acquisition
financing, the Company received a commitment for a $21,000,000 Bridge Loan from
Orion, for which the Company paid a $210,000 commitment fee.
During 1995, the Company converted the $20,896,000 Orion Notes
into 1,326,128 shares of common stock. See Note 6 for further discussion
related to this conversion. In 1995, the interest expense paid to Orion, prior
to the conversion, was $1,122,000.
Also, the Company has entered into certain reinsurance
agreements with subsidiaries of Orion (see Note 9).
In the opinion of management, the terms of the Company's
transactions with Orion are reasonable and representative of the terms that
would have been applicable in transactions with unrelated parties.
In 1993, the Company's insurance subsidiaries entered into a
reinsurance agreement with National Reinsurance Corporation ("NRC"), a wholly
owned subsidiary of National Re Holdings Corporation ("National Re"). The
agreement, which provides reinsurance limits up to $6,000,000 in excess of the
Company's retention of $150,000 to $300,000, is subject to certain renewal and
cancellation provisions. The Company ceded $38,215,000, $31,929,000 and
$27,722,000 in premiums during 1995, 1994, and 1993, respectively, to NRC. The
Company received $12,358,000, $10,337,000 and $9,010,000 in ceding commissions
during 1995, 1994, and 1993, respectively, from NRC. With the exception of 1992,
NRC has been a principal reinsurer of the Company since 1985. The son of the
Company's Chairman of the Board is a director of National Re. Neither person
participated in the negotiation of the reinsurance agreement with NRC. In
addition, this individual is a managing director of Insurance Partners Advisors
L.P., which manages Insurance Partners L.P., a partnership formed to make equity
investments in the insurance industry. The Company has committed initial capital
in an aggregate amount not to exceed $1,500,000 of the total $550,000,000
committed by all partners.
A member of the Board of Directors of the Company is the
owner of a general agency. Gross commissions paid by the Company to the agency,
under a standard agency contract, for business produced was $813,000, $789,000
and $770,000 in 1995, 1994, and 1993, respectively.
As a result of the Viking acquisition and the subsequent change
in control of VCM, VCM was required to increase its surplus to a minimum of
$2,000,000 as required by the Texas Insurance Code. The increase was
accomplished by the issuance of a surplus debenture to Viking in the amount of
$1,300,000 in exchange for cash. The debenture pays interest annually at a rate
of 8.5%. Interest earned in 1995 was $33,000. Also, the Company provides
management services to
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VCM. The fees paid by VCM are offset by policy issue fees paid to VCM by the
Company under 100% reinsurance agreements (see Note 9).
15. EMPLOYEE BENEFIT PLANS
The Company provides incentive plans for key employees. These
plans include the Company's 1987 Performance Unit Plan (the "Unit Plan") and the
1991 Long-Term Performance Incentive Plan (the "Incentive Plan"). Under the Unit
Plan, units granted increase in value in relationship to the book value per
share of the Company's common stock with certain adjustments. However, in 1993
the Unit Plan was amended to place a floor on the value of the awards equal to
their unit value as of September 30, 1994. As of December 31, 1995, 225,729
units are outstanding, including 15,994 units issued during 1995.
Under the Incentive Plan, shares of restricted stock as well as
stock options may be granted by the Company. The Incentive Plan, as adopted
September 12, 1991, reserved 800,000 common shares for grant to key employees.
Through December 31, 1995, 120,273 shares of restricted stock have been issued
by the Company, at a price range of $14.50 to $20.375, of which 6,011 shares
have been forfeited. A portion of the 12,000 shares of restricted stock issued
in 1995 was from treasury stock. Restricted stock is considered issued and
outstanding when awarded, and is recorded as deferred compensation.
Restrictions lapse through 1999. As of December 31, 1995, restrictions have not
lapsed on 45,448 shares of restricted stock. All stock options were granted at
fair market value at date of grant, become exercisable proportionately from the
first through the fourth anniversaries of the grant dates, and expire ten
years after the date of grant. At December 31, 1995, there were 237,625 options
exercisable and 172,738 common shares available for grant. The following is a
summary of the option transactions:
1995 1994 1993
--------------------- --------------------- ----------------------
Options Price Range Options Price Range Options Price Range
------- ----------- ------- ----------- ------- -----------
Balance-January 1 458,000 $14.50-23.25 291,500 $14.50-23.25 285,500 $14.50-17.50
Granted 90,000 17.25 166,500 17.50 6,000 20.75-23.25
Exercised (36,750) 14.50-17.50
Terminated (39,750) 14.50-17.50
------- ------- -------
Balance - December 31 471,500 $14.50-23.25 458,000 $14.50-23.25 291,500 $14.50-23.25
======= ======= =======
The Company, excluding Viking, also has a defined contribution
profit sharing plan, which qualifies under Section 401(k) of the Internal
Revenue Code, for which substantially all employees are eligible after a
specific waiting period. The plan is contributory and the Company matches
employee contributions unless changed by the Board of Directors. At year end
1995, Viking had its own separate Individual Retirement Plan which is pending
qualification under Section 401(k) of the Internal Revenue Code. All employees
are eligible to enroll in this plan after completion of the designated waiting
period. The plan is contributory, and Viking matches employee contributions
unless changed by the Board of Directors. Subsequent to year end 1995, the
Company received a favorable determination letter from the Internal Revenue
Service and intends to roll the Viking plan into its plan on April 1, 1996.
The Company, excluding Viking, has a non-qualified Supplemental
Executive Retirement Plan ("SERP") for employees whose compensation meets a
minimum requirement. This plan provides deferred benefits for those employees
who received less than the full employer contribution of the Company's defined
contribution profit sharing plan as a result of federal tax limitations on
participation in the plan. Eligible employees are entitled to receive payment of
funds upon retirement or termination unless terminated for good cause as
defined in the SERP. In 1996, certain Viking employees will be eligible to
participate in this plan.
Total expense for the Company's employee benefit plans is as
follows: 1995-$2,132,000; 1994-$1,602,000; 1993-$1,557,000.
The Company, excluding Viking, has a defined benefit health care
plan ("the Plan") that provides postretirement medical benefits to full-time
employees who have worked for ten years and attained age 55 while in service
with the Company. Benefits generally are provided under the Plan for retirees
and their dependents until the retirees attain age 65. The Plan is contributory
and contains other cost sharing features which may be adjusted annually for the
expected general inflation rate. The Company's policy is to fund the cost of the
Plan benefits in amounts determined at the discretion of management. To date, no
funding of the Plan has been made. The net periodic postretiretnent benefit cost
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of $159,000 for the year ended December 31, 1995, was comprised of a service
component of $104,000, an interest component of $60,000, and an amortization of
prior service cost and unrecognized gain component of ($5,000).
The following table presents the Plan's status reconciled with
amounts recognized in the Company's financial statements as follows (in
thousands):
December 31,
--------------
1995 1994
---- ----
Benefit costs for:
Fully eligible active Plan participants $ 178 $ 73
Other active Plan participants 748 539
Retirees 56 1
----- -----
Accumulated postretirement benefit obligation 982 613
Unrecognized prior service cost 4 4
Unrecognized net gain 9 234
----- -----
Accrued postretirement benefit obligation $ 995 $ 851
===== =====
The weighted average annual assumed rate of increase in the per
capita cost of covered benefits (i.e., health care cost trend rate) is 9.62% for
1996 (11.53% was assumed for 1995) and is assumed to decrease gradually to 5.0%
by 2016 and remain at that level thereafter. The health care cost trend rate
assumption has a significant effect on the amounts reported. If the assumed
health care cost trend rates increased by one percentage point each year, the
accumulated postretirement benefit obligation would have increased by $129,000
and $86,000 as of December 31, 1995, and December 31, 1994, respectively, and
the net periodic service and interest cost for 1995 would have increased by
$25,000. The weighted average discount rate used in determining the accumulated
postretirement benefit obligation was 6.75% at December 31, 1995, and 8.5% at
December 31,1994.
As of December 31, 1995, Viking terminated its defined benefit
health care plan that provided for post-retirement medical benefits to
individuals who retired or became permanently disabled while in service with
Viking. Employees who were retired or disabled as of December 31, 1995 continue
to be eligible for post-retirement medical benefits. Benefits generally are
provided under this plan for retirees and their dependents until the death of
the retiree. This plan is contributory and contains other cost sharing features
which may be adjusted annually. Viking's policy is to fund the cost of plan
benefits in amounts determined at the discretion of management. At year end
1995, Viking's estimated liability for post-retirement medical benefits was
approximately $112,000.
16. SHAREHOLDER RIGHTS AGREEMENT
On November 20, 1991, the Board of Directors approved the
adoption of a Shareholder Rights Agreement and in connection therewith declared
a dividend distribution of one Right for each outstanding share of Common
Stock until such time that separate Right certificates are distributed, or the
Rights are redeemed or expire. When exercisable, each Right will entitle a
holder to purchase from the Company a unit consisting of one one-hundredth of a
share of a new series of the Company's Preferred Stock at a purchase price of
$60 per share.
The Rights become exercisable ten days following a public
announcement that a person or group of acquires has acquired or obtained the
rights to acquire beneficial ownership of 20% or more of the Company's Common
Stock or ten business days following announcement of a tender offer or exchange
offer that could result in beneficial ownership of 20% or more of the Company's
Common Stock. Prior to consummation of such a transaction, each holder of a
Right is entitled to purchase shares of the Company's Common Stock having a
value equal to two times the exercise price of the Right. The Company has the
right to redeem the Rights at $.01 per Right prior to the time they become
exercisable. The Rights will expire on December 30, 2001.
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17. QUARTERLY FINANCIAL DATA (UNAUDITED)
Three Months Ended
--------------------------------------------------------
March 31 June 30 Sept 30 Dec 31
-------- -------- -------- --------
(In thousands, except per share data)
1995:
Total revenue $ 86,502 $ 88,306 $121,479 $127,997
Earnings (loss) before income taxes 7,535 6,575 (8,349) 1,571
Net earnings 5,768 4,851 (4,113) 2,423
Earnings (loss) per share $ 0.48 $ 0.40 $ (0.29) $ 0.16
1994:
Total revenue $ 82,341 $ 85,613 $ 90,178 $ 90,091
Earnings before income taxes 7,865 8,132 6,828 6,762
Net earnings 6,070 6,075 5,167 5,239
Earnings per share $ 0.49 $ 0.50 $ 0.43 $ 0.43
During the third quarter of 1995, the Company completed the
Viking acquisition (see Note 3), which significantly increased revenues in the
third and fourth quarters of 1995. Also in the third quarter of 1995, the
Company strengthened its loss reserves (losses and loss adjustment expenses) by
$13,971,000, as a result of adverse development within the personal and
commercial lines units (see Note 10).
18. SUBSEQUENT EVENT
In February 1996, Viking purchased an office building in
Freeport, Illinois. The cost of the building is approximately $1,000,000.
Management intends to move the current Viking Freeport operations into this new
building, from a leased facility, in mid-1996.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
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