1
ANNUAL REPORT ON FORM 10-K
Item 14 (c) - Exhibits
and
Item 14 (d) - Financial Statement Schedules
Year Ended December 31, 1997
McM CORPORATION AND SUBSIDIARIES
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SCHEDULE 1 -- SUMMARY OF INVESTMENTS
McM CORPORATION AND SUBSIDIARIES
December 31, 1997
AMOUNT
SHOWN ON
MARKET BALANCE
TYPE OF INVESTMENT COST VALUE SHEET
------------------ ---- ------ --------
(Thousands of dollars)
Fixed Maturity Secutities Available-for-Sale
Bonds
Mortgage-backed securities $ 2,572 $ 1,945 $ 1,945
U.S. Government, government
agencies and authorities 22,714 22,874 22,874
Public utilities and other bonds 469 465 465
------- ------- -------
Total Fixed Maturities Available-for-Sale 25,755 25,284 25,284
Short-term investments 21,522 21,522 21,522
------- ------- -------
Total Securities Available-for-Sale 47,277 46,806 46,806
Held-to-Maturity
U.S. Government, government
agencies and authorities 2,940 3,013 2,940
States, municipalities and political
subdivisions 194 222 194
------- ------- -------
Total Securities Held-to-Maturity 3,134 3,235 3,134
------- ------- -------
Total Investments $50,411 $50,041 $49,940
======= ======= =======
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SCHEDULE 2 - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
BALANCE SHEETS
McM CORPORATON (PARENT COMPANY)
(Thousands of dollars)
December 31
1997 1996
---- ----
ASSETS
Short term investments 35 30
Cash 108 107
Other assets 99 80
-------- --------
242 217
Investments in wholly-owned subsidiaries
at equity * 15,331 24,005
-------- --------
TOTAL ASSETS $ 15,573 $ 24,222
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Accrued expenses $ 1,619 $ 1,562
Income taxes payable to wholly-owned subsidiaries * 387 387
Payable to wholly-owned subsidiaries * 799 618
-------- --------
TOTAL LIABILITIES 2,805 2,567
Shareholders' Equity:
Common stock 4,696 4,678
Additional paid-in capital 1,530 1,489
Unrealized loss on securities available-for-sale,
including unrealized (loss) gain on securities
held by subsidiaries: 1997 - ($471); 1996 - $78 (471) (65)
Retained earnings 7,013 15,553
-------- --------
TOTAL SHAREHOLDERS' EQUITY 12,768 21,655
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 15,573 $ 24,222
======== ========
* Eliminated in consolidation
See notes to condensed financial information.
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SCHEDULE 2 - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF OPERATIONS
McM CORPORATON (PARENT COMPANY)
(Thousands of dollars)
Year Ended December 31
1997 1996 1995
---- ---- ----
INCOME
Administrative charges to subsidiaries * - Note B $ 650 $ 650 $ 650
Realized investment income (135) 8 5
------- ----- -------
515 658 655
General and administrative expenses 932 893 680
------- ----- -------
LOSSES BEFORE TAXES
AND EQUITY IN UNDISTRIBUTED
(LOSS) INCOME OF SUBSIDIARIES (416) (235) (25)
Income taxes (benefits) 0 (140) 8
------- ----- -------
LOSS BEFORE EQUITY IN UNDISTRIBUTED
(LOSS) INCOME OF SUBSIDIARIES (416) (95) (33)
Equity in undistributed (loss) income of subsidiaries (8,124) (693) 2,243
------- ----- -------
NET (LOSS) INCOME ($8,540) ($788) $ 2,210
======= ===== =======
* Eliminated in consolidation.
See notes to condensed financial information.
23
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SCHEDULE 2 - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF CASH FLOWS
McM CORPORATON (PARENT COMPANY)
(Thousands of dollars)
Year Ended December 31
1997 1996 1995
------- ----- -------
OPERATING ACTIVITIES
Net (Loss) Income ($8,540) ($788) $ 2,210
Adjustments to reconcile net (loss) income to net cash
(used by) provided by operating activities:
Depreciation 1 4 4
Equity in loss (income) of subsidiaries 8,124 693 (2,243)
Other assets (19) 33 (7)
Other liabilities 57 53 (72)
Income taxes payable to wholly-owned subsidiaries 0 182 126
Payables to wholly-owned subsidiaries 181 69 6
Permanent decrease in market value of fixed maturity 143 0 0
------- ----- -------
CASH (USED BY) PROVIDED BY OPERATING ACTIVITIES (53) 246 24
INVESTING ACTIVITIES
Disposals of fixed maturities 0 57 0
Increase in short-term investments (5) (30) 0
------- ----- -------
CASH (USED) PROVIDED BY INVESTING ACTIVITIES (5) 27 0
FINANCING ACTIVITIES
Employee stock purchases 59 15 0
Cash dividends paid 0 (282) 0
------- ----- -------
CASH PROVIDED (USED) BY FINANCING ACTIVITIES 59 (267) 0
------- ----- -------
INCREASE IN CASH $ 1 $ 6 $ 24
======= ===== =======
See notes to condensed financial information.
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SCHEDULE 2 -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT
NOTES TO CONDENSED FINANCIAL INFORMATION
McM CORPORATION (PARENT COMPANY)
The accompanying condensed financial information should be read in conjunction
with the consolidated financial statements and notes thereto of McM Corporation
and Subsidiaries.
NOTE A -- Significant Accounting Policies
In the parent company financial statements, the Company's investments
in wholly-owned subsidiaries are stated at cost plus equity in undistributed
earnings of the subsidiaries. McM is actively engaged through certain of its
subsidiaries in the property and casualty insurance business.
NOTE B -- Administrative Charges
McM is compensated by its subsidiaries in the form of management fees
for providing management support, planning assistance, financial reporting and
investment services.
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SCHEDULE 3 - REINSURANCE
McM CORPORATION AND SUBSIDIARIES
Year Ended December 31, 1997, 1996, and 1995
Premiums Earned
------------------------------------------------------------------
Percentage
Ceded to Assumed of Amount
Direct Other From Other Net Assumed
(Thousands of dollars) Amount Companies Parties Amount to Net
--------------- ---------------- ---------------- -------------- ----------------
YEAR ENDED DECEMBER 31, 1997 $65,205 $20,071 $10,573 $55,707 18.98%
=============== ================ ================ ==============
YEAR ENDED DECEMBER 31, 1996 $63,163 $21,714 $10,405 $51,854 20.07%
=============== ================ ================ ==============
YEAR ENDED DECEMBER 31, 1995 $63,731 $23,901 $ 5,871 $45,701 12.85%
=============== ================ ================ ==============
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SCHEDULE 4 - VALUATION AND QUALIFYING ACCOUNTS
McM CORPORATION AND SUBSIDIARIES
(Thousands of dollars)
ADDITIONS
--------------------------
(1) (2)
Charged to Charged to
Balance at (Recovery of) Other
Beginning Costs and Accounts- Deductions- Balance at End
DESCRIPTION of Period Expenses Describe Describe of Period
---------- ------------- ---------- ----------- --------------
YEAR ENDED DECEMBER 31, 1997
Deducted from asset account:
Allowance for uncollectible accounts $ 345 $ 0 $0 $ 0 $ 345
====== ===== == ==== ======
Included as liability account:
Allowance for bad debts on liquidated reinsurers $ 158 $ 402 $0 $802 (1) ($ 242)
====== ===== == ==== ======
YEAR ENDED DECEMBER 31, 1996
Deducted from asset account:
Allowance for uncollectible accounts $ 345 $ 0 $0 $ 0 $ 345
====== ===== == ==== ======
Included as liability account:
Allowance for bad debts on liquidated reinsurers $1,060 ($150) $0 $752 (1) $ 158
====== ===== == ==== ======
YEAR ENDED DECEMBER 31, 1995
Deducted from asset accounts:
Allowance for uncollectible accounts $ 315 $ 30 $0 $ 0 $ 345
====== ===== == ==== ======
Included as liability account:
Allowance for bad debts on liquidated reinsurers $1,349 $ 103 $0 $392 (1) $1,060
====== ===== == ==== ======
(1) Write-off of paid recoverable balances for insolvent/liquidated reinsurers
against provision established.
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SCHEDULE 5 - SUPPLEMENTAL INSURANCE INFORMATION
PROPERTY/CASUALTY INSURANCE SUBSIDIARIES
YEAR ENDED DECEMBER 31, 1997, 1996 AND 1995
(Thousands of dollars)
RESERVES FOR
DEFERRED UNPAID CLAIMS DISCOUNT
POLICY AND CLAIM IF ANY
ACQUISITION ADJUSTMENT DEDUCTED IN UNEARNED EARNED INVESTMENT
COSTS EXPENSES RESERVES PREMIUMS PREMIUMS INCOME
------------------- ------------------ --------------- ------------ ---------- -------------
YEAR ENDED DECEMBER 31:
Net of Reinsurance
1997 $2,802 $29,159 -- $ 9,363 $55,707 $2,977
1996 3,992 26,532 -- 13,857 51,854 3,151
1995 3,343 29,997 -- 12,291 45,701 3,492
Gross of Reinsurance
1997 $2,802 $57,283 -- $15,676 $75,778 $2,977
1996 3,992 55,300 -- 17,925 73,568 3,151
1995 3,343 66,152 -- 17,234 69,602 3,492
CLAIMS AND CLAIM
ADJUSTMENT EXPENSES
INCURRED RELATED TO AMORTIZATION
------------------------------------------- OF DEFERRED PAID CLAIMS
(1) (2) POLICY AND CLAIM
CURRENT PRIOR ACQUISITION ADJUSTMENT PREMIUMS
YEAR YEAR COSTS EXPENSES WRITTEN
--------------------- --------------------- --------------------- --------------------- --------
Net of Reinsurance
1997 $42,243 $ 5,774 $10,332 $45,390 $51,214
1996 37,651 1,559 9,116 42,675 53,420
1995 31,282 (248) 7,141 39,452 46,663
Gross of Reinsurance
1997 $54,266 $ 8,616 $10,332 $62,633 $73,529
1996 52,711 (930) 9,116 62,633 74,259
1995 45,395 660 7,141 71,403 72,025
28
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McM CORPORATION
1997 ANNUAL REPORT
29
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Corporate Mission and Profile
Mission
To market specialized insurance products within well defined
market areas at competitive prices and with exceptional service to
deliver better than average returns on investor capital.
Profile
McM Corporation is an insurance holding company headquartered in
Raleigh, North Carolina, which owns these major operating
subsidiary corporations:
Occidental Fire & Casualty Company of North Carolina ("OF&C")
Raleigh, North Carolina
Wilshire Insurance Company ("Wilshire")
Raleigh, North Carolina
Contents
- --------------------------------------------------------------------------------
IFC Corporate Mission and Profile
Consolidated Financial Highlights
Common Stock
Report to Shareholders
Market Overview
Management's Discussion and Analysis of Financial Condition
and Results of Operations
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Shareholders' Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Report of Independent Auditors
Summary of Quarterly Results of Operations
Officers and Directors
Corporate Information
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SELECTED FINANCIAL DATA
- ------------------------------------------------------------------------------------------------------------------
McM CORPORATION AND SUBSIDIARIES 1997 1996 1995 1994 1993
- ------------------------------------------------------------------------------------------------------------------
(Thousands of dollars, except per share data)
Assets $ 104,140 $ 112,870 $126,568 $137,665 $ 158,984
Liabilities 91,372 91,215 103,328 117,258 139,262
Retained earnings 7,013 15,553 16,623 14,413 13,059
Shareholders' equity 12,768 21,655 23,240 20,407 19,722
Net premiums earned 55,707 51,854 45,701 41,126 51,043
Net investment income 2,985 3,159 3,497 3,684 5,298
Realized investment gains 196 40 123 122 1,797
Total revenue 59,537 55,698 49,571 45,304 58,293
Net (loss) income (8,540) (788) 2,210 1,354 (295)
Per share data:
Shareholders' equity $ 2.72 $ 4.63 $ 4.97 $ 4.37 $ 4.22
Net (loss) income (1.82) (0.17) 0.47 0.29 (0.06)
Net (loss) income - assuming dilution (1.82) (0.17) 0.47 0.29 (0.06)
Cash dividends 0.00 0.06 0.00 0.00 0.00
Common Stock
- ------------------------------------------------------------------------------
McM Corporation Common Stock is traded over-the-counter securities
market, under the NASDAQ symbol, McMc.
The number of record shareholders of McM Corporation is 858 as of
December 31, 1997.
The table below sets forth by quarters, for the years 1997 and 1996,
the range of the high and low bid prices of McM Corporation's Common
Stock as reported in The Wall Street Journal. No dividends were
declared or paid during 1997. Dividends of $.02 per share were paid for
the second, third, and fourth quarters of 1996. See Management's
Disussion and Analysis and Note B to the consolidated financial
statements for information regarding restrictions on the ability of
McM's subsidiaries to transfer funds to McM and discussion regarding
nonpayment of dividends.
1997 1996
High Low High Low
---------------------------------------------------------------------
First Quarter $4 5/8 $3 7/8 $4 3/4 $3 1/2
Second Quarter 3 7/8 3 1/8 6 1/8 5 1/2
Third Quarter 3 3/8 2 7/8 5 7/8 5 1/4
Fourth Quarter 3 1/4 2 1/8 5 3/4 5 1/4
---------------------------------------------------------------------
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REPORT TO SHAREHOLDERS
McM Corporation's results for the year 1997 showed a net loss of
$8,540,000. This loss is primarily the result of a significant increase in
overall loss reserves during the latter part of 1997. The increase in overall
loss reserve levels resulted from the deterioration in the commercial and
private passenger automobile liability lines of business, particularly for the
1995 and 1996 accident years and increased claim costs in the current
underwriting year for commercial and private passenger automobile physical
damage coverages.
The Company, after a comprehensive actuarial analysis of loss trends
and projections at year end which confirmed this deterioration, increased prior
year loss reserves for ongoing lines of business by approximately $5.1 million
during 1997. As a result of these unfavorable loss trends, it was necessary to
also increase loss reserves for the current accident year.
As underwriting results for the 1995 and 1996 underwriting years
deteriorated, the Company undertook an extensive review of its operations. As a
result of this review management was able to isolate specific areas which were
identified as being primary contributors to the property and casualty companies'
performance decline. Significant strengthening of underwriting controls,
increases in rate levels and a complete re-underwriting of a specific segment of
the commercial automobile business was undertaken in mid 1997. Management
believes that the reserve increases taken in 1997 were prudent and is confident
in its course of action.
The specific causes of the unfavorable results for 1997 have been
identified and remedial actions are being taken to correct these problem areas.
The actions taken to date have not yet had time to run their complete course,
however, early indications show the desired positive impact.
Consolidated gross revenues for the year 1997 were $59,950,000 compared
to $56,155,000 for the same period in 1996. This increase in consolidated
revenues reflects growth in private passenger automobile premium writings and a
reduction in premiums ceded to the Company's reinsurers. Commercial automobile
writings, which have shown declines over the last three years, reflect market
conditions which continue to be highly competitive and price sensitive. The
Company continues to utilize highly regarded and financially sound reinsurers
which specialize in commercial and private passenger automobile coverages in its
reinsurance program. Included in consolidated gross revenues for the year 1997
was gross investment income of $3,398,000 compared to $3,616,000 for the year
1996. In addition, realized investment gains of $196,000 and $40,000 were
included in consolidated gross revenues for the years 1997 and 1996,
respectively.
Consolidated assets at December 31, 1997, totalled $104,140,000
compared to $112,870,000 at December 31, 1996. The decline in consolidated
assets in 1997 relates directly to the decline in invested assets during the
year. This decline in invested assets is attributable to
32
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the deteriorated loss experience discussed above and the accelerated settlement
of claim related liabilities. Shareholders' equity at December 31, 1997,
totalled $12,768,000 compared to $21,655,000 at December 31, 1996.
As discussed in prior years' reports to you, the McMillen Trust, which
owns 65% of the outstanding stock of McM Corporation was ordered by the Chancery
Court of Delaware on December 10, 1987, to divest itself of its ownership of the
shares of McM Corporation and to invest the proceeds from such a divestiture in
a diversified portfolio for the benefit of present and future beneficiaries of
the Trust. In April 1993, the Court further clarified existing orders to make
clear, among other things, that the timing and terms of any disposition or sale
of the Trust's shares shall be determined in the sound discretion of the
Trustee.
In last year's report to you, it was discussed that on February 4,
1997, McM Corporation announced that the Trustee of the McMillen Trust, then
holder of 65.9% of the stock of McM Corporation, had informed the Company that
the Trustee had granted to McM Acquisition Corporation an option to purchase all
the Trust's shares at $6.20 per share and that such option was to expire on
March 1, 1998. The announcement also stated that McM Acquisition Corporation was
controlled by a private investor and real estate developer who had also filed a
Form 13D with the Securities and Exchange Commission reflecting that the
possible purchase of the Trust's shares was subject to the ability of McM
Acquisition Corporation to obtain the necessary financing for the transaction as
well as the approval of the North Carolina Department of Insurance and other
regulatory bodies. The announcement included the statement that McM Corporation
was not a party to the option agreement and could not predict whether McM
Acquisition Corporation would exercise its option or would be able to obtain the
required approvals and financial arrangements.
McM Corporation further announced on February 4, 1997, that in a
separate, independent action it had extended an agreement with McM Acquisition
Corporation to allow McM Acquisition Corporation confidential access to Company
records and information to enable McM Acquisition Corporation to conduct due
diligence reviews and to pursue appropriate financial arrangements for a
possible acquisition of all of McM Corporation's shares. This agreement was to
expire on May 31, 1997, and was subsequently extended until September 29, 1997,
at which time it expired.
On September 22, 1997, an action was brought against the Company, its
directors, the McMillen Trust, Wilmington Trust Company as Trustee of the
McMillen Trust and McM Acquisition Corporation. The suit was filed in Guilford
County, North Carolina, Superior Court by two shareholders of McM on behalf of
all McM shareholders except for the McMillen Trust. The suit complained, among
other allegations, that because the Trust owned approximately two-thirds of the
shares of McM, it effectively exercised control of the corporation. It
challenged the composition of the McM Board of Directors and the actions of the
Board as being controlled by the majority shareholder. The complaint asked that
the Court void the action of the Trustee in connection with the McMillen Trust's
grant of the option to sell its shares to McM Acquisition
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Corporation. The suit also complained that the corporation had inappropriately
allowed McM Acquisition Corporation the above described exclusive due diligence
period.
On December 23, 1997, the Court approved an agreement to terminate McM
Acquisition Corporation's option and related agreements between the Trust and
McM Acquisition Corporation (the "Release"). The Release was signed by all
parties to the pending legal action and contains a mutual release between all
parties and McM Acquisition Corporation of any claims which could have arisen
from the option and related agreements and dismissed McM Acquisition Corporation
as defendant in the legal action.
On February 20, 1998, the Court approved a settlement of the legal
action discussed above. The settlement agreement, executed by all parties,
provides that McM Corporation, the current directors, the McMillen Trust and
Wilmington Trust Company will use their best efforts to nominate and elect Mr.
Jesse Greenfield to the McM Board of Directors at McM's 1998 annual
shareholders' meeting. The settlement agreement also contains provisions for
nominal monetary concessions by the Plaintiffs and McM and mutually releases all
parties.
With regard to McM Corporation's continuing efforts to consider all
strategies and alternatives to maximize shareholder value, the Company has
authorized PaineWebber, Incorporated to explore all reasonable methods to
increase the capital position of McM, including a possible sale of the Company.
The investment portfolios of Occidental Fire & Casualty Company and
Wilshire continue to be comprised almost entirely of high quality government
securities. McM and its subsidiaries have no investments in real estate. Though
the conservative nature of these investments generally result in lower
investment yields , the high level liquidity provided by these investments
ensure that the Company's obligations to its policyholders are met in a timely
manner. The stock of Wilshire Insurance Company, the wholly-owned subsidiary of
Occidental Fire & Casualty Company, is the only stock investment in the
investment portfolios of the insurance companies.
Insurance regulators and other nongovernmental insurance rating
entities continue their intensive oversight of an insurance company's financial
stability and operating activities. In 1994 these actions culminated with the
National Association of Insurance Commissioners (the "NAIC") adopting and
implementing Risk-Based Capital requirements for property and casualty insurance
companies. RBC was developed to evaluate the adequacy of an insurance company's
statutory capital and surplus in relation to the risk environment in which the
company operates. The RBC formulas serve as early warning tools for state
insurance regulators to help identify, for the purpose of initiating various
levels of regulatory action, companies which are potentially inadequately
capitalized.
Occidental Fire & Casualty Company, as a result of the increase in
overall reserve levels of both Occidental and Wilshire, triggered the first RBC
regulatory action threshold defined as Company Action Level RBC ("CAL") in 1997.
Triggering this threshold requires the insurer to
34
16
prepare and submit to its domiciliary state a comprehensive financial plan.
Among other items, the plan should identify the conditions in the insurer that
contributed to the CAL event and contain proposals for corrective actions that
the insurer intends to take that is expected to result in the elimination of the
CAL event. As discussed previously, management has already identified the issues
contributing to the decline in profitability and statutory capital and surplus
and has implemented remedial actions designed to improve the overall
profitability of the property and casualty companies' operations and eliminate
the RBC deficiency. Occidental, working within the framework of RBC guidelines,
will submit its plan of action to the Insurance Commissioner of the State of
North Carolina in the near future and believes that its indicated RBC deficiency
will be corrected under this plan. The statutory capital and surplus of Wilshire
is well in excess of any regulatory action thresholds defined by the NAIC.
The Board of Directors, on a quarterly basis, carefully reviews the
financial position of the Company to determine the advisability of the
declaration and payment of cash dividends to shareholders. In light of McM's
results during 1997 and after careful consideration of all other relevant
factors, the Board of Directors decided to forego quarterly dividend payments
during 1997. The Board of Directors will continue to evaluate all relevant
factors in the determination of future dividend payments.
In summary, we are very disappointed with the overall results for the
year 1997. An extensive actuarial review of loss trends has been completed and
we believe we have taken the appropriate action regarding our companies' level
of reserve adequacy that other companies have yet to realize in satisfying the
well documented industry-wide concerns insurance regulators and other insurance
rating entities have expressed. Also, after extensive reviews of the property
and casualty operations we have been able to identify the specific issues
contributing to the decline in profitability and have implemented remedial
actions to correct these deficiencies. We believe the steps taken will position
the Company for a return to profitability in 1998 and beyond.
GEORGE E. KING
Chairman Emeritus & Chief Executive Officer
STEPHEN L. STEPHANO
President & Chief Operating Officer
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Market Overview
McM Corporation provides its property and casualty products and
services through two North Carolina domiciled subsidiaries, Occidental Fire &
Casualty Company of North Carolina and Wilshire Insurance Company.
The major focus of the companies is to the transportation insurance
market providing commercial automobile liability, physical damage and inland
marine insurance coverages to owner-operators and small fleet carriers in the
trucking industry. The Companies also write nonstandard private passenger auto
coverages in select geographical areas.
Occidental Fire & Casualty Company of North Carolina actively markets
insurance coverages to local, intermediate and long haul carriers in twenty-one
states utilizing fifteen managing general agents. The majority of the Company's
commercial auto premium volume is produced through the Company's annual bill
program.
The insureds of Wilshire Insurance Company are served by the Marketing
and Service Center located in Lancaster, California, and four managing general
agents supervised by the home office. The California marketing unit deals
directly with selected local retail agents in the West Coast truck marketplace
utilizing a specialized monthly direct bill policy. The managing general agents
market intermediate and long haul coverages through an annual bill program.
Occidental and Wilshire's non-standard auto coverages are marketed
through a branch office located in Scottsdale, Arizona. The majority of this
business is produced utilizing a semi-annual policy and direct-bill program.
The home office located in Raleigh, North Carolina, provides general
management for both Occidental Fire & Casualty and Wilshire Insurance Company
operations including the corporate staff for claims, accounting, regulatory
compliance, data processing, human resource and investment functions. Also
located in the home office are the marketing, underwriting and service functions
for all commercial automobile business written through managing general agents.
36
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
McM Corporation and Subsidiaries
This section should be read in conjunction with the financial statements, notes
to the financial statements and related financial data included in this annual
report.
REVIEW OF OPERATIONS
McM Corporation reported a consolidated net loss for 1997 of $8,540,000
or a basic net loss per share of $1.82 compared to a net loss of $788,000 or a
basic net loss per share of $.17 for 1996 and net income of $2,210,000 or basic
net income per share of $.47 for 1995. Consolidated results for 1997 were
significantly affected by the need to increase prior year loss reserves by
approximately $5.8 million. This increase in reserves was necessary as a result
of the Company's comprehensive review of its actuarial loss projections. These
projections showed deterioration in the commercial and private passenger auto
liability lines of business for the 1996 and 1995 accident years. In light of
these unfavorable loss trends and higher than anticipated claim costs in
commercial and private passenger physical damage coverages the Company also
strengthened loss reserves for the current accident year by approximately $4.5
million.
Consolidated revenues increased approximately 6.9% in 1997, 12.4% in
1996, and 9.4% in 1995. The trend of increasing revenues experienced in 1996 and
1995 was the result of controlled growth in overall property & casualty
insurance premiums. The more moderate increase from 1996 to 1997 is the result
of continued growth in private passenger automobile premium writings partially
offset by a reduction in net retained commercial automobile premium writings.
Net earned property and casualty insurance premiums for 1997 were $55.7
million, compared to $51.9 million in 1996, and $45.7 million in 1995. As
mentioned above, the trend in increasing net premium revenue during 1996 and
1995 reflected the Company's commitment to controlled premium growth in all
insurance coverages. The increase for 1997 is primarily the result of continued
growth in private passenger automobile premium writings. Additionally, net
earned premiums increased by approximately $1.8 million due to a reduction in
the level of premiums ceded to the Company's private passenger quota share
reinsurance program.
Historically, the Company's property and casualty insurance writings
emphasized liability, cargo and physical damage coverages associated with the
transportation market with a primary emphasis on commercial automobile
insurance. To diversify its premium
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19
distribution, the Company entered the nonstandard personal automobile market in
1989. Gross written premium in the Company's commercial automobile lines of
business totalled $55.6 and $59.3 million and comprised approximately 75.6% and
79.9% of gross written premiums in 1997, and 1996, respectively. Private
passenger automobile premium writings increased 20% to $17.9 million in 1997,
from $14.9 million in 1996, and comprised 24.4% and 20.1% of gross production in
1997, and 1996, respectively. Commercial auto premium writings decreased in 1996
and again during 1997 reflecting market conditions which continue to be highly
competitive and price sensitive. The Company's continuing commitment to
diversify its premium portfolio is reflected in the growth of private passenger
auto premiums over the last several years.
To help control the Company's statutory net writings to surplus ratios
and premium growth in selected lines of business, the Company maintains quota
share reinsurance arrangements for its commercial auto liability and private
passenger automobile coverages. The Company maintained a 20% quota share
reinsurance arrangement on its private passenger business during 1997. This rate
was reduced from 30% and 40% in 1996 and 1995, respectively. Also maintained
during 1997 was a 5% quota share arrangement on commercial auto liability
business retained after excess of loss reinsurance coverage. The rate pertaining
to this treaty has remained unchanged since 1995, at which time it was lowered
from 10%. Management evaluates the necessity and levels of these quota share
arrangements and makes adjustments when appropriate.
Net investment income, excluding realized investment gains, decreased
to approximately $3.0 million in 1997 from approximately $3.2 million in 1996
and $3.5 million in 1995. This gradual decline corresponds to the decrease in
invested assets to $49.9 million in 1997, from $56.9 million in 1996, and $63.0
million in 1995. The decrease in invested assets is primarily attributed to the
deteriorated loss experience discussed above and accelerated settlement of claim
related liabilities. Claim liabilities totalled $47.7 million, net of the
reserve increases discussed previously, at December 31, 1997, and $51.8 million,
and $66.2 million at December 31, 1996 and 1995, respectively. Realized
investment gains of $196,000 are included in 1997 revenues compared to $40,000
in 1996 and $123,000 in 1995.
Underwriting results for cargo (inland marine) and commercial
automobile physical damage coverages have historically been more profitable than
commercial automobile liability. These coverages are generally easier to
determine and claims settled more rapidly. Accordingly, the Company has
implemented strategies to improve the ratio of these coverages to total
commercial premium production. As mentioned previously, commercial automobile
written premiums comprised 75.6% of gross written property & casualty premium in
1997 compared to 79.9% and 83.5% in 1996 and 1995, respectively.
38
20
The percentage of cargo and commercial automobile physical damage premiums to
total commercial automobile premiums increased to 29.7% in 1997 compared to
27.9% and 26.6% in 1995 and 1994, respectively.
At December 31, 1997, the market value of the total long-term fixed
income portfolio was $370,000 less than amortized cost and $100,000 greater than
its carrying value. The unrealized loss of $471,000 relates to those investments
the Company intends to hold to maturity. The full value of these securities will
be realized as they mature (see Note F to the consolidated financial
statements). At December 31, 1996, the market value of the fixed income
portfolio was $19,000 greater than its amortized cost and $84,000 greater than
its carrying value.
The overall ratio of net loss and settlement expenses to net premiums
earned was 86.2% for 1997 compared to 75.6% for 1996 and 67.9% for 1995. As
discussed previously, the increase in the loss ratio in 1997 resulted from the
deterioration in the commercial and private passenger automobile liability lines
of business, particularly for the 1995 and 1996 accident years and increased
claim costs in the current underwriting year for commercial and private
passenger automobile physical damage coverages. After a comprehensive actuarial
analysis of loss trends and projections at year end 1997 which confirmed this
deterioration and the need to increase prior year loss reserves, the Company
determined it was also necessary to increase loss reserves for the current
accident year.
Current year loss reserves were increased approximately $4.5 and prior
year loss reserves were increased approximately $5.8 million, for a total of
$10.3 million, net of reinsurance. Of the $4.5 increase to current year
reserves, approximately $1,925,000 related to commercial physical damage and
inland marine coverages, $1.1 million related to commercial auto liability
coverages, and $875,000 and $600,000 related to private passenger liability and
physical damage coverages, respectively.
Net losses and settlement expenses incurred in 1997 include total
adverse development of $5,774,000 on reserves of prior accident years. This
development includes adverse reserve development of approximately $844,000 in
private passenger automobile liability reserves, $813,000 in private passenger
and commercial physical damage and inland marine reserves and $3,531,000
relating to the commercial automobile liability lines of business. In addition,
the Company experienced adverse prior year development of approximately $586,000
relating to discontinued lines of business and participation in involuntary
pools and other residual market mechanisms.
The increase in the 1996 ratio of net loss and settlement expenses to
net premiums earned when compared to that of 1995 was
39
21
the result of an unusually high level of claims severity experienced by the
Company, primarily in the fourth quarter of 1996, in the commercial auto
liability line of business. In addition, property and casualty operations
experienced increased frequency in its other lines of business including private
passenger auto liability and commercial and private passenger auto physical
damage coverages throughout 1996. These factors resulted in the strengthening of
overall reserves for the 1996 accident year by approximately $3.5 million, net
of reinsurance, at December 31, 1996, including $1.2 million relating to
commercial auto liability, $1.5 million relating to commercial auto physical
damage and approximately $800,000 relating to private passenger auto coverages.
The ratio of net loss and settlement expenses to net premiums earned
for 1995 reflected improved underwriting results and favorable or minimal
adverse development on reserves of prior accident years.
The Company's ratio of underwriting, acquisition and administrative
expenses (including the provision for bad debts on liquidated reinsurance) to
net earned premium ("expense ratio") showed a slight increase to 36.0% following
declining trends over the last several years. Contributing to the increase in
1997 was the provision for liquidated reinsurance which totalled $401,000
representing an increase of $550,000 when compared to 1996. Increased production
levels coupled with budgetary control and reduction measures emphasized by
management, contributed to the declining trend in prior years. The expense ratio
for 1996 declined 2.4 percentage points to 33.3% when compared to the expense
ratio of 1995.
The Company utilizes a reinsurance intermediary with which it has a
long term relationship to assist in the development, placement and maintenance
of the Company's reinsurance program. The Company's current reinsurance program
has been placed with high quality and financially sound reinsurers specializing
in personal and commercial auto business. The creditworthiness of the Company's
reinsurers is continually reviewed by the Company and the intermediary. The
majority of the Company's reinsurance is placed through the London reinsurance
market. These participating reinsurers are generally very large international
reinsurers with capital and surplus in excess of $100 million and hold A.M. Best
ratings of B++ or better. Participating Lloyds syndicates are well regarded
syndicates which have been approved by the National Association of Insurance
Commissioners ("NAIC"). The Company's U.S. reinsurers are all rated A- or higher
by A.M. Best. For those reinsurers not admitted by the Company's state of
domicile, collateral is secured for the exposure ceded to them in the form of
letters of credit or other reinsurer funds held by the Company. This collateral
would minimize the impact of a potential reinsurer insolvency on the Company's
operations. A schedule of the
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Company's reinsurers whose balances are approximately 10% of McM's shareholders'
equity or greater is provided below:
Ceded
Reinsurer Balances Receivable
--------- -------------------
(Thousands of dollars)
Lloyds of London $ 8,998
CNA International 5,103
Unionamerica 4,685
AXA Reassurance 3,008
Zurich Re 2,976
Sphere Drake Insurance, PLC 2,004
All other 9,139
-------
Total $35,913
The allowance for bad debts on liquidated reinsurers relating to
discontinued property and casualty programs was increased by $401,000 in 1997,
decreased by $150,000 in 1996 and increased by $103,000 in 1995. Other than a
$2.5 million litigation settlement in 1993, overall exposure to losses
associated with discontinued property and casualty business has decreased
significantly over the last several years and has not had a material impact on
operations since 1990.
In the second quarter of 1995, the Company resolved a long standing
uncertainty concerning Proposition 103 by settling this issue with the
California Department of Insurance. The Company fully recognized this settlement
and its related cost in 1995 by including in consolidated results a $500,000
reduction of earned premiums attributable to this settlement. Offsetting this
charge and also included in results for 1995 is a $539,000 favorable arbitration
settlement related to discontinued property and casualty programs.
Amortization of deferred policy acquisition costs from continuing
operations was $10.3 million in 1997, compared to $9.1 million in 1996, and $7.1
million in 1995. Direct and assumed premiums earned increased by $2.2 million in
1997, $4.0 million in 1996, and $2.8 million in 1995 resulting in an increase in
the related amortization of deferred policy acquisition costs.
INCOME TAXES
McM Corporation files a consolidated tax return. The Company had
cumulative net operating loss tax carryforwards of approximately $98.0 million
as of December 31, 1997 (See Note D to the consolidated financial statements).
Subject to certain limitations and alternative minimum tax considerations,
future operations can earn up to the amount of these loss carryforwards without
being subject to federal income taxation.
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IMPACT OF YEAR 2000 ISSUE
The Year 2000 Issue is a worldwide problem relating to virtually all
computer programs that were written using two digits rather than four to define
the applicable year. Computer programs that have time-sensitive software may
recognize a date using "00" as the year 1900 rather than the year 2000. This
problem could result in systems failures or miscalculations causing disruptions
of operations, including, among other things, a temporary inability to process
premium transactions, pay claims or engage in similar normal business
activities.
The Company completed an assessment of its software applications and
determined that the system managing the Company's specialized monthly commercial
automobile direct bill program would have to be modified so that it would
function properly with respect to dates in the year 2000 and thereafter. This
modification was successfully completed in 1997 at an approximate cost of
$96,000. Other Company computer applications, most of which are licensed from
third party computer program vendors, were determined to be Year 2000 compliant
or, based upon communication with these vendors, would be compliant within the
Company's time estimate discussed below.
The project, as it relates to all of the Company's computer platforms,
is estimated to be completed not later than September 30, 1998, which is prior
to any anticipated impact on its operating systems. The Company believes that
with modifications to existing software, the Year 2000 Issue will not pose
significant operational problems for its computer systems. However, if such
modifications and conversions are not made, or are not completed timely, the
Year 2000 Issue could have a material impact on the operations of the Company.
NEW ACCOUNTING STANDARDS
The Financial Accounting Standards Board ("FASB") issued Statement of
Financial Accounting Standard No. 128, "Earnings Per Share" ("SFAS 128") in
1997. SFAS 128 replaced the calculation of primary and fully diluted earnings
per share with basic and diluted earnings per share. Unlike primary earnings per
share, basic earnings per share excludes any dilutive effects of options,
warrants and convertible securities. Diluted earnings per share is very similar
to the previously reported fully diluted earnings per share. All earnings per
share amounts for all periods presented have been calculated utilizing the new
requirements of SFAS 128.
In June 1997, the FASB issued the Statement of Financial Accounting
Standards No. 130 "Reporting Comprehensive Income". Also during June, the FASB
issued the Statement of Financial Accounting Standards No. 131 "Disclosures
about Segments of an Enterprise and Related Information". In February 1998, the
FASB
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issued the Statement of Financial Accounting Standards No. 132 "Employers'
Disclosures about Pensions and Other Postretirement Benefits". These new
accounting pronouncements must all be adopted for years beginning after December
15, 1997. The impact of the adoption of these accounting standards on the
Company's financial reporting and related disclosures is not expected to be
material.
LIQUIDITY AND CAPITAL RESOURCES
By statute, the majority of the Company's investments are required to
be held in investment grade securities which provide ample protection for both
the policyholder and the shareholder. Significant amounts of short-term
investments are held to meet the liquidity needs of the property and casualty
insurance operations.
As shown in the Consolidated Statements of Cash Flows, the Company
experienced negative cash flows from operations on a consolidated basis of $5.5
million in 1997 compared to $4.4 million in 1996 and $4.0 million in 1995. The
main source of the Company's cash flows is derived from its property and
casualty subsidiaries.
The Company's property and casualty subsidiaries experienced
consolidated negative cash flows from operations of $4.9 million, $3.9 million
and $2.2 in 1997, 1996 and 1995, respectively. The negative cash flows for the
property and casualty operations can be primarily attributed to the settlement
of claim liabilities, including settlements on discontinued run-off business.
Short-term investments held at December 31, 1997, were $21.5 million
compared to $14.1 million at December 31, 1996. This increase is due to the sale
of long-term fixed maturities during the fourth quarter of 1997 which enabled
the Company to recognize market gains in its fixed maturity portfolio. This
increase in liquidity was partially offset by cash used for operations as
discussed above, and the Company plans to invest remaining balances in other
high quality instruments during 1998. Total cash and invested assets at December
31, 1997, were approximately $49.9 million compared to $56.9 million at December
31, 1996.
The Company maintains a mix of high-quality investments which provides
adequate returns, while limiting credit risk and providing necessary levels of
liquidity to meet projected expenditures. At December 31, 1997, approximately
49.0% or $25.3 million of cash and invested assets were comprised of fixed
maturities available-for-sale, 6.0% or $3.1 million were recorded as securities
held-to-maturity and 45.0% or $23.2 million represented cash and short-term
investments. Of the total cash and invested assets at December 31, 1996,
approximately 62.9% or $36.9 million were comprised of fixed maturities
available-for-sale and 10.1% or $5.9 million were classified as securities
held-to-maturity. Cash and short-term investments totalling $15.8 million
comprised the remaining 27.0% of the investment portfolio. The fixed maturity
portfolio has a
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range of expected maturities which, as mentioned previously, management believes
are adequate to meet long- and short-term liquidity needs.
Statutory capital positions of the property and casualty insurance
companies are closely monitored by the Company. In addition, the NAIC has
adopted Risk-Based Capital ("RBC") requirements. Annual statutory financial
statements are filed with state insurance regulators on or before March 1
following each year's end.
RBC was developed to evaluate the adequacy of statutory capital and
surplus in relation to investment and insurance risks such as asset quality,
asset and liability matching, loss reserve adequacy and other business
environmental factors. The RBC formula is used by state insurance regulators as
an early warning tool to identify, for the purpose of initiating regulatory
action, insurance companies that may be inadequately capitalized. Regulatory
compliance is determined by a ratio of the enterprise's regulatory total
adjusted capital, as defined by the NAIC, to its authorized control level RBC,
as defined by the NAIC. Enterprises below specific ratios are classified within
certain levels, each of which requires specific corrective action.
OF&C, as a result of the need to significantly strengthen reserve
adequacy of the property and casualty companies during 1997, triggered the first
RBC regulatory action threshold defined as Company Action Level RBC ("CAL").
Triggering the CAL threshold requires that an insurer prepare and submit to its
domiciliary state a comprehensive financial plan. Among other items, the plan
should identify the conditions in the insurer that contributed to the CAL event
and contain proposals for corrective actions that the insurer intends to take
that are expected to result in the elimination of the company action level
event. The Company has identified specific areas of its business contributing to
the decline in profitability and statutory capital and surplus and has
implemented remedial steps designed to improve the overall profitability of
property and casualty operations and eliminate the RBC deficiency.
OF&C, working within the framework of RBC guidelines, will submit its
plan of action to the state of North Carolina in the near future and believes
that its indicated RBC deficiency will be corrected under this plan. The capital
and surplus of Wilshire is well in excess of any regulatory action thresholds
defined by the NAIC.
Combined statutory capital and surplus of the property and casualty
subsidiaries decreased by $6.7 million to $11.5 million at December 31, 1997,
compared to $18.2 million at December 31, 1996.
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At December 31, 1997, the Company had consolidated shareholders' equity
of $12.8 million compared to $21.7 million at December 31, 1996. The Company's
main source of funds from which dividends are paid to its shareholders is its
insurance subsidiaries which are subject to certain restrictions as to the
amount of dividends that can be paid in a given year. These restrictions are
discussed in Note B to the consolidated financial statements. No dividends were
declared or paid during 1997. During 1996 the Company paid three quarterly
dividends of $.02 per share, and prior to that had not paid a dividend since the
second quarter of 1987. The Board will continue to consider carefully the
Company's earnings, capital requirements, financial condition and other relevant
factors with regard to payment of dividends.
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27
Consolidated Balance Sheets
- ---------------------------------------------------------------------------------------------------------------------------
December 31
McM CORPORATION AND SUBSIDIARIES 1997 1996
- ---------------------------------------------------------------------------------------------------------------------------
(Thousands of dollars)
Assets
Invested assets:
Fixed maturity securities available-for-sale, at fair value (cost: 1997 - $25,755;
1996 - $36,938) $ 25,284 $ 36,873
Fixed maturity securities held-to-maturity, at amortized cost (fair value: 1997 - $3,235;
1996 - $6,022) 3,134 5,938
Short-term investments 21,522 14,061
- ---------------------------------------------------------------------------------------------------------------------------
49,940 56,872
Cash 1,698 1,776
Accrued investment income 531 803
Premiums receivable 8,552 9,380
Reinsurance balances recoverable on:
Paid losses and settlement expenses 1,476 3,676
Unpaid losses and settlement expenses 28,124 28,768
Unearned premiums 6,313 4,068
Deferred policy acquisition costs 2,802 3,992
Equipment, at cost less accumulated depreciation (1997 - $1,954; 1996 - $1,699) 1,833 1,331
Other assets 2,871 2,204
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 104,140 $ 112,870
===========================================================================================================================
LIABILITIES and SHAREHOLDERS' EQUITY
Liabilities:
Reserves for losses and settlement expenses $ 57,283 $ 55,300
Unearned premiums 15,676 17,925
Other policyholder funds 6,380 6,580
Amounts payable to reinsurers 4,461 3,089
Accrued expenses and other liabilities 7,572 8,321
- ---------------------------------------------------------------------------------------------------------------------------
91,372 91,215
Commitments and contingencies - Notes A, B, C and H
Shareholders' equity:
Common Stock, par value $1 per share - authorized 10,000,000 shares,
issued and outstanding: 1997 - 4,695,621; 1996 - 4,678,183 4,696 4,678
Additional paid-in capital 1,530 1,489
Unrealized loss on securities available-for-sale (471) (65)
Retained earnings 7,013 15,553
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY 12,768 21,655
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 104,140 $ 112,870
===========================================================================================================================
See notes to consolidated financial statements.
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Consolidated Statements of Operations
- ------------------------------------------------------------------------------------------------------------------------
Year Ended December 31
McM CORPORATION AND SUBSIDIARIES 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------
(Thousands of dollars, except per share data)
Revenues
Premiums earned $75,778 $73,568 $69,602
Premiums ceded (20,071) (21,714) (23,901)
----------------------------------------
Net premiums earned 55,707 51,854 45,701
Investment income, less investment expense (1997 - $413; 1996 - $457;
1995 - $474) 2,985 3,159 3,497
Realized investment gains 196 40 123
Other income 649 645 250
- ------------------------------------------------------------------------------------------------------------------------
TOTAL REVENUES 59,537 55,698 49,571
Losses and Expenses
Losses and settlement expenses 62,882 51,781 46,055
Losses and settlement expenses ceded (14,865) (12,571) (15,021)
----------------------------------------
Net losses and settlement expenses 48,017 39,210 31,034
Underwriting, acquisition and administrative expenses 19,659 17,426 16,224
Provision for (recoveries of) bad debts on liquidated reinsurers 401 (150) 103
- ------------------------------------------------------------------------------------------------------------------------
TOTAL LOSSES AND EXPENSES 68,077 56,486 47,361
- ------------------------------------------------------------------------------------------------------------------------
NET (LOSS) INCOME ($8,540) ($788) $2,210
========================================================================================================================
Per Share Data
Net (loss) income per share ($1.82) ($0.17) $0.47
Net (loss) income per share - assuming dilution ($1.82) ($0.17) $0.47
Dividends per share declared by McM $0.00 $0.06 $0.00
========================================================================================================================
See notes to consolidated financial statements.
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Consolidated Statements of Shareholders' Equity
- ---------------------------------------------------------------------------------------------------------------------------------
Net
Additional Unrealized
McM CORPORATION Common Paid-in Investment Retained
AND SUBSIDIARIES Stock Capital Gain (Loss) Earnings
- ---------------------------------------------------------------------------------------------------------------------------------
(Thousands of dollars)
BALANCES AT JANUARY 1, 1995 $4,675 $1,477 ($158) $14,413
Net income for 1995 2,210
Change in net unrealized loss or gain on securities available-for-sale 623
- ---------------------------------------------------------------------------------------------------------------------------------
BALANCES AT DECEMBER 31, 1995 4,675 1,477 465 16,623
Net loss for 1996 (788)
Change in net unrealized loss or gain on securities available-for-sale (530)
Employee stock purchases 3 12
Dividends declared and paid (282)
- ---------------------------------------------------------------------------------------------------------------------------------
BALANCES AT DECEMBER 31, 1996 4,678 1,489 (65) 15,553
Net loss for 1997 (8,540)
Change in net unrealized loss or gain on securities available-for-sale (406)
Employee stock purchases 18 41
- ---------------------------------------------------------------------------------------------------------------------------------
BALANCES AT DECEMBER 31, 1997 $4,696 $1,530 ($471) $7,013
=================================================================================================================================
See notes to consolidated financial statements.
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Consolidated Statements of Cash Flows
- ---------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31
McM CORPORATION AND SUBSIDIARIES 1997 1996 1995
- ---------------------------------------------------------------------------------------------------------------------------------
(Thousands of dollars)
Operating Activities
Net (loss) income ($ 8,540) ($ 788) $ 2,210
Adjustments to reconcile net (loss) income to net cash used by operating activities:
Policy liabilities (466) (10,828) (12,461)
Premiums receivable 828 555 (1,143)
Accrued investment income 272 37 176
Net recoverable from reinsurers 1,971 6,128 6,625
Amortization of deferred policy acquisition costs 10,332 9,116 7,141
Policy acquisition costs deferred (9,142) (9,765) (7,249)
Other (720) 1,150 673
- ---------------------------------------------------------------------------------------------------------------------------------
CASH USED BY OPERATING ACTIVITIES (5,465) (4,395) (4,028)
Investing Activities
Fixed maturity securities available-for-sale:
Purchases (10,499) (18,447) (109)
Sales 19,506 0 3,377
Maturities 2,050 12,974 1,408
Fixed maturity securities held-to-maturity:
Purchases 0 (1,118) (2,984)
Maturities 2,777 11,362 120
Purchases of property and equipment, net (1,045) (757) (474)
Change in short-term investments (7,461) 787 2,830
- ---------------------------------------------------------------------------------------------------------------------------------
CASH PROVIDED BY INVESTING ACTIVITIES 5,328 4,801 4,168
- ---------------------------------------------------------------------------------------------------------------------------------
Financing Activities
Employee stock purchases 59 15 0
Cash dividends paid 0 (282) 0
- ---------------------------------------------------------------------------------------------------------------------------------
CASH PROVIDED (USED) BY FINANCING ACTIVITIES 59 (267) 0
- ---------------------------------------------------------------------------------------------------------------------------------
NET (DECREASE) INCREASE IN CASH ($ 78) $ 139 $ 140
=================================================================================================================================
See notes to consolidated financial statements.
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Notes to Consolidated Financial Statements
McM Corporation and Subsidiaries
NOTE A Significant Accounting Policies
Basis of Presentation: The consolidated financial statements have been prepared
in accordance with generally accepted accounting principles (GAAP) which, as to
the insurance subsidiaries, vary in some respects from statutory accounting
practices which are prescribed or permitted by the various state insurance
departments.
The consolidated financial statements include the accounts and
operations of McM and its wholly-owned subsidiaries. McM is actively engaged
through certain of its subsidiaries in the property and casualty insurance
business. All significant intercompany accounts and transactions have been
eliminated. The Company's subsidiaries are as follows:
Subsidiary Abbreviation
- ---------- ------------
Property and Casualty:
Occidental Fire & Casualty Company of North Carolina OF&C
Wilshire Insurance Company Wilshire
Other:
Equity Holdings, Inc. Equity
The property and casualty insurance subsidiaries are primarily involved
in the sale of commercial automobile and private passenger automobile insurance.
The commercial automobile insurance consists primarily of liability, physical
damage and inland marine coverages. The commercial automobile lines of business
represented 77%, 80%, and 84% of gross written premium in 1997, 1996 and 1995,
respectively. Private passenger automobile insurance, which represents the
remainder of gross written premiums, consists primarily of liability and
physical damage coverages. The Company's products are generally marketed through
general and independent agents. In 1997, premiums were written in 27 states
throughout the U.S. Direct premiums written in California, all of which were for
commercial automobile insurance products, represented 32%, 34% and 37% of total
direct written premiums in 1997, 1996 and 1995, respectively.
Investments: Fixed maturity securities are classified as either held-to-maturity
or available-for-sale. Management determines the appropriate classification of
fixed maturity securities at the time of purchase. The Company has identified
and accounted for its investments as follows:
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Securities held-to-maturity and available-for-sale: Debt securities are
classified as held-to-maturity when the Company has the positive intent and
ability to hold the securities to maturity. Held-to-maturity securities are
stated at amortized cost. Securities not classified as held-to-maturity are
classified as available-for-sale. Available-for-sale securities are stated at
fair value, with the unrealized gains and losses reported as a separate
component of shareholders' equity. The amortized cost of securities classified
as held-to-maturity or available-for-sale is adjusted for amortization of
premiums and accretion of discounts to maturity, or in the case of
mortgage-backed securities, over the estimated life of the security. Such
amortization is included in investment income. Realized gains and losses include
any declines in value judged to be other-than-temporary. The cost of securities
sold is based on the specific identification method. Short-term investments are
comprised of corporate master notes and United States Treasury Notes and Bills
maturing in twelve months or less. These investments are carried at fair value.
The Company had fixed maturity securities with a face value of
approximately $12.0 million and $11.8 million on deposit with various state
insurance departments at December 31, 1997, and 1996, respectively. The Company
also had $3.4 million in short-term investments held in a security trust as
collateral for assumed reinsurance balances at December 31, 1997 and 1996.
Cash: Cash represents cash balances deposited in banking institutions. Balances
invested in corporate master notes and other interest bearing cash equivalents
are included in short-term investments.
Equipment: Equipment is stated at cost less allowances for accumulated
depreciation which are computed principally on the straight-line method.
Recognition of Insurance Revenues: Premiums for property and casualty insurance
policies are recognized as revenues on a monthly pro rata basis over the terms
of the policies.
The Company utilizes a general agency force to market its annual
commercial automobile business and a portion of its private passenger automobile
business. As of December 31, 1997, agents' balances receivable of approximately
$1.5 million were associated with one general agent.
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Deferred Policy Acquisition Costs: Costs which vary with and are primarily
related to the production of property and casualty policies are deferred to the
extent recoverable and are amortized over the lives of the policies in
proportion to the recognition of premiums earned. Anticipated investment income
is considered in the evaluation of recoverability of unamortized deferred
acquisition costs.
Reserves for Losses and Settlement Expenses: Reserves for estimated losses are
determined on a case basis for reported claims and on estimates based on Company
experience for loss settlement expenses and incurred but not reported claims.
These liabilities give effect to trends in claims severity and other factors
which may vary as the losses are ultimately settled. Although considerable
variability is inherent in such estimates for losses and loss settlement
expenses, management believes that these liabilities are adequate. The estimates
are continually reviewed and, as adjustments to these liabilities become
necessary, such adjustments are reflected in current operations.
The reserves for losses include amounts assumed from involuntary pools
and other residual market mechanisms of the various states in which the
Companies have written policies. The estimated liability for the assumed pools
is recorded based on information provided to the Company by the pools.
Reinsurance: McM assumes and cedes reinsurance and participates in various pools
and associations. The reinsurance arrangements allow management to control
exposure to potential losses arising from large risks, and provide additional
capacity for growth. The reinsurance is effected under quota-share contracts and
by excess-of-loss contracts. Amounts recoverable from reinsurers for unpaid
losses and settlement expenses are estimated in a manner consistent with the
related liabilities associated with reinsured policies.
Income Taxes: The Company accounts for income taxes using the liability method.
Deferred tax assets, net of a valuation allowance, and liabilities are
recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled. The
effect on deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date.
Leases: The Company and its subsidiaries rent office space and equipment under
various operating lease agreements. The
52
34
aggregate rental expense charged to operations was approximately $826,000 in
1997, $802,000 in 1996, and $737,000 in 1995. Future minimum lease commitments
require payments of approximately $709,000 in 1998 and $461,000 in 1999.
Use of Estimates: The preparation of financial statements requires management to
make estimates and assumptions that affect amounts reported in the financial
statements and accompanying notes. Such estimates and assumptions could change
in the future as more information becomes known which could impact the amounts
reported and disclosed herein.
Earnings per Share: Basic earnings per share are based on the weighted-average
number of common shares outstanding during the year. The weighted-average number
of common shares outstanding was 4,688,364, 4,675,701 and 4,675,038 at December
31, 1997, 1996 and 1995, respectively. Diluted earnings per share were computed
assuming that the weighted-average number of shares was increased by the
conversion of fixed awards (employee stock options). The diluted per share
computations reflect a change in the number of common shares outstanding (the
"denominator") to include the number of additional shares that would have been
outstanding if the potentially dilutive shares had been issued. In each year
presented, net income or loss, the numerator is the same for both basic and
dilutive per share computations. The denominator was unchanged for 1997 and
1996. However, for 1995 the weighted-average number of common shares outstanding
was increased by 17,785 shares relating to potentially dilutive employee stock
options.
New Accounting Standards: The Financial Accounting Standards Board issued
Statement of Financial Accounting Standard No. 128, "Earnings Per Share" ("SFAS
128") in 1997. SFAS 128 replaced the calculation of primary and fully diluted
earnings per share with basic and diluted earnings per share. Unlike primary
earnings per share, basic earnings per share excludes any dilutive effects of
options, warrants and convertible securities. Diluted earnings per share is very
similar to the previously reported fully diluted earnings per share. Earnings
per share restated under amounts for all periods presented have been calculated
utilizing the new requirements of SFAS 128.
NOTE B Statutory Results and Dividend Restrictions
The reporting practices for McM's insurance subsidiaries prescribed or
permitted by state regulatory authorities ("statutory accounting") differ from
generally accepted accounting principles. OF&C (which includes Wilshire on a
statutory equity basis) reported to insurance regulatory authorities a net loss
of $2.8 million in 1997, and net income of $49,000 and $2.0 million in 1996 and
1995, respectively. Combined capital and surplus reported to insurance
regulatory
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35
authorities totalled $11.5 million and $18.2 million at December 31, 1997 and
1996, respectively.
McM's insurance subsidiaries are subject to regulation and supervision
by regulatory authorities in the states in which they operate. The regulatory
bodies have broad administrative powers relating to standards of solvency,
minimum capital and surplus requirements, maintenance of required reserves,
payments of dividends, statutory accounting and reporting practices, and other
financial and operational matters. Generally, the net assets of the insurance
subsidiaries available for transfer to the parent company are limited to the
amounts by which the insurance subsidiaries' net assets, as determined in
accordance with statutory accounting practices, exceed the minimum statutory
capital requirement of $2,250,000. Also, by statute, dividends exceeding the
lesser of 10% of statutory-basis capital and surplus or the previous year's net
income, excluding net realized capital gains, require the prior approval of the
Commissioner of the North Carolina Department of Insurance.
OF&C and Wilshire are domiciled in the State of North Carolina and
prepare their statutory-basis financial statements in accordance with accounting
practices and procedures prescribed or permitted by the North Carolina
Department of Insurance. "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 may differ from state to state, may
differ from company to company within a state, and may change in the future. The
NAIC currently is in the process of codifying statutory accounting practices,
the result of which is expected to constitute the only source of "prescribed"
statutory accounting practices. The completion date of that project is currently
undeterminable. However, upon completion, prescribed statutory accounting
practices will likely change, to some extent, and may result in changes to the
accounting that insurance enterprises use to prepare their statutory financial
statements.
The North Carolina Department of Insurance imposes minimum risk-based
capital requirements on insurance enterprises that were developed by the NAIC.
The formulas for determining the amount of risk-based capital ("RBC") specify
various weighting factors that are applied to financial balances or various
levels of activity based on the perceived degree of risk. Regulatory compliance
is determined by a ratio ("the Ratio") of the enterprise's regulatory total
adjusted capital, as defined by the NAIC, to its authorized control level RBC as
defined by the NAIC. Enterprises below specific trigger points or ratios are
classified within certain levels, each of which requires corrective action.
54
36
OF&C, as a result of the need to significantly strengthen reserve
adequacy of the property and casualty companies during 1997, triggered the first
RBC regulatory threshold defined as Company Action Level RBC ("CAL"). OF&C,
working within the framework of RBC guidelines, will submit its plan of action
to the state of North Carolina in the near future and believes that its
indicated RBC deficiency will be corrected through this plan. The capital and
surplus of Wilshire exceeds any minimum RBC requirement.
NOTE C Reinsurance
The property and casualty insurance subsidiaries have entered into
reinsurance agreements with various reinsurers in order to reduce their ultimate
claim risk. Current reinsurance agreements provide for premium rates based on
the amount of coverage in excess of the defined retention level.
Generally, the Company's retention level for all accident years was
$100,000 with the exception of the 1991 accident year which was $250,000. These
retention levels are effected under the Company's casualty excess of loss
reinsurance treaties.
The Company is also party to quota share reinsurance arrangements on
its private passenger automobile and commercial auto liability coverages. A
quota share reinsurance treaty is maintained on the Company's private passenger
automobile business which became effective in April 1993. The rates pertaining
to this treaty were 20% during 1997, 30% during 1996, and 40% prior to 1996. An
addendum to the private passenger quota share treaty provided for the ceding of
100% of the unearned premium to the reinsurers as of December 31, 1997. The
quota share treaty was placed to help control the Company's statutory net
writings to surplus ratios as well as future premium growth in that market. A 5%
quota share reinsurance treaty is also maintained by the Company to help control
future growth in this line of business.
The effect of reinsurance on premiums written and earned in 1997, 1996
and 1995 was as follows:
For the Year Ended December 31
-------------------------------------------------------
1997 1996 1995
Premiums Premiums Premiums
Written Earned Written Earned Written Earned
------- ------ ------- ------ ------- ------
(Thousands of dollars)
Direct $63,699 $65,205 $62,698 $63,163 $64,099 $63,731
Assumed 9,830 10,573 11,561 10,405 7,926 5,871
Ceded (22,315) (20,071) (20,839) (21,714) (25,362) (23,901)
------- ------- ------- ------- ------- -------
Net $51,214 $55,707 $53,420 $51,854 $46,663 $45,701
======= ======= ======= ======= ======= =======
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37
To minimize its exposure to losses from reinsurance insolvencies, OF&C
and Wilshire evaluate the financial condition of their reinsurers and monitor
concentration of credit risk arising from similar geographic regions, activities
or economic characteristics of the reinsurers. At December 31, 1997, reinsurance
recoverables of $5.1 million were associated with a single reinsurer. The
remaining reinsurance recoverables were associated primarily with five
reinsurers. OF&C and Wilshire's policy is to hold collateral under related
reinsurance agreements in the form of letters of credit for all reinsurers not
licensed to do business in North Carolina.
To the extent that reinsuring companies may later be unable to meet
obligations under the reinsurance agreements, the insurance subsidiaries would
remain liable.
NOTE D Income Taxes
The Revenue Reconciliation Act of 1993 increased the U.S. Federal
income tax rate to 35% for taxable income in excess of $10 million. Because of
the large tax return net operating loss carryforwards of the Company and Company
estimates that annual taxable income in the near future, before utilization of
the carryforwards, will not exceed $10 million, a U.S. Federal income tax rate
of 34% has been used to compute deferred tax assets and liabilities for the
Company.
There was no income tax expense attributable to income from continuing
operations for the years ended December 31, 1997, 1996 and 1995. These amounts
differed from the amounts computed by applying the U.S. federal income tax rate
of 34 percent to pretax income from continuing operations as follows:
Year Ended December 31
1997 1996 1995
(Thousands of dollars)
Pretax income (loss) from
continuing operations $(8,540) $ (788) $2,210
------- ------ ------
Computed "expected" tax
expense (benefit) (2,904) (268) 751
Increase (decrease) in
taxes resulting from:
Change in valuation
allowance 2,897 257 (2,768)
Other 7 11 33
Net operating and
capital losses not
utilized - - 1,984
------- ------ ------
Income Tax Expense $ 0 $ 0 $ 0
======= ====== ======
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38
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities as of December
31, 1997 and December 31, 1996, are presented below.
December 31
---------------------
1997 1996
(Thousands of dollars)
Deferred tax asset:
Unearned premium reserves $ 637 $ 942
Claim reserves 1,270 1,279
Tax return net operating
and capital loss
carryforwards 33,432 30,810
Unrealized losses on fixed
maturity securities 160 22
Other 232 252
------- -------
Total gross deferred tax
assets 35,731 33,305
Less: Valuation allowance (34,521) (31,624)
------- -------
Net deferred tax assets $ 1,210 $ 1,681
Deferred tax liabilities:
Deferred policy acquisition
costs $ 953 $ 1,357
Agent balances 57 47
Other 200 277
------- -------
Total liabilities $ 1,210 $ 1,681
------- -------
Net deferred tax account $ 0 $ 0
======= =======
McM and its subsidiaries file a consolidated income tax return. The
Company had cumulative tax operating loss carryforwards of approximately $98
million as of December 31, 1997, with expiration dates of 1998 through 2012. No
income taxes were paid in 1997, 1996, or 1995.
NOTE E Pension Plan
McM and its subsidiaries have a non-contributory defined benefit
pension plan covering substantially all their employees. The plan provides for
payments to qualified employees based on compensation and years of service. The
Company and its subsidiaries make contributions to the plan, if necessary, equal
to the amounts required by ERISA.
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39
The following table sets forth the plan's funded status and amounts
recognized in the Company's balance sheets at December 31:
December 31
-----------------------------
1997 1996
-----------------------------
(Thousands of dollars)
Actuarial present value
of benefit obligations:
Accumulated benefit
obligation, including
vested benefits of
$2,339 in 1997 and
$1,890 in 1996 $ 2,577 $ 2,027
======= =======
Projected benefit
obligation for service
rendered to date $(3,356) $(2,816)
Plan assets at fair
value, primarily listed
stocks, U.S. bonds,
and money market
accounts 2,476 1,819
------- -------
Projected benefit obligation
in excess of plan
assets ( 880) ( 997)
Unrecognized net loss 434 356
Deferred asset gain ( 271) ( 157)
Unrecognized prior service
cost ( 47) ( 52)
Unrecognized net transition
asset ( 63) ( 78)
------- -------
Net pension liability $( 827) $( 928)
======= =======
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40
Net periodic pension expense included the following components:
Year Ended December 31
1997 1996 1995
----------------------------
(Thousands of dollars)
Service cost-benefits earned
during the period $ 255 $ 257 $ 208
Interest cost on projected
benefit obligation 227 206 176
Actual return on plan
assets (442) (277) (135)
Net amortization and
deferral 251 157 40
------ ----- -----
Net periodic pension cost $ 291 $ 343 $ 289
====== ===== =====
The weighted average discount rate used to determine the actuarial
present value of the projected benefit obligation was 7.25% and 7.75% at
December 31, 1997, and 1996, respectively. The rate of increase in future
compensation levels used to determine the actuarial present value of the
projected benefit obligation was 4.75% at December 31, 1997, and at December 31,
1996. The expected long-term rate of return on plan assets was 9% for the years
ended December 31, 1997, 1996, and 1995. The unrecognized prior service cost and
the cumulative net recognized gains and losses in excess of the greater of the
market value of plan assets and the projected benefit obligation are being
amortized using the optional straight-line method over the average expected
future service of active participants.
NOTE F Investment Operations
The sources of investment income are summarized as follows:
Year Ended December 31
------------------------------
1997 1996 1995
------------------------------
(Thousands of dollars)
Fixed maturities $2,694 $2,490 $3,155
Other long-term investments 44 48 36
Short-term investments 660 1,078 780
------------------------------
3,398 3,616 3,971
Investment expenses (413) (457) (474)
------------------------------
NET INVESTMENT INCOME $2,985 $3,159 $3,497
==============================
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41
The amortized cost and estimated market values of investments in fixed
maturities at December 31, 1997 and 1996, are as follows:
Gross Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
------------------------------------------
(Thousands of dollars)
Fixed Maturity Securities Available-for-Sale:
December 31, 1997:
U.S. Treasury
securities
and obligations of
U.S. governmental
corporations and
agencies $22,714 $ 178 $( 18) $22,874
Public utilities
and other 469 2 ( 6) 465
Mortgage-backed
securities 2,572 3 ( 630) 1,945
------------------------------------------
Total $25,755 $ 183 ( 654) $25,284
==========================================
Gross Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
------------------------------------------
(Thousands of dollars)
Fixed Maturity Securities Held-to-Maturity:
December 31, 1997:
U.S. Treasury securities
and obligations of
U.S. governmental
corporations and
agencies $2,940 $ 74 $( 1) $3,013
Obligations of states
and political
subdivisions 194 28 - 222
------------------------------------------
Total $3,134 $ 102 $( 1) $3,235
==========================================
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42
Gross Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
------------------------------------------
(Thousands of dollars)
Fixed Maturity Securities Available-for-Sale:
December 31, 1996:
U. S. Treasury securities
and obligations of U.S.
governmental
corporations and
agencies $17,449 $ 33 $( 111) $17,371
Public utilities 665 - ( 162) 503
Mortgage-backed
securities 18,824 291 ( 116) 18,999
------------------------------------------
Total $36,938 $324 $( 389) $36,873
==========================================
Gross Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
------------------------------------------
(Thousands of dollars)
Fixed Maturity Securities Held-to-Maturity:
December 31, 1996:
U.S. Treasury securities
and obligations of
U.S. governmental
corporations and
agencies $ 5,745 $ 58 $ (4) $ 5,799
Obligations of states
and political
subdivisions 193 30 - 223
------------------------------------------
Total $ 5,938 $ 88 $ (4) $ 6,022
==========================================
The amortized cost and estimated market value of fixed maturities at
December 31, 1997, by contractual maturity, are shown below. Expected maturities
may differ from contractual maturities as certain borrowers have the right to
call or prepay obligations without penalty.
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43
Estimated
Amortized Market
Cost Value
-----------------------
(Thousands of dollars)
Fixed Maturity Securities Available-for-Sale:
Due in one year or less $ 86 $ 86
Due after one year through
five years 10,355 10,346
Due after five years through
ten years 7,709 7,870
Due after ten years 5,033 5,037
-----------------------
23,183 23,339
Mortgage backed securities 2,572 1,945
-----------------------
$25,755 $25,284
=======================
Fixed Maturity Securities Held-to-Maturity:
Due in one year or less $ 1,002 $ 1,011
Due after one year through
five years 910 921
Due after five years through
ten years 1,222 1,303
Due after ten years - -
-----------------------
$3,134 $3,235
=======================
Realized gains and losses from sales of investments in fixed maturities
were as follows:
Year Ended December 31
1997 1996 1995
---------------------------
(Thousands of dollars)
Realized gains and losses:
Fixed maturity securities
available-for-sale:
Gross realized gains $ 367 $ 40 $ 123
Gross realized losses 171 - -
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44
The carrying value of investments in persons (other than the U.S.
Government or a Government Agency or Authority, State, Municipality, or
Political Subdivision) exceeding 10% of total shareholders' equity is as
follows:
December 31
---------------------
1997 1996
---------------------
(Thousands of dollars)
Southern Capital Corporation $ 3,431 $ 3,628
General Electric Capital Corporation $17,520 $ 8,903
NOTE G Reserves for Losses and Settlement Expenses
The consolidated financial statements include the estimated reserve for
losses and settlement expenses of the property and casualty insurance
subsidiaries. The subsidiaries primarily write commercial auto liability,
physical damage and cargo coverages and non-standard private passenger
automobile coverages. The liabilities for losses and settlement expenses are
determined using case basis evaluations and statistical projections and
represent estimates of the ultimate net cost of all unpaid losses and settlement
expenses incurred through December 31 of each year. These estimates give effect
to trends in claims severity and other factors which may vary as the liabilities
are ultimately settled. The estimates are continually reviewed and, as
adjustments to these liabilities become necessary, such adjustments are
reflected in current operations.
The following table provides a reconciliation of the beginning and
ending reserve balances for losses and settlement expenses, on a
gross-of-reinsurance basis, for 1997, 1996 and 1995, to the gross amounts
reported in McM's balance sheet.
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45
Year Ended December 31
-------------------------------
1997 1996 1995
-------------------------------
(Thousands of dollars)
Reserves for losses
and settlement expenses,
net of reinsurance
recoverables, at
beginning of year $26,532 $29,997 $38,415
Provision for insured
events of the current
year 42,243 37,651 31,282
Increase (decrease)in
provision for insured
events of prior years 5,774 1,559 (248)
-------------------------------
Incurred losses and
settlement expenses
during current year, net
of reinsurance 48,017 39,210 31,034
Payments for:
Losses and settlement
expenses attributable to
insured events of the
current year 26,123 22,853 18,113
Losses and settlement
expenses attributable to
insured events of prior
years 19,267 19,822 21,339
-------------------------------
45,390 42,675 39,452
-------------------------------
Reserves for losses and
settlement expenses, net
of reinsurance recoverables,
at end of year 29,159 26,532 29,997
Reinsurance recoverable on
unpaid losses and settlement
expenses at end of current
year 28,124 28,768 36,155
-------------------------------
Gross reserves for losses and
settlement expenses at end
of year $57,283 $55,300 $66,152
================================
The reconciliation above reflects the emergence of a $5,774,000
deficiency in the December 31, 1996, reserve during 1997. The deficiency at
December 31, 1997, included adverse reserve development of approximately
$844,000 in private passenger automobile liability reserves, $813,000 in private
passenger and commercial automobile physical damage and inland marine reserves
and $3,531,000 relating to the commercial
64
46
automobile liability line of business. In addition, approximately $586,000 of
this deficiency relates to discontinued lines of business and participation in
involuntary pools and other residual market mechanisms in which OF&C and
Wilshire are required to participate by the various states in which the
companies write insurance. The increase in overall reserve levels for 1997
resulted from prior year reserve deficiencies, particularly for the 1995 and
1996 accident years and increased claim costs in the current underwriting year
for commercial and private passenger automobile physical damage coverages.
The anticipated effect of inflation is implicitly considered when
estimating liabilities for losses and settlement expenses. While anticipated
cost increases due to inflation are considered in estimating the ultimate claim
costs, the increase in average severity of claims is caused by a number of
factors that vary with the individual type of policy written. Future average
severity is projected based on historical trends adjusted for anticipated
changes in these trends and general economic conditions. These anticipated
trends are monitored based on actual development and are modified as necessary.
NOTE H Contingencies
Litigation: In the normal course of operations, certain subsidiaries of the
Company have been named as parties to various pending and threatened litigation.
While the outcome of some of these matters cannot be estimated with certainty,
it is the opinion of management that the resolution of these matters will not
have a material adverse affect on the Company's consolidated financial position
or results of operations.
Guaranty Associations: The insurance subsidiaries are required to be members of
various state insurance guaranty associations in order to conduct business in
those states. These associations have the authority to assess member companies
in the event that an insurance company conducting business in that state is
unable to meet its policyholder obligations. The Company recognizes the expense
for these assessments in the year they are assessed. The Company incurred
expenses of $25,000 in 1997, and received net refunds of $26,000 and 12,000 in
1996 and 1995, respectively, related to these assessments.
NOTE I Stock Option Plan and Earnings Per Share
At December 31, 1996, the Company adopted Statement of Financial
Accounting Standards No. 123 "Accounting for Stock-Based Compensation" ("SFAS
123"). SFAS 123 introduces a fair-value based method of accounting for
stock-based compensation and encourages, but does not require, compensation
expense recognition for grants of stock, stock options and other equity
65
47
instruments to employees. In accordance with SFAS 123, the Company has elected
to continue to follow Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees" (APB 25) and related interpretations in
accounting for its employee stock options.
The Company had an Employee Incentive Stock Option Plan, the 1986
Employee Incentive Stock Option Plan ("1986 Plan"), which expired by its terms,
May 16, 1996. The 1986 Plan provided that options could be granted to selected
key employees at exercise prices equal to market value on the date the option is
granted. Options were granted for a period not exceeding ten years and were
exercisable at a rate of 20% per year starting one year from the date of grant.
Depending upon the circumstances of an optionee's termination of employment, the
optionee's options either a) remain exercisable for three or six months after
termination to the extent they were exercisable at termination unless vesting is
accelerated by the Compensation Committee, b) remain exercisable until a change
in control of the Company, as defined in the 1986 Plan, c) remain exercisable
for five years and one day from the date of the optionee's termination or d)
terminate as of the termination of the optionee's employment.
In 1996 the Company adopted the 1996 Employee Incentive Stock Option
Plan ("1996 Plan"). The terms of the 1996 Plan are are generally the same as the
1986 plan.
The Company had reserved 250,000 shares of common stock for
distribution under the 1986 Plan, and 300,000 shares have been reserved for
distribution under the 1996 Plan. The following options to purchase the
Company's common shares were outstanding under the 1986 and 1996 Plans as of
December 31, 1997 and 1996:
NUMBER OF SHARES
UNDERLYING
OUTSTANDING
OPTIONS
OPTION
PRICE
DATE OF GRANT 1997 1996 PER SHARE
- ---------------------------------------------------------------
January 15, 1988 1,000 1,000 $ 8.50
October 6, 1988 2,000 2,000 $10.00
January 15, 1993 42,962 42,962 $ 1.38
July 25, 1994 19,000 19,000 $ 2.25
August 17, 1994 81,000 81,000 $ 2.75
March 26, 1997 35,000 -0- $ 3.94
- ---------------------------------------------------------------
180,962 145,962
===============================================================
At December 31, 1997, 97,070 options were exercisable. No options have
been exercised under either Plan. The weighted-
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48
average exercise price is $2.71 per share and the weighted-average remaining
contractual life is 6.6 years at December 31, 1997.
The Company has a phantom stock plan under which shares of "phantom
stock" may be awarded to certain employees. A maximum of 250,000 shares of
phantom stock may be awarded under the plan. Upon maturity of an award, shares
of phantom stock are settled in cash equal to the market value of common shares
at the maturity date plus the amount of cash dividends paid on an equal number
of common shares over the life of the award. The awards generally vest over a
five year period beginning five years after the award date and mature on the two
year anniversary of the termination of the employee, or upon a change in control
(as defined in the plan) of the Company. There were no shares of phantom stock
granted in 1997. In 1996 and 1995, 50,000 shares of phantom stock were granted
under the plan. Related expenses of $10,000, $44,000 and $26,000 were accrued at
December 31, 1997, 1996, and 1995, respectively.
Pro forma information regarding net (loss) income and earnings per
share is required by SFAS 123, which also requires that the information be
determined as if the Company has accounted for its employee stock options and
awards granted subsequent to December 31, 1994, under the fair value method
prescribed by SFAS 123. The estimated fair value of the options was calculated
under the Black-Scholes valuation model using the following assumptions as of
December 31:
1997 1996 1995
----- ---- ----
Risk-free interest rate 6.96% 6.68% 6.10%
Dividend yield 0.00% 0.00% 0.00%
Volatility factor 63.5% 49.3% 33.5%
Expected life (years) 10 10 10
The pro forma basic and diluted net (loss) income per share did not
change from that which has been reported, for all periods presented, as a result
of SFAS 123. Further, because SFAS 123 is applicable only to stock-based awards
granted after December 31, 1994, the pro forma effect of the amortization of the
estimated fair value of the Company's outstanding stock is not likely to be
representative of the effects on the reported net (loss) income for future
years.
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49
NOTE J Summary of Fair Values
The method of determining fair values for investments in fixed maturity
securities is discussed in Note F. For all other financial instruments, carrying
value approximates fair value.
The following table summarizes the carrying value and fair value of
financial instruments:
December 31
1997 1996
----------------------------------------
Carrying Fair Carrying Fair
Value Value Value Value
----------------------------------------
(Thousands of dollars)
Financial Assets:
Cash $ 1,698 $ 1,698 $ 1,776 $ 1,776
Short-term investments $21,522 $21,522 $14,061 $14,061
Fixed maturity securities
available-for-sale
(Note F) $25,284 $25,284 $36,873 $36,873
Fixed maturity securities
held-to-maturity
(Note F) $ 3,134 $ 3,235 $ 5,938 $ 6,022
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50
Report of Independent Auditors
ERNST & YOUNG LLP
Board of Directors and Shareholders
McM Corporation
We have audited the accompanying consolidated balance sheets of McM
Corporation and subsidiaries as of December 31, 1997 and 1996, and the
related consolidated statements of operations, shareholders equity and
cash flows for each of the three years in the period ended December 31,
1997. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the
consolidated financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for
our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated financial position
of McM Corporation and subsidiaries at December 31, 1997 and 1996, and
the consolidated results of their operations and their cash flows for
each of the three years in the period ended December 31, 1997, in
conformity with generally accepted accounting principles.
Raleigh, North Carolina
March 9, 1998
ERNST & YOUNG LLP
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51
SUMMARY OF QUARTERLY RESULTS OF OPERATIONS
The following is a summary of quarterly results of operations for the years
ended December 31, 1997 and 1996.
- ------------------------------------------------------------------------------------------------------------------------------------
March 31 June 30 Sept. 30 Dec. 31
- ------------------------------------------------------------------------------------------------------------------------------------
(Thousands of dollars, except per share data)
1997
Premiums $13,848 $14,379 $13,892 $13,588
Investment Income, Less Investment Expense 740 764 768 713
Realized Gains 0 0 0 196
Losses and Expenses 14,377 15,230 19,432 19,038
Net Income (Loss) 308 27 (4,432) (4,443)
Net Income (Loss) Per Share * $0.07 $0.01 ($0.94) ($0.95)
Net Income (Loss) Per Share - assuming dilution * $0.07 $0.01 ($0.94) ($0.95)
1996
Premiums $12,758 $12,862 $12,883 $13,351
Investment Income, Less Investment Expense 890 717 764 788
Realized Gains 0 0 0 40
Losses and Expenses 13,038 13,087 13,305 17,056
Net Income (Loss) 671 598 423 (2,480)
Net Income (Loss) Per Share $0.14 $0.13 $0.09 ($0.53)
Net Income (Loss) Per Share - assuming dilution * $0.14 $0.13 $0.09 ($0.53)
* The sum of net income (loss) per share by quarter may not equal net income
(loss) per share for the year due to rounding. Addtionally, the year 1996
and first three quarters of 1997 net income (loss) per share have been
restated, where appropriate, to comply with the Statements of Financial
Accounting Standards No. 128, "Earnings Per Share".
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52
Officers and Directors
Officers
George E. King
Chairman Emeritus and
Chief Executive Officer
Stephen L. Stephano
President and
Chief Operating Officer
Michael D. Blinson
Senior Vice President
& Corporate Secretary
Kevin J. Hamm
Vice President &
Chief Financial Officer
Harold A. Strube
Vice President &
Assistant Corporate Secretary
Directors
Michael A. DiGregorio
Vice President/Senior Trust Counsel
Wilmington Trust Company
Wilmington, DE
George E. King
Chairman Emeritus and
Chief Executive Officer
McM Corporation
Raleigh, NC
Laurence F. Lee, Jr.
Retired
Jacksonville, FL
Laurence F. Lee III
President
Plan Analysts, Inc.
Jacksonville, FL
Claude G. Sanchez, Jr.
Sun Construction and Real
Estate Company
Albequerque, NM
Stephen L. Stephano
President and
Chief Operating Officer
McM Corporation
Raleigh, NC
R. Peyton Woodson III
President
Enterprise Holdings Proprietary, Inc.
Raleigh, NC
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53
Corporate Information
McM Corporation Corporate Office
702 Oberlin Road
P.O. Box 12317
Raleigh, North Carolina 27605
Telephone: (919)833-1600
Registrar-Transfer Agent
Wachovia Bank and Trust Company, N.A.
Winston-Salem, North Carolina
General Counsel
Ragsdale, Liggett & Foley, PLLC
Raleigh, North Carolina
Independent Auditors
Ernst & Young LLP
Raleigh, North Carolina
Form 10-K
Annual Report for the year ended December 31, 1997, has been
filed with the Securities and Exchange Commission. A copy will
be made available to shareholders without charge upon request.
Please write to Corporate Secretary at the Corporation's
Corporate Office.
Annual Meeting
The Annual Shareholders' Meeting of McM Corporation will be
held at the corporate offices of McM Corporation, 702 Oberlin
Road, Raleigh, North Carolina, on May 21, 1998, at 10:00 a.m.
72