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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d) of
The Securities Exchange Act of 1934
For the fiscal year ended Commission file number 0-5534
DECEMBER 31, 1997
BALDWIN & LYONS, INC.
(Exact name of registrant as specified in its charter)
INDIANA 35-0160330
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1099 NORTH MERIDIAN STREET, INDIANAPOLIS, INDIANA 46204
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (317) 636-9800
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
(TITLE OF CLASS)
Class A Common Stock, No Par Value
Class B Common Stock, No Par Value
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 periods that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [ X ] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ X ]
The aggregate market value of Class A and Class B Common Stock held by non-
affiliates of the Registrant as of March 12, 1998, based on the closing trade
prices on that date, was approximately $99,465,000.
The number of shares outstanding of each of the issuer's classes of common stock
as of March 12, 1998:
Common Stock, No Par Value:
Class A (voting) 2,397,354 shares
Class B (nonvoting) 11,302,520 shares
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for Annual Meeting of Shareholders to be held
May 5, 1998 are incorporated by reference into Part III.
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PART I
ITEM 1. BUSINESS
Baldwin & Lyons, Inc. was incorporated under the laws of the State of Indiana in
1930. Through its divisions and subsidiaries, it specializes in marketing and
underwriting property and casualty insurance. The Company's principal lines of
business consist of (1) the insurance brokerage and agency operations and
specialized insurance-related services carried on by Baldwin & Lyons, Inc.
(referred to herein as "B & L"); and (2) insurance underwriting operations
carried on by B & L's three wholly-owned property/casualty insurance company
subsidiaries: Protective Insurance Company (referred to herein as "Protective");
Sagamore Insurance Company (referred to herein as "Sagamore"); and B & L
Insurance, Ltd. (referred to herein as "BLI"). These subsidiaries are
collectively referred to herein as the "Insurance Subsidiaries." The "Company"
as used herein refers to Baldwin & Lyons, Inc. and all its subsidiaries unless
the context indicates otherwise.
On October 2, 1995, the Company sold Protective's subsidiary, Hoosier Insurance
Company (referred to herein as "Hoosier"), for $36.5 million. Included in the
Company's insurance underwriting segment prior to the sale, Hoosier marketed
general lines of insurance to individuals and small commercial customers in
Indiana. Income and expense amounts related to Hoosier for the prior periods
and the gain recognized on the sale of Hoosier are reported as discontinued
operations.
INSURANCE BROKERAGE, AGENCY AND SERVICES OPERATIONS
B & L acts as an agent and broker which places casualty, inland marine, property
and other types of insurance, serving customers in the motor carrier industry on
a nationwide basis. The following summary describes briefly the principal types
of insurance placed by B & L:
- Casualty insurance including motor vehicle liability and physical
damage insurance, other liability insurance, workers' compensation
insurance, specialized accident insurance and fidelity and surety bonds.
- Inland Marine consisting principally of cargo insurance.
- Property coverages including insurance against loss of property or the
use thereof by reason of fire, windstorm or other perils.
B & L also performs a variety of additional services for its clients such as
risk surveys and analyses, government compliance assistance, loss control and
cost studies and research, development, and consultation in connection with new
insurance programs including development of computerized systems to assist in
monitoring accident data. Extensive claims services are also provided by B & L,
frequently for a fee, primarily to clients with self-insurance programs.
B & L has active agency arrangements with a small number of insurance companies,
none of which is exclusive and all of which are terminable at will or on short
notice by either party. Of the commissions received by
B & L in 1997, approximately 99% was from marketing products for the Insurance
Subsidiaries.
INSURANCE UNDERWRITING OPERATIONS
Underwriting operations are currently conducted as follows:
- Protective is engaged in direct writing of multiple line property,
casualty and related insurance coverages for large trucking fleets
which retain substantial amounts of self-insurance and for medium-sized
trucking companies on a first-dollar or small deductible basis with no
self-insurance retention.
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Protective also accepts retrocessions from reinsurance companies,
covering both individual property and liability risks and high limit
catastrophe pools. Protective is licensed to do business in all
states, the District of Columbia and all Canadian provinces.
- Sagamore's premiums are produced primarily from private passenger
automobile liability and physical damage coverages. In addition,
Sagamore writes commercial automobile liability and physical damage
insurance for truck owner-operators with ten or fewer power units as
well as workers' compensation insurance for small businesses.
Sagamore is currently licensed in twenty-three states.
- BLI is a Bermuda domiciled reinsurance company which, to date, has
provided reinsurance for Protective only. This subsidiary provides the
availability of an insurance profit center concept allowing clients the
advantages of a "captive" insurance company without the attendant
expense or management demands.
Approximately 59% of the gross direct premiums written by the Insurance
Subsidiaries during 1997 was attributable to business placed with Protective by
B & L. The remaining 41% consists primarily of business written by Sagamore
within its private passenger automobile, small fleet and small business workers'
compensation programs, originating through an extensive network of independent
agents.
The Insurance Subsidiaries cede portions of their gross premiums written to
certain non-affiliated insurers under excess of loss and quota-share treaties
and by facultative placements. The Insurance Subsidiaries also assume
reinsurance voluntarily from other insurers under retrocession and treaty
arrangements. Reinsurance assumed to date has been comprised primarily of
retrocessional participation in property catastrophe pools. The Company intends
to participate in such retrocessions only as long as premium rates remain at
attractive levels. In addition, the Insurance Subsidiaries participate in
numerous mandatory government-operated reinsurance pools which require insurance
companies to provide coverages on assigned risks. These assigned risk pools
allocate participation to all insurers based upon each insurer's portion of
premium writings on a state or national level.
PROPERTY/CASUALTY LOSSES AND LOSS ADJUSTMENT EXPENSES
The consolidated financial statements include the estimated liability for unpaid
losses and loss adjustment expenses ("LAE") of the Insurance Subsidiaries. The
liabilities for losses and LAE are determined using case basis evaluations and
statistical projections and represent estimates of the ultimate net cost of all
unpaid losses and LAE incurred through December 31 of each year. These
estimates are subject to the effects of trends in claim severity and
frequency and are continually reviewed and, as experience develops and new
information becomes known, the liability is adjusted as necessary. Such
adjustments, either positive or negative, are reflected in current
operations. Reserves for incurred but not reported claims are determined on
the basis of actuarial calculations using historical data. The anticipated
effect of inflation is implicitly considered when estimating liabilities for
losses and LAE.
While anticipated price increases due to inflation are considered in estimating
the ultimate claim costs, the increase in average severities of claims is caused
by a number of factors that vary with the individual type of policy written.
Future average severities are projected based on historical trends adjusted for
anticipated changes in underwriting standards, policy provisions, and general
economic and social trends. These anticipated trends are monitored based on
actual development and are modified as new conditions would suggest that changes
are necessary.
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Loss reserves related to certain permanent total disability (PTD) workers'
compensation claims have been discounted to present value using tables provided
by the National Council on Compensation Insurance which are based upon a pretax
interest rate of 3.5% and adjusted for losses retained by the insured. The loss
and LAE reserves at December 31, 1997 have been reduced by approximately $5.4
million as a result of such discounting. Had the Company not discounted loss
and LAE reserves, pretax income would have been approximately $.7 million lower
for the year ended December 31, 1997.
The maximum amount for which the Company insures a trucking risk is $10 million
although, occasionally, limits above $10 million are provided but are 100%
reinsured. After giving effect to reinsurance arrangements which have been in
force for the past several years, the first $1 million of insured loss for a
single occurrence is retained by the Company. The Company has reinsured $9
million in excess of the first $1 million in coverage liability with several
companies. Certain of these reinsurance treaties contain aggregate recovery
limitations. To the extent that losses in these layers, in the aggregate,
exceed these limitations, the Company could be liable for amounts which would
otherwise be covered under these reinsurance treaties.
The Company's reinsurance structure has remained relatively constant since 1986.
Prior to September 1, 1986, the Company's maximum exposure on a $10 million loss
relating to its trucking insurance business ranged from $250,000 to
approximately $2 million. The higher exposures were retained during periods
when reasonably priced reinsurance was not available. Very few losses incurred
during these periods, with the exception of environmental liability losses,
remain unsettled at December 31, 1997. Effective September 1, 1986, and
continuing through December 31, 1997, the Company's exposure relating to
trucking risks is limited to $1 million on a $10 million loss, as noted in the
immediately preceding paragraph. With respect to Sagamore's small fleet
trucking business, the Company's maximum net exposure for a single occurrence is
$250,000. Effective January 1, 1998, this exposure has been reduced to $100,000
for a single occurrence. For Sagamore's private passenger automobile and small
business workers' compensation products, the Company's maximum exposure for a
single occurrence is $100,000.
The following table on page 5 sets forth a reconciliation of beginning and
ending loss and LAE liability balances, for 1997, 1996 and 1995. That table is
presented net of reinsurance recoverable to correspond with income statement
presentation. However, a reconciliation of these net reserves to those gross of
reinsurance recoverable, as presented in the balance sheet, is also shown. The
table on page 8 shows the development of the estimated liability, net of
reinsurance recoverable, for the ten years prior to 1997.
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RECONCILIATION OF LIABILITY FOR LOSSES AND LOSS ADJUSTMENT
EXPENSES (GAAP BASIS)
Year Ended December 31,
1997 1996 1995
----------- ----------- -----------
(IN THOUSANDS)
NET OF REINSURANCE RECOVERABLE:
Liability for losses and LAE at the
beginning of the year $154,537 $161,458 $175,554
Provision for losses and LAE:
Continuing operations:
Claims occurring during the current year 47,692 45,999 44,238
Claims occurring during prior years (7,838) (12,245) (5,484)
---------- ---------- ----------
39,854 33,754 38,754
Losses and LAE payments:
Continuing operations:
Claims occurring during the current year 15,946 12,891 7,760
Claims occurring during prior years 26,934 27,825 33,819
Discontinued operations - - 11,186
---------- ---------- ----------
42,880 40,716 52,765
Change in unpaid portion of uncollectible
amounts due from reinsurers (18) 41 (85)
---------- ---------- ----------
Liability for losses and LAE at end of year 151,493 154,537 161,458
REINSURANCE RECOVERABLE ON UNPAID
LOSSES AT END OF YEAR 45,702 42,402 50,031
---------- ---------- ----------
Liability for losses and LAE, gross of
reinsurance recoverables, at end of year $197,195 $196,939 $211,489
========== ========== ==========
The above reconciliation shows a $7.8 million (5.1%) savings in the liability
for losses and LAE recorded at December 31, 1996 and compares to a one-year
savings in 1996 of $12.2 million. The net savings is reflected in 1997
underwriting income. All major coverage groups produced redundancies during
each of the years 1997, 1996 and 1995. A more detailed discussion of reserve
savings experienced in recent years is presented beginning on page 6.
The differences between the liability for losses and LAE reported in the
accompanying 1997 consolidated financial statements in accordance with generally
accepted accounting principles ("GAAP") and that reported
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in the annual statements filed with state and provincial insurance
departments in the United States and Canada in accordance with statutory
accounting practices ("SAP") are as follows:
(IN THOUSANDS)
Liability reported on a SAP basis - net of reinsurance recoverable $152,258
Add differences:
Reinsurance recoverable on unpaid losses and LAE 45,702
Additional reserve for reinsurance assumed losses not
reported to the Company at the current year end 480
Reclassification of loss reserves ceded attributable
to insolvent reinsurers 480
Deduct differences:
Estimated salvage and subrogation recoveries recorded on
a cash basis for SAP and on an accrual basis for GAAP (1,725)
----------
Liability reported on a GAAP basis $197,195
==========
Loss reserves ceded attributable to insolvent reinsurers are treated as a
separate liability for SAP purposes but are classified as an addition to loss
reserves in the GAAP consolidated balance sheets. This classification was used
for GAAP since the uncollectible amounts are, in effect, a reversal of
reinsurance credits taken against gross loss and LAE reserves. Losses incurred,
however, do not include charges for uncollectible reinsurance, nor do the tables
on pages 5 and 8, since the inability to recover these amounts from insolvent
reinsurers is a credit loss and is not associated with the Company's reserving
process. Accordingly, loss and LAE developments would be distorted if amounts
related to insolvent reinsurance were included.
The table on page 8 presents the development of GAAP balance sheet liabilities
for each year end 1987 through 1997 net of all reinsurance credits. The top
line of the table shows the estimated liability for unpaid losses and LAE
recorded at the balance sheet date for each of the indicated years. The
liabilities shown on this line for each year end have been reduced by amounts
relating to loss reserves ceded attributable to insolvent reinsurers, as
discussed in the immediately preceding paragraph. This liability represents the
estimated amount of losses and LAE for claims arising in all prior years that
are unpaid at the balance sheet date, including losses that had been incurred
but not yet reported to the Company.
The upper portion of the table shows the reestimated amount of the previously
recorded liability based on experience as of the end of each succeeding year.
The estimate is increased or decreased as more information becomes known about
the frequency and severity of claims.
The "cumulative redundancy" represents the aggregate change in the estimates
over all prior years. For example, the 1987 liability has developed a $12.1
million redundancy over ten years. That amount has been reflected in income
over the ten years, as shown on the table. The effect on income of changes in
estimates of the liability for losses and LAE during the past three years is
shown in the table on page 5.
Historically, the Company's loss developments have been generally favorable.
Reserve developments for all year ends 1987 through 1996 have produced
redundancies as of December 31, 1997. In addition to improvements in reserving
methods, loss reserve developments since 1987 have been favorably affected by
several other factors. Perhaps the most significant single factor has been the
improvement in safety programs by the trucking industry in general and by the
Company's insureds specifically. Statistics produced by the American Trucking
Association show that driver quality has improved markedly in the past decade
resulting in
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fewer fatalities and serious accidents. The Company's experience also shows
that improved safety and hiring programs have had a dramatic impact on the
frequency and severity of trucking accidents. Higher self-insured retentions
also played a part in reduced insurance losses during much of this period.
Higher retentions not only raise the excess insurance entry point but also
encourage trucking company management to focus even more intensely on
safety programs. Further, reserve savings have been achieved by the use of
structured settlements on certain workers' compensation and liability claims of
a long-term liability nature.
The establishment of reserves requires the use of historical data where
available and generally a minimum of ten years of such data is required to
provide statistically valid samples. As previously mentioned, numerous factors
must be considered in reviewing historical data including inflation, tort reform
(or lack thereof), new coverages provided and trends noted in the current book
of business which are different from those present in the historical data.
Clearly, the Company's book of business in 1997 is different from that which
generated much of the ten year historical loss data used to establish reserves
in the past few years. Savings realized in recent years upon the closing of
claims, as reflected in the tables on pages 5 and 8, suggest that the Company's
insured selection process and the overall effect of improved safety programs and
other positive influences on claim frequency and severity have more than offset
the negative factors anticipated when reserves were established. The Company
and its actuaries will continue to review the trends noted and, should it appear
that such trends are permanent and projectable, they will be reflected in future
reserving method refinements.
The lower section of the table on page 8 shows the cumulative amount paid with
respect to the previously recorded liability as of the end of each succeeding
year. For example, as of December 31, 1997, the Company had paid $116.5 million
of losses and LAE that had been incurred, but not paid, through the end of 1987;
thus an estimated $35.9 million in losses incurred through 1987 remain unpaid as
of the current financial statement date ($152.4 million incurred less $116.5
million paid).
In evaluating this information, it is important to note that the method of
presentation causes development experience to be duplicated. For example, the
amount of any redundancy or deficiency related to losses settled in 1990, but
incurred in 1987, will be included in the cumulative development amount for year
ends 1987, 1988, and 1989. As such, this table does not present accident or
policy year development data which readers may be more accustomed to analyzing.
Also, conditions and trends that have affected development of the liability in
the past may not necessarily occur in the future. Accordingly, it may not be
appropriate to extrapolate future redundancies or deficiencies based on this
table.
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ANALYSIS OF LOSS AND LOSS ADJUSTMENT EXPENSE DEVELOPMENT--GAAP BASIS
(Dollars in thousands)
Year Ended December 31 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
- ---------------------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- ---------
Liability for Unpaid
Losses and LAE, Net
of Reinsurance
Recoverables * $164,531 $178,179 $186,517 $190,351 $198,790 $188,189 $175,395 $175,012 $161,001 $154,039 $151,013
Liability Reestimated
as of:
One Year Later 164,771 173,990 175,998 178,706 185,452 174,269 152,146 169,528 148,756 146,201
Two Years Later 158,108 161,331 162,434 164,977 171,069 153,548 147,577 159,000 140,811
Three Years Later 149,966 154,851 161,143 157,802 155,977 156,271 144,526 153,833
Four Years Later 147,293 154,075 155,059 149,946 160,477 155,104 142,178
Five Years Later 146,814 149,672 151,138 155,601 159,804 153,528
Six Years Later 145,207 147,993 157,020 155,666 158,972
Seven Years Later 144,884 154,164 158,430 155,038
Eight Years Later 152,061 155,365 157,644
Nine Years Later 152,991 154,773
Ten Years Later 152,417
Cumulative Redundancy $ 12,114 $ 23,406 $ 28,873 $ 35,313 $ 39,818 $ 34,661 $ 33,217 $ 21,179 $ 20,190 $ 7,838
======== ======== ======== ======== ======== ======== ======== ======== ======== ========
Cumulative Amount of
Liability Paid Through:
One Year Later $ 34,777 $ 41,889 $ 41,873 $ 40,939 $ 41,958 $ 38,511 $ 30,297 $ 45,005 $ 27,825 $ 26,934
Two Years Later 62,150 67,990 69,330 63,689 68,706 59,494 58,969 67,219 43,016
Three Years Later 79,848 84,940 81,291 81,746 83,413 82,122 71,375 76,248
Four Years Later 90,357 93,651 95,857 92,313 98,331 91,794 77,702
Five Years Later 97,390 98,666 103,035 103,190 104,915 96,617
Six Years Later 101,329 104,425 111,017 107,579 109,174
Seven Years Later 105,647 111,788 114,005 110,282
Eight Years Later 112,289 114,500 116,357
Nine Years Later 114,903 116,260
Ten Years Later 116,528
* Amounts shown for 1987 through 1997 do not include the unpaid portion of
uncollectible amounts due from insolvent reinsurers which are classified with
loss and LAE reserves for financial statement purposes of $2,097, $2,258,
$2,215, $818, $597, $611, $554, $542, $457, $498 and $480, respectively.
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ENVIRONMENTAL MATTERS: The Company's reserves for unpaid losses and loss
expenses at December 31, 1997 included amounts for liability related to
environmental damage claims. Given the Company's principal business is insuring
trucking companies, it does on occasion receive claims involving a trucking
accident which has resulted in the spill of a pollutant. Certain of the
Company's policies may cover these situations on the basis that they were caused
by an accident which resulted in the immediate spill of a pollutant. These
claims are typically reported and resolved within a short period of time.
However, the Company has also received a few environmental claims which did not
result from a "sudden and accidental" event. Some of these claims fall under
policies issued in the 1970's primarily to one account which was involved in the
business of hauling and disposing of hazardous waste. Although the Company had
pollution exclusions in its policies during that period, the courts have ignored
similar exclusions in many environmental cases. As such, the Company revised
the environmental exclusion in its policies in an attempt to prevent the courts
from mandating unintended coverages. During 1995 and 1996, the Company recorded
adverse development of $7.6 million and $2.4 million, respectively, on such
claims. Development during 1997 was minor. This development includes a
liability for losses and loss expenses of $5.0 million at December 31, 1997.
Establishing reserves for environmental claims is subject to uncertainties that
are greater than those represented by other types of claims. Factors
contributing to those uncertainties include a lack of historical data, long
reporting delays, uncertainty as to the number and identity of insureds with
potential exposure, unresolved legal issues regarding policy coverage, and the
extent and timing of any such contractual liability. Courts have reached
different and sometimes inconsistent conclusions as to when the loss occurred
and what policies provide coverage, what claims are covered, whether there is an
insured obligation to defend, how policy limits are determined, how policy
exclusions are applied and interpreted, and whether cleanup costs represent
insured property damage. Management believes that those issues are not likely
to be resolved in the near future.
However, to date, very few environmental claims have been reported to the
Company. In addition, a review of the businesses of our past and current
insureds indicates that exposure to further claims of an environmental nature is
limited because most of the Company's accounts are not currently, and have not
in the past been, involved in the hauling of hazardous substances. Also, the
revision of the pollution exclusion in the Company's policies in 1986 is
expected to further limit exposure to claims from that point forward. In
addition, the Company has never been presented with an environmental claim
relating to asbestos and, based on the types of business the Company has insured
over the years, it is not expected that the Company will have any asbestos
exposure.
MARKETING
The Company's primary marketing areas are: (1) sales and service of insurance
plans, involving some degree of self-insurance, to large trucking fleets; (2)
sales of insurance programs involving no self-insured retention to medium size
trucking fleets and small operators; (3) the sale of non-standard private
passenger automobile insurance; (4) the sale of workers' compensation insurance
to small businesses; and (5) other projects.
Since the mid-1980's, Protective has focused its marketing efforts to large and
medium trucking fleets utilizing Company salesmen. Protective has its largest
market share in the larger trucking fleets (over 150 units). These fleets self-
insure a portion of their risk and such self-insurance plans are a specialty of
the Company. The indemnity contract provided to self-insured customers is
designed to cover all aspects of trucking liability, including third party
liability, property damage, physical damage, cargo and workers' compensation,
arising from vehicular accident or other casualty loss. The self-insured
program is supplemented with large deductible workers' compensation policies in
states which do not allow for self-insurance. In 1989, Protective began
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offering accident insurance on a group basis to independent contractors under
contract to a fleet sponsor. Since 1989, the market for Protective's products
has grown increasingly competitive (see comments under "Competition",
following).
During the latter part of 1992, in the aftermath of Hurricane Andrew, property
catastrophe reinsurance, which protects insurance companies from such disasters,
became difficult to obtain and prices increased. In light of the favorable
markets, Protective has accepted retrocessions for catastrophe exposures from
certain reinsurers on terms which are considered to be very favorable. This
program was continued during 1997 with premiums earned from these retrocessions
totaling $9.9 million. To the extent that pricing remains favorable on these
retrocessions, this program is expected to continue into 1998. In addition,
Protective assumed certain property and liability reinsurance through
participation in a facultative pool managed by another reinsurer starting in
1997.
During the second quarter of 1995, Sagamore entered the private passenger
automobile insurance market for nonstandard insureds. This program is currently
being marketed in Indiana and other midwestern states with limited expansion
into additional states during 1998 anticipated. Market acceptance to date has
been favorable and approximately $23.6 million of premium was written in this
line during 1997.
Sagamore also offers a program of coverages for "small fleet" trucking concerns
(small operators with one to ten power units). This program was limited to a
small geographic area composed of midwestern states through the end of 1997.
However, significant geographic expansion is planned for this product group
during 1998 and thereafter. Approximately $3.1 million of premium was written
in this program during 1997.
During the first quarter of 1997, Sagamore began marketing a small business
workers' compensation product in Missouri and Illinois. To date, growth in this
product has been slow with premium written during 1997 of $.4 million.
Continuation of this program is dependent on the results of a review currently
underway by Sagamore's management.
INVESTMENTS
The Company manages its invested assets to provide a high degree of flexibility
to respond to opportunities in the financial markets and in the Company's
insurance lines. The resulting investment strategies emphasize relatively short
- -term maturities and high asset quality and are designed to produce reasonable
returns without jeopardizing principal. The Company's investment programs limit
risk taking in all major portions of the portfolio.
At December 31, 1997 the financial statement value of the Company's investment
portfolio was $475 million, including money market instruments classified as
cash equivalents. The following comparison, on page 11, of the Company's bond
and short-term investment portfolios, using par value as a basis, indicates the
changes in the portfolio during 1997.
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MATURITIES OF BONDS AND SHORT-TERM INVESTMENTS AT DECEMBER 31 (PAR VALUE)
1997 1996
--------- ---------
Less than one year 34.8% 39.7%
1 to 5 years 41.3 42.2
5 to 10 years 16.9 10.2
More than 10 years 7.0 7.9
--------- ---------
100.0% 100.0%
========= =========
Average life of portfolio
(years) 3.6 3.1
========= =========
The Company's concentration of invested assets in relatively short-term
investments provides it with a level of liquidity which is more than adequate to
provide for its anticipated cash flow needs. The structure of the investment
portfolio also provides the Company with the ability to restrict premium
writings during periods of intense competition, which typically result in
inadequate premium rates, and allows the Company to respond to new opportunities
in the marketplace as they arise.
A comparison of the diversification of the Company's investment portfolio, using
cost as a basis, is as follows:
December 31
1997 1996
--------- ---------
U.S. Government obligations 24.8% 36.8%
Common stocks 21.0 21.8
Municipal bonds 17.0 14.3
Corporate and other bonds 15.7 5.3
Mortgage-backed securities 10.0 12.6
Short-term and other investments 9.9 8.4
Preferred stocks 1.6 .8
--------- ---------
100.0% 100.0%
========= =========
Approximately $20.9 million of the fixed maturity portfolio (4.4% of total
invested assets) consists of bonds considered less than investment grade at
December 31, 1997. The unrealized net gain on the fixed maturity portfolio was
$2.9 million at December 31, 1997, before income taxes, and compares to a $.8
million unrealized gain at December 31, 1996.
Equity securities comprise 33% of the financial statement value of the
consolidated investment portfolio at December 31, 1997, up from 32% at the prior
year end. The unrealized gains on the equity security portfolio
increased $9 million to $67 million at December 31, 1997.
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A comparison of overall investment yields is as follows:
1997 1996
--------- ---------
Before federal tax:
Investment income 5.0% 5.3%
Investment income plus realized
investment gains 9.3 7.1
After federal tax:
Investment income 3.5 3.7
Investment income plus realized
investment gains 6.4 4.9
EMPLOYEES
As of March 1, 1998, the Company had 243 employees, 227 of whom are engaged
primarily in the business of the Company's Insurance Subsidiaries. The increase
in employees from 194 at March 1, 1997 is due primarily to the expansion in
Sagamore's private passenger automobile and small business workers' compensation
products.
COMPETITION
The insurance brokerage and agency business is highly competitive. B & L
competes with a large number of insurance brokerage and agency firms and
individual brokers and agents throughout the country, many of which are
considerably larger than B & L. B & L also competes with insurance companies
which write insurance directly with their customers.
Insurance underwriting is also highly competitive. The Insurance Subsidiaries
compete with other stock and mutual companies and inter-insurance exchanges
(reciprocals). There are numerous insurance companies offering the lines of
insurance which are currently written or may in the future be written by the
Insurance Subsidiaries. Many of these companies have been in business for
longer periods of time, have significantly larger volumes of business, offer
more diversified lines of insurance coverage and have greater financial
resources than the Company. In many cases, competitors are willing to provide
coverage for rates lower than those charged by the Insurance Subsidiaries. Many
potential clients self-insure workers' compensation and other risks for which
the Company offers coverage, and some concerns have organized "captive"
insurance companies as subsidiaries through which they insure their own
operations. Some states have workers' compensation funds which preclude private
companies from writing this business in those states. Federal law also
authorizes the creation of "Risk Retention Groups" which may write insurance
coverages similar to those offered by the Company.
In connection with the sale of Hoosier, the Company is restricted from issuing
any contract of insurance, of the type issued by Hoosier, in the state of
Indiana through December 31, 1998.
ITEM 101(B), (C)(1)(I) AND (VII), AND (D) OF REGULATION S-K:
Reference is made to Note K to the consolidated financial statements which
provides information concerning industry segments and is filed herewith under
Item 8, Financial Statements and Supplementary Data.
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ITEM 2. PROPERTIES
The Company leases office space at 1099 North Meridian Street, Indianapolis,
Indiana in the Landmark
Building. This building is located approximately one mile from downtown
Indianapolis. The lease covers approximately 65,000 square feet and expires in
August, 2003, with an option to renew for an additional ten years. The
Company's entire operations, with the exception of Baldwin & Lyons, California,
are conducted from these leased facilities.
The Company owns a small building and the adjacent real estate approximately two
miles from its main office. This building contains approximately 3,300 square
feet of usable space, and is used primarily as storage facilities and as a
contingent back up and disaster recovery site for computer operations.
Baldwin & Lyons, California leases approximately 2,700 square feet of office
space in a suburb of Los Angeles, California. The lease expires in August, 1998
with a three year renewal option which the company intends to exercise. All
west coast operations are conducted from these facilities.
The current facilities are expected to be adequate for the Company's operations
for the foreseeable future.
ITEM 3. LEGAL PROCEEDINGS
In the ordinary, regular and routine course of their business, the Company and
its Insurance Subsidiaries are frequently involved in various matters of
litigation relating principally to claims for insurance coverage provided. No
currently pending matter is deemed by management to be material to the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of 1997.
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PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS
The Company's Class A and Class B common stocks are traded in the NASDAQ
National Market System and are quoted on the National Association of Securities
Dealers Automated Quotation System ("NASDAQ") under the symbols BWINA and BWINB,
respectively. The Class A and Class B common shares have identical rights and
privileges except that Class B shares have no voting rights other than on
matters for which Indiana law requires class voting. As of December 31, 1997,
there were approximately 400 record holders of Class A Common Stock and
approximately 500 record holders of Class B Common Stock.
The table below sets forth the range of high and low sale prices for the Class A
and Class B Common Stock for 1997 and 1996, as reported by the National
Association of Security Dealers, Inc. through NASDAQ and published in the
financial press. The quotations reflect interdealer prices without retail
markup, markdown or commission and do not necessarily represent actual
transactions.
Class A Class B Cash
---------------------- ---------------------- Dividends
High Low High Low Declared
--------- --------- --------- --------- ---------
Year ended December 31:
1997:
FOURTH QUARTER $28 3/4 $19 1/4 $28 3/4 $20 3/8 $.10
THIRD QUARTER 23 1/2 19 1/4 21 3/4 18 1/2 .10
SECOND QUARTER 21 1/2 17 1/2 22 5/8 17 3/8 .10
FIRST QUARTER 18 3/8 17 19 17 3/8 .10
1996:
Fourth Quarter $19 $16 1/2 $19 $17 3/4 $.10
Third Quarter 19 3/4 18 3/4 20 3/4 18 1/4 .10
Second Quarter 20 1/2 16 1/2 20 3/4 14 1/4 .08
First Quarter 18 3/4 16 3/4 18 14 1/4 .08
The Company expects to continue its policy of paying regular cash dividends
although there is no assurance as to future dividends because they are dependent
on future earnings, capital requirements and financial conditions and are
subject to regulatory restrictions as described in Note G to the consolidated
financial statements.
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ITEM 6. SELECTED FINANCIAL DATA
Year Ended December 31
------------------------------------------------------------
1997 1996 1995 1994 1993
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Net premiums written $ 69,575 $ 61,431 $ 63,065 $ 61,503 $ 53,820
Net premiums earned 61,675 58,743 58,793 61,187 53,210
Net investment income and realized
gains on investments 35,780 26,440 26,371 15,272 21,447
Losses and loss expenses incurred 39,854 33,754 38,754 32,910 26,960
Income from continuing operations 24,446 21,334 20,594 20,505 24,654
Net income 24,446 21,692 29,360 20,791 25,234
Earnings per share -- net income (1) 1.75 1.51 1.96 1.37 1.62
Cash dividends per share .40 .36 .30 .33 .183
Investment portfolio (3) 475,328 454,791 424,833 386,646 382,904
Total assets 557,015 526,460 512,225 503,899 487,522
Shareholders' equity 293,963 273,122 247,008 205,933 203,380
Book value per share (1) 21.23 19.46 16.78 13.66 13.01
Underwriting ratios (2):
Losses and loss expenses 64.6% 57.5% 65.9% 53.8% 50.7%
Underwriting expenses 33.3% 29.2% 28.0% 27.6% 29.9%
Combined 97.9% 86.7% 93.9% 81.4% 80.6%
(1) Earnings and book value per share are adjusted for the dilutive effect of
stock options outstanding. Earnings per share has been restated in
accordance with Financial Accounting Standards Board Statement
No. 128, EARNINGS PER SHARE.
(2) Data is for all coverages combined and is presented based upon generally
accepted accounting principles.
(3) Includes money market instruments classified with cash in the Consolidated
Balance Sheets.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
LIQUIDITY AND CAPITAL RESOURCES
The primary sources of the Company's liquidity are (1) funds generated from
insurance premiums, (2) net investment income and (3) maturing investments. The
Company generally experiences positive cash flow resulting from the fact that
premiums are collected on insurance policies in advance of the disbursement of
funds in payment of claims. Operating costs of the insurance subsidiaries,
other than loss and loss expense payments and commissions paid to the parent
company, generally average between 25% and 35% of premiums earned on a
consolidated basis and the remaining amount is available for investment for
varying periods of time depending on the type of insurance coverage provided.
During extended periods of declining premium volume, however, operating cash
flows may turn negative as loss settlements exceed net premium revenue and
receipts of investment income.
For several years, the Company's investment philosophy has emphasized the
purchase of short-term instruments with maximum quality and liquidity. As
interest rates have remained relatively low and yield curves have been
essentially flat in recent years, the Company has not committed funds to longer
term fixed maturity investments. The average life of the Company's bond and
short-term investment portfolio was 3.6 years compared to 3.1 years for 1996.
The Company also remains an active participant in the equity securities market.
Investments made by the Company's domestic insurance subsidiaries are regulated
by guidelines promulgated by the National Association of Insurance Commissioners
which are designed to provide protection for both policyholders and
shareholders.
The Company's assets at December 31, 1997 included $24.9 million in short-term
investments which are readily convertible to cash without market penalty and an
additional $76.5 million of fixed maturity investments maturing in less than one
year. The Company believes that these liquid investments, plus the expected
cash flow from current operations, are more than sufficient to provide for
projected claim payments and operating cost demands. In addition, the Company's
reinsurance program is structured to avoid serious cash drains that might
accompany catastrophic losses. In the event competitive conditions continue to
produce inadequate rates and the Company chooses to further reduce volume, the
Company believes that the liquidity of its investment portfolio would permit it
to continue to pay claims as settlements are reached without requiring the
disposal of investments at a loss, regardless of interest rates in effect at the
time.
Net premiums written by the Company's U.S. insurance subsidiaries for 1997 were
approximately 24% of the combined statutory surplus of these subsidiaries.
Premium writings of 200% to 300% of surplus are generally considered acceptable
by regulatory authorities. Accordingly, the Company has the ability to
significantly increase its business without seeking additional capital to meet
statutory guidelines.
Shareholders' equity increased to $294.0 million at December 31, 1997, from
$273.1 million at December 31, 1996. In addition to current year earnings, this
increase includes a $7.1 million increase in unrealized net gains on the
Company's investment portfolio from $38.5 million at December 31, 1996 to $45.6
million at December 31, 1997. The increase in shareholders' equity is net of
$5.1 million in treasury share purchases and $5.5 million of dividends to
shareholders. Book value per common share outstanding increased 9% to $21.23 at
December 31, 1997 from $19.46 per share at December 31, 1996.
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As more fully discussed in Note G to the consolidated financial statements, at
December 31, 1997, $64.8 million, or 22.0% of shareholders' equity, represented
net assets of the Company's insurance subsidiaries which, at that time, could
not be transferred in the form of dividends, loans or advances to the parent
company due to statutory restrictions on the allowable transfers. However,
management believes that these restrictions pose no material liquidity concerns
for the Company. The financial strength and stability of the subsidiaries
permit ready access by the parent company to short-term and long-term sources of
credit. The parent company had cash and marketable investments of approximately
$40.1 million at December 31, 1997.
RESULTS OF OPERATIONS
1997 COMPARED TO 1996
Direct premiums written for 1997 totaled $66.0 million, an increase of $2.6
million (4.2%) from 1996. This increase is primarily attributable to an
increase in nonstandard private passenger automobile business of $9.9 million
(72.2%) from 1996 offset by decreases in the majority of the Company's trucking-
related products although "work accident" program premiums increased $1.7
million (13.2%) from 1996. Premium writings from small trucking fleet risks
also increased by $.4 million while the new small business workers' compensation
program generated $.4 million in new premium. Large and medium fleet trucking
premium writings declined $6.4 million (26.6%) and $.9 million (30.5%),
respectively, reflecting the continued intense competition in these markets. In
addition, premiums for large deductible workers' compensation policies decreased
$2.4 million.
Premium writings from reinsurance assumed increased by $1.8 million (18.7%) to
$11.7 million during 1997. This increase is due principally to $3.9 million
relating to the Company's participation in a new excess facultative program,
partially offset by lower premiums assumed from voluntary property catastrophe
retrocession pools during 1997. The decreased catastrophe assumed premium is
attributable to reductions in the Company's shares in these pools during 1997 as
well as decreases in gross pool revenues.
Premium writings ceded to reinsurers decreased $3.6 million (30.8%) during 1997
to $8.2 million. The percentage of premiums ceded to direct premiums written
decreased to 12.4% for 1997 from 18.6% for 1996 due primarily to the decline in
trucking-related premiums which carry larger reinsurance rates than the
Company's other products and the increased use of lower cost facultative
placements. In addition, ceded premium declined due to the termination of the
quota share treaty on the Company's "work accident" program in April, 1996.
Ceding rates on the Company's primary treaties for 1997 were consistent with the
prior year.
After giving effect to changes in unearned premiums, net premiums earned
increased 5.0% to $61.7 million for 1997 from $58.7 for 1996. Net premiums
earned from all trucking-related insurance products, including small fleet
trucking, decreased by $5.3 million (13.7%). Premiums earned from voluntary
reinsurance assumed decreased by $.6 million. The above decreases were offset
by a $7.9 million increase in nonstandard private passenger automobile premium
during 1997.
Net investment income decreased by $1.1 million (5.8%) during 1997 due to across
- -the-board declines in the pre-tax yields on invested assets. The average pre-
tax yield on invested assets for 1997 was 5.0% compared to 5.3% for 1996 while
the after-tax yield for 1997 was 3.5% compared to 3.7% for 1996. Investment
expenses, which are netted directly against income, were relatively unchanged
from 1997 and were 6.2% of gross investment income compared to 5.6% for 1996.
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Realized net capital gains were $17.3 million in 1997 compared to $6.9 million
for 1996. The current year net gain consisted of gains on equity securities and
fixed maturities of $18.2 million and $.1 million, respectively, and losses on
other investments of $1.0 million.
Losses and loss expenses incurred during 1997 increased $6.1 million (18.1%) to
$39.9 million. The 1997 consolidated loss and loss expense ratio was 64.6%
compared to 57.5% for 1996. Losses and loss expenses incurred for 1996 included
adverse development on environmental liability claims of $2.4 million relating
to policies written in the 1970's. Adjusted for the development on
environmental liability claims, the consolidated loss and loss expense ratio for
1996 was 53.4%. The increase in the loss and loss expense ratio is principally
attributable to a decline in the savings realized on the closing of prior year
claims during 1997 as compared to 1996. These savings related predominantly to
the Company's trucking and trucking-related business. Because of the high
limits provided by the Company to its insureds, the length of time required to
settle larger, more complex claims and the volatility of the trucking liability
insurance business, the Company believes it is important to have a high degree
of comfort in its reserving process. As claims are settled in years subsequent
to their occurrence, the Company's claim handling process has, historically,
tended to produce savings from the reserves provided. The Company believes that
the favorable loss development may be attributable, at least in part, to changes
in trucking safety in general resulting from the implementation of the national
commercial driver license, mandatory drug testing and an increased awareness by
trucking companies of the cost of unsafe operations. It is further believed
that the Company's selection techniques, minimum safety standards and claims
handling have also contributed to the current favorable loss experience. The
Company has established provisions for incurred but not reported environmental
losses at December 31, 1997 which are believed to be sufficient to cover all
anticipated exposure.
Other operating expenses for 1997, before credits for allowances from
reinsurers, increased $1.9 million (8.4%) to $24.4 million. Personnel related
expenses, including amounts allocated to loss expenses and investment income,
decreased $.4 million (2.7%) despite a net 22% increase in the number of
employees during the year, attributable to the expansion of the Company's new
products. Salary expense during 1996 was increased, as compared to 1997, by
larger accruals for equity appreciation rights which are tied to book value and
by the issuance of discounted stock options to employees. Direct commission
expense increased $2.4 million (71.6%) as the result of increases in premiums
from Sagamore's personal automobile product and voluntary reinsurance assumed
from catastrophe pools. Allowances from reinsurers decreased $.2 million
(21.2%) as the result of the termination of the quota share reinsurance treaty
covering the Company's "work accident" program partially offset by an increase
in facultative placements. The ratio of net operating expenses of the insurance
subsidiaries to net premiums earned was 33.3% during 1997 compared to 29.2% for
1996. Including the agency operations, which absorbed a portion of the
development costs for the Company's new products, the ratio of other operating
expenses to total revenue, adjusted to remove net realized gains, was 28.9% for
1997 compared with 27.1% for 1996.
The effective federal tax rate for consolidated operations for 1997 was 31.4%.
This rate is lower than the statutory rate primarily because of tax-exempt
investment income.
As a result of the factors mentioned above, income from consolidated continuing
operations for 1997 was $24.4 million compared to $21.3 million for 1996 and net
income for 1997 totaled $24.4 million compared to $21.7 million reported
during 1996. Diluted earnings per share increased to $1.75 in 1997 from
$1.51 in 1996 due primarily to the increase in realized gains on investments.
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1996 COMPARED TO 1995
Direct premiums written for 1996 totaled $63.4 million, a decrease of $4.0
million (6.0%) from 1995. This decrease is primarily attributable to decreases
in the majority of the Company's trucking-related products. Large fleet and
medium fleet trucking premium writings decreased $9.9 million (29.1%) and $.8
million (20.7%), respectively, reflecting the continued intense competition in
these markets which resulted in the non-renewal of several accounts and rate
reductions on those accounts renewed. Premium writings for Protective's "work
accident" program also decreased by $2.1 million (13.8%) from 1995, reflecting
rate reductions on renewed accounts. Decreases in premium writings were also
derived from Sagamore's program for small trucking fleet risks and surety
premiums related to large fleet risks of $.7 million each. The above decreases
were partially offset by an increase in Sagamore's nonstandard private passenger
automobile business of $8.8 million (181.6%) from 1995. In addition, premiums
for retrospectively rated workers' compensation policies increased $1.3 million
reflecting loss development on prior year policies.
Premium writings from reinsurance assumed decreased by $2.3 million (19.2%) to
$9.9 million during 1996. This decrease relates principally to a $2.1 million
reduction in premiums assumed from voluntary property catastrophe retrocession
pools, to $9.2 million, during 1996. The lower catastrophe assumed premium is
attributable to withdrawal from certain markets by the ceding reinsurers as the
result of declining premium rates.
Premium writings ceded to reinsurers decreased $4.7 million (28.7%) during 1996
to $11.8 million. The percentage of premiums ceded to direct premiums written
decreased to 18.6% for 1996 from 24.5% for 1995 due primarily to the termination
of the quota share treaty on the Company's "work accident" program in April,
1996. Ceding rates on the Company's primary treaties for 1996 were consistent
with the prior year.
After giving effect to changes in unearned premiums, net premiums earned were
$58.7 million for 1996, nearly unchanged from 1995. Net premiums earned from
all trucking liability insurance products, including small fleet trucking,
decreased by $5.7 million (12.8%). Premiums earned from voluntary reinsurance
assumed decreased by $1.8 million. The above decreases were offset by a $7.6
million increase in Sagamore's nonstandard private passenger automobile program
during 1996.
Net investment income decreased by $.6 million (2.9%) during 1996 due to $.9
million in non-recurring income from the liquidation of a limited partnership
during 1995. The average pre-tax yield on invested assets for 1996 was 5.3%
compared to 5.9% for 1995 while the after-tax yield for 1996 was 3.7% compared
to 4.1% for 1995. Investment expenses, which are netted directly against
income, were relatively unchanged from 1995 and were 5.6% of gross investment
income compared to 5.3% for 1995.
Consolidated realized net capital gains were $6.9 million in 1996 compared to
$6.2 million for 1995. The current year net gain consisted of gains on equity
securities and fixed maturities of $6.5 million and $.4 million, respectively.
Losses and loss expenses during 1996 decreased $5.0 million (12.9%) to $33.8
million. The 1996 consolidated loss and loss expense ratio was 57.5% compared
to 65.9% for 1995. Losses and loss expenses incurred for 1996 and 1995 included
adverse development on environmental
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liability claims of $2.4 million and $7.6 million, respectively, relating to
policies written in the 1970's. Adjusted for the development on
environmental liability claims, the consolidated loss and loss expense ratios
for 1996 and 1995 were 53.4% and 53.0%, respectively. The consolidated
savings on all prior year losses was $12.2 million for 1996 compared to $5.5
million for 1995. Adjusted for the development on environmental liability
claims, savings on prior accident year losses were $14.6 million and $13.1
million during 1996 and 1995, respectively. See comments in the foregoing
discussion of operations for 1997 compared to 1996 regarding the development
of prior year reserves.
Other operating expenses for 1996, before credits for allowances from
reinsurers, increased $3.3 million (17.2%) to $22.5 million. Salary related
expenses increased $2.1 million (18.7%) due primarily to a 16% increase in the
number of employees, as the Company's new products continue to expand, and
equity appreciation rights accruals which are tied to the Company's book value.
Direct commission expense increased $.9 million (34.5%) as the result of
increases in premiums from Sagamore's personal automobile product. Allowances
from reinsurers decreased $.7 million (42.7%) as the result of the termination
of the quota share reinsurance treaty covering the Company's "work accident"
program. The ratio of net operating expenses of the insurance subsidiaries to
net premiums earned was 29.2% during 1996 compared to 28.0% for 1995. Including
the agency operations, the ratio of other operating expenses to total revenue,
adjusted for net realized gains, was 27.1% for 1996 compared with 21.9% for
1995.
The effective federal tax rate for consolidated operations for 1996 was 31.6%.
This rate is lower than the statutory rate primarily because of tax-exempt
investment income.
As a result of the factors mentioned above, income from consolidated continuing
operations for 1996 was $21.3 million compared to $20.6 million for 1995.
The Company's net income for 1996 totaled $21.7 million compared to a record
$29.4 million reported during 1995, which included a $7.6 million gain on the
sale of Hoosier Insurance Company. Earnings per share decreased to $1.51 in
1996 from a record $1.96 in 1995.
FORWARD-LOOKING INFORMATION
Any forward-looking statements in this report, including without limitation,
statements relating to the Company's plans, strategies, objectives,
expectations, intentions and adequacy of resources, are made pursuant to the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995.
Investors are cautioned that such forward-looking statements involve risks and
uncertainties including without limitation the following: (i) the Company's
plans, strategies, objectives, expectations and intentions are subject to change
at any time at the discretion of the Company; (ii) the Company's business is
highly competitive and the entrance of new competitors into or the expansion of
the operations by existing competitors in the Company's markets and other
changes in the market for insurance products could adversely affect the
Company's plans and results of operations; and (iii) other risks and
uncertainties indicated from time to time in the Company's filings with the
Securities and Exchange Commission.
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FEDERAL INCOME TAX CONSIDERATIONS
The liability method is used in accounting for federal income taxes. Using this
method, deferred tax assets and liabilities are determined based on differences
between financial reporting and tax bases of assets and liabilities and are
measured using the enacted tax rates and laws that will be in effect when the
differences are expected to reverse. The provision for deferred federal income
tax was based on items of income and expense that were reported in different
years in the financial statements and tax returns and were measured at the tax
rate in effect in the year the difference originated. Net deferred tax
liabilities of $16.2 million and $10.7 million were recorded at December 31,
1997 and 1996, respectively. The net deferred tax liability at December 31,
1997 included $6.2 million in special tax deposits covered under Section 847 of
the Internal Revenue Code, as explained in the following paragraph, which
compares to $7.0 million in special tax deposits at December 31, 1996. Adjusted
for the special deposits, a net deferred tax liability of $22.4 million was
recorded at December 31, 1997 compared to a net deferred tax liability of $17.7
million at December 31, 1996. The increase in deferred federal taxes payable is
primarily attributable to changes in unrealized capital gains in the investment
portfolio.
A provision in the Technical and Miscellaneous Revenue Act of 1988 created a
mechanism which would allow for a recognizable deferred tax asset specifically
for property and casualty loss reserves discounted for tax purposes. Adopted as
Section 847 of the Internal Revenue Code, this provision allows an insurer to
take a special tax deduction equal to the discount on post 1986 accident year
loss and loss expense reserves while making "special estimated tax payments"
equal to the amount of the tax benefit derived from the special deduction. The
"special estimated tax payments" can be carried forward for fifteen years to
offset taxes arising from decreases in the special deduction and can be treated
as regular estimated payments or refunded at the end of the carryforward period.
Based upon the concerns regarding the recognition of deferred tax assets, the
Company adopted the provisions of Section 847 for all tax years 1987 and
subsequent and has taken deductions for the entire amount of discount on post-
1986 loss reserves. As mentioned above, special Section 847 estimated tax
deposits totaling $6.2 million have been paid in connection with this election.
IMPACT OF INFLATION
To the extent possible, the Company attempts to recover the costs of inflation
by increasing the premiums it charges. A majority of the Company's premiums are
charged as a percentage of an insured's gross revenue or payroll. As these
charging bases increase with inflation, so does premium. The remaining premium
rates charged are adjustable only at periodic intervals and often require state
regulatory approval. Such periodic increases in premium rates may lag far
behind cost increases.
To the extent inflation influences yields on investments, the Company is also
affected. The Company maintains a sizable portion of its investment portfolio
in short-term instruments and changes in current market interest rates
correspondingly affect yields on these investments. Further, as inflation
affects current market rates of return, previously committed investments may
rise or decline in value depending on the type and maturity of investment.
Inflation must also be considered by the Company in the creation and review of
loss and loss adjustment expense reserves since portions of these reserves are
expected to be paid over extended periods of time. The anticipated effect of
inflation is implicitly considered when estimating liabilities for losses and
loss adjustment expenses.
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IMPACT OF THE YEAR 2000
The Year 2000 Issue is the result of computer programs being written using two
digits rather than four to define the applicable year. Any of the Company's
computer programs that have time-sensitive features may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions, send invoices, or
engage in normal business activities. The insurance industry is especially
aware of the Year 2000 concern given that the majority of its products and
services are time and date sensitive (e.g., policy effective periods and loss
occurrence dates).
The Company has been in the process of developing software for its new and
rapidly expanding products since 1995. All internally developed new product
software is Year 2000 compliant, with minor exceptions, and currently handles
approximately 90% of the Company's processed transactions. The Company is also
engaged in an ongoing analysis of its remaining systems to determine the nature
and extent of existing deficiencies and the appropriate corrective solutions.
The Company believes that with modifications to existing software and
conversions to new software, the Year 2000 Issue will not pose significant
operational problems for its computer systems. However, if such modifications
and conversions are not made, or are not completed on a timely basis, the Year
2000 Issue could have a significant impact on the operations of the Company.
The Company will communicate with its significant suppliers and large customers
to determine the extent to which the Company's interface systems are vulnerable
to third party failures to remediate Year 2000 system deficiencies. It is
believed that the Company's total Year 2000 project costs will not be
significantly impacted by third party Year 2000 Issues based on presently
available information. However, there can be no guarantee that the systems of
other companies on which the Company's systems rely will be converted on a
timely basis and would not have an adverse effect on the Company's systems. The
Company has determined it has no exposure to contingencies related to the Year
2000 Issue for the products it has sold.
The Company will utilize existing staff and other internal resources to
reprogram and test its internally developed software, and to test its purchased
software, for Year 2000 compliance. Any internally developed software that is
deemed unworthy of Year 2000 conversion will be replaced with new internally
developed or purchased software that is Year 2000 compliant. Any currently
owned purchased software for which Year 2000 upgrades are unavailable will also
be replaced with purchased software that is Year 2000 compliant. The Company
anticipates completing the Year 2000 project by the first quarter of 1999. The
majority of the past and future costs associated with the Year 2000 project can
be attributed to internal staffing requirements associated with the development
of new product software and would have largely been incurred regardless of the
Year 2000 Issue. These costs, and the costs associated with the acquisition of
Year 2000 compliant software from outside vendors, are not material with respect
to the Company's operations or financial position.
The costs of the project and the date on which the Company believes it will
complete its Year 2000 effort are based on management's best estimates, which
were derived utilizing numerous assumptions of future events, including the
continued availability of certain resources, third party modification plans and
other factors. However, there can be no guarantee that these estimates will be
achieved and actual results could differ materially from those anticipated.
Specific factors that might cause such material differences include, but are not
limited to, the availability and cost of personnel trained in this area, the
ability to locate and correct all relevant computer codes, and similar
uncertainties.
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OTHER ITEMS
COMPREHENSIVE INCOME
During 1997, the Company adopted Financial Accounting Standards Board Statement
No. 130, REPORTING COMPREHENSIVE INCOME. Statement No. 130 requires companies
to report certain unrealized potential income or loss items, previously
recognized only in separate components of shareholders' equity, as "other
comprehensive income". Companies are also required to report "comprehensive
income" that is comprised of net income and such other comprehensive income
items. The Company's only material item of other comprehensive income is the
unrealized gain or loss associated with its investment portfolio.
Management believes that the disclosures required by Statement No. 130 are
unnecessary in that all components of such disclosures are currently available
in the Company's financial statements. Management also believes that the new
disclosures may serve to confuse shareholders and other readers regarding the
Company's future earnings and cash flows. The disclosures required by Statement
No. 130 should be viewed by the reader with the understanding that there are
many factors that might affect the future realizable value of items of other
comprehensive income which are beyond management's control. As such, there can
be no assurance that amounts recorded as unrealized gains or losses will ever
result in a realized transaction.
EARNINGS PER SHARE
During 1997, the Company adopted Financial Accounting Standards Board Statement
No. 128, EARNINGS PER SHARE. Statement No. 128 requires companies to present
per share data on both basic (without the dilutive effect of stock equivalents)
and diluted bases. The Company has restated all per share data for prior years
in conformity with Statement No. 128, with minimal effect on previously reported
amounts.
SEGMENTS
In June, 1997, the Financial Accounting Standards Board issued Statement No.
131, DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION. The
Company will report segment information in accordance with Statement No. 131 in
its 1998 annual report. At this time, the Company has not completed its
analysis of Statement No. 131, but anticipates changes from its current
disclosure.
23
24
ANNUAL REPORT ON FORM 10-K
ITEM 8--FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
YEAR ENDED DECEMBER 31, 1997
BALDWIN & LYONS, INC.
INDIANAPOLIS, INDIANA
24
25
REPORT OF INDEPENDENT AUDITORS
Shareholders and Board of Directors
Baldwin & Lyons, Inc.
We have audited the accompanying consolidated balance sheets of Baldwin & Lyons,
Inc. and subsidiaries as of December 31, 1997 and 1996, and the related
consolidated statements of income and retained earnings, changes in equity other
than capital, and cash flows for each of the three years in the period ended
December 31, 1997. Our audits also included the financial statement schedules
listed in the index at item 14(a). These financial statements and schedules are
the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements and schedules based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Baldwin
& Lyons, Inc. and subsidiaries at December 31, 1997 and 1996, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1997, in conformity with generally
accepted accounting principles. Also, in our opinion, the related financial
statement schedules, when considered in relation to the basic financial
statements taken as a whole, present fairly, in all material respects, the
information set forth therein.
/s/ ERNST & YOUNG LLP
Indianapolis, Indiana
February 26, 1998
25
26
CONSOLIDATED BALANCE SHEETS
Baldwin & Lyons, Inc. and Subsidiaries
December 31
-------------------------
1997 1996
---------- ----------
(DOLLARS IN THOUSANDS)
ASSETS
Investments:
Fixed maturities $ 276,109 $ 273,828
Equity securities 158,614 147,196
Short-term and other 17,902 19,698
--------- ---------
452,625 440,722
Cash and cash equivalents 23,402 14,642
Accounts receivable 21,454 13,967
Accrued investment income 4,046 3,888
Reinsurance recoverable 47,276 43,829
Deferred policy acquisition costs 2,522 1,425
Current federal income taxes - 568
Property and equipment--less accumulated depreciation
(1997, $5,097; 1996, $4,223) 4,167 3,259
Other assets 1,523 4,160
--------- ---------
$ 557,015 $ 526,460
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Reserves:
Losses and loss expenses $ 197,195 $ 196,939
Unearned premiums 18,806 10,835
--------- ---------
216,001 207,774
Reinsurance payable 8,428 7,318
Accounts payable and other liabilities 21,234 27,512
Deferred federal income taxes 16,249 10,734
Current federal income taxes 1,140 -
--------- ---------
263,052 253,338
Shareholders' equity:
Common stock, no par value:
Class A -- authorized 3,000,000 shares;
outstanding -- 1997, 2,397,354 shares;
1996, 2,444,329 shares 128 130
Class B -- authorized 20,000,000 shares;
outstanding -- 1997, 11,292,445 shares;
1996, 11,515,145 shares 602 614
Additional paid-in capital 41,361 42,100
Unrealized net gains on investments 45,614 38,472
Retained earnings 206,258 191,806
--------- ---------
293,963 273,122
--------- ---------
$ 557,015 $ 526,460
========= =========
See notes to consolidated financial statements.
26
27
CONSOLIDATED STATEMENTS OF INCOME AND RETAINED EARNINGS
Baldwin & Lyons, Inc. and Subsidiaries
Year Ended December 31
------------------------------------
1997 1996 1995
--------- --------- ---------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
REVENUE:
Net premiums earned $ 61,675 $ 58,743 $ 58,793
Net investment income 18,442 19,580 20,161
Realized net gains on investments 17,338 6,860 6,210
Commissions, service fees and other income 1,655 1,304 1,164
--------- --------- ---------
99,110 86,487 86,328
EXPENSES:
Losses and loss expenses incurred 39,854 33,754 38,754
Other operating expenses 23,633 21,542 17,541
--------- --------- ---------
63,487 55,296 56,295
--------- --------- ---------
INCOME FROM CONTINUING OPERATIONS
BEFORE FEDERAL INCOME TAXES 35,623 31,191 30,033
Federal income taxes 11,177 9,857 9,439
--------- --------- ---------
INCOME FROM CONTINUING OPERATIONS 24,446 21,334 20,594
DISCONTINUED OPERATIONS, NET OF FEDERAL INCOME TAXES:
Income from discontinued operations - 358 1,126
Gain on sale of Hoosier Insurance Company - - 7,640
--------- --------- ---------
NET INCOME 24,446 21,692 29,360
Retained earnings at beginning of year 191,806 183,360 162,934
Cash dividends (per share - 1997, $.40;
1996, $.36; and 1995, $.30) (5,508) (5,107) (4,421)
Treasury shares purchased (4,283) (8,112) (4,617)
Foreign exchange adjustment (203) (27) 104
--------- --------- ---------
RETAINED EARNINGS AT END OF YEAR $ 206,258 $ 191,806 $ 183,360
========= ========= =========
PER SHARE DATA:
DILUTED:
Income before discontinued operations and realized net gains $ .94 $ 1.18 $ 1.11
Realized net gains on investments .81 .31 .27
Income from discontinued operations - .02 .07
Gain on sale of Hoosier Insurance Company - - .51
--------- --------- ---------
NET INCOME $ 1.75 $ 1.51 $ 1.96
========= ========= =========
BASIC:
Income before discontinued operations and realized net gains $ .95 $ 1.19 $ 1.12
Realized net gains on investments .82 .31 .27
Income from discontinued operations - .03 .08
Gain on sale of Hoosier Insurance Company - - .52
--------- --------- ---------
NET INCOME $ 1.77 $ 1.53 $ 1.99
========= ========= =========
See notes to consolidated financial statements.
27
28
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY OTHER THAN CAPITAL
Baldwin & Lyons, Inc. and Subsidiaries
1997 1996 1995
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
BALANCES AT BEGINNING OF YEAR:
Retained earnings $ 191,806 $ 183,360 $ 162,934
Unrealized gains (losses) on investments 38,472 19,251 (1,111)
--------- --------- ---------
230,278 202,611 161,823
CHANGES ARISING FROM INCOME-PRODUCING ACTIVITIES:
Net income 24,446 21,692 29,360
Gains on investments:
Holding gains arising during period,
before federal income taxes 28,326 36,431 37,536
Federal income taxes 9,914 12,751 13,138
--------- --------- ---------
18,412 23,680 24,398
Gains realized during period included in net income,
before federal income taxes (17,338) (6,860) (6,210)
Federal income taxes (6,068) (2,401) (2,174)
--------- --------- ---------
(11,270) (4,459) (4,036)
--------- --------- ---------
Change in unrealized gains or losses on investments 7,142 19,221 20,362
Foreign exhange adjustment (203) (27) 104
--------- --------- ---------
TOTAL REALIZED AND UNREALIZED INCOME 31,385 40,886 49,826
OTHER CHANGES AFFECTING RETAINED EARNINGS:
Cash dividends paid to shareholders (5,508) (5,107) (4,421)
Cost of treasury shares purchased in excess of
proceeds from original issue (4,283) (8,112) (4,617)
--------- --------- ---------
(9,791) (13,219) (9,038)
--------- --------- ---------
TOTAL CHANGES 21,594 27,667 40,788
========= ========= =========
BALANCES AT END OF YEAR:
Retained earnings 206,258 191,806 183,360
Unrealized gains on investments 45,614 38,472 19,251
--------- --------- ---------
$ 251,872 $ 230,278 $ 202,611
========= ========= =========
See notes to consolidated financial statements.
28
29
CONSOLIDATED STATEMENTS OF CASH FLOWS
Baldwin & Lyons, Inc. and Subsidiaries
Year Ended December 31
-----------------------------------
1997 1996 1995
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
OPERATING ACTIVITIES
Net Income $ 24,446 $ 21,692 $ 29,360
Adjustments to reconcile net income to net cash
provided by operating activities:
Change in accounts receivable and unearned premium 484 1,780 5,195
Change in accrued investment income (158) 727 (1,140)
Change in losses and loss expenses and
reinsurance recoverable (3,192) (3,677) (4,744)
Change in other assets, other liabilities and
current income taxes (2,424) (11,028) (2,417)
Amortization of net policy acquisition costs 5,742 5,145 2,146
Net policy acquisition costs deferred (6,839) (5,806) (2,805)
Provision for deferred income tax credits 1,670 (642) (312)
Bond amortization 372 556 360
Loss (gain) on sale of property 3 48 (17)
Depreciation 995 676 549
Net realized gain on investments (17,538) (7,210) (6,597)
Income from discontinued operations - (359) (1,822)
Gain on sale of Hoosier Insurance Company - - (7,640)
Compensation expense related to discounted stock options 78 516 402
--------- --------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES 3,639 2,417 10,518
INVESTING ACTIVITIES
Purchases of long-term investments (237,473) (218,611) (246,789)
Proceeds from maturities 102,065 81,963 64,641
Proceeds from sales of fixed maturities 10,956 27,860 14,391
Proceeds from sales of equity securities 138,428 100,976 120,706
Net proceeds from sales of short-term investments 3,308 10,663 6,126
Net proceeds from the sale of Hoosier Insurance Company - - 35,614
Distributions from limited partnerships 366 3,018 3,790
Purchases of property and equipment (2,027) (2,359) (887)
Proceeds from disposals of property and equipment 121 208 148
--------- --------- ---------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES 15,744 3,718 (2,260)
FINANCING ACTIVITIES
Dividends paid to shareholders (5,508) (5,107) (4,421)
Proceeds from sale of common stock 1 - 1,200
Cost of treasury stock (5,116) (10,182) (5,931)
--------- --------- ---------
NET CASH USED IN FINANCING ACTIVITIES (10,623) (15,289) (9,152)
--------- --------- ---------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 8,760 (9,154) (894)
Cash and cash equivalents at beginning of year 14,642 23,796 24,690
--------- --------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 23,402 $ 14,642 $ 23,796
========= ========= =========
See notes to consolidated financial statements.
29
30
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Baldwin & Lyons, Inc. and Subsidiaries
(DOLLARS IN THOUSANDS)
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION: The consolidated financial statements include the
accounts of Baldwin & Lyons, Inc. and its wholly owned subsidiaries (the
Company). All significant intercompany transactions and accounts have been
eliminated in consolidation.
DISCONTINUED OPERATIONS: The Company sold its interests in Hoosier Insurance
Company (Hoosier) and Amli Realty, Inc. (Amli) in 1995 and 1996, respectively.
Related income and expense amounts for the prior years and the gain recognized
on the sale of Hoosier are reported as discontinued operations. No gain or loss
was realized on the Amli sale which was treated as a non-monetary, tax-free
exchange. The consolidated statements of cash flows for 1996 and 1995 include
changes in certain assets and liabilities which are presented without the
effects of the sales of Amli in 1996 and Hoosier in 1995.
USE OF ESTIMATES: Preparation of the consolidated financial statements requires
management to make estimates and assumptions that affect the amounts reported in
the consolidated financial statements and accompanying notes. Actual results
could differ from those estimates.
Cash and cash equivalents: The Company considers investments in money market
funds to be cash equivalents. Carrying amounts for these instruments
approximate their fair values.
INVESTMENTS: Carrying amounts for fixed maturity securities (bonds, notes and
redeemable preferred stocks) represent fair value and are based on quoted market
prices, where available, or broker/dealer quotes for specific securities where
quoted market prices are not available. Equity securities (nonredeemable
preferred stocks and common stocks) are carried at quoted market prices (fair
value). Other investments are carried at either market value, cost or cost
adjusted for operations of limited partnerships, depending on the nature of the
investment. All fixed maturity and equity securities are considered to be
available for sale; the related unrealized net gains or losses (net of
applicable tax effect) are reflected directly in shareholders' equity. Although
the Company has classified fixed maturity investments as available for sale, it
has the ability to hold its fixed maturity investments to maturity. Short-term
investments are carried at cost which approximates their fair values. Realized
gains and losses on disposals of investments are determined by specific
identification of cost of investments sold and are included in income.
PROPERTY AND EQUIPMENT: Property and equipment is carried at cost.
Depreciation is computed substantially by the straight-line method.
RESERVES FOR LOSSES AND LOSS EXPENSES: The reserves for losses and loss
expenses are determined using case basis evaluations and statistical analyses
and represent estimates of the ultimate cost of all reported and unreported
losses which are unpaid at year end. These reserves include estimates of future
trends in claim severity and frequency and other factors which could vary as the
losses are ultimately settled. Although it is not possible to measure the
degree of variability inherent in such estimates, management believes that the
reserves for losses and loss expenses are adequate. The estimates are
continually reviewed and as adjustments to these reserves become necessary, such
adjustments are reflected in current operations.
Certain loss reserves related to permanent total disability claims under
workers' compensation coverages are discounted to present value using tables
provided by the National Council on Compensation Insurance which are based upon
a pretax interest rate of 3.5 percent, and adjusted for losses retained by the
insured.
30
31
NOTE A - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECOGNITION OF REVENUE AND COSTS: Premiums are earned over the period for which
insurance protection is provided. A reserve for unearned premiums, computed by
the daily pro-rata method, is established to reflect amounts applicable to
subsequent accounting periods. Commissions to unaffiliated companies and other
acquisition costs applicable to unearned premiums are deferred and expensed as
the related premiums are earned. Anticipated investment income is considered in
determining recoverability of deferred acquisition costs.
Reinsurance premiums, commissions, expense reimbursements and reserves related
to reinsured business are accounted for on bases consistent with those used in
accounting for the original policies issued and the terms of the reinsurance
contracts. Premiums ceded to other insurers have been reported as a reduction
of premium income. Amounts applicable to reinsurance ceded for unearned premium
and claim loss reserves have been reported as reinsurance recoverable assets.
Certain reinsurance contracts provide for additional or return premiums and
commissions based upon profits or losses to the reinsurer over prescribed
periods. Estimates of additional or return premiums and commissions are
adjusted quarterly to recognize actual loss experience to date as well as
projected loss experience applicable to the various contract periods.
STOCK-BASED COMPENSATION: Accounting Principles Board Opinion No. 25,
ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and related Interpretations are used
in accounting for stock options, stock purchases and equity appreciation rights
which are, from time to time, granted to employees and outside directors.
FEDERAL INCOME TAXES: A consolidated federal income tax return is filed by the
Company and includes all wholly owned subsidiaries.
EARNINGS PER SHARE: Diluted earnings per share of common stock are based on the
average number of shares of Class A and Class B common stock outstanding during
the year, adjusted for the effect, if any, of options outstanding. Basic
earnings per share are presented exclusive of the effect of options outstanding.
See note M.
RECLASSIFICATION: Certain prior year balances have been reclassified to conform
to the current year presentation.
31
32
NOTE B - INVESTMENTS
The following is a summary of available-for-sale securities at December 31:
Cost or Gross Gross Net
Fair Amortized Unrealized Unrealized Unrealized
Value Cost Gains Losses Gains
--------------------------------------------------------------
1997:
U. S. government obligations $ 100,679 $ 100,279 $ 454 $ (54) $ 400
Mortgage-backed securities 40,934 40,548 443 (57) 386
Obligations of states and political subdivisions 69,663 69,020 650 (7) 643
Corporate securities 64,833 63,339 1,584 (90) 1,494
--------- --------- --------- --------- ---------
Total fixed maturities 276,109 273,186 3,131 (208) 2,923
Equity securities 158,614 91,705 71,196 (4,287) 66,909
Short-term and other 17,902 17,558 418 (74) 344
--------- --------- --------- --------- ---------
Total available-for-sale securities $ 452,625 $ 382,449 $ 74,745 $ (4,569) 70,176
========= ========= ========= =========
Applicable federal income taxes (24,562)
---------
Net unrealized gains - net of tax $ 45,614
=========
1996:
U. S. government obligations $ 145,855 $ 145,755 $ 451 $ (351) $ 100
Mortgage-backed securities 49,973 49,926 312 (265) 47
Obligations of states and political subdivisions 56,747 56,585 189 (27) 162
Corporate securities 21,253 20,764 489 - 489
--------- --------- --------- --------- ---------
Total fixed maturities 273,828 273,030 1,441 (643) 798
Equity securities 147,196 89,344 60,645 (2,793) 57,852
Short-term and other 19,698 19,315 503 (120) 383
Short positions - see note below - - 155 - 155
--------- --------- --------- --------- ---------
Total available-for-sale securities $ 440,722 $ 381,689 $ 62,744 $ (3,556) 59,188
========= ========= ========= =========
Applicable federal income taxes (20,716)
---------
Net unrealized gains - net of tax $ 38,472
=========
Note: The fair value of the Company's short positions at December 31, 1996 was
$744 and is included in accounts payable.
32
33
NOTE B - INVESTMENTS (CONTINUED)
Gross realized gains and losses on investments for the years ended December 31
are summarized below:
1997 1996 1995
-------------------------------------
Fixed maturities:
Gains $ 317 $ 622 $ 351
Losses (199) (230) (69)
--------- --------- ---------
Net gains 118 392 282
Equity securities:
Gains 20,836 9,204 11,170
Losses (2,633) (2,717) (4,438)
--------- --------- ---------
Net gains 18,203 6,487 6,732
Short-term and other - net losses (983) (19) (804)
--------- --------- ---------
TOTAL NET GAINS $ 17,338 $ 6,860 $ 6,210
========= ========= =========
The fair values and the cost or amortized cost of fixed maturity investments at
December 31, 1997, by contractual maturity, are shown below. Actual maturities
may differ from contractual maturities because borrowers have, in some cases,
the right to call or prepay obligations with or without call or prepayment
penalties. Maturities for mortgage-backed securities are determined on a
specific identification basis.
Fair Values Cost or Amortized Cost
----------------------------------- -----------------------------------
Mortgage- Total Mortgage- Total
Backed Fixed Backed Fixed
Securities All Other Maturities Securities All Other Maturities
---------- ---------- ---------- ---------- ---------- ----------
One year or less $ - $ 77,256 $ 77,256 $ - $ 77,125 $ 77,125
Excess of one year to five years 10,682 116,125 126,807 10,626 115,049 125,675
Excess of five years to ten years 12,220 38,391 50,611 12,150 37,123 49,273
Excess of ten years 18,032 2,750 20,782 17,772 2,750 20,522
--------- --------- --------- --------- --------- ---------
Total maturities 40,934 234,522 275,456 40,548 232,047 272,595
Redeemable preferred stock - 653 653 - 591 591
--------- --------- --------- --------- --------- ---------
$ 40,934 $ 235,175 $ 276,109 $ 40,548 $ 232,638 $ 273,186
========= ========= ========= ========= ========= =========
Major categories of investment income for the years ended December 31 are
summarized as follows:
1997 1996 1995
---------- ---------- ----------
Fixed maturities $ 16,193 $ 16,769 $ 14,937
Equity securities 1,729 2,197 2,111
Money market funds 1,208 1,123 1,263
Short-term and other 532 653 2,973
--------- --------- ---------
19,662 20,742 21,284
Investment expenses (1,220) (1,162) (1,123)
--------- --------- ---------
NET INVESTMENT INCOME $ 18,442 $ 19,580 $ 20,161
========= ========= =========
Approximately 38% of purchases and 53% of sales of investments during the three
years ended December 31, 1997 were made through securities broker-dealers in
which certain directors of the Company were officers, directors or owners. Fees
earned by affiliated investment advisors were $604, $932 and $965 in 1997, 1996
and 1995, respectively.
33
34
NOTE B - INVESTMENTS (CONTINUED)
At December 31, 1997, the Company had investments in common stock and bonds of
UICI, a publicly traded insurance and holding company with current market
capitalization of approximately $1.3 billion. The market value of the Company's
investments in UICI was $40,077 with a cost basis of $11,886 at December 31,
1997.
The Company has holdings in money-market accounts which were managed by or
purchased through companies affiliated with certain directors of the Company.
Other investments includes $2,161 and $2,237 at December 31, 1997 and 1996,
respectively, representing limited partnership interests in ventures in which
Amli serves as general partner. A director of the Company is also a director
and officer of Amli.
NOTE C - LOSS AND LOSS EXPENSE RESERVES
Activity in the reserves for losses and loss expenses is summarized as follows.
All amounts are shown net of reinsurance recoverable.
Year Ended December 31,
1997 1996 1995
----------- ----------- -----------
Reserves at the beginning of the year $ 154,537 $ 161,458 $ 175,554
Provision for losses and loss expenses:
Claims occurring during the current year 47,692 45,999 44,238
Claims occurring during prior years (7,838) (12,245) (5,484)
--------- --------- ---------
Total incurred 39,854 33,754 38,754
Loss and loss expense payments:
Continuing operations:
Claims occurring during the current year 15,946 12,891 7,760
Claims occurring during prior years 26,934 27,825 33,819
Discontinued operations - - 11,186
--------- --------- ---------
Total paid 42,880 40,716 52,765
Change in unpaid portion of uncollectible
amounts due from reinsurers (18) 41 (85)
--------- --------- ---------
Reserves at the end of the year 151,493 154,537 161,458
Reinsurance recoverable on
reserves at the end of the year 45,702 42,402 50,031
--------- --------- ---------
Reserves, gross of reinsurance
recoverables, at the end of the year $ 197,195 $ 196,939 $ 211,489
========= ========= =========
The reserves for losses and loss expenses, net of related reinsurance
recoverables, at December 31, 1996, 1995 and 1994 were decreased by $7,838,
$12,245 and $5,484, respectively, for claims that had occurred on or prior to
those dates. These decreases are the result of the settlement of claims at
amounts lower than previously reserved and changes in estimates of losses
incurred but not reported as part of the normal reserving process. Development
during 1997 and 1996, on reserves outstanding at December 31, 1996 and 1995
included $8 and $2,395, respectively, of incurred losses and loss expenses
related to environmental damage claims. Reported cases relate primarily to
policies issued in the 1970's to one account which was involved in the business
of hauling and disposing of hazardous waste. Included in the above amounts are
reserves for incurred but not reported environmental losses of $5,000 at both
December 31, 1997 and 1996. Adjusted for environmental claims, management
believes that the more favorable than anticipated experience may be
attributable, at least in part, to changes in trucking safety in general
resulting from the implementation of the national commercial driver license,
mandatory drug testing and an increased awareness by trucking companies of the
cost of unsafe operations. It is further believed that the Company's selection
techniques, minimum safety standards and claims handling have also contributed
to the current favorable loss experience. These trends were considered in the
establishment of the Company's reserves at December 31, 1997.
34
35
NOTE C - LOSS AND LOSS EXPENSE RESERVES (CONTINUED)
The Company participates in mandatory residual market pools in various states.
The Company records the results from participation in these pools as reported
and records an additional provision in the financial statements for operating
periods unreported by the pools.
Loss reserves on certain permanent total disability workers' compensation
reserves have been discounted to present value at pre-tax rates not exceeding
3.5%. At December 31, 1997 and 1996, loss reserves have been reduced by
approximately $5,431 and $4,694, respectively. Discounting is applied to these
claims since the amount of periodic payments to be made during the lifetime of
claimants is fixed and determinable.
Loss reserves have been reduced by estimated salvage and subrogation recoverable
of approximately $1,725 at both December 31, 1997 and 1996.
NOTE D - INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components
of the Company's deferred tax assets and liabilities as of December 31 are as
follows:
1997 1996
----------- -----------
DEFERRED TAX ASSETS:
Discounts of loss and loss expense reserves $ 6,210 $ 7,031
Deferred compensation 3,517 3,347
Unearned premiums 1,292 734
Other 1,107 1,076
--------- ---------
Total deferred tax assets 12,126 12,188
--------- ---------
DEFERRED TAX LIABILITIES:
Unrealized gain on investments 25,119 21,273
Limited partnerships 1,324 -
Deferred acquisition costs 884 499
Salvage and subrogation 604 604
Other 444 546
--------- ---------
Total deferred tax liabilities 28,375 22,922
--------- ---------
NET DEFERRED LIABILITIES $ (16,249) $ (10,734)
========= =========
Federal income tax expense consists of the following:
1997 1996 1995
---------- ---------- ----------
Taxes (credits) on income from continuing operations:
Current $ 9,507 $ 10,116 $ 10,343
Deferred 1,670 (259) (904)
--------- --------- ---------
$ 11,177 $ 9,857 $ 9,439
========= ========= =========
Taxes on income from discontinued operations:
Current:
Income $ - $ - $ 139
Gain on sale - - 3,850
Deferred - 193 326
--------- --------- ---------
$ - $ 193 $ 4,315
========= ========= =========
35
36
NOTE D - INCOME TAXES (CONTINUED)
A summary of the difference between federal income tax expense computed at the
statutory rate and that reported in the consolidated financial statements is as
follows:
1997 1996 1995
----------- ----------- -----------
Statutory federal income rate applied to
pretax income from continuing operations $ 12,468 $ 10,917 $ 10,512
Tax effect of (deduction):
Tax-exempt investment income (1,219) (1,079) (905)
Other (72) 19 (168)
--------- --------- ---------
Federal income tax expense $ 11,177 $ 9,857 $ 9,439
========= ========= =========
The components of the provision for deferred federal income taxes (credits) are
as follows:
1997 1996 1995
----------- ----------- -----------
Discounts of loss and loss expense reserves $ 821 $ 230 $ 498
Limited partnerships 1,324 - -
Deferred compensation (170) (1,088) (896)
Other (305) 792 (180)
--------- --------- ---------
PROVISION FOR DEFERRED FEDERAL INCOME TAX $ 1,670 $ (66) $ (578)
========= ========= =========
Cash flows related to federal income taxes paid, net of refunds received, for
1997, 1996 and 1995 were $7,800, $11,805 and $13,600, respectively, including
Section 847 special tax deposits. Future tax benefits on approximately $6,210
of deferred tax assets at December 31, 1997 arising from loss reserve
discounting is assured based on Section 847 of the Internal Revenue Code.
Note E - Reinsurance
The insurance subsidiaries cede portions of their gross premiums written to
certain other insurers under excess and quota share treaties and by facultative
placements. Risks are reinsured with other companies to permit the recovery of
a portion of related direct losses. Protective also serves as an assuming
reinsurer under retrocessions from certain other reinsurers. These
retrocessions include individual risks as well as catastrophe pools.
Accordingly, the occurrence of a major catastrophic event could have a
significant impact on the Company's financial statements. In addition, the
insurance subsidiaries participate in certain involuntary reinsurance pools
which require insurance companies to provide coverages on assigned risks. The
assigned risk pools allocate participation to all insurers based upon each
insurer's portion of premium writings on a state or national level.
Net premiums earned for 1997, 1996 and 1995 have been reduced by reinsurance
ceded premiums of approximately $8,091, $11,698 and $16,340, respectively. Net
losses and loss expenses incurred for 1997, 1996 and 1995 have been reduced by
reinsurance recoveries of approximately $11,155, $991 and $26,554, respectively.
Ceded reinsurance premiums and loss recoveries for catastrophe reinsurance
contracts were not material. The Company remains liable to the extent the
reinsuring companies are unable to meet their obligations under reinsurance
contracts. Net premiums earned for 1997, 1996 and 1995 include approximately
$10,609, $10,220 and $12,322, respectively, relating to the assumption of
reinsurance from other companies and from reinsurance pools.
Components of reinsurance recoverable at December 31 are as follows:
1997 1996
----------- -----------
Paid losses and loss expenses $ 1,160 $ 1,085
Unpaid losses and loss expenses 45,702 42,402
Unearned premiums 414 342
--------- ---------
$ 47,276 $ 43,829
========= =========
36
37
NOTE F - OTHER OPERATING EXPENSES
Details of other operating expenses are as follows:
Years Ended December 31
1997 1996 1995
----------- ----------- -----------
Amortization of deferred policy acquisition costs $ 6,486 $ 6,088 $ 3,792
Other underwriting expenses 8,314 5,161 5,673
Expense allowances from reinsurers (744) (943) (1,646)
--------- --------- ---------
TOTAL UNDERWRITING EXPENSES 14,056 10,306 7,819
Operating expenses of non-insurance companies 9,577 11,236 9,722
--------- --------- ---------
TOTAL OTHER OPERATING EXPENSES $ 23,633 $ 21,542 $ 17,541
========= ========= =========
NOTE G - SHAREHOLDERS' EQUITY
Changes in common stock outstanding and additional paid-in capital are as
follows:
Additional
Class A Class B Paid-in
Shares Amount Shares Amount Capital
----------- ----------- ----------- ----------- -----------
Balance at January 1, 1995 2,446,029 $ 131 12,368,209 $ 659 $ 43,320
Discounted stock options issued - - - - 459
Stock options exercised 30,000 1 121,200 7 1,192
Discounted stock options forfeited - - - - (58)
Treasury shares purchased - - (388,248) (21) (1,293)
---------- ---------- ---------- ---------- ----------
Balance at December 31, 1995 2,476,029 132 12,101,161 645 43,620
Discounted stock options issued - - - - 516
Discounted stock options exercised - - 1,200 - -
Treasury shares purchased (31,700) (2) (587,216) (31) (2,036)
---------- ---------- ---------- ---------- ----------
Balance at December 31, 1996 2,444,329 130 11,515,145 614 42,100
Discounted stock options issued - - - - 78
Discounted stock options exercised - - 4,314 - 1
Treasury shares purchased (46,975) (2) (227,014) (12) (818)
---------- ---------- ---------- ---------- ----------
Balance at December 31, 1997 2,397,354 $ 128 11,292,445 $ 602 $ 41,361
========== ========== ========== ========== ==========
During 1997, 1996 and 1995, purchases of treasury stock included 96,214, 49,000
and 41,198 shares, respectively, from officers and directors for $1,850, $821
and $644, respectively, at prices based upon the midpoint between the bid and
ask prices on the date of purchase.
Shareholders' equity at December 31, 1997 includes $273,094 representing GAAP
shareholder's equity of insurance subsidiaries, of which $38,437 may be
transferred by dividend or loan to the parent company without approval by, or
notification to, regulatory authorities. An additional $169,879 of
shareholder's equity of such insurance subsidiaries may be advanced or loaned to
the Company with prior notification to regulatory authorities.
Net income of the insurance subsidiaries, as determined in accordance with
statutory accounting practices, was $24,975, $20,249 and $22,849 for 1997, 1996
and 1995, respectively. Consolidated statutory shareholder's equity for these
subsidiaries was $248,154 and $222,720 at December 31, 1997 and 1996,
respectively.
Note H - Employee Benefit Plans
The Company maintains a defined contribution 401(k) Employee Savings and Profit
Sharing Plan ("the Plan") which covers all employees who have completed one year
of service. The Company's contributions to the Plan for 1997, 1996 and 1995
were $585, $499 and $465, respectively.
37
38
NOTE I - COMPREHENSIVE INCOME
In June 1997, the Financial Accounting Standards Board issued Statement No. 130,
REPORTING COMPREHENSIVE INCOME. Statement No. 130 requires companies to report,
as an addition to net income, certain unrealized potential income or loss items
that, previously, were included only as separate components of shareholders'
equity until realized. Statement No. 130 requires disclosure of other
comprehensive income items related to unrealized gains and losses on securities,
foreign currency items and minimum pension liability adjustments. The Company
has elected to adopt the provisions of Statement No. 130 as of December 31,
1997.
The Company records accumulated other comprehensive income from unrealized gains
and losses on available-for-sale securities as a separate component of
shareholders' equity. Foreign exchange adjustments are immaterial and the
Company has no pension plan.
The enclosed STATEMENT OF CHANGES IN EQUITY OTHER THAN CAPITAL refers to
comprehensive income as TOTAL REALIZED AND UNREALIZED INCOME. Items of other
comprehensive income included in this statement are referred to as CHANGE IN
UNREALIZED GAINS (LOSSES) ON INVESTMENTS and FOREIGN EXCHANGE ADJUSTMENT. A
reclassification adjustment to other comprehensive income is made for GAINS
REALIZED DURING PERIOD INCLUDED IN NET INCOME.
NOTE J - STOCK PURCHASE AND OPTION PLANS
In accordance with the terms of the 1981 Stock Purchase Plan (1981 Plan), the
Company is obligated to repurchase shares issued under the 1981 Plan, at a price
equal to 90% of the book value of the shares at the end of the quarter
immediately preceding the date of repurchase. No shares were repurchased during
1997, 1996 or 1995. At December 31, 1997 there were 156,854 shares (Class A)
and 398,641 shares (Class B) outstanding which are eligible for repurchase by
the Company.
During 1985, in accordance with the terms of the 1984 Stock Option and Stock
Appreciation Plan (1984 Plan, amended during 1991), the Company granted options
to purchase 30,000 shares (Class A) and 120,000 shares (Class B) of common stock
at the then book value of $3.22 per share. These options were exercised during
1995 and no further shares are available for issuance. The exercise of these
options is included in the following option table.
The Company maintains stock option plans and has reserved an aggregate of
1,050,000 shares of Class B common stock for the granting of stock options to
employees and directors. Discounted options granted to employees are generally
exercisable immediately while discounted options granted to directors are
generally not exercisable for one year from the date of grant. During 1997, the
Company issued 497,000 market value options which become exercisable in one-
third increments on the first, second and third anniversary of the date of
grant, assuming continued employment with the Company of the optionee. All
options expire ten years after the date of grant.
38
39
NOTE J - STOCK PURCHASE AND OPTION PLANS (CONTINUED)
A summary of the Company's stock option activity and related information for the
years ended December 31 follows:
1997 1996 1995
------------------------ ------------------------ ------------------------
Weighted Weighted Weighted
Average Average Average
Excercise Excercise Excercise
Options Price Options Price Options Price
---------- ---------- ---------- ---------- ---------- ----------
Outstanding at beginning of year 196,329 $ .569 168,251 $ .510 293,869 $ 1.863
Granted:
At exercise prices equaling market 497,000 25.750 - - - -
At exercise prices below market 4,206 .679 29,278 .903 29,782 .893
Exercised 4,314 .333 1,200 .333 151,200 3.202
Forfeited - - - - 4,200 1.000
--------- --------- ---------
Outstanding at end of year 693,221 18.625 196,329 .569 168,251 .510
========= ========= =========
Exercisable at end of year 192,015 .575 192,051 .574 163,469 .515
Weighted average fair value
of options granted during the year:
At exercise prices equaling market 497,000 8.950 - - - -
At exercise prices below market 4,206 18.561 29,278 17.617 29,782 15.429
The fair value of the market value options granted during 1997 was determined
using a Black Scholes option pricing model with the following assumptions: risk-
free interest rate of 5.8%; dividend yield of 1.8%; volatility factor of the
expected market price of the Company's common stock of .21; and an expected life
of the option of 10 years. If the Company had followed Financial Acounting
Standards Board Statement No. 123, Accounting for Stock-Based Compensation, the
effect on net income and earnings per share related to the issuance of market
value options during 1997 would not be material.
Exercise prices for options outstanding as of December 31, 1997 were $.33, $1.00
or $25.75. The weighted-average remaining contractual life of options
exercisable at either $.33 or $1.00 is 4.6 years with a weighted-average
exercise price of $.577. The remaining contractual life of options exercisable
at $25.75 is 10 years. The compensation cost that has been charged against
income for all stock-based compensation plans was $.1 million, $.5 million and
$.5 million for 1997, 1996 and 1995, respectively.
NOTE K - INDUSTRY SEGMENTS
The Company and its consolidated subsidiaries operate within the
property/casualty insurance industry in two identifiable segments: the insurance
brokerage/agency segment and the insurance underwriting segment. The insurance
brokerage/agency segment obtains property and casualty insurance coverage for
its customers from the insurance underwriting segment and other non-affiliated
insurance companies and provides other insurance-related services. The
insurance underwriting segment provides multiple line property and casualty
insurance coverage for its insureds, primarily for coverage of motor vehicle
liability and physical damage and workers' compensation risks. The insurance
brokerage/agency segment specializes exclusively in insurance for the trucking
industry. The insurance underwriting segment's fleet trucking business is
produced by the insurance brokerage/agency segment on a direct basis. Premiums
from the private passenger automobile, small fleet trucking and small business
workers' compensation markets are produced through an extensive network of
independent agents. The insurance underwriting segment also serves as assuming
reinsurer on numerous retrocessions from other reinsurers covering both
individual property and liability risks and high limit catastrophe pools.
39
40
NOTE K - INDUSTRY SEGMENTS (CONTINUED)
Intersegment commissions, which are eliminated in the consolidated statements of
income, are included in revenue and income for the insurance brokerage/agency
segment.
Year Ended December 31
1997 1996 1995
----------- ----------- -----------
REVENUE:
Insurance underwriting segment:
Net premiums earned $ 61,675 $ 58,743 $ 58,793
Net investment income 17,245 17,505 18,418
Net realized gains 16,530 6,112 5,646
Other income 946 632 448
--------- --------- ---------
REVENUE FROM INSURANCE UNDERWRITING SEGMENT 96,396 82,992 83,305
Insurance brokerage/agency segment:
Commissions, service fees and other income 7,164 7,524 9,354
Net investment income 6,198 4,077 37,743
Net realized gains 808 748 564
--------- --------- ---------
REVENUE FROM INSURANCE BROKERAGE/AGENCY SEGMENT 14,170 12,349 47,661
Eliminations:
Intersegment commission (6,456) (6,852) (8,638)
Intersegment dividends (5,000) (2,002) (36,000)
--------- --------- ---------
$ 99,110 $ 86,487 $ 86,328
========= ========= =========
INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE FEDERAL INCOME TAXES:
Insurance underwriting segment $ 36,030 $ 32,080 $ 28,095
Insurance brokerage/agency segment (407) (889) 1,938
--------- --------- ---------
$ 35,623 $ 31,191 $ 30,033
========= ========= =========
The brokerage/agency segment received essentially all of its commission income
from the insurance underwriting segment in 1997, 1996 and 1995. Intersegment
commission rates are generally comparable to the average commission rates paid
by unaffiliated insurance companies. The insurance underwriting segment
received approximately 59% of its direct premium revenue by providing insurance
coverage to customers of the brokerage/agency segment (74% and 86%,
respectively, in 1996 and 1995). Premiums charged by the insurance underwriting
segment to customers of the brokerage/agency segment are comparable to premiums
charged to other insureds for similar insurance coverages. Intersegment
reimbursements for certain expenses (office space, equipment costs, salaries,
etc.) are based upon actual usage and other predetermined allocation methods.
Underwriting expenses of the insurance underwriting segment include
approximately $10,562 in 1997, $8,303 in 1996 and $7,418 in 1995 representing
allocations of general operating expenses from the brokerage/agency segment,
which records these reimbursements as reductions in its operating expenses.
Net premium earned by the insurance underwriting segment is produced in all
states and all Canadian provinces. The following products accounted for more
than 10% of net premium earned by this segment for the years ended December 31,
as follows:
1997 1996 1995
-------------------------
Trucking and trucking related 55% 66% 76%
Private passenger automobile 28 16 3
Voluntary reinsurance assumed 16 16 20
Other 1 2 1
40
41
NOTE K - INDUSTRY SEGMENTS (CONTINUED)
One customer of the insurance underwriting segment and the insurance
brokerage/agency segment accounted for 29% and 42% of premiums written and
intersegment commission income, respectively, in 1997. This same customer
accounted for 30% and 38% of premiums written and intersegment commission
income, respectively, in 1996 and 42% and 47%, respectively, in 1995.
Identifiable assets of the insurance underwriting segment and the insurance
brokerage/agency segment give effect to allocations of property and equipment
used by both segments. Capital expenditures and depreciation expense are not
material.
December 31
1997 1996 1995
-----------------------------------
IDENTIFIABLE ASSETS
Insurance underwriting segment $ 502,560 $ 464,547 $ 449,679
Insurance brokerage/agency segment 62,979 71,624 73,995
Eliminations (8,524) (9,711) (11,449)
--------- --------- ---------
$ 557,015 $ 526,460 $ 512,225
========= ========= =========
NOTE L - DISCONTINUED OPERATIONS
On November 9, 1996, Amli closed an agreement with UICI, a publicly traded
financial services and insurance company, which resulted in UICI acquiring 100%
of Amli's outstanding stock. The Company received 617,278 shares of UICI common
stock in a non-monetary, tax-free exchange for its 38% stake in Amli. The
Company accounted for its minority investment in Amli by the equity method. The
book value of the Company's investment in Amli at the date of the exchange was
$7.5 million.
On October 2, 1995, the Company sold its subsidiary, Hoosier, for $36.5 million.
Included in the Company's insurance underwriting segment, Hoosier marketed
general lines of insurance to individuals and small commercial customers in the
state of Indiana.
NOTE M - EARNINGS PER SHARE
In February, 1997, the Financial Accounting Standards Board issued Statement No.
128, Earnings Per Share. Statement No. 128 redefined the computation of
earnings per share and requires companies to report per share earnings on both
basic (without dilution) and diluted bases. The effect of restatement of
earnings per share for the years 1996 and 1995, resulting from the adoption of
Statement No. 128, was not material.
The following is a reconciliation of the denominators used in the calculations
of basic and diluted earnings per share for the years ended December 31:
1997 1996 1995
-------------------------------------
Average shares outstanding
for basic earnings per share 13,776,881 14,183,922 14,756,784
Dilutive effect of options 192,371 190,702 208,648
---------- ---------- ----------
Average shares outstanding
for diluted earnings per share 13,969,252 14,374,624 14,965,432
========== ========== ==========
No effect on net income was considered to result from the presumed exercise of
the options used in calculating diluted earnings per share. Options to purchase
497,000 shares of common stock at $25.75 per share were issued in December, 1997
and were outstanding at December 31, 1997. These options were not included in
the computation of diluted earnings per share because the exercise price was
greater than the average market price of the Company's stock.
41
42
NOTE N - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
Quarterly results of operations are as follows:
Results by Quarter
-------------------------------------------------------------------------------------------
1997 1996
-------------------------------------------- --------------------------------------------
1ST 2ND 3RD 4TH 1st 2nd 3rd 4th
-------------------------------------------- --------------------------------------------
Net premiums earned $13,322 $14,987 $16,633 $16,733 $15,294 $16,142 $13,971 $13,336
Net investment income 4,611 4,664 4,534 4,633 4,986 4,877 4,832 4,885
Realized net gains on investments 5,444 3,887 4,493 3,514 579 3,105 1,775 1,401
Losses and loss expenses incurred 8,863 9,486 10,670 10,835 9,761 10,224 7,418 6,351
Income from continuing operations 6,573 6,239 6,227 5,407 4,270 6,245 5,609 5,210
Discontinued operations - - - - 241 28 (19) 108
Net income 6,573 6,239 6,227 5,407 4,511 6,273 5,590 5,318
Per share - diluted:
Income from continuing operations $ .47 $ .45 $ .45 $ .39 $ .29 $ .44 $ .39 $ .37
Discontinued operations - - - - .02 - - -
Net income .47 .45 .45 .39 .31 .44 .39 .37
42
43
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
No response to this item is required.
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information with respect to the directors of the Registrant to be provided
under this item is omitted from this Report because the Registrant will file
with the Commission a definitive proxy statement pursuant to Regulation 14A
involving the election of directors not later than 120 days after the close of
its fiscal year.
The information required by Item 10 of this Report with respect to directors
which will appear in the definitive proxy statement is incorporated by reference
herein.
The executive officers of the Company will serve until the next annual meeting
of the Board of Directors and until their respective successors are elected and
qualified. Except as otherwise indicated, the occupation of each officer during
the past five years has been in his current position with the Company.
The following summary sets forth certain information concerning the Company's
executive officers:
Served in
Such Capacity
Name Age Title Since
- ------------------------- ---- ------------------------------------ -------------
Gary W. Miller 57 Chairman, President and CEO 1983 (1)
G. Patrick Corydon 49 Vice President and Treasurer 1979
Joseph J. DeVito 46 Vice President 1986
James W. Good 54 Vice President 1980
James E. Kirschner 52 Vice President and Secretary 1977 (2)
(1) Mr. Miller was elected Chairman and CEO of the Company in 1997.
(2) Mr. Kirschner was elected Secretary of the Company in 1985.
Item 11. EXECUTIVE COMPENSATION *
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT *
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS *
* The information to be provided under Items 11, 12 and 13 is omitted from this
Report because the Registrant will file with the Commission a definitive proxy
statement pursuant to Regulation 14A involving the election of directors not
later than 120 days after the close of its fiscal year. The information
required by these items of this Report which will appear in the definitive proxy
statement is incorporated by reference herein.
43
44
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. List of Financial Statements--The following consolidated financial
statements of the registrant and its subsidiaries (including the
Report of Independent Auditors) are submitted in Item 8 of this
report.
Consolidated Balance Sheets - December 31, 1997 and 1996
Consolidated Statements of Income and Retained Earnings -
Years ended December 31, 1997, 1996 and 1995
Consolidated Statements of Changes in Equity Other Than Capital -
Years ended December 31, 1997, 1996 and 1995
Consolidated Statements of Cash Flows -
Years ended December 31, 1997, 1996 and 1995
Notes to Consolidated Financial Statements
2. List of Financial Statement Schedules--The following consolidated
financial statement schedules of Baldwin & Lyons, Inc. and
subsidiaries are included in Item 14(d):
Pursuant to Article 7:
Schedule I--Summary of Investments--Other than Investments
in Related Parties
Schedule III--Supplementary Insurance Information
Schedule IV--Reinsurance
Schedule V--Valuation and Qualifying Accounts
Schedule VI--Supplemental Information Concerning Property/Casualty
Insurance Operations
All other schedules to the consolidated financial statements required by Article
7 and Article 5 of Regulation S-X are not required under the related
instructions or are inapplicable and therefore have been omitted.
44
45
3. Listing of Exhibits:
Number & Caption
from Exhibit Table of
Item 601 of Regulation
S-K Exhibit Number and Description
- ------------------------ ------------------------------------------------
(3) EXHIBIT 3(i)--
(Articles of Incorpor- Articles of Incorporation of Baldwin & Lyons, Inc.,
ation & By Laws) as amended (Incorporated as an exhibit by reference
to Exhibit 3(a) to the Company's Annual Report on
Form 10-K for the year ended December 31, 1986)
EXHIBIT 3(ii)--
By-Laws of Baldwin & Lyons, Inc., as restated
(Incorporated as an exhibit by reference to
Exhibit 3(ii) to the Company's Quarterly Report
on Form 10-Q for the quarter ended June 30, 1997)
(10) EXHIBIT 10(a)--
(Material Contracts) 1981 Employee Stock Purchase Plan (Incorporated
as an exhibit by reference to Exhibit A to the
Company's definitive Proxy Statement for its
Annual Meeting held May 5, 1981)
EXHIBIT 10(b)--
Baldwin & Lyons, Inc. Employee Discounted Stock
Option Plan (Incorporated as an exhibit by
reference to Appendix A to the Company's
definitive Proxy Statement for its Annual
Meeting held May 2, 1989)
EXHIBIT 10(c)--
Baldwin & Lyons, Inc. Deferred Directors Fee
Option Plan (Incorporated as an exhibit by
reference to Exhibit 10(f) to the Company's
Annual Report on Form 10-K for the year
ended December 31, 1989)
EXHIBIT 10(d)--
Baldwin & Lyons, Inc. Amended Employee Discounted
Stock Option Plan (Incorporated as an exhibit by
reference to Exhibit 10(f) to the Company's
Annual Report on Form 10-K for the year ended
December 31, 1992)
45
46
Number & Caption
from Exhibit Table of
Item 601 of Regulation
S-K Exhibit Number and Description
- ------------------------ --------------------------------------------------
EXHIBIT 10(e)--
Stock Purchase Agreement by and among General
Casualty Company of Wisconsin, Baldwin & Lyons,
Inc. and Protective Insurance Company as of
August 8, 1996 (Incorporated as an exhibit by
reference to Exhibit 10(g) to the Company's Annual
Report on Form 10-K for the year ended December
31, 1996)
EXHIBIT 10(f)--
Baldwin & Lyons, Inc. Restated Employee Discounted
Stock Option Plan
(11) EXHIBIT 11--
(Statement regarding Computation of Per Share Earnings
computation of per
share earnings)
(21) EXHIBIT 21--
(Subsidiaries of the Subsidiaries of Baldwin & Lyons, Inc.
registrant)
(23) EXHIBIT 23--
(Consents of experts Consent of Ernst & Young LLP
and counsel)
(24) EXHIBIT 24--
(Powers of Attorney) Powers of Attorney for certain Officers and
Directors
46
47
(b) No reports on Form 8-K were filed by the Company in the fourth quarter of
1997.
(c) Exhibits. The response to this portion of Item 14 is submitted as a
separate section of this report.
(d) Financial Statement Schedules. The response to this portion of Item 14 is
submitted on pages 48 through 52 of this report.
47
48
SCHEDULE I -- SUMMARY OF INVESTMENTS-
OTHER THAN INVESTMENTS IN RELATED PARTIES
December 31, 1997
BALDWIN & LYONS, INC. & SUBSIDIARIES
- ----------------------------------------------------------------------------
Column A Column B Column C Column D
- ----------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
Amount At
Which Shown
Fair In The Balance
Type of Investment Cost Value Sheet (A)
- ---------------------------------- ----------- ----------- --------------
Fixed Maturities:
Bonds:
United States government and
government agencies and
authorities $100,279 $100,679 $100,679
Mortgage backed securities 40,548 40,934 40,934
States, municipalities and
political subdivisions 69,020 69,663 69,663
Public utilities 4,897 5,000 5,000
All other corporate bonds 57,851 59,180 59,180
Redeemable preferred stock 591 653 653
--------- --------- ---------
Total fixed maturities 273,186 276,109 276,109
Equity Securities:
Common Stocks:
Banks, trust and insurance
companies 27,504 73,903 73,903
Industrial, miscellaneous
and all other 57,705 78,135 78,135
Nonredeemable preferred stocks 6,496 6,576 6,576
--------- --------- ---------
Total equity securities 91,705 158,614 158,614
Short-term and Other:
Certificates of deposit 2,202 2,202 2,202
All other short-term (B) 22,703 22,703 22,703
Other long-term investments 15,356 15,700 15,700
--------- --------- ---------
Total short-term and other 40,261 40,605 40,605
--------- --------- ---------
Total investments $405,152 $475,328 $475,328
========= ========= =========
(A) All securities listed are considered available-for-sale and, accordingly,
are presented at fair value
in the financial statements.
(B) Money market instruments classified as cash equivalents.
48
49
SCHEDULE III -- SUPPLEMENTARY INSURANCE INFORMATION
BALDWIN & LYONS, INC. AND SUBSIDIARIES
(DOLLARS IN THOUSANDS)
- ----------------------------------------------------------------------------------------------------------------------------------
Column A Column B Column C Column D Column E Column F Column G Column H Column I Column J Column K
- ----------------------------------------------------------------------------------------------------------------------------------
As of December 31, Year Ended December 31,
-------------------------------------------- -------------------------------------------------------------------
Reserves
for Unpaid Other Benefits, Amortization
Deferred Claims Policy Claims, of Deferred
Policy and Claim Claims and Net Net Losses and Policy Other Net
Acquisition Adjustment Unearned Benefits Premium Investment Settlement Acquisition Operating Premiums
Segment Costs Expenses Premiums Payable Earned Income Expenses Costs Expenses Written
- --------------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
(A) (A) (A) (B)
Property/Casualty
Insurance
1997 $2,522 $197,195 $18,806 --- $61,675 $18,442 $39,854 $6,486 $7,570 $69,575
1996 1,425 196,939 10,835 --- 58,743 17,505 33,754 6,088 4,218 61,431
1995 763 211,489 8,262 --- 58,793 18,418 38,754 3,792 4,027 63,065
(A) Allocations of certain expenses have been made to investment income,
settlement expenses and other operating expenses and are based on a number of
assumption and estimates. Results among these catagories would change if
different methods were applied.
(B) Commissions paid to the Parent Company have been eliminated for this
presentation. Commission allowances resulting from reinsurance transactions
are offset against other operating expenses.
49
50
SCHEDULE IV -- REINSURANCE
BALDWIN & LYONS, INC. & SUBSIDIARIES
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
Column A Column B Column C Column D Column E Column F
- --------------------------------------------------------------------------------
% of
Ceded Assumed Amount
Gross to Other from Other Net Assumed to
Amount Companies Companies Amount Net
---------- ---------- ---------- ---------- ----------
Premiums Earned -
Property/casualty
insurance:
Years Ended
December 31:
1997 $ 59,157 $ 8,091 $ 10,609 $ 61,675 17.2
1996 60,221 11,698 10,220 58,743 17.4
1995 62,811 16,340 12,322 58,793 21.0
50
51
SCHEDULE V--VALUATION AND QUALIFYING ACCOUNTS
BALDWIN & LYONS, INC. & SUBSIDIARIES
(DOLLARS IN THOUSANDS)
- -----------------------------------------------------------------------------------
Column A Column B Column C Column D Column E
- -----------------------------------------------------------------------------------
Additions
-----------------------
(1) (2)
Charged to
Balance at Charged to Other Balance
Beginning Cost and Accounts- Deductions- at End of
Description of Period Expenses Describe Describe Period
- -------------------- ----------- ----------- ----------- ----------- -----------
Allowance for doubtful
accounts:
Years ended
December 31:
1997 $346 $413 $0 $363 (A) $396
1996 300 192 0 146 (A) 346
1995 300 (1) 0 (1)(A) 300
(A) Bad debts written off during the year net of recoveries of previously
written off amounts, if any.
51
52
SCHEDULE VI--SUPPLEMENTAL INFORMATION
CONCERNING PROPERTY/CASUALTY INSURANCE OPERATIONS
BALDWIN & LYONS, INC. & SUBSIDIARIES
(DOLLARS IN THOUSANDS)
- -----------------------------------------------------------------------------------------------------------------------------------
Column A Column B Column C Column D Column E Column F Column G Column H Column I Column J Column K
- -----------------------------------------------------------------------------------------------------------------------------------
As of December 31, Year Ended December 31,
-------------------------------------------- -----------------------------------------------------------------------
Claims and Claim
Reserves Adjustment Expenses Amortiza-
for Unpaid Discount, Incurred Related to tion of
Deferred Claims if any ------------------- Deferred Paid Claims
AFFILIATION Policy and Claim Deducted Net (1) (2) Policy and Claim Net
WITH Acquisi- Adjustment in Unearned Earned Investment Current Prior Acquisition Adjustment Premiums
REGISTRANT tion Costs Expenses Column C Premiums Premiums Income Year Years Costs Expenses Written
- -------------- ---------- ---------- ---------- ---------- -------- ---------- -------- -------- ----------- ----------- ----------
(A) (B)
Consolidated
Property/
Casualty
Subsidiaries:
1997 $2,522 $197,195 $5,431 $18,806 $61,675 $18,442 $47,692 ($7,838) $6,486 $42,880 $69,575
1996 1,425 196,939 4,694 10,835 58,743 17,505 45,999 (12,245) 6,088 40,716 61,431
1995 763 211,489 8,096 8,262 58,793 18,418 44,238 (5,484) 3,792 52,765 63,065
(A) Loss reserves on certain reinsurance assumed and permanent total disability
worker's compensation claims have been discounted to present value using
pretax interest rates not exceeding 3.5%.
(B) 1995 paid claims and claim adjustment expenses include $11,186 related to
Hoosier representing all reserves for unpaid claims and claim adjustment
expenses at December 31, 1994.
52
53
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
BALDWIN & LYONS, INC.
March 25, 1998 By /s/ Gary W. Miller
------------------------------------
Gary W. Miller, Chairman
and CEO
(Chief Operating Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
March 25, 1998 By /s/ Gary W. Miller
------------------------------------
Gary W. Miller, Chairman
and CEO; Director
March 25, 1998 By /s/ G. Patrick Corydon
------------------------------------
G. Patrick Corydon, Vice President -
Finance and Treasurer (Principal
Financial Officer and Principal
Accounting Officer)
March 25, 1998 By /s/ Joseph DeVito
------------------------------------
Joseph DeVito, Director and
Vice President
March 25, 1998 By /s/ James Good
------------------------------------
James Good, Director and
Vice President
March 25, 1998 By /s/ Stuart D. Bilton (*)
------------------------------------
Stuart D. Bilton, Director
March 25, 1998 By /s/ Otto N. Frenzel III (*)
------------------------------------
Otto N. Frenzel III, Director
53
54
SIGNATURES (CONTINUED)
March 25, 1998 By /s/ Gregory T. Mutz (*)
------------------------------------
Gregory T. Mutz, Director
March 25, 1998 By /s/ John M. O'Mara (*)
------------------------------------
John M. O'Mara, Director
March 25, 1998 By /s/ Thomas H. Patrick (*)
------------------------------------
Thomas H. Patrick, Director
March 25, 1998 By /s/ Nathan Shapiro (*)
------------------------------------
Nathan Shapiro, Director
March 25, 1998 By /s/ Norton Shapiro (*)
------------------------------------
Norton Shapiro, Director
March 25, 1998 By /s/ L. Leslie Waters (*)
------------------------------------
L. Leslie Waters, Director
March 25, 1998 By /s/ John D. Weil (*)
------------------------------------
John D. Weil, Director
March 25, 1998 By /s/ Robert Shapiro (*)
------------------------------------
Robert Shapiro, Director
March 25, 1998 By /s/ John Pigott (*)
------------------------------------
John Pigott, Director
(*) By Gary W. Miller, Attorney-in-Fact
54
55
ANNUAL REPORT ON FORM 10-K
ITEM 14(c)--CERTAIN EXHIBITS
YEAR ENDED DECEMBER 31, 1997
BALDWIN & LYONS, INC.
INDIANAPOLIS, INDIANA
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56
BALDWIN & LYONS, INC.
Form 10-K for the Fiscal Year
Ended December 31, 1997
INDEX TO EXHIBITS
Begins on sequential page
Exhibit No. number of Form 10-K
- ----------------------------------------- --------------------------
EXHIBIT 3(i)--
Articles of Incorporation of
Baldwin & Lyons, Inc. as amended
(Incorporated as an exhibit by
reference to Exhibit 3(a) to the
Company's Annual Report on Form
10-K for the year ended December
31, 1986) N/A
EXHIBIT 3(ii)--
By-Laws of Baldwin & Lyons, Inc.,
as restated (Incorporated as an
exhibit by reference to Exhibit
3(ii) to the Company's Quarterly
Report on Form 10-Q for the quarterly
ended June 30, 1997) N/A
EXHIBIT 10(a)--
1981 Employees Stock Purchase Plan
(Incorporated as an exhibit by
reference to Exhibit A to the
Company's definitive Proxy
Statement for its Annual Meeting
held May 5, 1981) N/A
EXHIBIT 10(b)--
Baldwin & Lyons, Inc. Employee
Discounted Stock Option Plan
(Incorporated as an exhibit by reference
to Appendix A to the Company's definitive
Proxy Statement for its Annual Meeting
held May 2, 1989) N/A
EXHIBIT 10(c)--
Baldwin & Lyons, Inc. Deferred Directors
Fee Option Plan (Incorporated as an
exhibit by reference to Exhibit 10(f) to
the Company's Annual Report on Form 10-K
for the year ended December 31, 1989) N/A
56
57
INDEX TO EXHIBITS (CONTINUED)
Begins on sequential page
Exhibit No. number of Form 10-K
- ----------------------------------------- -------------------------
EXHIBIT 10(d)--
Baldwin & Lyons, Inc. Amended Employee
Discounted Stock Option Plan
(Incorporated as an exhibit by reference
to Exhibit 10(f) to he Company's Annual
Report on Form 10-K for the year ended
December 31, 1989) N/A
EXHIBIT 10(e)--
Stock Purchase Agreement by and among
General Casualty Company of Wisconsin,
Baldwin & Lyons, Inc. and Protective
InsuranceCompany as of August 8, 1996
(Incorporated as an exhibit by reference
to Exhibit 10(g) to the Company's Annual
Report on Form 10-K for the year ended
December 31, 1996) N/A
EXHIBIT 10(f)--
Baldwin & Lyons, Inc. Restated Employee
Discounted Stock Option Plan p. 58
EXHIBIT 11--
Computation of Per Share Earnings p. 62
EXHIBIT 21--
Subsidiaries of Baldwin & Lyons, Inc. p. 63
EXHIBIT 23--
Consent of Ernst & Young LLP p. 64
EXHIBIT 24--
Powers of Attorney for certain
Officers and Directors p. 65
57