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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
COMMISSION FILE NUMBER 1-8007
FREMONT GENERAL CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
NEVADA 95-2815260
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
2020 SANTA MONICA BOULEVARD,
SANTA MONICA, CALIFORNIA 90404
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (310) 315-5500
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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
COMMON STOCK, $1.00 PAR VALUE
LIQUID YIELD OPTION(TM) NOTES DUE 2013 (ZERO COUPON-SUBORDINATED)
FREMONT GENERAL FINANCING I -- 9% TRUST ORIGINATED PREFERRED SECURITIES(SM)
(TITLE OF EACH CLASS)
NEW YORK STOCK EXCHANGE
(NAME OF EACH EXCHANGE ON WHICH REGISTERED)
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. [ ]
The aggregate market value of the voting stock held by non-affiliates of
the registrant as of February 29, 2000:
COMMON STOCK, $1.00 PAR VALUE -- $329,095,000
The number of shares outstanding of each of the issuer's classes of common
stock as of February 29, 2000:
COMMON STOCK, $1.00 PAR VALUE -- 70,032,000 SHARES
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the proxy statement for the 2000 annual meeting of stockholders
are incorporated by reference into Part III of this report.
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FREMONT GENERAL CORPORATION
ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1999
TABLE OF CONTENTS
PAGE
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PART I
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 26
Item 3. Legal Proceedings........................................... 26
Item 4. Submission of Matters to a Vote of Security Holders......... 26
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 27
Item 6. Selected Financial Data..................................... 28
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 29
Item 7(a). Quantitative and Qualitative Disclosures About Market
Risk........................................................ 50
Item 8. Financial Statements and Supplementary Data (Index to
Consolidated Financial Statements and Financial Statement
Schedules on Page 56)....................................... 50
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 50
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 51
Item 11. Executive Compensation...................................... 51
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 51
Item 13. Certain Relationships and Related Transactions.............. 51
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K......................................................... 52
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ITEM 1. BUSINESS
The following business section contains forward looking statements within
the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934. The Company's actual results could differ
materially from those projected in these forward looking statements as a result
of certain risks and uncertainties, including those factors set forth in this
"Item 1. Business" section and elsewhere in this Form 10-K including, but not
limited to, "Competition," "Reinsurance Ceded," "Loss and Loss Adjustment
Expense Reserves," "Analysis of Loss and Loss Adjustment Expense Development,"
"Investment Portfolio," "Competition," "Discontinued Operations," "Regulation,"
"Risk Factors," and "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations."
GENERAL
Fremont General Corporation is an insurance and financial services holding
company operating select businesses nationally in niche markets. The reported
assets of Fremont General Corporation and its subsidiaries ("Fremont" or "the
Company") as of December 31, 1999 were $8.0 billion. The Company incurred a loss
before taxes from continuing operations of $66.3 million in the year ended
December 31, 1999, resulting entirely from losses recognized within the
Company's property and casualty insurance segment. (See "Property and Casualty
Insurance Operation.") Additionally, Fremont recorded a net loss from
discontinued operations of $25 million which resulted primarily from a
deterioration in the Company's estimated reserves for asbestos and environmental
claims. (See "Discontinued Operations.")
Fremont's business strategy includes achieving income balance and
geographic diversity among its business units in order to limit its exposure to
market and regional concentrations. The Company's business strategy also
includes growing its business through new business development and acquisitions.
The Company's stock is traded on the New York Stock Exchange under the symbol
"FMT".
The Company's businesses are managed within two reportable segments:
property and casualty insurance and financial services. Revenues from these
segments are derived from two basic financial products; policies of insurance
(property and casualty insurance), and loans (financial services). They are
managed separately and use different pricing, distribution, and operating
methods. Fremont evaluates the performance of its reportable segments based on
income before taxes using accounting policies which are the same as those
described in the summary of significant accounting policies. (See Note A of
Notes to Consolidated Financial Statements.) Additionally, there are certain
corporate revenues and expenses, comprised primarily of investment income,
interest expense and certain general and administrative expenses, that Fremont
does not allocate to its segments.
Substantially all of Fremont's property and casualty insurance operation is
represented by the underwriting of workers' compensation insurance policies,
which are distributed primarily through non-exclusive independent insurance
agents and brokers nationwide. The Company's property and casualty insurance
segment posted income (loss) before taxes of $(116.2) million, $169.2 million
and $144.7 million for the years ended December 31, 1999, 1998 and 1997,
respectively, on revenues of $984.6 million, $729.7 million and $738.1 million
for the same respective periods. Fremont's financial services operation consists
of operating units that conduct collateralized lending activities on a national
basis. Lending activities included: commercial and residential real estate
lending; commercial working capital lines of credit ("commercial finance"); the
Company's interest in large syndicated commercial loans originated and serviced
by other financial institutions ("syndicated loans"); and insurance premium
financing. In December 1999, the Company discontinued its commercial finance
lending activities through the sale on December 20, 1999 of Fremont Financial
Corporation, a commercial finance subsidiary, to FINOVA Capital Corporation, a
subsidiary of The FINOVA Group, Inc. for approximately $708 million in cash
including the refinancing and assumption of existing debt. (See "Financial
Services Operation.") The financial services business is developed through
independent loan brokers, the Company's own marketing representatives and
referrals from various financial intermediaries and financial institutions.
Fremont's financial services operation earned $79.9 million, $55.5 million and
$42.3 million in income before taxes for the years ended December 31, 1999, 1998
and 1997,
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respectively, on revenues of $411.6 million, $297.5 million and $232.3 million
for the same respective periods. (See Note O of Notes to Consolidated Financial
Statements.)
Fremont's workers' compensation insurance business currently has premium
volume concentrated in California, Illinois, and to a lesser degree, Alaska,
Arizona, Colorado, Indiana, Michigan, New Jersey, Texas and Wisconsin. For the
year ended December 31, 1999, these states collectively accounted for over 80%
of the Company's premium. At December 31, 1999, the Company had premiums inforce
in forty-five states and the District of Columbia. The Company ranked as the
seventh largest writer in direct premiums of workers' compensation insurance in
the United States for the year ended December 31, 1998, according to A.M. Best.
Additionally, for the year ended December 31, 1998, Fremont was ranked by A.M.
Best in the top five writers of direct workers' compensation insurance premiums
in Alaska, Arizona, California, Idaho, Illinois and Montana. For the years ended
December 31, 1999, 1998, and 1997, the Company had workers' compensation
insurance premiums earned of $831 million, $551 million, and $571 million,
respectively. Over the last five years, the Company has focused on creating a
broad national platform upon which to build its businesses, while providing
geographic diversity to mitigate potential fluctuations in earnings from
cyclical downturns in various regional economies. (See "Property and Casualty
Insurance Operation" and "Risk Factors.") A.M. Best rates the Company's workers'
compensation insurance subsidiaries on a pool basis as "B++" (Very Good). This
rating represents a change of one notch from "A-", announced by A.M. Best on
March 1, 2000, and resulted from both company specific issues, as well as to
their general concerns relating to workers' compensation market conditions in
California. (See "Competition.") The "B++" rating remains in A.M. Best's
"Secure" range, which indicates that A.M. Best has evaluated the Company as
having a good ability to meet its ongoing obligations to policyholders. A "B++"
rating is A.M. Best's fifth highest rating category out of fifteen rating
categories ranging from "A++" (Superior) to "F" (In Liquidation).
Fremont's financial services operation originates loans and purchases
interests in syndicated bank loans on a national basis through its
California-chartered thrift and loan subsidiary, Fremont Investment & Loan. The
Company, to a lesser degree, purchases pools of loans from time to time that
meet its new loan origination underwriting guidelines. Fremont's lending is done
primarily on a senior and secured basis and it seeks to minimize its credit
exposure through conservative loan underwriting and appropriate loan to
collateral valuations and cash flow coverages. The Company continues to focus on
loan origination by broadening its existing distribution channels and creating
new distribution channels. The outstanding loan portfolio of Fremont's financial
services operation has grown from $1.4 billion at December 31, 1995 to $3.1
billion at December 31, 1999. In addition, the Company had residential real
estate loans of approximately $1.3 billion under three securitizations at
December 31, 1999 which are not included in the Company's balance sheet. (See
"Financial Services Operation -- Residential Real Estate Lending.")
After the sale of the Company's commercial finance subsidiary in December
1999, Fremont's remaining lending activities include commercial and residential
real estate lending, syndicated loans and insurance premium financing.
Commercial real estate loans are originated and purchased primarily for the
Company's own portfolio and are secured mainly by first mortgages on
income-producing properties. Residential real estate loans are originated and
purchased for the Company's own portfolio, for securitization and for resale to
other financial institutions. The residential real estate loans are generally
secured by first deeds of trust on single-family residences. Syndicated loans
represent Fremont's interest in large syndicated commercial loans which are
originated and serviced by other financial institutions. These loans are senior
obligations of the borrowers and are secured by substantially all of the assets
of the borrower. Insurance premium financing represents the financing of
property and casualty insurance premiums for small businesses and is secured by
the unearned premiums of the underlying insurance policies. (See "Financial
Services Operation.")
By engaging in geographically diverse businesses nationwide, the Company
believes it has provided opportunities for growth in its revenues. Since the
year ended December 31, 1995 to the year ended December 31, 1999, the Company's
revenues grew at a compound annual rate of approximately 11% to $1.4 billion for
1999. The Company's book value increased to $731 million at December 31, 1999
from $498 million at December 31, 1995.
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Management believes that ownership of Fremont's common stock by employees
has been an important element in the Company's success by enabling the Company
to attract and retain the best available personnel for positions of substantial
responsibility and to provide additional incentive and motivation to such
individuals to promote the success of the Company. As of December 31, 1999,
officers and directors of the Company, their families and the Company's benefit
plans beneficially owned approximately 37% of the Company's outstanding common
stock.
Fremont General Corporation, a Nevada corporation, was incorporated in
1972. Its corporate office is located at 2020 Santa Monica Boulevard, Suite 600,
Santa Monica, California 90404 and its phone number is (310) 315-5500.
PROPERTY AND CASUALTY INSURANCE OPERATION
Fremont Compensation Insurance Group, Inc., through its subsidiaries
("Fremont Comp"), underwrites workers' compensation insurance, and had premiums
inforce in forty-five states and the District of Columbia as of December 31,
1999. Over the last five years, the Company's focus on creating a broad national
platform through acquisitions and new business development has resulted in
Fremont Comp becoming one of the largest workers' compensation insurers in the
United States. Fremont Comp continues to underwrite a significant amount of its
premiums in California and Illinois. Using Fremont Comp's estimated annual
premiums on policies in effect at December 31, 1999, 1998 and 1997 (referred to
as "inforce premium"), the percentage of Fremont Comp's inforce premium in
California and Illinois totaled 60%, 65%, and 61%, respectively. Fremont Comp
also has significant premium volume in Alaska, Arizona, Colorado, Indiana,
Michigan, New Jersey, Texas and Wisconsin. These states collectively accounted
for 23%, 23% and 27% of Fremont Comp's inforce premium at December 31, 1999,
1998 and 1997, respectively. A.M. Best rates the Company's workers' compensation
insurance subsidiaries on a pool basis as "B++" (Very Good).
Workers' compensation insurance is a government-mandated ("statutory")
system which requires every employer to either purchase insurance or self-insure
in order to provide its employees with medical care and other specified benefits
for work-related injuries or illnesses. Compensation is payable regardless of
which party was at fault. Most employers provide for this potential liability by
purchasing workers' compensation insurance from insurance carriers. There are
four types of benefits payable under workers' compensation policies: medical
benefits, vocational rehabilitation benefits, disability benefits and death
benefits. The amounts of disability and death benefits payable for claims are
established by statute, vocational rehabilitation benefits are provided with
certain limitations in some jurisdictions, including California, and no dollar
limitation is set forth for medical benefits. (See "Regulation -- Insurance
Regulation.")
Premiums. Workers' compensation insurance premiums are based upon the
policyholder's payroll and the nature of their business and may be affected
significantly by changes in general economic conditions which impact employment
and wage levels, as well as by government regulation. Insurance premiums are
also subject to supervision and regulation by the state insurance authority in
each state. Most of the states in which Fremont Comp does business, including
California and Illinois, operate under an open rating system. Generally, in an
open rating system, workers' compensation insurers are provided with advisory
premium rates (expected losses and expenses) or loss costs (expected losses
only) which vary by job classification. Each insurance company sets its base
rates to reflect its particular loss experience and operating costs. These rates
are then modified to reflect individual risk characteristics and other expenses
in determining a final premium rate. (See "Regulation -- Insurance
Regulation -- Workers' Compensation Regulation.")
Underwriting and Loss Control. Prior to insuring a workers' compensation
policy, Fremont Comp's underwriting department reviews the employer's prior loss
experience, safety record, credit history, operations and employment
classifications. Fremont Comp generally avoids industries and businesses
involving hazardous conditions or high exposure to multiple injuries resulting
from a single occurrence. Fremont Comp targets accounts that appear to have a
strong work ethic among employees, long-term employees, and a genuine interest
in the adoption of and adherence to loss control standards. Fremont Comp's
primary market is small to medium sized employers. The average policy size,
using inforce premium at December 31, 1999, was $13,642 with approximately
76,000 policies issued.
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Fremont Comp's loss control department participates in the initial
underwriting process and also provides ongoing services to policyholders based
on individual needs and potential risk exposure. In the initial underwriting
phase, the underwriter will review both the loss experience and description of
operations and, where there is a concern about the potential hazards or claim
trends, a loss control consultant may be requested to pre-screen the account
prior to policy issuance. This pre-screening process may involve meeting with
the employer's management to assess the extent to which management is committed
to safety in the workplace, surveying the employer's operations, reviewing past
loss patterns and evaluating the safety program.
After the policy is issued, the loss control department provides service
calls to the insured based on both regulatory requirements and specific needs to
assist the employer in developing and maintaining safety programs and
procedures, reviews periodic loss reports, identifies weaknesses in the
employer's loss prevention programs and assists in correcting these weaknesses.
In some states, loss control must target those employers who have high loss
ratios and/or experience modifications, and provide specific services to assist
in accident prevention. Accident and claim records maintained by Fremont Comp
are also reviewed by the loss control department and service calls may be
initiated when adverse claim trends develop. Any insured who requests loss
control service is provided this service free of charge. Accident prevention
services include physical surveys for hazard recognition, safety program
evaluation, loss trend analysis and employee training.
Policyholders' Dividends. Since 1995, Fremont Comp's workers' compensation
insurance policies have generally been written as non-participating and,
therefore, do not include provisions for the insurer to declare and pay
dividends to a policyholder after the expiration of the policy. (See
"Regulation -- Workers' Compensation Regulation.")
Claims Administration. Fremont Comp's policy is to settle valid claims
promptly and to work closely with policyholders to return injured workers to
their jobs quickly, while avoiding litigation if possible. Claims personnel
communicate frequently with policyholders, injured employees and medical
providers. Fremont Comp's policy is to control the number of cases assigned to
its claims personnel, to identify and investigate questionable claims and to
produce early and cost-effective case settlements of valid claims. As part of
its "zero tolerance" program, Fremont Comp refuses to settle any claim that it
believes to be fraudulent without a comprehensive investigation.
Fremont Comp's litigation management is an integral part of its claim cost
control process. Fremont Comp utilizes in-house lawyers and hearing
representatives, where statutes permit, who understand the complex
administrative system and handle all aspects of the litigation process. Outside
counsel are also used when the unique aspects of a claim warrant it.
Fremont Comp provides early return-to-work programs for injured workers and
aggressively pursues the containment of medical costs. Utilizing Fremont Comp's
team-based medical management, claims examiners and registered nurses work with
the health care provider to return the injured worker to good health and back to
work. Fremont Comp's claims personnel utilize a network of directly-contracted
preferred providers, who have unique experience in industrial medicine, to
control costs. Fremont Comp also provides medical bill review to evaluate
compliance to state fee schedules and medical peer review panels to obtain
detailed evaluation of treatment protocols designed to return injured workers to
their jobs as quickly as possible.
Competition. The insurance industry is characterized by competition on the
basis of price and service. Service considerations include loss control and
claims administration, the ability to respond promptly to agents and brokers,
and commission schedules for agents and brokers. The repeal of the California
minimum rate law, effective January 1, 1995, has resulted in increased price
competition which has adversely affected the Company's results of operations for
its workers' compensation insurance business in California. In Illinois, price
competition has also impacted the Company's results of operations. The advisory
premium rates in Illinois, which are established by the National Council on
Compensation Insurance and which workers' compensation insurance companies in
Illinois tend to follow, increased 1.2% effective January 1, 2000 as opposed to
decreases of 0.2% and 7.9% effective January 1, 1999 and 1998, respectively.
(See "Regulation -- Insurance Regulation.") Beginning in the second half of
1999, however, Fremont Comp observed a lessening of price competition in its
primary regions of California and Illinois. More recently, in January 2000,
Fremont
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Comp experienced weighted average renewal premium rate increases of 26% and 14%
in California and Illinois, respectively, and Fremont Comp's total inforce
premiums for all regions combined remained in excess of $1 billion at January
31, 2000. It is uncertain however, whether the observed lessening in the
competitive environment and Fremont Comp's ability to increase premium rates
will continue. Over the past several years, Fremont Comp has also observed a
reduction in the number of competitors resulting from the consolidation of
companies into other entities, companies who are forced to terminate
underwriting activities through regulatory actions by state insurance
authorities, as well as from companies electing to reduce or discontinue the
writing of workers' compensation insurance in certain jurisdictions. (See "Risk
Factors.")
Fremont Comp expanded its workers' compensation operation through the
acquisition on August 1, 1997 of Industrial Indemnity Holdings, Inc.
("Industrial"), which underwrites workers' compensation insurance in most
western states. Although the acquisition of Industrial, and the acquisition of
Illinois-based Casualty Insurance Company ("Casualty") on February 22, 1995,
have provided Fremont Comp with major market positions in several states outside
of California, based on the competitive nature of the insurance industry and the
inherent risks associated with Fremont Comp entering into a new geographic
market, there can be no assurance that Fremont Comp will continue to maintain
its market share in the future.
Marketing. Fremont Comp primarily markets its workers' compensation
insurance policies through more than 2,800 non-exclusive independent insurance
agents and brokers, many of whom have been associated with Fremont Comp for more
than 15 years. At December 31, 1999, the ten largest agents accounted for
approximately 18.5% of Fremont Comp's workers' compensation insurance premiums.
The largest producer accounted for 3.9%.
As part of its September 1, 1998 acquisition of UNICARE Specialty Services,
Inc. ("Unicare") from Wellpoint Health Networks, Inc. ("Wellpoint"), Fremont
Comp formed a strategic joint marketing partnership with Wellpoint. Under this
program, a Fremont Comp workers' compensation insurance policy is integrated
with Wellpoint's non-occupational benefit programs, such as group medical and
non-occupational disability coverage ("the integrated product"). This integrated
product is marketed through approximately 1,800 agents, who are part of
Wellpoint's life and health product distribution system.
Fremont Comp also markets group insurance programs, which allow trade
associations and small businesses within an industry to pool their workers'
compensation insurance premium dollars and maximize their purchasing power.
These group insurance programs include customized safety programs that address
issues specific to an industry or association.
Reinsurance Ceded. Reinsurance is ceded primarily to reduce the liability
on individual risks and to protect against catastrophic losses. Fremont Comp
follows the industry practice of reinsuring a portion of its risks. For this
coverage, Fremont Comp pays the reinsurer a portion of the premiums received on
all covered policies.
Fremont Comp maintains excess of loss reinsurance treaties with various
reinsurers. Under the workers' compensation reinsurance treaties in effect as of
and for the year ended December 31, 1999, various reinsurers assumed liability
for up to a maximum of $399,950,000 of loss and certain allocated loss
adjustment expenses in excess of $50,000 per loss occurrence. Effective January
1, 2000, these reinsurance limits were reduced. Currently, Fremont Comp's excess
of loss reinsurance for new and renewal workers' compensation insurance policies
with effective dates of January 1, 2000 or after assumes liability for up to a
maximum of $399,000,000 of loss and certain allocated loss adjustment expenses
in excess of $1,000,000 per loss occurrence. (See "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Property and Casualty Insurance Operation -- Premiums.") Although reinsurance
makes the assuming reinsurer liable to the insurer to the extent of the
reinsurance ceded, it does not legally discharge an insurer from its primary
liability for the full amount of the policy liability. All of the foregoing
reinsurance is with non-affiliated reinsurers. The Company believes that the
terms of its reinsurance contracts are consistent with industry practice and,
based on its understanding of the reinsurers' financial condition and
reputations in the reinsurance marketplace, that its reinsurers are financially
sound. Fremont Comp encounters disputes from time to time with its reinsurers,
which, if not settled, are typically resolved in arbitration.
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Most of Fremont Comp's treaties are for annual terms. However, for the
specific treaties which became effective January 1, 1998 and under which the
reinsurers assume liability for loss and certain allocated loss adjustment
expense that exceeds $50,000 per occurrence, up to a maximum of $950,000, the
terms were for a period of two years, and expired December 31, 1999.
In general, the reinsurance agreements are of the treaty variety and cover
all underwritten risks of types specified in the treaties. As of December 31,
1999, Gerling Global Reinsurance Corporation of America, Reliance Insurance
Company, Great Southern Insurance Company and United States Fire Insurance
Company were the only reinsurers that accounted for more than 10% of the
Company's total reinsurance recoverables on paid and unpaid losses.
On February 28, 2000, Fremont Comp reached an agreement with one of its
reinsurers, Reliance Insurance Company ("Reliance"), to settle all obligations
between Fremont Comp and Reliance under a contract of reinsurance which was in
effect for the period January 1, 1998 through December 31, 1999. The reinsurance
treaty afforded Fremont Comp coverage for loss and certain loss adjustment
expense that exceeded $100,000 per occurrence, up to a maximum of $150,000.
Under the terms of the settlement agreement, Fremont Comp will receive in excess
of $100 million in cash and will no longer have any involvement with the
Reliance workers' compensation reinsurance programs brokered for Reliance by
Unicover Managers, Inc. In recognition of this settlement, Fremont recorded a
charge to its operating results in the quarter ended December 31, 1999 of
approximately $48.8 million after taxes, consisting primarily of the adjustment
necessary to bring the estimated unpaid reinsurance recoverables under the
reinsurance contract to a present value basis at December 31, 1999. The Company
anticipates this charge to be mitigated through future investment income earned
on the cash to be received under the agreement. The cash payment is expected to
be made to Fremont Comp on or shortly after the effective date of the agreement,
which is anticipated by the end of the first quarter of 2000.
The Company evaluated the adequacy of the expected cash settlement under
the Reliance settlement agreement through an independent actuarial analysis of
the expected losses and allocated loss adjustment expenses to be paid under the
Reliance reinsurance contract after December 31, 1999. A range of expected loss
payments was estimated and then discounted to a present value basis using
investment yields considered appropriate. Based on these indications, the cash
settlement is within the range of present values. The Company believes that the
cash settlement coupled with the estimated future investment income earned from
these proceeds, will approximate the future loss and allocated loss adjustment
expense payments that would have been reinsured and paid by Reliance under the
reinsurance contract. Based on the results of this evaluation, the Company
believes the net effect of this transaction will be economically neutral.
Medical Malpractice Insurance. Fremont's medical malpractice insurance
operation underwrote primarily standard professional liability insurance on a
"claims made" basis, through non-exclusive independent brokers mainly in
California. On January 1, 1998, the Company entered into reinsurance and
assumption agreements with a reinsurer whereby substantially all of the assets
and liabilities related to the medical malpractice policies were ceded to the
reinsurer. These reinsurance agreements are part of several other agreements
which collectively resulted in the sale of Fremont's medical malpractice
operation effective January 1, 1998. The effect on operations from these
agreements was not material, and revenue and operating income from medical
malpractice operations were not significant in 1997.
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Operating Data. Set forth below is certain information pertaining to
Fremont's property and casualty insurance business as determined in accordance
with generally accepted accounting principles ("GAAP") for the years indicated.
(See "Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations" for a discussion of certain of this information.)
YEAR ENDED DECEMBER 31,
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1999 1998 1997 1996 1995
--------- -------- -------- -------- --------
(THOUSANDS OF DOLLARS, EXCEPT PERCENTS)
Net premiums earned................ $ 831,005 $552,078 $601,183 $486,860 $606,917
Net investment income and
other(1)......................... 122,140 148,040 102,645 92,254 85,912
Underwriting profit (loss)......... (238,318) 21,195 42,022 25,339 (2,820)
Income (loss) before taxes......... (116,178) 169,235 144,667 117,593 83,092
Loss ratio....................... 92.7% 60.8% 64.7% 68.9% 76.0%
Expense ratio.................... 31.6% 34.5% 27.5% 25.9% 24.5%
Policyholders' dividend ratio.... 4.4% 0.9% 0.8% -- --
--------- -------- -------- -------- --------
Total combined ratio..... 128.7% 96.2% 93.0% 94.8% 100.5%
========= ======== ======== ======== ========
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(1) Includes net realized investment gains (losses), other revenues and interest
expense.
Statutory Combined Ratio. The following table reflects the combined ratios
of Fremont's workers' compensation insurance business determined in accordance
with statutory accounting practices, together with the workers' compensation
industry-wide combined ratios after policyholders' dividends, as compiled by
A.M. Best, for the years indicated.
YEAR ENDED DECEMBER 31,
----------------------------------------------------
1999 1998 1997 1996 1995
------------- ----- ----- ---- -----
Workers' Compensation:
Company................................. 120.0% 113.4%(2) 96.6%(3) 97.9% 100.1%(4)
Industry(1)............................. not available 107.6% 100.7% 99.7% 97.0%
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(1) Nationwide statutory combined ratio information for the workers'
compensation insurance industry for 1995 through 1998 is from A.M. Best's
Aggregates & Averages, Property-Casualty (1996 through 1999 editions).
(2) Includes the statutory results for Unicare for the period January 1, 1998
through August 31, 1998, which was prior to the Company's acquisition of
Unicare on September 1, 1998. The significant increase in the statutory
combined ratio in 1998 as compared to 1997 is due primarily to significant
increases in the liability for losses and LAE for Unicare, which occurred
prior to its acquisition by the Company.
(3) Includes the statutory results for Industrial for the period January 1, 1997
through July 31, 1997, which was prior to the Company's acquisition of
Industrial on August 1, 1997.
(4) Includes the statutory results for Casualty for the period January 1, 1995
through February 21, 1995, which was prior to the Company's acquisition of
Casualty on February 22, 1995.
Premium-to-Surplus Ratio. Regulatory authorities regard the
premium-to-surplus ratio as an important indicator of operating leverage. A
lower ratio indicates a greater ability on the part of an insurer to withstand
abnormal loss experience. Guidelines established by the National Association of
Insurance Commissioners ("NAIC") provide that a property and casualty insurer's
premium-to-surplus ratio is satisfactory if it is below 3 to 1.
7
10
The following table sets forth the Company's consolidated ratio of net
property and casualty premiums written during the period to policyholders'
surplus on a statutory basis at the end of the period, for the periods
indicated, including a proforma result for the 1999 year had the previously
discussed Reliance reinsurance settlement been recognized on a statutory basis:
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------
PROFORMA
1999(1) 1999 1998(2) 1997(3) 1996 1995(4)
-------- -------- -------- -------- -------- --------
(THOUSANDS OF DOLLARS, EXCEPT RATIOS)
Net premiums written during the year.............. $896,833 $896,833 $644,218 $820,532 $473,123 $683,711
Policyholders' surplus at end of year............. 508,000 562,879 646,828 548,280 399,893 299,408
Ratio............................................. 1.8x 1.6x 1.0x 1.5x 1.2x 2.3x
- ---------------
(1) Since the Reliance reinsurance settlement was not executed until February
28, 2000, the effect of this settlement was not recognized in the Company's
statutory results for the year ended December 31, 1999. The proforma
premium-to-surplus ratio represents the estimated ratio had the Reliance
reinsurance settlement been recognized in the statutory results for the year
ended December 31, 1999.
(2) Includes net written premium for Unicare for the period January 1, 1998
through August 31, 1998, which was prior to the Company's acquisition of
Unicare on September 1, 1998.
(3) Includes net written premium for Industrial for the period January 1, 1997
through July 31, 1997, which was prior to the Company's acquisition of
Industrial on August 1, 1997.
(4) Includes net written premium for Casualty for the period January 1, 1995
through February 21, 1995, which was prior to the Company's acquisition of
Casualty on February 22, 1995.
Loss and Loss Adjustment Expense Reserves. In many cases, significant
periods of time, ranging up to several years or more, may elapse between the
occurrence of an insured loss, the reporting of the loss to the insurer, and the
insurer's payment of that loss. To recognize liabilities for future unpaid
losses, insurers establish reserves, which are balance sheet liabilities,
representing estimates of future amounts needed to pay claims with respect to
insured events that have occurred. Reserves are also established for loss
adjustment expense reserves ("LAE") representing the estimated expenses of
settling claims, including legal and other fees, and general expenses of
administering the claims adjustment process. Associated with the liabilities for
future unpaid losses and LAE are estimates of reinsurance recoverables related
to these future unpaid losses and LAE, which are reported on the balance sheet
as assets.
Reserves for losses and LAE ("loss reserves") are based not only on
historical experience but also on management's judgment of the effects of
matters such as future economic and social forces likely to impact the insurer's
experience with the type of risk involved, circumstances surrounding individual
claims, and trends that may affect the probable number and nature of claims
arising from losses not yet reported. Consequently, loss reserves are inherently
subject to a number of highly variable circumstances.
Loss reserves and reinsurance recoverables on unpaid losses are revalued
periodically using a variety of actuarial and statistical techniques for
producing current estimates of expected claim costs and reinsurance recoveries.
Claim frequency and severity and other economic and social factors are
considered in the re-evaluation process. A provision for inflation in the
calculation of estimated future claim costs and reinsurance recoverables is
implicit since reliance is placed on both actual historical data, which reflect
past inflation, and on other factors which are judged to be appropriate
modifiers of past experience. Adjustments to loss reserves and reinsurance
recoverables are reflected in operating results for the periods to which they
are made.
8
11
Reconciliation of Loss and Loss Adjustment Expense Reserves. The following
table shows the GAAP reconciliation of the estimated liability for loss and LAE
for Fremont's property and casualty insurance subsidiaries (excluding
discontinued operations) and the effect on income for each of the three years
indicated.
RECONCILIATION OF RESERVES FOR LOSS AND LAE
YEAR ENDED DECEMBER 31,
------------------------------------
1999 1998 1997
---------- ---------- ----------
(THOUSANDS OF DOLLARS)
Reserves for loss and LAE, net of reinsurance recoverable,
at beginning of year...................................... $1,597,116 $1,809,395 $1,010,886
Incurred loss and LAE:
Provision for insured events of the current year, net of
reinsurance............................................ 677,756 348,897 441,524
Increase (decrease) in provision for insured events of
prior years, net of reinsurance........................ 92,767 (13,447) (52,323)
---------- ---------- ----------
Total incurred loss and LAE....................... 770,523 335,450 389,201
Payments:
Loss and LAE, net of reinsurance, attributable to insured
events of:
Current year......................................... (296,039) (245,177) (253,323)
Prior years.......................................... (576,320) (590,197) (386,469)
---------- ---------- ----------
Total payments.................................... (872,359) (835,374) (639,792)
---------- ---------- ----------
Subtotal.......................................... 1,495,280 1,309,471 760,295
Liability for loss and LAE for companies acquired during the
year...................................................... -- 287,645 1,049,100
---------- ---------- ----------
Reserves for loss and LAE, net of reinsurance recoverable,
at end of year............................................ 1,495,280 1,597,116 1,809,395
Reinsurance recoverable for loss and LAE, at end of year.... 939,477 701,002 353,928
---------- ---------- ----------
Reserves for loss and LAE, gross of reinsurance recoverable,
at end of year............................................ $2,434,757 $2,298,118 $2,163,323
========== ========== ==========
9
12
Analysis of Loss and Loss Adjustment Expense Development. The following
table shows the cumulative amount paid, net of reinsurance recoveries, against
the previously recorded liability, net of reinsurance recoverables, at the end
of each succeeding year and the cumulative development of the estimated net
liability for the ten years ending December 31, 1999. Conditions and trends that
have affected the development of these net reserves and net payments in the past
will not necessarily recur in the future. Accordingly, management does not
believe that it is appropriate to use this cumulative history to project future
performance.
The re-estimated net liability portion of the following table shows the
year-by-year development of the previously estimated net liability at the end of
each succeeding year. The re-estimated net liabilities are increased or
decreased as more information becomes known about the frequency and severity of
claims for individual years. The increases or decreases are reflected in the
current year's operating earnings. Each column shows the net reserve held at the
indicated calendar year-end and cumulative data on re-estimated net liabilities
for the year and all prior years making up those calendar year-end net
liabilities. The effect on income of the charge (credit) during the current
period (i.e., the difference between the estimated net liability at December 31
and the net liability estimated one year later) is shown in the previous table
above for each of the three most recent years as "Increase (decrease) in
provision for insured events of prior years, net of reinsurance".
CHANGES IN HISTORICAL RESERVES FOR LOSS AND LAE FOR THE LAST TEN YEARS
GAAP BASIS AS OF DECEMBER 31, 1999
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------------------------------
1989 1990 1991 1992 1993 1994 1995 1996
-------- -------- -------- -------- -------- -------- ---------- ----------
(THOUSANDS OF DOLLARS)
Reserves for Loss and LAE, net of
reinsurance recoverable......... $647,559 $652,284 $627,103 $633,394 $644,190 $610,510 $1,185,706 $1,010,886
Net reserve re-estimated as of:
One year later.................. 636,039 624,953 668,107 629,268 626,956 611,892 1,186,456 958,563
Two years later................. 607,253 647,959 660,729 615,747 633,333 632,397 1,116,673 955,644
Three years later............... 607,492 638,879 651,482 621,348 641,166 644,485 1,116,103 978,872
Four years later................ 599,052 627,194 654,403 626,174 659,968 641,581 1,096,712
Five years later................ 593,527 631,165 659,050 685,517 656,549 698,045
Six years later................. 596,808 634,628 717,517 681,811 698,918
Seven years later............... 600,646 675,661 714,447 720,800
Eight years later............... 630,176 672,560 747,198
Nine years later................ 627,227 694,387
Ten years later................. 646,381
Net cumulative redundancy
(deficiency).................... 1,178 (42,103) (120,095) (87,406) (54,728) (87,535) 88,994 32,014
Cumulative amount of reserve
paid, net of reserve recoveries,
through:
One year later.................. 226,101 245,777 257,951 240,552 236,774 241,667 401,980 386,469
Two years later................. 374,876 403,105 419,638 402,048 392,237 397,640 662,943 607,273
Three years later............... 461,366 495,707 521,729 499,924 484,474 495,825 812,174 714,248
Four years later................ 514,890 550,404 583,013 558,935 545,574 548,109 883,106
Five years later................ 547,535 585,094 623,022 600,071 580,503 577,367
Six years later................. 567,871 608,802 652,990 624,813 599,414
Seven years later............... 583,580 629,321 670,625 637,967
Eight years later............... 597,623 641,031 680,387
Nine years later................ 605,926 646,969
Ten years later................. 609,778
Net reserve -- December 31,......
Reinsurance recoverable..........
Gross reserve -- December 31,....
Net re-estimated reserve.........
Re-estimated reinsurance
recoverable.....................
Gross re-estimated reserve.......
Gross cumulative redundancy
(deficiency)....................
YEAR ENDED DECEMBER 31,
------------------------------------
1997 1998 1999
---------- ---------- ----------
(THOUSANDS OF DOLLARS)
Reserves for Loss and LAE, net of
reinsurance recoverable......... $1,809,395 $1,597,116 $1,495,280
Net reserve re-estimated as of:
One year later.................. 1,795,948 1,689,883
Two years later................. 1,745,340
Three years later...............
Four years later................
Five years later................
Six years later.................
Seven years later...............
Eight years later...............
Nine years later................
Ten years later.................
Net cumulative redundancy
(deficiency).................... 64,055 (92,767)
Cumulative amount of reserve
paid, net of reserve recoveries,
through:
One year later.................. 590,197 576,320
Two years later................. 895,834
Three years later...............
Four years later................
Five years later................
Six years later.................
Seven years later...............
Eight years later...............
Nine years later................
Ten years later.................
---------- ---------- ----------
Net reserve -- December 31,...... $1,809,395 $1,597,116 $1,495,280
Reinsurance recoverable.......... 353,928 701,002 939,477
---------- ---------- ----------
Gross reserve -- December 31,.... $2,163,323 $2,298,118 $2,434,757
========== ========== ==========
Net re-estimated reserve......... $1,745,340 $1,689,883
Re-estimated reinsurance
recoverable..................... 508,358 727,899
---------- ----------
Gross re-estimated reserve....... $2,253,698 $2,417,782
========== ==========
Gross cumulative redundancy
(deficiency).................... $ (90,375) $ (119,664)
========== ==========
10
13
The Company regularly reviews its reserving techniques, overall reserve
position and its reinsurance estimates. In light of present facts and current
legal interpretations, management believes that adequate provision has been made
for loss reserves and for reinsurance recoverables. In making this
determination, management has considered its claims experience to date, loss
development history for prior accident years, estimates of future trends of
claims frequency and severity, and various external factors such as judicial
theories of liability. (See "Risk Factors.")
In 1999, the Company increased its net loss and LAE reserves for 1998 and
prior accident years by $92.8 million. The increase resulted primarily from the
combined effect of a lower than expected level of reinsurance recoveries than
had been actuarially predicted, coupled with the effect on the 1998 accident
year of the Company's recognition of the settlement agreement with Reliance
under a reinsurance treaty that expired December 31, 1999. (See "Reinsurance
Ceded.") While the prior years' development during calendar year 1999 was
comprised primarily of adjustments to reinsurance recoverables on unpaid losses,
the Company has observed for its primary regions relative stability in its
workers' compensation gross loss and allocated loss adjustment expense ratios
derived from the actuarial indications of reserves for loss and allocated loss
adjustment expense, gross of reinsurance recoverables.
With regard to the lower than expected reinsurance recoveries, in the third
and fourth quarters of 1999, the Company lowered its estimate of reinsurance
recoverables on unpaid losses for the 1998 accident year by approximately $49
million. This re-estimation was in recognition of a lower than actuarially
predicted level of incurred loss ceded under certain reinsurance contracts that
were in effect from January 1, 1998 through December 31, 1999. These reinsurance
contracts reduced Fremont Comp's net loss exposure from a historical retention
of $1 million per occurrence to $50,000 per occurrence. Prior to entering into
these reinsurance agreements the Company had estimated its expected gross
incurred loss and LAE. Estimates of net incurred loss and LAE were then
established utilizing actuarial indications based upon historical experience and
other factors considered appropriate to forecast incurred losses to be ceded
under these reinsurance agreements. During the third quarter of 1999 and
pursuant to its regular review of net incurred loss and LAE estimates, the
Company observed a deterioration in these net loss and LAE estimates as compared
to the actuarial predictions. To assist the Company in its determination of net
loss and LAE reserve estimates, the Company retained outside actuarial
consultants who performed an independent actuarial analysis of the Company's net
loss and LAE reserves as of June 30, 1999. These actuarial indications were
reaffirmed at September 30, 1999 and further re-evaluated by the independent
outside actuaries at December 31, 1999, which resulted in the Company's
recognition of the deterioration in reinsurance recoverables in the third and
fourth quarters of 1999. Based on the Company's review of these actuarial
indications and consequent recognition of the deterioration in estimated
reinsurance recoverables on the 1998 accident year, the Company believes its
estimates of reinsurance recoverables on unpaid losses are an adequate provision
for loss recoveries under reinsurance agreements. (See "Reinsurance Ceded.")
Also contributing to the increase in 1999 to the Company's net loss and LAE
reserves for the 1998 and prior accident years is $26 million in lower
reinsurance recoverables on the 1998 accident year pursuant to a settlement
agreement entered into February 28, 2000 between the Company and Reliance under
a reinsurance contract that was in effect from January 1, 1998 through December
31, 1999. Under the settlement agreement, Fremont Comp is to receive in excess
of $100 million in cash and will no longer have any involvement with Reliance
under the reinsurance contract. The Company evaluated the adequacy of the
expected cash settlement under the agreement through an independent actuarial
analysis of the expected loss and allocated loss adjustment expenses to be paid
under the Reliance reinsurance contract after December 31, 1999. A range of
expected loss payments was estimated and then discounted to a present value
basis using investment yields considered appropriate. Based on these
indications, the cash settlement is within the range of present values. The $26
million decrease in reinsurance recoverables represents primarily the adjustment
necessary to bring the estimated reinsurance recoverables relating to the 1998
accident year under the reinsurance contract with Reliance to a present value
basis at December 31, 1999. (See "Reinsurance Ceded.")
In 1998, Fremont decreased its net loss and LAE reserves for 1997 and prior
accident years by $13.4 million. This decrease resulted primarily from the
combined effect of a decrease to 1997 and prior
11
14
accident year loss and LAE reserves under certain assigned risk plans that
Fremont Comp is required to participate in, and an increase in the discount
established for certain accident and health permanent disability and death
reserves. (See "Regulation -- Insurance Regulation" and Note A of Notes to
Consolidated Financial Statements.)
In 1997, Fremont decreased its net loss and LAE reserves for 1996 and prior
accident years by $52.3 million. This reserve decrease related primarily to loss
and LAE reserves on workers' compensation policies written in Fremont Comp's
midwest region and represents the recognition of a decrease in the frequency of
reported claims on the 1996 and 1995 accident years. Additionally, the Company's
management believes that its implementation of more effective claims handling
procedures in the midwest region contributed to the reduction in LAE reserves on
the 1996 and prior accident years during calendar year 1997.
Fremont Comp acquired Casualty on February 22, 1995. This acquisition
provided Fremont Comp a significant presence in several midwestern states,
primarily Illinois. By the end of 1995, the Company observed a significant
reduction in the frequency of reported claims on the 1995 accident year as
compared to Casualty's historical experience prior to 1995. Also during 1995,
Fremont Comp had been active in assimilating the operations of Casualty into its
existing operating environment, which included, among other things, implementing
more effective claims handling procedures. Therefore, the Company could not
determine with certainty whether or not the observed lower frequency in reported
claims was a one-time event occurring as a result of these changes in claims
handling procedures. In 1997, Fremont observed the continued trend in lower
reported claim experience on the 1996 and 1995 accident years, which also had
been confirmed in the industry through an evaluation of industry data.
Appropriate reserve adjustments were, therefore, made by the Company in 1997 in
recognition of this confirmed trend in lower loss experience on the 1996 and
1995 accident years for the midwest region. Fremont is not able to determine
with certainty the specific cause or causes of increases and decreases in claims
experience that led to these changes in reserves but has reached its own
conclusion based on a review of its internal data and a subjective evaluation of
external factors. The previous discussion is a summary of the principal
considerations that the Company evaluated in determining workers' compensation
insurance reserves adjustments in 1997.
INVESTMENT PORTFOLIO
Fremont manages its investments internally. The following investment
portfolio information reflects the Company's continuing property and casualty
insurance and financial services operations.
12
15
The following table reflects the amortized cost and fair value of fixed
maturity investments and non-redeemable preferred equity securities by major
category, all of which are held as available for sale, as well as the amortized
cost and fair value of cash and short-term investments on the dates indicated.
DECEMBER 31, 1999 DECEMBER 31, 1998
----------------------- -----------------------
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
---------- ---------- ---------- ----------
(THOUSANDS OF DOLLARS)
Available for sale:
United States Treasury securities and
obligations of other US government
agencies and corporations............... $ 64,601 $ 64,467 $ 87,615 $ 89,328
Obligations of states and political
subdivisions............................ 139,559 132,138 240,067 247,222
Redeemable preferred stock................. 80,127 73,800 38,035 38,306
Mortgage-backed securities................. 344,649 326,993 355,747 369,246
Corporate securities
Banks................................... 136,401 125,996 79,398 83,993
Financial............................... 179,600 166,623 195,937 198,624
Transportation.......................... -- -- 27,211 30,149
Industrial.............................. 513,784 501,212 573,575 589,904
---------- ---------- ---------- ----------
Total.............................. 1,458,721 1,391,229 1,597,585 1,646,772
Non-redeemable preferred stock............. 407,903 369,103 489,714 500,376
---------- ---------- ---------- ----------
Total.............................. $1,866,624 $1,760,332 $2,087,299 $2,147,148
========== ========== ========== ==========
Short-term investments....................... $ 410,457 $ 410,457 $ 222,719 $ 222,719
Cash......................................... 65,102 65,102 79,875 79,875
As of December 31, 1999, substantially all of the investments in the
portfolio were rated investment grade by Standard and Poor's, Moody's, Duff and
Phelps and Fitch's rating services. Of these investments, 79% were rated A or
higher, 20% were rated BBB and 1% were rated BB. As of December 31, 1999, these
investment securities had an approximate fair value of $1.8 billion, which was
lower than amortized cost by approximately $106 million. Fremont does not
currently plan or intend to invest in securities rated below investment grade.
In 1999, portions of the corporate securities financial sector were reclassified
to the banks sector.
The following table reflects average amortized cost of investment assets of
the Company for the periods indicated.
YEAR ENDED DECEMBER 31,
-----------------------------------------
1999 1998 1997
----------- ----------- -----------
(THOUSANDS OF DOLLARS, EXCEPT PERCENTS)
Average investment assets.............................. $2,260,957 $2,345,464 $1,970,602
========== ========== ==========
Investment yield earned on investment assets:
Excluding realized gains and losses.................. 7.52% 8.25% 7.68%
Including realized gains and losses.................. 7.37% 8.23% 7.58%
Fremont has designated its entire portfolio as investments that would be
available for sale in response to changing market conditions, liquidity
requirements, interest rate movements and other investment factors. At December
31, 1999 and 1998, the Company held securities having an amortized cost of
$1.867 billion and $2.087 billion, respectively, as available for sale. (See
Notes A and C of Notes to Consolidated Financial Statements.)
13
16
The following table sets forth maturities in the fixed maturity investment
portfolio at December 31, 1999:
AMORTIZED
COST PERCENTAGE
---------- ----------
(THOUSANDS OF DOLLARS,
EXCEPT PERCENTS)
One year or less............................................ $ 57,793 4%
Over 1 year through 5 years................................. 126,604 9
Over 5 years through 10 years............................... 138,990 9
Over 10 years............................................... 790,685 54
Mortgage-backed securities.................................. 344,649 24
---------- ---
Totals............................................ $1,458,721 100%
========== ===
FINANCIAL SERVICES OPERATION
The operations of the financial services segment are consolidated within
Fremont General Credit Corporation, which is engaged in collateralized lending
to businesses and individuals nationwide through its California-chartered thrift
and loan subsidiary, Fremont Investment & Loan ("the thrift"). The Company's
financial services loan portfolio as of the dates indicated is summarized in the
following table by loan type.
YEAR ENDED DECEMBER 31,
--------------------------------------
1999 1998 1997
---------- ---------- ----------
(THOUSANDS OF DOLLARS)
Commercial real estate loans........................... $2,332,880 $1,561,145 $1,046,441
Residential real estate loans.......................... 388,297 549,400 380,126
Syndicated loans....................................... 331,705 360,150 146,790
Premium finance loans.................................. 64,596 58,319 54,257
Commercial finance loans............................... -- 485,508 400,475
---------- ---------- ----------
Loans receivable before allowance for possible loan
losses............................................... 3,117,478 3,014,522 2,028,089
Less allowance for possible loan losses................ (56,494) (56,346) (44,402)
---------- ---------- ----------
Loans receivable, net................................ $3,060,984 $2,958,176 $1,983,687
========== ========== ==========
Commercial Real Estate Lending
The commercial real estate lending operation of Fremont currently consists
of more than 600 loans. The Company originates commercial real estate loans
nationwide primarily through independent loan brokers and through its own
marketing representatives. The origination of commercial real estate loans are
generally held for the Company's own portfolio. There were $217 million in
commercial real estate loans sold to other financial institutions in 1999,
representing approximately 14% of origination volume in 1999, and no loans were
sold in 1998 or 1997. Commercial real estate loan origination volume grew 61% to
$1.54 billion in 1999 from $959 million in 1998. The commercial real estate loan
portfolio grew to $2.33 billion or 74.8% of the Company's financial services
loan portfolio at December 31, 1999 from $1.56 billion or 49.4% of the financial
services loan portfolio at December 31, 1998.
The commercial real estate loan originations are primarily secured by first
mortgages on income-producing properties in California and, to a lesser degree,
Illinois, Texas and many other states. The real estate securing these loans
include a wide variety of property types including office, retail, industrial,
multi-family and mixed-use properties. Loans include short-term bridge
facilities for the rehabilitation and lease-up of existing properties, as well
as five to ten year permanent loans and single tenant loans. The majority of the
commercial real estate loans originated are adjustable rate loans and generally
range in loan size between $1 million and $15 million. As of December 31, 1999,
the average loan size was $3.5 million and the average loan-to-value ratio was
65.3%, using the most current available appraised values and current balances
outstanding. At December 31, 1999, the Company had 8 non-performing commercial
real estate loans totaling approximately $14.4 million and no commercial real
estate owned.
14
17
Residential Real Estate Lending
The Company's residential real estate lending operation is currently
comprised of more than 6,000 loans. Fremont originates residential real estate
loans nationwide through independent loan brokers, through its own marketing
representatives and through bulk purchase. The real estate securing these loans
are single family residences located in California, and to a lesser degree
Illinois, Florida, Washington, New Jersey, and many other states. The Company's
origination volume increased 89% to $1.72 billion in 1999 from $906 million in
1998. Contributing to the significant growth in 1999 was the expansion of new
business in Illinois and Florida, as well as the acquisition of a
California-based wholesale loan production unit in November 1998. The
residential real estate loan portfolio, excluding loans held for sale, was $388
million or 12.5% of the Company's financial services loan portfolio at December
31, 1999, down from $549 million or 29.3% of the financial services loan
portfolio at December 31, 1998.
Substantially all of the Company's residential real estate loans are
secured by first deeds of trust. These loans generally have principal amounts
below $350,000, have maturities generally of thirty years and are underwritten
in accordance with lending policies approved by the thrift's Board of Directors,
which include standards covering, among other things, collateral value, loan to
value and customer debt ratio. These loans generally are "hybrid" loans which
have a fixed rate of interest for an initial period after origination, typically
two to three years, after which the interest rate will be adjusted to a rate
equal to the sum of six month LIBOR and a margin as set forth in the mortgage
note. This interest rate will then be adjusted at each six-month interval
thereafter, subject to various lifetime and periodic rate caps and floors. These
loans have been originated using underwriting standards that are less stringent
than the Federal National Mortgage Association's guidelines and are commonly
known as "subprime" loans. To mitigate the higher potential for credit losses
that accompanies these types of borrowers, Fremont attempts to maintain
underwriting standards that require conservative loan to collateral valuations.
(See "Risk Factors.") At December 31, 1999, the average single-family loan
amount was $101,000, and the average loan-to-value ratio was 77.5%, using
appraised values at the time of loan origination and current balances
outstanding. At December 31, 1999, Fremont had 167 non-performing residential
real estate loans totaling approximately $15.5 million and residential real
estate owned of approximately $3.7 million.
In years prior to 1999, the Company originated residential real estate
loans for its own portfolio and for whole loan sale to other financial
institutions. In the second half of 1998, Fremont observed that prices for the
residential real estate loans began to decrease due to market disruptions and
oversupply. The Company, rather than sell the loans at prices lower than what it
believed was the economic benefit to be derived, began a program to retain these
benefits by either retaining the loans in its portfolio or securitizing them.
During 1999, Fremont sold $1.75 billion in residential real estate loans,
comprised of $1.4 billion in loans sold in three securitizations and $343.5
million in whole loan sales to other financial institutions. In 1998 and 1997,
residential real estate loan sales of $746.5 million and $162.8 million,
respectively, were represented entirely by whole loan sales. The Company's
residential real estate loan disposition strategy will continue to include
securitization in addition to whole loan sales and retaining loans in its
portfolio, depending on market conditions, profitability and cash flows.
In the Company's securitizations, the Company sells residential real estate
loans to a special purpose entity, which is established for the limited purpose
of purchasing the loans and issuing interest bearing securities that represent
interests in the loans. The securitization is treated as a sale and the loans
sold are removed from the Company's balance sheet. The securities issued to
third party investors are collateralized by the underlying pool of residential
real estate loans. The investors and the special purpose entity have no recourse
to the Company for failure of the residential loan borrowers to pay when due.
The Company retains a residual interest, which represents the right to receive
certain future cash flows which are generally equal to the value of the
principal and interest to be collected on the loans in excess of: (i) the
principal and interest to be paid on the securities; and (ii) various
contractual net servicing fees and other expenses. Most of the Company's
residual interests, however, are generally restricted until investors and other
expenses have been paid or otherwise are subordinate to investor's interests.
Upon completion of the securitization, the Company records its residual
interests as an asset on the balance sheet. Gains or losses on a securitization
are based on the estimated fair value of the proceeds from the sale, net of
related transaction costs and the allocated
15
18
carrying value of the loans sold. Fair value is determined by computing the net
present value of the estimated cash flows retained, using the dates that such
cash flows are expected to be released to the Company (the cash-out method), at
a discount rate considered commensurate with the risks associated with the cash
flows. The amounts and timing of the cash flows are estimated after considering
various economic factors and other factors, including prepayment speeds and
delinquency, default and loss rates. The outstanding balance of the Company's
residual interests at December 31, 1999 was $63 million. Since the value of the
residual interests is subject to substantial credit, prepayment, and interest
rate risks on the loans sold, the Company has recognized no gain on the residual
interests it has retained. This reduces the amounts of gain recognized in the
current period; however, income may be recognized in future periods if the
Company's original assumptions develop favorably. (See "Risk Factors.")
In a whole loan sale for cash, the Company generally enters into an
agreement to sell the loans for cash, without recourse, on a servicing released
basis. After the sale, the Company retains no interest in the underlying loans.
Syndicated Loans
Fremont has interests in large syndicated commercial loans which are
originated and serviced by other financial institutions. These loans are senior
obligations of the borrowers and are secured by substantially all of the assets
of the borrower and, if applicable, its subsidiaries. The syndicated loans are
variable rate loans and are originated on both a revolving and fixed-term basis.
The term loans are generally issued with terms not in excess of seven years. The
Company funds these loans using thrift deposits. The syndicated loan portfolio
was $332 million at December 31, 1999, or 10.6% of the financial services loan
portfolio, as compared to $360 million or 11.9% of the financial services loan
portfolio at December 31, 1998. These loans are originated through development
of the Company's relationships with various financial institutions. As of
December 31, 1999, the average outstanding syndicated loan balance was $7.2
million. Loan commitments to a single borrower generally range in size from $5
million to $10 million.
Insurance Premium Financing
The Company finances property and casualty insurance premiums for small
businesses. Fremont funds this activity in the thrift, mainly through deposits.
This premium finance loan portfolio is collateralized by the unearned premiums
of the underlying insurance policies. At December 31, 1999, insurance premium
finance loans represented $64.6 million or 2.1% of Fremont's financial services
loan portfolio. (See "Regulation -- Thrift and Loan Regulation -- California
Law.")
Funding Sources
Fremont's real estate lending activities are financed mainly through
deposit accounts offered by the Company's thrift (80,000 accounts at December
31, 1999), which are insured by the Federal Deposit Insurance Corporation
("FDIC"). (See "Regulation -- Thrift and Loan Regulation.") Fremont offers
certificates of deposit and installment investment certificates (which are
similar to passbook accounts and money market accounts) insured by the FDIC to
the legal maximum through its 19 branches in California. The Company has
typically offered higher interest rates to its depositors than do most full
service financial institutions. At the same time, the Company has minimized the
cost of maintaining its accounts by not offering traditional checking, safe
deposit boxes, money orders, ATM access and other traditional retail services,
which have higher maintenance costs. Fremont generally effects deposit
withdrawals by issuing checks rather than disbursing cash, which minimizes
operating costs associated with handling and storing cash. Deposits totaled $3.4
billion at December 31, 1999. Fremont's syndicated loans and insurance premium
finance loans are also funded by the thrift. Additional financing is available
to the thrift from the Federal Home Loan Bank of San Francisco ("FHLB"). The
financing by the FHLB is available at varying rates and terms. As of December
31, 1999, $363.9 million was available from the FHLB and $10.0 million was
outstanding. In 1999, the thrift obtained a line of credit with the Federal
Reserve Bank of San Francisco, and at December 31, 1999 had a borrowing capacity
of $272.5 million, with no amounts outstanding.
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In October 1999, the thrift established a warehouse financing facility that
may be used to finance certain residential real estate loans held for sale
through securitization or whole loan sale. The facility permits secured
borrowings for up to $200 million with a variable interest rate of LIBOR plus
0.375%. As of December 31, 1999, there were no borrowings under this facility.
The table below summarizes the Company's certificates of deposit as of
December 31, 1999, which are stated in amounts of $100,000 or more, by maturity
and by type.
CERTIFICATES OF DEPOSIT $100,000 OR MORE, MATURING
------------------------------------------------------
3 MONTHS OVER 3 THROUGH OVER 6 THROUGH OVER
OR LESS 6 MONTHS 12 MONTHS 12 MONTHS TOTAL
-------- -------------- -------------- --------- --------
(THOUSANDS OF DOLLARS)
Retail................................. $79,169 $37,111 $64,054 $ 26,444 $206,778
IRA's.................................. 4,067 2,554 6,979 3,986 17,586
Wholesale.............................. 2,107 1,504 1,412 -- 5,023
Brokered............................... -- -- -- 231,649 231,649
------- ------- ------- -------- --------
Total........................ $85,343 $41,169 $72,445 $262,079 $461,036
======= ======= ======= ======== ========
Commercial Finance
In December 1999, the Company discontinued its commercial finance lending
activities through the sale on December 20, 1999 of Fremont Financial
Corporation, its commercial finance subsidiary, to FINOVA Capital Corporation, a
subsidiary of The FINOVA Group, Inc. for approximately $708 million in cash
including the refinancing and assumption of existing debt. Included in the
Company's results of operations for the year ended December 31, 1999 is the
recognition of a $10.3 million gain before taxes on the sale of this subsidiary.
(See Note B of Notes to Consolidated Financial Statements.) Prior to the sale,
this commercial finance subsidiary provided working capital loans, primarily
secured by accounts receivable, inventory, machinery and equipment to small and
middle market companies on a nationwide basis.
Competition
Fremont's financial services businesses compete in markets that are highly
competitive and are characterized by factors that vary based upon product and
geographic region. The markets in which the Company competes are typically
characterized by a large number of competitors who compete based primarily upon
price, terms and loan structure. Fremont primarily competes with banks,
mortgage, insurance and finance companies, many of which are larger and have
greater financial resources than Fremont. The competitive forces of these
markets could adversely affect the Company's net finance income, loan
origination volume or net credit losses.
LIFE INSURANCE
Prior to January 1, 1996, the Company offered life insurance products,
including annuities, credit life and disability insurance and term life
insurance for consumers, through a subsidiary. Effective December 31, 1995 and
January 1, 1996, the Company entered into reinsurance and assumption agreements
with a reinsurer whereby assets and liabilities related to certain life
insurance and annuity policies were ceded to the reinsurer. These reinsurance
agreements are part of several other agreements which have collectively resulted
in the substantial reduction of the Company's life insurance operation. The
Company continues to remain primarily obligated for approximately $110 million
in statutory reserve value of annuities which, at December 31, 1999, have been
fully co-insured with Great Southern Insurance Company. Revenue and operating
results from this subsidiary were not significant in 1999, 1998 or 1997.
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DISCONTINUED OPERATIONS
Fremont's discontinued operations consist primarily of assumed treaty and
facultative reinsurance business that was discontinued between 1986 and 1991. In
1990, the Company established a management group to actively manage the
liquidation of this business by the commutation of liabilities and as claims are
paid. The liabilities associated with this business are long term in duration
and, therefore, the Company continues to be subject to claims being reported.
Claims under these reinsurance treaties include professional liability, product
liability and general liability which include asbestos and environmental claims.
During the third quarter of 1999, the Company incurred an after tax charge
of $25 million in recognition of an increase in asbestos and environmental
claims reserves over previous estimates. This charge is represented by the
Company's contribution of $25 million to the discontinued operations to ensure
that sufficient funds are available to discharge estimated liabilities as they
become due.
The discontinued operations' assets at December 31, 1999 consisted of $178
million in cash and investment grade fixed income securities, reinsurance
recoverables of $50 million and other assets totaling $22 million. Fremont
estimates that the dedicated assets supporting these operations and all future
cash inflows will be adequate to fund future obligations. However, should those
assets ultimately prove to be insufficient, the Company believes that its
property and casualty subsidiaries would be able to provide whatever additional
funds might be needed to complete the liquidation without having a material
adverse effect on the Company's consolidated financial position. (See Note N of
Notes to Consolidated Financial Statements.)
REGULATION
Insurance Regulation
Fremont's workers' compensation insurance operation now has premiums
inforce in forty-five states and the District of Columbia. Insurance companies
are subject to supervision and regulation by the state insurance authority in
each state in which they transact business. Such supervision and regulation
relate to numerous aspects of an insurance company's business and financial
condition. The primary purpose of such supervision and regulation is the
protection of injured workers and policyholders rather than investors or
shareholders of an insurer. The extent of such regulation varies, but generally
derives from state statutes that delegate regulatory, supervisory and
administrative authority to state insurance departments. Accordingly, the
authority of the state insurance departments includes the establishment of
minimum solvency standards which must be met and maintained by insurers, the
licensing to do business of insurers and agents, restrictions on investments by
insurers, establishing premium rates for certain property and casualty insurance
and life and disability insurance, establishing the provisions which insurers
must make for current losses and future liabilities and the approval of policy
forms. Additionally, excluding California, most states require insurers to
participate in assigned risk plans which provide insurance coverage to
individuals or entities who are unable to obtain coverage from existing insurers
in those states. The net profit or loss incurred in the administration of these
plans is allocated back to participant insurers based on the insurers' relative
market share (i.e., insurance premiums) in each state. State insurance
departments also conduct periodic examinations of the affairs of insurance
companies and require the filing of annual and other reports relating to the
financial condition of insurance companies. Fremont's multistate insurance
operations require, and will continue to require, significant resources of the
Company in order to continue to comply with the regulations of each state in
which it transacts business.
Workers' Compensation Regulation. A significant portion of Fremont's
workers' compensation insurance premiums is derived from policies issued in
California and Illinois. Illinois began operating under an open rating system in
1982 and California began operating under such a system effective January 1,
1995. Generally, in an open rating system, workers' compensation insurance
companies are provided with advisory premium rates (expected losses and
expenses) or loss costs (expected losses only) which vary by job classification.
Each insurance company sets its base rates to reflect its particular loss
experience and operating costs. These rates are then modified to reflect
individual risk characteristics and other expenses in determining a final
premium rate. Before January 1, 1995, California operated under a minimum rate
law, whereby
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premium rates established by the California Department of Insurance were the
minimum rates which could be charged by an insurance carrier. The repeal of the
minimum rate law on January 1, 1995 resulted in lower premiums and lower
profitability in the Company's California workers' compensation insurance
business due to increased price competition. (See "Risk Factors.")
Beginning in 1995, Fremont's policies have generally been written as
non-participating, which does not include provisions for policyholder dividend
consideration. Prior to January 1, 1995, the Company's policies, which were
written mainly in California, were primarily written as participating, which
obligated Fremont to consider policyholder dividend payments. This shift in
policy type was due primarily to the increased competition in the California
market which resulted from the repeal of the minimum rate law, effective January
1, 1995. The shift to non-participating policies has continued and is a
characteristic element of the competitive environment.
Fremont's insurance subsidiaries are required in certain states to maintain
on deposit investments meeting specified standards that have an aggregate market
value equal to the Company's workers' compensation loss reserves.
Insurance Guaranty Association Laws. Under insolvency or guaranty fund laws
in most states in which the Company's insurance subsidiaries operate, insurers
doing business in those states can be assessed, up to the prescribed limits, for
losses incurred by policyholders as a result of the insolvency of other
insurance companies. The amount and timing of such assessments are beyond the
control of Fremont and generally have not had an adverse impact on Fremont's
earnings in years in which such assessments have been made. Premiums written
under workers' compensation policies are generally subject to assessment only
with respect to covered losses incurred by the insolvent insurer under workers'
compensation policies. The Company believes it does not face any material
exposure to guaranty fund assessments.
Holding Company Regulation. The Company is subject to the California
Insurance Holding Company System Regulatory Act (the "Holding Company Act").
This act, and similar laws in other states, require the Company to periodically
file information with the California Department of Insurance and other state
regulatory authorities, including information relating to its capital structure,
ownership, financial condition and general business operations. Certain
transactions between an insurance company and its affiliates, including sales,
loans or investments which in any twelve month period aggregate at least 5% of
its admitted assets or 25% of its statutory capital and surplus, also are
subject to prior approval by the California Department of Insurance.
The Holding Company Act also provides that the acquisition or change of
"control" of a California domiciled insurance company or of any person who
controls such an insurance company cannot be consummated without the prior
approval of the Insurance Commissioner. In general, a presumption of "control"
arises from the ownership of voting securities and securities that are
convertible into voting securities, that in the aggregate constitute 10% or more
of the voting securities of a California insurance company or of a person that
controls a California insurance company, such as Fremont General Corporation.
The Liquid Yield Option(TM) Notes ("LYONs") issued by the Company constitute a
security convertible into the voting common stock of the Company, and the shares
of common stock into which a holder's LYONs are convertible and any other
securities convertible into common stock must be aggregated with any other
shares of common stock of the holder for purposes of determining the percentage
ownership. A person seeking to acquire "control," directly or indirectly, of
Fremont must generally file with the Insurance Commissioner an application for
change of control containing certain information required by statute and
published regulations and provide a copy of the application to the Company. The
Holding Company Act also effectively restricts Fremont from consummating certain
reorganizations or mergers without prior regulatory approval.
The Holding Company Act also limits the ability of Fremont's insurance
subsidiaries to pay dividends to the Company. The act permits a property and
casualty insurance company to pay dividends in any year which, together with
other dividends or other distributions made within the preceding twelve months,
do not exceed the greater of 10% of its statutory surplus or 100% of its net
income as of the end of the preceding year, subject to certain limitations.
Larger dividends are payable only upon prior regulatory approval. Applicable
regulations further require that an insurer's statutory surplus following a
dividend or other distribution be reasonable in
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relation to its outstanding liabilities and adequate to its financial needs.
Based upon these restrictions, the maximum amount available for payment of
dividends by the Company's property and casualty insurance subsidiaries during
2000 without prior regulatory approval is approximately $56.3 million. In
addition, insurance regulations in California require that the Department of
Insurance be given ten days advance notice of any dividend payment.
Other Regulations. The NAIC adopted a formula to calculate risk based
capital ("RBC") of property and casualty insurance companies for inclusion in
annual statements filed with state insurance departments. The purpose of the RBC
model is to help state regulatory authorities monitor the capital adequacy of
property and casualty insurance companies by measuring several major areas of
risk facing property and casualty insurers including underwriting, credit and
investment risks. Companies having less statutory surplus than the RBC model
calculates will be required to adequately address these risk factors and will be
subject to varying degrees of regulatory intervention, depending on the level of
capital inadequacy. As of December 31, 1999 the Company's insurance subsidiaries
engaged in continuing operations exceeded all RBC levels requiring any
regulatory intervention.
Thrift and Loan Regulation
Fremont's thrift is subject to supervision and regulation by the Department
of Financial Institutions of the State of California (the "DFI") and, as an
insured institution, by the FDIC. None of the Company's subsidiaries are
regulated or supervised by the Office of Thrift Supervision, which regulates
savings and loan institutions. Fremont General Corporation is generally not
directly regulated or supervised by the DFI, the FDIC, the Federal Reserve Board
or any other bank regulatory authority, except with respect to guidelines
concerning its relationship with the thrift subsidiary. Such guidelines include
(i) general regulatory and enforcement authority of the DFI and the FDIC over
transactions and dealings between Fremont General Corporation and the thrift,
(ii) specific limitations regarding ownership of the capital stock of the parent
company of any thrift and loan company, and (iii) specific limitations regarding
the payment of dividends from the thrift as discussed below. The thrift is
examined on a regular basis by both agencies. At December 31, 1999, the thrift
was in compliance with the regulatory requirements of these agencies.
Federal and state regulations prescribe certain minimum capital
requirements and the thrift is currently in compliance with such requirements.
Federal and state regulatory authorities also have the power to prohibit or
limit the payment of dividends by the thrift. Fremont does not believe that the
restrictions on the thrift's ability to pay dividends imposed by federal or
state law will adversely affect the ability of Fremont General Corporation to
meet its obligations. (See "Risk Factors.")
California Law. The thrift and loan business conducted by Fremont's thrift
is governed by the California Industrial Loan Law and the rules and regulations
of the Commissioner of the DFI which, among other things, regulate the
collateral requirements and maximum maturities of the various types of loans
that are permitted to be made by California-chartered industrial loan companies,
i.e., industrial banks, thrift and loan, investment and loan, or premium
financing companies.
Subject to restrictions imposed by applicable California law, the thrift is
permitted to make secured and unsecured consumer and non-consumer loans. The
maximum term for repayment of loans made by thrift and loan companies is forty
years depending upon collateral and priority of secured position, except that
loans with repayment terms in excess of thirty years and thirty days may not in
the aggregate exceed 5% of total outstanding loans and obligations of the
thrift. Consumer loans secured by real property with terms in excess of three
years must be repayable in substantially equal periodic payments unless such
loans are covered under the Garn-St. Germain Depository Institutions Act of 1982
(primarily single-family residential loans). Non-consumer loans may be repayable
in unequal periodic payments during their respective terms until December 31,
1999. California law limits lending activities outside of California by thrift
and loan companies to no more than 20% of total assets and upon application to
and consent by the Commissioner, 40% of total assets. Effective January 1, 2000,
these percentages changed to 25% and 50%, respectively. Loans for purchase or
refinance of single or multi-family residential property, which are saleable in
the secondary market,
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evidenced by a commitment to buy by a buyer in the secondary market and held for
90 days or less, are exempt from the out-of-state lending limits.
California law contains statutory requirements for the diversification of
the loan portfolios of thrift and loan companies. A thrift and loan with
outstanding investment certificates may not, among other things, make any one
loan secured primarily by improved real property which exceeds 20% of its
paid-up and unimpaired capital stock and surplus not available for dividends;
may not lend an amount in excess of 5% of its paid-up and unimpaired capital
stock and surplus not available for dividends upon the security of the stock of
any one corporation, which stock collateral may not be greater than 10% of the
stock of said corporation; may not make loans to, or hold the obligations of,
any one person as primary obligor in an aggregate principal amount exceeding 20%
of its paid-up and unimpaired capital stock and surplus not available for
dividends; and may, until December 31, 1999 and subject to certain exceptions,
have no more than 70% of its total assets in loans which have remaining terms to
maturity in excess of seven years and are secured solely or primarily by real
property, which 70% limitation was repealed effective January 1, 2000.
Additionally, loans having a principal balance in excess of $10,000 and secured
primarily by real property are limited to a maximum loan to value of 90%, with
certain exceptions which include: (i) government insured or guaranteed loans,
(ii) loans made to facilitate sale of real property owned resulting from
foreclosure or deeds in lieu thereof, (iii) restructured loans, (iv) loans
saleable in the secondary market, or (v) loans held for less than 90 days.
Effective January 1, 1999, the California legislature clarified the law and
expressly authorized a thrift and loan company to issue credit cards and to
acquire or hold obligations resulting from the use of credit cards. It was also
in that legislation that the words "industrial bank" were authorized to be used
in the name of a thrift and loan company and the Industrial Loan Law to be
referred to as the Industrial Banking Law.
A thrift and loan generally may not make any loans to, or hold an
obligation of, any of its directors or officers or any director or officer of
its holding company or affiliates, except in specified cases and subject to
regulation by the DFI. Further, a thrift and loan may not make any loan to, or
hold an obligation of, any of its shareholders or any shareholder of its holding
company or affiliates, except that this prohibition does not apply to persons
who own less than 10% of the stock of a holding company or affiliate which is
listed on a national securities exchange, such as Fremont General Corporation.
Any person who wishes to acquire (i) 10% or more of the capital stock of a
California thrift and loan company, or (ii) 10% or more of the voting securities
of a holding company of a California thrift and loan company, such as Fremont
General Corporation, must obtain the prior written approval of the DFI. The
LYONs are not voting securities of the Company, but the shares of common stock
into which such LYONs are convertible constitute voting securities of the
Company. Fremont's thrift must also obtain prior written approval from the DFI
before it may open or relocate any branch or loan production office or close a
branch office.
The Industrial Banking Law prohibits an industrial loan company from having
deposits at any time in an aggregate sum in excess of 20 times the aggregate
amount of its paid-up unimpaired capital and surplus not available for
dividends. The Company's thrift currently has an authorized ratio of deposits to
such capital of 17 to 1.
Federal Law. The thrift's deposits are insured by the FDIC to the full
extent permitted by law. As an insurer of deposits, the FDIC issues regulations,
conducts examinations, requires the filing of reports and generally supervises
the operations of institutions to which it provides deposit insurance. Fremont's
thrift is subject to the rules and regulations of the FDIC to the same extent as
other financial institutions which are insured by that entity. The approval of
the FDIC is required prior to any merger, consolidation or change in control or
the establishment or relocation of any branch office of the thrift. This
supervision and regulation is intended primarily for the protection of the
insured deposit funds. Prior written notice to the FDIC is required to close a
branch office. No approval, however, is required to open, relocate, or close a
loan production office.
The thrift is subject to federal risk-based capital adequacy guidelines
which provide a measure of capital adequacy and are intended to reflect the
degree of risk associated with both on- and off-balance sheet items, including
residential real estate loans sold with recourse, legally binding loan
commitments and standby letters of credit. A financial institution's risk-based
capital ratio is calculated by dividing its qualifying capital by its
risk-weighted assets. Financial institutions are generally expected to meet a
minimum ratio of qualifying total
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capital to risk-weighted assets of 8%, of which at least 4% of qualifying total
capital must be in the form of core capital ("Tier 1") -- common stock,
noncumulative perpetual preferred stock, minority interests in equity capital
accounts of consolidated subsidiaries and allowed mortgage servicing rights,
less all intangible assets other than allowed mortgage servicing rights and
eligible purchased credit card relationships. Supplementary capital ("Tier 2")
consists of the allowance for loan and lease losses up to 1.25% of risk-
weighted assets, cumulative perpetual preferred stock, long-term preferred stock
(original maturity of at least 20 years), perpetual preferred stock, hybrid
capital instruments, term subordinated debt and intermediate term preferred
stock (original average maturity of five years or more). The maximum amount of
Tier 2 capital which may be recognized for risk-based capital purposes is
limited to 100% of Tier 1 capital (after any deductions for disallowed
intangibles). The aggregate amount of term subordinated debt and intermediate
term preferred stock that may be treated as Tier 2 capital is limited to 50% of
Tier 1 capital. Certain other limitations and restrictions also apply. As of
December 31, 1999, the thrift's allowance for possible loan losses for Tier 2
capital was $40.5 million. At December 31, 1998, the Tier 2 capital of the
thrift consisted of approximately $25.5 million of allowance for possible loan
losses. The following table presents the thrift's risk-based capital position at
the dates indicated:
DECEMBER 31, 1999 DECEMBER 31, 1998
-------------------------- --------------------------
PERCENT OF PERCENT OF
RISK-WEIGHTED RISK-WEIGHTED
AMOUNT ASSETS AMOUNT ASSETS
---------- ------------- ---------- -------------
(THOUSANDS OF DOLLARS, EXCEPT PERCENTS)
Tier 1 capital............................... $ 338,939 9.48% $ 186,520 9.17%
Minimum requirement.......................... 142,981 4.00 81,371 4.00
---------- ----- ---------- -----
Excess..................................... $ 195,958 5.48% $ 105,149 5.17%
========== ===== ========== =====
Total capital...................... $ 379,396 10.61% $ 212,048 10.42%
Minimum requirement.......................... 285,961 8.00 162,743 8.00
---------- ----- ---------- -----
Excess..................................... $ 93,435 2.61% $ 49,305 2.42%
========== ===== ========== =====
Risk-weighted assets......................... $3,574,514 $2,034,280
========== ==========
The FDIC has adopted a 3% minimum leverage ratio which is intended to
supplement risk-based capital requirements and to ensure that all financial
institutions continue to maintain a minimum level of core capital. A minimum
leverage ratio of 3% is required for institutions which have been determined to
be the highest of five categories used by regulators to rate financial
institutions. All other institutions (including the Company's thrift) will
likely be required to maintain leverage ratios of at least 1% to 2% above the 3%
minimum. It is improbable, however, that an institution with a 3% core
capital-to-total assets ratio would be rated in the highest category since a
strong capital position is so closely tied to the rating system. Therefore, the
"minimum" leverage ratio is, for all practical purposes, significantly above 3%.
The following table presents the thrift's leverage ratio (the ratio of Tier 1
capital to the quarterly average total assets) at the dates indicated:
DECEMBER 31, 1999 DECEMBER 31, 1998
-------------------------- --------------------------
PERCENT OF PERCENT OF
AVERAGE TOTAL AVERAGE TOTAL
AMOUNT ASSETS AMOUNT ASSETS
---------- ------------- ---------- -------------
(THOUSANDS OF DOLLARS, EXCEPT PERCENTS)
Tier 1 capital................................. $ 338,939 8.97% $ 186,520 8.81%
Minimum requirement............................ 113,313 3.00 63,510 3.00
---------- ---- ---------- ----
Excess.................................... $ 225,626 5.97% $ 123,010 5.81%
========== ==== ========== ====
Average total assets for the quarter ended
December 31,................................. $3,777,101 $2,117,009
========== ==========
The FDIC has designated Fremont's thrift as a "well-capitalized"
institution under the regulations promulgated under the Federal Deposit
Insurance Corporation Improvement Act of 1991. A "well-capitalized" institution
has a total risk-based capital ratio of at least 10%, has a Tier 1 risk-based
capital ratio
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of at least 6%, has a leverage ratio of at least 5% and is not subject to any
written agreement, order, capital directive or prompt corrective action
directive issued by the FDIC under Section 8 or Section 38 of the Federal
Deposit Insurance Act to meet and maintain a specific capital level for any
capital measure. The total risk-based capital ratio is the ratio of qualifying
total capital to risk-weighted assets and the Tier 1 risk-based capital ratio is
the ratio of Tier 1 capital to risk-weighted assets.
As a "well-capitalized" institution, the thrift's annual FDIC insurance
premiums currently are 2.1 cents per $100 of eligible domestic deposits in 2000.
The insurance premium payable is subject to semi-annual adjustment. The FDIC, by
the first day of the month preceding each semi-annual period, is required to
notify each insured institution of its assessment risk-classification upon which
the insurance premium assessment for the following period will be based. The
FDIC has the authority to assess to all insured institutions collectively,
additional premiums to cover losses and expenses associated with insuring
deposits maintained at financial institutions and for other purposes it deems
necessary.
In November 1999, the FDIC announced proposed new regulations which are
designed primarily to increase the capital requirements for insured financial
institutions engaged in subprime lending. These proposed regulations address the
concentration of subprime risk in loan portfolios of insured financial
institutions, formalizes the definition of subprime lending which would be
subject to the proposed regulations and establishes higher levels of required
capital for insured financial institutions engaged in the type of subprime
lending as defined in the proposed regulations. It is unclear what changes, if
any, will be made to these proposed regulations by the FDIC before they are
finalized and implemented. While the Company's FDIC insured thrift originates
subprime residential real estate loans, it is unclear what impact, if any, these
proposed regulations, once finalized and implemented, will have on the Company's
financial position or operating results.
Limitations on Dividends. Under California law, a thrift is not permitted
to declare dividends on its capital stock unless it has at least $750,000 of
unimpaired capital plus additional capital of $50,000 for each branch office
maintained. In addition, no distribution of dividends is permitted unless: (i)
such distribution would not exceed a thrift's retained earnings; (ii) any
payment would not result in violation of the approved maximum capital to thrift
investment certificate ratio; or (iii) in the alternative, after giving effect
to the distribution, the sum of a thrift and loan's qualified assets would be
not less than 125% of certain of its liabilities, or with certain exceptions,
current assets would be not less than current liabilities. In addition, a thrift
and loan is prohibited from paying dividends from that portion of capital which
its board of directors has declared restricted for dividend payment purposes. In
policy statements, the FDIC has advised insured institutions that the payment of
cash dividends in excess of current earnings from operations is inappropriate
and may be cause for supervisory action. Under the Financial Institutions
Supervisory Act and the Financial Institutions Reform, Recovery and Enforcement
Act of 1989, federal regulators also have authority to prohibit financial
institutions from engaging in business practices which are considered to be
unsafe or unsound. It is possible that, depending upon the financial condition
of the Company's thrift and other factors, such regulators could assert that the
payment of dividends in some circumstances might constitute unsafe or unsound
practices and could prohibit payment of dividends even though technically
permissible.
Fremont's thrift is also subject to federal consumer protection laws,
including the Truth In Savings Act, the Truth in Lending Act, the Community
Reinvestment Act and the Real Estate Settlement Procedures Act.
Intercompany Transactions
The payment of stockholders' dividends and the repayment of loans to
Fremont General Corporation by its subsidiaries are and may continue to be
subject to certain statutory and regulatory restrictions.
Fremont General Corporation receives management fees from its property and
casualty insurance subsidiaries as reimbursement for certain administrative and
investment portfolio management services rendered by Fremont General
Corporation.
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EMPLOYEES
At December 31, 1999, the Company had 3,314 employees, none of whom is
represented by a collective bargaining agreement. Fremont believes its relations
with employees are good.
RISK FACTORS
Operating Results and Financial Condition May Vary
The Company's profitability can be affected significantly by many factors
including competition, the severity and frequency of claims, fluctuation in
interest rates and the rate of inflation, legislation and regulations, court
decisions, the judicial climate and general economic conditions and trends, all
of which are outside of the Company's control. In addition, Fremont's results
may be affected by its ability to assess and integrate successfully the
operations of acquired companies, as well as the Company's ability to contain
expenses and to implement appropriate technological changes. Any of these
factors could contribute to significant variation in the Company's results of
operations within the different aspects of its business, or businesses taken as
a whole, from quarter to quarter and from year to year.
With respect to Fremont's workers' compensation insurance business, changes
in economic conditions can lead to reduced premium levels due to lower payrolls
as well as increased claims due to the tendency of workers who are laid off to
submit workers' compensation insurance claims. Changes in market interest rates
can affect the amount of interest income that the Company earns on its
investment portfolio, as well as the amount of realized and unrealized gains or
losses on specific holdings within the Company's investment portfolio.
Legislative and regulatory changes can also cause the operating results of the
Company's workers' compensation insurance businesses to vary.
During periods when economic conditions are unfavorable, the Company's
financial services businesses may not be able to originate new loan products or
maintain the credit quality of its finance receivables, both in its portfolio
and for those loans that have been securitized, at previously attained levels.
This may result in increased levels of non-performing assets and net credit
losses. Changes in market interest rates, or in the relationships between
various interest rates could cause Fremont's interest margins to be reduced and
may result in significant changes in the prepayment patterns of the Company's
finance receivables. These ris