1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K/A
(AMENDMENT NO.2)
[ ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended DECEMBER 31, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission file number 1-11733
AMERICAN STATES FINANCIAL CORPORATION
INDIANA NO. 35-1976549
State of Incorporation I.R.S. Employer Identification No.
500 NORTH MERIDIAN STREET
INDIANAPOLIS , INDIANA 46204 - 1275 (317) 262-6262
Address of principal executive offices Telephone Number
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
------------------- ----------------------
Common Stock, No Par Value New York Stock Exchange, Inc.
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X ] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. [ ]
Aggregate market value of Common Stock held by nonaffiliates (computed as of
January 31, 1997): $265,082,333
Shares of Common Stock outstanding as of January 31, 1997: 60,050,515
DOCUMENTS INCORPORATED BY REFERENCE: None
The exhibit index to this report is located on page 70 of Form 10-K filed by
the registrant for the fiscal year ended December 31, 1996.
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ITEM 1. BUSINESS
GENERAL DEVELOPMENT
American States Financial Corporation ("ASFC"), is an Indiana domiciled
holding company incorporated in 1996. Its principal place of business is 500
North Meridian Street, Indianapolis, Indiana 46204. Unless the context
otherwise indicates; (i) the "Company" refers to ASFC and its wholly-owned,
consolidated subsidiaries; (ii) "ASI" refers to American States Insurance
Company, the Company's sole direct wholly-owned subsidiary, and its
consolidated subsidiaries; and (iii) the "Subsidiaries" refer to the direct and
indirect subsidiaries of the Company, which include ASI and its subsidiaries.
On May 16, 1996, Lincoln National Corporation ("LNC") transferred all of the
outstanding shares of ASI to the Company in exchange for 50,000,000 shares of
the Company's Common Stock. Concurrently with the transfer of the ASI stock,
the Company assumed $100 million of LNC debt ("Assumed Debt") and issued a $200
million note to LNC (the "Term Note"). LNC holds approximately 83% of the
outstanding shares of ASFC.
For a description of recent developments affecting the business of ASFC,
see Item 7, "Management 's Discussion and Analysis of Financial Condition and
Results of Operations - Recent Developments," below.
GENERAL DESCRIPTION
The Company operates in two business segments: (1) property and casualty
insurance; and (2) life insurance. One or more of the Subsidiaries has
underwritten property and casualty insurance since 1929 and life insurance
since 1959. In 1993 the Company withdrew from the property and casualty
reinsurance business, which it had engaged in since 1964. A portion of that
business was sold, and the remainder is in run off. This is the only instance
in which the Company has withdrawn from, or otherwise acquired or disposed of
part of a business segment during the past five years.
The Company's business is not materially affected by any of the following
considerations: the availability of raw materials; the effect of patents,
trademarks, licenses (except those granted by state insurance regulators
authorizing the Company to conduct business within their jurisdictions),
franchises or other concessions held; backlogs; or government contracts which
are or might be subject to termination or re-negotiation of profits. Generally,
the property and casualty industry is not considered seasonal, however, claims
and expenses for property and casualty insurance tend to be higher for periods
of severe or inclement weather. During their last three fiscal years, the
Company has not spent a material amount on research and development activities.
The Company's business is not directly affected in any material way by
compliance with federal, state or local provisions regulating the discharge of
materials into the environment or otherwise relating to protection of the
environment, though such provisions do affect the liability of those insured
under some of its policies, and thus its obligations under those policies (see
Reserves For Losses And Loss Adjustment Expenses). The Company is not dependent
upon any one customer or group of affiliated customers, the loss of any one or
more of which would have a material adverse effect on the Company. Similarly,
not one of the independent insurance agents making up its distribution network
(or any group of affiliated agents) accounts for so much of its business in any
business segment that the termination of the relationship with that agent or
group of agents would have a material adverse effect upon the Company.
The Company's total employment was 3,483 on December 31, 1996. None of
the employees are represented by a labor union or subject to a collective
bargaining agreement.
The following briefly describes the Company's business segments. For
financial information regarding each of the Company's business segments,
including revenues, pre-tax income and identifiable assets, please see the
consolidated financial statements, note 13, on page 55.
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PROPERTY AND CASUALTY INSURANCE
The Company's property and casualty insurance sales and underwriting
activities are conducted through six subsidiary companies. The Company's
multiple line property and casualty business includes the following types of
personal and commercial lines policies: businessowners ("BOPs"), commercial
multi-peril, commercial automobile, workers' compensation, private passenger
automobile, and homeowners multi-peril. Although other potentially profitable
markets will be considered, the Company's focus is on small to medium-sized
businesses. Substantially all of the Company's policies are written on an
annual basis, except for (i) private passenger automobile, which is typically a
six-month policy and (ii) a small amount of multi-year BOP policies recently
introduced by the Company. The Company is noted as the second largest writer
of property and casualty insurance to businesses with fewer than 50 employees,
with 3.4% of this segment of the U.S. market, based on 1995 estimated premiums.
Although the Company writes business in most of the United States, its primary
geographic focus is on those areas such as the Midwest and the Pacific
Northwest which have relatively modest exposure to catastrophe losses and in
which management believes insurers generally have been permitted to manage risk
selection and pricing without undue regulatory interference. Field operations
are managed through four regional offices, each with broad responsibility for a
particular territory. Distribution is through a network of approximately 4,750
independent agencies.
3,371 employees are involved in this business segment.
LIFE INSURANCE.
The Company conducts its life insurance sales and underwriting operations
through American States Life Insurance Company ("ASL"), an Indiana domiciled
corporation whose principal office is in Indianapolis, Indiana.
Life insurance is treated by the Company as a business segment which
markets an integrated product line through the same independent agency
distribution network as the Company's property and casualty insurance policies.
The Company stresses the sale of universal life and term life policies,
although it also writes whole life, individual annuities and disability income
policies. The Company sells its life products in most of the United States.
112 employees are involved in this business segment.
REINSURANCE
The Company follows the customary industry practice of reinsuring portions
of its risks and paying for that protection based upon premiums received on all
policies subject to such reinsurance. Insurance is ceded principally to reduce
the Company's exposure on large individual risks and to provide protection
against large losses, including catastrophe losses.
In 1996, the Company's property catastrophe reinsurance program, its
"Primary Coverage", provided protection of 93% of $150 million, or
approximately $139.5 million, in excess of a $30 million retention per
occurrence. In 1997, the Primary Coverage will provide protection of 90% of
$150 million, or approximately $135 million, in excess of a $30 million
retention per occurrence. In addition, in 1997 the Company has also purchased
an additional coverage layer of 90% of $100 million, or $90 million, in excess
of its primary coverage. This additional 1997 layer provides protection solely
for non-California earthquake exposure. During the past twenty years, the
Company exceeded its current catastrophe retention only once. The Company also
reinsures a portion of its life business. The maximum net retention on any one
life is currently $250,000.
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COMPETITION AND REGULATION
The insurance industry is diverse and highly competitive. The Company
competes with other stock insurers, mutual insurance companies and other
underwriting organizations. At the end of 1995, the latest year for which data
is available, there are over 1,100 groups and unaffiliated individual companies
writing property and casualty insurance. The Company ranked 31st in net
written premiums for 1995 (A.M. Best Aggregates and Averages, June 1996) among
all such groups and companies.
The factors influencing purchasing decisions by the Company's customers
include price, breadth of coverage, reputation of the selling agency,
reputation of the insurer, service, financial strength and ratings. The
Company competes against other property and casualty and life insurance
companies, including direct writers (which deal with customers directly or
through exclusive agencies) and other independent agency companies, seeking to
write business in its target markets, including other companies utilizing the
same independent agencies which represent the Company.
Like all insurers similarly situated, the Company, with one or more of
it's subsidiaries licensed in all 50 states and the District of Columbia, is
subject to comprehensive regulation by government agencies in the states in
which it does business. The nature and extent of that regulation varies from
jurisdiction to jurisdiction, but typically involves prior approval of the
acquisition of control of an insurance company or of any company controlling an
insurance company, regulation of certain transactions entered into by an
insurance company with any of its affiliates, limitations on dividends,
approval or filing of premium rates and policy forms for many lines of
insurance, solvency standards, minimum amounts of capital and surplus which
must be maintained, reserve requirements, limitations on types and amounts of
investments, restrictions on the size of risks which may be insured by a single
company, limitation of the right to cancel or non-renew policies in some lines,
regulation of the right to withdraw from markets or agencies, licensing of
insurers and agents, deposits of securities for the benefit of policyholders,
reporting with respect to financial conditions, regulation of market conduct
and other matters. In addition, state insurance department examiners perform
periodic financial and market conduct examination of insurance companies. Such
regulation is generally intended for the protection of policyholders, not
investors.
RESERVES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
The Company is required by applicable insurance laws and regulations, as
well as GAAP accounting, to maintain reserves for payment of losses and loss
adjustment expenses ("LAE") for claims, both reported and incurred but not
reported ("IBNR"), arising from the policies issued. These laws and
regulations, as well as GAAP accounting, require that provision be made for
the ultimate cost of claims without regard to how long it takes to settle them
or the time value of money. The determination of reserves involves actuarial
and statistical projections of what the Company expects to be the cost of the
ultimate settlement and administration of such claims based upon facts and
circumstances then known, estimates of future trends in claims severity, and
other variable factors such as inflation and changing judicial theories of
liability. The estimation of ultimate liability for losses and LAE is an
inherently uncertain process and does not represent an exact calculation of
that liability. The Company's reserving policy recognizes this uncertainty by
maintaining reserves at a level providing for the possibility of adverse
development relative to the estimation process.
When a claim is reported to the Company, its claims personnel establish a
"case reserve" for the estimated amount of the ultimate payment. This estimate
reflects an informed judgment, based upon general insurance reserving practices
and on the experience and knowledge of the estimator regarding the nature and
value of the specific claim, the severity of injury or damage, and the policy
provisions relating to the type of loss. Case reserves are adjusted by the
Company's claims staff as more information becomes available.
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The Company maintains IBNR reserves, the purpose of which is to provide
for future development on reported claims and IBNR claims. The IBNR reserve is
determined by estimating the Company's ultimate liability for both reported
and IBNR claims and then subtracting the open case reserves and claim payments
made.
Each quarter, the Company's actuaries compute its estimated ultimate
liability using actuarial principles and procedures applicable to the lines of
business written. Such reserves are also considered annually by the Company's
independent auditors in connection with their audit of the Company's financial
statements. However, because the establishment of loss reserves is an
inherently uncertain process, there can be no assurance that ultimate losses
will not exceed the Company's loss reserves. As required by insurance
regulatory authorities, the Company submits to the various jurisdictions in
which it is licensed a statement of opinion by its appointed actuary concerning
the adequacy of the statutory reserves.
The primary actuarial projection techniques utilized by the Company are
the "reported loss development method" and the "paid loss development method."
These methods involve projecting reported losses to ultimate levels based on
either historical loss reporting or historical loss payment patterns.
Loss-based methods are considered most appropriate for the product lines
primarily written by the Company. These methods are supplemented, when
appropriate, by premium-based techniques utilizing estimated loss ratios and
earned premiums. As part of the process, the Company's actuaries review
historical data and anticipate the impact of various factors such as
legislative enactment's and judicial decisions which may affect future claim
settlements. Such factors include the increasing propensity of juries to
return large damage awards, changes in political attitudes that may affect the
tendency of legislators and judges to impose liability for certain types of
losses, and trends in general economic conditions, including the effects of
inflation. Adjustments are also made to take into account changes in the
volume of business written, claim frequency and severity, the mix of business,
changes in the claim settlement process and other factors which can be expected
to affect the Company's liability for losses. This process assumes that past
experience, adjusted for the effects of current and anticipated trends, is an
appropriate basis for predicting future events. Other techniques utilized
include (i) utilization of industry loss exposure estimates coupled with the
Company's estimated industry market share, and (ii) the occasional use of
outside consultants to confirm the Company's estimate for specific loss
exposures (see later discussion concerning construction defect exposure and
reinsurance in run-off).
The following table provides a reconciliation of the Company's property
and casualty losses and LAE reserve balances for the years indicated.
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Year Ended December 31,
----------------------------
1996 1995 1994
-------- -------- --------
(Dollars in Millions)
Balance as of January 1, net of related reinsurance recoveries........................ $2,294.5 $2,377.2 $2,458.4
Add:
Provision for losses and LAE occurring in the current year,
net of reinsurance............................................................ 1,245.6 1,233.6 1,318.2
Increase/(decrease) in estimated losses and LAE occurring
in prior years, net of reinsurance............................................ (45.7) (39.9) (92.0)
-------- -------- --------
Incurred losses and LAE during the current year,
net of reinsurance............................................................ 1,199.9 1,193.7 1,226.2
Deduct:
Losses and LAE payments for claims, net of reinsurance,
occurring during:
Current year.................................................................. 654.0 613.5 617.4
Prior years................................................................... 578.7 662.9 690.0
-------- -------- --------
Total.................................................................... 1,232.7 1,276.4 1,307.4
-------- -------- --------
Balance as of December 31, net of related reinsurance recoveries.... 2,261.7 2,294.5 2,377.2
Reinsurance recoverables on losses and LAE at end of year........... 164.4 120.1 119.5
-------- -------- --------
Reserves for losses and LAE, gross of related reinsurance
recoverables, at end of year.................................... $2,426.1 $2,414.6 $2,496.7
======== ======== ========
The liability for property and casualty losses and LAE included in the
preceding table is determined on a basis prescribed by generally accepted
accounting principles ("GAAP"). Such liabilities differ from that reported to
state insurance regulators. A reconciliation of the GAAP liability and the
corresponding liability reported to state insurance regulators is as follows:
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Year Ended
December 31,
------------------------
1996 1995
----------- -----------
(Dollars in Millions)
Liability reported to state insurance regulators...................................... $2,298.8 $2,331.6
Increase (decrease) related to:
Estimated salvage and subrogation recoveries...................................... (37.1) (37.1)
Amount recoverable from reinsurers................................................ 164.4 120.1
----------- -----------
Liability reported on a GAAP basis............................................ $2,426.1 $2,414.6
=========== ===========
The following table shows the development of the reserves for unpaid
losses and LAE, net of reinsurance, from 1986 through 1996 for the Company's
property and casualty subsidiaries on a GAAP basis. The top line of the table
shows the liabilities at the balance sheet date for each of the indicated
years. This reflects the estimated amounts of losses and LAE for claims
arising in that year and all prior years that are unpaid at the balance sheet
date, including losses incurred but not yet reported to the Company. The upper
portion of the table shows the cumulative amounts subsequently paid as of
successive years with respect to the liability. The lower portion of the table
shows the re-estimated amount of the previously recorded liability based on
experience as of the end of each succeeding year. The estimates change as more
information becomes known about the frequency and severity of claims for
individual years. The redundancy (deficiency) exists when the re-estimated
liability at each December 31 is less (greater) than the prior liability
estimate. The "cumulative total redundancy (deficiency)" depicted in the
table, for any particular calendar year, represents the aggregate change in the
initial estimates over all subsequent calendar years. Company management
believes that overall loss and LAE reserves as of December 31, 1996 make an
adequate and reasonable provision for loss and LAE expense, with these reserves
having been determined based upon conservative actuarial techniques
consistently applied. The Company's reserving philosophy seeks to maintain
reserves that will provide for the ultimate incurred loss amount. Nonetheless,
the conditions and trends which have affected the development of these
liabilities in the past may not necessarily recur in the future and it would
not, therefore, be appropriate to use this cumulative history to project future
performance:
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Year Ended December 31,
------------------------------------------------------------------------------------------------------------------------
1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996
(Dollars in Millions)
Liability for unpaid losses and LAE, net of reinsurance recoverable:
$1,257.6 $1,395.8 $1,643.9 $1,890.7 $2,148.6 $2,370.3 $2,538.5 $2,458.4 $2,377.2 $2,294.5 $2,261.7
Cumulative amount of liability paid through: (First column represents number of years later)
1 477.0 509.5 606.0 710.3 777.7 779.7 800.6 690.0 662.9 578.7
2 727.1 785.2 937.0 1,096.2 1,183.1 1,230.8 1,225.1 1,094.3 996.8
3 887.6 931.0 1,152.6 1,321.7 1,453.7 1,495.6 1,501.6 1,322.7
4 971.6 1,052.4 1,272.2 1,479.7 1,617.9 1,685.4 1,663.6
5 1,046.3 1,124.7 1,361.9 1,580.1 1,740.6 1,807.5
6 1,095.7 1,180.3 1,422.1 1,659.9 1,828.1
7 1,134.3 1,219.8 1,471.4 1,716.6
8 1,164.1 1,253.5 1,509.8
9 1,190.4 1,282.9
10 1,214.1
Liability re-estimated as of: (First column represents number of years later)
1 1,189.2 1,335.6 1,608.7 1,900.9 2,153.4 2,397.9 2,490.4 2,366.4 2,337.3 2,248.8
2 1,205.9 1,328.7 1,635.5 1,924.6 2,195.5 2,407.0 2,458.0 2,399.5 2,342.7
3 1,227.9 1,354.6 1,651.4 1,969.1 2,247.7 2,402.5 2,534.3 2,454.6
4 1,259.6 1,375.3 1,685.6 2,028.9 2,265.3 2,505.3 2,618.1
5 1,285.2 1,420.9 1,764.7 2,052.7 2,373.5 2,603.1
6 1,326.6 1,507.0 1,779.4 2,159.3 2,472.5
7 1,410.9 1,515.1 1,871.8 2,237.8
8 1,417.4 1,604.7 1,935.6
9 1,507.1 1,655.0
10 1,543.0
Cumulative total redundancy (deficiency) (1)
$ (285.4) $ (259.2) $ (291.7) $ (347.1) $ (323.9) $ (232.8) $ (79.6) $ 3.8 $ 34.5 $ 45.7
======== ======== ======== ======== ======== ======== ======== ======== ======== ========
Change in cumulative total redundancy (deficiency)
$ 26.2 $ (32.5) $ (55.4) $ 23.2 $ 91.1 $ 153.2 $ 83.4 $ 30.7 $ 11.2 $ (45.7)
Net reserve - December 31 $2,377.2 $2,294.5 $2,261.7
Reinsurance recoverables 119.5 120.1 164.4
-------- -------- --------
Gross reserve, December 31 $2,496.7 $2,414.6 $2,426.1
======== ======== ========
Cumulative redundancy (deficiency):
Personal and Commercial lines
$ (48.5) $ (36.2) $ (75.8) $ (99.6) $ (87.1) $ (12.1) $ 78.5 $ 126.5 $ 129.5 $ 71.9
Reinsurance business in run-off
(236.9) (223.0) (215.9) (247.5) (236.8) (220.7) (158.1) (122.7) (95.0) (26.2)
------- ------- ------- ------- ------- -------- ------ ------ ----- -----
Total $ (285.4) $ (259.2) $ (291.7) $ (347.1) $ (323.9) $ (232.8) $ (79.6) $ 3.8 $ 34.5 $ 45.7
======== ======== ======== ======== ======== ======== ======== ======== ======== ========
Change in cumulative redundancy (deficiency):
Personal and Commercial lines
$ 12.3 $ (39.6) $ (23.8) $ 12.5 $ 75.0 $ 90.6 $ 48.0 $ 3.0 $ (57.6) $ (71.9)
Reinsurance business in run-off
13.9 7.1 (31.6) 10.7 16.1 62.6 35.4 27.7 68.8 26.2
----- ------- ------- ----- ----- ------ ----- ----- ----- -------
Total
$ 26.2 $ (32.5) $ (55.4) $ 23.2 $ 91.1 $ 153.2 $ 83.4 $ 30.7 $ 11.2 $ (45.7)
======== ======== ======== ======== ======== ======== ======== ======== ======== ========
______________________________
(1) The cumulative deficiency in reserves for the years 1986-1992 is
primarily attributable to environmental and asbestos claims incurred under
assumed reinsurance.
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The following table is derived from the preceding table and summarizes the
effect of reserve re-estimates, net of reinsurance, on calendar year operations
for the same ten-year period ended December 31, 1996. The total of each column
details the amount of reserve re-estimates made in the indicated calendar year
and shows the accident years to which the re-estimates are applicable. The
amounts in the total accident year column on the far right represent the
cumulative reserve re-estimates for the indicated accident year(s). At the end
of each calendar year shown below, Company management was unaware of any loss
reserve deficiency or redundancy, and believed that the reported loss reserves
were in full compliance with GAAP accounting.
Cumulative
Deficiency
(Redundancy)
Effect of Reserve Re-estimates on Calendar Year Operations from
----------------------------------------------------------------------------------------------- Re-estimates
Increase (Decrease) in Reserves for Calendar Year for Each
----------------------------------------------------------------------------------------------- Accident
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 Year
---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
Accident Years
1986 and prior $(68.4) $16.7 $22.0 $31.6 $25.6 $41.4 $84.3 $6.5 $89.7 $36.0 $285.4
1987 (76.9) (29.0) (5.7) (4.9) 4.2 1.8 1.6 (.1) 14.4 (94.6)
1988 (28.2) .9 (4.9) (11.4) (7.0) 6.6 2.8 13.5 (27.7)
1989 (16.6) 7.9 10.3 (19.3) 9.1 14.2 14.6 20.2
1990 (18.9) (2.5) (7.5) (6.2) 1.7 20.5 (12.9)
1991 (14.4) (43.2) (22.1) (5.5) (1.2) (86.3)
1992 (57.2) (27.9) (26.5) (14.0) (125.6)
1993 (59.6) (43.2) (28.7) (131.6)
1994 (73.0) (49.7) (122.7)
1995 (51.1) (51.1)
Total calendar year effect:
------ ------ ------ ------ ------ ------ ------ ------ ------ ------ -------
$(68.4) $(60.2) $(35.2) $ 10.2 $ 4.8 $ 27.6 $(48.1) $(92.0) $(39.9) $(45.7) $(346.9)
====== ====== ====== ====== ====== ====== ====== ====== ====== ====== =======
In personal and commercial lines excluding reinsurance in run-off, the
Company benefited from positive prior year loss reserve development during both
1996 and 1995 on the Company's core book of on-going business, which includes
businessowners, commercial multi-peril, commercial automobile, workers'
compensation, homeowners and personal automobile. This positive development
was consistent with industry trends, but was also due in part to the continuing
effects of the Company's "New Directions" initiative. Under New Directions,
which was implemented in 1991, the Company elected to reduce market share in
lines of business and geographic areas which were producing less than
acceptable loss ratios computed in accordance with statutory accounting
principles ("SAP"). The New Directions program has been primarily responsible
for the 10.6 percentage point improvement in the Company's loss ratio from
71.6% for 1991 to 61.0% for 1996. Another factor contributing to favorable loss
reserve development was the on-going improvement in the claim evaluation and
management process. Additionally, workers' compensation reform and tort reform
have created some improvement in loss cost trends for both the Company and the
industry. Notwithstanding the above, favorable loss reserve development on
prior accident years may not necessarily occur in the future, and there can be
no assurance that earnings will continue to benefit from positive reserve
developments.
The Company continued to experience adverse loss development on
construction defect claims which is netted within the aggregate 1996 favorable
development on prior year loss and LAE reserves in personal and commercial
lines excluding reinsurance in run-off. Construction defect claims are a subset
of claims that arise from coverage provided by general property damage
liability insurance. The Company defines construction defect claims as those
involving allegations of defective work which result in claims for damages
related to the diminution in value of large construction projects, such as
condominiums, office buildings, shopping centers and housing developments.
Prior to 1993, the number of construction defect claims reported to the Company
were insignificant relative to the total number of general property damage
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liability claims; therefore, these claims were not separated for the purpose of
reserve analysis. The reporting pattern and incurred losses and LAE for
construction defect claims are as follows:
Number of
Calendar Reported Incurred
Year Claims Losses and LAE (1)
---- ------ ------------------
(Dollars in Millions)
1991 & prior...................... 442 $12.0
1992.............................. 804 25.0
1993.............................. 1,257 46.1
1994.............................. 1,274 88.8
1995.............................. 1,227 110.8
1996.............................. 1,709 134.3
___________________
(1) Incurred losses and LAE include reported claims and IBNR claims, net of
reinsurance.
Approximately 90% of the reported claims involve construction activity in
California, with the majority of reported claims through 1996 being incurred in
accident years prior to 1994. Management believes that the increase in 1996
reportings is attributable, in large part, to the California Supreme Court's
landmark decision in Montrose Chemical Corp. v. Admiral Ins. Co., 10 Cal. 4th
654 (1995), which was handed down in July 1995. In Montrose, the court held
that in progressive damage cases, such as environmental and construction defect
cases (where damage begins in one policy period and advances in subsequent
policy periods), any policy in effect while the damage progressed is triggered
and is potentially exposed to the loss. The adoption of this "continuous"
trigger theory in the interpretation of liability insurance policies marked a
significant departure from the "manifestation" trigger the court had adopted in
the interpretation of first-party property insurance policies, which many
intermediate California courts had applied prior to Montrose. The adoption of
the continuous trigger in conjunction with the ten year statute of limitations
for construction defect claims greatly expanded the number of primary carriers
which would potentially have exposure for losses arising from any one project.
Those factors combined with an aggressive plaintiffs bar and a receptive
California judiciary to produce the experienced growth in reportings.
From an operational perspective, in late 1992, the Company established a
dedicated claim unit specifically for the management of construction defect
claims. Also, beginning in 1993, the Company intentionally began reducing the
volume of new contractor business written in California, and currently is not
writing any new California contractor business. The Company has significantly
reduced its in-force book of contractor business in California. Further, as
the number of construction defect claims increased during 1993 and 1994, the
Company decided, at the end of 1994, to segregate construction defect claims
from all other general property damage liability claims for reserve analysis.
As a result of a separate analysis of the construction defect losses, the
reserves were increased. This analysis was repeated at the end of 1995 and
1996 as part of the Company's analysis of its total reserves for general
property damage liability.
In addition, in 1996, the Company engaged an outside consulting firm to
perform a construction defect reserve analysis and claims management study. The
Company adopted the firm's recommendations resulting from the study and
recorded the proposed addition to construction defect loss and LAE reserves as
of December 31, 1996. The Company believes that based on its own analysis and
that of the consultant, its total provision for construction defect exposures
is adequate at December 31, 1996.
The Company's reinsurance in run-off business incurred adverse prior year
loss reserve development of $26.2 million in 1996 versus $69.3 million in
1995. The adverse development in 1996 was attributable to asbestosis and
environmental ("A&E") loss exposures related to accident years prior to 1988.
10
11
The Company engaged an independent actuarial firm in 1996 to review the
sufficiency of total reinsurance in run-off reserves, with a particular
emphasis on A&E reserves. The Company also obtained previously unavailable
information from a large property and casualty pool from which the Company
assumes an approximate 2% pro-rata share. The pool indicated that it was
experiencing adverse development related to its A&E exposure. Additionally, new
actuarial techniques and methodologies were applied to pre-existing data. The
cumulative effect of these initiatives has been to help identify the various
components of the adverse development. They appear to be approximately $13.0
million related to the pool with the remaining $13.2 million of adverse
development related primarily to various casualty excess-of-loss exposures.
As a result of the above, the Company increased its A&E reinsurance in
run-off reserves, net of reinsurance recoverables, to $143.9 million at year
end, up from $127.1 million at year end 1995. In addition, in January of 1996
the Company agreed to assume $61.4 million of reserves, from an affiliate of
LNC, on a closed block of specialty lines business. This run-off business
covers primarily property, casualty, accident and health exposures on sports,
leisure and entertainment venues. Reserves as of December 31, 1996 totaled
$41.3 million. Due to the increase in A&E reserves and the assumption of the
closed block of specialty business, total reinsurance in run-off reserves, net
of reinsurance recoverables, increased to $262.4 million at year end 1996, up
from $210.3 million at year end 1995. The Company believes its total
reinsurance in run-off loss reserves are appropriate as of December 31, 1996.
Establishing reserves for A&E claims is subject to uncertainties that are
greater than those presented by other types of claims. The Company continually
monitors and evaluates A&E claims and re-estimates its reserves accordingly.
In addition to the periodic utilization of outside experts, another method used
by the Company to evaluate its reserves for A&E claims is to compute the number
of years of claim payments which are being carried in reserve (the survival
ratio). Based on losses and LAE payments made during the preceding twelve
months, the Company's survival ratio for total A&E reserves increased to 18.5
years at December 31, 1996 versus 17.4 years at December 31, 1995. With a
survival ratio of 18.5 compared to an industry average of 9.1, the Company
believes that total Company A&E loss exposures are adequately reserved. The
loss and LAE reserves for reported and unreported A&E liabilities, net of
reinsurance recoverables, are as follows:
Calendar Asbestos Environmental
Year Reserves Reserves
---- -------- --------
(Dollars in Millions)
1994........................... $69.6 $128.6
1995........................... 77.8 163.4
1996........................... 112.3 138.2
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The following table summarizes the Company's property and casualty reserves,
net of reinsurance recoverables, by type of claim as of the dates indicated:
At December 31,
-----------------------------------
1996 1995 1994
---- ---- ----
(Dollars in Millions)
Commercial and personal:
Core commercial and personal .................... $1,562.7 $1,724.6 $1,941.7
Construction defect ............................. 330.0 245.5 173.9
A&E.............................................. 106.6 114.1 101.3
-------- -------- --------
Total commercial and personal ............. $1,999.3 $2,084.2 $2,216.9
-------- -------- --------
Reinsurance in run-off:
A&E.............................................. 143.9 127.1 96.9
All other reinsurance in run-off ................ 118.5 83.2 63.4
-------- -------- --------
Total reinsurance in run-off .............. 262.4 210.3 160.3
-------- -------- --------
Total reserves, net of reinsurance recoverables ..... $2,261.7 $2,294.5 $2,377.2
======== ======== ========
The following table provides a detailed reconciliation of the Company's
property and casualty losses and LAE reserve balances for the years indicated:
Consolidated Less Construction
Defects and A&E
----------------------------------
Year Ended December 31,
----------------------------------
1996 1995 1994
---------- ---------- ----------
Balance as of January 1, net of related
reinsurance recoveries............................ $1,807.8 $2,005.1 $2,142.8
Add:
Provision for losses and LAE occurring
in the current year, net of reinsurance 1,235.0 1,221.8 1,303.9
Increase/(decrease) in estimated losses
and LAE occurring in prior years, net
of reinsurance................................ (192.3) (195.8) (178.0)
---------- ---------- ----------
Incurred losses and LAE during the
current year, net of reinsurance.............. 1,042.7 1,026.0 1,125.9
Deduct:
Losses and LAE payments for claims,
net of reinsurance, occurring during:
Current year.................................. 652.4 613.2 617.1
Prior years................................... 516.9 610.1 646.5
---------- ---------- ----------
Total...................................... 1,169.3 1,223.3 1,263.6
---------- ---------- ----------
Balance as of December 31, net of related
reinsurance recoveries............................ 1,681.2 1,807.8 2,005.1
Reinsurance recoverables on losses and
LAE at end of year................................ 132.7 97.4 99.6
---------- ---------- ----------
Reserves for losses and LAE, gross of
related reinsurance recoverables, at end
of year........................................... $1,813.9 $1,905.2 $2,104.7
========== ========== ==========
Construction Defects A&E
---------------------------- --------
Year Ended December 31, Year Ended December 31,
---------------------------- ----------------------------
1996 1995 1994 1996 1995 1994
-------- -------- -------- -------- -------- --------
Balance as of January 1, net of related
reinsurance recoveries........................... $245.5 $173.9 $114.9 $241.2 $198.2 $200.7
Add:
Provision for losses and LAE occurring
in the current year, net of reinsurance 8.4 8.9 8.4 2.2 2.9 5.9
Increase/(decrease) in estimated losses
and LAE occurring in prior years, net
of reinsurance............................... 125.9 101.9 80.4 20.7 54.0 5.6
------ ------ ------ ------ ------ ------
Incurred losses and LAE during the
current year, net of reinsurance............. 134.3 110.8 88.8 22.9 56.9 11.5
Deduct:
Losses and LAE payments for claims,
net of reinsurance, occurring during:
Current year................................. 1.5 .2 .1 .1 .1 .2
Prior years.................................. 48.3 39.0 29.7 13.5 13.8 13.8
------ ------ ------ ------ ------ ------
Total..................................... 49.8 39.2 29.8 13.6 13.9 14.0
------ ------ ------ ------ ------ ------
Balance as of December 31, net of related
reinsurance recoveries........................... 330.0 245.5 173.9 250.5 241.2 198.2
Reinsurance recoverables on losses and
LAE at end of year............................... 1.2 2.4 1.6 30.5 20.3 18.3
------ ------ ------ ------ ------ ------
Reserves for losses and LAE, gross of
related reinsurance recoverables, at end
of year.......................................... $331.2 $247.9 $175.5 $281.0 $261.5 $216.5
====== ====== ====== ====== ====== ======
Total
-----
Year Ended December 31,
----------------------------
1996 1995 1994
-------- -------- --------
Balance as of January 1, net of related
reinsurance recoveries............................ $2,294.5 $2,377.2 $2,458.4
Add:
Provision for losses and LAE occurring
in the current year, net of reinsurance 1,245.6 1,233.6 1,318.2
Increase/(decrease) in estimated losses
and LAE occurring in prior years, net
of reinsurance................................ (45.7) (39.9) (92.0)
-------- -------- --------
Incurred losses and LAE during the
current year, net of reinsurance.............. 1,199.9 1,193.7 1,226.2
Deduct:
Losses and LAE payments for claims,
net of reinsurance, occurring during:
Current year.................................. 654.0 613.5 617.4
Prior years................................... 578.7 662.9 $690.0
-------- -------- --------
Total...................................... 1,232.7 1,276.4 1,307.4
-------- -------- --------
Balance as of December 31, net of related
reinsurance recoveries............................ 2,261.7 2,294.5 2,377.2
Reinsurance recoverables on losses and
LAE at end of year................................ 164.4 120.1 119.5
-------- -------- --------
Reserves for losses and LAE, gross of
related reinsurance recoverables, at end
of year........................................... $2,426.1 $2,414.6 $2,496.7
======== ======== ========
The above reconciliation shows a decrease to the total liability for estimated
losses and LAE in 1994, 1995 and 1996 by $92.0, $39.9 and $45.7 million,
respectively. Such reserve adjustments, which affected current operations in
1994, 1995 and 1996, resulted from developed losses from prior years being
different than were anticipated when the liabilities for losses and LAE expense
were originally estimated. The favorable reserve development each year has
been the result of improving trends, both industry-wide and
12
13
related to the Company's New Directions initiatives as well as enhancements
made in the claim evaluation and settlement processes. These development
trends as they emerged each year were considered inestablishing the liability
for losses and LAE at that year end. The breakout of construction defects and
A&E have been provided for additional disclosure to highlight the complexity of
establishing loss and LAE reserves. The amounts represent a subset of claims
from the Company's commercial and reinsurance business. Prior to 1994, the
Company had insufficient loss history in these types of losses and, accordingly,
it was difficult to estimate an adequate reserve for the ultimate incurred
loss. In subsequent years (1994,1995 and 1996), the actual experience on these
losses has proven to be greater (adeficiency) than provided for in each of the
immediate preceding year ends.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Except for historical information contained herein, the discussion in this
Annual Report on Form 10-K includes certain forward-looking statements based
upon management expectations. Factors which could cause future results to
differ from these expectations include the following: financial markets (e.g.
interest rates and securities markets), state and federal legislative and
regulatory initiatives, acts of God (e.g. hurricanes, earthquakes and storms),
other insurance risks and competition.
The Management's Discussion and Analysis of Financial Condition and
Results of Operations should be read in conjunction with the accompanying
audited consolidated financial statements, including the notes.
RECENT DEVELOPMENTS
On June 6, 1997, ASFC entered into an Agreement and Plan of Merger dated
as of the same date (the "Merger Agreement"), by and among ASFC, SAFECO
Corporation ("Buyer") and ASFC Acquisition Co., a wholly owned subsidiary of
Buyer ("Buyer Sub"). The Merger Agreement provides for, among other things,
the merger of Buyer Sub with and into ASFC (the "Merger"), with ASFC surviving
the Merger as a wholly owned subsidiary of Buyer. Pursuant to the Merger
Agreement and upon consummation of the Merger, each outstanding share of
Common Stock of ASFC ("ASFC Common Stock") will be converted into the right to
receive $47.00 in cash without interest thereon. Consummation of the Merger is
subject to certain conditions, including, among others, (i) the approval by
certain state insurance regulators of the Merger and (ii) compliance with
applicable provisions of the Hart-Scott-Rodino Antitrust Improvements Act of
1976, as amended (the "HSR Act"). Early termination of the HSR Act waiting
period was received on July 15, 1997.
In connection with the Merger Agreement, LNC and Buyer entered into a
Voting, Support and Indemnification Agreement dated June 6, 1997 (the "Voting
Agreement"), certain sections of which were agreed to and acknowledged by ASFC.
Pursuant to the Voting Agreement, LNC agreed, among other things, (i) to vote
all ASFC Common Stock held by it or any of its subsidiaries in favor of the
Merger, the Merger Agreement and the transactions contemplated thereby, (ii) to
grant Buyer an irrevocable proxy in all ASFC Common Stock held by it or any of
its subsidiaries for purposes of a vote at a meeting of the holders of ASFC
Common Stock held to consider the Merger and (iii) to allocate between LNC and
Buyer certain tax and employee benefits liabilities; and Buyer agreed, among
other things, to pay to LNC (i) $100 million plus an amount equal to the
accrued but unpaid interest on the outstanding 7 1/8% notes due July 15, 1999,
originally issued to the public by LNC on July 15, 1992, in consideration of
the termination of the agreement relating to the Assumed Debt, and (ii) the
outstanding principle balance of, plus accrued but unpaid interest on, the Term
Note, in consideration of the surrender of the Term Note by LNC to ASFC for
cancellation.
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14
For further information regarding the Merger, see ASFC's Current Report on
Form 8-K filed with the Securities and Exchange Commission on June 17, 1997.
RESULTS OF OPERATIONS
The Company's revenues from operations are derived primarily from net
premiums earned on policies written by the Company, investment income and
realized gain on investments. Expenses consist primarily of payments for
claims incurred, claims adjustment expenses and underwriting expenses,
including agents' commissions and other operating expenses.
Significant factors influencing results of operations include the supply
and demand for property and casualty insurance and life insurance, as well as
the number and magnitude of catastrophe or natural peril losses, such as losses
caused by wind, hail, water (including freezing water) and earthquakes.
Although the property and casualty insurance industry has historically been
highly cyclical, management of the Company believes that variability within
each product line has become more pronounced than industry-wide cyclicality.
Premium rate levels are related to the availability of insurance coverage,
which varies according to, among other things, the level of surplus in the
industry. The level of surplus in the industry varies with returns on invested
capital and regulatory barriers to withdrawal of surplus. Surplus levels have
been relatively high in recent years due in part to the gains in the investment
portfolios of many insurers. Increases in surplus have generally been
accompanied by increased price competition among property and casualty
insurers. The industry's profitability can also be affected significantly by
fluctuations in interest rates and other changes in the investment environment
which affect market prices of insurance companies' investments and the income
from those investments, inflationary pressures that affect the size of losses
and judicial decisions affecting insurers' liabilities. The demand for
property and casualty insurance can also vary, generally rising as the overall
level of economic activity increases and falling as such activity decreases.
The Company seeks to manage its risk exposure by adjusting the mix and
volume of business written in response to changes in price and by balancing the
geographic distribution of its risks. Management believes that this strategy
accounts, in part, for loss ratios that are lower than the property and
casualty industry average.
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15
COMPARISON OF THE YEAR ENDED DECEMBER 31, 1996 TO THE YEAR ENDED DECEMBER 31,
1995
CONSOLIDATED
The Company's revenues decreased 2.1% or $41.6 million to $1,984.0 million
in 1996 from $2,025.6 million in 1995. Net premiums earned and other revenue
decreased 4.1% or $72.3 million to $1,674.1 million in 1996 from $1,746.4
million in 1995. Net investment income increased by $7.7 million, or 2.9%,
while realized gain on investments decreased by $5.5 million.
The Company's net income of $169.7 million for 1996 was down 4.8% from
$178.3 million for 1995. The provision for consolidated income taxes was $26.0
million in 1996 compared to $30.8 million in 1995.
PROPERTY AND CASUALTY
The following table sets forth certain summarized financial data and key
operating ratios for the Company's property and casualty operations for 1996
and 1995. All ratios are computed using data reported in accordance with SAP.
Year Ended December 31,
--------------------------
1996 1995
---- ----
(Dollars in Millions)
Net premiums written.................................................. $1,600.9 $1,671.6
Net premiums earned and other revenue................................. $1,617.2 $1,689.6
Losses and loss adjustment expense.................................... 1,199.9 1,193.7
Other costs and expenses.............................................. 505.4 552.8
-------- --------
Underwriting loss............................................ (88.1) (56.9)
Net investment income................................................. 238.2 233.8
Realized gain on investments.......................................... 34.2 38.8
Loss on operating properties.......................................... - 28.4
Income tax expense.................................................... 22.1 23.5
-------- --------
Net income................................................... $162.2 $163.8
======== ========
Loss ratio............................................................ 61.0% 59.3%
Loss adjustment expense ratio......................................... 13.6 11.8
Underwriting expense ratio............................................ 31.2 32.3
Policyholder dividend ratio........................................... .1 .2
Combined ratio............................................... 105.8% 103.6%
Percentage point effect of natural peril losses on loss ratio (1)..... 10.3 7.3
Percentage point effect of Realignment costs on combined ratio........ - 1.2
Underwriting results by source:
Net premiums written:
Commercial........................................................ $915.5 $991.6
Personal.......................................................... 684.5 681.1
Reinsurance in run-off............................................ .9 (1.1)
-------- --------
Total......................................................... $1,600.9 $1,671.6
Underwriting gain (loss) (1):
Commercial........................................................ $(1.5) $45.8
Personal.......................................................... (60.0) (32.8)
Reinsurance in run-off............................................ (26.6) (69.9)
-------- --------
Total......................................................... $(88.1) $(56.9)
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Year Ended December 31,
--------------------------
1996 1995
------------ ------------
Combined ratios (1):
Commercial............................................................ 100.4% 95.8%
Personal.............................................................. 109.3 104.8
Reinsurance in run-off................................................ N/A N/A
Total............................................................ 105.8 103.6
Percentage point effect of reinsurance in run-off on combined ratio....... 1.6 4.2
____________________
(1) Most expenses specifically relate to, and are identified to, lines of
business. Fixed expenses, including salaries and other operating
expenses, are allocated to lines of business based on cost and time
studies.
Net Premiums Written
Total reported net premiums written decreased by $70.7 million, or 4.2%,
to $1,600.9 million for 1996, from $1,671.6 million for 1995. This premium
decline was attributable to (i) lower volume from involuntary workers'
compensation (ii) the Company's planned reduction of exposure in California
and Florida and (iii) a decrease in premium related to a retrospectively rated
errors and omissions ("E&O") policy written on LNC.
Involuntary workers' compensation net premiums written, primarily from
state mandated pools and associations, decreased $40.1 million, to $3.5
million, in 1996. This decrease was due in large part to the continuing impact
of aggressive pricing and de-population programs implemented by most large
state workers' compensation pools over the last few years. Another
contributing factor was the decrease in the Company's share of the voluntary
workers' compensation market in several states in 1995. Voluntary market share
is a major component in the calculation of the volume of involuntary business
assumed in each state. A decrease in voluntary market share tends to decrease
the volume of involuntary business assumed. 1995 voluntary market share was
used in determination of 1996 involuntary assumed percentages. Finally,
reported premiums were negatively impacted by the re-estimation of premiums
receivable. Reporting from the National Council of Compensation Insurers
("NCCI"), which constitutes nearly 90% of total assumed involuntary workers'
compensation business, is two quarters in arrears, requiring the Company to
estimate premium for the most recent two quarters. Reported premiums from NCCI
declined dramatically in 1996, requiring a decrease in premiums receivable of
approximately $12.9 million.
The Company's continued planned reduction of exposure in California and
Florida, excluding all involuntary markets premium , decreased premiums $25.9
million, to $150.3 million, in 1996. While the Company plans continued risk
exposure reduction in these two states in 1997, the rate of premium reduction
should moderate from 1996 levels. This forward looking statement is based on
(i) the gradual and continuous net decrease of agencies under contract in these
markets in 1996 (ii) management's intention of achieving a continuing, yet much
smaller net reduction of agency appointments in these markets in 1997 (iii) a
continued de-emphasis of the sale of certain classes and lines of business in
these markets, and (iv) no current plans by management to introduce new
products or growth initiatives in these markets in 1997.
Finally, premiums on the retrospectively rated LNC E&O policy decreased
$15.1 million in 1996. Prior year premiums were unusually high due to the
settlement of a large casualty claim in 1995. The Company expects to record
approximately $1.5 to $2.0 million in net written premium on this policy in
1997. This forward looking statement assumes that the frequency and severity
of claim activity presented against this policy in 1997 will be consistent with
historic levels, adjusted for unusual and isolated claims.
Net premiums written for commercial lines products decreased by $76.1
million, or 7.7%, to $915.5 million for 1996, compared to $991.6 million for
1995. Net premiums written for personal lines products increased by $3.4
million, or .5%, to $684.5 million for 1996, compared to $681.1 million for
1995.
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17
Excluding the impacts of premium decreases caused by involuntary workers'
compensation, the Company's planned reduction of exposure in California and
Florida and the impacts of the E&O policy, net premiums written increased .3%
in 1996 to $1,440.2 million, from $1,435.3 million in 1995. Net premiums
written for commercial lines products decreased by $3.4 million, or .4%, to
$831.1 million for 1996, compared to $834.5 million for 1995. Net premiums
written for personal lines products increased by $8.4 million, or 1.4%, to
$609.1 million for 1996, compared to $600.7 million for 1995.
Net Premiums Earned and Other Revenue
Consistent with the decrease in net premiums written, net premiums earned
and other revenue (primarily finance and service fees) decreased by $72.4
million to $1,617.2 million for 1996, from $1,689.6 million for 1995.
Losses and Loss Adjustment Expense ("LAE")
Losses and LAE increased by $6.2 million to $1,199.9 million for 1996,
from $1,193.7 million for 1995. The SAP loss ratio for 1996 was 61.0% as
compared to 59.3% for 1995. The 1.7 percentage point increase in the loss
ratio in 1996 was the net result of several factors.
The SAP loss ratio was adversely affected by an increase of $43.5 million
in natural peril losses resulting from widespread severe winter storm activity
and frequent wind and hail storms across the Midwest, as well as a severe
Pacific Northwest winter storm in late December. Natural peril losses were
$165.6 million and $122.1 million for 1996 and 1995, respectively.
In addition, as discussed in the Business section under "Reserves for
Losses and Loss Adjustment Expenses", the Company experienced $45.7 million in
favorable prior year loss reserve development in 1996, an increase of $5.8
million when compared to favorable loss reserve development of $39.9 million in
1995. Of the total $45.7 favorable loss development in 1996, $71.9 million
was attributable to personal and commercial lines excluding reinsurance in
run-off, and ($26.2) million was attributable to the reinsurance operations.
Of the total $39.9 million favorable loss development in 1995, $109.2 was
attributable to personal and commercial lines excluding reinsurance in run-off,
and ($69.3) was attributable to the reinsurance operations.
Finally, as a result of continued price competition in the industry, the
SAP loss ratio for 1996 was adversely impacted by a slight deterioration in the
1996 accident year underlying loss ratio on most commercial and personal lines
of business. The underlying loss ratio is the total loss ratio less the impact
of (i) natural peril losses and (ii) development on prior accident year loss
reserves. The Company expects a continued slight deterioration in the 1997
accident year underlying loss ratio. This forward looking statement assumes
(i) a continuation of significant price competition in most lines of business
and (ii) no significant deviation from current underlying claim frequency or
severity trends in the 1997 accident year.
The SAP LAE ratio was 13.6% for 1996 compared to 11.8% for 1995. The
increase was primarily attributable to an increase in LAE reserves of
approximately $18.7 million compared to a $6.0 million decrease in 1995. This
LAE reserve increase was primarily driven by an increase in legal expense
reserves related to construction defect claims. As noted in the "Other Costs
and Expenses" section below, the SAP LAE ratio also benefited to a slight
degree from Realignment savings. Finally, earned premium decreased $68.6
million in 1996, creating upward pressure on the LAE ratio.
17
18
Other Costs and Expenses
Other costs and expenses decreased by $47.4 million, or 8.6%, to $505.4
million for 1996, from $552.8 million for 1995. This was the result of several
factors. The Company experienced a $16.7 million decrease, or 5.1%, in
variable expenses, primarily commission expense and premium taxes, due to a
4.2% decline in net written premium in 1996.
In November 1995, the Company approved a realignment plan which included
the consolidation of the field operations from 20 divisional offices into four
regional offices. Certain of the locations will be converted to service
offices. Those operating properties owned by the Company that will not be used
as a regional office will be sold. For each location to be downsized, job
classifications, positions to be eliminated and individuals impacted were
identified and severance benefits were communicated. This process was started
in 1995 with the majority of the Realignment occurring in 1996 and the balance
to be completed in 1997. Management estimated that the costs of realignment
and valuation allowance for the sale of the operating properties based on
independent appraisals with net carrying value representing the lower of cost
or market, net of taxes, approximated $13.7 million and $18.5 million,
respectively, and was charged to income in 1995; accordingly, net income
decreased $32.2 million.
During 1996, the Company sold 4 of the divisional offices. At December
31, 1995, the Company had estimated that it would incur approximately $21.0
million related to the various costs associated with the realignment plan and
had accrued such costs. Through December 31, 1996, approximately $14.0 million
of the accrued costs have been paid. Management believes the balance of $7.0
million is adequate to cover future expected payments.
Realignment related fixed expense savings totaled approximately $13.4
million in 1996; approximately 77% of these savings, or $10.3 million, are
attributable to Other Costs and Expenses, with the remaining 23%, or $3.1
million, reducing LAE expense. In addition, the Realignment, office closings
prior to the Realignment and an early retirement program added $21.9 million to
expenses in 1995.
The SAP underwriting expense ratio for 1996 was 31.2%, as compared to
32.3% for 1995. Realignment expense savings accounted for a reduction of
approximately .7% in the underwriting expense ratio in 1996. In 1995, the
Realignment, office closings prior to Realignment and early retirement
accounted for 1.3% of the underwriting expense ratio. Including the continuing
impact of Realignment related expense reduction measures undertaken in 1996,
coupled with planned 1997 expense reduction activities, the Company expects to
realize approximately $30 million in Realignment related expense savings in
1997, approximately 80% of which, or $24 million, will benefit the SAP
underwriting ratio. This forward looking statement assumes successful
completion of the Company's Realignment operational plan, including the closing
and consolidation of various division, service center and other offices around
the country into the Company's regional structure. The operational
implementation of this plan was nearly 75% complete as of year end 1996.
Combined Ratio
The SAP combined ratio, after policyholder dividends, was 105.8% in 1996,
versus 103.6% in 1995. After peaking at 112.5% in 1992, the Company's combined
ratio had decreased in 1993 through 1995, with an increase in 1996, due
primarily to natural peril losses. The reinsurance in run-off has a negative
impact of 1.6 percentage points on the Company's combined ratio in 1996, versus
4.2 percentage points in 1995.
Commercial Lines
Commercial lines results weakened in 1996, with the SAP combined ratio
increasing to 100.4% from 95.8% in 1995. The majority of this increase was due
to an increase in the LAE ratio, driven primarily by the aforementioned
increase in legal expense reserves related to construction defect claims.
Increased natural peril losses accounted for the remainder of deterioration in
the combined ratio.
18
19
Personal Lines
In 1996 the personal lines SAP combined ratio also increased to 109.3%,
from 104.8% in 1995, with all of the increase being attributable to the loss
ratio component. Natural peril losses accounted for approximately half of this
deterioration, with the most significant impact in the homeowners line of
business. Private passenger results also deteriorated due to price competition
and increased loss costs, primarily physical damage coverages.
Net Investment Income
Net investment income increased $4.4 million, or 1.9%, to $238.2 million
for 1996, from $233.8 million in 1995. This increase was due primarily to an
increased investment in taxable securities. The pre-tax yield on invested
assets (excluding realized and unrealized gains) was 6.6% for 1996, compared
with 6.3% in 1995. The increase in net investment income occurred despite a
decrease in average invested assets.
Realized Gain On Investments
Realized gain on investments was $34.2 million for 1996, compared to $38.8
million in 1995. This decrease was due primarily to the reduction in the
Company's investment in unaffiliated common stocks during 1995, many of which
were sold at a gain.
Loss On Operating Properties
In 1995, a $28.4 million provision was made to recognize the expected loss
on operating properties which the Company occupied and plans to dispose of in
connection with the Realignment.
Income Tax Expense
Federal income taxes decreased by $1.4 million to $22.1 million for 1996
from $23.5 million for 1995. The decrease in expense is due primarily to a
decline in underwriting results.
LIFE.
The following table sets forth certain summarized financial and key
operating data for the Company's life insurance operations for 1996 and 1995.
As of and for the Year
Ended December 31,
-----------------------
1996 1995
---- ----
(Dollars in Millions)
Account values - Universal life and Annuities.... $ 341.5 $ 315.5
Life insurance in-force.......................... 15,366.9 15,405.8
Invested assets (at amortized cost).............. 466.1 432.3
Policy income.................................... $ 56.9 $56.8
Benefits and expenses............................ 70.1 70.1
Net investment income............................ 34.0 32.8
Realized gain on investments..................... 1.2 2.3
Income tax expense............................... 7.6 7.3
--------- ---------
Net income................................. $ 14.4 $ 14.5
========= =========
Life insurance policy income was flat in 1996 compared to 1995. Account
values at December 31, 1996, increased by 8.2% from December 31, 1995 levels.
Net investment income increased by 3.7% during 1996, reflecting the growth in
account values as well as the general growth of invested assets. Net
investment income increased despite a decrease in the average pre-tax yield
from 7.7% in 1995 to 7.5% in 1996. Realized gain on investments decreased $1.1
million to $1.2 million primarily as a result of 1995 sales of securities to
take advantage of market opportunities. Net income declined slightly to $14.4
million compared to $14.5 million in 1995.
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COMPARISON OF THE YEAR ENDED DECEMBER 31, 1995 TO THE YEAR ENDED DECEMBER 31,
1994
CONSOLIDATED.
The Company's revenues for 1995 aggregated $2,025.6 million, virtually
unchanged from its 1994 revenues which totaled $2,026.4 million. Net premiums
earned and other revenue of $1,746.4 million for 1995 slightly exceeded the
$1,746.0 million recorded in 1994. Net investment income increased by $6.1
million, or 2.3%, while realized gain on investments increased by $21.1
million.
The Company's net income of $178.3 million for 1995 was down 3.4% from
$184.6 million for 1994. The cost relating to Realignment, which aggregated
$49.5 million, resulted in the decrease in net income despite significant
improved underwriting results. Realized gain on investments increased $21.1
million to $41.0 million in 1995 compared to $19.9 million in 1994. The
provision for consolidated income taxes was $30.8 million in 1995 compared to
$15.7 million in 1994. This increase was due to improved underwriting results
and a greater proportion of taxable investment income.
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PROPERTY AND CASUALTY.
The following table sets forth certain summarized financial data and key
operating ratios for the Company's property and casualty operations for 1995
and 1994. All ratios are computed using data reported in accordance with SAP.
Year Ended December 31,
--------------------------
1995 1994
---- ----
(Dollars in Millions)
Net premiums written.......................................................... $1,671.6 $1,655.5
Net premiums earned and other revenue......................................... $1,689.6 $1,693.5
Losses and loss adjustment expense............................................ 1,193.7 1,226.2
Other costs and expenses...................................................... 552.8 536.3
-------- --------
Underwriting loss.................................................... (56.9) (69.0)
Net investment income......................................................... 233.8 230.9
Realized gain on investments.................................................. 38.8 19.2
Loss on operating properties.................................................. 28.4 -
Income tax expense............................................................ 23.5 9.4
-------- --------
Net income........................................................... $163.8 $171.7
======== ========
Loss ratio.................................................................... 59.3% 61.1%
Loss adjustment expense ratio................................................. 11.8 11.8
Underwriting expense ratio.................................................... 32.3 31.6
Policyholder dividend ratio................................................... .2 .1
Combined ratio....................................................... 103.6% 104.6%
Percentage point effect of natural peril losses on loss ratio ................ 7.3 8.4
Percentage point effect of Realignment costs on combined ratio................ 1.2 -
Underwriting results by source:
Net premiums written:
Commercial................................................................ $991.6 $985.1
Personal.................................................................. 681.1 668.3
Reinsurance in run-off.................................................... (1.1) 2.1
-------- --------
Total................................................................ $1,671.6 $1,655.5
Underwriting gain (loss) (1):
Commercial................................................................ $45.8 $4.5
Personal.................................................................. (32.8) (49.7)
Reinsurance in run-off.................................................... (69.9) (23.8)
-------- --------
Total................................................................ $ (56.9) $(69.0)
Combined ratios (1):
Commercial................................................................ 95.8% 100.1%
Personal.................................................................. 104.8 107.8
Reinsurance in run-off.................................................... N/A N/A
Total................................................................ 103.6 104.6
Percentage point effect of reinsurance in run-off on combined ratio........... 4.2 1.4
____________________
(1) Most expenses specifically relate to, and are identified to, lines of
business. Fixed expenses, including salaries and other operating
expenses, are allocated to lines of business based on cost and time
studies.
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Net Premiums Written
Net premiums written increased by $16.1 million, or 1.0%, to $1,671.6
million for 1995, from $1,655.5 million for 1994. This growth was largely
attributable to an increase in premiums written on private passenger automobile
and businessowners policies designed specifically for owners of small business.
Net premiums written for commercial lines products increased by $6.5 million,
or .7%, to $991.6 million for 1995, compared to $985.1 million for 1994. Net
premiums written for personal lines products increased by $12.8 million, or
1.9%, to $681.1 for 1995, compared to $668.3 million for 1994. For the states
of Illinois, Indiana, Kansas, Michigan, Missouri, Ohio, Oregon and Washington,
which comprise the most significant part of the Company's target market, direct
premiums written increased by 3.6% in 1995, while for the states of California
and Florida, where the Company has been reducing its exposure due to
unfavorable results, direct premiums written decreased by 6.5%. For all other
states, 1995 direct premiums written were virtually unchanged from 1994.
Net Premiums Earned and Other Revenue
Net premiums earned and other revenue (primarily finance and service fees)
decreased by $3.9 million to $1,689.6 million for 1995, from $1,693.5 million
for 1994.
Losses and Loss Adjustment Expense
Losses and LAE decreased by $32.5 million to $1,193.7 million for 1995,
from $1,226.2 million for 1994. The SAP loss ratio for 1995 was 59.3% as
compared to 61.1% for 1994. The 1.8 percentage point decline in the loss ratio
in 1995 was due primarily to the continuing benefit from the New Directions
strategy implemented in late 1991. The Company's results of operations
benefited materially in 1995 and 1994, as a result of reductions in the
estimated amounts needed to settle prior years' claims, with such benefit being
most significant in 1994. The overall favorable reserve development in both
1995 and 1994 was the result of improving trends, both industry-wide and
related to the Company's New Directions initiatives, as well as enhancements
made in the claim evaluation process.
For 1995, natural peril losses were $122.1 million versus $140.5 million
for 1994. During the spring months of 1995, the Company experienced a
relatively high frequency of wind and hail losses. Hurricane Opal, which
struck the Florida panhandle in October, 1995, resulted in approximately $15.0
million of losses to the Company in Florida and other southeastern states.
Natural peril losses in 1994 were largely due to a severe winter freeze and the
Northridge, California earthquake. Gross losses from Northridge were $32.4
million; $31.1 million net of reinsurance recoveries. Additional incurred
losses from the earthquake of $2.6 million were recorded in 1995.
The SAP LAE ratio was 11.8% for 1995, the same as in 1994. While the
Company's SAP loss ratio decreased due to New Directions and other initiatives,
the impact on the Company's LAE ratio has been less evident, due partially to
increases in legal expense reserves relating to environmental claims. In 1995,
the LAE ratio was favorably impacted by approximately $10.7 million of LAE
reserve release due to positive development of prior accident years.
Offsetting this, some unusual items increased expense in 1995. In the first
quarter of 1995, the Company announced an early retirement plan for certain
levels of management and the closing of two division offices and a service
office; the second quarter of 1995 included the costs of settling a lawsuit and
the fourth quarter included the costs of Realignment. These unusual items
added $9.5 million of LAE-related expense during 1995.
Other Costs and Expenses
Other costs and expenses increased by $16.5 million, or 3.1%, to $552.8
million for 1995, from $536.3 million for 1994. The SAP underwriting expense
ratio for 1995 was 32.3%, as compared to 31.6% for 1994. The Realignment,
office closings prior to the Realignment and early retirement added $21.9
million to expenses and accounted for 1.3% of the underwriting expense ratio
for 1995.
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Combined Ratio
The SAP combined ratio, after policyholder dividends, was 103.6% in 1995,
versus 104.6% in 1994. After peaking at 112.5% in 1992, the Company's combined
ratio has decreased each of the last three years. Both commercial and personal
lines reflected improvement due to lower natural peril losses, the continued
favorable impact of New Directions and the release of losses and LAE reserves
related to prior accident years. The reinsurance in run-off has a negative
impact of 4.2 percentage points on the Company's combined ratio in 1995, versus
1.4 percentage points in 1994.
Commercial Lines
Commercial lines results were substantially improved in 1995, with the SAP
combined ratio decreasing to 95.8% from 100.1% in 1994. Improved results, as
reflected by the loss ratio, were broad based across most commercial lines.
The key lines of BOPs, commercial multi-peril, commercial auto and workers'
compensation all improved.
Personal Lines
The personal lines SAP combined ratio also improved in 1995, decreasing to
104.8% from 107.8% in 1994. Improvement, as reflected by the loss ratio, was
evident in both personal automobile and homeowners.
Net Investment Income
Net investment income increased $2.9 million, or 1.2%, to $233.8 million
for 1995, from $230.9 million in 1994. This increase was due primarily to an
increase in higher yielding securities, a reduction in unaffiliated common
stock holdings and subsequent reinvestment of proceeds in an unconsolidated
subsidiary, EMPHESYS Financial Group, Inc. The pre-tax yield on invested
assets (excluding realized and unrealized gains) was 6.3% for 1995, compared
with 6.2% in 1994.
Realized Gain On Investments
Realized gain on investments was $38.8 million for 1995, compared to $19.2
million in 1994. This increase was due to the reduction in the Company's
investment in unaffiliated common stocks, many of which were sold at a gain.
Loss On Operating Properties
In 1995, a $28.4 million provision was made to recognize the expected loss
on operating properties which the Company now occupies and plans to dispose of
in connection with the Realignment.
Income Tax Expense
Federal income taxes increased by $14.1 million to $23.5 million for 1995
from $9.4 million for 1994. The increase was due primarily to improved
underwriting results and net investment income which reflected an investment
portfolio containing a higher proportion of taxable securities.
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LIFE.
The following table sets forth certain summarized financial and key
operating data for the Company's life insurance operations for 1995 and 1994.
As of and for the Year
Ended December 31,
------------------------
1995 1994
---- ----
(Dollars in Millions)
Account values - Universal life and Annuities............. $ 315.5 $ 285.7
Life insurance in-force................................... 15,405.8 14,743.0
Invested assets (at amortized cost)....................... 432.3 412.3
Policy income............................................. $56.8 $ 52.5
Benefits and expenses..................................... 70.1 63.6
Net investment income..................................... 32.8 29.6
Realized gain on investments.............................. 2.3 .7
Income tax expense........................................ 7.3 6.3
--------- ---------
Net income.......................................... $ 14.5 $ 12.9
========= =========
Life insurance reflects steady growth in policy income, which increased by
8.2% for 1995, compared to 1994. Sales of life insurance, primarily universal
life products, were strong. Account values at December 31, 1995, increased by
10.4% from December 31, 1994 levels. Net investment income increased by 10.8%
during 1995, reflecting the growth in account values as well as the general
growth of invested assets. Realized gain on investments increased $1.6 million
to $2.3 million primarily as a result of sales of securities to take advantage
of market opportunities. Net income increased by 12.4 % to $14.5 million in
1995, compared to 1994.
FINANCIAL CONDITION AND LIQUIDITY
The primary sources of funds available to the Company are premiums,
investment income and proceeds from the sale or maturity of invested assets.
Such funds are used principally for the payment of claims, operating expenses,
commissions, dividends, debt service and the purchase of investments. Cash
outflows can be variable because of uncertainties regarding settlement dates
for liabilities for unpaid losses and because of the potential for large losses
either individually or in the aggregate. Accordingly, the Company maintains
investment programs generally intended to provide adequate funds to pay claims
without the forced sale of investments. Finally, as noted below, the Company
has a $200 million revolving credit agreement, and intends to establish a
medium-term note program, to augment its available liquidity. Based upon a
quarterly dividend of $.21 per share and the terms of the Assumed Debt, Term
Note and Line of Credit, Company management believes the Company has adequate
liquidity and resources to meet its obligations.
CASH PROVIDED BY OPERATIONS
Net cash provided by operating activities of the Company was $45.4
million, $107.9 million and $73.8 million for 1996, 1995 and 1994,
respectively. The decrease in cash provided by operating activities for 1996
compared to 1995 is primarily due to a decrease in premiums collected. The
decrease in collected premiums was driven by (i) a $70.7 million decrease in
net premiums written and (ii) a $35.6 million increase in premium receivable,
which was largely the result of the Company allowing more of its customer base
to pay its premium on a monthly basis in 1996. The decrease in premiums
collected was offset in part by a decrease in claims and operating expenses
paid. The increase for 1995 compared to 1994 was primarily due to a decrease
in the level of paid losses and LAE relative to the amount of
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25
premiums collected for the period. Operating cash flows in each of the last
three years have been more than adequate to meet the liquidity requirements of
the Company.
INVESTED ASSETS
Since a substantial portion of the Company's revenues are generated from
its invested assets, the performance, quality and liquidity of its investment
portfolio materially effects the Company's financial condition and results of
operations. The Company pursues a total return investment strategy which seeks
an attractive level of current income combined with long-term capital
appreciation. The following table details, at carrying value, the distribution
of the Company's investment portfolio at December 31, 1996 (dollars in
millions):
Fixed maturity securities:
Tax-exempt municipal $2,096.1 48.3%
US government 195.8 4.5
Mortgage-backed and asset-backed 300.8 6.9
Corporate and other 1,093.9 25.2
Redeemable preferred stock 77.3 1.8
Equities:
Perpetual preferred stock 192.0 4.4
Common stock 243.1 5.6
Mortgage loans 32.3 .7
Short-term investments 73.3 1.7
Other 38.0 .9
-------- ------
Total $4,342.6 100.0%
======== ======
The total investment portfolio decreased $87.7 million in 1996. This
decrease is the net result of (i) the distribution of the Dividended Assets to
LNC, (ii) a decrease in unrealized gains on securities available-for-sale and
(iii) offset by an increase in invested assets from the proceeds of the
issuance of Common Stock to the public.
The Company attempts to minimize the risk of loss due to default by the
borrower by maintaining a quality investment portfolio. As of December 31,
1996, approximately 89% of the Company's bond portfolio was rated "A" or
higher, or was a U.S. government obligation, and only $24.4 million, or .7% of
the carrying value of the bond portfolio, was rated below investment grade (Ba
and below). Ratings are based on the ratings, if any, assigned by Moody's
and/or Standard & Poors. If ratings were split, the rating used is generally
the higher of the two. Approximately $241.5 million of securities are private
placements for which ratings have been assigned by the Company based generally
on equivalent ratings supplied by the National Association of Insurance
Commissioners.
As of December 31, 1996, 48.3% of the Company's investment portfolio
consisted of tax-exempt municipal securities as compared to 53.6% as of
December 31, 1995. The Company has reduced its position in tax-exempt
municipal securities in order to provide for greater diversification of the
portfolio and to give the Company greater margin relative to the possibility of
being in a federal alternative minimum tax position.
The Company's fixed maturity securities are classified as
available-for-sale and accordingly, are carried at fair value. The difference
between amortized cost and fair value, less deferred income taxes, is reflected
as a component of shareholders' equity.
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CAPITALIZATION
The following table summarizes the Company's capitalization at the end of
the last three years (dollars in millions):
December 31,
----------------------------
1996 1995 1994
---- ---- ----
Debt.................................................................. $ 299.5 $ - $ -
Shareholders' equity:
Common stock and retained earnings................................ $1,172.4 $1,456.9 $1,477.7
Net unrealized gain (loss) on securities available-for-sale.... 163.6 211.8 (9.1)
-------- -------- --------
Total shareholders' equity................................... 1,336.0 1,668.7 1,468.6
-------- -------- --------
Total capitalization...................................... $1,635.5 $1,668.7 $1,468.6
======== ======== ========
Ratio of debt to total capitalization ............................... 18% n/a n/a
On February 5, 1996, the Company was incorporated in the State of Indiana
to serve as the holding company for ASI. The formation of the Company was done
in contemplation of an initial public offering. On April 22, 1996, ASI
declared, and on May 15, 1996, it distributed to its parent, LNC, the $300
million Dividended Assets. On May 16, 1996, LNC transferred all of the
outstanding shares of ASI to the Company in exchange for 50,000,000 shares of
the Company's Common Stock. Concurrently with the transfer of the ASI stock,
the Company assumed $100 million of LNC debt ("Assumed Debt") and issued a $200
million note to LNC (the "Term Note"). On May 29, 1996, the Company issued
10,000,000 shares of Common Stock at $23 per share to the public (the
"Offering").
The net proceeds from the Offering (after deduction of underwriting
discounts and offering expenses) were $215.2 million. The Company contributed
$140.5 million of such net proceeds to ASI to enable it to invest in taxable
securities for its investment portfolio to partially replace the Dividended
Assets. The remainder of the net proceeds were retained by the Company for
general corporate purposes. As a result of the Offering, LNC's ownership was
reduced to approximately 83%. The Company retained $74.7 million of the net
proceeds from the Offering for general corporate purposes, including the
funding of its regular cash dividends, debt service obligations and other
general corporate obligations. Until utilized for such purposes, the net
proceeds from the Offering not contributed to ASI is invested and will continue
to be invested in short-term, interest bearing, investment-grade securities.
SUBSIDIARY DIVIDEND RESTRICTIONS
Historically, ASI has paid dividends to LNC, as its parent, based upon its
annual operating results and statutory surplus requirements. ASI paid cash
dividends to LNC of $46.1 million, $244.0 million and $215.0 million in 1996,
1995 and 1994 respectively. After taking into account the one-time
distribution of the Dividended Assets paid by ASI to LNC, ASI will not be able
to pay any additional dividends to the Company until May 15, 1997 without
notifying the Indiana Commissioner of Insurance and giving the Commissioner 30
days to object. Regulatory restrictions on the ability of ASI to pay dividends
or make other payments to the Company could affect the Company's ability to pay
dividends and service its debt.
NOTES PAYABLE AND DEBT WITH LNC
The Assumed Debt is governed by an agreement between the Company and LNC
(the "Assumption Agreement") which provides for the payment by the Company of
the currently outstanding 7 1/8% notes due July 15, 1999, originally issued to
the public by LNC on July 15, 1992. The Assumption Agreement also provides that
interest at 7 1/8% is payable semi-annually by the Company.
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The Term Note pays interest quarterly at a rate of 50 basis points over
the rate on three year Treasury Notes from the effective date through and
including November 14, 1997, 50 basis points over the rate on two year Treasury
Notes from November 15, 1997 through and including November 14, 1998 and 50
basis points over the rate on one-year Treasury Bills from November 15, 1998
through the maturity date. The current rate on the Term Note is approximately
6.7%. The Term Note will be payable in three equal principal payments of $66.7
million due on August 15, 1997, 1998 and 1999. Pursuant to the provisions on
the Term Note, the Company has the right to prepay the Term Note at any time.
The Term Note also contains covenants that, among other things, (i) requires
the Company to maintain certain levels of adjusted consolidated net worth (as
defined in the Term Note), and (ii) restricts the ability of the Company to
incur indebtedness in excess of 50% of its adjusted consolidated net worth and
to enter into a major corporate transaction unless the Company is the survivor
and would not be in default.
The Company incurred $12.4 million in interest expense on the foregoing
debt in 1996.
LINE OF CREDIT
On May 29, 1996, the Company entered into a revolving credit agreement
with third party financial institutions in which the Company may borrow and
repay amounts up to a maximum of $200 million (the "Line of Credit").
Borrowings using the Line of Credit will bear interest generally at variable
rates tied to LIBOR, an adjusted certificate of deposit rate or other
short-term indices. No debt was outstanding using the Line of Credit at
December 31, 1996.
MEDIUM TERM NOTE PROGRAM
For additional liquidity, the Company intends to establish a medium-term
note program (the "MTN Program") within the next year. The MTN Program, if
established, would enable the Company to issue debt from time to time for
general corporate purposes.
INFLATION
The effects of inflation on the Company are implicitly considered in
estimating reserves for unpaid losses and LAE, and in the premium rate-making
process. The actual effects of inflation on the Company's results of
operations cannot be accurately known until the ultimate settlement of claims.
However, based upon the actual results reported to date, it is management's
opinion that the Company's loss reserves, including reserves for losses that
have been incurred but not yet reported, make adequate provision for the
effects of inflation.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
AMERICAN STATES FINANCIAL CORPORATION
(Registrant)
Date: August 11,1997 /s/ Thomas M. Ober
----------------------------
(Signature)
Thomas M. Ober, Secretary
28