1
EXHIBIT 13
KEY FINANCIAL INFORMATION
Years ended December 31, 1995 1994 1993 1992 1991
- ----------------------------------------------------------------------------------------------
(in thousands)
Revenues $ 94,186 80,885 50,712 46,376 45,071
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Operating income $ 3,918 7,261 2,818 6,544 7,133
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Net income $ 2,139 4,981 2,138 4,379 4,015
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Total assets $116,166 128,423 114,841 87,753 77,157
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Total stockholder's equity $ 43,621 39,921 38,527 29,619 15,031
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(per share amounts)
Net income from continuing operations $ 0.28 0.65 0.30 0.68 0.73
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Dividends $ 0.18 0.18 0.17 0.08 --
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Combined ratio (1) 103.6% 97.5% 101.5% 94.5% 94.8%
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(1) Combined ratios have been computed, for all years, on a GAAP basis (see
Management's Discussion and Analysis).
2
MANAGEMENT'S DISCUSSION AND ANALYSIS
OVERVIEW
On December 18, 1995 Kingsway Financial Services, Inc. ("Kingsway") sold 1.8
million shares of its common stock in a public offering. The Company
participated in that transaction by selling 600 thousand of its 3.0 million
Kingsway common shares, reducing its equity interest in Kingsway from 100% to
50%. In January, 1996, as a result of the exercise of underwriter's over
allotment option, Kingsway sold an additional 180 thousand shares and the
Company sold an additional 60 thousand of its remaining shares, thereby
reducing its equity in Kingsway to 46.99%.
In accordance with generally accepted accounting principles, Kingsway's
financial position is not consolidated at December 31, 1995. The Company has
consolidated its 100% equity in Kingsway's 1995 results of operations through
December 18, 1995.
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Company's total revenue for the year ended December 31, 1995,
increased to $94.2 million, or 16.4%, over $80.9 million for the year ended
December 31, 1994, which was an increase of 59.5% over the $50.7 million in
1993. Revenues from U.S. and U.K. sources increased $11.2 million in 1995 and
$9.5 million in 1994 over 1993. Revenues from the Company's Canadian
subsidiary, Kingsway, increased $2.2 million in 1995 over 1994 and $20.6
million in 1994 over 1993.
In 1995, net premium written in U.S. operations increased 16.5% to
$52.3 million from $44.9 million in 1994. The 1994 level had increased 21.4%
from $37.0 million in 1993. Professional liability net premium written
increased 77.5% in 1995 on increased sales of the International Transportation
Liability (ITL) policy. The ITL policy is an occurrence form which combines
the traditional professional liability coverage with bill of lading liability.
Professional liability was unchanged in 1994 from 1993 at $1.5 million,
reflecting management's efforts to revise pricing and underwriting in an effort
to achieve profitability. In 1995, marine net premium written increased 26.2%
to $18.6 million reflecting the sixth consecutive annual increase. Surety (U.S.
Customs bonds and contract surety bonds) net premium written increased 5.2% in
1995 to $25.6 million. Other property and casualty net premium written
increased 25.3% in 1995 principally from increased sales in its truck program.
In 1994, other property and casualty operations had the highest percentage
increase over 1993, increasing 162.2% to $4.3 million, followed by marine at
21.5% to $14.8 million, and surety at 12.4% to $24.4 million.
In 1995, net premium written in Canadian operations declined 0.5% from
1994 after an increase of 95.3% in 1994 over 1993. Auto net premium written
decreased 11.5% in 1995 to $25.5 million after increasing to $28.8 million, or
95.6% in 1994 over 1993. Sales efforts and lack of significant competition
3
afforded an excellent opportunity to achieve production increases in 1994.
The rate of production slowed in the second half of 1994 as rate increases had
the desired effect of moderating production in order to maintain premium to
surplus ratios at acceptable levels. The 1995 premium volume reflects
Kingsway's capital and surplus underwriting capacity. Canadian property net
premium written increased 51.0% to $9.0 million in 1995 from $6.0 million in
1994. The 1994 premium volume had increased 97.0% in 1994 over 1993.
Earned premium increased to $86.2 million in 1995 from $74.8 million in
1994 and $45.5 million in 1993. Earned premium from U.S. operations increased
18.8% to $51.2 million in 1995. Surety earned premium increased $1.7 million,
marine increased $3.6 million, professional liability increased $700 thousand
and other property and casualty increased $2.1 million in 1995 (see "Results by
Line") over 1994. In 1994, earned premium from U.S. operations increased 25.4%
or $8.7 million over 1993. Surety earned premium increased $3.3 million,
marine increased $2.2 million, and professional liability increased $696
thousand in 1994 over 1993. U.K. operations contributed $2.9 million in earned
marine premium in 1995 and $700 thousand during its first eight months of
operations in 1994. Canadian earned premium increased 3.3% in total to $32.1
million in 1995 after increasing 178.5% to $31.0 million in 1994 from 1993.
Auto earned premium declined 6.2% to $24.0 million in 1995 compared to a 189.4%
increase in 1994 to $25.6 million. Canadian property earned premium increased
50.4% in 1995 to $7.6 million with the acquisition of a book of business from
another insurance company. Property earned premium had increased 146.9% to $5.1
million in 1994 from 1993. Earned premiums from Canadian operations increased
$19.9 million, or 178.5%, in 1994 over 1993. Automobile earned premiums
increased by $16.8 million, property by $3.0 million, and other property and
casualty by $88 thousand in 1994 over 1993.
In 1995, net investment income increased $1.9 million over 1994, or
43.3% to $6.4 million. Net investment income had increased $388 thousand in
1994 from 1993 results. Investment income for 1995 includes $244 thousand in
gains on the sale of Kingsway stock (net of related expenses). Investment
income for U.S. and U.K. operations (excluding the Kingsway gain) increased
20.4% to $3.5 million, as a result of increased investment balances in 1995
over 1994. Investment income from U.S. and U.K. operations had increased $214
thousand, or 7.8%, in 1994 over 1993. The modest increase in U.S. and U.K.
investment income in 1994 reflected efforts to align the duration of the
investment portfolio relative to the estimated claim payment pattern of loss
reserves. This had the effect of shortening the overall U.S. and U.K.
portfolio duration and the related yield.
Kingsway's investment income increased by $1.0 million in 1995, or 73.3%, over
1994. Kingsway's net investment income had increased $175 thousand in 1994 over
1993. Increased cash flows from premiums written were invested at prevailing
market rates. Premium finance income increased 14.2% to $1.0 million in 1995
after increasing $563 thousand, or 165.3%, to $903 thousand in 1994 from 1993
due to the leveling of Canadian premium production in 1995.
4
The Company's investment policy requires that assets be comprised primarily of
investment grade, fixed income securities of short to medium term duration. As
a result of the Company's investment policy and a high concentration of tax
exempt securities, the Company's yield on its investment portfolio has been
lower than the insurance industry in general. The Company endeavors to hold its
investments to maturity, where feasible, but will reorganize its positions where
market changes allow assets to be redeployed at no loss to the Company. The
Company does not invest in real estate securities, high yield securities, or
derivatives.
In 1995, loss and loss adjustment expenses increased 24.4% to $51.7 million
from $41.6 million in 1994. Loss and loss adjustment expenses had increased
97.0% in 1994 from $21.1 million in 1993.
In 1995, loss and loss adjustment expenses related to U.S. operations increased
37.0% to $29.2 million from $21.3 million in 1994. Incurred losses on the
marine line of business increased 47.5% to $14.8 million as the Company
continued to expand volume with new sources of distribution and sales of
related products. Loss and loss adjustment expenses for professional liability
decreased 4.5% in 1995 from 1994, and the loss ratio improved to 106.7% from
144.3% as a result of adjustments in underwriting guidelines and pricing. In
1995, losses for the other property and casualty lines increased 132.9% and the
related loss ratio increased to 101.0% from 71.0% in 1994. Adverse development
on losses incurred prior to 1994, related to the trucker program and commercial
multi-peril policies, resulted in an increase in the calendar year 1995 loss
ratio. This further translated to an increase in the level of reserve provided
for the premiums produced in the current year. Loss and loss adjustment
expenses for surety increased 2.0% while the loss ratio decreased to 22.7% in
1995 from 23.9% in 1994. The loss ratio for U.S. Customs bonds improved to
12.0% in 1995 from 23.2% in 1994 while the contract surety bond loss ratio
increased to 46.2% in 1995 from 25.8% in 1994.
Management has implemented a program of targeted rate increases and evaluation
of relationship profitability in response to loss reserve developments in 1995.
Rate making for each line is considered in the context of total profitability
and premium volume at the level of the broker/forwarder relationship as well as
the stand-alone line of business. As a result, loss ratios that exceed
permissible levels may appear on a line of business basis but are managed
across lines to develop desired underwriting results in total.
Incurred losses for U.K. operations increased 234.1% to $1.3 million in 1995
from $381 thousand in 1994. The 1994 level reflects eight months of operations.
Despite the increase, the 1995 loss ratio for U.K. operations declined to 44.1%
from 56.1% for 1994 as actual experience from 1994 indicates loss experience
should be less for 1995.
In 1994, loss and loss adjustment expenses increased 97% or $20.5 million from
1993. Loss and loss adjustment expenses for U.S. and U.K. operations increased
approximately $7.1 million in 1994 and included $2.6 million for adverse
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development on prior year reserves. Higher than expected losses on marine
policies issued in 1993 were almost offset by reserve savings on U.S. Customs
bonds. Underwriting losses increased in professional liability in 1994 over
prior year increases. The Company isolated certain risks as the source of
unfavorable experience and modified underwriting guidelines and pricing
accordingly.
Canadian incurred loss and loss adjustment expenses increased 6.8% to $21.2
million in 1995 from $19.9 million in 1994. Adverse development relating to 1994
and prior periods amounting to $4.0 million was recorded in 1995. Despite the
charge for adverse development, Kingsway's 1995 loss ratio increased modestly to
66.2% for 1995 from 64.0% in 1994. Kingsway's 1993 loss ratio was to 57.7%.
Loss and loss adjustment expense for Canadian operations increased $13.4
million or 208.7% in 1994 over 1993. Increased premium production starting in
1993 and continuing for most of 1994, was the source of the increase in 1994.
During 1994, Canadian operations incurred a deficiency of 4.0% on its December
31, 1993 reserve estimates.
Acquisition and other issue costs increased 23.3% to $22.8 million in 1995 from
$18.5 million in 1994 and the 1994 level was an increase of 29.1% over 1993.
U.S. and U.K. acquisition and other issue costs increased 27.1% to $16.9 million
from $13.3 million in 1994. U.S. policy acquisition costs were higher in 1995
due to increased premium volume and limitations on the ability to capitalize
acquisition costs according to GAAP due to high loss ratios on certain lines.
The 1994 acquisition cost level reflected the significant premium growth in
Canadian operations over 1993. Canadian acquisition and other issue costs
increased 13.6% in 1995 to $6.0 million. This increase is consistent with the
change in premium volume mix as the property program incurs a higher rate of
acquisition costs than auto.
Total other underwriting expenses increased 14.9% in 1995 to $14.7 million from
$12.8 million in 1994, which represented a 19.4% increase over $10.7 million
incurred in 1993. Other underwriting expenses for U.S. and U.K. operations
increased 23.8% to $10.9 million from $8.8 million in 1994. The 1995 total
other underwriting expenses include provisions for doubtful accounts amounting
to $700 thousand, agency operating expense increases of $600 thousand and a
full year of U.K. underwriting costs which amounted to $869 thousand in 1995,
39.3% more than 1994. Canadian other underwriting expenses amounted to $3.7
million in 1995, 4.8% less than the 1994 level of $3.9 million. The 1994
Canadian other underwriting expense increased 62.6% from $2.4 million incurred
in 1993 reflecting the significant increase in premium volume in 1994. The
combined ratio is an insurance industry performance ratio. The Company has
computed combined ratios on a GAAP basis for this presentation which the
Company feels provides a conservative and consistent representation of the
U.S. and U.K., and Canadian operations' performance as a whole.
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A combined ratio of less than 100.0% indicates an underwriting profit. Many of
the large property and casualty companies which sell standard commercial and
personal lines of insurance have historically posted combined ratios well in
excess of 100.0%. No assurance can be made that loss and loss adjustment
expense accruals upon which the Company's combined ratios are based may not
prove contrary to the ultimate actual results.
The Company's combined ratio was 103.6% in 1995 compared to 97.5% in 1994 and
101.5% in 1993. The Company's U.S. and U.K. operations have experienced an
increase to 110.2% in 1995 compared to a decrease to 100.2% in 1994 from 103.6%
in 1993. The combined ratio for Canadian operations increased to 96.3% after
decreasing to 93.6% in 1994 from 94.9% in 1993.
RESULTS BY LINE
Underwriting results declined slightly in the Company's surety business in 1995
following a significant improvement in 1994 over 1993. The contract surety
bond loss ratio increased from 12.6% in 1993 to 25.8% in 1994 to 46.2% in 1995,
while premium grew 29.5% to $7.7 million in 1995 after increasing 148.9% to
$5.9 million in 1994, compared to $1.8 million in 1993. U.S. Customs bond
results improved in 1995 over 1994 and in 1994 over 1993 as a result of
favorable loss developments during those years. Calendar year 1994 loss reserve
estimates for U.S. Customs bonds developed favorably by $3.0 million in 1995,
and 1993 estimates developed favorably by $1.2 million in 1994.
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U.S. AND U.K. OPERATIONS
(DOLLARS IN THOUSANDS)
OTHER
SURETY MARINE PROFESSIONAL LIABILITY PROPERTY & CASUALTY TOTAL
----------------------------------------------------------------------------------------------------------------------------
YEAR PREMIUM COMBINED PREMIUM COMBINED PREMIUM COMBINED PREMIUM COMBINED PREMIUM COMBINED
EARNED RATIO(%) EARNED RATIO(%) EARNED RATIO(%) EARNED RATIO(%) EARNED RATIO(%)
1995 $24,700 83.5 $20,808 124.7 $3,069 160.3 $5,498 146.8 $54,075 110.2
1994 23,019 80.4 14,996 114.2 2,377 195.4 3,362 106.3 43,754 100.2
1993 19,739 106.5 12,154 85.8 1,681 175.2 772 156.2 34,346 103.6
1992 17,720 105.8 10,773 74.3 2,090 131.5 566 165.2 31,149 97.7
1991 15,415 93.6 8,062 86.9 2,284 157.6 117 127.4 25,878 97.3
CANADIAN OPERATIONS
(DOLLARS IN THOUSANDS)
OTHER
AUTO PROPERTY PROPERTY & CASUALTY TOTAL
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YEAR PREMIUM COMBINED PREMIUM COMBINED PREMIUM COMBINED PREMIUM COMBINED
EARNED RATIO(%) EARNED RATIO(%) EARNED RATIO(%) EARNED RATIO(%)
1995 $24,046 92.7 $7,647 109.0 $386 73.6 $32,079 96.3
1994 25,646 92.9 5,084 98.5 313 76.4 31,043 93.6
1993 8,863 88.6 2,059 121.8 225 97.8 11,147 94.9
1992 9,302 79.6 1,154 130.7 -- -- 10,456 85.2
1991 12,841 87.8 816 103.2 -- -- 13,657 88.7
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Indications are that losses settle sooner than originally estimated. However,
contract surety bonds posted adverse development of $1.6 million in 1995
compared to a small savings on 1993 reserves recorded in 1994. Certain agency
relationships have been terminated and underwriting authorities of other agents
have been reduced or eliminated in response to this adverse development.
Marine earned premium reflects growth of $5.8 million in 1995 over 1994 compared
to $2.8 million in 1994 over 1993. A full year's production from the London
branch office of IIC, and continued emphasis on the addition of new national
accounts by IAS in 1995 are the source of the increase. Despite the production
increases, 1995 marine underwriting results were negatively affected by adverse
development on claims incurred in 1994 and prior. The Company terminated
certain sales relationships whose underwriting performance did not meet
expectations and plans a series of targeted rate increases to improve
profitability.
The Company's other property and casualty lines grew significantly in 1995 and
1994 with the introduction of new products, particularly the truckers liability
program, and the further development of existing marketing programs. The
combined ratio for these lines increased to 146.8% after declining in 1994 to
106.3% from 156.2% in 1993. The improvement in the 1994 combined ratio was a
result of the increased production absorbing more of the related overhead. The
increase in 1995 reflects adverse development on loss incurred prior to 1994.
The professional liability program reflects an increase in earned premium of
$692 thousand or 29.1% in 1995 compared to $696 thousand or 41.4% in 1994 over
1993. Premium increases are the result of marketing efforts in connection with
the ITL policy introduced in 1994. The overall combined ratio decrease reflects
expected improvements in loss experience related to the ITL policy.
The 1995 combined ratio for the Canadian auto line was level at 92.7% compared
to 92.9% for 1994. The loss ratio remained level as well at 66.1% for 1995
compared to 65.5% for 1994 despite recording adverse development of $3.8
million. The Canadian property line reported a combined ratio of 109.0% in 1995
compared to 98.5% in 1994. The related loss ratio increased to 66.6% from 55.9%
due to unfavorable experience on the Canadian farm program. As a result,
Kingsway management has decided to terminate the program.
Earned premiums on Canadian property had increased by 146.9% in 1994 over 1993
and the related combined ratio also improved to 98.5% from 121.8% in 1993.
INFLATION AND OTHER FACTORS
Periods of inflation have varying effects on the Company and other companies in
the insurance industry. Because premium rates for the Company's U.S. Customs
bond and marine cargo insurance products are usually tied to the value of cargo
being
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imported or exported, an increase in price levels may result in revenue
increases. In periods of inflation, the property and casualty industry
generally experiences higher losses, loss adjustment expenses, and operating
costs. In contrast, the Company's U.S. Customs bond and marine cargo premiums
and losses are tied to the value of goods as of the date of shipment and
generally are not adversely affected by inflation.
The value of the dollar relative to other world currencies also affects the
Company's U.S. Customs bond and marine cargo business. When the dollar is
strong relative to other world currencies, imports generally increase and U.S.
Customs bond volume increases. When the dollar is weak relative to other world
currencies, exports generally increase and marine cargo insurance volume
increases.
U.S. AND CANADIAN FEDERAL INCOME TAXES
The Company's effective tax rates for the years 1995, 1994 and 1993 were 47.7%,
31.4% and 24.1%, respectively. The effective tax rate differs from the U.S.
federal corporate tax rate due to the Company's investments in tax exempt
securities and the Canadian tax rate differential (see accompanying Notes to
Consolidated Financial Statements).
LIQUIDITY AND CAPITAL RESOURCES
The capacity of an insurance company to underwrite insurance is based upon
maintaining liquidity and capital resources sufficient to pay claims and
expenses as they become due. The Company has historically generated adequate
capital resources to support its current operations. This position is further
enhanced by its investment policy which emphasizes high quality, short to
medium term investments. The primary sources of the Company's liquidity are
funds generated from insurance premiums, investment income, and proceeds from
investment maturities. The principal application of such funds are payments of
losses and loss adjustment expenses, investments, reinsurance, and operating
expenses.
Cash flow from operations amounted to $5.1 million in 1995 compared to $12.8
million in 1994 and $1.6 million in 1993. Increased loss levels coupled with a
leveling of premium growth account for the decline in 1995. Premium production
increases in late 1993 and 1994 were the source of the increase in 1994.
Proceeds from the sale of Kingsway common stock amounting to $4.1 million were
used to increase the statutory capital and surplus of IIC.
The Company maintains a $10.0 million line of credit which has been used to
facilitate the integration of IAS operations and other general purposes. The
Company is currently in negotiations to amend the line to expand borrowing
capacity to $15.0 million and to change the pricing to a LIBOR base from bank
10
prime. This change in pricing should translate to lower borrowing costs in the
future as a percent of balances outstanding.
In December 1994, borrowings totaling $4.3 million were made to increase the
statutory capital and surplus of IIC and Kingsway. The Kingsway contribution
made in the form of a note, was repaid in December 1995, with proceeds from the
sale of Kingsway stock. The Company does not have any material commitments for
capital expenditures.
DIVIDENDS
The Company paid dividends of $0.18 per share, or $1.4 million in 1995 and 1994
and $1.1 million or $0.17 per share in 1993. Any future dividends will depend
upon the earnings and financial position of the Company's principal operating
subsidiary, IIC, and Kingsway, as well as legal and contractual restrictions.
In addition, the insurance laws of Illinois, the domicile of IIC, require that
dividends be paid only out of earned surplus, and are limited to the greater of
10% of statutory surplus or statutory net income, as defined. The Company's line
of credit restricts dividend payments to 25% of consolidated net income of the
Company for the four quarters prior to payment.
MARKET INFORMATION
Quarter High Low
------- ---- ---
4th 1995 14.75 8.25
3rd 1995 14.75 11.00
2nd 1995 11.75 9.00
1st 1995 9.75 8.00
4th 1994 9.25 7.25
3rd 1994 10.50 7.25
2nd 1994 11.00 8.75
1st 1994 12.25 7.50
The Company's common stock, par value $1.00, is traded on the Nasdaq National
Market under the symbol ICAR. The table shown on the left contains the range of
high and low closing sale prices of the common stock of the Company as reported
by Nasdaq for each calendar quarter for the last two fiscal years.
HOLDERS
The number of holders of record of Company common stock on March 13, 1996, was
approximately 144. Certain information made available to the Company from
Automatic Data Processing (ADP) and other broker dealers holding securities in
street name indicates there are approximately 2,000 beneficial owners of the
Company's common stock.
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THE BOARD OF DIRECTORS AND STOCKHOLDERS OF
INTERCARGO CORPORATION:
We have audited the consolidated balance sheets of Intercargo Corporation and
subsidiaries as of December 31, 1995 and 1994, and the related consolidated
statements of income, stockholders' equity, and cash flows for each of the years
in the three-year period ended December 31, 1995. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated 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 consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Intercargo
Corporation and subsidiaries at December 31, 1995 and 1994, and the results of
their operations and their cash flows for each of the years in the three-year
period ended December 31, 1995, in conformity with generally accepted
accounting principles.
As discussed in note 1 to the consolidated financial statements, the Company
changed its method of accounting for investments to adopt the provisions of the
Financial Accounting Standards Board's Statement of Financial Accounting
Standards No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," at January 1, 1994.
KPMG PEAT MARWICK LLP
Chicago, Illinois
March 28, 1996
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CONSOLIDATED BALANCE SHEETS
At December 31,
1995 1994
-------------------------
(in thousands)
ASSETS
Investments
Fixed maturities available-for-sale, at fair value $44,769 53,201
Equity securities, at fair value 3,474 7,577
Investee at cost plus cumulative undistributed
earnings (fair value: 1995, $17,590) 11,898 -
-------------------------
Total investments 60,141 60,778
Cash and cash equivalents 16,478 19,011
Premiums receivable 14,920 21,887
Accrued investment income 804 925
Deferred policy acquisition costs 4,898 6,602
Reinsurance recoverable on loss and loss expenses:
Paid claims 1,192 1,123
Unpaid claims 2,964 3,375
Prepaid reinsurance premiums 2,089 3,792
Notes receivable 349 825
Income tax recoverable 1,092 -
Deferred income tax 822 1,966
Equipment, at cost less accumulated depreciation 1,738 2,496
Goodwill 2,468 3,217
Other assets 6,211 2,426
-------------------------
Total assets $116,166 128,423
=========================
LIABILITIES
Losses and loss adjustment expenses $ 36,293 38,836
Unearned premiums 17,691 31,586
Funds held by Company 748 268
Supplemental duty deposits 2,669 3,147
Accrued expenses and other liabilities 5,409 6,029
Notes payable 9,735 8,636
-------------------------
Total liabilities 72,545 88,502
-------------------------
Commitments and contingencies
STOCKHOLDERS' EQUITY
Common stock--$1 par value; authorized 20,000,000
shares; issued and outstanding, 7,640,981 shares in 1995
and 1994 7,641 7,641
Additional paid-in capital 24,104 24,104
Net unrealized loss on foreign currency translation (1,179) (2,002)
Net unrealized gain (loss) on available-for-sale securities 567 (1,546)
Retained earnings 12,488 11,724
-------------------------
Total stockholders' equity 43,621 39,921
-------------------------
Total liabilities and stockholders' equity $116,166 128,423
=========================
See accompanying Notes to Consolidated Financial Statements.
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CONSOLIDATED STATEMENTS OF INCOME
Year Ended December 31,
1995 1994 1993
-------------------------------------
(in thousands, except per share data)
REVENUES
Insurance premium income $86,154 74,797 45,493
Net investment income 6,273 4,378 3,990
Commission income 531 433 573
Other income 1,228 1,277 656
-----------------------------------
Total 94,186 80,885 50,712
-----------------------------------
LOSSES AND EXPENSES
Losses and loss adjustment expenses 51,746 41,599 21,114
Policy acquisition and other issue costs 22,829 18,511 14,336
Other underwriting expenses 14,706 12,801 10,724
Interest expense 987 512 406
Litigation settlement expense - 201 1,314
-----------------------------------
Total 90,268 73,624 47,894
-----------------------------------
Operating income 3,918 7,261 2,818
Income tax expense 1,868 2,280 680
-----------------------------------
Net income before equity in net income
of investee 2,050 - -
Equity in net income of investee 89 - -
-----------------------------------
NET INCOME $ 2,139 4,981 2,138
===================================
Average number of shares of common
stock and equivalents outstanding 7,668 7,662 7,121
NET INCOME PER SHARE $ 0.28 0.65 0.30
===================================
See accompanying Notes to Consolidated Financial Statements.
14
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Net
Unrealized Net
Gain (Loss) Unrealized
Additional on Foreign Gain Stock-
Number Common Paid-in Currency (Loss) on Retained holders'
of Shares Stock Capital Translation Securities Earnings Equity
--------------------------------------------------------------------------------------------
(in thousands)
Balance at
December 31, 1992 6,891 $6,891 16,662 (953) (102) 7,121 29,619
- ------------------
Net income 2,138 2,138
Change in foreign
currency translation (422) (422)
Change in unrealized
gain (loss) on equity securities 191 191
Dividends paid to stockholders
($0.17 per share) (1,141) (1,141)
Warrants exercised 89 89 245 334
Employee stock options exercised 5 5 20 25
New shares issued--private
placement 500 500 5,875 6,375
New shares issued--
acquisition 146 146 1,262 1,408
- --------------------------------------------------------------------------------------------------------------------------------
Balance at
December 31, 1993 7,631 7,631 24,064 (1,375) 89 8,118 38,527
- ------------------
Cumulative effect of the
implementation of SFAS
No. 115 1,166 1,166
Net income 4,981 4,981
Change in foreign
currency translation (627) (627)
Change in unrealized gain (loss)
on available-for-sale
securities (2,801) (2,801)
Dividends paid to
stockholders
($0.18 per share) (1,375) (1,375)
Employee stock options
exercised 10 10 40 50
- --------------------------------------------------------------------------------------------------------------------------------
Balance at
December 31, 1994 7,641 7,641 24,104 (2,002) (1,546) 11,724 39,921
- -----------------
Net income 2,139 2,139
Change in foreign
currency translation 823 823
Change in unrealized gain (loss)
on available-for-sale
securities 2,113 2,113
Dividends paid to stockholders
($0.18 per share) (1,375) (1,375)
- --------------------------------------------------------------------------------------------------------------------------------
Balance at
December 31, 1995 7,641 $7,641 24,104 (1,179) 567 12,488 43,621
================================================================================================================================
See accompanying Notes to Consolidated Financial Statements.
15
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31,
1995 1994 1993
------------------------------------
(in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $2,139 4,981 2,138
Adjustments to reconcile net income to net cash
provided from operating activities:
Realized gains (415) (43) (97)
Depreciation and amortization 702 680 457
Amortization of premiums (discounts) on investments 52 (422) (393)
Undistributed earnings of affiliate (2,662) - -
Increase in premiums receivable (5,417) (4,598) (6,086)
Increase in deferred policy acquisition costs (420) (1,387) (2,845)
Decrease (increase) in reinsurance recoverable (1,406) (1,868) 1,820
Decrease (increase) in notes receivable 2,297 433 (155)
Change in income tax accounts (1,453) 948 (991)
Increase in other assets (1,171) (924) (390)
Increase (decrease) in liability for losses and
loss adjustment expenses 9,571 9,140 (906)
Increase in unearned premiums 1,831 5,116 11,028
Increase (decrease) in funds held 480 300 (1,523)
Decrease in supplemental duty deposits (478) (938) (757)
Other, net 1,476 1,400 251
------------------------------------
Net cash provided from operating activities 5,126 12,818 1,551
------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Fixed maturities available-for-sale:
Purchases (21,957) (20,102) -
Sales 8,080 5,005 -
Maturities and calls 4,563 5,715 -
Fixed maturities held-to-maturity:
Purchases - - (17,932)
Sales - - 4,183
Maturities and calls - - 6,205
Equity securities:
Purchases - (1,472) (5,761)
Sales 4,191 2,743 1,690
Calls - 187 995
Net sales (purchases) of short-term investments (260) 4,721 1,065
Purchase of subsidiary (1,499) - -
Subsidiary cash at purchase date 170 - 815
Sale of Kingsway common stock 4,107 - -
Decrease in cash due to deconsolidation of Kingsway (3,964) - -
Purchase of property and equipment, net (814) (1,191) (504)
------------------------------------
Net cash used in investing activities (7,383) (4,394) (9,244)
------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from stock offerings - - 6,375
Proceeds from (payment of) notes payable 1,099 (2,312) 8,098
Proceeds from the exercise of stock options - 50 359
Dividends paid to stockholders (1,375) (1,375) (1,141)
------------------------------------
Net cash provided (used in) from financing activities (276) (3,637) 13,691
------------------------------------
Net increase (decrease) in cash and cash equivalents (2,533) 4,787 5,998
Cash and cash equivalents:
Beginning of the period 19,011 14,224 8,226
------------------------------------
End of the period $16,478 19,011 14,224
====================================
See accompanying Notes to Consolidated Financial Statements.
16
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) ORGANIZATION
Intercargo Corporation is an insurance holding company incorporated in the
State of Delaware whose wholly owned subsidiaries at December 31, 1995,
consist of Intercargo Insurance Company (IIC), International Advisory Services,
Inc. (IAS), Intercargo International Limited (IIL), and TRM Insurance Services,
Inc. (TRM). IIL's name was changed from Interocean Company, Ltd. in 1995.
In October, 1995, IIC purchased the stock of Eastern Insurance Company (H.K.),
a Hong Kong licensed insurance company for $1.5 million. The company was
renamed Intercargo Insurance Company H.K. Limited (IIC - H.K.). The acquisition
is accounted for by the purchase method, and accordingly, the operations of IIC
- - H.K. are included in the Company's financial statements from the date of
acquisition. In connection with the acquisition, the Company has recorded an
intangible asset of $2.7 million related to IIC - H.K.'s license to operate as
an insurance company in Hong Kong. IIC owned 100% of Oceanic Insurance
and Surety Company (Oceanic). In December 1995, the Illinois Department of
Insurance approved a plan of merger which merged all of Oceanic's assets and
liabilities into IIC.
On December 18, 1995, Kingsway Financial Services (Kingsway), a then wholly
owned subsidiary of the Company, sold 1.8 million shares of its common stock in
a public offering. The Company sold 600 thousand of its 3.0 million Kingsway
shares in that transaction thereby reducing its equity interest in Kingsway to
50% at December 31, 1995. The Company's consolidated results of operations
include 100% of Kingsway's results of operations through December 18,
1995. The Company's financial position reflects the remaining 50% interest in
Kingsway on the equity method of accounting to December 31, 1995.
Kingsway is a property and casualty insurance holding company based in Ontario,
Canada, which primarily writes and assumes commercial and other automobile
insurance considered to be non-standard, and other specialty insurance
for commercial properties through its 100% owned subsidiary, Kingsway General
Insurance Company.
IIC is a property and casualty insurer based in the United States, which
primarily writes U.S. Customs bonds, marine cargo, and professional liability
insurance. IIC conducts business in the United Kingdom through a branch office
operation. Its products are sold to importers and exporters through
customs brokers, freight forwarders, and other service firms engaged in the
international and domestic movement of cargo.
The Company primarily operates in the business of underwriting property and
casualty insurance. Business placed by the insurance agency subsidiaries with
insurance companies unrelated to the Company is not significant, and therefore,
the Company believes property and casualty insurance is its only reportable
business segment.
17
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Basis of Presentation
The consolidated financial statements of the Company have been prepared in
accordance with generally accepted accounting principles. All significant
intercompany balances and transactions have been eliminated.
The preparation of financial statements in conformity with generally accepted
accounting principles requires the use of estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at 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.
(b) Investment Valuations
Effective January 1, 1994, the Company adopted Statement of Financial
Accounting Standard (SFAS) No. 115, "Accounting for Certain Investments in Debt
and Equity Securities." SFAS No. 115 requires that investments in all debt
securities and those equity securities with readily determinable market values
be classified into one of three categories: held-to-maturity, trading, or
available-for-sale.
Held-to-Maturity Securities:
Debt securities that the Company has the positive intent and ability to
hold to maturity are classified as held-to-maturity and carried at amortized
cost. Except for declines that are other than temporary, changes in the fair
value are not reflected in the financial statements. The Company holds no debt
securities in this category.
18
Trading Securities:
Debt and equity securities purchased for short-term resale are classified as
trading securities. Unrealized gains and losses are included in earnings. The
Company holds no debt or equity securities in this category.
Available-for-Sale Securities:
All other debt and equity securities not included in the above categories are
classified as available-for-sale and reported at fair value. Unrealized gains
and losses are excluded from earnings and reported in a separate component of
stockholders' equity net of deferred income taxes. All of the Company's equity
securities and debt securities are classified as available-for-sale.
Prior to the adoption of SFAS No. 115, the Company classified all of its debt
securities as held-to-maturity which were carried at amortized cost.
Investments in equity securities were carried at fair value with unrealized
appreciation or depreciation included in stockholders' equity. In conjunction
with the adoption of SFAS No. 115, all of the Company's debt securities were
deemed as available-for-sale. Unrealized holding gains on adoption amounted to
$1.2 million, net of tax. The adoption of SFAS No. 115 had no effect on net
income as the amount was credited directly to stockholders' equity.
Gains and losses on sales of investments are computed on the specific
identification method and are reflected in net income. Fair values are based
upon quoted market prices or values obtained from independent pricing sources.
(c) Investment in Investee
The Company does not recognize into income its equity share of changes in an
investee's reported net assets resulting from an investee's issuance of
stock. Unconsolidated investees between 20% and 50% owned are accounted for
under the equity method accounting.
(d) Liability for Losses and Loss Adjustment Expenses
The liability for losses and loss adjustment expenses represents estimates of
the ultimate unpaid cost of all claims incurred, including claims incurred but
not yet reported. These estimates are based upon historical experience of the
business written by the Company and other direct writers reinsured by the
Company, adjusted for current trends. Management believes that the provision
for losses and loss adjustment expenses is adequate to cover the ultimate
liability; however, such estimates may be more or less than the amount
ultimately paid when the claims are settled. Reinsurance recoverables on unpaid
losses and ceded unearned premiums are reported as assets instead of netting
these against related reserves (see note 4).
(e) Premium Recognition
Insurance premiums are recognized as revenue ratably over the terms of
the policies. Unearned premiums are computed on the daily pro rata basis.
(f) Policy Acquisition Costs
19
Policy acquisition costs are costs such as commissions and certain other
underwriting and agency expenses which vary with and are directly related to
the production of business. Such costs are deferred to the extent recoverable
from future earned premiums and are amortized ratably over the terms of the
related policies. Costs deferred and amortized over the past three years are
summarized as follows (in thousands):
20
Year ended December 31,
1995 1994 1993
---------------------------
Deferred policy acquisition
costs, beginning of period $6,602 5,215 2,442
Deferred:
Direct commissions 17,766 15,636 11,775
Premium taxes 2,536 2,234 1,610
Other direct underwriting
expenses 6,740 4,894 5,239
Ceding commissions (3,201) (2,866) (1,515)
---------------------------
Net deferred 23,841 19,898 17,109
Amortized (22,829) (18,511) (14,336)
Adjustment due to
deconsolidation of Kingsway (2,716) - -
---------------------------
Deferred policy acquisition
costs, end of period $4,898 6,602 5,215
---------------------------
(g) Federal Income Tax
Deferred tax assets and liabilities are recognized for the estimated future
tax consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
in effect for the year in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period in which the change
is enacted.
(h) Cash and Cash Equivalents
Cash includes $170 thousand on deposit with Hong Kong regulatory authorities
at December 31, 1995. Cash equivalents consist of investments with an original
or remaining maturity of three months or less at purchase.
(i) Earnings Per Share
Earnings per share are computed based upon the weighted average number of
shares of common stock and common stock equivalents (to the extent dilutive)
outstanding each year. Common stock equivalents consist of shares issuable
under the Company's stock option plan.
(j) Foreign Exchange
Assets and liabilities relating to foreign operations are translated to
U.S. dollars using current exchange rates. Revenues and expenses are translated
to U.S. dollars using the average exchange rate as determined on a yearly
basis. Translation adjustments for financial reporting in U.S. dollars are
reflected as a separate component of stockholders' equity.
(k) Commission Income
The Company recognizes commission income when the premiums are billed
to the customer, or the effective date of the policy, whichever is later.
21
(l) Premiums Receivable
Current accounts receivable are stated net of allowances for uncollectible
accounts of $605 thousand and $239 thousand at December 31, 1995 and 1994,
respectively.
22
(m) Goodwill and Other Intangible Assets Goodwill is the excess of the fair
value of consideration paid for companies acquired over the fair value of the
related net assets acquired. Goodwill is amortized using the straight-line
method over periods not exceeding 20 years.
Intangible assets relate to the acquisition of licenses, customer lists,
non-compete agreements, and employment agreements and are amortized using the
straight-line method over periods not exceeding 20 years.
(n) Premium Trust Funds Premiums collected from insureds but not yet remitted
to insurance carriers are restricted as to use by laws in certain states in
which IAS operates. The amount of cash and cash equivalents so restricted was
$1.3 million at December 31, 1995.
(o) Reclassifications Certain reclassifications have been made to the prior
years' financial statements to conform with the current presentation.
(3) INVESTMENTS
Amortized cost, unrealized gains and losses, and estimated fair value of
investments as of December 31, 1995 and 1994, are summarized as follows (in
thousands):
December 31, 1995
-------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
-------------------------------------------------------------------
(Available-for-Sale)
Fixed maturities:
U.S. Government and Agency obligations $13,670 111 (42) 13,739
State, municipal, and other tax advantaged
securities 19,776 689 (20) 20,445
Corporate securities 9,545 275 (8) 9,812
Other fixed maturity investments 774 - (1) 773
-------------------------------------------------------------------
Total fixed maturities $43,765 1,075 (71) 44,769
Equity securities $ 3,618 11 (155) 3,474
-------------------------------------------------------------------
Total $47,383 1,086 (226) 48,243
===================================================================
December 31, 1995
-------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
-------------------------------------------------------------------
(Available-for-Sale)
Fixed maturities:
U.S. Government and Agency obligations $5,347 - (433) 4,914
Canadian Government and Provincial obligations 17,995 - (293) 17,702
State, municipal, and other tax advantaged
securities 22,001 304 (336) 21,969
Corporate securities 6,818 - (238) 6,580
Other fixed maturity investments 2,135 - (99) 2,036
-------------------------------------------------------------------
Total fixed maturities 54,296 304 (1,399) 53,201
Equity securities 8,834 1 (1,258) 7,577
-------------------------------------------------------------------
Total $63,130 305 (2,657) 60,778
===================================================================
23
Amortized cost and estimated fair value for fixed maturities held as of
December 31, 1995, summarized by maturity, are as follows (in thousands):
Estimated
Amortized Fair
Cost Value
---------------------
Due in one year or less $ 4,477 4,488
Due after one year through five years 16,203 16,624
Due after five years through ten years 21,837 22,365
Due after ten years 1,248 1,292
------- ------
$43,765 44,769
======= ======
In 1995, gross gains of $390 thousand and gross losses of $28 thousand were
realized on the sale of investments. In 1994, gross gains of $187 thousand and
gross losses of $144 thousand were realized on the sale of investments. In
1993, gross gains of $170 thousand and gross losses of $73 thousand were
realized on the sale of investments.
Investment securities carried at $9.6 million and $11.0 million at December 31,
1995 and 1994, respectively, were on deposit or pledged to governmental
authorities as required by law.
The sources of net investment income are as follows (in thousands):
Year ended December 31,
1995 1994 1993
--------------------------
Income from fixed maturities
in excess of one year $3,064 2,699 2,755
Income from short-term
investments and cash equivalents 2,421 828 308
Income from other sources 74 379 311
Income from equity issues 641 699 752
Gain on sale of Kingsway common stock 244 - -
Investment expenses (171) (227) (136)
--------------------------
Net investment income $6,273 4,378 3,990
==========================
At December 31, 1995, the net unrealized gain on of available-for-sale
securities was net of a deferred tax liability of $292 thousand. At December
31, 1994, the net unrealized depreciation of available-for-sale securities was
net of deferred tax benefit totaling $800 thousand.
(4) REINSURANCE
In the normal course of business, the Company assumes and cedes reinsurance
with other insurers. Reinsurance is ceded primarily to limit losses from
large exposures and to permit recovery of a portion of direct losses; however,
such a transfer does not relieve the originating insurance company of
contingent liability.
The majority of the Company's ceded reinsurance is placed with a limited number
of reinsurers, however, the Company evaluates the financial condition of
its reinsurers and monitors concentrations of credit risk to minimize its
exposure
24
to significant losses from insolvencies. A contingent liability exists to the
extent that the Company's reinsurers are unable to meet their contractual
obligations. Management makes provision for uncollectible reinsurance when
warranted and is of the opinion that no additional liability will accrue to the
Company with respect to this contingency.
25
The effects of reinsurance on premiums written, premiums earned, and loss and
loss adjustment expenses incurred for the three years ended December 31,
1995, 1994, and 1993, are as follows (in thousands):
Direct Ceded Assumed Net
--------------------------------------------
Year ended December 31, 1995
- ----------------------------
Premiums written $103,396 14,001 1,409 90,804
Premiums earned $ 98,460 13,594 1,288 86,154
Loss and loss adjustment expenses incurred $ 58,431 7,208 523 51,746
Year ended December 31, 1994
- ----------------------------
Premiums written $ 92,047 11,561 251 80,737
Premiums earned $ 86,216 11,565 146 74,797
Loss and loss adjustment expenses incurred $ 49,140 7,540 (1) 41,599
Year ended December 31, 1993
- ----------------------------
Premiums written $ 66,264 11,512 254 55,006
Premiums earned $ 54,924 9,722 291 45,493
Loss and loss adjustment expenses incurred $ 25,211 3,210 (887) 21,114
5) FEDERAL INCOME TAX
The components of income tax expense are as follows (in thousands):
Year ended December 31,
1995 1994 1993
-------------------------
Current $2,308 2,639 797
Deferred (440) (359) (117)
-------------------------
$1,868 2,280 680
Tax on unrealized gain (loss) on -------------------------
investments $ 292 (800) (46)
=========================
The tax effects of temporary differences that give rise to significant portions
of the Company's net deferred tax asset at December 31, 1995 and 1994, were
(in thousands):
December 31,
1995 1994
----------------------
Deferred tax assets:
Loss reserves $1,257 1,099
Unearned premium reserves 1,061 2,176
Future benefit of net operating losses 1,476 1,476
Unrealized investment loss - 800
Other 550 103
Less: valuation allowance (1,476) (1,119)
----------------------
Deferred tax assets 2,868 4,535
----------------------
Deferred tax liabilities:
Deferred policy acquisition costs (1,617) (2,463)
Unrealized investment gain (292) -
Depreciation (128) (80)
Other (9) (26)
----------------------
Deferred tax liabilities (2,046) (2,569)
----------------------
Net deferred tax asset $ 822 1,966
======================
26
The valuation allowances of approximately $1.5 million and $1.1 million at
December 31, 1995 and 1994, respectively, pertain solely to net operating losses
(NOL) of IAS. These NOLs are considered to have arisen in separate return
limitation years (SRLY) and under Federal tax law can only be utilized against
future taxable income generated by IAS. Valuation allowances have been
established to reduce the deferred tax asset related to the pre-acquisition NOLs
of IAS to the amount that, based upon available evidence, is, in management's
judgment, more likely than not to be realized. The NOL carryforwards at December
31, 1995, begin expiring in 2002.
Income taxes paid (net of taxes recovered) were $3.2 million, $1.6 million, and
$1.8 million in 1995, 1994, and 1993, respectively. The actual Federal income
tax expense for 1995, 1994, and 1993 differed from the "expected" tax expense
for those years as described below (in thousands). "Expected" tax expense is
computed by applying the U.S. Federal corporate tax rate of 34% to operating
income.
Year ended December 31,
1995 1994 1993
-------------------------------
Computed expected tax $1,332 2,469 958
Foreign tax rate differential 475 451 243
Tax exempt interest and dividend
received deduction (487) (577) (581)
Realization of pre-merger operating
loss benefit - (212) (164)
Foreign source income 106 (98) 154
Other 442 247 70
-------------------------------
$1,868 2,280 680
-------------------------------
The Company and its U.S. subsidiaries file a consolidated tax return. Federal
income tax expenses are calculated on an entity basis and are allocated
accordingly.
Foreign income not expected to be taxed in the United States has arisen because
Kingsway is not subject to U.S. income taxes. For 1995, 1994, and 1993, pre-tax
income includes $4.5 million, $4.2 million, and $2.1 million, respectively,
attributable to Kingsway. Included in 1995, 1994, and 1993 income tax expense
is $1.9 million, $1.9 million, and $1.0 million, respectively, related to such
income. Kingsway's income has been subject to Canadian federal and provincial
income taxes at the cumulative corporate rate of 44.5% in 1995, and 44.3% in
1994 and 1993. Temporary differences relating to Kingsway arising from tax law
for Canadian insurance companies are similar to those of the U.S. subsidiaries.
(6) RELATED PARTY TRANSACTIONS
Certain of the Company's reinsurers are affiliated insurance companies. The
Company ceded to these affiliates premiums written of $524 thousand, $381
thousand, and $60 thousand in 1995, 1994, and 1993 respectively. Current and
former employees of the Company are indebted to the Company for loans
27
outstanding. At December 31, 1995 and 1994, employee indebtedness amounted to
$140 thousand and $367 thousand, respectively. The loans receivable are current
as to principal and interest at December 31, 1995.
(7) LITIGATION
In July 1993, the Company settled a lawsuit in which the Company and its
Chairman of the Board, James R. Zuhlke, were named defendants. The suit sought
to recover damages for the return of insurance premiums purportedly written by
G. Nicholas Brueggen on behalf of Binford Insurance Company. The lawsuit, which
sought damages up to $3 million, was settled by the payment of $875 thousand in
full satisfaction of all claims. Other costs related to the matter amounted to
$439 thousand. In July, 1994, the Company obtained a judgment of $1.4 million
against Mr. Brueggen and an associate which is not reflected in the financial
statements.
During 1994, the Company settled litigation in the amount of $201 thousand for
which there is no continuing liability.
There are no other pending legal proceedings to which the Company or its
subsidiaries is a party or of which any of the properties of the Company or its
subsidiaries is subject, except for claims arising in the ordinary course of
business. In the opinion of management, the ultimate resolution of such
litigation will not have a material effect on the financial condition of the
Company.
(8) RECONCILIATIONS TO STATUTORY ACCOUNTING
The Company's insurance subsidiaries are required to file statutory financial
statements with insurance regulatory authorities. Accounting principles used to
prepare these statutory financial statements differ from financial statements
prepared on the basis of generally accepted accounting principles.
Reconciliations of combined net income and statutory capital and surplus as
determined using statutory accounting principles to the amounts included in the
accompanying financial statements are as follows (in thousands):
Year ended December 31,
1995 1994 1993
---------------------------
Statutory net income of insurance subsidiaries $2,634 2,510 1,320
Increases (decreases):
Net income (loss) from
non-insurance operations (564) 822 (486)
Deferred policy acquisition
costs (U.S. operations) 420 1,590 1,290
Deferred income taxes 440 177 206
Provision for uncollectible reinsurance (400) - -
Consolidating eliminations
other adjustments, net (391) (118) (192)
---------------------------
Consolidated net income
as reported herein $2,139 4,981 2,138
---------------------------
28
Year ended December 31,
1995 1994
-----------------------
Statutory capital and surplus of insurance
subsidiaries $26,639 34,424
Increases (decreases):
Non-insurance net assets
(liabilities) 7,859 (2,438)
Non-admitted assets and other
statutory adjustments, net 2,146 2,942
Deferred policy acquisition
costs (U.S. operations) 4,898 4,478
Costs in excess of net assets
of purchased businesses 2,468 3,217
Deferred income taxes 822 1,572
Unrealized loss on foreign
currency translation (1,179) (2,002)
Adjustment to GAAP
fair values 681 (1,546)
Consolidating eliminations
and other adjustments (713) (726)
-----------------------
Stockholders' equity as reported herein $43,621 39,921
-----------------------
The statutory surplus and capital of the Company's U.S. insurance subsidiary is
sufficient to satisfy current regulatory requirements. Dividend payments to the
Company from its insurance subsidiaries are restricted by insurance laws as to
the amount that may be paid without prior approval of insurance regulatory
authorities. Under the insurance regulations of Illinois, IIC's state of
domicile, ordinary dividends are limited to the greater of 10% of statutory
surplus or statutory net income, as defined, for the prior twelve month period.
Under Canadian provincial insurance laws, dividends are limited to 50% of prior
year net income. The estimated dividend distribution which can be made to the
Company by its subsidiaries in 1996 based on these regulatory guidelines is
approximately $3.3 million.
The Company's U.S. insurance subsidiary, IIC, is required to file annual
statements with insurance regulatory authorities which are prepared on an
accounting basis prescribed or permitted by such authorities. Prescribed
statutory accounting practices include state laws, regulations, and general
administrative rules, as well as a variety of publications of the National
Association of Insurance Commissioners (NAIC). Permitted statutory accounting
practices encompass all accounting practices that are not prescribed; such
practices differ from state to state, may differ from company to company within
a state, and may change in the future. Furthermore, the NAIC has a project to
codify statutory accounting practices, the result of which is expected to
constitute the only source of "prescribed" statutory accounting practices.
Accordingly, that project, which is expected to be completed in 1996, will
likely change the definition of what comprises prescribed versus permitted
statutory accounting practices, and may result in changes to the accounting
policies that
29
insurance enterprises use to prepare their statutory financial statements. IIC
does not currently use permitted statutory accounting practices which could have
a significant impact on its statutory financial statements.
30
(9) UNAUDITED INTERIM FINANCIAL INFORMATION (in thousands)
- ----------------------------------------------------------
Three months ended
March 31 June 30 Sept 30 Dec 31
-----------------------------------------
1995
Revenues $23,166 24,126 23,103 23,791
-----------------------------------------
Net income from operations $2,075 2,075 1,628 (3,728)
Net income from investee - - - 89
-----------------------------------------
Net income $2,075 2,075 1,628 (3,639)
-----------------------------------------
Net income per share $0.27 0.27 0.21 (0.47)
-----------------------------------------
1994
Revenues $17,405 18,794 23,119 21,567
-----------------------------------------
Net income from operations $860 539 1,928 1,654
Net income from investee - - - -
-----------------------------------------
Net income $860 539 1,928 1,654
-----------------------------------------
Net income per share $0.11 0.07 0.25 0.22
-----------------------------------------
During the fourth quarter of 1995, the Company, on a pre-tax basis, increased
its provision for loss and loss adjustment expenses by approximately $4.0
million, wrote-off approximately $600 thousand of deferred acquisition costs
deemed unrecoverable related to its professional liability business, and
recorded $400 thousand in charges for contingently non-recoverable reinsurance
on programs terminated in 1993.
(10) STOCK OPTIONS AND WARRANTS
On July 28, 1987, the Company's stockholders approved the Company's 1987
Non-Qualified and Incentive Stock Option Plan (Option Plan). A total of 600
thousand shares of common stock are authorized for issuance under the Option
Plan upon exercise of incentive stock options and non-qualified stock options.
On November 13, 1989, options were granted which were exercisable at $5.00 per
share, totaling 54 thousand shares. During 1991, an additional 44 thousand
options were granted with an exercise price of $14.50 per share, the market
value of the Company's stock at the date of issue. On November 12, 1992, an
additional 33 thousand options were granted at the then current market price of
$14.00 per share as the exercise price. During 1993, options granted at $5.00
per share were exercised, resulting in the issuance of 5 thousand new shares. On
May 19, 1994, an additional 4 thousand options were granted at the then current
market price of $10.25 per share as the exercise price. On November 10, 1994,
29 thousand options were granted at the then current market price of $8.00 per
share as the exercise price. During 1994, options granted at $5.00 per share
were exercised, resulting in the issuance of 10 thousand new shares. On August
22, 1995, 6,000 options were granted at an exercise price of $11.75. On
November 10, 1995, 36,000 options were granted at an exercise price of $13.25.
No options were exercised in 1995. There are vested and non-vested options
outstanding to purchase 191 thousand shares of stock at prices ranging from
$5.00 to $14.50 at December 31, 1995.
In conjunction with the Company's initial public offering in May 1988, the
Company sold warrants to purchase 89 thousand shares of common stock to the
representative of the underwriters of the offering. The warrants, exercised in
1993, resulted in the issuance of 89 thousand new shares for $334 thousand.
31
(11) COMMITMENTS
The Company has obligations under long-term operating leases for its office
premises in the United States, Canada, and the United Kingdom. The future
minimum lease payments are as follows (in thousands):
1996 $1,107
1997 1,032
1998 963
1999 930
2000 877
2001 and thereafter 922
------
$5,831
======
32
Included in other underwriting expenses is rental expense of $1.3
million, $1.1 million, and $1.0 million for 1995, 1994, and 1993,
respectively.
The Company has indemnification agreements (Agreements) with each of the
Company's directors whereby the Company has agreed to indemnify each director
from certain losses and expenses. Certain amounts are excluded from the
Company's indemnification obligation, including any illegal payments or
fraudulent, dishonest, or willful misconduct. In addition, the directors have
agreed to reimburse the Company for all losses and expenses paid by the Company
in connection with any action, suit, or proceeding in which a court in a final
adjudication decides that the director is not entitled to indemnification.
(12) CAPITALIZATION
In March 1993, the Company obtained a $10.0 million revolving bank line of
credit. At December 31, 1995 and 1994, the outstanding balance on the line of
credit amounted to approximately $9.7 million and $8.3 million, respectively.
The line of credit matures the earlier of two years or when outstanding
balances amount to $10.0 million at which time the line of credit is converted
to a term loan with a three year maturity. Interest on the revolving line is
adjustable to the bank prime rate plus 0.25%; interest on the term loan, if
converted, is adjustable to the bank prime rate plus 0.50%. Debt service on
the revolving line of credit is limited to interest only payable monthly. If
converted, the term loan balance is payable 5% quarterly with interest payable
monthly and the balance due at maturity. The proceeds from the line of credit
borrowings were used to cure deficiencies in IAS's premium trust fund accounts
and to increase the capital and surplus of the Company's insurance
subsidiaries. The line of credit and the term loan are collateralized by
the Company's stock of IIC and Kingsway.
Under the terms of the loan agreement, the Company must maintain tangible net
worth, as defined (based on generally accepted accounting principles), of at
least $27 million at December 31, 1995 (increasing $2.5 million per year,
thereafter), maintain statutory net worth of IIC at certain levels, and
limit dividends to 25% of consolidated net income for the prior four quarters.
The Company paid interest expense of $987 thousand, $512 thousand, and $406
thousand in 1995, 1994, and 1993, respectively.
33
In December 1993, the Company sold 500 thousand new shares of its common stock
to Orion Capital Corporation (Orion) for $6.4 million. The new shares issued
are restricted and unregistered. In addition, Orion acquired 1,006,484
shares of the Company's common stock in a private transaction with The Harper
Group, Inc.
(13) SUPPLEMENTAL DUTY DEPOSITS
Supplemental duty deposits are security deposits held by IAS until the insured
bond principal (Depositor) has settled duty charges imposed by U.S. Customs.
Under the terms of the agreement with the Depositor, the Depositor is not
entitled to a refund of its deposit until it has provided competent written
legal evidence that the conditions of each and every bond connected with the
deposit has been fully satisfied.
IAS considers its liability to the Depositor to have expired after seven years
if the Depositor has not met the conditions necessary to receive a refund under
the terms of the deposit agreement. The expiration of the liability for these
deposits was $31 thousand, $119 thousand, and $87 thousand in 1995, 1994, and
1993, respectively, and is reflected in the accompanying consolidated
statements of income.
(14) FOREIGN OPERATIONS
Revenues, operating income, and identifiable assets included in the
accompanying consolidated financial statements related to foreign operations as
of and for the years ended December 31, 1995, 1994, and 1993, were as follows:
December 31,
1995 1994 1993
---------------------------
(dollars in millions)
Revenues $35.9 32.6 12.7
Operating income $ 4.6 3.9 2.1
Identifiable assets $ 3.4 42.9 37.3
(15) LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
Loss and loss adjustment expense reserves are based on long-range
projections which are subject to uncertainty. Uncertainty regarding reserves of
a given accident year is gradually reduced as new information emerges each
succeeding year, allowing more reliable reevaluations of such reserves. While
management believes that reserves as of December 31, 1995, are adequate,
uncertainties in the reserving process could cause such reserves to develop
favorably or unfavorably as new or additional information emerges. Any
adjustments to reserves are reflected in the operating results of the periods
in which they are made. Movements in reserves which are small relative to the
amount of such reserves could significantly impact future reported earnings of
the Company.
34
Activity related to unpaid loss and loss adjustment expenses (LAE)
follows (in thousands):
Year Ended December 31,
1995 1994 1993
------ ------ ------
Unpaid Losses and LAE at the beginning
of the period, net of reinsurance recoverables
of $3,830, $3,407, and $5,231 $35,006 26,289 23,940
Unpaid Losses and LAE of acquired entities at
the beginning of the period 1,300 - 1,945
------- ------- -------
Adjusted unpaid losses and LAE at the beginning
of the period 36,306 26,289 25,885
------- ------- -------
Provision for Losses and LAE for claims occurring
during:
Current year 45,642 39,462 19,326
Prior years 6,104 2,137 1,788
------- ------- -------
Total 51,746 41,599 21,114
------- ------- -------
Less Losses and LAE payments for claims
occurring during:
Current year (17,491) (18,638) (7,654)
Prior years (20,205) (14,244) (13,056)
------- ------- -------
Total (37,696) (32,882) (20,710)
------- ------- -------
Adjustment due to deconsolidation of Kingsway (17,201) - -
------- ------- -------
Unpaid Losses and LAE at the end of period,
net of reinsurance recoverables of $3,138,
$3,830, and $3,407 $33,155 35,006 26,289
======= ======= =======
During 1995, it became apparent that the estimated unpaid claims for liabilities
established at December 31, 1994 on Kingsway's business lines would exceed
initial expectations and loss reserves were increased accordingly by $4.0
million. Also, during 1995, loss experience related to U.S. operations for 1994
and prior years suggested reserve increases amounting to $5.2 million were
required for the marine cargo, contract surety and other property and casualty
lines. These increases were offset by savings of $3.1 million on 1994 and prior
U.S. customs bonds reserve estimates.
(16) EMPLOYEE BENEFIT PLAN
The Company sponsors a defined contribution plan covering substantially all
employees. The plan provides for Company contribution at the discretion of the
board of directors. For 1995 and 1994, the Company contributed $0.50 for each
$1.00 contributed by the participants up to 5% of employee compensation. The
Company's cost of this plan was $94 thousand and $88 thousand in 1995 and 1994
(inception), respectively.
(17) FINANCIAL INSTRUMENTS
In the normal course of business, the Company invests in various financial
assets and incurs various financial liabilities. The fair value estimates of
financial instruments presented below are not necessarily indicative of the
amounts the
35
Company might pay or receive in actual market transactions. Potential taxes
and other transaction costs have not been considered in estimating fair value.
As a number of the Company's significant assets and liabilities are not
considered financial instruments, the disclosures that follow do not reflect
the fair value of the Company as a whole.
The estimated fair values of the Company's financial instruments
of December 31, 1995 are as follows (in thousands):
Carrying Fair
Value Value
---------------------
Assets:
Fixed maturities $44,769 44,769
Equity securities 3,474 3,474
Investment in investee 11,898 17,590
Cash and cash equivalents 16,478 16,478
Premiums receivable 14,920 14,920
Reinsurance recoverable on paid claims 1,192 1,192
Notes receivable 349 349
Income tax recoverable 1,092 1,092
Liabilities:
Funds held by Company 748 748
Supplemental duty deposits 2,669 2,669
Notes payable 9,735 9,735
Fixed maturities, equity securities, and the investment in investee are
valued at quoted market prices, where available, or from independent pricing
sources. Cash and cash equivalents, premiums receivable, reinsurance
recoverable on paid claims, income tax recoverable, funds held, and
supplemental duty deposits are valued at their carrying value due to their
short-term nature. The carrying value of notes receivable and notes payable
approximates fair value as the notes bear a floating rate of interest.
(18) FOREIGN CURRENCY TRANSLATION
The net assets of the Company's foreign operations are translated into
U.S. dollars using exchange rates in effect at each year end. An analysis of
this account for the respective years ended December 31 follows (amounts in
thousands):
36
Year Ended December 31,
1995 1994 1993
------------------------------
Beginning amount of cumulative translation
adjustments $(2,002) (1,375) (953)
Included in Kingsway's basis at sale 319 - -
Aggregate adjustment for the period resulting
from translation adjustments 504 (627) (422)
======= ====== ======
Net aggregate translation included in equity 823 (627) (422)
======= ====== ======
Ending amount of cumulative translation
adjustments $(1,179) (2,002) (1,375)
======= ====== ======
Canadian foreign exchange rate at end of year 0.73290 0.71290 0.75540
British foreign exchange rate at end of year 1.55300 1.56500 1.47950
Hong Kong foreign exchange rate at end of year 0.12930 0.12925 0.12948
(19) ACCOUNTING PRONOUNCEMENTS TO BE ADOPTED
In March 1995, SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of," was issued which requires
impairment losses to be recorded on long-lived assets used in operations when
indicators of impairment are present and the undiscounted cash flows estimated
to be generated by those assets are less than the assets' carrying amount.
SFAS No. 121 also addresses the accounting for long-lived assets that are
expected to be disposed of by a company. The Company will adopt SFAS No. 121
in the first quarter of 1996 and based on current circumstances, does not
believe the effect of adoption will be material.
The Company will adopt the disclosure requirements of SFAS No. 123,
"Accounting for Stock Based Compensation" in the first quarter of 1996. The
adoption will have no effect on the Company's financial position or its results
of operations.
(20) INVESTMENT IN KINGSWAY
The following presents summary financial data for Kingsway as of
December 31, 1995 and 1994, and for each of the years in the three-year period
ended December 31, 1995 (in thousands).
37
December 31,
1995 1994
---------------------
Assets:
Investments $43,918 22,344
Other assets 20,434 19,088
------- ------
Total assets $64,352 41,432
======= ======
Liabilities:
Unpaid claims $17,826 12,111
Unearned premiums 17,531 13,932
Other liabilities 2,115 3,514
------- ------
Total liabilities $37,472 29,557
Shareholders' equity 26,880 11,875
------- ------
Total liabilities and shareholders'
equity $64,352 41,432
======= ======
Year Ended December 31,
1995 1994 1993
-------------------------------------
Revenues:
Net premiums earned $33,617 31,043 11,146
Other revenues 3,585 2,441 1,634
------- ------ ------
Total revenues 37,202 33,484 12,780
------- ------ ------
Expenses:
Claims incurred 22,360 19,870 6,437
Other expenses 10,118 9,276 4,116
------- ------ ------
Total expenses 32,478 29,146 10,553
------- ------ ------
Income before income taxes 4,724 4,338 2,227
Income taxes 1,975 1,926 1,000
------- ------ ------
Net income $2,749 2,412 1,227
======= ====== ======