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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(MARK ONE)
( X ) Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the year ended December 31, 1997.
( ) Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from ________ to _________.
Commission File Number: 000-24366
GORAN CAPITAL INC.
(Exact name of registrant as specified in its charter)
CANADA Not Applicable
(State or other jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or organization)
181 University Avenue, Suite 1101 M5H 3M7
Toronto, Ontario Canada
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including
area code: (416) 594-1155 (Canada)
(317) 259-6400 (U.S.A.)
Securities registered pursuant to
Section 12(b) of the Act: Common Shares
Securities registered pursuant to
Section 12(g) of the Act: (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 statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. (X)
The aggregate market value of the Issuer's Common Stock held by nonaffiliates,
as of March 20, 1998 was $28.50 (US).
The number of shares of Common Stock of the Registrant, without par value,
outstanding as of March 20, 1998 was 10,419,332.
Documents Incorporated By Reference:
Portions of the Annual Report to Shareholders and the Proxy Statement for the
1998 Annual Meeting of Shareholders are incorporated into Parts II and III.
Exhibit Index on Page 46. Page 1 of 55
Exchange Rate Information
The Company's accounts and financial statements are maintained in U.S. Dollars.
In this Report all dollar amounts are expressed in U.S. Dollars except where
otherwise indicated.
The following table sets forth, for each period indicated, the average exchange
rates for U.S. Dollars expressed in Canadian Dollars on the last day of each
month during such period, the high and the low exchange rate during that period
and the exchange rate at the end of such period, based upon the noon buying rate
in New York City for cable transfers in foreign currencies, as certified for
customs purposes by the Federal Reserve Bank of New York (the "Noon Buying
Rate").
Foreign Exchange Rates
U.S. to Canadian Dollars
For The Years Ended December 31,
1993 1994 1995 1996 1997
Average .7733 .7322 .7287 .7339 .7222
Period End .7544 .7129 .7325 .7301 .6995
High .8046 .7642 .7465 .7472 .7351
Low .7439 .7097 .7099 .7270 .6938
Accounting Principles
The financial information contained in this document is stated in U.S. Dollars
and is expressed in accordance with Canadian Generally Accepted Accounting
Principles unless otherwise stated.
GORAN CAPITAL INC.
ANNUAL REPORT ON FORM 10-K
December 31, 1997
Page
PART I
ITEM 1. Business ....................................................... 4
Forward Looking Statements - Safe Harbor Provisions............. 35
ITEM 2. Properties...................................................... 41
ITEM 3. Legal Proceedings............................................... 42
ITEM 4. Submission of Matters to a Vote of Security Holders............. 42
PART II
ITEM 5. Market For Registrant's Common Equity And Related
Shareholder Matters............................................. 43
ITEM 6. Selected Consolidated Financial Data............................ 44
ITEM 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations............................. 45
ITEM 8. Financial Statements and Supplementary Data..................... 45
ITEM 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure............................. 45
PART III
ITEM 10. Directors and Executive Officers of the Registrant.............. 45
ITEM 11. Executive Compensation.......................................... 45
ITEM 12. Security Ownership of Certain Beneficial Owners and Management.. 45
ITEM 13. Certain Relationships and Related Transactions.................. 45
PART IV
ITEM 14. Exhibits, Financial Statement Schedules, and Reports Form 8-K... 46
SIGNATURES ................................................................ 55
ITEM 1 - BUSINESS
(figures stated in U.S. dollars)
General
Goran Capital Inc. ("Goran" or the "Company") is a Canadian federally
incorporated holding company principally engaged in the business of underwriting
property and casualty insurance through its insurance subsidiaries Pafco General
Insurance Company ("Pafco"), Superior Insurance Company ("Superior") and IGF
Insurance Company ("IGF"), which maintain their headquarters in Indianapolis,
Indiana, Atlanta, Georgia and Des Moines, Iowa, respectively. Goran owns 67% of
a U.S. holding company, Symons International Group, Inc. ("SIG"). SIG owns IGF
and GGS Management Holdings, Inc. ("GGS Holdings") and GGS Management, Inc.
("GGS") which are the holding company and management company for Pafco and
Superior. Goran sold 33% of SIG in an Initial Public Offering in November, 1996.
The Company's other subsidiaries include Granite Reinsurance Company Ltd.
("Granite Re"), Granite Insurance Company ("Granite"), a Canadian federally
licensed insurance company and Symons International Group, Inc. - Florida
("SIGF"), a surplus lines underwriter located in Florida. In 1997, the Company
discontinued the operations of SIGF with a sale of such operations expected in
early 1998.
Granite Re is a specialized reinsurance company that underwrites niche products
such as nonstandard automobile, crop, property casualty reinsurance and offers
(on a non-risk bearing, fee basis), rent-a-captive facilities for Bermudian,
Canadian and U.S. reinsurance companies.
Through a rent-a-captive program, Granite Re offers the use of its capital and
its underwriting facilities to write specific programs on behalf of its clients,
including certain programs ceded from IGF and Pafco. Granite Re alleviates the
need for its clients to establish their own insurance company and also offers
this facility in an offshore environment.
Granite sold its book of business in January 1990 to an affiliate which
subsequently sold to third parties in June 1990. Granite currently has
approximately 40 outstanding claims and maintains an investment portfolio
sufficient to support those claim liabilities which will likely be settled
between now and the year 2000.
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Goran Capital, Inc., a specialty property and casualty insurer,
underwrites and markets nonstandard private passenger automobile insurance and
crop insurance. Through its Subsidiaries, the Company writes business in the
United States exclusively through independent agencies and seeks to distinguish
itself by offering high quality, technology based services for its agents and
policyholders. The Company had consolidated Gross Premiums Written of
approximately $449 million for the twelve months ended December 31, 1997. Based
on the Company's Gross Premiums Written in 1997, the Company believes that it is
the tenth largest underwriter of nonstandard automobile insurance in the United
States. Based on premium information compiled in 1996 by the NCIS, the Company
believes that IGF is the fourth largest underwriter of MPCI in the United
States.
The following table sets forth the premiums written by line of business for the
periods indicated (amounts exclude commercial premiums from discontinued
operations):
GORAN CAPITAL INC.
For The Years Ended December 31,
(In Thousands) 1995 1996 1997
Nonstandard Automobile (1)
Gross Premiums Written $49,005 $187,176 $323,915
Net Premiums Written 37,302 186,579 256,745
Crop Hail
Gross Premiums Written $16,966 $27,957 $38,349
Net Premiums Written 11,608 23,013 20,796
MPCI (2)
Gross Premiums Written $53,408 $82,102 $88,052
Net Premiums Written --- --- --
Finite Reinsurance
Gross Premiums Written $27,224 $2,141 $(1,334)
Net Premiums Written 32,912 4,186 4,355
Total (3)
Gross Premiums Written $146,603 $299,376 $448,982
Net Premiums Written $81,822 $213,778 $281,896
(1) Does not reflect net premiums written for Superior for the year ended
December 31, 1995 and for the four months ended April 30, 1996. For the year
ended December 31,1995, Superior and its subsidiaries had gross premiums written
of $94.8 million and net premiums written of $94.1 million. For the four months
ended April 30, 1996, Superior and its subsidiaries had gross premiums written
of $44.0 million and net premiums written of $43.6 million.
(2) For a discussion of the accounting treatment of MPCI premiums, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations of the Company".
(3) For additional financial segment information concerning the Company's
nonstandard automobile and crop insurance operations, see "Management's
Discussion and Analysis of Financial Condition and Results of Operations of the
Company".
-5-
Nonstandard Automobile Insurance
Industry Background
The Company, through its Subsidiaries, Pafco and Superior, is engaged
in the writing of insurance coverage on automobile physical damage and liability
policies for "nonstandard risks." The Company believes that the voluntary
nonstandard market has accounted for approximately 15% of total private
passenger automobile insurance premiums written in recent years. According to
statistical information derived from insurer annual statements compiled by A.M.
Best, the nonstandard automobile market accounted for $19 billion in annual
premium volume for 1997.
Strategy
The Company has multiple strategies with respect to its nonstandard
automobile insurance operations, including:
o The Company seeks to achieve profitability through a
combination of internal growth and the acquisition of other
insurers and blocks of business. The Company regularly
evaluates acquisition opportunities.
o The Company will seek to expand the multi-tiered marketing
approach currently employed in certain states in order to
offer to its independent agency network a broader range of
products with different premium and commission structures.
o The Company is committed to the use of integrated technologies
which permit it to rate, issue, bill and service policies in
an efficient and cost effective manner.
o The Company competes primarily on the basis of underwriting
criteria and service to agents and insureds and generally does
not match price decreases implemented by competitors which are
directed towards obtaining market share.
o The Company encourages agencies to place a large share of
their profitable business with its subsidiaries by offering,
in addition to fixed commissions, a contingent commission
based on a combination of volume and profitability.
o The Company responds to claims in a manner designed to reduce
the costs of claims settlements by reducing the number of
pending claims and uses computer databases to verify repair
and vehicle replacement costs and to increase subrogation and
salvage recoveries.
Products
The Company offers both liability and physical damage coverage in the
insurance marketplace, with policies having terms of three to twelve months,
with the majority of policies having a term of six months. Most nonstandard
automobile insurance policyholders choose the basic limits of liability coverage
which, though varying from state to state, generally are $25,000 per person and
$50,000 per accident for bodily injury and in the range of $10,000 to $20,000
for property damage. Of the approximately 300,218 combined policies of Pafco and
Superior in force on December 31, 1997, fewer than approximately 10% had policy
limits in excess of these basic limits of coverage. Of the 72,626 policies of
Pafco in force on December 31, 1997, approximately 81.9% had policy periods of
six months or less. Of the approximately 227,592 policies of Superior in force
as of December 31, 1997, approximately 62.5% had policy periods of six months
and approximately 37.5% had policy periods of twelve months.
The Company offers several different policies which are directed toward
different classes of risk within the nonstandard market. The Superior Choice
policy covers insureds whose prior driving record, insurability and other
relevant characteristics indicate a lower risk profile than other risks in the
nonstandard marketplace. The Superior
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Standard policy is intended for risks which do not qualify for Superior Choice
but which nevertheless present a more favorable risk profile than many other
nonstandard risks. The Superior Specialty policies cover risks which do not
qualify for either the Superior Choice or the Superior Standard. Pafco offers a
product similar to the Superior product.
Marketing
The Company's nonstandard automobile insurance business is concentrated
in the states of Florida, California, Virginia, Indiana and Georgia and also
writes nonstandard automobile insurance in 14 additional states, with plans to
continue to expand selectively into additional states. The Company will select
states for expansion based on a number of criteria, including the size of the
nonstandard automobile insurance market, state-wide loss results, competition
and the regulatory climate. The following table sets forth the geographic
distribution of Gross Premiums Written for the Company for the periods indicated
including Gross Premiums Written for Superior prior to its acquisition by the
Company on April 30, 1996.
-7-
Goran Capital, Inc. and Superior Insurance Company (Combined)
Year Ended December 31,
(in thousands)
State 1995 1996 1997
- ----- ---- ---- ----
Arkansas $1,796 $2,004 $1,539
California 15,350 25,131 59,819
Colorado 9,257 10,262 9,865
Florida 54,535 97,659 141,907
Georgia 5,927 7,398 11,858
Illinois 2,483 2,994 3,541
Indiana 13,842 16,599 17,227
Iowa 3,832 5,818 7,079
Kentucky 7,840 11,065 9,538
Mississippi 2,721 2,250 2,830
Missouri 8,513 13,423 9,705
Nebraska 3,660 5,390 6,613
Nevada --- --- 4,273
Ohio 3,164 3,643 3,731
Oklahoma 317 2,559 3,418
Oregon --- --- 2,302
Tennessee 332 (2) ---
Texas 3,464 10,122 7,192
Virginia 5,035 14,733 21,446
Washington 1,693 106 32
------- ------- -------
Total $143,761 $231,154 $323,915
======= ======= =======
The Company markets its nonstandard products exclusively through
approximately 6,000 independent agencies and focuses its marketing efforts in
rural areas and the peripheral areas of metropolitan centers. As part of its
strategy, management is continuing its efforts to establish the Company as a low
cost provider of nonstandard automobile insurance while maintaining a commitment
to provide quality service to both agents and insureds. This element of the
Company's strategy is being accomplished primarily through the automation of
certain marketing, underwriting and administrative functions. In order to
maintain and enhance its relationship with its agency base, the Company has 27
territorial managers, each of whom resides in a specific marketing region and
has access to the technology and software necessary to provide marketing, rating
and administrative support to the agencies in his or her region.
The Company attempts to foster strong service relationships with its
agencies and customers. The Company is currently completing its development of
computer software that will provide on-line communication with its agency force.
In addition, to deliver prompt service while ensuring consistent underwriting,
the Company offers rating software to its agents in some states which permits
them to evaluate risks in their offices. The agent has the authority to sell and
bind insurance coverages in accordance with procedures established by the
Company, which is a common practice in the nonstandard automobile insurance
business. The Company reviews all coverages bound by the agents promptly and
generally accepts all coverages which fall within its stated underwriting
criteria. In most jurisdictions, the Company has the right within a specified
time period to cancel any policy even if the risk falls within its underwriting
criteria. See "Business -- Nonstandard Automobile Insurance -- Underwriting."
-8-
The Company compensates its agents by paying a commission based on a
percentage of premiums produced. The Company also offers its agents a contingent
commission based on volume and profitability, thereby encouraging the agents to
enhance the placement of profitable business with the Company.
The Company believes that the combination of Pafco with Superior and
its two Florida-domiciled insurance subsidiaries allows the Company the
flexibility to engage in multi-tiered marketing efforts in which specialized
automobile insurance products are directed toward specific segments of the
market. Since certain state insurance laws prohibit a single insurer from
offering similar products with different commission structures or, in some
cases, premium rates, it is necessary to have multiple licenses in certain
states in order to obtain the benefits of market segmentation. The Company is
currently offering multi-tiered products in its major states. The Company
intends to continue the expansion of the marketing of its multi-tiered products
into other states and to obtain multiple licenses for its subsidiaries in these
states to permit maximum flexibility in designing commission structures.
Underwriting
The Company underwrites its nonstandard automobile business with the
goal of achieving adequate pricing. The Company seeks to classify risks into
narrowly defined segments through the utilization of all available underwriting
criteria. The Company maintains an extensive, proprietary database which
contains statistical records with respect to its insureds on driving and repair
experience by location, class of driver and type of automobile. Management
believes this database gives the Company the ability to be more precise in the
underwriting and pricing of its products. Further, the Company uses motor
vehicle accident reporting agencies to verify accident history information
included in applications.
The Company utilizes many factors in determining its rates. Some of the
characteristics used are type, age and location of the vehicle, number of
vehicles per policyholder, number and type of convictions or accidents, limits
of liability, deductibles, and, where allowed by law, age, sex and marital
status of the insured. The rate approval process varies from state to state;
some states, such as Indiana, Colorado, Kentucky and Missouri, allow filing and
use of rates, while others, such as Florida, Arkansas and California, require
approval of the insurance department prior to the use of the rates.
The Company has integrated its automated underwriting process with the
functions performed by its agency force. For example, the Company has a rating
software package for use by agents in some states. In many instances, this
software package, combined with agent access to the automated retrieval of motor
vehicle reports, ensures accurate underwriting and pricing at the point of sale.
The Company believes the automated rating and underwriting system provides a
significant competitive advantage because it (i) improves efficiencies for the
agent and the Company, thereby reenforcing the agents' commitment to the
Company, (ii) makes more accurate and consistent underwriting decisions possible
and (iii) can be changed easily to reflect new rates and underwriting
guidelines.
Underwriting results of insurance companies are frequently measured by
their Combined Ratios. However, investment income, federal income taxes and
other non-underwriting income or expense are not reflected in the Combined
Ratio. The profitability of property and casualty insurance companies depends on
income from underwriting, investment and service operations. Underwriting
results are generally considered profitable when the Combined Ratio is under
100% and unprofitable when the Combined Ratio is over 100%. The following table
sets forth Loss and LAE Ratios, Expense Ratios and Combined Ratios for the
periods indicated for the nonstandard automobile insurance business of the
Company. The ratios exclude the effects of Superior prior to the acquisition by
the Company on April 30, 1996. The Ratios shown in the table below are computed
based upon GAAP.
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Years Ended December 31,
----------------------------
1995 1996 1997
Loss and LAE Ratio 73.8% 73.7% 78.0%
Underwriting Expense Ratio, net of
billing fees 32.3% 23.2% 22.7%
----- ----- -----
Combined Ratio 106.1% 96.9% 100.7%
====== ===== ======
In an effort to maintain and improve underwriting profits, the
territorial managers regularly monitor loss ratios of the agencies in their
regions and meet periodically with the agencies in order to address any adverse
trends in Loss Ratios.
Claims
The Company's nonstandard automobile claims department handles claims
on a regional basis from its Indianapolis, Indiana; Atlanta, Georgia; Tampa,
Florida and Anaheim, California locations. Management believes that the
employment of salaried claims personnel, as opposed to independent adjusters,
results in reduced ultimate loss payments, lower LAE and improved customer
service. The Company generally retains independent appraisers and adjusters on
an as needed basis for estimation of physical damage claims and limited elements
of investigation. The Company uses the Audapoint, Audatex and Certified
Collateral Corporation computer programs to verify, through a central database,
the cost to repair a vehicle and to eliminate duplicate or "overlap" costs from
body shops. Autotrak, which is a national database of vehicles, allows the
Company to locate vehicles nearly identical in model, color and mileage to the
vehicle damaged in an accident, thereby reducing the frequency of disagreements
with claimants as to the replacement value of damaged vehicles.
Claims settlement authority levels are established for each adjuster or
manager based on the employee's ability and level of experience. Upon receipt,
each claim is reviewed and assigned to an adjuster based on the type and
severity of the claim. All claim-related litigation is monitored by a home
office supervisor or litigation manager. The claims policy of the Company
emphasizes prompt and fair settlement of meritorious claims, appropriate
reserving for claims and controlling claims adjustment expenses.
Reinsurance
The Company follows the customary industry practice of reinsuring a
portion of its risks and paying for that protection based upon premiums received
on all policies subject to such Reinsurance. Insurance is ceded principally to
reduce the Company's exposure on large individual risks and to provide
protection against large losses, including catastrophic losses. Although
Reinsurance does not legally discharge the ceding insurer from its primary
obligation to pay the full amount of losses incurred under policies reinsured,
it does render the reinsurer liable to the insurer to the extent provided by the
terms of the Reinsurance treaty. As part of its internal procedures, the Company
evaluates the financial condition of each prospective reinsurer before it cedes
business to that carrier. Based on the Company's review of its reinsurers'
financial health and reputation in the insurance marketplace, the Company
believes its reinsurers are financially sound and that they therefore can meet
their obligations to the Company under the terms of the Reinsurance treaties.
-10-
Effective January 1, 1997, Pafco and Superior ceded 20% of its
nonstandard automobile business written during the first three quarters of 1997
and 25% during the fourth quarter in accordance with a quota share Reinsurance
agreement. 90% of the cession was with Vesta Fire Insurance Company (rated "A"
by A.M. Best) and 10% was with Granite Re. Effective January 1, 1998, the
cession rate was changed to a minimum of 10% and includes the same reinsurers.
In 1997, Pafco and Superior maintained casualty excess of loss
reinsurance on its nonstandard automobile insurance business covering 100% of
losses on an individual occurrence basis in excess of $200,000 up to a maximum
of $5,000,000.
Amounts recoverable from reinsurers relating to nonstandard automobile
operations as of December 31, 1997 follows:
Reinsurance
Recoverables as of
A.M. Best December 31, 1997 (1)
Reinsurers Rating (in thousands)
Everest Reinsurance Company A (2) 1,880
Federal Government A+ (3) 1,248
Sentinel Reinsurance Company, Ltd. 345
Vesta Fire Insurance Company A 12,939
(1) Only recoverable greater than $200,000 are shown. Total third party
nonstandard automobile reinsurance recoverables as of December 31, 1997 were
approximately $31,932,000.
(2) An A.M. Best Rating of "A" is the third highest of 15 ratings.
(3) An A.M. Best Rating of "A+" is the second highest of 15 ratings.
On April 29, 1996, Pafco retroactively ceded all of its commercial
business relating to 1995 and previous years to Granite Re, with an effective
date of January 1, 1996. Approximately $3,519,000 and $2,380,000 of loss and
loss adjustment expense reserves and unearned premium reserves, respectively,
were ceded and no gain or loss recognized. Effective January 1, 1998, Granite Re
ceded the 1995 and prior commercial business back to Pafco. Approximately
$1,803,000 in loss and loss adjustment expense reserves were ceded back to Pafco
and no gain or loss was recognized.
On April 29, 1996, Pafco also entered into a 100% quota share
reinsurance agreement with Granite Re, whereby all of Pafco's commercial
business from 1996 and thereafter was ceded effective January 1, 1996.
Neither Pafco nor Superior has any facultative Reinsurance with respect
to its nonstandard automobile insurance business.
Competition
The Company competes with both large national and smaller regional
companies in each state in which it operates. The Company's competitors include
other companies which, like the Company, serve the agency market, as well as
companies which sell insurance directly to customers. Direct writers may have
certain competitive advantages over agency writers, including increased name
recognition, increased loyalty of their customer base and, potentially, reduced
acquisition costs. The Company's primary competitors are Progressive Casualty
Insurance Company, Guaranty National Insurance Company, Integon Corporation
Group, Deerbrook Insurance Company (a member of the Allstate
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Insurance Group) and the companies of the American Financial Group. Generally,
these competitors are larger and have greater financial resources than the
Company. The nonstandard automobile insurance business is price sensitive and
certain competitors of the Company have, from time to time, decreased their
prices in an apparent attempt to gain market share. Although the Company's
pricing is inevitably influenced to some degree by that of its competitors,
management of the Company believes that it is generally not in the Company's
best interest to match such price decreases, choosing instead to compete on the
basis of underwriting criteria and superior service to its agents and insureds.
Crop Insurance
Industry Background
The two principal components of the Company's crop insurance business
are MPCI and private named peril, primarily crop hail insurance. Crop insurance
is purchased by farmers to reduce the risk of crop loss from adverse weather and
other uncontrollable events. Farms are subject to drought, floods and other
natural disasters that can cause widespread crop losses and, in severe cases,
force farmers out of business. Because many farmers rely on credit to finance
their purchases of such agricultural inputs as seed, fertilizer, machinery and
fuel, the loss of a crop to a natural disaster can reduce their ability to repay
these loans and to find sources of funding for the following year's operating
expenses.
MPCI was initiated by the federal government in the 1930s to help
protect farmers against loss of their crops as a result of drought, floods and
other natural disasters. In addition to MPCI, farmers whose crops are lost as a
result of natural disasters have, in the past, occasionally been supported by
the federal government in the form of ad hoc relief bills providing low interest
agricultural loans and direct payments. Prior to 1980, MPCI was available only
on major crops in major producing areas. In 1980, Congress expanded the scope
and coverage of the MPCI program. In addition, the delivery system for MPCI was
expanded to permit private insurance companies and licensed agents and brokers
to sell MPCI policies and the FCIC was authorized to reimburse participating
companies for their administrative expenses and to provide federal Reinsurance
for the majority of the risk assumed by such private companies.
Although expansion of the federal crop insurance program in 1980 was
expected to make crop insurance the farmer's primary risk management tool,
participation in the MPCI program was only 32% of eligible acreage in the 1993
crop year. Due in part to low participation in the MPCI program, Congress
provided an average of $1.5 billion per year in ad hoc disaster payments over
the six years prior to 1994. In view of the combination of low participation
rates in the MPCI program and large federal payments on both crop insurance
(with an average loss ratio of 147%) and ad hoc disaster payments since 1980,
Congress has, since 1990, considered major reform of its crop insurance and
disaster assistance policies. The 1994 Reform Act was enacted in order to
increase participation in the MPCI program and eliminate the need for ad hoc
federal disaster relief payments to farmers.
The 1994 Reform Act required farmers for the first time to purchase at
least CAT Coverage (i.e., the minimum available level of MPCI providing coverage
for 50% of farmers' historic yield at 60% of the price per unit for such crop
set by the FCIC) in order to be eligible for other federally sponsored farm
benefits, including, but not limited to, low interest loans and crop price
supports. The 1994 Reform Act also authorized the marketing and selling of CAT
Coverage by the local USDA offices which has been eliminated for the 1998 crop
year.
The Federal Agriculture Improvement and Reform Act of 1996 ("the 1996
Reform Act"), signed into law by President Clinton in April 1996, limited the
role of the USDA offices in the delivery of MPCI coverage beginning in July
1996, which was the commencement of the 1997 crop year, and also eliminated the
linkage between CAT Coverage and qualification for certain federal farm program
benefits. This limitation should provide the Company with the opportunity to
realize increased revenues from the distribution and servicing of its MPCI
product. In accordance with the 1996 Reform Act, the USDA announced in July
1996, the following 14 states in which CAT Coverage will no longer be available
through USDA offices but rather will be solely available through private
companies: Arizona, Colorado, Illinois, Indiana, Iowa, Kansas, Minnesota,
Montana, Nebraska, North Carolina, North Dakota, South Dakota, Washington and
Wyoming. Through June 1996, the FCIC transferred to the Company approximately
8,900 insureds for CAT Coverage who previously purchased such coverage from USDA
field offices. The Company believes that any
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future potential negative impact of the delinkage mandated by the 1996 Reform
Act will be mitigated by, among other factors, the likelihood that farmers will
continue to purchase MPCI to provide basic protection against natural disasters
since ad hoc federal disaster relief programs have been reduced or eliminated.
In addition, the Company believes that (i) lending institutions will likely
continue to require this coverage as a condition to crop lending and (ii) many
of the farmers who entered the MPCI program as a result of the 1994 Reform Act
have come to appreciate the reasonable price of the protection afforded by CAT
Coverage and will remain with the program regardless of delinkage. There can,
however, be no assurance as to the ultimate effect which the 1996 Reform Act may
have on the business or operations of the Company.
On June 9, 1997, the Secretary of Agriculture announced that the USDA
would no longer provide CAT Coverage through USDA offices in any state effective
for the 1998 crop year. This is to be implemented by a transferring of CAT
policies to the various members of the crop insurance industry. At this time,
the Company has been preliminarily informed that it will receive approximately
17,000 policies that were formerly written by USDA offices, although there can
be no assurance that the Company will receive this number of policies. Based on
historical, per-policy averages, the Company has preliminarily estimated that it
will receive an additional approximate $2 to $3 million in premium from such
transferred policies, however, there can be no assurance that this number will
be realized.
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Strategy
The Company has multiple strategies for its crop insurance operations,
including the following:
o The Company seeks to enhance underwriting profits and reduce
the volatility of its crop insurance business through
geographic diversification and the appropriate allocation of
risks among the federal reinsurance pools and the effective
use of federal and third-party catastrophic Reinsurance
arrangements.
o The Company also limits the risks associated with crop
insurance through selective underwriting of crop risks based
on its historical loss experience data base.
o The Company continues to develop and maintain a proprietary
knowledge-based underwriting system which utilizes a database
of Company-specific underwriting rules.
o The Company has further strengthened its independent agency
network by using technology to provide fast, efficient service
to its agencies and providing application documentation
designed for simplicity and convenience.
o Unlike many of its competitors, the Company employs
approximately 89 full-time claims adjusters, most of whom are
agronomy-trained, to reduce the cost of losses experienced by
IGF.
o The Company stops selling its crop hail policies after certain
selected dates to prevent farmers from adversely selecting
against IGF when a storm is forecast or hail damage has
already occurred.
o The Company continues to explore growth opportunities and
product diversification through new specialty coverages,
including Crop Revenue Coverage (CRC) and specific named peril
crop insurance. Further, IGF is in the initial stages of
opening new markets and attracting new customers by developing
timber, crop completion and agricultural production
interruption coverages.
o The Company continues to explore new opportunities in
administrative efficiencies and product underwriting made
possible by advances in Precision Farming software, Global
Positioning System (GPS) software and Geographical Information
System (GIS) technology, all of which continue to be adopted
by insureds in their farming practices.
Products
MPCI is a federally subsidized program which is designed to provide
participating farmers who suffer insured crop damage with funds needed to
continue operating and plant crops for the next growing season. All of the
material terms of the MPCI program and of the participation of private insurers,
such as the Company, in the program are set by the FCIC under applicable law.
MPCI provides coverage for insured crops against substantially all natural
perils. Purchasing an MPCI policy permits a farmer to insure against the risk
that his crop yield for any growing season will be less than 50% to 75% (as
selected by the farmer at the time of policy application or renewal) of his
historic crop yield. If a farmer's crop yield for the year is greater than the
yield coverage he selected, no payment is made to the farmer under the MPCI
program. However, if a farmer's crop yield for the year is less than the yield
coverage selected, MPCI entitles the farmer to a payment equal to the yield
shortfall multiplied by 60% to 100% of the price for such crop (as selected by
the farmer at the time of policy application or renewal) for that season as set
by the FCIC.
In order to encourage farmers to participate in the MPCI program and
thereby reduce dependence on traditional disaster relief measures, the 1994
Reform Act established CAT Coverage as a new minimum level of MPCI coverage,
which farmers may purchase upon payment of a fixed administrative fee of $50 per
policy instead of any premium. CAT Coverage insures 50% of historic crop yield
at 60% of the FCIC-set crop price for the applicable commodities standard unit
of measure, i.e., bushel, pound, etc. CAT Coverage can be obtained from private
insurers such as the
-14-
Company.
In addition to CAT Coverage, MPCI policies that provide a greater level
of protection than the CAT Coverage level are also offered ("Buy-up Coverage").
Most farmers purchasing MPCI have historically purchased at Buy-up Coverage
levels, with the most frequently sold policy providing coverage for 65% of
historic crop yield at 100% of the FCIC-set crop price per bushel. Buy-up
Coverages require payment of a premium in an amount determined by a formula set
by the FCIC. Buy-up Coverage can only be purchased from private insurers. The
Company focuses its marketing efforts on Buy-up Coverages, which have higher
premiums and which the Company believes will continue to appeal to farmers who
desire, or whose lenders encourage or require, revenue protection.
The number of MPCI Buy-up policies written has historically tended to
increase after a year in which a major natural disaster adversely affecting
crops occurs and to decrease following a year in which favorable weather
conditions prevail.
The Company, like other private insurers participating in the MPCI
program, generates revenues from the MPCI program in two ways. First, it
markets, issues and administers policies, for which it receives administrative
fees; and second, it participates in a profit-sharing arrangement in which it
receives from the government a portion of the aggregate profit, or pays a
portion of the aggregate loss, in respect of the business it writes.
The Company's share of profit or loss on the MPCI business it writes is
determined under a complex profit sharing formula established by the FCIC. Under
this formula, the primary factors that determine the Company's MPCI profit or
loss share are (i) the gross premiums the Company is credited with having
written, (ii) the amount of such credited premiums retained by the Company after
ceding premiums to certain federal reinsurance pools and (iii) the loss
experience of the Company's insureds. The following discussion provides more
detail about the implementation of this profit sharing formula.
The Company recently began offering a new product in its crop insurance
business called Crop Revenue Coverage ("CRC"). In contrast to standard MPCI
coverage, which features a yield guarantee or coverage for the loss of
production, CRC provides the insured with a guaranteed revenue stream by
combining both yield and price variability protection. CRC protects against a
grower's loss of revenue resulting from fluctuating crop prices and/or low
yields by providing coverage when any combination of crop yield and price
results in revenue that is less than the revenue guarantee provided by the
policy. CRC was approved by the FCIC as a pilot program for revenue insurance
coverage plans for the 1996 Crop Year and has been available for corn and
soybeans in all counties in Iowa and Nebraska since 1996. CRC policies
represented approximately 30% of the combined corn policies written by IGF in
Iowa and Nebraska since 1996. Since July 1996, CRC was made available for winter
wheat in the entire states of Kansas, Michigan, Nebraska, South Dakota, Texas
and Washington and in parts of Montana. In May 1997, the FCIC announced that CRC
will be expanded to include wheat in twenty-five additional states. Currently,
CRC represents approximately 7% of all of the Company's wheat policies.
Revenue insurance coverage plans such as CRC are the result of the 1994
Reform Act, which directed the FCIC to develop a pilot crop insurance program
providing coverage against loss of gross income as a result of reduced yield
and/or price. CRC was developed by a private insurance company other than the
Company under the auspices of this pilot program, which authorizes private
companies to design alternative revenue coverage plans and to submit them for
review, approval and endorsement by the FCIC. As a result, although CRC is
administered and reinsured by the FCIC and risks are allocated to the federal
reinsurance pools, CRC remains partially influenced by the private sector,
particularly with respect to changes in its rating structure.
CRC plans to use the policy terms and conditions of the Actual
Production History ("APH") plan of MPCI as the basic provisions for coverage.
The APH provides the yield component by utilizing the insured's historic yield
records. The CRC revenue guarantee is the producer's approved APH times the
coverage level, times the higher of the spring futures price or harvest futures
price (in each case, for post-harvest delivery) of the insured crop for each
unit of farmland. The coverage levels and exclusions in a CRC policy are similar
to those in a standard MPCI policy. For the 1997 Crop Year, the Company received
from the FCIC an expense reimbursement payment equal to 25% of Gross
-15-
Premiums Written in respect of each CRC policy it writes. The MPCI Buy-up
Expense Reimbursement Payment is currently administratively established by FCIC
in the absence of a applicable legislation. This expense reimbursement payment
was reduced from 27% in 1996 to 23.25% in 1998.
CRC protects revenues by extending crop insurance protection based on
APH to include price as well as yield variability. Unlike MPCI, in which the
crop price component of the coverage is set by the FCIC prior to the growing
season and generally does not reflect actual crop prices, CRC uses the commodity
futures market as the basis for its pricing component. Pricing occurs twice in
the CRC plan. The spring futures price is used to establish the initial policy
revenue guarantee and premium, and the harvest futures price is used to
establish the crop value to count against the revenue guarantee and to recompute
the revenue guarantee (and resulting indemnity payments) when the harvest price
is higher than the spring price.
In addition to MPCI, the Company offers stand alone crop hail
insurance, which insures growing crops against damage resulting from hail storms
and which involves no federal participation, as well as its proprietary
HAILPLUS(R) product which combines the application and underwriting process for
MPCI and hail coverages. The HAILPLUS(R) product tends to produce less volatile
loss ratios than the stand alone product since the combined product generally
insures a greater number of acres, thereby spreading the risk of damage over a
larger insured area. Approximately 50% of IGF's hail policies are written in
combination with MPCI. Although both crop hail and MPCI provide insurance
against hail damage, under crop hail coverages farmers can receive payments for
hail damage which would not be severe enough to require a payment under an MPCI
policy. The Company believes that offering crop hail insurance enables it to
sell more MPCI policies than it otherwise would.
In addition to crop hail insurance, the Company also sells a small
volume of insurance against crop damage from other specific named perils. These
products cover specific crops, including hybrid seed corn, cranberries, cotton,
sugar cane, sugar beets, citrus, tomatoes and onions and are generally written
on terms that are specific to the kind of crops and farming practices involved
and the amount of actuarial data available. The Company plans to seek potential
growth opportunities in this niche market by developing basic policies on a
diverse number of named crops grown in a variety of geographic areas and to
offer these polices primarily to large producers through certain select agents.
The Company's experienced product development team will develop the underwriting
criteria and actuarial rates for the named peril coverages. As with the
Company's other crop insurance products, loss adjustment procedures for named
peril policies are handled by full-time professional claims adjusters who have
specific agronomy training with respect to the crop and farming practice
involved in the coverage. IGF is currently in the initial stages of opening new
markets and attracting new customers by developing timber, crop completion and
agricultural production interruption coverages.
Gross Premiums
For each year, the FCIC sets the formulas for determining premiums for
different levels of Buy-up Coverage. Premiums are based on the type of crop,
acreage planted, farm location, price per bushel for the insured crop as set by
the FCIC for that year and other factors. The federal government will generally
subsidize a portion of the total premium set by the FCIC and require farmers to
pay the remainder. Cash premiums are received by the Company from farmers only
after the end of a growing season and are then promptly remitted to the federal
government. Although applicable federal subsidies change from year to year, such
subsidies will range up to approximately 40% of the Buy-up Coverage premium
depending on the crop insured and the level of Buy-up Coverage purchased, if
any. Federal premium subsidies are recorded on the Company's behalf by the
government. For purposes of the profit sharing formula, the Company is credited
with having written the full amount of premiums paid by farmers for Buy-up
Coverages, plus the amount of any related federal premium subsidies (such total
amount, its "MPCI Premium").
As previously noted, farmers pay an administrative fee of $50 per
policy but are not required to pay any premium for CAT Coverage. However, for
purposes of the profit sharing formula, the Company is credited with an imputed
premium (its "MPCI Imputed Premium") for all CAT Coverages it sells. The amount
of such MPCI Imputed Premium credited is determined by formula. In general, such
MPCI Imputed Premium will be less than 50% of the premium that would be payable
for a Buy-up Coverage policy that insured 65% of historic crop yield at 100% of
the FCIC-set crop price per standard unit of measure for the commodity,
historically the most frequently sold Buy-up
-16-
Coverage. For income statement purposes under GAAP, the Company's Gross Premiums
Written for MPCI consist only of its MPCI Premiums and do not include MPCI
Imputed Premiums.
Reinsurance Pools
Under the MPCI program, the Company must allocate its MPCI Premium or
MPCI Imputed Premium in respect of a farm to one of three federal reinsurance
pools, at its discretion. These pools provide private insurers with different
levels of Reinsurance protection from the FCIC on the business they have
written. For insured farms allocated to the "Commercial Pool," the Company, at
its election, generally retains 50% to 100% of the risk and the FCIC assumes 0%
- - 50% of the risk; for those allocated to the "Developmental Pool," the Company
generally retains 35% of the risk and the FCIC assumes 65%; and for those
allocated to the "Assigned Risk Pool," the Company retains 20% of the risk and
the FCIC assumes 80%. The MPCI Retention is protected by private third-party
stop-loss treaties.
Although the Company in general must agree to insure any eligible farm,
it is not restricted in its decision to allocate a risk to any of the three
pools, subject to a minimum aggregate retention of 35% of its MPCI Premiums and
MPCI Imputed Premiums written. The Company uses a sophisticated methodology
derived from a comprehensive historical data base to allocate MPCI risks to the
federal reinsurance pools in an effort to enhance the underwriting profits
realized from this business. The Company has crop yield history information with
respect to over 100,000 farms in the United States. Generally, farms or crops
which, based on historical experience, location and other factors, appear to
have a favorable net loss ratio and to be less likely to suffer an insured loss,
are placed in the Commercial Pool. Farms or crops which appear to be more likely
to suffer a loss are placed in the Developmental Pool or Assigned Risk Pool. The
Company has historically allocated the bulk of its insured risks to the
Commercial Pool.
The Company's share of profit or loss depends on the aggregate amount
of MPCI Premium and MPCI Imputed Premium on which the Company retains risk after
allocating farms to the foregoing pools (its "MPCI Retention"). As previously
described, the Company purchases Reinsurance from third parties other than the
FCIC to further reduce its MPCI loss exposure.
Loss Experience of Insureds
Under the MPCI program the Company pays losses to farmers through a
federally funded escrow account as they are incurred during the growing season.
The Company requests funding of the escrow account when a claim is settled and
the escrow account is funded by the federal government within three business
days. After a growing season ends, the aggregate loss experience of the
Company's insureds in each state for risks allocated to each of the three
Reinsurance pools is determined. If, for all risks allocated to a particular
pool in a particular state, the Company's share of losses incurred is less than
its aggregate MPCI Retention, the Company shares in the gross amount of such
profit according to a schedule set by the FCIC for each year. The profit and
loss sharing percentages are different for risks allocated to each of the three
Reinsurance pools and private insurers will receive or pay the greatest
percentage of profit or loss for risks allocated to the Commercial Pool.
The percentage split between private insurers and the federal
government of any profit or loss that emerges from an MPCI Retention is set by
the FCIC and generally is adjusted from year to year. For 1995, 1996 and 1997
crop years, the FCIC increased the maximum potential profit share of private
insurers for risks allocated to the Commercial Pool above the maximum potential
profit share set for 1994, without increasing the maximum potential share of
loss for risks allocated to that pool for 1995. This change increased the
potential profitability of risks allocated to the Commercial Pool by private
insurers.
-17-
The following table presents MPCI Premiums, MPCI Imputed Premiums and
underwriting gains or losses of IGF for the periods indicated:
(in thousands) Years Ended December 31,
---------------------------
1995 1996 1997
MPCI premiums $53,408 $82,102 $88,052
MPCI imputed premiums $19,552 $38,944 $33,294
Gross underwriting gain $10,870 $15,801 $30,325
Net private third party reinsurance
expense and other (1,217) (3,524) (3,736)
------ ------ ------
Net underwriting gain $9,653 $12,277 $26,589
===== ====== ======
MPCI Fees and Reimbursement Payments
The Company receives Buy-up Expense Reimbursement Payments from the
FCIC for writing and administering Buy-up Coverage policies. These payments
provide funds to compensate the Company for its expenses, including agents'
commissions and the costs of administering policies and adjusting claims. For
1995, 1996 and 1997, the maximum Buy-up Expense Reimbursement Payment was set at
31%, 31% and 29%, respectively, of the MPCI Premium. Historically, the FCIC has
paid the maximum MPCI Buy-up Expense Reimbursement Payment rate allowable under
law, although no assurance can be given that this practice will continue.
Although the 1994 Reform Act directs the FCIC to alter program procedures and
administrative requirements so that the administrative and operating costs of
private insurance companies participating in the MPCI program will be reduced in
an amount that corresponds to the reduction in the expense reimbursement rate,
there can be no assurance that the Company's actual costs will not exceed the
expense reimbursement rate. For the 1998 crop year, the Buy-up Expense
Reimbursement payment has been set at 27%.
Farmers are required to pay a fixed administrative fee of $50 per
policy (maximum of $100 per county) in order to obtain CAT Coverage. This fee is
retained by the Company to defray the cost of administration and policy
acquisition. The Company also receives from the FCIC a separate CAT LAE
Reimbursement Payment equal to approximately 13.0% of MPCI Imputed Premiums in
respect of each CAT Coverage policy it writes and a small MPCI Excess LAE
Reimbursement Payment. In general, fees and payments received by the Company in
respect of CAT Coverage are significantly lower than those received for Buy-up
Coverage.
In addition to premium revenues, the Company received the following
fees and commissions from its crop insurance segment for the periods indicated:
(in thousands) Years Ended December 31,
-------------------------
1995 1996 1997
CAT Coverage Fees (1) $1,298 $1,181 $1,191
Buy-up Expense Reimbursement Payments 16,366 24,971 24,788
CAT LAE Reimbursement Payments and
MPCI Excess LAE Reimbursement Payments 3,427 5,753 4,565
----- ----- -----
Total $21,091 $31,905 $30,544
====== ====== ======
-18-
(1) See "Management's Discussion and Analysis of Financial Condition and
Results of Operations of the Company" for a discussion of the
accounting treatment accorded to the crop insurance business.
Third-Party Reinsurance In Effect for 1997
In order to reduce the Company's potential loss exposure under the MPCI
program, the Company purchases stop loss Reinsurance from other private
reinsurers in addition to Reinsurance obtained from the FCIC. In addition, since
the FCIC and state regulatory authorities require IGF to limit its aggregate
writings of MPCI Premiums and MPCI Imputed Premiums to no more than 900% of
capital, and retain a net loss exposure of not in excess of 50% of capital, IGF
may also obtain Reinsurance from private reinsurers in order to permit it to
increase its premium writings. Such private Reinsurance would not eliminate the
Company's potential liability in the event a reinsurer was unable to pay or
losses exceeded the limits of the stop loss coverage. For crop hail insurance,
the Company has in effect quota share Reinsurance of 40% of business, although
the reinsurer is only liable to participate in losses of the Company up to a
150% pure loss ratio. The Company also has stop loss treaties for its crop hail
business which reinsure net losses in excess of an 80% pure Loss Ratio to 130%
at 95% coverage with IGF retaining the remaining 5%. With respect to its MPCI
business, the Company has stop loss treaties which reinsure 93.75% of the
underwriting losses experienced by the Company to the extent that aggregate
losses of its insureds nationwide are in excess of 100% of the Company's MPCI
Retention up to 125% of MPCI Retention. The Company also has an additional layer
of MPCI stop loss Reinsurance which covers 95% of the underwriting losses
experienced by the Company to the extent that aggregate losses of its insureds
nationwide are in excess of 125% of MPCI Retention up to 160% of MPCI Retention.
Based on a review of the reinsurers' financial health and reputation in
the insurance marketplace, the Company believes that the reinsurers for its crop
insurance business are financially sound and that they therefor can meet their
obligations to the Company under the terms of the Reinsurance treaties. Reserves
for uncollectible Reinsurance are provided as deemed necessary. The following
table provides information with respect to ceded premiums in excess of $250,000
on crop hail and named perils and for any affiliates.
-19-
Year Ended December 31, 1997 (1)
(in thousands, except footnotes)
A.M. Best Ceded
Reinsurers Rating Premiums
Folksam International Insurance Co. Ltd. (2) A- $746
Frankona Ruckversicherungs AG (3) A $415
Insurance Corporation of Hannover A- $268
Liberty Mutual Insurance Co. (UK) Ltd. A $433
Monde Re (4) Not Rated $4,213
Munich Re (5) A+ $3,004
National Grange A- $736
Partner Reinsurance Company Ltd. A $1,112
R & V Versicherung AG (4) Not Rated $1,286
Reinsurance Australia Corporation, Ltd. (REAC) (4) Not Rated $4,956
Scandinavian Reinsurance Company Ltd. A+ ---
- --------
(1) For the twelve months ended December 31, 1997, total ceded premiums were
$17,169.
(2) An A.M. Best rating of "A-" is the fourth highest of 15 ratings.
(3) An A.M. Best rating of "A" is the third highest of 15 ratings.
(4) Monde Re is owned by REAC.
(5) An A.M. Best rating of "A+" is the second highest of 15 ratings.
As of December 31, 1997, IGF's Reinsurance recoverables aggregated
approximately $268,766 excluding recoverables from the FCIC.
Marketing; Distribution Network
IGF markets its products to the owners and operators of farms in 42
states through approximately 2,400 agents associated with approximately 925
independent insurance agencies, with its primary geographic concentration in the
states of Iowa, Texas, Illinois, Kansas and Minnesota. The Company has, however,
diversified outside of the Midwest and Texas in order to reduce the risk
associated with geographic concentration. IGF is licensed in 23 states and
markets its products in additional states through a fronting agreement with a
third-party insurance company. IGF has a stable agency base and it experienced
negligible turnover in its agencies in 1997. Through its agencies, IGF targets
farmers with an acreage base of at least 1,000 acres. Such larger farms
typically have a lower risk exposure since they tend to utilize better farming
practices and to have noncontiguous acreage, thereby making it less likely that
the entire farm will be affected by a particular occurrence. Many farmers with
large farms tend to buy or rent acreage which is increasingly distant from the
central farm location. Accordingly, the likelihood of a major storm (wind, rain
or hail) or a freeze affecting all of a particular farmer's acreage decreases.
-20-
The following table presents MPCI and crop hail premiums written by IGF
by state for the periods indicated.
(in thousands)
-----------------------------------------------------------------------
Year Ended Year Ended
December 31, 1996 December 31, 1997
-------------------------------- ---------------------------------
State Crop Hail MPCI Total Crop Hail MPCI Total
- ----- --------- ---- ----- --------- ---- -----
Alabama $97 $2,951 $3,048 $144 $1,707 $1,851
Arkansas 314 1,784 2,098 652 2,270 2,922
California 1,164 1,992 3,156 1,062 4,418 5,480
Colorado 1,651 3,334 4,985 1,309 3,183 4,492
Florida --- 1,738 1,738 19 1,809 1,828
Illinois 526 11,228 11,754 655 12,221 12,876
Indiana 115 3,870 3,985 92 4,540 4,632
Iowa 6,590 15,205 21,795 7,628 12,949 20,577
Kansas 662 5,249 5,911 832 6,278 7,110
Louisiana 28 1,674 1,702 41 856 897
Minnesota 2,300 2,244 4,544 4,405 3,469 7,874
Mississippi 482 2,222 2,704 509 2,711 3,220
Missouri 556 2,427 2,983 383 1,711 2,094
Montana 5,632 1,554 7,186 2,879 1,854 4,733
Nebraska 1,567 3,206 4,773 1,597 3,160 4,757
North Dakota 2,294 2,796 5,090 787 3,014 3,801
Oklahoma 403 1,436 1,839 451 1,127 1,578
South Dakota 1,457 1,106 2,563 932 1,541 2,473
Texas 1,262 12,361 13,623 3,211 1,593 4,804
Wisconsin 370 2,187 2,557 407 1,479 1,886
All Other 487 1,538 2,025 10,354 16,162 26,516
----- ----- ----- ------ ------ ------
Total $27,957 $82,102 $110,059 $38,349 $88,052 $126,401
====== ====== ======= ====== ====== =======
-21-
The Company seeks to maintain and develop its agency relationships by
providing agencies with faster, more efficient service as well as marketing
support. IGF owns an IBM AS400 along with all peripheral and networking
equipment and has developed its own proprietary software package, APlus, which
allows agencies to quote and examine various levels of coverage on their own
personal computers. The Company's regional managers are responsible for the
Company's field operations within an assigned geographic territory, including
maintaining and enhancing relationships with agencies in those territories. IGF
also uses application documentation which is designed for simplicity and
convenience. The Company believes that IGF is the only crop insurer which has
created a single application for MPCI, crop hail and named peril coverage.
IGF generally compensates its agents based on a percentage of premiums
produced and, in the case of CAT Coverage and crop hail insurance, a percentage
of underwriting gain realized with respect to business produced. This
compensation structure is designed to encourage agents to place profitable
business with IGF (which tends to be insurance coverages for larger farms with
respect to which the risk of loss is spread over larger, frequently
noncontiguous insured areas).
Underwriting Management
Because of the highly regulated nature of the MPCI program and the fact
that rates are established by the FCIC, the primary underwriting functions
performed by the Company's personnel with respect to MPCI coverage are (i)
selecting of marketing territories for MPCI based on the type of crops being
grown in the area, typical weather patterns and loss experience of both agencies
and farmers within a particular area, (ii) recruiting agencies within those
marketing territories which service larger farms and other more desirable risks
and (iii) ensuring that policies are underwritten in accordance with the FCIC
rules.
With respect to its hail coverage, IGF seeks to minimize its
underwriting losses by maintaining an adequate geographic spread of risk by rate
group. In addition, IGF establishes sales closing dates after which hail
policies will not be sold. These dates are dependent on planting schedules, vary
by geographic location and range from May 15 in Texas to July 15 in North
Dakota. Prior to these dates, crops are either seeds in the ground or young
growth newly emerged from the ground and hail damage to crops in either of these
stages of growth is minimal. The cut-off dates prevent farmers from adversely
selecting against IGF by waiting to purchase hail coverage until a storm is
forecast or damage has occurred. For its hail coverage, IGF also sets limits by
policy ($400,000 each) and by township ($2.0 million per township). The Company
also uses a daily report entitled "Severe Weather Digest" which shows the time
and geographic location of all extraordinary weather events to check incoming
policy applications against possible previous damage.
Claims/Loss Adjustments
In contrast to most of its competitors who retain independent adjusters
on a part-time basis for loss adjusting services, IGF employs full-time
professional claims adjusters, most of whom are agronomy trained, as well as
part-time adjusters. Management believes that the professionalism of the IGF
full-time claims staff coupled with their exclusive commitment to IGF helps to
ensure that claims are handled in a manner designed to reduce overpayment of
losses experienced by IGF. The adjusters are located throughout IGF's marketing
territories. In order to promote a rapid claims response, the Company has
available several small four wheel drive vehicles for use by its adjusters. The
adjusters report to a field service representative in their territory who
manages adjusters' assignments, assures that all preliminary estimates for loss
reserves are accurately reported and assists in loss adjustment. Within 72 hours
of reported damage, a loss notice is reviewed by an IGF service office claims
manager and a preliminary loss reserve is determined which is based on the
representative's and/or adjuster's knowledge of the area or the particular storm
which caused the loss. Generally, within approximately two weeks, hail and MPCI
claims are examined and reviewed on site by an adjuster and the insured signs a
proof of loss form containing a final release. As part of the adjustment
process, IGF's adjusters use Global Positioning System Units, which are hand
held devices using navigation satellites to determine the precise location where
a claimed loss has occurred. IGF has a team of catastrophic claims specialists
who are available on 48 hours notice to travel to any of IGF's six regional
service offices to assist in heavy claim work load situations.
-22-
Competition
The crop insurance industry is highly competitive. The Company competes
against other private companies for MPCI, crop hail and named peril coverage.
Many of the Company's competitors have substantially greater financial and other
resources than the Company and there can be no assurance that the Company will
be able to compete effectively against such competitors in the future. The
Company competes on the basis of the commissions paid to agents, the speed with
which claims are paid, the quality and extent of services offered, the
reputation and experience of its agency network and, in the case of private
insurance, policy rates. Because the FCIC establishes the rates that may be
offered for MPCI policies, the Company believes that quality of service and
level of commissions offered to agents are the principal factors on which it
competes in the area of MPCI. The Company believes that the crop hail and other
named peril crop insurance industry is extremely rate-sensitive and the ability
to offer competitive rate structures to agents is a critical factor in the
agent's ability to write crop hail and other named peril premiums. Because of
the varying state laws regarding the ability of agents to write crop hail and
other named peril premiums prior to completion of rate and form filings (and, in
some cases, state approval of such filings), a company may not be able to write
its expected premium volume if its rates are not competitive.
The crop insurance industry has become increasingly consolidated. From
the 1985 crop year to the 1997 crop year, the number of insurance companies
having agreements with the FCIC to sell and service MPCI policies has declined
from fifty to thirty-six. The Company believes that IGF is the fourth largest
MPCI crop insurer in the United States based on premium information compiled in
1996 by the FCIC and NCIS. The Company's primary competitors are Rain & Hail
Insurance Service, Inc. (affiliated with Cigna Insurance Company), Rural
Community Insurance Services, Inc. (which is owned by Norwest Corporation),
American Growers Insurance Company (Redland), Crop Growers Insurance, Inc.,
Great American Insurance Company, Blakely Crop Hail (an affiliate of Farmers
Alliance Mutual Insurance Company) and North Central Crop Insurance, Inc. The
Company believes that in order to compete successfully in the crop insurance
business it will have to market and service a volume of premiums sufficiently
large to enable the Company to continue to realize operating efficiencies in
conducting its business. No assurance can be given that the Company will be able
to compete successfully if this market further consolidates.
Reserves for Losses and Loss Adjustment Expenses
Loss Reserves are estimates, established at a given point in time based
on facts then known, of what an insurer predicts its exposure to be in
connection with incurred losses. LAE Reserves are estimates of the ultimate
liability associated with the expense of settling all claims, including
investigation and litigation costs resulting from such claims. The actual
liability of an insurer for its Losses and LAE Reserves at any point in time
will be greater or less than these estimates.
The Company maintains reserves for the eventual payment of Losses and
LAE with respect to both reported and unreported claims. Nonstandard automobile
reserves for reported claims are established on a case-by-case basis. The
reserving process takes into account the type of claim, policy provisions
relating to the type of loss and historical paid Loss and LAE for similar
claims. Reported crop insurance claims are reserved based upon preliminary
notice to the Company and investigation of the loss in the field. The ultimate
settlement of a crop loss is based upon either the value or the yield of the
crop.
Loss and LAE Reserves for claims that have been incurred but not
reported are estimated based on many variables including historical and
statistical information, inflation, legal developments, economic conditions,
trends in claim severity and frequency and other factors that could affect the
adequacy of loss reserves.
The Company's reserves are reviewed by independent actuaries on a
semi-annual basis. The Company's recorded Loss Reserves are certified by an
independent actuary for each calendar year.
The following loss reserve development table illustrates the change
over time of reserves established for loss and loss expenses as of the end of
the various calendar years for the nonstandard automobile segment of the
Company. The table includes the loss reserves acquired from the acquisition of
Superior in 1996 and the related loss reserve
-23-
development thereafter. The first section shows the reserves as originally
reported at the end of the stated year. The second section, reading down, shows
the cumulative amounts paid as of the end of successive years with respect to
the reserve liability. The third section, reading down, shows the re-estimates
of the original recorded reserve as of the end of each successive year which is
a result of sound insurance reserving practices of addressing new emerging facts
and circumstances which indicate that a modification of the prior estimate is
necessary. The last section compares the latest re-estimated reserve to the
reserve originally established, and indicates whether or not the original
reserve was adequate or inadequate to cover the estimated costs of unsettled
claims.
The loss reserve development table is cumulative and, therefore, ending
balances should not be added since the amount at the end of each calendar year
includes activity for both the current and prior years.
The reserve for losses and loss expenses is an accumulation of the
estimated amounts necessary to settle all outstanding claims as of the date for
which the reserve is stated. The reserve and payment data shown below have been
reduced for estimated subrogation and salvage recoveries. The Company does not
discount its reserves for unpaid losses and loss expenses. No attempt is made to
isolate explicitly the impact of inflation from the multitude of factors
influencing the reserve estimates though inflation is implicitly included in the
estimates. The Company regularly updates its reserve forecasts by type of claim
as new facts become known and events occur which affect unsettled claims.
During 1997, the Company, as part of its efforts to reduce costs and
combine the operations of the two nonstandard automobile insurance companies,
emphasized a unified claim settlement practice as well as reserving philosophy
for Superior and Pafco. Superior had historically provided strengthened case
reserves and a level of IBNR which reflected the strength of the case reserves.
Pafco had historically carried case reserves which generally did not reflect the
level of future payments but yet a higher IBNR reserve. This change in claims
management philosophy during 1997 coupled with the growth in premium volume
produced sufficient volatility in prior year loss patterns to warrant the
Company to re-estimate its 1996 reserve for losses and loss expenses and record
an additional reserve during 1997. The effects of changes in settlement
patterns, costs, inflation, growth and other factors have all been considered in
establishing the current year reserve for unpaid losses and loss expenses.
-24-
Symons International Group, Inc.
Nonstandard Automobile Insurance Only
For The Years Ended December 31, (in thousands)
1987 1988 1989 1990 1991 1992 1993 1994 1995(A) 1996 1997
---- ---- ---- ---- ---- ---- ---- ---- ------- ---- ----
Gross reserves for unpaid
losses and LAE $25,248 $71,748 $79,551 $101,185
Deduct reinsurance
recoverable 10,927 9,921 8,124 16,378
Reserve for unpaid losses and
LAE, net of reinsurance $4,687 $10,747 $13,518 $15,923 $15,682 $17,055 $14,822 14,321 61,827 71,427 84,807
Paid cumulative as of:
One Year Later 2,708 5,947 7,754 7,695 7,519 10,868 8,875 7,455 42,183 59,410
Two Years Later 4,448 7,207 10,530 10,479 12,358 15,121 11,114 10,375 53,350 --
Three Years Later 4,570 7,635 11,875 12,389 13,937 16,855 13,024 12,040 -- --
Four Years Later 4,310 7,824 12,733 13,094 14,572 17,744 13,886 -- -- --
Five Years Later 4,331 8,009 12,998 13,331 14,841 18,195 -- -- -- --
Six Years Later 4,447 8,135 13,095 13,507 14,992 -- -- -- -- --
Seven Years Later 4,448 8,154 13,202 13,486 -- -- -- -- -- --
Eight Years Later 4,447 8,173 13,216 -- -- -- -- -- -- --
Nine Years Later 4,447 8,174 -- -- -- -- -- -- -- --
Ten Years Later 4,447 -- -- -- -- -- -- -- -- --
Liabilities re-estimated as of:
One Year Later 5,352 8,474 13,984 13,888 14,453 17,442 14,788 13,365 59,626 82,011
Two Years Later 4,726 8,647 13,083 13,343 14,949 18,103 13,815 12,696 60,600 --
Three Years Later 4,841 8,166 13,057 13,445 15,139 18,300 14,051 13,080 -- --
Four Years Later 4,474 8,108 13,152 13,514 15,218 18,313 14,290 -- -- --
Five Years Later 4,412 8,179 13,170 13,589 15,198 18,419 -- -- -- --
Six Years Later 4,471 8,165 13,246 13,612 15,114 -- -- -- -- --
Seven Years Later 4,448 8,196 13,260 13,529 -- -- -- -- -- --
Eight Years Later 4,462 8,198 13,248 -- -- -- -- -- -- --
Nine Years Later 4,447 8,199 -- -- -- -- -- -- -- --
Ten Years Later 4,447 -- -- -- -- -- -- -- -- --
Net cumulative (deficiency)
or redundancy 240 2,548 270 2,394 568 (1,364) 532 1,241 1,227 (10,584)
Expressed as a percentage of
unpaid losses and LAE 5.1% 23.7% 2.0% 15.0% 3.6% (8.0%) 3.6% 8.7% 2.0% (14.8%)
(A) Includes Superior loss and loss expense reserves of $44,423 acquired on
April 29, 1996 and subsequent development thereon.
-25-
Investments
Insurance company investments must comply with applicable laws and
regulations which prescribe the kind, quality and concentration of investments.
In general, these laws and regulations permit investments, within specified
limits and subject to certain qualifications, in federal, state and municipal
obligations, corporate bonds, preferred and common securities, real estate
mortgages and real estate. The Company's investment policies are determined by
the Company's Board of Directors and are reviewed on a regular basis. The
Company's investment strategy is to maximize the after-tax yield of the
portfolio while emphasizing the stability and preservation of the Company's
capital base. Further, the portfolio is invested in types of securities and in
an aggregate duration which reflect the nature of the Company's liabilities and
expected liquidity needs, and the Company's fixed maturity and common equity
investments are substantially all in public companies. The Company's investments
in real estate and mortgage loans represent 1.1% of the Company's aggregate
investments. The investment portfolios of the Company are managed by third-party
professional administrators, in accordance with pre-established investment
policy guidelines established by the Company. The investment portfolios of the
Company at December 31, 1997, consisted of the following:
(in thousands)
Cost or
Amortized Market
Type of Investment Cost Value
Fixed maturities:
U.S. and Canadian Treasury securities and
obligations of U.S. and Canadian government
corporation and agencies $84,371 $84,801
Obligations of states, provinces and political
subdivisions 1,082 1,082
Corporate securities 86,948 88,332
------ ------
Total Fixed Maturities 172,401 174,215
Equity Securities:
Common stocks 35,446 36,631
Short-term investments 23,233 23,233
Real estate 450 450
Mortgage loans 2,220 2,220
Other loans 50 50
------ ------
Total Investments $233,800 $236,799
======= =======
- ---------------
-26-
The following table sets forth the composition of the fixed maturity
securities portfolio of the Company by time to maturity as of December 31:
(in thousands) 1996 1997
-------------------- --------------------
Market Percent Market Percent
Time To Maturity Value Market Value Market
1 year or less $9,169 6.6% $3,678 2.1%
More than 1 year through 5 years 79,042 57.1% 60,008 34.4%
More than 5 years through 10 years 43,404 31.4% 31,599 18.1%
More than 10 years 6,768 4.9% 8,390 4.8%
------- ----- ----- ----
138,383 100.0% 103,675 59.4%
Mortgage-backed securities --- --- 70,540 40.6%
------- ----- ------ -----
Total $138,383 100.0% $174,215 100.0%
======= ====== ======= ======
The following table sets forth the ratings assigned to the fixed
maturity securities of the Company as of December 31:
(in thousands) 1996 1997
-------------------- -------------------
Market Percent Market Percent
Rating (1) Value Value Value Value
Aaa or AAA $50,444 36.5% $112,920 64.8%
Aa or AA 2,976 2.1% 4,145 2.4%
A 50,365 36.4% 20,679 11.9%
Baa or BBB 11,671 8.4% 19,116 11.0%
Ba or BB 2,840 2.1% 16,519 9.5%
Other below investment grade 2,091 1.5% 82 0.1%
Not rated (2) 17,996 13.0% 754 0.3%
------ ----- --- ----
Total $138,383 100.0% $174,215 100.0%
======= ====== ======= ======
(1) Ratings are assigned by Moody's Investors Service, Inc., and when not
available, are based on ratings assigned by Standard & Poor's Corporation.
(2) These securities were not rated by the rating agencies. However, these
securities are designated as Category 1 securities by the NAIC, which is the
equivalent rating of "A" or better.
-27-
The investment results of the Company for the periods indicated are set
forth below:
(in thousands) Years Ended December 31,
------------------------
1995 1996 1997
Net investment income (1) $3,868 $7,745 $12,777
Average investment portfolio (2) $45,101 $122,363 $215,694
Pre-tax return on average investment portfolio 8.6% 6.3% 5.9%
Net realized gains (losses) ($198) ($637) $9,393
- ---------------
(1) Includes dividend income received in respect of holdings of common stock.
(2) Average investment portfolio represents the average (based on amortized
cost) of the beginning and ending investment portfolio and excludes
cash. For 1996, the average investment portfolio was adjusted for the
effect of the Acquisition.
Ratings
A.M. Best has currently assigned a "B+" rating to Superior and a "B-"
rating to Pafco.
A.M. Best's ratings are based upon a comprehensive review of a
company's financial performance, which is supplemented by certain data,
including responses to A.M. Best's questionnaires, phone calls and other
correspondence between A.M. Best analysts and company management, quarterly NAIC
filings, state insurance department examination reports, loss reserve reports,
annual reports, company business plans and other reports filed with state
insurance departments. A.M. Best undertakes a quantitative evaluation, based
upon profitability, leverage and liquidity, and a qualitative evaluation, based
upon the composition of a company's book of business or spread of risk, the
amount, appropriateness and soundness of reinsurance, the quality,
diversification and estimated market value of its assets, the adequacy of its
loss reserves and policyholders' surplus, the soundness of a company's capital
structure, the extent of a company's market presence and the experience and
competence of its management. A.M. Best's ratings represent an independent
opinion of a company's financial strength and ability to meet its obligations to
policyholders. A.M. Best's ratings are not a measure of protection afforded
investors. "B+" and "B-" ratings are A.M. Best's sixth and eighth highest rating
classifications, respectively, out of 15 ratings. A "B+" rating is awarded to
insurers which, in A.M. Best's opinion, "have demonstrated very good overall
performance when compared to the standards established by the A.M. Best Company"
and "have a good ability to meet their obligations to policyholders over a long
period of time." A "B-" rating is awarded to insurers which, in A.M. Best's
opinion, "have demonstrated adequate overall performance when compared to the
standards established by the A.M. Best Company" and "have an adequate ability to
meet their obligations to policyholders, but their financial strength is
vulnerable to unfavorable changes in underwriting or economic conditions." There
can be no assurance that such ratings or changes therein will not in the future
adversely affect the Company's competitive position.
Recent Acquisitions
On January 31, 1996, Goran, SIG, Fortis, Inc. and its wholly-owned
subsidiary, Interfinancial, Inc., a holding company for Superior, entered into a
Stock Purchase Agreement (the "Superior Purchase Agreement") pursuant to which
SIG agreed to purchase Superior from Interfinancial, Inc. for a purchase price
of approximately $66.6 million. Simultaneously with the execution of the
Superior Purchase Agreement, Goran, SIG, GGS Holdings and the GS Funds, a
Delaware limited partnership, entered into an agreement (the "GGS Agreement") to
capitalize GGS Holdings and to cause GGS Holdings to issue its capital stock to
SIG and to the GS Funds, so as to give SIG a 52% ownership interest and the GS
Funds a 48% ownership interest (the "Formation Transaction"). Pursuant to the
GGS Agreement (a) SIG contributed to GGS Holdings (i) all the outstanding common
stock of Pafco, with a book value of $16.9 million, (ii) its right to acquire
Superior pursuant to the Superior Purchase Agreement and (iii) certain fixed
assets, including office
-28-
furniture and equipment, having a value of approximately $350,000 and (b) the GS
Funds contributed to GGS Holdings $21.2 million in cash. The Formation
Transaction and the Acquisition were completed on April 30, 1996. On August 12,
1997, SIG acquired the remaining 48% interest in GGS Holdings that had been
owned by the GS funds for $61 million with a portion of the proceeds from the
sale of the Preferred Securities.
On August 12, 1997, SIG issued $135 million in Trust Originated
Preferred Securities ("Preferred Securities"). These Preferred Securities were
offered through a wholly-owned trust subsidiary of SIG and are backed by Senior
Subordinated Notes to the Trust from SIG. These Preferred Securities were
offered under Rule 144A of the SEC ("Offering") and, pursuant to the
Registration Rights Agreement executed at closing, SIG filed a Form S-4
Registration Statement with the SEC on September 16, 1997 to effect the Exchange
Offer. The S-4 Registration Statement was declared effective on September 30,
1997 and the Exchange Offer successfully closed on October 31, 1997. The
proceeds of the Preferred Securities Offering were used to repurchase the
remaining minority interest in GGSH for $61 million, repay the balance of the
term debt of $44.9 million and SIG expects to contribute the balance, after
expenses, of approximately $24 million to the nonstandard automobile insurers of
which $10.5 million was contributed in 1997. Expenses of the issue aggregated
$5.1 million and will be amortized over the term of the Preferred Securities (30
years). In the third quarter SIG wrote off the remaining unamortized costs of
the term debt of approximately $1.1 million pre-tax or approximately $0.09 per
share to Goran after income taxes and minority interest.
The Preferred Securities have a term of 30 years with semi-annual
distribution payments at 9.5% per annum commencing February 15, 1998. The
Preferred Securities may be redeemed in whole or in part after 10 years.
SIG shall not, and shall not permit any subsidiary, to incur directly
or indirectly, any indebtedness unless, on the date of such incurrence (and
after giving effect thereto), the Consolidated Coverage Ratio exceeds 2.5 to 1.
The Coverage Ratio is the aggregate of net earnings, plus interest expense,
income taxes, depreciation, and amortization divided by interest expense for the
same period.
Regulation
General
The Company's insurance businesses are subject to comprehensive,
detailed regulation throughout the United States, under statutes which delegate
regulatory, supervisory and administrative powers to state insurance
commissioners. The primary purpose of such regulations and supervision is the
protection of policyholders and claimants rather than stockholders or other
investors. Depending on whether the insurance company is domiciled in the state
and whether it is an admitted or non-admitted insurer, such authority may extend
to such things as (i) periodic reporting of the insurer's financial condition,
(ii) periodic financial examination, (iii) approval of rates and policy
forms,(iv) loss reserve adequacy, (v) insurer solvency, (vi) the licensing of
insurers and their agents, (vii) restrictions on the payment of dividends and
other distributions, (viii) approval of changes in control and (ix) the type and
amount of permitted investments.
Pafco, IGF and Superior and its insurance subsidiaries are subject to
triennial examinations by state insurance regulators. All of these Companies
have been examined through December 31, 1996 and each of the final reports are
pending. The Company does not expect any material findings from the examinations
of its insurance subsidiaries.
Insurance Holding Company Regulation
The Company also is subject to laws governing insurance holding
companies in Florida and Indiana, where the insurers are domiciled. These laws,
among other things, (i) require the Company to file periodic information with
state regulatory authorities including information concerning its capital
structure, ownership, financial condition and general business operations, (ii)
regulate certain transactions between the Company, its affiliates and IGF, Pafco
and Superior (the "Insurers"), including the amount of dividends and other
distributions , SIG and (iii) restrict the ability of any one person to acquire
certain levels of the Company's voting securities without prior regulatory
approval.
-29-
Any purchaser of 10% or more of the outstanding shares of Common Stock
of SIG would be presumed to have acquired control of Pafco and IGF unless the
Indiana Commissioner, upon application, has determined otherwise. In addition,
any purchaser of 5% or more of the outstanding shares of Common Stock of SIG
will be presumed to have acquired control of Superior unless the Florida
Commissioner, upon application, has determined otherwise.
Indiana law defines as "extraordinary" any dividend or distribution
which, together with all other dividends and distributions to shareholders
within the preceding twelve months, exceeds the greater of: (i) 10% of statutory
surplus as regards policyholders as of the end of the preceding year or (ii) the
prior year's net income. Dividends which are not "extraordinary" may be paid ten
days after the Indiana Department receives notice of their declaration.
"Extraordinary" dividends and distributions may not be paid without prior
approval of the Indiana Commissioner or until the Indiana Commissioner has been
given thirty days prior notice and has not disapproved within that period. The
Indiana Department must receive notice of all dividends, whether "extraordinary"
or not, within five business days after they are declared. Notwithstanding the
foregoing limit, a domestic insurer may not declare or pay a dividend of funds
other than earned surplus without the prior approval of the Indiana Department.
"Earned surplus" is defined as the amount of unassigned funds set forth in the
insurer's most recent annual statement, less surplus attributable to unrealized
capital gains or reevaluation of assets. As of December 31, 1997, IGF and Pafco
had earned surplus of $27,952,000 and $(4,713,000), respectively. Further, no
Indiana domiciled insurer may make payments in the form of dividends or
otherwise to shareholders as such unless it possesses assets in the amount of
such payment in excess of the sum of its liabilities and the aggregate amount of
the par value of all shares of its capital stock; provided, that in no instance
shall such dividend reduce the total of (i) gross paid-in and contributed
surplus, plus (ii) special surplus funds, plus (iii) unassigned funds, minus
(iv) treasury stock at cost, below an amount equal to 50% of the aggregate
amount of the par value of all shares of the insurer's capital stock.
Under Florida law, a domestic insurer may not pay any dividend or
distribute cash or other property to its stockholders except out of that part of
its available and accumulated surplus funds which is derived from realized net
operating profits on its business and net realized capital gains. A Florida
domestic insurer may not make dividend payments or distributions to stockholders
without prior approval of the Florida Department if the dividend or distribution
would exceed the larger of (i) the lesser of (a) 10% of surplus or (b) net
income, not including realized capital gains, plus a two-year carryforward, (ii)
10% of surplus with dividends payable constrained to unassigned funds minus 25%
of unrealized capital gains or (iii) the lesser of (a) 10% of surplus or (b) net
investment income plus a three-year carryforward with dividends payable
constrained to unassigned funds minus 25% of unrealized capital gains.
Alternatively, a Florida domestic insurer may pay a dividend or distribution
without the prior written approval of the Florida Department if the dividend is
equal to or less than the greater of (i) 10% of the insurer's surplus as regards
policyholders derived from realized net operating profits on its business and
net realized capital gains or (ii) the insurer's entire net operating profits
and realized net capital gains derived during the immediately preceding calendar
year; (2) the insurer will have policyholder surplus equal to or exceeding 115%
of the minimum required statutory surplus after the dividend or distribution,
(3) the insurer files a notice of the dividend or distribution with the
department at least ten business days prior to the dividend payment or
distribution and (4) the notice includes a certification by an officer of the
insurer attesting that, after the payment of the dividend or distribution, the
insurer will have at least 115% of required statutory surplus as to
policyholders. Except as provided above, a Florida domiciled insurer may only
pay a dividend or make a distribution (i) subject to prior approval by the
Florida Department or (ii) thirty days after the Florida Department has received
notice of such dividend or distribution and has not disapproved it within such
time. In the consent order approving the Acquisition, the Florida Department has
prohibited Superior from paying any dividends (whether extraordinary or not) for
four years from the date of acquisition without the prior written approval of
the Florida Department.
Under these laws, the maximum aggregate amounts of dividends permitted
to be paid to the Company in 1998 by IGF and Pafco without prior regulatory
approval are $13,404,000 and $0, respectively, none of which have been paid.
Although the Company believes that amounts required for it to meet its financial
and operating obligations will be available, there can be no assurance in this
regard. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations of the Company -- Liquidity and Capital Resources."
Further, there can be no assurance that, if requested, the Indiana Department
will approve any request for extraordinary dividends from Pafco or IGF or that
the Florida Department will allow any dividends to be paid by Superior during
the four year period
-30-
described above.
The maximum dividends permitted by state law are not necessarily
indicative of an insurer's actual ability to pay dividends or other
distributions to a parent company, which also may be constrained by business and
regulatory considerations, such as the impact of dividends on surplus, which
could affect an insurer's competitive position, the amount of premiums that can
be written and the ability to pay future dividends. Further, state insurance
laws and regulations require that the statutory surplus of an insurance company
following any dividend or distribution by such company be reasonable in relation
to its outstanding liabilities and adequate for its financial needs.
While the non-insurance company subsidiaries are not subject directly
to the dividend and other distribution limitations, insurance holding company
regulations govern the amount which a subsidiary within the holding company
system may charge any of the Insurers for services (e.g., management fees and
commissions). These regulations may affect the amount of management fees which
may be paid by Pafco and Superior to GGS Management. The management agreement
between the Company and Pafco has been assigned to GGS Management, Inc. ("GGS
Management") and provides for an annual management fee equal to 15% of gross
premiums. A similar management agreement with a management fee of 17% of gross
premiums has been entered into between GGS Management and Superior. Employees of
SIG relating to the nonstandard automobile insurance business and all Superior
employees became employees of GGS Management effective April 30, 1996. In the
consent order approving the Acquisition, the Florida Department has reserved,
for three years, the right to reevaluate the reasonableness of fees provided for
in the Superior management agreement at the end of each calendar year and to
require Superior to make adjustments in the management fees based on the Florida
Department's consideration of the performance and operating percentages of
Superior and other pertinent data. There can be no assurance that either the
Indiana Department or the Florida Department will not in the future require a
reduction in these management fees.
Federal Regulation
The Company's MPCI program is federally regulated and supported by the
federal government by means of premium subsidies to farmers, expense
reimbursement and federal reinsurance pools for private insurers. Consequently,
the MPCI program is subject to oversight by the legislative and executive
branches of the federal government, including the FCIC. The MPCI program
regulations generally require compliance with federal guidelines with respect to
underwriting, rating and claims administration. The Company is required to
perform continuous internal audit procedures and is subject to audit by several
federal government agencies. No material compliance issues were noted during
IGF's most recent FCIC compliance review.
The MPCI program has historically been subject to change by the federal
government at least annually since its establishment in 1980, some of which
changes have been significant. The most recent significant changes to the MPCI
program came as a result of the passage by Congress of the 1994 Reform Act and
the 1996 Reform Act.
Certain provisions of the 1994 Reform Act, when implemented by the
FCIC, may increase competition among private insurers in the pricing of Buy-up
Coverage. The 1994 Reform Act authorizes the FCIC to implement regulations
permitting insurance companies to pass on to farmers in the form of reduced
premiums certain cost efficiencies related to any excess expense reimbursement
over the insurer's actual cost to administer the program, which could result in
increased price competition. To date, the FCIC has not enacted regulations
implementing these provisions but is currently collecting information from the
private sector regarding how to implement these provisions.
The 1994 Reform Act required farmers for the first time to purchase at
least CAT Coverage in order to be eligible for other federally sponsored farm
benefits, including but not limited to low interest loans and crop price
supports. The 1994 Reform Act also authorized for the first time the marketing
and selling of CAT Coverage by the local USDA offices. Partly as a result of the
increase in the size of the MPCI market resulting from the 1994 Reform Act, the
Company's MPCI Premium increased to $53.4 million in 1995 from $44.3 million in
1994. However, the 1996 Reform Act, signed into law by President Clinton in
April 1996, eliminated the linkage between CAT Coverage and qualification for
certain federal farm program benefits and also limited the role of the USDA
offices in the delivery of MPCI coverage. In accordance with the 1996 Reform
Act, the USDA announced in July 1996 the following 14
-31-
states where CAT Coverage will no longer be available through USDA offices but
rather would solely be available through private agencies: Arizona, Colorado,
Illinois, Indiana, Iowa, Kansas, Minnesota, Montana, Nebraska, North Carolina,
North Dakota, South Dakota, Washington and Wyoming. The limitation of the USDA's
role in the delivery system for MPCI should provide the Company with the
opportunity to realize increased revenues from the distribution and servicing of
its MPCI product. The Company has not experienced any material negative impact
in 1996 from the delinkage mandated by the 1996 Reform Act. In addition, through
June 30, 1996, the FCIC transferred to the Company approximately 8,900 insureds
for CAT Coverage who previously purchased such coverage from USDA field offices.
The Company believes that any future potential negative impact of the delinkage
mandated by the 1996 Reform Act will be mitigated by, among other factors, the
likelihood that farmers will continue to purchase MPCI to provide basic
protection against natural disasters since ad hoc federal disaster relief
programs have been reduced or eliminated. In addition, the Company believes that
(i) lending institutions will likely continue to require this coverage as a
condition to crop lending and (ii) many of the farmers who entered the MPCI
program as a result of the 1994 Reform Act have come to appreciate the
reasonable price of the protection afforded by CAT Coverage and will remain with
the program regardless of delinkage. There can, however, be no assurance as to
the ultimate effect which the 1996 Reform Act may have on the business or
operations of the Company.
Underwriting and Marketing Restrictions
During the past several years, various regulatory and legislative
bodies have adopted or proposed new laws or regulations to deal with the
cyclical nature of the insurance industry, catastrophic events and insurance
capacity and pricing. These regulations include (i) the creation of "market
assistance plans" under which insurers are induced to provide certain coverages,
(ii) restrictions on the ability of insurers to rescind or otherwise cancel
certain policies in mid-term, (iii) advance notice requirements or limitations
imposed for certain policy non-renewals and (iv) limitations upon or decreases
in rates permitted to be charged.
Insurance Regulatory Information System
The NAIC Insurance Regulatory Information System ("IRIS") was developed
primarily to assist state insurance departments in executing their statutory
mandate to oversee the financial condition of insurance companies. Insurance
companies submit data on an annual basis to the NAIC, which analyzes the data
using ratios concerning various categories of financial data. IRIS ratios
consist of twelve ratios with defined acceptable ranges. They are used as an
initial screening process for identifying companies that may be in need of
special attention. Companies that have several ratios that fall outside of the
acceptable range are selected for closer review by the NAIC. If the NAIC
determines that more attention may be warranted, one of five priority
designations is assigned and the insurance department of the state of domicile
is then responsible for follow-up action.
During 1997, Pafco had unusual values for three IRIS tests. These
included two-year overall operating ratio where Pafco's ratio was 107 compared
to the IRIS upper limit of 100, change in surplus where Pafco's ratio was
(26.7%) compared to the IRIS lower limit of (10%) and one year reserve
development to surplus where Pafco's ratio was 31.2 compared to the IRIS upper
limit of 20. Pafco failed these tests due to the additional reserves of $7.5
million booked in 1997 on accident years 1996 and prior due to deficient reserve
development. Pafco does not expect such results to continue. However, reserves
are subjective and based on estimates and there is no guarantee such results
will not continue.
During 1997 IGF had unusual values for three IRIS tests. IGF continued
to have unusual values in the liabi