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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 (Fee Required) For the fiscal year ended December 31, 1998
or
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (No Fee Required) For the transition period from
___________ to ___________
Commission file number: 1-5721
LEUCADIA NATIONAL CORPORATION
- --------------------------------------------------------------------------------
(Exact Name of Registrant as Specified in its Charter)
NEW YORK 13-2615557
- -------------------------------------- ----------------------------------------
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
315 PARK AVENUE SOUTH
NEW YORK, NEW YORK 10010
(212) 460-1900
- --------------------------------------------------------------------------------
(Address, Including Zip Code, and Telephone Number, Including Area Code,
of Registrant's Principal Executive Offices)
Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class on Which Registered
- -------------------------------------- ----------------------------------------
COMMON SHARES, PAR VALUE $1 PER SHARE NEW YORK STOCK EXCHANGE
PACIFIC STOCK EXCHANGE
7-3/4% SENIOR NOTES DUE AUGUST 15, 2013 NEW YORK STOCK EXCHANGE
8-1/4% SENIOR SUBORDINATED NOTES DUE
JUNE 15, 2005 NEW YORK STOCK EXCHANGE
7-7/8% SENIOR SUBORDINATED NOTES DUE
OCTOBER 15, 2006 NEW YORK STOCK EXCHANGE
Securities registered pursuant to Section 12(g) of the Act:
NONE.
- --------------------------------------------------------------------------------
(Title of Class)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [x] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statement
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [ ].
Aggregate market value of the voting stock of the registrant held by
non-affiliates of the registrant at March 12, 1999 (computed by reference to the
last reported closing sale price of the Common Stock on the New York Stock
Exchange on such date): $1,220,637,876.
On March 12, 1999, the registrant had outstanding 60,246,116 shares of Common
Stock.
DOCUMENTS INCORPORATED BY REFERENCE:
Certain portions of the registrant's definitive proxy statement pursuant to
Regulation 14A of the Securities Exchange Act of 1934 in connection with the
1999 annual meeting of shareholders of the registrant are incorporated by
reference into Part III of this Report.
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NYFS04...:\30\76830\0146\347\FRM1129V.19N
PART I
Item 1. Business.
THE COMPANY
The Company is a diversified financial services holding company
principally engaged in personal and commercial lines of property and casualty
insurance, banking and lending, manufacturing and real estate activities. The
Company concentrates on return on investment and cash flow to build long-term
shareholder value, rather than emphasizing volume or market share. Additionally,
the Company continuously evaluates the retention and disposition of its existing
operations and investigates possible acquisitions of new businesses in order to
maximize shareholder value.
Shareholders' equity has grown from a deficit of $7,657,000 at December
31, 1978 (prior to the acquisition of a controlling interest in the Company by
the Company's Chairman and President), to a positive shareholders' equity of
$1,853,159,000 at December 31, 1998, equal to a book value per common share of
the Company (a "Common Share") of negative $.11 at December 31, 1978 and $29.90
at December 31, 1998.
In 1998, the Company announced that it was considering the payment of a
significant cash dividend. The Company has received a ruling from the Internal
Revenue Service providing that any gain realized on such a dividend (up to a
maximum of approximately $812,000,000) would be treated as a capital gain. The
Company anticipates that, prior to the date of its 1999 Annual Meeting scheduled
for May 5, 1999, its Board of Directors will declare a dividend in an aggregate
amount of approximately $812,000,000, minus amounts paid to repurchase Common
Shares from March 17, 1999 through the date of declaration. Payment of such
dividend would require the Company to make an offer to purchase all of its
outstanding 8-1/4% Senior Subordinated Debentures due 2005 and its 7-7/8% Senior
Subordinated Debentures due 2006, outstanding in the aggregate principal amount
of $235,000,000, at a purchase price of 101% of principal, plus accrued and
unpaid interest thereon pursuant to the terms of the indentures governing these
Debentures. These offers would be required to be made within five business days
after the payment of such dividend, unless the terms of the Debentures can be
modified on terms that are acceptable to the Company.
As of December 31, 1998, the Company owned a 30% interest in Caja de
Ahorro y Seguro S.A. ("Caja"), a holding company whose subsidiaries are engaged
in property and casualty insurance, life insurance, workers' compensation
insurance and banking in Argentina. During 1998, the Company's previously
announced agreement to sell substantially all of its interest in Caja to its
Argentine partner was restructured. In March 1999, the Company sold all of its
interest in Caja to Assicurazioni Generali Group, an Italian insurance company,
for $126,000,000 in cash and a $40,000,000 collateralized note maturing April
2001 from its Argentine partner. The Company will record a pre-tax gain of
approximately $120,000,000 in its first quarter 1999 results of operations in
connection with this transaction.
In February 1999, the Company sold its entire interest in its Russian
joint venture to its joint venture partner, PepsiCo, Inc. for consideration of
approximately $39,190,000. Although the Company will recognize a pre-tax gain of
approximately $29,545,000 in the first quarter 1999 results of operations, when
combined with the Company's share of the joint venture's losses since inception,
the Company's net loss from this investment is approximately $40,310,000. For
more information concerning this transaction, see Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operations" of
this Report.
In February 1999, the Company sold its wholly-owned subsidiary, The Sperry
and Hutchinson Company, Inc. (through which the Company had conducted a trading
stamps business) and will reflect a pre-tax gain of approximately $19,000,000 in
its first quarter 1999 results of operations.
In the fourth quarter of 1998, the Company acquired a 95.4% interest in
Fidei S.A., a French company listed on the Paris Stock Exchange that is engaged
directly and through subsidiaries in real estate activities, for approximately
$62,300,000. In connection with this acquisition, the Company entered into
currency swap agreements to hedge approximately $55,000,000 of its foreign
currency exposure.
In September 1998, the Company reinsured substantially all of its life
insurance business to Allstate Life Insurance Company ("Allstate") and a
subsidiary thereof in an indemnity reinsurance transaction (the "Reinsurance
Transaction"). In December 1998, the Company agreed to sell its life insurance
subsidiaries, Charter National Life Insurance Company ("Charter") and
Intramerica Life Insurance Company ("Intramerica"), to Allstate. Consummation of
this transaction, which is expected to occur in the second quarter of 1999, is
subject to regulatory approval and the satisfaction of certain other conditions.
The transaction is expected to result in a pre-tax gain of approximately
$20,000,000, principally resulting from the recognition of deferred gains from
prior reinsurance transactions. The consolidated financial statements of the
Company included in this Report reflect the life insurance operations as
discontinued operations and the consolidated financial statements for prior
periods have been restated to be consistent with such presentation.
In 1998, the Company declared a special pro rata dividend to shareholders
of record on August 25, 1998 relating to the stock of HomeFed Corporation
("HomeFed"), a publicly held real estate development company. For additional
information concerning this dividend, see Item 5, "Market for Registrant's
Common Equity and Related Stockholder Matters" of this Report.
The Company's insurance operations consist of personal and commercial
property and casualty insurance primarily conducted through Empire Insurance
Company ("Empire") and Allcity Insurance Company ("Allcity"). For the year ended
December 31, 1998, these insurance operations accounted for 57% of the Company's
revenues from continuing operations and at December 31, 1998, 25% of the
Company's assets.
The Company's insurance operations have a diversified investment portfolio
of securities, of which approximately 84% are issued or guaranteed by the U.S.
Treasury or by U.S. governmental agencies or are rated "investment grade" by
Moody's Investors Service Inc. ("Moody's") and/or Standard & Poor's Corporation
("S&P").
The Company's banking and lending operations principally consist of making
instalment loans to niche markets primarily funded by customer banking deposits
insured by the Federal Deposit Insurance Corporation (the "FDIC"). The Company's
principal lending activities consist of providing collateralized personal
automobile loans to individuals with poor credit histories.
The Company's manufacturing operations manufacture and market plastic
netting used for a variety of purposes including, among other things,
construction, agriculture, packaging, carpet padding and filtration.
The Company and certain of its subsidiaries have tax loss carryforwards.
The amount and availability of the tax loss carryforwards are subject to certain
qualifications, limitations and uncertainties as more fully discussed in the
Notes to the Consolidated Financial Statements.
As used herein, the term "Company" refers to Leucadia National
Corporation, a New York corporation organized in 1968, and its subsidiaries,
except as the context otherwise may require.
2
FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
In 1998, the Company adopted Statement of Financial Accounting Standards
No. 131, "Disclosures about Segments of an Enterprise and Related Information"
("SFAS 131"), which requires a "management" approach for segment disclosure. The
management approach designates the internal organization that is used by
management for making operating decisions and assessing performance as the
source of the Company's reportable segments. SFAS 131 also requires disclosures
about products and services, geographic areas and major customers. The Company's
reportable segments consist of its operating units, which offer different
products and services and are managed separately. These reportable segments are:
property and casualty insurance, banking and lending, manufacturing and other
operations. The property and casualty insurance operations provide personal and
commercial lines of insurance primarily to niche markets in the New York
metropolitan area. The banking and lending operations principally make
collateralized personal automobile instalment loans to individuals who have
difficulty obtaining credit, at interest rates above those charged to
individuals with good credit histories. Such loans are primarily funded by
deposits insured by the FDIC. The manufacturing operations manufacture and
market proprietary plastic netting used for a variety of purposes. Other
operations primarily consist of real estate activities. Associated companies
consists of entities which the Company does not control but has the ability to
exercise significant influence over and which are accounted for on the equity
method of accounting. The information in the following tables for corporate
assets primarily consists of investments, notes receivable from the sale of
certain businesses and cash and cash equivalents. Corporate revenues primarily
consist of investment income on the above corporate assets. Corporate assets,
revenues, overhead expenses and interest expense are not allocated to the
operating units. The Company's business is conducted principally in the United
States; foreign operations and investments have not been material.
Certain information concerning the Company's segments for 1998, 1997 and
1996 is presented in the following table.
1998 1997 1996
---- ---- ----
(In millions)
Revenues:
- ---------
Property and Casualty Insurance $ 299.8 $ 363.2 $ 419.4
Banking and Lending 46.0 45.8 55.1
Manufacturing 56.6 133.7 148.4
Other Operations 69.9 102.0 55.8
------- ------- -------
Total revenue for reportable segments 472.3 644.7 678.7
Equity in Associated Companies 23.3 (56.5) (33.6)
Corporate (a) 34.9 42.5 25.3
------- ------- -------
Total consolidated revenues $ 530.5 $ 630.7 $ 670.4
======= ======= =======
3
1998 1997 1996
---- ---- ----
(In millions)
Income (loss) from continuing operations
before income taxes, minority expense of
trust preferred securities and
extraordinary loss:
- ----------------------------------------
Property and Casualty Insurance $ (7.9) $ 4.1 $ 22.4
Banking and Lending 13.9 5.8 14.5
Manufacturing 10.1 .3 .4
Other Operations 22.8 57.3 (1.3)
------- ------- -------
Total income (loss) from continuing
operations before income taxes,
minority expense of trust preferred
securities and extraordinary loss
for reportable segments 38.9 67.5 36.0
Equity in Associated Companies 23.3 (56.5) (33.6)
Corporate (a) (32.8) (35.2) (50.6)
-------- -------- --------
Total consolidated income (loss) from
continuing operations before income
taxes, minority expense of trust
preferred securities and
extraordinary loss $ 29.4 $ (24.2) $ (48.2)
======= ======= =======
Identifiable assets employed:
- -----------------------------
Property and Casualty Insurance $ 990.1 $1,047.8 $1,082.5
Banking and Lending 269.3 265.1 291.3
Manufacturing 41.8 45.4 68.7
Other Operations 673.6 170.0 218.9
-------- -------- --------
Total assets of reportable
segments 1,974.8 1,528.3 1,661.4
Investments in Associated Companies 172.4 207.9 202.5
Net Assets of Discontinued
Operations 45.0 71.9 596.1
Corporate 1,766.8 1,937.2 315.6
-------- -------- --------
Total consolidated assets $3,959.0 $3,745.3 $2,775.6
======== ======== ========
- ------------------
(a) Includes securities losses relating to the writedown of investments in
Russian and Polish securities, as described in Item 7, "Management's
Discussion and Analysis of Financial Condition and Operations" of this
Report.
At December 31, 1998, the Company and its consolidated subsidiaries had
1,391 full-time employees.
4
PROPERTY AND CASUALTY INSURANCE
General
The Company's principal property and casualty insurance operations are
conducted through the Empire Group, which consists of Empire and Allcity. The
Empire Group specializes in personal and commercial property and casualty
insurance business primarily in the New York metropolitan area. The Empire Group
provides personal automobile and homeowners insurance and commercial insurance
coverage for vehicles (including medallion and radio-controlled livery
vehicles), multi-family residential real estate, workers' compensation and
various other business classes. The Empire Group is rated "B+" (very good) by
A.M. Best Company ("Best") and rated "BBB+" (good) by S&P. As with all ratings,
Best and S&P ratings are subject to change at any time.
In 1998, a new president and chief executive officer was named at the
Empire Group and, effective in 1999, the business was reorganized into three
divisions: the Small Business Division, the Personal Lines and Residual Market
Division, and the Mid-Market Division. Each of these divisions has separate
management teams responsible for all marketing, sales and underwriting decisions
within their divisions. The reorganization is designed to provide a greater
degree of accountability for underwriting results and to create a closer
relationship with agents and customers of the Empire Group. The Small Business
Division will primarily focus on commercial package products for small
businesses; the Personal Lines and Residual Market Division will primarily
concentrate on personal automobile and homeowners insurance; and the Mid-Market
Division will focus on commercial auto, commercial package and workers'
compensation insurance for larger accounts.
For the years ended December 31, 1998, 1997 and 1996, net earned premiums
for the Empire Group were $228,600,000, $275,000,000 and $326,400,000,
respectively. The decline in the Empire Group's net earned premiums is primarily
due to the continuing reduction in the assigned risk business and reductions in
certain commercial lines. During the year ended December 31, 1998, approximately
56%, 30% and 14% of net earned premiums of the Empire Group were derived from
personal and commercial automobile lines, other commercial lines and other
personal lines, respectively. Substantially all of the Empire Group's policies
are written in New York for a one-year period. The Empire Group is licensed in
New York to write most lines of insurance that may be written by a property and
casualty insurer. The Empire Group is also licensed to write insurance in
Connecticut, Massachusetts, Missouri, New Hampshire and New Jersey.
The voluntary business of the Empire Group is produced through general
agents, local agents and insurance brokers, who are compensated for their
services by payment of commissions on the premiums they generate. There are
seven general agents, one of which is owned by Empire, and approximately 379
local agents and insurance brokers presently acting under agreements with the
Empire Group. These agents and brokers also represent other competing insurance
companies. The Empire Group's owned general agent is its largest producer and
generated approximately 12% of its total premium volume for the year ended
December 31, 1998.
The Empire Group has acquired blocks of assigned risk business from other
insurance companies (the "service business") relating to private passenger and
commercial automobile insurance. These contractual arrangements, which are
negotiated for one or two year periods, provide for fees paid to the Empire
Group within parameters established by the New York Insurance Department.
On a quarterly basis, the Empire Group reviews and adjusts its estimated
loss reserves for any changes in trends and actual loss experience. Included in
the Empire Group's results for 1998 was approximately $42,000,000 for reserve
strengthening related to losses from prior accident years. The Empire Group will
5
continue to evaluate the adequacy of its loss reserves and record future
adjustments to its loss reserves as appropriate. Beginning in 1996, the Empire
Group has taken certain steps to improve its operations, including systems
enhancements and actions relating to pricing and improved underwriting and
claims handling; these efforts have continued into 1999. In addition, the Empire
Group may initiate additional changes in the future. The Company believes that
the results of these efforts taken to date will not be known for some time,
given the nature of the property and casualty insurance business and the
inherently long period of time involved in settling claims.
Set forth below is certain statistical information for the Empire Group
prepared in accordance with generally accepted accounting principles ("GAAP")
and statutory accounting principles ("SAP"). The Loss Ratio is the ratio of net
incurred losses and loss adjustment expenses to net premiums earned. The Expense
Ratio is the ratio of underwriting expenses (policy acquisition costs,
commissions, and a portion of administrative, general and other expenses
attributable to underwriting operations) to net premiums written, if determined
in accordance with SAP, or to net premiums earned, if determined in accordance
with GAAP. A Combined Ratio below 100% indicates an underwriting profit and a
Combined Ratio above 100% indicates an underwriting loss. The Combined Ratio
does not include the effect of investment income.
YEAR ENDED DECEMBER 31,
---------------------------------
1998 1997 1996
---- ---- ----
Loss Ratio:
GAAP 102.6% 100.3% 92.1%
SAP 102.6% 100.3% 89.5%
Industry (SAP) (a) N/A 72.8% 78.4%
Expense Ratio:
GAAP 26.7% 18.2% 22.6%
SAP 31.4% 17.5% 18.4%
Industry (SAP) (a) N/A 28.8% 27.4%
Combined Ratio (b):
GAAP 129.3% 118.5% 114.7%
SAP 134.0% 117.8% 107.9%
Industry (SAP) (a) N/A 101.6% 105.8%
- ---------------
(a) Source: Best's Aggregates & Averages, Property/Casualty, 1998 Edition.
Industry Combined Ratios may not be fully comparable as a result of, among
other things, differences in geographical concentration and in the mix of
property and casualty insurance products.
(b) For 1998, the difference in the accounting treatment for curtailment
gains relating to defined benefit pension plans was the principal reason
for the difference between the GAAP Combined Ratio and the SAP Combined
Ratio. For 1996, a change in the statutory accounting treatment for
retrospectively rated reinsurance agreements was the principal reason
for the difference between the GAAP Combined Ratio and the SAP Combined
Ratio. Additionally for all three years, the difference relates to the
accounting for certain costs which are treated differently under SAP and
GAAP. For further information about the Empire Group's Combined Ratios,
see Item 7, "Management's Discussion and Analysis of Financial Condition
and Results of Operations," of this Report.
6
Losses and Loss Adjustment Expenses
Liabilities for unpaid losses, which are not discounted (except for
certain workers' compensation liabilities), and loss adjustment expenses ("LAE")
are determined using case-basis evaluations, statistical analyses and estimates
for salvage and subrogation recoverable and represent estimates of the ultimate
claim costs of all unpaid losses and LAE. Liabilities include a provision for
losses that have occurred but have not yet been reported. These estimates are
subject to the effect of trends in future claim severity and frequency
experience. Adjustments to such estimates are made from time to time due to
changes in such trends as well as changes in actual loss experience. These
adjustments are reflected in current earnings.
The Empire Group relies upon standard actuarial ultimate loss projection
techniques to obtain estimates of liabilities for losses and LAE. These
projections include the extrapolation of both losses paid and incurred by
business line and accident year and implicitly consider the impact of inflation
and claims settlement patterns upon ultimate claim costs based upon historical
patterns. In addition, methods based upon average loss costs, reported claim
counts and pure premiums are reviewed in order to obtain a range of estimates
for setting the reserve levels. For further input, changes in operations in
pertinent areas including underwriting standards, product mix, claims management
and legal climate are periodically reviewed.
In the following table, the liability for losses and LAE of the Empire
Group is reconciled for each of the three years ended December 31, 1998.
Included therein are current year data and prior year development.
7
RECONCILIATION OF LIABILITY FOR LOSSES AND
LOSS ADJUSTMENT EXPENSES
1998 1997 1996
---- ---- ----
(In thousands)
Net SAP liability for losses
and LAE at beginning of year $487,116 $481,138 $476,692
-------- --------- --------
Provision for losses and
LAE for claims occurring
in the current year 191,482 248,408 271,633
Increase in estimated
losses and LAE for
claims occurring in
prior years 42,290 27,027 28,183
-------- --------- --------
Total incurred losses
and LAE 233,772 275,435 299,816
-------- --------- --------
Losses and LAE payments for claims
occurring during:
Current year 64,739 80,149 93,036
Prior years 186,831 189,308 202,334
-------- --------- --------
251,570 269,457 295,370
-------- --------- --------
Net SAP liability for losses and
LAE at end of year 469,318 487,116 481,138
Reinsurance
recoverable 72,956 58,592 51,181
-------- --------- --------
Liability for losses and
LAE at end of year as
reported in financial
statements (GAAP) $542,274 $545,708 $532,319
======== ========= ========
The following table presents the development of balance sheet liabilities
from 1988 through 1998 for the Empire Group. The liability line at the top of
the table indicates the estimated liability for unpaid losses and LAE recorded
as of the dates indicated. The middle section of the table shows the
re-estimated amount of the previously recorded liability based on experience as
of the end of each succeeding year. As more information becomes available and
claims are settled, the estimated liabilities are adjusted upward or downward
with the effect of decreasing or increasing net income at the time of
adjustment. The lower section of the table shows the cumulative amount paid with
respect to the previously recorded liability as of the end of each succeeding
year.
The "cumulative redundancy (deficiency)" represents the aggregate change
in the estimates over all prior years. For example, the initial 1988 liability
estimate indicated on the table of $222,814,000 has been
8
re-estimated during the course of the succeeding ten years, resulting in a
re-estimated liability at December 31, 1998 of $210,837,000, or a redundancy of
$11,977,000. If the re-estimated liability exceeded the liability initially
established, a cumulative deficiency would be indicated.
In evaluating this information, it should be noted that each amount shown
for "cumulative redundancy (deficiency)" includes the effects of all changes in
amounts for prior periods. For example, the amount of the redundancy
(deficiency) related to losses settled in 1992, but incurred in 1988, will be
included in the cumulative redundancy (deficiency) amount for 1988, 1989, 1990
and 1991. This table is not intended to and does not present accident or policy
year loss and LAE development data. Conditions and trends that have affected
development of the liability in the past may not necessarily occur in the
future. Accordingly, it would not be appropriate to extrapolate future
redundancies or deficiencies based on these tables.
For further discussion of the Empire Group's loss development experience,
see Item 7, "Management's Discussion and Analysis of Financial Condition and
Results of Operations" of this Report.
9
ANALYSIS OF LOSS AND LOSS ADJUSTMENT EXPENSE DEVELOPMENT
Year Ended December 31,
--------------------------------------------------------------------------------------------------------------------
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
(In thousands)
Liability
for Unpaid
Losses and Loss
Adjustment
Expenses $222,814 $235,223 $251,401 $280,679 $322,516 $353,917 $ 406,695 $ 476,692 $481,138 $487,116 $469,318
Liability
Re-estimated
as of:
One Year Later $213,671 $227,832 $249,492 $280,020 $321,954 $344,156 $ 441,165 $ 504,875 $508,165 $529,406 $ -
Two Years Later 206,088 217,432 245,141 277,866 324,262 374,158 467,659 537,372 546,724
Three Years Later 198,500 212,649 243,849 284,052 345,576 394,418 500,286 577,266
Four Years Later 194,324 211,859 247,314 296,484 361,903 415,251 534,014
Five Years Later 196,070 211,952 255,045 306,094 377,097 442,696
Six Years Later 196,646 216,545 260,031 316,887 395,291
Seven Years Later 199,502 219,786 265,525 330,866
Eight Years Later 201,600 222,556 277,626
Nine Years Later 202,989 231,152
Ten Years Later 210,837
Cumulative
Redundancy
(Deficiency) $ 11,977 $ 4,071 $(26,225) $(50,187) $(72,775) $(88,779) $(127,319)$(100,574) $(65,586) $(42,290) $ -
======== ======== ======== ======== ======== ======== ========= ========= ======== ======== ========
Cumulative
Amount of
Liability Paid
Through:
One Year Later $ 64,140 $ 65,822 $ 78,954 $ 89,559 $113,226 $116,986 $ 152,904 $ 202,334 $189,308 $186,831 $ -
Two Years Later 101,206 109,479 126,908 150,043 182,250 199,214 270,020 318,693 314,755
Three Years Later 131,705 140,916 167,330 197,848 239,092 272,513 353,649 407,833
Four Years Later 152,330 166,023 196,099 233,244 285,880 326,637 415,919
Five Years Later 168,117 182,001 216,749 259,946 320,044 363,873
Six Years Later 178,095 193,943 231,892 279,682 341,636
Seven Years Later 185,310 203,169 242,275 293,860
Eight Years Later 191,292 209,115 253,104
Nine Years Later 194,965 214,687
Ten Years Later 198,618
Gross Liability -
End of Year $ 391,829 $ 451,442 $ 517,422 $532,319 $545,708 $542,274
Reinsurance 37,912 44,747 40,730 51,181 58,592 72,956
--------- --------- --------- -------- -------- --------
Net Liability -
End of Year as
Shown Above $ 353,917 $ 406,695 $ 476,692 $481,138 $487,116 $469,318
========= ========= ========= ======== ======== ========
Gross Re-estimated
Liability - Latest $ 514,882 $ 605,549 $ 649,486 $623,588 $592,063
Re-estimated
Reinsurance - Latest 72,186 71,535 72,220 76,864 62,657
--------- --------- --------- -------- --------
Net Re-estimated
Liability - Latest $ 442,696 $ 534,014 $ 577,266 $546,724 $529,406
========= ========= ========= ======== ========
Gross Cumulative
(Deficiency) $(123,053) $(154,107) $(132,064) $(91,269) $(46,355)
========= ========= ========= ======== ========
10
Investments
Investment activities represent a significant part of the Company's
insurance related revenues and profitability. Investments are managed by the
Company's investment advisors under the direction of, and upon consultation
with, the Company's investment committees.
The Company's insurance subsidiaries have a diversified investment
portfolio of securities, substantially all of which are rated "investment grade"
by Moody's and/or S&P or issued or guaranteed by the U.S. Treasury or by
governmental agencies. The Company's insurance subsidiaries do not generally
invest in less than "investment grade" or "non-rated" securities, real estate or
mortgages, although from time to time they may make such investments in amounts
not expected to be material.
The composition of the Company's insurance subsidiaries' investment
portfolio as of December 31, 1998 and 1997 was as follows:
1998 1997
---- ----
(Dollars in thousands)
Bonds and notes:
U.S. Government and agencies 76% 87%
Rated investment grade 8 11
Non rated - other 4 1
Rated less than investment grade - -
Equity securities, primarily preferred 10 -
Other, principally accrued interest 2 1
--- ---
Total 100% 100%
=== ===
Estimated average yield to maturity
of bonds and notes (a) 5.3% 6.1%
Estimated average remaining
life of bonds and notes (a) 3.3 yrs. 3.5 yrs.
Carrying value of investment portfolio $748,818 $869,073
Market value of investment portfolio $749,147 $869,232
- -------------------------
(a) Excludes trading securities, which are not significant.
Reinsurance
The Empire Group's maximum retained limit was $500,000 for workers'
compensation; for other property and casualty lines, the Empire Group's maximum
retained limit was $300,000 for 1998, 1997 and 1996. Additionally, the Empire
Group has entered into certain excess of loss and catastrophe treaties to
protect against certain losses. The Empire Group's retention of lower level
losses in such treaties is $7,500,000 for 1999, and was $7,500,000 for 1998,
$5,000,000 for 1997 and $3,000,000 for 1996.
Although reinsurance does not legally discharge an insurer from its
primary liability for the full amount of the policy liability, it does make the
assuming reinsurer liable to the insurer to the extent of the reinsurance ceded.
The Company's reinsurance generally has been placed with certain of the largest
reinsurance companies, including (with their respective Best ratings) American
Re-Insurance Company (A++), General Reinsurance Corporation (A++) and Zurich
Reinsurance (North America), Inc. (A). The Company has reinsured substantially
all of its discontinued life insurance operations pursuant to the Reinsurance
Transaction with Allstate and certain other transactions. As mentioned above,
the Company has agreed to sell its remaining life insurance subsidiaries to
Allstate, and expects to close this sale in the second quarter of 1999. The
Company believes its reinsurers to be financially capable of meeting their
respective obligations. However, to the extent that any reinsuring company is
unable to meet its
11
obligations, the Company's insurance subsidiaries would be liable for the
reinsured risks. The Company has established reserves, which the Company
believes are adequate, for any nonrecoverable reinsurance.
Competition
The insurance industry is a highly competitive industry, in which many of
the Company's competitors have substantially greater financial resources, larger
sales forces, more widespread agency and broker relationships, and more
diversified lines of insurance coverage. Additionally, certain competitors
market their products with endorsements from affinity groups, while the
Company's products are unendorsed, which may give these other companies a
competitive advantage. Federal administrative, legislative and judicial activity
may result in changes to federal banking laws that increase the ability of
national banks to offer insurance products in direct competition with the
Company. The Company is unable to determine what effect, if any, such changes
may have on the Company's operations.
The Company believes that property and casualty insurers generally compete
on the basis of price, customer service, consumer recognition, product design,
product mix and financial stability. The industry has historically been cyclical
in nature, with periods of less intense price competition generating significant
profits, followed by periods of increased price competition resulting in reduced
profitability or loss. The current cycle of intense price competition has
continued for a longer period than in the past, suggesting that the significant
infusion of capital into the industry in recent years, coupled with larger
investment returns has been, and may continue to be, a depressing influence on
policy rates. In addition, the Company is experiencing increased competition
from low cost insurance providers that write personal lines business on a direct
response basis through direct mail and telemarketing. The profitability of the
property and casualty insurance industry is affected by many factors, including
rate competition, severity and frequency of claims (including catastrophe
losses), interest rates, state regulation, court decisions and judicial climate,
all of which are outside the Company's control.
Government Regulation
Insurance companies are subject to detailed regulation and supervision in
the states in which they transact business. Such regulation pertains to matters
such as approving policy forms and various premium rates, minimum reserves and
loss ratio requirements, the type and amount of investments, minimum capital and
surplus requirements, granting and revoking licenses to transact business,
levels of operations and regulating trade practices. Insurance companies are
required to file detailed annual reports with the supervisory agencies in each
of the states in which they do business, and are subject to examination by such
agencies at any time. Increased regulation of insurance companies at the state
level and new regulation at the federal level is possible, although the Company
cannot predict the nature or extent of any such regulation or what impact it
would have on the Company's operations.
The National Association of Insurance Commissioners ("NAIC") has adopted
model laws incorporating the concept of a "risk based capital" ("RBC")
requirement for insurance companies. Generally, the RBC formula is designed to
measure the adequacy of an insurer's statutory capital in relation to the risks
inherent in its business. The RBC formula is used by the states as an early
warning tool to identify weakly capitalized companies for the purpose of
initiating regulatory action. The Company's continuing insurance operations' RBC
ratio as of December 31, 1998 exceeded minimum requirements. The NAIC also has
adopted various ratios for insurance companies which, in addition to the RBC
ratio, are designed to serve as a tool to assist state regulators in discovering
potential weakly capitalized companies or companies with unusual trends. While
the Company's continuing insurance operations had certain "other than normal"
NAIC ratios for the year ended December 31, 1998, the Company believes that
there are no material underlying problems or weaknesses in its insurance
operations and that it is unlikely that material adverse regulatory action will
be taken.
12
The Company's insurance subsidiaries are members of state insurance funds
which provide certain protection to policyholders of insolvent insurers doing
business in those states. Due to insolvencies of certain insurers in recent
years, the Company's insurance subsidiaries have been assessed certain amounts
which have not been material and are likely to be assessed additional amounts by
state insurance funds. The Company believes that it has provided for all
anticipated assessments and that any additional assessments will not have a
material adverse effect on the Company's financial condition or results of
operations.
BANKING AND LENDING
The Company's banking and lending operations principally are conducted
through American Investment Bank, N.A. ("AIB"), a national bank subsidiary, and
American Investment Financial ("AIF"), an industrial loan corporation. AIB and
AIF take money market and other non-demand deposits that are eligible for
insurance provided by the FDIC. AIB and AIF had deposits of $189,782,000 and
$198,582,000 at December 31, 1998 and 1997, respectively. AIB and AIF currently
have several deposit-taking and lending facilities in the Salt Lake City area.
The funds generated by the deposits are primarily used to fund consumer
instalment loans.
The Company's consolidated banking and lending operations had outstanding
loans (net of unearned finance charges) of $185,183,000 and $202,938,000 at
December 31, 1998 and 1997, respectively. At December 31, 1998, 76% were loans
to individuals generally collateralized by automobiles; 12% were instalment
loans to consumers, substantially all of which were collateralized by real or
personal property; 5% were unsecured loans to individuals acquired from others
in connection with investments in limited partnerships; 4% were unsecured loans
to executives and professionals, generally with good credit histories; and 3%
were loans to small businesses.
It is the Company's policy to charge to income an allowance for losses
which, based upon management's analysis of numerous factors, including current
economic trends, aging of the loan portfolio and historical loss experience, is
deemed adequate to cover reasonably expected losses on outstanding loans. At
December 31, 1998, the allowance for loan losses for the Company's entire loan
portfolio was $9,398,000 or 5.1% of the net outstanding loans, compared to
$10,199,000 or 5% of net outstanding loans at December 31, 1997.
Collateralized personal automobile instalment loans are made to
individuals who have difficulty obtaining credit, at interest rates above those
charged to individuals with good credit histories. In determining which
individuals qualify for these loans, the Company takes into account a number of
highly selective criteria with respect to the individual as well as the
collateral to attempt to minimize the number of defaults. Additionally, the
Company closely monitors these loans and takes prompt possession of the
collateral in the event of a default. For the three year period ended December
31, 1998, the Company generated $146,085,000 of these loans ($72,848,000 during
1998). Due in part to the recent failures of some of the Company's competitors,
the Company has been able to increase its new loan volume at acceptable risk
levels. In addition, during 1998 the Company purchased a $36,900,000 portfolio
of such loans. The Company intends to continue to acquire additional portfolios
of such loans that meet the Company's underwriting standards if they can be
purchased on attractive terms. During 1998, AIB and AIF sold substantially all
of their executive and professional loan portfolios for aggregate proceeds of
$89,500,000.
The Company's banking and lending operations compete with banks, savings
and loan associations, credit unions, credit card issuers and consumer finance
companies, many of which are able to offer financial services on very
competitive terms. Additionally, substantial national financial services
networks have been formed by major brokerage firms, insurance companies,
retailers and bank holding companies. Some competitors have substantial local
market positions; others are part of large, diversified organizations.
13
The Company's principal banking and lending operations are subject to
detailed supervision by state authorities, as well as federal regulation
pursuant to the Federal Consumer Credit Protection Act and regulations
promulgated by the Federal Trade Commission. The Company's banking operations
are subject to federal and state regulation and supervision by, among others,
the Office of the Comptroller of the Currency (the "OCC"), the FDIC and the
State of Utah. AIB's primary federal regulator is the OCC, while the primary
federal regulator for AIF is the FDIC.
The Competitive Equality Banking Act of 1987 ("CEBA") places certain
restrictions on the operations of AIB and restricts further acquisitions of
banks and savings institutions by the Company. CEBA does not restrict AIF as
currently operated.
MANUFACTURING
Through its plastics division, the Company manufactures and markets
proprietary plastic netting used for a variety of purposes including, among
other things, construction, agriculture, packaging, carpet padding and
filtration. The plastics division markets its products both domestically and
internationally, with approximately 13% of its 1998 sales exported to Europe,
Latin America, Japan and Australia. New product development focuses on niches
where the division's proprietary technology and expertise can lead to
sustainable competitive economic advantages. For the years ended December 31,
1998, 1997 and 1996, the plastics division's revenues were approximately
$56,600,000, $50,900,000 and $47,600,000, respectively.
The plastics division is subject to domestic and international
competition, generally on the basis of price, service and quality. Additionally,
certain products are dependent on cyclical industries, including the
construction industry. The Company holds patents on certain improvements to the
basic manufacturing processes and on applications thereof. The Company believes
that the expiration of these patents, individually or in the aggregate, is
unlikely to have a material effect on the plastics division.
OTHER OPERATIONS
The Company has a 90% interest in two operating wineries, Pine Ridge
Winery in Napa Valley, California and Archery Summit in the Willamette Valley of
Oregon. Pine Ridge, which was acquired in 1991, has been an operating winery
since 1981, while Archery Summit was started by the Company in 1993. These
wineries produce and sell super-ultra-premium wines. During 1998, the wineries
sold approximately 62,000 9-liter equivalent cases of wine generating revenues
of approximately $8,987,000. Since acquisition, the Company's investment in
winery operations has grown, principally to fund the Company's acquisition of
land for vineyard development and to increase production capacity and storage
facilities at both of the wineries. It can take up to five years for a new
vineyard property to reach full production and, depending upon the varietal
produced, up to an additional two years before the wine can be sold. At December
31, 1998, the Company's combined investment in these wineries was approximately
$49,000,000.
At December 31, 1998, the carrying value of the Company's real estate
investments totaled $397,404,000. Of such amount, approximately $245,870,000
consists of real estate assets held by the Company's 95.4% French subsidiary,
Fidei. These assets consisted of 150 buildings (primarily office buildings
located in Paris, France and its environs) totaling more than 3,500,000 square
feet of space. The Company acquired Fidei to maximize its value by marketing all
of its real estate holdings for sale. The remainder of the Company's real estate
investments consist of a variety of domestic projects, some of which are in the
process of development and all of which are available for sale. Included in the
Company's domestic real estate is an office complex located on Capitol Hill in
Washington, D.C. This complex consists of two office buildings with a total of
630,000 square feet of rentable office and retail space and two underground
garages. A comprehensive renovation upgrade to the building is in process. The
D.C. Government has signed a ten year lease for the
14
space and full occupancy is anticipated in the second quarter of 1999. At
December 31, 1998, the Company's investment in this complex had a carrying value
of $60,200,000.
OTHER INVESTMENTS
The Company owns equity interests representing more than 5% of the
outstanding capital stock of each of the following domestic public companies at
December 31, 1998: Carmike Cinemas, Inc. ("Carmike") (approximately 6% of Class
A shares), GFSI Holdings, Inc. ("GFSI") (approximately 6%), Jordan Industries,
Inc. ("JII") (approximately 10%) , Jordan Telecommunications Products, Inc.
("JTP") (approximately 10%) and MK Gold Company ("MK Gold") (approximately 46%).
During 1998, the Company's previously announced agreement to sell
substantially all of its interest in Caja to its Argentine partner was
restructured, and in March 1999, the Company sold all of its interest in Caja to
Assicurazioni Generali Group for $126,000,000 in cash and a $40,000,000
collateralized note maturing April 2001 from its Argentine partner. The Company
will record a pre-tax gain of approximately $120,000,000 in its first quarter
1999 results of operations in connection with this transaction.
A subsidiary of the Company is an owner in The Jordan Company LLC and
Jordan/Zalaznick Capital Company. These entities each specialize in structuring
leveraged buyouts in which the owners are given the opportunity to become equity
participants. Since 1982, the Company has invested an aggregate of $68,021,000
in these entities and related companies and, through December 31, 1998, has
received $104,456,000 (including cash, interest bearing notes and other
receivables) relating to the disposition of investments and management and other
fees. At December 31, 1998, through these entities, the Company had interests in
JII, JTP, Carmike, GFSI and a total of 21 other companies, which in total are
carried in the Company's consolidated financial statements at $27,564,000.
For further information about the Company's business, reference is made to
Item 7, "Management's Discussion and Analysis of Financial Condition and Results
of Operations," of this Report and Notes to Consolidated Financial Statements.
Item 2. Properties.
Through its various subsidiaries, the Company owns and utilizes in its
operations two offices in Salt Lake City, Utah used for corporate and banking
and lending activities (totaling approximately 77,000 sq. ft.). In addition, a
subsidiary of the Company owns a facility (totaling approximately 158,500 sq.
ft.) primarily used for manufacturing located in Georgia.
The Company and its subsidiaries lease numerous manufacturing,
warehousing, office and headquarters facilities. The facilities vary in size and
have leases expiring at various times, subject, in certain instances, to renewal
options. See Notes to Consolidated Financial Statements.
Item 3. Legal Proceedings.
On May 11, 1994, a shareholder of the Company filed a purported derivative
action entitled Pinnacle Consultants, Ltd. v. Leucadia National Corporation, et
al. (C.A. No. 94 Civ. 3496) against the Company's current Board of Directors and
two former directors, John W. Jordan II and Melvin Hirsch. The action, which was
filed in the United States District Court for the Southern District of New York,
alleged certain Racketeer Influence and Corrupt Organizations Act, securities
law, conversion and fraud claims. On December 10, 1996, the Second Circuit Court
of Appeals affirmed the judgment of the District Court dismissing these claims.
15
On May 13, 1997, Pinnacle filed a purported derivative complaint in New
York State Supreme Court. The action, entitled Pinnacle Consultants, Ltd. v.
Leucadia National Corp., et al. (no. 602470/97), is substantially similar to the
federal court complaint that was dismissed in 1996. Pinnacle has alleged claims
for fraud, waste, breach of fiduciary duty and conversion against the same
current and former Leucadia directors who were named as defendants in the
federal court action. Defendants' motion to dismiss was granted in part and
denied in part. This decision is being appealed to the Appellate Division, First
Department, by Pinnacle and the defendants. The appeal remains sub judice.
In addition to the foregoing, the Company and its subsidiaries are parties
to legal proceedings that are considered to be either ordinary, routine
litigation incidental to their business or not material to the Company's
consolidated financial position.
The Company does not believe that any of the foregoing actions will have a
material adverse effect on its consolidated financial position or consolidated
results of operations.
16
Item 10. Executive Officers of the Registrant.
All executive officers of the Company are elected at the organizational
meeting of the Board of Directors of the Company held annually and serve at the
pleasure of the Board of Directors. As of March 12, 1999, the executive officers
of the Company, their ages, the positions held by them and the periods during
which they have served in such positions were as follows:
NAME AGE POSITION WITH LEUCADIA OFFICE HELD SINCE
- ---- --- ---------------------- -----------------
Ian M. Cumming 58 Chairman of the Board June 1978
Joseph S. Steinberg 55 President January 1979
Thomas E. Mara 53 Executive Vice President May 1980;
and Treasurer January 1993
Joseph A. Orlando 43 Vice President and January 1994;
Chief Financial Officer April 1996
Barbara L. Lowenthal 44 Vice President and April 1996
Comptroller
Paul J. Borden 50 Vice President August 1988
Mark Hornstein 51 Vice President July 1983
Mr. Cumming has served as a director and Chairman of the Board of the
Company since June 1978. In addition, he has served as a director of Allcity
since February 1988 and MK Gold since June 1995. Mr. Cumming has also been a
director of Skywest, Inc., a Utah-based regional air carrier, since June 1986.
Mr. Steinberg has served as a director of the Company since December 1978
and as President of the Company since January 1979. In addition, he has served
as a director of Allcity since February 1988, as a director of MK Gold since
June 1995, as a director of JII since June 1988, and as a director of HomeFed, a
California real estate developer, since August 1998.
Mr. Mara joined the Company in April 1977 and was elected Vice President
of the Company in May 1977. He has served as Executive Vice President of the
Company since May 1980 and as Treasurer of the Company since January 1993. In
addition, he has served as a director of Allcity since October 1994.
Mr. Orlando, a certified public accountant, has served as Chief Financial
Officer of the Company since April 1996 and as Vice President of the Company
since January 1994. Mr. Orlando previously served in a variety of capacities
with the Company and its subsidiaries since 1987, including Comptroller of the
Company from March 1994 to April 1996. In addition, he served as a director of
Allcity since October 1998.
Ms. Lowenthal, a certified public accountant, has served as Vice President
and Comptroller of the Company since April 1996. For the prior four years, Ms.
Lowenthal served as Director of Policies, Systems and Procedures and Assistant
Controller of W.R. Grace & Co., a specialty chemicals company.
Mr. Borden joined the Company as Vice President in August 1988 and has
served in a variety of other capacities with the Company and its subsidiaries.
Mr. Borden has served as a director of HomeFed since May 1998.
Mr. Hornstein joined the Company as Vice President in July 1983 and has
served in a variety of other capacities with the Company and its subsidiaries.
17
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
(a) Market Information.
The Common Shares of the Company are traded on the New York Stock Exchange
and Pacific Stock Exchange under the symbol LUK. The following table sets forth,
for the calendar periods indicated, the high and low sales price per Common
Share on the consolidated transaction reporting system, as reported by the Dow
Jones Historical Stock Quote Reporter Service.
COMMON SHARE
------------
HIGH LOW
---- ---
1997
----
First Quarter $29.00 $25.75
Second Quarter 31.88 27.38
Third Quarter 34.75 31.00
Fourth Quarter 36.63 33.00
1998
----
First Quarter $41.13 $33.56
Second Quarter 40.13 32.81
Third Quarter 34.75 27.63
Fourth Quarter 32.38 26.25
1999
----
First Quarter (through March 12, 1999) $33.06 $29.50
(b) Holders.
As of March 12, 1999, there were approximately 3,685 record holders of the
Common Shares.
(c) Dividends.
The Company paid a cash dividend of $.25 per Common Share on December 31,
1997. The payment of dividends in the future is subject to the discretion of the
Board of Directors and will depend upon general business conditions, legal and
contractual restrictions on the payment of dividends and other factors that the
Board of Directors may deem to be relevant.
The HomeFed Dividend. The Company acquired a 41.2% interest in HomeFed in
1995. HomeFed is a publicly traded real estate development company (OTC
(Non-NASDAQ): "HFDC") with its principal office at 1903 Wright Place, Suite 220,
Carlsbad, California 92008 (telephone number 706-918-8200).
In 1998, the Company distributed to its shareholders of record on August
25, 1998 (the "HomeFed Dividend Holders") a pro rata dividend of all of the
beneficial interests in a trust that holds 41.2% of the common stock of HomeFed
and contracts to increase that ownership to 89.6% of HomeFed. This dividend
resulted in 1998 dividend income to the HomeFed Dividend Holders of $.1426 for
each Common Share of the Company held on August 25, 1998, even though no
physical distribution was made because the trust interests are uncertificated. A
Form 1099-DIV was sent to HomeFed Dividend Holders reflecting this distribution.
18
The Company anticipates that, following effectiveness of a registration
statement to be filed with respect to the HomeFed shares, the HomeFed Dividend
Holders will receive 1.0 share of HomeFed common stock for each 1.26 Common
Shares of the Company owned of record on August 25, 1998. The Company expects
that the distribution of HomeFed securities will be made in the third quarter of
1999.
In connection with the declaration of dividends or the making of
distributions on, or the purchase, redemption or other acquisition of Common
Shares, the Company is required to comply with certain restrictions contained in
certain of its debt instruments. The Company's regulated subsidiaries are
restricted in the amount of distributions that can be made to the Company
without regulatory approval. For further information see Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
included in this Report.
19
Item 6. Selected Financial Data.
The following selected financial data have been summarized from the
Company's consolidated financial statements and are qualified in their entirety
by reference to, and should be read in conjunction with, such consolidated
financial statements and Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations," of this Report.
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(In thousands, except per share amounts)
SELECTED INCOME STATEMENT DATA:
Revenues $530,506 $630,737 $670,443 $753,999 $646,380
Net securities gains (losses) (60,871) 3,249 24,117 15,101 (7,239)
Interest expense (a) 45,139 46,007 53,599 52,538 43,751
Insurance losses, policy benefits and
amortization of deferred acquisition costs 279,110 327,468 355,148 364,957 292,872
Income (loss) from continuing operations
before income taxes, minority expense of
trust preferred securities and extraordinary loss 29,377 (24,238) (48,187) 10,286 (11,477)
Income (loss) from continuing operations
before minority expense of trust preferred
securities and extraordinary loss 54,450 (14,347) (28,861) 24,203 (3,731)
Minority expense of trust preferred securities,
net of taxes (8,248) (7,942) - - -
Income (loss) from continuing operations
before extraordinary loss 46,202 (22,289) (28,861) 24,203 (3,731)
Income from discontinued operations, including
gain on sale, net of taxes 8,141 686,161 84,376 83,300 74,567
Extraordinary loss from early
extinguishment of debt, net of taxes - (2,057) (6,838) - -
Net income 54,343 661,815 48,677 107,503 70,836
Per share:
Basic earnings (loss) per common share:
Income (loss) from continuing operations
before extraordinary loss $.73 $ (.36) $(.48) $ .42 $(.07)
Income from discontinued operations, including
gain on sale .13 11.03 1.40 1.45 1.33
Extraordinary loss - (.03) (.11) - -
---- ------ ----- ----- -----
Net income $.86 $10.64 $ .81 $1.87 $1.26
==== ====== ===== ===== =====
Diluted earnings (loss) per common share:
Income (loss) from continuing operations
before extraordinary loss $.73 $ (.36) $(.48) $ .41 $(.07)
Income from discontinued operations, including .13 11.03 1.40 1.40 1.33
gain on sale
Extraordinary loss - (.03) (.11) - -
---- ------ ----- ----- -----
Net income $.86 $10.64 $ .81 $1.81 $1.26
==== ====== ===== ===== =====
AT DECEMBER 31,
--------------------------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(In thousands, except per share amounts)
SELECTED BALANCE SHEET DATA:
Cash and investments $2,229,895 $2,453,555 $1,246,220 $1,250,746 $ 940,993
Total assets 3,958,951 3,745,336 2,776,591 2,766,501 2,343,295
Debt, including current maturities 722,601 352,872 520,263 513,810 422,166
Customer banking deposits 189,782 198,582 209,261 203,061 179,888
Common shareholders' equity 1,853,159 1,863,531 1,118,107 1,111,491 881,815
Book value per common share $29.90 $29.17 $18.51 $18.47 $15.72
Cash dividends per common share $ - $ .25 $ .25 $ .25 $ .13
20
YEAR ENDED DECEMBER 31,
--------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
SELECTED INFORMATION ON PROPERTY AND
CASUALTY INSURANCE OPERATIONS (Unaudited): (b)
GAAP Combined Ratio 129.3% 118.5% 114.7% 113.0% 103.5%
SAP Combined Ratio 134.0% 117.8% 107.9% 107.4% 101.3%
Industry SAP Combined Ratio (c) N/A 101.6% 105.8% 106.4% 108.4%
Premium to Surplus Ratio (d) 1.2x 1.4x 1.8x 2.2x 2.3x
- ---------------------
(a) Includes interest on customer banking deposits.
(b) The Combined Ratio does not reflect the effect of investment income. For
1998, the difference in the accounting treatment for curtailment gains
relating to the defined benefit pension plans was the principal reason for
the difference between the GAAP Combined Ratio and the SAP Combined Ratio.
For 1996 and 1995, a change in the statutory accounting treatment for
retrospectively rated reinsurance agreements was the principal reason for
the difference between the GAAP Combined Ratios and the SAP Combined
Ratios. Additionally in 1998, 1997 and 1996, the difference relates to the
accounting for certain costs which are treated differently under SAP and
GAAP.
(c) Source: Best's Aggregates & Averages, Property/Casualty, 1998 Edition.
Industry Combined Ratios may not be fully comparable as a result of, among
other things, differences in geographical concentration and in the mix of
property and casualty insurance products.
(d) Premium to Surplus Ratio was calculated by dividing statutory property and
casualty insurance premiums written by statutory capital at the end of the
year.
21
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
The purpose of this section is to discuss and analyze the Company's
consolidated financial condition, liquidity and capital resources and results of
operations. This analysis should be read in conjunction with the consolidated
financial statements and related notes which appear elsewhere in this Report.
LIQUIDITY AND CAPITAL RESOURCES
Parent Company Liquidity
Leucadia National Corporation (the "Parent") is a holding company whose
assets principally consist of the stock of its several direct subsidiaries and
cash and liquid investments. The Parent continuously evaluates the retention and
disposition of its existing operations and investigates possible acquisitions of
new businesses in order to maximize shareholder value. Accordingly, while the
Parent does not have any material arrangement, commitment or understanding with
respect thereto (except as disclosed in this Report), further acquisitions,
divestitures, investments and changes in capital structure are possible. Its
principal sources of funds are its available cash resources, bank borrowings,
public financings, repayment of subsidiary advances, funds distributed from its
subsidiaries as tax sharing payments, management and other fees, and borrowings
and dividends from its regulated and non-regulated subsidiaries. It has no
substantial recurring cash requirements other than payment of interest and
principal on its debt, tax payments and corporate overhead expenses. As of
December 31, 1998, the Company's cash, cash equivalents and marketable
securities, excluding those amounts held by its regulated subsidiaries and
collateralizing letters of credit, totaled approximately $1,219,000,000. In
addition, the book value of the principal amount of promissory notes received
from Conseco, Inc. upon the 1997 sale of the Colonial Penn Life Group was
$400,000,000 at December 31, 1998.
In 1998, the Company announced that it was considering the payment of a
significant cash dividend. The Company has received a ruling from the Internal
Revenue Service providing that any gain realized on such a dividend (up to a
maximum of approximately $812,000,000) would be treated as a capital gain. The
Company anticipates that, prior to the date of its 1999 Annual Meeting scheduled
for May 5, 1999, its Board of Directors will declare a dividend in an aggregate
amount of approximately $812,000,000, minus amounts paid to repurchase Common
Shares from March 17, 1999 through the date of declaration. Payment of such
dividend would require the Company to make an offer to purchase all of its
outstanding 8-1/4% Senior Subordinated Debentures due 2005 and its 7-7/8% Senior
Subordinated Debentures due 2006, outstanding in the aggregate principal amount
of $235,000,000, at a purchase price of 101% of principal, plus accrued and
unpaid interest thereon pursuant to the terms of the indentures governing these
Debentures. These offers would be required to be made within five business days
after the payment of such dividend, unless the terms of the Debentures can be
modified on terms that are acceptable to the Company.
Except for the Euro denominated debt of Fidei, which is described below,
the Parent maintains the principal borrowings for the Company and its
non-banking subsidiaries and has provided working capital to certain of its
subsidiaries. These borrowings have primarily been made from banks through
various credit agreement facilities and through public financings. The Company
borrowed $62,300,000 under its $100,000,000 bank credit facility to fund the
purchase price of Fidei, including expenses. In addition, the Company entered
into currency swap agreements to hedge approximately $55,000,000 of its foreign
currency exposure. The counterparties to these currency swap agreements are
major financial institutions, which management believes are able to fulfill
their obligations. The swap agreements mature in tranches in March 2000 and
September 2001. At December 31, 1998, $65,500,000 was outstanding under the bank
credit facility.
22
During 1998, the Company's Board of Directors increased to 6,000,000 the
maximum number of its Common Shares that the Company is authorized to purchase.
Through December 31, 1998, the Company repurchased in the open market 1,996,400
Common Shares for an aggregate cost of approximately $58,071,000. From January
1, 1999 through March 12, 1999, the Company acquired 1,738,570 Common Shares for
an aggregate cost of approximately $52,119,000. As a result, as of March 13,
1999, the Company is authorized to repurchase 3,788,717 Common Shares.
At December 31, 1998, a maximum of approximately $25,200,000 was available
to the Parent as dividends from its regulated subsidiaries without regulatory
approval. Additional amounts may be available to the Parent in the form of loans
or cash advances from regulated subsidiaries, although no amounts were
outstanding at December 31, 1998 or borrowed to date in 1999. There are no
restrictions on distributions from the non-regulated subsidiaries. The Parent
also receives tax sharing payments from subsidiaries included in its
consolidated income tax return, including certain regulated subsidiaries.
Because of the tax loss carryforwards available to the Parent and certain
subsidiaries, together with current interest deductions and corporate expenses,
the amount paid by the Parent for income taxes has been substantially less than
tax sharing payments received from its subsidiaries. Payments from regulated
subsidiaries for dividends, tax sharing payments and other services totaled
approximately $1,295,600,000 (including $1,230,000,000 relating to the sales of
the Colonial Penn companies in 1997) for the year ended December 31, 1998.
Based on discussions with commercial and investment bankers, the Company
believes that it has the ability to raise additional funds under acceptable
conditions for use in its existing businesses or for appropriate investment
opportunities. Since 1993, the Company's senior debt obligations have been rated
as investment grade by S&P and Duff & Phelps Inc. Ratings issued by bond rating
agencies are subject to change at any time.
Consolidated Liquidity
In 1998, net cash was used for operations, principally to purchase
investments classified as trading and for the payment of income taxes, partially
offset by the repayment of the Company's bridge financing to PIB, its Russian
joint venture described below. In 1997, net cash was used for operations
principally to fund the Company's capital commitments and bridge financing to
PIB, and for the purchase of investments classified as trading.
In December 1998, a subsidiary of the Company repurchased for $42,200,000
plus accrued interest, $51,800,000 liquidation amount of 8.65% trust issued
preferred securities of Leucadia Capital Trust I, a wholly-owned subsidiary of
the Company. The difference between the book value and the amount paid was
credited directly to shareholders' equity.
During 1998, the Company's previously announced agreement to sell
substantially all of its interest in Caja to its Argentine partner was
restructured and, in March 1999, the Company sold all of its interest in Caja to
Assicurazioni Generali Group, an Italian insurance company, for $126,000,000 in
cash and a $40,000,000 collateralized note maturing April 2001 from its
Argentine partner. The Company will record a pre-tax gain of approximately
$120,000,000 in its first quarter 1999 results of operations in connection with
this transaction.
In September 1998, the Company reinsured, retroactive to January 1, 1998,
substantially all of its remaining life insurance business to Allstate and a
subsidiary thereof in an indemnity reinsurance transaction. While the premium
received on this transaction was approximately $28,675,000, the gain on the
reinsurance transaction was deferred and is being amortized into income based
upon actuarial estimates of the premium revenue of the underlying insurance
contracts. In December 1998, the Company signed an agreement to sell its
23
remaining life insurance subsidiaries, Charter and Intramerica, to Allstate for
statutory surplus at the date of sale (approximately $62,200,000 at December 31,
1998), plus $3,575,000. The transaction is expected to result in a pre-tax gain
of approximately $20,000,000, principally resulting from recognition of deferred
gains from prior reinsurance transactions (including the September 1998 Allstate
transaction described above). The transaction is subject to regulatory approvals
and customary closing conditions and is expected to close in the second quarter
of 1999.
As of December 31, 1998, the Company's consolidated debt was $722,601,000
as compared to $352,872,000 as of December 31, 1997. This increase is primarily
related to the Company's acquisition of 95.4% of Fidei in 1998. At December 31,
1998, the principal amount of Fidei's Euro denominated outstanding debt, all of
which is non-recourse to the Company, was approximately $249,400,000
(approximately 213,656,000 Euros). Inasmuch as Fidei's Euro demoninated assets
will be sold over time and such assets are presently funded with Fidei's Euro
demoninated debt, the Company has determined not to acquire a currency hedge for
Fidei's Euro denominated debt.
In 1996, the Company formed PIB, a joint venture with PepsiCo, Inc., to be
the exclusive bottler and distributor of PepsiCo beverages in a large portion of
central and eastern Russia, Kyrgyzstan and Kazakstan. The Company contributed
$79,500,000 to PIB for a 75% equity interest. Effective as of January 30, 1998,
the Company entered into an agreement with PepsiCo, pursuant to which, among
other things, PIB repaid in full the Company's $77,705,000 bridge financing
(which was funded in 1997) and the Company's equity interest in PIB was reduced
to 37.9%. The agreement relieved the Company of any future funding obligation
with respect to PIB and created an option, exercisable by either the Company or
PepsiCo, pursuant to which PepsiCo was obligated to purchase all of the
Company's interest in PIB (the "Option") for $37,000,000, plus interest. In
February 1999, PepsiCo exercised the Option for approximately $39,190,000,
including interest, and the Company recognized a pre-tax gain of approximately
$29,545,000. However, when combined with the Company's share of the joint
venture losses since inception, the Company's net loss from this investment was
approximately $40,310,000.
The investment portfolios of the Company's insurance subsidiaries are
principally fixed maturity investments; the balance of their portfolio consists
largely of preferred securities. Of the fixed maturity securities, the majority
consists of those rated "investment grade" or U.S. governmental agency issued or
guaranteed obligations, although limited investments in "non-rated" or rated
less than investment grade securities have been made from time to time.
Principally as a result of changes in market interest rates during 1998,
the unrealized gain on investments at the end of 1997 of approximately
$5,630,000 (net of taxes) decreased to an unrealized loss of approximately
$982,000 (net of taxes) as of December 31, 1998. While this has resulted in a
decrease in shareholders' equity, it had no effect on results of operations or
cash flows.
The Company provides collateralized automobile loans to individuals with
poor credit histories. Prior to 1998, the Company's loan volume was in decline
primarily as a result of heavy competition in this line of business. However, in
1998, the Company began to see growth in its automobile lending business as it
expanded into new locations and developed new programs. The Company also
benefited from the decline in competition due to the failure of certain
competitors and a reduction in capital available for securitizations. In
addition, in December 1998, the Company purchased a $36,900,000 sub-prime
automobile portfolio. The Company's investment in automobile loans was
$140,400,000, $77,607,000 and $96,338,000 at December 31, 1998, 1997 and 1996,
respectively. During 1998, the Company's banking and lending subsidiaries sold
substantially all of their executive and professional loan portfolios for
aggregate proceeds of $89,500,000 and reported a pre-tax gain on these sales of
approximately $6,500,000.
24
The Company and certain of its subsidiaries have loss carryforwards and
other tax attributes. The amount and availability of tax loss carryforwards are
subject to certain qualifications, limitations and uncertainties. As described
in the Notes to the Consolidated Financial Statements, significant additional
amounts of loss carryforwards may be available under certain circumstances. In
order to reduce the possibility that certain changes in ownership could impose
limitations on the use of these carryforwards, the Company's certificate of
incorporation contains provisions which generally restrict the ability of a
person or entity from accumulating at least five percent of the Common Shares
and the ability of persons or entities now owning at least five percent of the
Common Shares from acquiring additional Common Shares.
RESULTS OF OPERATIONS
Property and Casualty Insurance
The Company's most significant operation is its insurance business, where
it is a provider of property and casualty insurance primarily in the New York
metropolitan area. For the year ended December 31, 1998, the Company's insurance
segment contributed 57% of total revenues from continuing operations and, at
December 31, 1998, constituted 25% of total assets.
Net earned premium revenues of the Empire Group were $228,600,000,
$275,000,000 and $326,400,000 for the years ended December 31, 1998, 1997 and
1996, respectively. In 1998, the decrease in earned premium revenues was
primarily due to a decline in the number of assigned risk automobile pool
contracts acquired due to competition and the depopulation of the assigned risk
automobile pools ($24,600,000) and a reduction in certain lines, principally
voluntary commercial automobile ($8,500,000), private passenger automobile
($6,000,000), commercial package policies ($4,300,000) and workers' compensation
($3,700,000), due to tighter underwriting standards, reunderwriting and
increased competition. In 1997, the decline in earned premium revenues was
primarily due to the depopulation of the assigned risk pools ($31,700,000) and a
reduction in certain commercial lines, principally voluntary commercial
automobile ($10,200,000) and workers' compensation ($8,800,000) due to
competition, reunderwriting and repricing. In addition, earned premium revenues
were reduced in 1997 by $5,500,000 to record premiums due under retrospectively
rated reinsurance contracts written for 1995 and prior accident years. The
Empire Group re-estimated the premium due based upon its then current estimate
of loss ratios for 1995 and prior accident years. Partially offsetting these
reductions was an increase in certain voluntary personal lines, principally
private passenger automobile and homeowners.
The Empire Group's combined ratios as determined under GAAP and SAP were
as follows:
Year Ended December 31,
-----------------------
1998 1997 1996
---- ---- ----
GAAP 129.3% 118.5% 114.7%
SAP 134.0% 117.8% 107.9%
The Empire Group's combined ratios increased in 1998 primarily due to the
reduction in premium volume at a rate greater than the reduction in net
underwriting and other costs. In addition, the reduction in servicing fees in
1998 negatively affected the expense ratios. Included in the Empire Group's
results for 1998, 1997 and 1996 were approximately $42,000,000, $27,000,000 and
$28,000,000, respectively, for reserve strengthening related to losses from
prior accident years.
25
During 1998, the Empire Group reviewed the adequacy of the reserves
carried for its open claims' files, focusing on workers' compensation,
commercial auto and other commercial liability lines of business. Such reviews
are part of the Empire Group's normal ongoing practice. Particular emphasis
during this review was placed on reserves carried for the workers' compensation
line of business. As part of the review, substantially all open workers'
compensation claim files were reviewed for every accident year up to and
including 1998. The Empire Group also conducted a comprehensive review of
reserves carried for other commercial liability lines of business in which
approximately 28% of the open claim files were reviewed, with a primary focus on
accident years 1995 to 1997. As a result of these reviews, the Empire Group
revised its assumptions regarding average claims costs and probable ultimate
losses and, accordingly, reserves were strengthened by $13,000,000 for workers'
compensation and $14,000,000 for other commercial liability lines of business.
Additionally, during 1998, the Empire Group reorganized the commercial auto
claims department. As part of this realignment, more complex claims files were
reviewed by the most experienced claims examiners and assumptions regarding
average claims severity and probable ultimate losses were revised and reserves
were strengthened by $14,000,000 for commercial automobile lines of business.
The 1997 reserve strengthening included approximately $11,000,000 for
commercial package lines of business and approximately $7,000,000 for voluntary
commercial automobile lines of business. During 1997, the Empire Group reviewed
the adequacy of the reserves carried for its open claims' files, as part of its
normal ongoing practice, focusing on the commercial package, general liability
and commercial automobile lines of business. As a result of this review and the
continued unfavorable development of prior accident years losses, particularly
the 1992 through 1994 accident years, the Empire Group revised its assumptions
regarding future increases in average claims severity and reserves were
strengthened.
The 1996 reserve strengthening included approximately $20,000,000, for
voluntary commercial automobile lines of business and approximately $8,000,000
for commercial package lines of business. Beginning in 1992, the Empire Group
entered into new market segments of the voluntary commercial business, including
specialty programs for sanitation trucks, gas stations, fuel oil deliveries and
limousines. Initially, the Empire Group based its loss ratio estimate upon its
experience with similar lines of business, industry statistics and standard
actuarial ultimate loss projection techniques, which consider expected loss
ratios. During 1996, claims began to develop unfavorably and the Empire Group
used such claim development to revise the assumptions that formed the basis of
actuarial studies and reserves were increased. With respect to commercial
package lines, general liability claims for business written in 1992 through
1994 also developed unfavorably. These claims showed an increased frequency of
losses as well as an increase in the time between the date the loss occurred and
when the loss was reported compared to prior experience. General liability
claims are susceptible to the emergence of losses over an extended period of
time.
For the lines of business discussed above, as well as all other property
and casualty lines of business, the Company employs a variety of standard
actuarial ultimate loss projection techniques, statistical analyses and
case-basis evaluations to estimate its liability for unpaid losses. The
actuarial projections include an extrapolation of both losses paid and incurred
by business line and accident year and implicitly consider the impact of
inflation and claims settlement patterns upon ultimate claim costs based upon
historical patterns. These estimates are performed quarterly and consider any
changes in trends and actual loss experience. Any resulting change in the
estimate of the liability for unpaid losses, including those discussed above, is
reflected in current year earnings during the quarter the change in estimate is
identified.
The reserving process relies on the basic assumption that past experience
is an appropriate basis for predicting future events. The probable effects of
current developments, trends and other relevant matters are also considered.
Since the establishment of loss reserves is affected by many factors, some of
which are outside the Company's control or affected by future conditions,
reserving for property and casualty claims is a complex and uncertain process
requiring the use of informed estimates and judgements. As additional experience
and
26
other data become available and are reviewed, the Company's estimates and
judgements may be revised. While the effect of any such changes in estimates
could be material to future results of operations, the Company does not expect
such changes to have a material effect on its liquidity or financial condition.
In management's judgment, information currently available has been
appropriately considered in estimating the Company's loss reserves. The Company
will continue to evaluate the adequacy of its loss reserves on a quarterly
basis, incorporating any future changes in trends and actual loss experience,
and record adjustments to its loss reserves as appropriate.
Manufacturing
In December 1997, the Company completed the disposition of certain of its
manufacturing operations. As a result, since December 1997, the Company's
manufacturing operations solely have consisted of its plastics division. In
1998, the gross profit for the plastics division increased by 14% to
approximately $21,400,000. This increase was primarily due to greater sales in
most of the division's product lines and lower raw material costs. The decline
in manufacturing revenues during the last three years was due to the sale of
certain divisions and the discontinuance of certain non-performing product lines
in 1997 and prior years. The Company recorded charges of $4,300,000 in 1997 and
$3,700,000 in 1996 for losses on sales and shutdown expenses, which are
primarily reflected in the caption "Selling, general and other expenses."
Banking and Lending
Finance revenues and operating profits reflect the level of consumer
instalment loans, and for 1998, the sale of substantially all of the Company's
executive and professional loan portfolio which resulted in a pre-tax gain of
approximately $6,500,000, as discussed above. In addition, automobile loan
losses declined in 1998 and 1997. In 1997, operating profit was also adversely
affected by $3,500,000 in costs to settle litigation related to a lending
program that is in liquidation. In 1996, operating profit was also affected by
increased interest expense on customer banking deposits.
Other
In 1998, investment and other income increased by approximately
$16,300,000 primarily due to increased interest income ($63,700,000), the sale
of the Company's executive and professional loan portfolio referred to above
($6,500,000) and increased income from real estate activities ($8,800,000),
partially offset by reduced gains from sales of real estate and other assets
($40,700,000) and reduced income relating to the service business ($19,100,000).
In 1997, investment and other income increased by approximately $81,800,000,
primarily due to increased gains from sales of real estate properties
($63,500,000) including the sale of a New York City office building and
increased interest income ($28,100,000) including earnings on the proceeds from
the sales of the Colonial Penn Life Group and Colonial Penn P&C Group. Such
increases were partially offset by reduced trading stamp and miscellaneous other
revenues in 1997 and a litigation settlement gain recorded in 1996.
During 1998, due to declines in values that were deemed other than
temporary, the Company recorded a pre-tax writedown of approximately $75,000,000
related to its investments in Russian and Polish debt and equity securities.
Such writedowns are reflected in the caption "Net securities gains (losses)." At
December 31, 1998, the remaining book value of the Company's investments in
these debt and equity securities was approximately $19,000,000.
Equity in income (losses) of associated companies improved in 1998 as
compared to 1997 primarily due to a reduction of approximately $48,400,000 in
the Company's equity losses related to PIB resulting from
27
discontinuance of the equity method of accounting in early 1998 and income from
an investment partnership of approximately $30,800,000. In December 1997, the
Company invested $20,000,000 to acquire a limited partnership interest in this
partnership. The partnership currently is in the process of liquidating and
making final distributions. The Company does not anticipate that the amount of
income to be realized from this investment will be significant in 1999. Equity
in losses of associated companies increased in 1997 as compared to 1996
primarily due to start-up losses from the Company's equity investment in PIB of
$50,481,000 in 1997 as compared to $17,104,000 in 1996. The equity in losses of
associated companies included losses from the Company's investment in MK Gold of
$4,251,000 in 1997 and $6,478,000 in 1996 and a write-off of $6,540,000 in 1996,
representing the Company's investment in an unsuccessful well drilled by its
Siberian oil exploration joint venture.
Interest expense primarily reflects the level of external borrowings
outstanding throughout the periods. The reduction in interest expense in 1997
was primarily due to the decline in such borrowings.
The decrease in selling, general and other expenses in 1998 as compared to
1997 principally reflects decreased expenses of the manufacturing segment
principally as a result of the sale of certain divisions in 1997, decreased
pension expense due to the recognition of net curtailment gains of $6,500,000, a
1997 charge for estimated costs to settle litigation relating to a lending
program that is in liquidation and lower provisions for bad debts. The decrease
in selling, general and other expenses in 1997 as compared to 1996 principally
reflects the Empire Group's decreased expenses related to reduced premium
volume, decreased operating expenses of real estate properties, decreased
expenses relating to certain investment activities and lower provisions for bad
debts. This decrease was partially offset by the losses recorded by the
manufacturing segment related to sold divisions and the charge for estimated
costs to settle litigation relating to a lending program that is in liquidation.
Income taxes for 1998 reflect a benefit of approximately $39,000,000 for a
change in the Company's estimated 1997 federal tax liability and the favorable
resolution of certain contingencies. The 1997 and 1996 income tax benefits were
greater than the expected normal corporate tax rate primarily due to the
favorable resolution of certain contingencies.
As discussed above, in December 1998, the Company signed an agreement to
sell its remaining life insurance subsidiaries, Charter and Intramerica, to
Allstate. The transaction is subject to regulatory approvals and customary
closing conditions and is expected to close in the second quarter of 1999. In
1998, the Company classified these life insurance operations as discontinued
operations and the consolidated financial statements for prior periods have been
restated to be consistent with such presentation.
The number of shares used to calculate basic earnings (loss) per share was
63,409,000, 62,205,000 and 60,301,000 for 1998, 1997 and 1996, respectively. The
number of shares used to calculate diluted earnings (loss) per share was
63,510,000, 62,205,000 and 60,301,000 for 1998, 1997 and 1996, respectively. For
diluted per share amounts, the Company's 5-1/4% Convertible Subordinated
Debentures due 2003 (which were redeemed in 1997) were not assumed to have been
converted since the effect of such assumed conversion would have been to
increase earnings per share.
Year 2000 and Information Technology Systems
The Company is in the process of evaluating its information technology
systems to determine the potential impact of the Year 2000. The Year 2000 issue
is the result of computer programs being written using two digits (rather than
four) to define the applicable year. Any programs that have time-sensitive
software may recognize a date using "00" as the year 1900 rather than the year
2000, which could result in miscalculations or
28
system failures. As a result, before the end of 1999, computer hardware and
software may need to be upgraded with new hardware and software which can
distinguish 21st century dates from 20th century dates.
Since 1996, the Company has been evaluating its Year 2000 readiness. Its
program to address its Year 2000 readiness consists of (i) the preparation of an
inventory of all computer related hardware and software, all non-computer
related hardware that may have embedded technology and all third parties that
are material to the Company's business operations, (ii) the identification of a
senior officer at each of the Company's operating subsidiaries and significant
investments to be responsible for overseeing the implementation of the Year 2000
program and reporting on compliance therewith to the Company's senior
management, (iii) the identification of mission critical aspects of the
Company's business, and assessment of the Year 2000 readiness of such mission
critical systems and components, (iv) the development of a plan to upgrade,
repair or replace systems as required for Year 2000 compliance, (v) the
development of a plan to test the readiness of all critical systems, (vi) making
inquiry of material third parties as to the state of their Year 2000 compliance,
and (vii) as appropriate, the development of a contingency plan for either
non-compliant internal systems or non-compliant material third parties. Where
appropriate, outside consultants have been engaged to advise the Company on its
Year 2000 readiness. Substantially all of the Company's operations have
completed the inventory and identification process and are in the process of
upgrading and testing critical systems. The Company's primary focus during the
balance of 1999 will be on continued testing of mission critical systems and
software provider upgrades, as well as monitoring the readiness of material
third parties.
In 1996, the Empire Group began to evaluate its information technology
systems and their ability to support future business needs. This led to a
decision to acquire new policy management and accounting systems. These systems
provide enhanced functionality and improved processing for underwriting, claims,
billing, collection, reinsurance, reporting and accounting and are designed to
be Year 2000 compliant. The Empire Group anticipates that these new systems will
be fully implemented in 1999 and that any non-compliant programs will become
compliant during 1999. All but one of the manufacturing operation's material
systems (involving the storage of historical information) have tested as being
Year 2000 compliant. The Company is exploring alternative systems to maintain
this information. Until an acceptable replacement for this system can be found,
the Company can maintain these records in hard copy. The banking and lending
operations have successfully completed testing of mission critical systems and
testing of non-mission critical systems is currently underway. In addition,
deposit customers have been sent letters to inform them about the Year 2000
issue and to educate them about the progress made in addressing this issue.
The Year 2000 issue may affect other entities with which the Company
transacts business. The Company has made inquiry of third parties with whom it
has material relationships as to the Year 2000 compliance of such third parties.
Many of such parties have reported plans to be fully compliant by the end of
1999 and most have reported substantial progress at the end of 1998. However, at
this time the Company cannot predict the effect of the Year 2000 on its material
third parties or the impact any deficiency in the Year 2000 readiness of such
parties could have on the Company.
Through December 31, 1998, expenses incurred by the Company in connection
with the Year 2000 issue (excluding expenses related to the Empire Group's
acquisition of new systems, which was not motivated by Year 2000 concerns) did
not exceed $500,000. Based upon current information, the Company does not expect
that the Year 2000 issue will have a material effect on its consolidated
financial position or consolidated results of operations.
Cautionary Statement for Forward-Looking Information
Statements included in this Report may contain forward-looking statements.
Such forward-looking statements are made pursuant to the safe-harbor provisions
of the Private Securities Litigation Reform Act of
29
1995. Such statements may relate, but are not limited, to projections of
revenues, income or loss, capital expenditures, fluctuations in insurance
reserves, plans for growth and future operations (including Year 2000
compatibility), competition and regulation as well as assumptions relating to
the foregoing. Forward-looking statements are inherently subject to risks and
uncertainties, many of which cannot be predicted or quantified. When used in
this Report, the words "estimates", "expects", "anticipates", "believes",
"plans", "intends" and variations of such words and similar expressions are
intended to identify forward-looking statements that involve risks and
uncertainties. Future events and actual results could differ materially from
those set forth in, contemplated by or underlying the forward-looking
statements. The factors that could cause actual results to differ materially
from those suggested by any such statements include, but are not limited to,
those discussed or identified from time to time in the Company's public filings,
including general economic and market conditions, changes in foreign and
domestic laws, regulations and taxes, changes in competition and pricing
environments, regional or general changes in asset valuation, the occurrence of
significant natural disasters, the inability to reinsure certain risks
economically, the adequacy of loss reserves, prevailing interest rate levels,
weather related conditions that may affect the Company's operations, the
difficulty in identifying hardware and software that may not be Year 2000
compliant, the lack of success of third parties to adequately address the Year
2000 issue, vendor delays and technical difficulties affecting the Company's
ability to upgrade or replace its hardware and/or software for Year 2000
compliance, and changes in the composition of the Company's assets and
liabilities through acquisitions or divestitures. Undue reliance should not be
placed on these forward-looking statements, which are applicable only as of the
date hereof. The Company undertakes no obligation to revise or update these
forward-looking statements to reflect events or circumstances that arise after
the date of this Report or to reflect the occurrence of unanticipated events.
30
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
The following includes "forward-looking statements" that involve risk and
uncertainties. Actual results could differ materially from those projected in
the forward-looking statements.
The Company's market risk arises principally from interest rate risk
related to its investment portfolio, its borrowing activities and the banking
and lending activities of certain subsidiaries. The Company does not enter into
material derivative financial instrument transactions.
The Company's investment portfolio is primarily classified as available
for sale, and consequently, is recorded on the balance sheet at fair value with
unrealized gains and losses reflected in shareholders' equity. Included in the
Company's investment portfolio are fixed income securities, which comprised
approximately 90% of the Company's total investment portfolio at December 31,
1998. These fixed income securities are primarily rated "investment grade" or
are U.S. governmental agency issued or guaranteed obligations, although limited
investments in "non-rated" or rated less than investment grade securities have
been made from time to time. The estimated weighted average remaining life of
these fixed income securities was approximately 2.5 years at December 31, 1998.
The Company's fixed income securities, like all fixed income instruments, are
subject to interest rate risk and will fall in value if market interest rates
increase. At December 31, 1998, the Company's portfolio of trading securities
was not material. The Company manages the investment portfolio of its insurance
subsidiaries to preserve principal, maintain a high level of quality, comply
with applicable insurance industry regulations and achieve an acceptable rate of
return. In addition, the Company considers the duration of its insurance
reserves in comparison with that of its investments.
The Company is subject to interest rate risk on its long-term fixed
interest rate debt and the Company-obligated mandatorily redeemable preferred
securities of its subsidiary trust holding solely subordinated debt securities
of the Company. Generally, the fair market value of debt and preferred
securities with a fixed interest rate will increase as interest rates fall, and
the fair market value will decrease as interest rates rise.
The Company's banking and lending operations are subject to risk resulting
from interest rate fluctuations to the extent that there is a difference between
the amount of the interest-earning assets and the amount of interest-bearing
liabilities that are prepaid/withdrawn, mature or reprice in specified periods.
The principal objectives of the Company's banking and lending asset/liability
management activities are to provide maximum levels of net interest income while
maintaining acceptable levels of interest rate and liquidity risk and to
facilitate funding needs. The Company utilizes an interest rate sensitivity
model as the primary quantitative tool in measuring the amount of interest rate
risk that is present. The model quantifies the effects of various interest rate
scenarios on the projected net interest margin over the ensuing twelve-month
period. Derivative financial instruments, including interest rate swaps, may be
used to modify the Company's indicated net interest sensitivity to levels deemed
to be appropriate based on risk management policies and the Company's current
economic outlook. Counterparties to such agreements are major financial
institutions, which the Company believes are able to fulfill their obligations;
however, if they are not, the Company believes that any losses are unlikely to
be material.
The following table provides information about the Company's financial
instruments used for purposes other than trading that are sensitive to changes
in interest rates. For investment securities and debt obligations, the table
presents principal cash flows by expected maturity dates. For the variable rate
notes receivable and variable rate borrowings, the weighted average interest
rates are based on implied forward rates in the yield curve at the reporting
date. For loans, securities and liabilities with contractual maturities, the
table presents contractual principal cash flows adjusted for the Company's
historical experience of loan prepayments and prepayments of mortgage-backed
securities. For banking and lending's variable rate products, the weighted
average variable rates are based upon the respective pricing index at the
reporting date. For money market
31
deposits that have no contractual maturity, the table presents principal cash
flows based on the Company's historical experience and management's judgment
concerning their most likely withdrawal behaviors. For interest rate swaps, the
table presents notional amounts by contractual maturity date.
32
Expected Maturity Date
----------------------
1999 2000 2001 2002 2003 Thereafter Total Fair Value
---- ---- ---- ---- ---- ---------- ----- ----------
(Dollars in thousands)
THE COMPANY, EXCLUDING
BANKING AND LENDING:
RATE SENSITIVE ASSETS:
Available for Sale Fixed
Income Securities:
U.S. Government $783,303 $146,339 $9,306 $198,045 $12,784 $160,629 $1,310,406 $1,310,406
Weighted Average
Interest Rate 5.08% 5.91% 7.17% 6.38% 5.86% 6.22%
Other Fixed Maturities:
Rated Investment Grade $7,555 $3,808 $15,020 $2,832 $18,112 $46,063 $93,390 $93,390
Weighted Average
Interest Rate 6.84% 8.03% 9.35% 12.15% 7.29% 7.99%
Rated Less Than
Investment Grade/Not
Rated $20,440 $25,727 $18,040 $33,598 $10,248 $11,575 $119,628 $119,628
Weighted Average
Interest Rate 9.26% 1.84% 2.04% 5.12% 6.80% 8.05%
Held to Maturity Fixed
Income Securities:
U.S. Government $774 $- $- $5,230 $- $2,148 $8,152 $8,481
Weighted Average
Interest Rate 6.75% - - 6.47% - 6.88%
Variable Rate Notes
Receivable $- $- $- $- $400,000 $- $400,000 $400,000
Weighted Average
Interest Rate 5.66% 5.64% 5.71% 5.75% 5.79% -
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