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FORM 10-K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(MARK ONE)
( X ) Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the year ended December 31, 1998.
( ) Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from ________ to ________.
Commission File Number: 000-24366
GORAN CAPITAL INC.
(Exact name of registrant as specified in its charter)
CANADA Not Applicable
(State or other jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or organization)
181 University Avenue, Suite 1101 M5H 3M7
Toronto, Ontario Canada
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number: (416) 594-1155 (Canada)
(317) 259-6400 (U.S.A.)
Securities registered pursuant to
Section 12(b) of the Act: Common Shares
Securities registered pursuant to None
Section 12(g) of the Act: (Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days: Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein and will not be contained, to the best
of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. (X)
The aggregate market value of the 2,813,654 shares of the Issuer's Common Stock
held by nonaffiliates, as of March 22, 1999 was $26,729,713 (US).
The number of shares of Common Stock of the Registrant, without par value,
outstanding as of March 22, 1999 was 5,876,398.
Documents Incorporated By Reference:
Portions of the Annual Report to Shareholders and the Proxy Statement for the
1999 Annual Meeting of Shareholders are incorporated into Parts II and III.
Exhibit Index on Page 42 Page 1 of 49
Exchange Rate Information
The Company's accounts and financial statements are maintained in U.S. Dollars.
In this Report all dollar amounts are expressed in U.S. Dollars except where
otherwise indicated.
The following table sets forth, for each period indicated, the average exchange
rates for U.S. Dollars expressed in Canadian Dollars on the last day of each
month during such period, the high and the low exchange rate during that period
and the exchange rate at the end of such period, based upon the noon buying rate
in New York City for cable transfers in foreign currencies, as certified for
customs purposes by the Federal Reserve Bank of New York (the "Noon Buying
Rate").
Foreign Exchange Rates
U.S. to Canadian Dollars
For The Years Ended December 31,
1994 1995 1996 1997 1998
Average .7322 .7287 .7339 .7222 .6745
Period End .7129 .7325 .7301 .6995 .6532
High .7642 .7465 .7472 .7351 .7061
Low .7097 .7099 .7270 .6938 .6376
Accounting Principles
The financial information contained in this document is stated in U.S. Dollars
and is expressed in accordance with Canadian Generally Accepted Accounting
Principles unless otherwise stated.
GORAN CAPITAL INC.
ANNUAL REPORT ON FORM 10-K
December 31, 1998
PART I Page
ITEM 1. Business .................................................. 4
Forward Looking Statements - Safe Harbor Provisions....... 33
ITEM 2. Properties................................................ 38
ITEM 3. Legal Proceedings......................................... 39
ITEM 4. Submission of Matters to a Vote of Security Holders....... 39
PART II
ITEM 5. Market For Registrant's Common Equity And
Related Shareholder Matters............................... 39
ITEM 6. Selected Consolidated Financial Data...................... 40
ITEM 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations....................... 41
ITEM 8. Financial Statements and Supplementary Data............... 41
ITEM 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure....................... 41
PART III
ITEM 10. Directors and Executive Officers of the Registrant........ 41
ITEM 11. Executive Compensation.................................... 41
ITEM 12. Security Ownership of Certain Beneficial
Owners and Management..................................... 41
ITEM 13. Certain Relationships and Related Transactions............ 41
PART IV
ITEM 14. Exhibits, Financial Statement Schedules, and
Reports Form 8-K.......................................... 42
SIGNATURES .......................................................... 49
ITEM 1 - BUSINESS
(figures stated in U.S. dollars)
General
Goran Capital Inc. ("Goran" or the "Company") is a Canadian federally
incorporated holding company principally engaged in the business of underwriting
property and casualty insurance through its insurance subsidiaries Pafco General
Insurance Company ("Pafco"), Superior Insurance Company ("Superior") and IGF
Insurance Company ("IGF"), which maintain their headquarters in Indianapolis,
Indiana, Atlanta, Georgia and Des Moines, Iowa, respectively. Goran owns
approximately 67% of a U.S. holding company, Symons International Group, Inc.
("SIG"). SIG owns IGF and GGS Management Holdings, Inc. ("GGS Holdings") and GGS
Management, Inc. ("GGS") which are the holding company and management company
for Pafco and Superior. Goran sold 33% of SIG in an Initial Public Offering in
November, 1996. The Company's other subsidiaries include Granite Reinsurance
Company Ltd. ("Granite Re"), Granite Insurance Company ("Granite"), a Canadian
federally licensed insurance company and Symons International Group, Inc. -
Florida ("SIGF"), a surplus lines underwriter located in Florida. In 1997, the
Company announced its intention to discontinue the operations of SIGF with a
sale of such operations completed effective January 1, 1999.
Granite Re is a specialized reinsurance company that underwrites niche
products such as nonstandard automobile, crop, property casualty reinsurance and
offers (on a non-risk bearing, fee basis), rent-a-captive facilities for
Bermudian, Canadian and U.S. reinsurance companies.
Through a rent-a-captive program, Granite Re offers the use of its
capital and its underwriting facilities to write specific programs on behalf of
its clients, including certain programs ceded from IGF and Pafco. Granite Re
alleviates the need for its clients to establish their own insurance company and
also offers this facility in an offshore environment.
Granite sold its book of business in January 1990 to an affiliate which
subsequently sold to third parties in June 1990. Granite currently has
approximately 40 outstanding claims and maintains an investment portfolio
sufficient to support those claim liabilities which will likely be settled
between now and the year 2000.
Goran Capital Inc., a specialty property and casualty insurer,
underwrites and markets nonstandard private passenger automobile insurance and
crop insurance. Through its Subsidiaries, the Company writes business in the
United States exclusively through independent agencies and seeks to distinguish
itself by offering high quality, technology based services for its agents and
policyholders. Based on the Company's Gross Premiums Written in 1998, the
Company believes that it is the twelfth largest underwriter of nonstandard
automobile insurance in the United States. Based on premium information compiled
in 1997 by the NCIS, the Company believes that IGF is the fourth largest
underwriter of crop insurance in the United States.
Nonstandard Automobile Insurance
Industry Background
The Company, through its Subsidiaries, Pafco and Superior, is engaged
in the writing of insurance coverage on automobile physical damage and liability
policies for "nonstandard risks." The nonstandard market accounted for
approximately 19% of total private passenger automobile insurance premiums
written in 1997. According to statistical information derived from insurer
annual statements compiled by A.M. Best, the nonstandard automobile market
accounted for $22 billion in annual premium volume for 1997.
Strategy
The Company has multiple strategies with respect to its nonstandard
automobile insurance operations, including:
o The Company seeks to achieve profitability through a
combination of internal growth and the acquisition of other
insurers and blocks of business. The Company regularly
evaluates acquisition opportunities.
4
o The Company will seek to expand the multi-tiered marketing
approach currently employed in certain states in order to
offer to its independent agency network a broader range of
products with different premium and commission structures.
o The Company is committed to the use of integrated technologies
which permit it to rate, issue, bill and service policies in
an efficient and cost effective manner.
o The Company competes primarily on the basis of underwriting
criteria and service to agents and insureds and generally does
not match price decreases implemented by competitors which are
directed towards obtaining market share.
o The Company encourages agencies to place a large share of
their profitable business with its subsidiaries by offering,
in addition to fixed commissions, a contingent commission
based on a combination of volume and profitability.
o The Company responds to claims in a manner designed to reduce
the costs of claims settlements by reducing the number of
pending claims and uses computer databases to verify repair
and vehicle replacement costs and to increase subrogation and
salvage recoveries.
Products
The Company offers both liability and physical damage coverage in the
insurance marketplace, with policies having terms of three to twelve months,
with the majority of policies having a term of six months. Most nonstandard
automobile insurance policyholders choose the basic limits of liability coverage
which, though varying from state to state, generally are $25,000 per person and
$50,000 per accident for bodily injury and in the range of $10,000 to $20,000
for property damage.
The Company offers several different policies which are directed toward
different classes of risk within the nonstandard market. The Superior Choice
policy covers insureds whose prior driving record, insurability and other
relevant characteristics indicate a lower risk profile than other risks in the
nonstandard marketplace. The Superior Standard policy is intended for risks
which do not qualify for Superior Choice but which nevertheless present a more
favorable risk profile than many other nonstandard risks. The Superior Specialty
policies cover risks which do not qualify for either the Superior Choice or the
Superior Standard. Pafco offers a product similar to the Superior product.
Marketing
The Company's nonstandard automobile insurance business is concentrated
in the states of Florida, California, Virginia, Indiana and Georgia and also
writes nonstandard automobile insurance in 16 additional states, with plans to
continue to expand selectively into additional states. The Company will select
states for expansion based on a number of criteria, including the size of the
nonstandard automobile insurance market, state-wide loss results, competition
and the regulatory climate. The following table sets forth the geographic
distribution of Gross Premiums Written for the Company for the periods indicated
including Gross Premiums Written for Superior prior to its acquisition by the
Company on April 30, 1996.
5
Goran Capital Inc. and Superior Insurance Company (Combined)
Year Ended December 31,
(in thousands)
State 1996 1997 1998
Arizona $ -- $ -- $6,228
Arkansas 2,004 1,539 1,383
California 25,131 59,819 48,181
Colorado 10,262 9,865 8,115
Florida 97,659 141,907 107,746
Georgia 7,398 11,858 21,575
Illinois 2,994 3,541 2,908
Indiana 16,599 17,227 18,735
Iowa 5,818 7,079 6,951
Kentucky 11,065 9,538 8,108
Mississippi 2,250 2,830 5,931
Missouri 13,423 9,705 8,669
Nebraska 5,390 6,613 6,803
Nevada -- 4,273 8,849
Ohio 3,643 3,731 2,106
Oklahoma 2,559 3,418 3,803
Oregon -- 2,302 6,390
Tennessee (2) -- 1,443
Texas 10,122 7,192 7,520
Virginia 14,733 21,446 22,288
Washington 106 32 5
------- ------- -------
Total $231,154 $323,915 $303,737
======= ======= =======
The Company markets its nonstandard products exclusively through
approximately 6,000 independent agencies and focuses its marketing efforts in
rural areas and the peripheral areas of metropolitan centers. As part of its
strategy, management is continuing its efforts to establish the Company as a low
cost provider of nonstandard automobile insurance while maintaining a commitment
to provide quality service to both agents and insureds. This element of the
Company's strategy is being accomplished primarily through the automation of
certain marketing, underwriting and administrative functions. In order to
maintain and enhance its relationship with its agency base, the Company has
several territorial managers, each of whom resides in a specific marketing
region and has access to the technology and software necessary to provide
marketing, rating and administrative support to the agencies in his or her
region.
The Company attempts to foster strong service relationships with its
agencies and customers. The Company is currently completing its development of
computer software that will provide on-line communication with its agency force.
In addition, to delivering prompt service while ensuring consistent
underwriting, the Company offers rating software to its agents in some states
which permits them to evaluate risks in their offices. The agent has the
authority to sell and bind insurance coverages in accordance with procedures
established by the Company, which is a common practice in the nonstandard
automobile insurance business. The Company reviews all coverages bound by the
agents promptly and generally accepts all coverages which fall within its stated
underwriting criteria. In most jurisdictions, the Company has the right within a
specified time period to cancel any policy even if the risk falls within its
underwriting criteria. See "Business -- Nonstandard Automobile Insurance --
Underwriting."
6
The Company compensates its agents by paying a commission based on a
percentage of premiums produced. The Company also offers its agents a contingent
commission based on volume and profitability, thereby encouraging the agents to
enhance the placement of profitable business with the Company.
The Company believes that the combination of Pafco with Superior and
its two Florida-domiciled insurance subsidiaries allows the Company the
flexibility to engage in multi-tiered marketing efforts in which specialized
automobile insurance products are directed toward specific segments of the
market. Since certain state insurance laws prohibit a single insurer from
offering similar products with different commission structures or, in some
cases, premium rates, it is necessary to have multiple licenses in certain
states in order to obtain the benefits of market segmentation. The Company is
currently offering multi-tiered products in its major states. The Company
intends to continue the expansion of the marketing of its multi-tiered products
into other states and to obtain multiple licenses for its subsidiaries in these
states to permit maximum flexibility in designing commission structures.
Underwriting
The Company underwrites its nonstandard automobile business with the
goal of achieving adequate pricing. The Company seeks to classify risks into
narrowly defined segments through the utilization of all available underwriting
criteria. The Company maintains an extensive, proprietary database which
contains statistical records with respect to its insureds on driving and repair
experience by location, class of driver and type of automobile. Management
believes this database gives the Company the ability to be more precise in the
underwriting and pricing of its products. Further, the Company uses motor
vehicle accident reporting agencies to verify accident history information
included in applications.
The Company utilizes many factors in determining its rates. Some of the
characteristics used are type, age and location of the vehicle, number of
vehicles per policyholder, number and type of convictions or accidents, limits
of liability, deductibles, and, where allowed by law, age, sex and marital
status of the insured. The rate approval process varies from state to state;
some states, such as Indiana, Colorado, Kentucky and Missouri, allow filing and
use of rates, while others, such as Florida, Arkansas and California, require
approval of the insurance department prior to the use of the rates.
The Company has integrated its automated underwriting process with the
functions performed by its agency force. For example, the Company has a rating
software package for use by agents in some states. In many instances, this
software package, combined with agent access to the automated retrieval of motor
vehicle reports, ensures accurate underwriting and pricing at the point of sale.
The Company believes the automated rating and underwriting system provides a
significant competitive advantage because it (i) improves efficiencies for the
agent and the Company, thereby reinforcing the agents' commitment to the
Company, (ii) makes more accurate and consistent underwriting decisions possible
and (iii) can be changed easily to reflect new rates and underwriting
guidelines.
Underwriting results of insurance companies are frequently measured by
their Combined Ratios. However, investment income, federal income taxes and
other non-underwriting income or expense are not reflected in the Combined
Ratio. The profitability of property and casualty insurance companies depends on
income from underwriting, investment and service operations. Underwriting
results are generally considered profitable when the Combined Ratio is under
100% and unprofitable when the Combined Ratio is over 100%. Refer to
"Management's Discussion and Analysis of Results of Operations and Financial
Condition" for a further discussion on the Combined Ratio.
In an effort to maintain and improve underwriting profits, the
territorial managers regularly monitor loss ratios of the agencies in their
regions and meet periodically with the agencies in order to address any adverse
trends in Loss Ratios.
Claims
The Company's nonstandard automobile claims department handles claims
on a regional basis from its Indianapolis, Indiana; Atlanta, Georgia; Tampa,
Florida and Anaheim, California locations. Management believes that the
employment of salaried claims personnel, as opposed to independent adjusters,
results in reduced ultimate loss payments, lower LAE and improved customer
service. The Company generally retains independent appraisers and adjusters on
an as needed basis for estimation of physical damage claims and limited elements
of investigation. The Company uses the Audapoint, Audatex and Certified
7
Collateral Corporation computer programs to verify, through a central database,
the cost to repair a vehicle and to eliminate duplicate or "overlap" costs from
body shops. Autotrak, which is a national database of vehicles, allows the
Company to locate vehicles nearly identical in model, color and mileage to the
vehicle damaged in an accident, thereby reducing the frequency of disagreements
with claimants as to the replacement value of damaged vehicles.
Claims settlement authority levels are established for each adjuster or
manager based on the employee's ability and level of experience. Upon receipt,
each claim is reviewed and assigned to an adjuster based on the type and
severity of the claim. All claim-related litigation is monitored by a home
office supervisor or litigation manager. The claims policy of the Company
emphasizes prompt and fair settlement of meritorious claims, appropriate
reserving for claims and controlling claims adjustment expenses.
Reinsurance
The Company follows the customary industry practice of reinsuring a
portion of its risks and paying for that protection based upon premiums received
on all policies subject to such Reinsurance. Insurance is ceded principally to
reduce the Company's exposure on large individual risks and to provide
protection against large losses, including catastrophic losses. Although
Reinsurance does not legally discharge the ceding insurer from its primary
obligation to pay the full amount of losses incurred under policies reinsured,
it does render the reinsurer liable to the insurer to the extent provided by the
terms of the Reinsurance treaty. As part of its internal procedures, the Company
evaluates the financial condition of each prospective reinsurer before it cedes
business to that carrier. Based on the Company's review of its reinsurers'
financial health and reputation in the insurance marketplace, the Company
believes its reinsurers are financially sound and that they therefore can meet
their obligations to the Company under the terms of the Reinsurance treaties.
Effective January 1, 1997, Pafco and Superior ceded 20% of its
nonstandard automobile business written during the first three quarters of 1997
and 25% during the fourth quarter in accordance with a quota share Reinsurance
agreement. 90% of the cession was with Vesta Fire Insurance Company (rated "A"
by A.M. Best) and 10% was with Granite Re. Effective January 1, 1998, the
cession rate was changed to 10%. These treaties were commuted effective October
1, 1998, thereby completely and fully discharging Vesta and Granite Re of any
obligations relative to this business for payments of $7,698,977 and $1,123,294,
respectively.
In 1998, 1997 and 1996, Pafco and Superior maintained casualty excess
of loss reinsurance on its nonstandard automobile insurance business covering
100% of losses on an individual occurrence basis in excess of $200,000 up to a
maximum of $5,000,000.
Amounts recoverable from reinsurers relating to nonstandard automobile
operations as of December 31, 1998 follows:
Reinsurance
A.M. Best Recoverable as of
Reinsurers Rating December 31, 1998 (1)
(in thousands)
Everest Reinsurance Company A+ (2) $315
Q.B.I. Insurance (UK) Ltd. Not Rated $249
Constitution Reinsurance Corporation A+ $251
Federal Emergency Management Administration Not Rated $463
(1) Only recoverable greater than $200,000 are shown. Total nonstandard
automobile reinsurance recoverables as of December 31, 1998 were
approximately $2,292,000.
(2) An A.M. Best Rating of "A+" is the second highest of 15 ratings.
8
On April 29, 1996, Pafco retroactively ceded all of its commercial
business relating to 1995 and previous years to Granite Re, with an effective
date of January 1, 1996. Approximately $3,519,000 and $2,380,000 of loss and
loss adjustment expense reserves and unearned premium reserves, respectively,
were ceded and no gain or loss recognized. Effective January 1, 1998, Granite Re
ceded the 1995 and prior commercial business back to Pafco. Approximately
$1,803,000 in loss and loss adjustment expense reserves were ceded back to Pafco
and no gain or loss was recognized.
On April 29, 1996, Pafco also entered into a 100% quota share
reinsurance agreement with Granite Re, whereby all of Pafco's commercial
business from 1996 and thereafter was ceded effective January 1, 1996.
Neither Pafco nor Superior has any facultative Reinsurance with respect
to its nonstandard automobile insurance business.
Competition
The Company competes with both large national and smaller regional
companies in each state in which it operates. The Company's competitors include
other companies which, like the Company, serve the agency market, as well as
companies which sell insurance directly to customers. Direct writers may have
certain competitive advantages over agency writers, including increased name
recognition, increased loyalty of their customer base and, potentially, reduced
acquisition costs. The Company's primary competitors are Progressive Casualty
Insurance Company, Guaranty National Insurance Company, Integon Corporation
Group, Deerbrook Insurance Company (a member of the Allstate Insurance Group)
and the companies of the American Financial Group. Generally, these competitors
are larger and have greater financial resources than the Company. The
nonstandard automobile insurance business is price sensitive and certain
competitors of the Company have, from time to time, decreased their prices in an
apparent attempt to gain market share. Although the Company's pricing is
inevitably influenced to some degree by that of its competitors, management of
the Company believes that it is generally not in the Company's best interest to
match such price decreases, choosing instead to compete on the basis of
underwriting criteria and superior service to its agents and insureds.
Crop Insurance
Industry Background
The two principal components of the Company's crop insurance business
are MPCI and private named peril, primarily crop hail insurance. Crop insurance
is purchased by farmers to reduce the risk of crop loss from adverse weather and
other uncontrollable weather events. Farms are subject to drought, floods and
other natural disasters that can cause widespread crop losses and, in severe
cases, force farmers out of business. Because many farmers rely on credit to
finance their purchases of such agricultural inputs as seed, fertilizer,
machinery and fuel, the loss of a crop to a natural disaster can reduce their
ability to repay these loans and to find sources of funding for the following
year's operating expenses.
MPCI was initiated by the federal government in the 1930s to help
protect farmers against loss of their crops as a result of drought, floods and
other natural disasters. In addition to MPCI, farmers whose crops are lost as a
result of natural disasters have, in the past, occasionally been supported by
the federal government in the form of ad hoc relief bills providing low interest
agricultural loans and direct payments. Prior to 1980, MPCI was available only
on major crops in major producing areas. In 1980, Congress expanded the scope
and coverage of the MPCI program. In addition, the delivery system for MPCI was
expanded to permit private insurance companies and licensed agents and brokers
to sell MPCI policies and the FCIC was authorized to reimburse participating
companies for their administrative expenses and to provide federal Reinsurance
for the majority of the risk assumed by such private companies.
Although expansion of the federal crop insurance program in 1980 was
expected to make crop insurance the farmer's primary risk management tool,
participation in the MPCI program was only 32% of eligible acreage in the 1993
crop year. Due in part to low participation in the MPCI program, Congress
provided an average of $1.5 billion per year in ad hoc disaster payments over
the six years prior to 1994. In view of the combination of low participation
rates in the MPCI program and large federal payments on both crop insurance
(with an average loss ratio of 147%) and ad hoc disaster payments since 1980,
Congress has, since 1990, considered major reform of its crop insurance and
disaster assistance policies. The 1994 Reform Act was enacted in order to
increase participation in the MPCI program and eliminate the need for ad hoc
federal disaster relief payments to farmers.
9
The 1994 Reform Act required farmers for the first time to purchase at
least CAT Coverage (i.e., the minimum available level of MPCI providing coverage
for 50% of farmers' historic yield at 60% of the price per unit for such crop
set by the FCIC) in order to be eligible for other federally sponsored farm
benefits, including, but not limited to, low interest loans and crop price
supports. The 1994 Reform Act also authorized the marketing and selling of CAT
Coverage by the local USDA offices which has since been eliminated by the
Federal Agriculture Improvement and Reform Act of 1996 ("the 1996 Reform Act").
The 1996 Reform Act was signed into law by President Clinton in April 1996 and
also eliminated the linkage between CAT Coverage and qualification for certain
federal farm program benefits.
In June 1998, President Clinton signed the Agricultural Research,
Extension and Education Reform Act of 1998 into law ("Ag Research Act"). That
Act contained a number of changes in the crop insurance program, the largest of
which was the conversion of funding for the MPCI Expense Reimbursement subsidy
that had previously been 50% permanent (mandatory spending) under the federal
budget and 50% discretionary (dependent on annual Congressional appropriations)
to 100% permanent/mandatory funding. Thus, the program and the companies are no
longer subject to the annual budget battles in Washington with respect to
administrative funding. This is a major positive change in the stability of the
program.
Other changes included a reduction in the rate of MPCI Expense
Reimbursement from the general 27% in the 1998 reinsurance year to 24.5% in
1999. The reinsurance terms of the 1998 (and now 1999 and 2000) SRA were also
frozen for subsequent reinsurance years thereby providing another aspect of
stability to the program. Two other changes were made related to the
Catastrophic (CAT) level of insurance under the MPCI program. The law
significantly changed the administrative fee structure attached to such policies
(farmers pay no premium only administrative fees for CAT) - the previous $50 per
crop per county (with $200/county, $600 overall limit) was changed to the higher
of $50 or 10% of the imputed premium for such policies plus $10 and no part of
the fees would be retained by the participating reinsured company any longer
(previously up to $100 per county could be retained). Starting in 1999, all fees
would go directly to the Federal Government rather than the Company. In
addition, the CAT LAE Reimbursement was lowered from approximately 13.7% of
imputed premium in 1998 to 11% of premium in 1999.
In October 1998, President Clinton signed the Fiscal Year 1999 Omnibus
Consolidated and Emergency Supplemental Appropriations Act into law. This
provided a total of $2.375 billion in disaster assistance to help producers
weather 1998 and multi-year disasters. Any producer receiving a payment under
that program who did not have crop insurance in 1998 will be required to secure
coverage (CAT or MPCI Buy-up) for the 1999 and 2000 crop years. In addition, on
December 12, 1998, President Clinton and the USDA announced that $400 million of
the $2.375 billion would be set aside as a 1999 crop year crop insurance premium
incentive to encourage producers to secure additional coverage on their 1999
crops. In addition, on January 8, 1999, the FCIC announced that it would accept
additional applications for insurance or accept changes in insurance coverage
from producers for their 1999 crops (2000 crop of citrus) in cases where sales
closing dates had already passed and it would extend upcoming spring application
periods across the country to allow producers additional time to take advantage
of the premium incentive. Additional options for allowing the reinsured
companies to manage the risk associated with these actions were also provided.
The Company expects to more than offset these reimbursement reductions
through growth in fee income from non-federally subsidized programs such as
AgPI(R) and GEO Ag Plus(R) initiated in 1998. The Company has also been working
to reduce its costs. While the Company fully believes it can more than offset
these reductions, there is no assurance the Company will be successful in its
efforts or that further reductions in federal reimbursements will not continue
to occur.
In addition to MPCI, the Company offers stand alone crop hail
insurance, which insures growing crops against damage resulting from hail storms
and which involves no federal participation, as well as its proprietary product
which combines the application and underwriting process for MPCI and hail
coverages. This product tends to produce less volatile loss ratios than the
stand alone product since the combined product generally insures a greater
number of acres, thereby spreading the risk of damage over a larger insured
area. Approximately half of the Company's hail policies are written in
combination with MPCI. Although both crop hail and MPCI provide coverage against
hail damage, under crop hail coverages farmers can receive payments for hail
damage which would not be severe enough to require a payment under an MPCI
policy. The Company believes that offering crop hail insurance enables it to
sell more MPCI policies than it otherwise would.
10
Strategy
The Company has multiple strategies for its crop insurance operations,
including the following:
o The Company seeks to enhance underwriting profits and reduce the
volatility of its crop insurance business through geographic
diversification and the appropriate allocation of risks among the
federal reinsurance pools and the effective use of federal and
third-party catastrophic Reinsurance arrangements.
o The Company also limits the risks associated with crop insurance
through selective underwriting of crop risks based on its
historical loss experience data base.
o The Company continues to develop and maintain a proprietary
knowledge-based underwriting system which utilizes a database of
Company-specific underwriting rules.
o The Company has further strengthened its independent agency network
by using technology to provide fast, efficient service to its
agencies and providing application documentation designed for
simplicity and convenience.
o Unlike many of its competitors, the Company employs approximately
135 full-time claims adjusters, most of whom are agronomy-trained,
to reduce the cost of losses experienced by IGF and to provide
opportunity to produce fee based income.
o The Company stops selling its crop hail policies after certain
selected dates to prevent farmers from adversely selecting against
IGF when a storm is forecast or hail damage has already occurred.
o The Company continues to explore growth opportunities and product
diversification through new specialty coverages, including
Agriculture Production Interruption (AgPI), Agriculture Revenue
Interruption (AgRI) and specific named peril crop insurance.
Further, IGF has recently released new products such as timber,
fresh market vegetables and environmental ("green") coverages.
o The Company has recently launched a new fee based service for
farmers called Geo AgPLUS(TM).
o The Company continues to explore new opportunities in
administrative efficiencies and product underwriting made possible
by advances in Precision Farming software, Global Positioning
System (GPS) software and Geographical Information System (GIS)
technology, all of which continue to be adopted by insureds in
their farming practices.
Products
MPCI is a federally subsidized program which is designed to provide
participating farmers who suffer insured crop damage with funds needed to
continue operating and plant crops for the next growing season. All of the
material terms of the MPCI program and of the participation of private insurers,
such as the Company, in the program are set by the FCIC under applicable law.
MPCI provides coverage for insured crops against substantially all natural
perils. Purchasing an MPCI policy permits a farmer to insure against the risk
that his crop yield for any growing season will be less than 50% to 75% (as
selected by the farmer at the time of policy application or renewal) of his
historic crop yield. If a farmer's crop yield for the year is greater than the
yield coverage he selected, no payment is made to the farmer under the MPCI
program. However, if a farmer's crop yield for the year is less than the yield
coverage selected, MPCI entitles the farmer to a payment equal to the yield
shortfall multiplied by 60% to 100% of the price for such crop (as selected by
the farmer at the time of policy application or renewal) for that season as set
by the FCIC.
In order to encourage farmers to participate in the MPCI program and
thereby reduce dependence on traditional disaster relief measures, the 1996
Reform Act established CAT Coverage as a new minimum level of MPCI coverage,
which farmers may purchase upon payment of a fixed administrative fee of $60 per
policy instead of any premium. CAT Coverage insures 50% of historic crop yield
at 55% of the FCIC-set crop price for the applicable commodities standard unit
11
of measure, i.e., bushel, pound, etc. CAT Coverage can be obtained from private
insurers such as the Company.
In addition to CAT Coverage, MPCI policies that provide a greater level of
protection than the CAT Coverage level are also offered ("Buy-up Coverage").
Most farmers purchasing MPCI have historically purchased at Buy-up Coverage
levels, with the most frequently sold policy providing coverage for 65% of
historic crop yield at 100% of the FCIC-set crop price per bushel. Buy-up
Coverages require payment of a premium in an amount determined by a formula set
by the FCIC. Buy-up Coverage can only be purchased from private insurers. The
Company focuses its marketing efforts on Buy-up Coverages, which have higher
premiums and which the Company believes will continue to appeal to farmers who
desire, or whose lenders encourage or require production and revenue protection.
The number of MPCI Buy-up policies written has historically tended to
increase after a year in which a major natural disaster adversely affecting
crops occurs and to decrease following a year in which favorable weather
conditions prevail.
The Company, like other private insurers participating in the MPCI
program, generates revenues from the MPCI program in two ways. First, it
markets, issues and administers policies, for which it receives administrative
fees; and second, it participates in a profit-sharing arrangement in which it
receives from the government a portion of the aggregate profit, or pays a
portion of the aggregate loss, in respect of the business it writes.
The Company's share of profit or loss on the MPCI business it writes is
determined under a complex profit sharing formula established by the FCIC. Under
this formula, the primary factors that determine the Company's MPCI profit or
loss share are (i) the gross premiums the Company is credited with having
written, (ii) the amount of such credited premiums retained by the Company after
ceding premiums to certain federal reinsurance pools and (iii) the loss
experience of the Company's insureds.
The Company also offers Crop Revenue Coverage ("CRC"). In contrast to
standard MPCI coverage, which features a yield guarantee or coverage for the
loss of production, CRC provides the insured with a guaranteed revenue stream by
combining both yield and price variability protection. CRC protects against a
grower's loss of revenue resulting from fluctuating crop prices and/or low
yields by providing coverage when any combination of crop yield and price
results in revenue that is less than the revenue guarantee provided by the
policy. CRC was approved by the FCIC as a pilot program for revenue insurance
coverage plans for the 1996 Crop Year and since then it has been expanded
virtually nationwide on corn, soybeans and wheat and to additional crops in new
pilot areas. Currently, CRC represents approximately 20% of all of the Company's
MPCI policies.
Revenue insurance coverage plans such as CRC are largely the result of
the 1996 Reform Act, which directed the FCIC to develop a crop insurance program
providing coverage against loss of gross income as a result of reduced yield
and/or price. CRC was developed by a private insurance company other than the
Company under the Federal Crop Insurance Act, which authorizes private companies
to design alternative coverage plans and to submit them for review, approval and
endorsement by the FCIC. As a result, although CRC is administered and reinsured
by the FCIC and risks are allocated to the federal reinsurance pools, CRC
remains partially influenced by the private sector, particularly with respect to
changes in its rating structure.
CRC plans to use the policy terms and conditions of the Actual
Production History ("APH") plan of MPCI as the basic provisions for coverage.
The APH provides the yield component by utilizing the insured's historic yield
records. The CRC revenue guarantee is the producer's approved APH times the
coverage level, times the higher of the spring futures price or harvest futures
price (in each case, for post-harvest delivery) of the insured crop for each
unit of farmland. The coverage levels and exclusions in a CRC policy are similar
to those in a standard MPCI policy. For the 1998 Crop Year, the Company received
from the FCIC an expense reimbursement payment equal to 23.5% of Gross Premiums
Written in respect of each CRC policy it writes. The MPCI Buy-up Expense
Reimbursement Payment is currently established by legislation. The expense
reimbursement payment on CRC was 31% in 1996, 29% in 1997, 23.25% in 1998 and
21.1% in 1999.
12
CRC protects revenues by extending crop insurance protection based on
APH to include price as well as yield variability. Unlike MPCI, in which the
crop price component of the coverage is set by the FCIC prior to the growing
season and generally does not reflect actual crop prices, CRC uses the commodity
futures market as the basis for its pricing component. Pricing occurs twice in
the CRC plan. The spring futures price is used to establish the initial policy
revenue guarantee and premium, and the harvest futures price is used to
establish the crop value to count against the revenue guarantee and to recompute
the revenue guarantee (and resulting indemnity payments) when the harvest price
is higher than the spring price.
In addition to MPCI (including CRC), the Company offers stand alone
crop hail insurance, which insures growing crops against damage resulting from
hail storms and which involves no federal participation, as well as its
proprietary HAILPLUS(R) product which combines the application and underwriting
process for MPCI and hail coverages. The HAILPLUS(R) product tends to produce
less volatile loss ratios than the stand alone product since the combined
product generally insures a greater number of acres, thereby spreading the risk
of damage over a larger insured area. Approximately 50% of IGF's hail policies
are written in combination with MPCI. Although both crop hail and MPCI provide
insurance against hail damage, under crop hail coverages farmers can receive
payments for hail damage which would not be severe enough to require a payment
under an MPCI policy. The Company believes that offering crop hail insurance
enables it to sell more MPCI policies than it otherwise would.
In addition to crop hail insurance, the Company also sells a small
volume of insurance against crop damage from other specific named perils. These
products cover specific crops, including hybrid seed corn, cranberries, cotton,
sugar cane, sugar beets, citrus, tomatoes and onions and are generally written
on terms that are specific to the kind of crops and farming practices involved
and the amount of actuarial data available. The Company plans to seek potential
growth opportunities in this niche market by developing basic policies on a
diverse number of named crops grown in a variety of geographic areas and to
offer these polices primarily to large producers through certain select agents.
The Company's experienced product development team will develop the underwriting
criteria and actuarial rates for the named peril coverages. As with the
Company's other crop insurance products, loss adjustment procedures for named
peril policies are handled by full-time professional claims adjusters who have
specific agronomy training with respect to the crop and farming practice
involved in the coverage.
AgPI(R) protects agriculture based businesses that depend upon a steady
flow of a crop (or crops) to stay in business. This protection is available to
those involved in agribusiness who are a step beyond the farm gate, such as
elevator operators, custom harvesters, cotton gins and businesses that are
dependent upon a single supplier of products, (i.e., popping corn).
These businesses have been able to buy normal business interruption
insurance to protect against on-site calamities such as a fire, wind storm or
tornado. But until now, they have been totally unprotected by the insurance
industry if they encounter a production shortfall in their trade area which
limited their ability to bring raw materials to their operation. AgPI(R) allows
the agricultural business to protect against a disruption in the flow of the raw
materials it depends on. AgPI(R) was formally introduced at the beginning of the
1998 crop year.
Geo AgPLUS(TM) provides to the farmer mapping and soil sampling
services combined with fertility maps and the software that is necessary to run
their precision farming program. Grid soil sampling, when combined with
precision farming technology, allows the farmer to apply just the right amount
of fertilization, thus balancing the soil for a maximum crop yield. Precision
farming increases the yield to the farmer, reduces the cost of unnecessary
fertilization and enhances the environment by reducing overflows of
fertilization into the ecosystem. Geo AgPLUS(TM) is an IGF Insurance Company
trademarked precision farming division that is now marketing its fee based
products to the farmer.
13
Gross Premiums
Each year the FCIC sets the formulas for determining premiums for
different levels of Buy-up Coverage. Premiums are based on the type of crop,
acreage planted, farm location, price per bushel for the insured crop as set by
the FCIC for that year and other factors. The federal government will generally
subsidize a portion of the total premium set by the FCIC and require farmers to
pay the remainder. Cash premiums are received by the Company from farmers only
after the end of a growing season and are then promptly remitted to the federal
government. Although applicable federal subsidies change from year to year, such
subsidies will range up to approximately 40% of the Buy-up Coverage premium
depending on the crop insured and the level of Buy-up Coverage purchased, if
any. Federal premium subsidies are recorded on the Company's behalf by the
government. For purposes of the profit sharing formula, the Company is credited
with having written the full amount of premiums paid by farmers for Buy-up
Coverages, plus the amount of any related federal premium subsidies (such total
amount, its "MPCI Premium").
As previously noted, farmers pay an administrative fee of $60 per
policy but are not required to pay any premium for CAT Coverage. However, for
purposes of the profit sharing formula, the Company is credited with an imputed
premium (its "MPCI Imputed Premium") for all CAT Coverages it sells. The amount
of such MPCI Imputed Premium credited is determined by formula. In general, such
MPCI Imputed Premium will be less than 50% of the premium that would be payable
for a Buy-up Coverage policy that insured 65% of historic crop yield at 100% of
the FCIC-set crop price per standard unit of measure for the commodity,
historically the most frequently sold Buy-up Coverage. For income statement
purposes under GAAP, the Company's Gross Premiums Written for MPCI consist only
of its MPCI Premiums and do not include MPCI Imputed Premiums.
Reinsurance Pools
Under the MPCI program, the Company must allocate its MPCI Premium or
MPCI Imputed Premium in respect of a farm to one of seven federal reinsurance
pools, at its discretion. These pools provide private insurers with different
levels of Reinsurance protection from the FCIC on the business they have
written. The seven pools have three fundamental designations; Commercial,
Developmental and Assigned Risk. For insured farms allocated to the "Commercial
Pool," the Company, at its election, generally retains 50% to 100% of the risk
and the FCIC assumes 0% - 50% of the risk; for those allocated to the
"Developmental Pool," the Company generally retains 35% of the risk and the FCIC
assumes 65%; and for those allocated to the "Assigned Risk Pool," the Company
retains 20% of the risk and the FCIC assumes 80%. The MPCI Retention is
protected by private third-party stop-loss treaties.
Although the Company in general must agree to insure any eligible farm,
it is not restricted in its decision to allocate a risk to any of the seven
pools, subject to a minimum aggregate retention of 35% of its MPCI Premiums and
MPCI Imputed Premiums written. The Company uses a sophisticated methodology
derived from a comprehensive historical data base to allocate MPCI risks to the
federal reinsurance pools in an effort to enhance the underwriting profits
realized from this business. The Company has crop yield history information with
respect to over 100,000 farms in the United States. Generally, farms or crops
which, based on historical experience, location and other factors, appear to
have a favorable net loss ratio and to be less likely to suffer an insured loss,
are placed in the Commercial Pool. Farms or crops which appear to be more likely
to suffer a loss are placed in the Developmental Pool or Assigned Risk Pool. The
Company has historically allocated the bulk of its insured risks to the
Commercial Pool.
The Company's share of profit or loss depends on the aggregate amount
of MPCI Premium and MPCI Imputed Premium on which the Company retains risk after
allocating farms to the foregoing pools (its "MPCI Retention"). As previously
described, the Company purchases Reinsurance from third parties other than the
FCIC to further reduce its MPCI loss exposure.
Loss Experience of Insureds
Under the MPCI program the Company pays losses to farmers through a
federally funded escrow account as they are incurred during the growing season.
The Company requests funding of the escrow account when a claim is settled and
the escrow account is funded by the federal government within three business
days. After a growing season ends, the aggregate loss experience of the
Company's insureds in each state for risks allocated to each of the seven
Reinsurance pools is determined. If, for all risks allocated to a particular
pool in a particular state, the Company's share of losses incurred is less than
its aggregate MPCI Retention, the Company shares in the gross amount of such
14
profit according to a schedule set by the FCIC Standard Reinsurance Agreement
(SRA). The profit and loss sharing percentages are different for risks allocated
to each of the seven Reinsurance pools and private insurers will receive or pay
the greatest percentage of profit or loss for risks allocated to the Commercial
Pool. The percentage split between private insurers and the federal government
of any profit or loss that emerges from an MPCI Retention is set by the FCIC's
SRA. The FCIC has extended the SRA for the 1999 reinsurance year to 2000.
MPCI Fees and Reimbursement Payments
The Company receives Buy-up Expense Reimbursement Payments from the
FCIC for writing and administering Buy-up Coverage policies. These payments
provide funds to compensate the Company for its expenses, including agents'
commissions and the costs of administering policies and adjusting claims. For
1996, 1997 and 1998, the maximum Buy-up Expense Reimbursement Payment was set at
31%, 29% and 27%, respectively, of the MPCI Premium. Historically, the FCIC has
paid the maximum MPCI Buy-up Expense Reimbursement Payment rate allowable under
law, although no assurance can be given that this practice will continue.
Although the 1994 Reform Act directs the FCIC to alter program procedures and
administrative requirements so that the administrative and operating costs of
private insurance companies participating in the MPCI program will be reduced in
an amount that corresponds to the reduction in the expense reimbursement rate,
there can be no assurance that the Company's actual costs will not exceed the
expense reimbursement rate. For the 1999 crop year, the Buy-up Expense
Reimbursement payment has been set at 24.5%.
Farmers are required to pay a fixed administrative fee of $60 per
policy in order to obtain CAT Coverage. This fee through 1998 was retained by
the Company (maximum of $100 per county) to defray the cost of administration
and policy acquisition. The Company also receives from the FCIC a separate CAT
LAE Reimbursement Payment equal to approximately 13.0% of MPCI Imputed Premiums
(11.0% for the 1999 crop year) in respect of each CAT Coverage policy it writes
and a small MPCI Excess LAE Reimbursement Payment. Beginning with the 1999 crop
year, the Company will no longer receive the CAT Coverage Fee. All such fees
will now go to the federal government.
In addition to premium revenues, the Company received the following
Federally funded fees and commissions from its crop insurance segment for the
periods indicated:
(in thousands) Year Ended December 31,
1996 1997 1998
CAT Coverage Fees (1) $1,181 $1,191 $2,346
Buy-up Expense Reimbursement Payments 24,971 24,788 37,982
CAT LAE Reimbursement Payments and MPCI Excess
LAE Reimbursement Payments 5,753 4,565 6,520
------ ------ ------
Total $31,905 $30,544 $46,848
====== ====== ======
(1) See "Management's Discussion and Analysis of Financial Condition and
Results of Operations of the Company" for a discussion of the accounting
treatment accorded to the crop insurance business.
15
Third-Party Reinsurance
In order to reduce the Company's potential loss exposure under the MPCI
program, the Company purchases stop loss Reinsurance from other private
reinsurers in addition to Reinsurance obtained from the FCIC. In addition, since
the FCIC and state regulatory authorities require IGF to limit its aggregate
writings of MPCI Premiums and MPCI Imputed Premiums to no more than 900% of
capital, and retain a net loss exposure of not in excess of 50% of capital, IGF
may also obtain Reinsurance from private reinsurers in order to permit it to
increase its premium writings. Such private Reinsurance would not eliminate the
Company's potential liability in the event a reinsurer was unable to pay or
losses exceeded the limits of the stop loss coverage. For crop hail insurance,
the Company had in effect quota share Reinsurance of 40% of business for 1996
and 1997 and 25% for 1998, although the reinsurer is only liable to participate
in losses of the Company up to a 150% pure loss ratio. The Company also has stop
loss treaties for its crop hail business which reinsure net losses in excess of
an 80% pure Loss Ratio to 130% at 95% coverage with IGF retaining the remaining
5%. With respect to its MPCI business, the Company has stop loss treaties which
reinsure 93.75% of the underwriting losses experienced by the Company to the
extent that aggregate losses of its insureds nationwide are in excess of 100% of
the Company's MPCI Retention up to 125% of MPCI Retention. The Company also has
an additional layer of MPCI stop loss Reinsurance which covers 95% of the
underwriting losses experienced by the Company to the extent that aggregate
losses of its insureds nationwide are in excess of 125% of MPCI Retention up to
160% of MPCI Retention. The Company maintains a 50% quota share reinsurance
treaty for its named peril product. For 1999, the Company plans to increase its
crop hail and AgPI quota share portion to 80% and add AgPI to its MPCI stop loss
coverage.
Based on a review of the reinsurers' financial health and reputation in
the insurance marketplace, the Company believes that the reinsurers for its crop
insurance business are financially sound and that they therefor can meet their
obligations to the Company under the terms of the Reinsurance treaties. Reserves
for uncollectible Reinsurance are provided as deemed necessary. The following
table provides information with respect to ceded premiums in excess of $250,000
on crop hail and named perils and for any affiliates.
16
Year Ended December 31, 1998 (1)
(in thousands, except footnotes)
A.M. Best Ceded
Reinsurers Rating Premiums
Continental Casualty Insurance Co. (CNA)(2) A $10,796
Muchener Ruckversicherungs-Gesellschaft Not Rated $2,532
New Cap Re Not Rated $1,056
Monde Re (3) Not Rated $2,844
Partner Reinsurance Company Ltd. Not Rated $832
R & V Versicherung AG Not Rated $1,451
Reinsurance Australia Corporation, Ltd. (REAC) (3) Not Rated $2,848
Swiss Reinsurance Company (4) A+ $384
- ---------------
(1) For the twelve months ended December 31, 1998, total ceded premiums were
$200,658.
(2) An A.M. Best rating of "A" is the third highest of 15 ratings.
(3) Monde Re is owned by REAC.
(4) An A.M. Best rating of "A+" is the second highest of 15 ratings.
As of December 31, 1998, IGF's Reinsurance recoverables aggregated
approximately $5,305 excluding recoverables from the FCIC and recoverables from
affiliates on nonstandard automobile business.
Marketing; Distribution Network
IGF markets its products to the owners and operators of farms in 43 states
through approximately 4,670 agents associated with approximately 2,007
independent insurance agencies, with its primary geographic concentration in the
states of Texas, North Dakota, Iowa, Minnesota, Illinois, California, Nebraska,
Mississippi, Arkansas and South Dakota. IGF is licensed in 30 states and markets
its products in additional states through a fronting agreement with a
third-party insurance company. IGF has a stable agency base and it experienced
negligible turnover in its agencies in 1998. Through its agencies, IGF targets
farmers with an acreage base of at least 1,000 acres. Such larger farms
typically have a lower risk exposure since they tend to utilize better farming
practices and to have noncontiguous acreage, thereby making it less likely that
the entire farm will be affected by a particular occurrence. Many farmers with
large farms tend to buy or rent acreage which is increasingly distant from the
central farm location. Accordingly, the likelihood of a major storm (wind, rain
or hail) or a freeze affecting all of a particular farmer's acreage decreases.
17
The following table presents MPCI and crop hail premiums written by IGF
by state for the periods indicated.
(in thousands)
Year Ended Year Ended
December 31, 1997 December 31, 199
State Crop Hail MPCI/CAT Total Crop Hail MPCI/CAT Other(1) Total
Alabama $144 $1,958 $2,102 $83 $2,714 $--- $2,797
Arkansas 652 7,455 8,107 1,460 11,141 --- 12,601
California 1,062 8,498 9,560 661 9,754 7,797 18,212
Colorado 1,309 3,322 4,631 1,626 3,024 7 4,657
Florida 19 5,730 5,749 6 1,994 --- 2,000
Illinois 655 14,023 14,678 2,409 20,407 151 22,967
Indiana 92 4,971 5,063 244 7,031 --- 7,275
Iowa 7,628 13,798 21,426 9,724 16,554 --- 26,278
Kansas 832 6,881 7,713 1,904 4,703 57 6,664
Louisiana 41 3,630 3,671 36 5,486 35 5,557
Minnesota 4,405 4,088 8,493 4,222 16,017 497 20,736
Mississippi 509 9,025 9,534 445 10,382 --- 10,827
Missouri 383 2,116 2,499 1,228 5,822 --- 7,050
Montana 2,879 2,122 5,001 4,280 5,338 --- 9,618
Nebraska 1,597 3,315 4,912 5,752 6,635 --- 12,387
North Dakota 787 3,363 4,150 10,131 20,423 254 30,808
Oklahoma 451 1,727 2,178 857 2,232 --- 3,089
South Dakota 932 1,575 2,507 5,320 6,017 --- 11,337
Texas 3,211 18,071 21,282 9,492 35,212 306 45,010
Wisconsin 407 1,887 2,294 269 3,219 288 3,776
All Other 10,354 3,791 14,145 16,049 13,247 211 29,507
------ ------- ------- ------ ------- ----- -------
Total $38,349 $121,346 $159,695 $76,198 $207,352 $9,603 $293,153
====== ======= ======= ====== ======= ===== =======
(1) Includes named peril and AgPI(R). There is a small amount of named peril
premiums included with crop hail in 1997. No AgPI(R) I policies were written in
1997.
18
The Company seeks to maintain and develop its agency relationships by
providing agencies with faster, more efficient service as well as marketing
support. IGF owns an IBM AS400 along with all peripheral and networking
equipment and has developed its own proprietary software package, AgentPlus,
which allows agencies to quote and examine various levels of coverage on their
own personal computers. The Company's regional managers are responsible for the
Company's field operations within an assigned geographic territory, including
maintaining and enhancing relationships with agencies in those territories. IGF
also uses application documentation which is designed for simplicity and
convenience. The Company believes that IGF is the only crop insurer which has
created a single application for MPCI, crop hail and named peril coverage.
IGF generally compensates its agents based on a percentage of premiums
produced and, in the case of CAT Coverage and crop hail insurance, a percentage
of underwriting gain realized with respect to business produced. This
compensation structure is designed to encourage agents to place profitable
business with IGF (which tends to be insurance coverages for larger farms with
respect to which the risk of loss is spread over larger, frequently
noncontiguous insured areas).
Underwriting Management
Because of the highly regulated nature of the MPCI program and the fact
that rates are established by the FCIC, the primary underwriting functions
performed by the Company's personnel with respect to MPCI coverage are (i)
selecting of marketing territories for MPCI based on the type of crops being
grown in the area, typical weather patterns and loss experience of both agencies
and farmers within a particular area, (ii) recruiting agencies within those
marketing territories which service larger farms and other more desirable risks
and (iii) ensuring that policies are underwritten in accordance with the FCIC
rules.
With respect to its hail coverage, IGF seeks to minimize its
underwriting losses by maintaining an adequate geographic spread of risk by rate
group. In addition, IGF establishes sales closing dates after which hail
policies will not be sold. These dates are dependent on planting schedules, vary
by geographic location and range from May 15 in Texas to July 15 in North
Dakota. Prior to these dates, crops are either seeds in the ground or young
growth newly emerged from the ground and hail damage to crops in either of these
stages of growth is minimal. The cut-off dates prevent farmers from adversely
selecting against IGF by waiting to purchase hail coverage until a storm is
forecast or damage has occurred. For its hail coverage, IGF also sets limits by
policy ($400,000 each) and by township ($2.0 million per township). The Company
also uses a daily report entitled "Severe Weather Digest" which shows the time
and geographic location of all extraordinary weather events to check incoming
policy applications against possible previous damage.
Claims/Loss Adjustments
In contrast to most of its competitors who retain independent adjusters
on a part-time basis for loss adjusting services, IGF employs full-time
professional claims adjusters, most of whom are agronomy trained, as well as
part-time adjusters. Management believes that the professionalism of the IGF
full-time claims staff coupled with their exclusive commitment to IGF helps to
ensure that claims are handled in a manner designed to reduce overpayment of
losses experienced by IGF. The adjusters are located throughout IGF's marketing
territories. As an aid to promote a rapid claims response, the Company has
available numerous all terrain four wheel drive vehicles for use by its
adjusters. The adjusters report to a Field Service Manager in their territory
who manages adjusters' assignments, assures that all preliminary estimates for
loss reserves are accurately reported and assists in loss adjustment. Within 72
hours of reported damage, a loss notice is reviewed by an IGF Field Service
Manager and a preliminary loss reserve is determined which is based on the
representative's and/or adjuster's knowledge of the area or the particular storm
which caused the loss. Generally, within approximately two weeks, hail and MPCI
claims are examined and reviewed on site by an adjuster and the insured signs a
proof of loss form containing a final release. As part of the adjustment
process, IGF's adjusters may use Global Positioning System Units to determine
the precise location where a claimed loss has occurred. IGF has a team of
catastrophic claims specialists who are available on 48 hours notice to travel
to any of IGF's seven regional service offices to assist in heavy claim work
load situations.
19
In September of 1998, IGF restructured its loss adjustment services. A new
Field Service Department was created with an organization structure designed to
provide better efficiency and accountability at the point of service in the
field. The restructuring eliminated one middle level management layer
stimulating quicker response and more accurate communication. The new structure
placed claim distribution and coordination in the field. It also coordinated the
activities of loss adjustment and precision agriculture support services. The
new structure was also designed to establish better information flow for loss
reserving.
Competition
The crop insurance industry is highly competitive. The Company competes
against other private companies for MPCI, crop hail and named peril coverage.
Many of the Company's competitors have substantially greater financial and other
resources than the Company and there can be no assurance that the Company will
be able to compete effectively against such competitors in the future. The
Company competes on the basis of the commissions paid to agents, the speed with
which claims are paid, the quality and extent of services offered, the
reputation and experience of its agency network and, in the case of private
insurance, policy rates. Because the FCIC establishes the rates that may be
offered for MPCI policies, the Company believes that quality of service and
level of commissions offered to agents are the principal factors on which it
competes in the area of MPCI. The Company believes that the crop hail and other
named peril crop insurance industry is extremely rate-sensitive and the ability
to offer competitive rate structures to agents is a critical factor in the
agent's ability to write crop hail and other named peril premiums. Because of
the varying state laws regarding the ability of agents to write crop hail and
other named peril premiums prior to completion of rate and form filings (and, in
some cases, state approval of such filings), a company may not be able to write
its expected premium volume if its rates are not competitive.
The crop insurance industry has become increasingly consolidated. From
the 1985 crop year to the 1998 crop year, the number of insurance companies
having agreements with the FCIC to sell and service MPCI policies has declined
from fifty to seventeen. The Company believes that IGF is the fourth largest
MPCI crop insurer in the United States based on premium information compiled in
1997 by the FCIC and NCIS. The Company's primary competitors are Rain & Hail LLC
(affiliated with Cigna Insurance Company), Rural Community Insurance Services,
Inc. (which is owned by Norwest Corporation), Acceptance Insurance Company
(Redland), FF Agribusiness (affiliated with Fireman's Fund), Great American
Insurance Company, Blakely Crop Hail (an affiliate of Farmers Alliance Mutual
Insurance Company) and North Central Crop Insurance, Inc. (an affiliate of
Farmers Alliance Mutual Insurance Company). The Company believes that in order
to compete successfully in the crop insurance business it will have to market
and service a volume of premiums sufficiently large to enable the Company to
continue to realize operating efficiencies in conducting its business. No
assurance can be given that the Company will be able to compete successfully if
this market further consolidates.
Reserves for Losses and Loss Adjustment Expenses
Loss Reserves are estimates, established at a given point in time based
on facts then known, of what an insurer predicts its exposure to be in
connection with incurred losses. LAE Reserves are estimates of the ultimate
liability associated with the expense of settling all claims, including
investigation and litigation costs resulting from such claims. The actual
liability of an insurer for its Losses and LAE Reserves at any point in time
will be greater or less than these estimates.
The Company maintains reserves for the eventual payment of Losses and
LAE with respect to both reported and unreported claims. Nonstandard automobile
reserves for reported claims are established on a case-by-case basis. The
reserving process takes into account the type of claim, policy provisions
relating to the type of loss and historical paid Loss and LAE for similar
claims. Reported crop insurance claims are reserved based upon preliminary
notice to the Company and investigation of the loss in the field. The ultimate
settlement of a crop loss is based upon either the value or the yield of the
crop.
Loss and LAE Reserves for claims that have been incurred but not
reported are estimated based on many variables including historical and
statistical information, inflation, legal developments, economic conditions,
trends in claim severity and frequency and other factors that could affect the
adequacy of loss reserves.
20
The Company's reserves are reviewed by independent actuaries on a
semi-annual basis. The Company's recorded Loss Reserves are certified by an
independent actuary for each calendar year.
The following loss reserve development table illustrates the change
over time of reserves established for loss and loss expenses as of the end of
the various calendar years for the nonstandard automobile segment of the
Company. The table includes the loss reserves acquired from the acquisition of
Superior in 1996 and the related loss reserve development thereafter. The first
section shows the reserves as originally reported at the end of the stated year.
The second section, reading down, shows the cumulative amounts paid as of the
end of successive years with respect to the reserve liability. The third
section, reading down, shows the re-estimates of the original recorded reserve
as of the end of each successive year which is a result of sound insurance
reserving practices of addressing new emerging facts and circumstances which
indicate that a modification of the prior estimate is necessary. The last
section compares the latest re-estimated reserve to the reserve originally
established, and indicates whether or not the original reserve was adequate or
inadequate to cover the estimated costs of unsettled claims.
The loss reserve development table is cumulative and, therefore, ending
balances should not be added since the amount at the end of each calendar year
includes activity for both the current and prior years.
The reserve for losses and loss expenses is an accumulation of the
estimated amounts necessary to settle all outstanding claims as of the date for
which the reserve is stated. The reserve and payment data shown below have been
reduced for estimated subrogation and salvage recoveries. The Company does not
discount its reserves for unpaid losses and loss expenses. No attempt is made to
isolate explicitly the impact of inflation from the multitude of factors
influencing the reserve estimates though inflation is implicitly included in the
estimates. The Company regularly updates its reserve forecasts by type of claim
as new facts become known and events occur which affect unsettled claims.
During 1997 and 1998, the Company, as part of its efforts to reduce
costs and combine the operations of the two nonstandard automobile insurance
companies, emphasized a unified claim settlement practice as well as reserving
philosophy for Superior and Pafco. Superior had historically provided
strengthened case reserves and a level of IBNR which reflected the strength of
the case reserves. Pafco had historically carried case reserves which generally
did not reflect the level of future payments but yet a higher IBNR reserve. This
change in claims management philosophy during 1997 and 1998 coupled with the
growth in premium volume produced sufficient volatility in prior year loss
patterns to warrant the Company to re-estimate its 1996 and 1997 reserve for
losses and loss expenses and record an additional reserve during 1997 and 1998.
The effects of changes in settlement patterns, costs, inflation, growth and
other factors have all been considered in establishing the current year serve
for unpaid losses and loss expenses.
21
Symons International Group, Inc.
Nonstandard Automobile Insurance Only
For The Years Ended December 31, (in thousands)
1988 1989 1990 1991 1992 1993 1994 1995(A) 1996 1997 1998
Gross reserves for unpaid
losses and LAE $25,248 $71,748 $79,551 $101,185 $121,333
Deduct reinsurance
recoverable 10,927 9,921 8,124 16,378 6,515
Reserve for unpaid losses
and LAE, net of reinsurance $10,747 $13,518 $15,923 $15,682 $17,055 $14,822 14,321 61,827 71,427 84,807 114,818
Paid cumulative as of:
One Year Later 5,947 7,754 7,695 7,519 10,868 8,875 7,455 42,183 59,410 62,962
Two Years Later 7,207 10,530 10,479 12,358 15,121 11,114 10,375 53,350 79,319
Three Years Later 7,635 11,875 12,389 13,937 16,855 13,024 12,040 58,993 --
Four Years Later 7,824 12,733 13,094 14,572 17,744 13,886 12,822 -- --
Five Years Later 8,009 12,998 13,331 14,841 18,195 14,229 -- -- --
Six Years Later 8,135 13,095 13,507 14,992 18,408 -- -- -- --
Seven Years Later 8,154 13,202 13,486 15,099 -- -- -- -- --
Eight Years Later 8,173 13,216 13,567 -- -- -- -- -- --
Nine Years Later 8,174 13,249 -- -- -- -- -- -- --
Ten Years Later 8,175 -- -- -- -- -- -- -- --
Liabilities re-estimated as of:
One Year Later 8,474 13,984 13,888 14,453 17,442 14,788 13,365 59,626 82,011 97,905
Two Years Later 8,647 13,083 13,343 14,949 18,103 13,815 12,696 60,600 91,735
Three Years Later 8,166 13,057 13,445 15,139 18,300 14,051 13,080 63,812 --
Four Years Later 8,108 13,152 13,514 15,218 18,313 14,290 13,561 -- --
Five Years Later 8,179 13,170 13,589 15,198 18,419 14,586 -- -- --
Six Years Later 8,165 13,246 13,612 15,114 18,651 -- -- -- --
Seven Years Later 8,196 13,260 13,529 15,321 -- -- -- -- --
Eight Years Later 8,198 13,248 13,738 -- -- -- -- -- --
Nine Years Later 8,199 13,374 -- -- -- -- -- -- --
Ten Years Later 8,217 -- -- -- -- -- -- -- --
Net cumulative (deficiency)
or redundancy 2,548 270 2,394 568 (1,364) 532 1,241 1,227 (10,584) (13,098)
Expressed as a percentage
of unpaid losses and LAE 23.7% 2.0% 15.0% 3.6% (8.0%) 3.6% 8.7% 2.0% (14.8%) (15.4%)
(A) Includes Superior loss and loss expense reserves of $44,423 acquired on
April 29, 1996 and subsequent development thereon.
22
Investments
Insurance company investments must comply with applicable laws and
regulations which prescribe the kind, quality and concentration of investments.
In general, these laws and regulations permit investments, within specified
limits and subject to certain qualifications, in federal, state and municipal
obligations, corporate bonds, preferred and common securities, real estate
mortgages and real estate. The Company's investments in real estate and mortgage
loans represent 1.3% of the Company's aggregate investments. The investment
portfolios of the Company at December 31, 1998, consisted of the following:
(in thousands)
Cost or
Amortized Market
Type of Investment Cost Value
Fixed maturities:
U.S. and Canadian Treasury securities and obligations
of U.S. and Canadian government corporation and agencies $74,060 $76,079
Obligations of states, provinces and political subdivisions 7,080 6,968
Corporate securities 113,137 114,204
------- -------
Total Fixed Maturities 194,277 197,251
Equity Securities:
Common stocks 13,691 12,988
Short-term investments 27,636 27,636
Mortgage loans 2,100 2,100
Real estate 890 890
------- -------
Total Investments $238,594 $240,865
======= =======
- ---------------
23
The following table sets forth the composition of the fixed maturity
securities portfolio of the Company by time to maturity as of December 31:
(in thousands) 1997 1998
Market Percent Market Percent
Time To Maturity Value Market Value Market
1 year or less $3,678 2.1% $7,937 4.0%
More than 1 year through 5 years 60,008 34.4% 53,327 27.0%
More than 5 years through 10 years 31,599 18.1% 38,236 19.4%
More than 10 years 8,390 4.8% 23,034 11.7%
------- ----- ------- -----
103,675 59.4% 122,534 62.1%
Mortgage-backed securities 70,540 40.6% 74,717 37.9%
------- ----- ------- -----
Total $174,215 100.0% $197,251 100.0%
======= ===== ======= =====
The following table sets forth the ratings assigned to the fixed
maturity securities of the Company as of December 31:
(in thousands) 1997 1998
Market Percent Market Percent
Rating (1) Value Market Value Market
Aaa or AAA $112,920 64.8% $76,484 38.8%
Aa or AA 4,145 2.4% 2,256 1.1%
A 20,679 11.9% 81,270 41.2%
Baa or BBB 19,116 11.0% 23,504 11.9%
Ba or BB 16,519 9.5% 13,737 7.0%
Other below investment grade 82 0.1% -- 0.0%
Not rated (2) 754 0.3% -- 0.0%
------- ----- ------- -----
Total $174,215 100.0% $197,251 100.0%
======= ===== ======= =====
(1) Ratings are assigned by Moody's Investors Service, Inc., and when not
available, are based on ratings assigned by Standard & Poor's
Corporation.
(2) These securities were not rated by the rating agencies. However, these
securities are designated as Category 1 securities by the NAIC, which is
the equivalent rating of "A" or better.
24
The investment results of the Company for the periods indicated are set
forth below:
(in thousands) Years Ended December 31,
1996 1997 1998
Net investment income (1) $7,745 $12,777 $13,401
Average investment portfolio (2) $122,363 $215,694 $236,197
Pre-tax return on average investment portfolio 6.3% 5.9% 5.7%
Net realized gains (losses) ($637) $9,393 $4,104
- ---------------
(1) Includes dividend income received in respect of holdings of common stock.
(2) Average investment portfolio represents the average (based on amortized
cost) of the beginning and ending investment portfolio and excludes
cash. For 1996, the average investment portfolio was adjusted for the
effect of the Acquisition.
Market-Sensitive Instruments and Risk Management
The Company's investment strategy is to invest available funds in a
manner that will maximize the after-tax yield of the portfolio while emphasizing
the stability and preservation of the capital base. The Company seeks to
maximize the total return on investment through active investment management
utilizing third-party professional administrators, in accordance with
pre-established investment policy guidelines established and reviewed regularly
by the Board of Directors of the Company. Accordingly, the entire portfolio of
fixed maturity securities is available to be sold in response to changes in
market interest rate; changes in relative values of individual securities and
asset sectors; changes in prepayment risks; changes in credit quality; liquidity
needs and other factors.
The portfolio is invested in types of securities and in an aggregate
duration which reflect the nature of the Company's liabilities and expected
liquidity needs diversified among industries, issuers and geographic locations.
The Company's fixed maturity and common equity investments are substantially all
in public companies.
The following table provides information about the Company's financial
instruments that are sensitive to changes in interest rates. For investment
securities and debt obligations, the table presents principal cash flows and
related weighted-average interest rates by expected maturity date. Additionally,
the Company has assumed its available for sale securities are similar enough to
aggregate those securities for presentation purposes.
Interest Rate Sensitivity
Principal Amount by Expected Maturity
Average Interest Rate
(dollars in thousands)
Fair
There- Value
1999 2000 2001 2002 2003 after Total 12/31/98
---- ---- ---- ---- ---- ----- ----- --------
Assets:
Available for sale $7,883 $5,363 $22,787 $19,705 $13,970 $137,998 $207,706 $197,251
Average interest rate 6.1% 6.5% 7.2% 8.1% 7.1% 5.9% 6.4% 6.7%
Liabilities:
IGF line of credit $12,000 $ - $ - $ - $ - $ - $12,000 $12,000
Preferred securities $ - $ - $ - $ - $ - $135,000 $135,000 $135,000
Average interest rate 7.75% -% -% -% -% 9.5% 9.4% 9.4%
25
The Company has the ability to hold its fixed maturity securities to
maturity. If interest rates were to increase 10% from the December 31, 1998
levels, the decline in fair value of the fixed maturity securities would not
significantly affect the Company's ability to meet its obligations to
policyholders and debtors.
Ratings
A.M. Best has currently assigned a "B+" rating to Superior and a "B-"
rating to Pafco.
A.M. Best's ratings are based upon a comprehensive review of a
company's financial performance, which is supplemented by certain data,
including responses to A.M. Best's questionnaires, phone calls and other
correspondence between A.M. Best analysts and company management, quarterly NAIC
filings, state insurance department examination reports, loss reserve reports,
annual reports, company business plans and other reports filed with state
insurance departments. A.M. Best undertakes a quantitative evaluation, based
upon profitability, leverage and liquidity, and a qualitative evaluation, based
upon the composition of a company's book of business or spread of risk, the
amount, appropriateness and soundness of reinsurance, the quality,
diversification and estimated market value of its assets, the adequacy of its
loss reserves and policyholders' surplus, the soundness of a company's capital
structure, the extent of a company's market presence and the experience and
competence of its management. A.M. Best's ratings represent an independent
opinion of a company's financial strength and ability to meet its obligations to
policyholders. A.M. Best's ratings are not a measure of protection afforded
investors. "B+" and "B-" ratings are A.M. Best's sixth and eighth highest rating
classifications, respectively, out of 15 ratings. A "B+" rating is awarded to
insurers which, in A.M. Best's opinion, "have demonstrated very good overall
performance when compared to the standards established by the A.M. Best Company"
and "have a good ability to meet their obligations to policyholders over a long
period of time." A "B-" rating is awarded to insurers which, in A.M. Best's
opinion, "have demonstrated adequate overall performance when compared to the
standards established by the A.M. Best Company" and "have an adequate ability to
meet their obligations to policyholders, but their financial strength is
vulnerable to unfavorable changes in underwriting or economic conditions." There
can be no assurance that such ratings or changes therein will not in the future
adversely affect the Company's competitive position.
Recent Acquisitions
On January 31, 1996, Goran, SIG, Fortis, Inc. and its wholly-owned
subsidiary, Interfinancial, Inc., a holding company for Superior, entered into a
Stock Purchase Agreement (the "Superior Purchase Agreement") pursuant to which
SIG agreed to purchase Superior from Interfinancial, Inc. for a purchase price
of approximately $66.6 million. Simultaneously with the execution of the
Superior Purchase Agreement, Goran, SIG, GGS Holdings and the GS Funds, a
Delaware limited partnership, entered into an agreement (the "GGS Agreement") to
capitalize GGS Holdings and to cause GGS Holdings to issue its capital stock to
SIG and to the GS Funds, so as to give SIG a 52% ownership interest and the GS
Funds a 48% ownership interest (the "Formation Transaction"). Pursuant to the
GGS Agreement (a) SIG contributed to GGS Holdings (i) all the outstanding common
stock of Pafco, with a book value of $16.9 million, (ii) its right to acquire
Superior pursuant to the Superior Purchase Agreement and (iii) certain fixed
assets, including office furniture and equipment, having a value of
approximately $350,000 and (b) the GS Funds contributed to GGS Holdings $21.2
million in cash. The Formation Transaction and the Acquisition were completed on
April 30, 1996. On August 12, 1997, SIG acquired the remaining 48% interest in
GGS Holdings that had been owned by the GS funds for $61 million with a portion
of the proceeds from the sale of the Preferred Securities.
On August 12, 1997, SIG issued $135 million in Trust Originated
Preferred Securities ("Preferred Securities"). These Preferred Securities were
offered through a wholly-owned trust subsidiary of SIG and are backed by Senior
Subordinated Notes to the Trust from SIG. These Preferred Securities were
offered under Rule 144A of the SEC ("Offering") and, pursuant to the
Registration Rights Agreement executed at closing, SIG filed a Form S-4
Registration Statement with the SEC on September 16, 1997 to effect the Exchange
Offer. The S-4 Registration Statement was declared effective on September 30,
1997 and the Exchange Offer successfully closed on October 31, 1997. The
proceeds of the Preferred Securities Offering were used to repurchase the
remaining minority interest in GGSH for $61 million, repay the balance of the
term debt of $44.9 million and SIG expects to contribute the balance, after
expenses, of approximately $24 million to the nonstandard automobile insurers of
which $10.5 million was contributed in 1997. Expenses of the issue aggregated
$5.1 million and are amortized over the term of the Preferred Securities (30
years). In the third quarter of 1997 SIG wrote off the remaining unamortized
costs of the term debt of approximately $1.1 million pre-tax or approximately
$0.09 per share to Goran after income taxes and minority interest.
26
The Preferred Securities have a term of 30 years with semi-annual
distribution payments at 9.5% per annum commencing February 15, 1998. The
Preferred Securities may be redeemed in whole or in part after 10 years.
SIG shall not, and shall not permit any subsidiary, to incur directly
or indirectly, any indebtedness unless, on the date of such incurrence (and
after giving effect thereto), the Consolidated Coverage Ratio exceeds 2.5 to 1.
The Coverage Ratio is the aggregate of net earnings, plus interest expense,
income taxes, depreciation, and amortization divided by interest expense for the
same period. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations of the Company" for a discussion of the impact of
these covenants on the Company's operations.
On March 2, 1998, the Company announced that it had signed an agreement
with CNA to assume its multi-peril and crop hail operations. CNA wrote
approximately $80 million of multi-peril and crop hail insurance business in
1997. The Company will reinsure a small portion of the Company's total crop book
of business (approximately 22% MPCI and 15% crop hail) to CNA. Starting in the
year 2000, assuming no event of change in control as defined in the agreement,
the Company can purchase this reinsurance from CNA through a call provision or
CNA can require the Company to buy the premiums reinsured to CNA. Regardless of
the method of takeout of CNA, CNA must not compete in MPCI or crop hail for a
period of time. There was no purchase price. The formula for the buyout in the
year 2000 is based on a multiple of average pre-tax earnings that CNA received
from reinsuring the Company's book of business.
On July 8, 1998, the Company acquired North American Crop Underwriters
(NACU) a Henning, Minnesota based managing general agency which focuses
exclusively on crop insurance. The acquisition price was $4 million with $3
million paid at closing and $1 million due July 1, 2000 without interest. This
acquisition captures 100% of the MPCI underwriting gain and fees on
approximately $27 million of premiums. Prior to this transaction, NACU received
all fees and 50% of the underwriting gain with the balance going to the Company
through the CNA transaction.
Regulation
General
The Company's insurance businesses are subject to comprehensive,
detailed regulation throughout the United States, under statutes which delegate
regulatory, supervisory and administrative powers to state insurance
commissioners. The primary purpose of such regulations and supervision is the
protection of policyholders and claimants rather than stockholders or other
investors. Depending on whether the insurance company is domiciled in the state
and whether it is an admitted or non-admitted insurer, such authority may extend
to such things as (i) periodic reporting of the insurer's financial condition,
(ii) periodic financial examination, (iii) approval of rates and policy
forms,(iv) loss reserve adequacy, (v) insurer solvency, (vi) the licensing of
insurers and their agents, (vii) restrictions on the payment of dividends and
other distributions, (viii) approval of changes in control and (ix) the type and
amount of permitted investments.
Pafco, IGF and Superior and its insurance subsidiaries are subject to
triennial examinations by state insurance regulators. All of these Companies
have been examined through December 31, 1996. The Company did not receive any
material findings from the examinations of its insurance subsidiaries.
Insurance Holding Company Regulation
The Company also is subject to laws governing insurance holding
companies in Florida and Indiana, where the insurers are domiciled. These laws,
among other things, (i) require the Company to file periodic information with
state regulatory authorities including information concerning its capital
structure, ownership, financial condition and general business operations, (ii)
regulate certain transactions between the Company, SIG, its affiliates and IGF,
Pafco and Superior (the "Insurers"), including the amount of dividends and other
distributions , and (iii) restrict the ability of any one person to acquire
certain levels of SIG's voting securities without prior regulatory approval.
Any purchaser of 10% or more of the outstanding shares of Common Stock
of SIG would be presumed to have acquired control of Pafco and IGF unless the
Indiana Commissioner, upon application, has determined otherwise. In addition,
any purchaser of 5% or more of the outstanding shares of Common Stock of SIG
will be presumed to have acquired control of Superior unless the Florida
Commissioner, upon application, has determined otherwise.
27
Indiana law defines as "extraordinary" any dividend or distribution which,
together with all other dividends and distributions to shareholders within the
preceding twelve months, exceeds the greater of: (i) 10% of statutory surplus as
regards policyholders as of the end of the preceding year or (ii) the prior
year's net income. Dividends which are not "extraordinary" may be paid ten days
after the Indiana Department receives notice of their declaration.
"Extraordinary" dividends and distributions may not be paid without prior
approval of the Indiana Commissioner or until the Indiana Commissioner has been
given thirty days prior notice and has not disapproved within that period. The
Indiana Department must receive notice of all dividends, whether "extraordinary"
or not, within five business days after they are declared. Notwithstanding the
foregoing limit, a domestic insurer may not declare or pay a dividend of funds
other than earned surplus without the prior approval of the Indiana Department.
"Earned surplus" is defined as the amount of unassigned funds set forth in the
insurer's most recent annual statement, less surplus attributable to unrealized
capital gains or reevaluation of assets. As of December 31, 1998, IGF and Pafco
had earned surplus of $16,377 and $(8,362), respectively. Further, no Indiana
domiciled insurer may make payments in the form of dividends or otherwise to
shareholders as such unless it possesses assets in the amount of such payment in
excess of the sum of its liabilities and the aggregate amount of the par value
of all shares of its capital stock; provided, that in no instance shall such
dividend reduce the total of (i) gross paid-in and contributed surplus, plus
(ii) special surplus funds, plus (iii) unassigned funds, minus (iv) treasury
stock at cost, below an amount equal to 50% of the aggregate amount of the par
value of all shares of the insurer's capital stock.
Under Florida law, a domestic insurer may not pay any dividend or
distribute cash or other property to its stockholders except out of that part of
its available and accumulated surplus funds which is derived from realized net
operating profits on its business and net realized capital gains. A Florida
domestic insurer may not make dividend payments or distributions to stockholders
without prior approval of the Florida Department if the dividend or distribution
would exceed the larger of (i) the lesser of (a) 10% of surplus or (b) net
income, not including realized capital gains, plus a two-year carryforward, (ii)
10% of surplus with dividends payable constrained to unassigned funds minus 25%
of unrealized capital gains or (iii) the lesser of (a) 10% of surplus or (b) net
investment income plus a three-year carryforward with dividends payable
constrained to unassigned funds minus 25% of unrealized capital gains.
Alternatively, a Florida domestic insurer may pay a dividend or distribution
without the prior written approval of the Florida Department if the dividend is
equal to or less than the greater of (i) 10% of the insurer's surplus as regards
policyholders derived from realized net operating profits on its business and
net realized capital gains or (ii) the insurer's entire net operating profits
and realized net capital gains derived during the immediately preceding calendar
year; (2) the insurer will have policyholder surplus equal to or exceeding 115%
of the minimum required statutory surplus after the dividend or distribution,
(3) the insurer files a notice of the dividend or distribution with the
department at least ten business days prior to the dividend payment or
distribution and (4) the notice includes a certification by an officer of the
insurer attesting that, after the payment of the dividend or distribution, the
insurer will have at least 115% of required statutory surplus as to
policyholders. Except as provided above, a Florida domiciled insurer may only
pay a dividend or make a distribution (i) subject to prior approval by the
Florida Department or (ii) thirty days after the Florida Department has received
notice of such dividend or distribution and has not disapproved it within such
time. In the consent order approving the Acquisition, the Florida Department has
prohibited Superior from paying any dividends (whether extraordinary or not) for
four years from the date of acquisition without the prior written approval of
the Florida Department.
Under these laws, the maximum aggregate amounts of dividends permitted
to be paid to the Company in 1999 by IGF and Pafco without prior regulatory
approval are $3,123 and $0, respectively, none of which have been paid. Although
the Company believes that amounts required for it to meet its financial and
operating obligations will be available, there can be no assurance in this
regard. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations of the Company -- Liquidity and Capital Resources."
Further, there can be no assurance that, if requested, the Indiana Department
will approve any request for extraordinary dividends from Pafco or IGF or that
the Florida Department will allow any dividends to be paid by Superior during
the four year period described above.
The maximum dividends permitted by state law are not necessarily
indicative of an insurer's actual ability to pay dividends or other
distributions to a parent company, which also may be constrained by business and
regulatory considerations, such as the impact of dividends on surplus, which
could affect an insurer's competitive position, the amount of premiums that can
be written and the ability to pay future dividends. Further, state insurance
28
laws and regulations require that the statutory surplus of an insurance company
following any dividend or distribution by such company be reasonable in relation
to its outstanding liabilities and adequate for its financial needs.
While the non-insurance company subsidiaries are not subject directly to
the dividend and other distribution limitations, insurance holding company
regulations govern the amount which a subsidiary within the holding company
system may charge any of the Insurers for services (e.g., management fees and
commissions). These regulations may affect the amount of management fees which
may be paid by Pafco and Superior to GGS Management. The management agreement
between SIG and Pafco has been assigned to GGS Management, Inc. ("GGS
Management") and provides for an annual management fee equal to 15% of gross
premiums. A similar management agreement with a management fee of 17% of gross
premiums has been entered into between GGS Management and Superior. Employees of
SIG relating to the nonstandard automobile insurance business and all Superior
employees became employees of GGS Management effective April 30, 1996. In the
consent order approving the Acquisition, the Florida Department has reserved,
for three years, the right to reevaluate the reasonableness of fees provided for
in the Superior management agreement at the end of each calendar year and to
require Superior to make adjustments in the management fees based on the Florida
Department's consideration of the performance and operating percentages of
Superior and other pertinent data. There can be no assurance that either the
Indiana Department or the Florida Department will not in the future require a
reduction in these management fees.
Federal Regulation
The Company's MPCI program is federally regulated and supported by the
federal government by means of premium subsidies to farmers, expense
reimbursement and federal reinsurance pools for private insurers. Consequently,
the MPCI program is subject to oversight by the legislative and executive
branches of the federal government, including the FCIC. The MPCI program
regulations generally require compliance with federal guidelines with respect to
underwriting, rating and claims administration. The Company is required to
perform continuous internal audit procedures and is subject to audit by several
federal government agencies. No material compliance issues were noted during
IGF's most recent FCIC compliance review.
The MPCI program has historically been subject to change by the federal
government at least annually since its establishment in 1980, some of which
changes have been significant. See Industry Background for further discussion of
Federal Regulations impacting crop insurance.
Underwriting and Marketing Restrictions
During the past several years, various regulatory and legislative
bodies have adopted or proposed new laws or regulations to deal with the
cyclical nature of the insurance industry, catastrophic events and insurance
capacity and pricing. These regulations include (i) the creation of "market
assistance plans" under which insurers are induced to provide certain coverages,
(ii) restrictions on the ability of insurers to rescind or otherwise cancel
certain policies in mid-term, (iii) advance notice requirements or limitations
imposed for certain policy non-renewals and (iv) limitations upon or decreases
in rates permitted to be charged.
Insurance Regulatory Information System
The NAIC Insurance Regulatory Information System ("IRIS") was developed
primarily to assist state insurance departments in executing their statutory
mandate to oversee the financial condition of insurance companies. Insurance
companies submit data on an annual basis to the NAIC, which analyzes the data
using ratios concerning various categories of financial data. IRIS ratios
consist of twelve ratios with defined acceptable ranges. They are used as an
initial screening process for identifying companies that may be in need of
special attention. Companies that have several ratios that fall outside of the
acceptable range are selected for closer review by the NAIC. If the NAIC
determines that more attention may be warranted, one of five priority
designations is assigned and the insurance department of the state of domicile
is then responsible for follow-up action.
During 1998, Pafco had unusual values for three IRIS tests. These
included two-year overall operating ratio where Pafco's ratio was 116.7 compared
to the IRIS upper limit of 100, change in surplus where Pafco's ratio was
(24.4%) compared to the IRIS lower limit of (10%) and two-year reserve
development where Pafco's ratio was 39.1% compared to 20%. Pafco failed the
first two tests due primarily to a high loss ratio. Pafco failed the third test
29
due to adverse development on accident year 1996 due to higher than normal
severity as a result of a disruption in claims management in early 1997. Pafco
does not expect such results to continue due to improvements in product
development and rate filing, hiring of a chief actuary, focus on improved claims
management and continued consolidation of operations with its affiliate,
Superior Insurance Company. Pafco expects these actions will improve loss ratio
which will lead to a reduction in the combined ratio, stabilization of surplus
and elimination of significant adverse reserve development. However, such
projections involve a high degree of subjectivity in a competitive marketplace.
Therefore, there is no assurance such results will not continue.
During 1998, Superior had unusual values for three IRIS tests. These
included two-year overall operating ratio where Superior's ratio was 108
compared to the IRIS upper limit of 100, change in surplus where Superior's
ratio was (10%) compared to the IRIS lower limit of (10%) and estimated current
reserve deficiency to surplus where Superior's ratio was (5%) compared to the
IRIS lower limit of 0. Superior failed these tests for the same reasons as Pafco
and expects results to improve in 1999 for the same reasons as Pafco. However,
such projections involve a high degree of subjectivity in a competitive
marketplace. Therefore, there is no assurance such results will not continue.
During 1998, IGF had unusual values for seven IRIS tests. These
included gross premiums to surplus where IGF's ratio was 1,006 compared to the
IRIS upper limit of 900, net premiums to surplus where IGF's ratio was 359.9
compared to the IRIS upper limit of 300, change in net writings where IGF's
ratio was 440.6 compared to the IRIS upper limit of 33, investment yield where
IGF's ratio was 195.5 compared to the IRIS upper limit of 10, change in surplus
where IGF's ratio was (27) compared to the IRIS lower limit of (10), liabilities
to liquid assets where IGF's ratio was 735.7 compared to the IRIS upper limit of
105 and agent's balances to surplus where IGF's ratio was 235.8 compared to the
IRIS upper limit of 40. IGF failed the first three premium writing tests due to
the assumption of the CNA book of business and the fourth quarter assumption of
auto premiums from Pafco and Superior combined with the reduction in surplus due
to catastrophic losses. IGF expects to maintain compliance with these covenants
in 1999 through a return to profitability and greater utilization of quota share
reinsurance. IGF failed the investment test in a positive way due to the high
amount of interest received from farmers which is generally offset by interest
expense to the FCIC. IGF generally fails the final two tests due to the nature
of its business whereby such amounts are settled in full subsequent to year end.
IGF's projections involve a high degree of subjectivity in a competitive
marketplace. Therefore, there is no assurance such results will not continue.
Risk-Based Capital Requirements
In order to enhance the regulation of insurer solvency, the NAIC has
adopted a formula and model law to implement risk-based capital ("RBC")
requirements for property and casualty insurance companies designed to assess
minimum capital requirements and to raise the level of protection that statutory
surplus provides for policyholder obligations. Indiana and Florida have
substantially adopted the NAIC model law, and Indiana directly, and Florida
indirectly, have adopted the NAIC model formula. The RBC formula for property
and casualty insurance companies measures four major areas of risk facing
property and casualty insurers: (i) underwriting, which encompasses the risk of
adverse loss developments and inadequate pricing, (ii) declines in asset values
arising from credit risk, (iii) declines in asset values arising from investment
risks and (iv) off-balance sheet risk arising from adverse experience from
non-controlled assets, guarantees for affiliates, contingent liabilities and
reserve and premium growth. Pursuant to the model law, insurers having less
statutory surplus than that required by the RBC calculation will be subject to
varying degrees of regulatory action, depending on the level of capital
inadequacy.
The RBC model law provides for four levels of regulatory action. The
extent of regulatory intervention and action increases as the level of surplus
to RBC falls. The first level, the Company Action Level (as defined by the
NAIC), requires an insurer to submit a plan of corrective actions to the
regulator if surplus falls below 200% of the RBC amount. The Regulatory Action
Level (as defined by the NAIC) requires an insurer to submit a plan containing
corrective actions and requires the relevant insurance commissioner to perform
an examination or other analysis and issue a corrective order if surplus falls
below 150% of the RBC amount. The Authorized Control Level (as defined by the
NAIC) gives the relevant insurance commissioner the option either to take the
aforementioned actions or to rehabilitate or liquidate the insurer if surplus
falls below 100% of the RBC amount. The fourth action level is the Mandatory
Control Level (as defined by the NAIC) which requires the relevant insurance
commissioner to rehabilitate or liquidate the insurer if surplus falls below 70%
of the RBC amount. Based on the foregoing formulae, as of December 31, 1998, the
RBC ratios of the Insurers were in excess of the Company Action Level, the first
trigger level that would require regulatory action except for Pafco, which was
30
1.2 million below the Company Action Level as its ratio of surplus to the RBC
amount was 186%. The required plan of action has been filed by Pafco with the
IDOI. Pafco expects to be in compliance in 1999 through either greater use of
unaffiliated quota share reinsurance or a contribution of capital from its
parent.
Guaranty Funds; Residual Markets
The Insurers also may be required under the solvency or guaranty laws of
most states in which they do business to pay assessments (up to certain
prescribed limits) to fund policyholder losses or liabilities of insolvent or
rehabilitated insurance companies. These assessments may be deferred or forgiven
under most guaranty laws if they would threaten an insurer's financial strength
and, in certain instances, may be offset against future premium taxes. Some
state laws and regulations further require participation by the Insurers in
pools or funds to provide some types of insurance coverages which they would not
ordinarily accept. The Company recognizes its obligations for guaranty fund
assessments when it receives notice that an amount is payable to the fund. The
ultimate amount of these assessments may differ from that which has already been
assessed.
It is not possible to predict the future impact of changing state and
federal regulation on the Company's operations and there can be no assurance
that laws and regulations enacted in the future will not be more restrictive
than existing laws.
Contingencies
The California Department of Insurance (CDOI) has advised the Company
that they are reviewing a possible assessment which could total $3 million. The
Company does not believe it will owe anything for this possible assessment. This
possible assessment relates to the charging of brokers fees to policyholders by
independent agents who have placed business for one of the Company's nonstandard
automobile carriers, Superior Insurance Company. The CDOI has indicated that
such broker fees charged by the independent agent to the policyholder were
improper and has requested reimbursement to the policyholders by Superior
Insurance Company. The Company did not receive any of these broker fees. As the
ultimate outcome of this potential assessment is not deemed probable the Company
has not accrued any amount in its consolidated financial statements. Although
the assessment has not been formally made by the CDOI at this time, the Company
believes it will prevail and will vigorously defend any potential assessment.
Canadian Federal Income Tax Considerations
This summary is based upon the current provisions of the Income Tax Act
(Canada) (the "Canadian Tax Act"), the regulations thereunder, proposed
amendments thereto publicly announced by the Department of Finance, Canada prior
to the date hereof and the provisions of the Canada-U.S. Income Tax Convention
(1980) (the "Convention") as amended by the Third Protocol (1995).
Amounts in respect of common shares paid or credited or deemed to be
paid or credited as, on account or in lieu of payment of, or in satisfaction of,
dividends to a shareholder who is not a resident in Canada within the meaning of
the Canadian Tax Act will generally be subject to Canadian non-resident
withholding tax. Such withholding tax is levied at a basic rate of 25% which may
be reduced pursuant to the terms of an applicable tax treaty between Canada and
the country of resident of the non-resident.
Currently, under the Convention, the rate of Canadian non-resident
withholding tax on the gross amount of dividends beneficially owned by a person
who is a resident of the United States for the purpose of the Convention and who
does not have a "permanent establishment" or "fixed base" in Canada is 15%.
However, where such beneficial owner is a company which owns at least 10% of the
voting stock of the company, the rate of such withholding is 5%.
A purchase for cancellation of common shares by the Company (other than
a purchase of common shares by the Company on the open market) will give rise to
a deemed dividend under the Canadian Tax Act equal to the amount paid by the
Company on the purchase in excess of the paid-up capital of such shares
determined in accordance with the Canadian Tax Act. Any such dividend deemed to
have been received by a person not resident in Canada will be subject to
nonresident withholding tax as described above. The amount of any such deemed
dividend will reduce the proceeds of disposition to a holder of common shares
for purposes of computing the amount of his capital gain or loss under the
Canadian Tax Act.
31
A holder of common shares who is not a resident of Canada within the
meaning of the Canadian Tax Act will not be subject to tax under the Canadian
Tax Act in respect of any capital gain on a disposition of common shares
(including on a purchase by the Company) unless such shares constitute taxable
Canadian property of the shareholder for purposes of the Canadian Tax Act and
such shareholder is not entitled to relief under an applicable tax treaty.
Common shares will generally not constitute taxable Canadian property of a
shareholder who is not a resident of Canada for purposes of the Canadian Tax Act
in any taxation year in which such shareholder owned common shares unless such
shareholder uses or holds or is deemed to use or hold such shares in or in the
course of carrying on business in Canada or, a share of the capital stock of a
corporation resident in Canada, that is not listed on a prescribed stock
exchange or a share that is listed on prescribed stock exchange, if at any time
during the five year period immediately preceding the disposition of the common
shares owned, either alone or together with persons with whom he does not deal
at arm's length, not less than 25% of the issued shares of any class of the
capital stock of the Company. In any event, under the Convention, gains derived
by a resident of the United States from the disposition of common shares will
generally not be taxable in Canada unless 50% or more of the value of the common
shares is derived principally from real property situated in Canada.
U.S. Federal Income Tax Considerations
The following is a general summary of certain U.S. federal income tax
consequence to U.S. Holders of the purchase, ownership and disposition of common
shares. This summary is based on the U.S. Internal Revenue Code of 1986, as
amended (the "Code"), Treasury Regulations promulgated thereunder, and judicial
and administrative interpretations thereof, all as in effect on the date hereof
and all of which are subject to change. This summary does not address all
aspects of U.S. federal income taxation that may be relevant to a particular
U.S. Holder based on such U.S. Holder's particular circumstances. In particular,
the following summary does not address the tax treatment of U.S. Holders who are
broker dealers or who own, actually or constructively, 10% or more of the
Company's outstanding voting stock, and certain U.S. Holders (including, but not
limited to, insurance companies, tax-exempt organizations, financial
institutions and persons subject to the alternative minimum tax) may be subject
to special rules not discussed below.
For U.S. federal income tax purposes, a U.S. Holder of common shares
generally will realize, to the extent of the Company's current and accumulated
earnings and profits, ordinary income on the receipt of cash dividends on the
common shares equal to the U.S. dollar value of such dividends on the date of
receipt (based on the exchange rate on such date) without reduction for any
Canadian withholding tax. Dividends paid on the common shares will not be
eligible for the dividends received deduction available in certain cases to U.S.
corporations. In the case of foreign currency received as a dividend that is not
converted by the recipient into U.S. dollars on the date of receipt, a U.S.
Holder will have a tax basis in the foreign currency equal to its U.S. dollars
value on the date of receipt. Any gain or loss recognized upon a subsequent sale
or other disposition of the foreign currency, including an exchange for U.S.
dollars, will be ordinary income or loss. Subject to certain requirements and
limitations imposed by the Code, a U.S. Holder may elect to claim the Canadian
tax withheld or paid with respect to dividends on the common shares either as a
deduction or as a foreign tax credit against the U.S. federal income tax
liability of such U.S. Holder. The requirements and limitations imposed by the
Code with respect to the foreign tax credit are complex and beyond the scope of
this summary, and consequently, prospective purchasers of common shares should
consult with their own tax advisors to determine whether and to what extent they
would be entitled to such credit.
For U.S. federal income tax purposes, upon a sale or exchange of a
common share, a U.S. Holder will recognize gain or loss equal to the difference
between the amount realized on such sale or exchange and the tax basis of such
common share. If a common share is held as a capital asset, any such gain or
loss will be capital gain or loss, and will be long-term capital gain or loss if
the U.S. Holder has held such common share for more than one year.
Under current Treasury regulations, dividends paid on the common share to
U.S. Holders will not be subject to the 31% U.S. backup withholding tax.
Proposed Treasury regulations which are not yet in effect and which will only
apply prospectively, however, would subject dividends paid on the common shares
through a U.S. or U.S. related broker to the 31% U.S. backup withholding tax
unless certain information reporting requirements are satisfied. Whether and
when such proposed Treasury regulations will become effective cannot be
determined at this time. The payment of proceeds of a sale or other disposition
of common shares in the U.S. through a U.S. or U.S. related broker generally
will be subject to U.S. information reporting requirements and may also be
subject to the 31% U.S. backup withholding tax, unless the U.S. Holder furnishes
the broker with a duly completed and signed Form W-9. Any amounts withheld under
the U.S. backup withholding tax rules may be refunded or credited against the
U.S. Holder's U.S. federal income tax liability, if any, provided that the
required information is furnished to the U.S. Internal Revenue Service.
32
Employees
At December 31, 1998 the Company and its subsidiaries employed
approximately 1,270 persons. The Company believes that relations with its
employees are excellent.
Recent Developments
On March 4, 1999, Gary Hutchcraft and James Lund, the Company's Chief
Financial Officer and Chief Accounting Officer, resigned from the Company
effective April 9, 1999. The Company has hired Mr. Thomas Kaehr effective April
19, 1999 as the Company's new Chief Financial Officer. Mr. Kaehr was formerly
Second Vice President of Lincoln National Corporation, Fort Wayne.
FORWARD LOOKING STATEMENTS - SAFE HARBOR PROVISIONS
The statements contained in this Annual Report which are not historical
facts, including but not limited to, statements concerning (i) the impact of
federal and state laws and regulations, including but not limited to, the 1994
Reform Act and 1996 Reform Act, on the Company's business and results of
operations, (ii) the competitive advantage afforded to IGF by approaches adopted
by management in the areas of information, technology, claims handling and
underwriting, (iii) the sufficiency of the Company's cash flow to meet the
operating expenses, debt service obligations and capital needs of the Company
and its subsidiaries, and (iv) the impact of declining MPCI Buy-up Expense
Reimbursements on the Company's results of operations, are forward-looking
statements within the meanings of Section 27A of the Securities Act of 1933, as
amended and Section 21E of the Securities Exchange Act of 1934, as amended. From
time to time the Company may also issue other statements either orally or in
writing, which are forward looking within the meaning of these statutory
provisions. Forward looking statements are typically identified by the words
"believe", "expect", "anticipate", "intend", "estimate", "plan" and similar
expressions. These statements involve a number of risks and uncertainties,
certain of which are beyond the Company's control. Actual results could differ
materially from the forward looking statements in this Form 10-K or from other
forward looking statements made by the Company. In addition to the risks and
uncertainties of ordinary business operations, some of the facts that could
cause actual results to differ materially from the anticipated results or other
expectations expressed in the Company's forward-looking statements are the risks
and uncertainties (i) discussed herein, (ii) contained in the Company's other
filings with the Securities and Exchange Commission and public statements from
time to time, and (iii) set forth below.
Uncertain Pricing and Profitability
One of the distinguishing features of the property and casualty
industry is that its products generally are priced, before its costs are known,
because premium rates usually are determined before losses are reported. Premium
rate levels are related in part to the availability of insurance coverage, which
varies according to the level of surplus in the industry. Increases in surplus
have generally been accompanied by increased price competition among property
and casualty insurers. The nonstandard automobile insurance business in recent
years has experienced very competitive pricing conditions and there can be no
assurance as to the Company's ability to achieve adequate pricing. Changes in
case law, the passage of new statutes or the adoption of new regulations
relating to the interpretation of insurance contracts can retroactively and
dramatically affect the liabilities associated with known risks after an
insurance contract is in place. New products also present special issues in
establishing appropriate premium levels in the absence of a base of experience
with such products' performance.
The number of competitors and the similarity of products offered, as
well as regulatory constraints, limit the ability of property and casualty
insurers to increase prices in response to declines in profitability. In states
which require prior approval of rates, it may be more difficult for the Company
to achieve premium rates which are commensurate with the Company's underwriting
experience with respect to risks located in those states. In addition, the
Company does not control rates on its MPCI business, which are instead set by
the FCIC. Accordingly, there can be no assurance that these rates will be
sufficient to produce an underwriting profit.
33
The reported profits and losses of a property and casualty insurance
company are also determined, in part, by the establishment of, and adjustments
to, reserves reflecting estimates made by management as to the amount of losses
and loss adjustment expenses ("LAE") that will ultimately be incurred in the
settlement of claims. The ultimate liability of the insurer for all losses and
LAE reserved at any given time will likely be greater or less than these
estimates, and material differences in the estimates may have a material adverse
effect on the insurer's financial position or results of operations in future
periods.
Nature of Nonstandard Automobile Insurance Business
The nonstandard automobile insurance business is affected by many
factors which can cause fluctuation in the results of operations of this
business. Many of these factors are not subject to the control of the Company.
The size of the nonstandard market can be significantly affected by, among other
factors, the underwriting capacity and underwriting criteria of standard
automobile insurance carriers. In addition, an economic downturn in the states
in which the Company writes business could result in fewer new car sales and
less demand for automobile insurance. Severe weather conditions could also
adversely affect the Company's business through higher losses and LAE. These
factors, together with competitive pricing and other considerations, could
result in fluctuations in the Company's underwriting results and net income.
Nature of Crop Insurance Business
The Company's operating results from its crop insurance program can
vary substantially from period to period as a result of various factors,
including timing and severity of losses from storms, drought, floods, freezes
and other natural perils and crop production cycles. Therefore, the results for
any quarter or year are not necessarily indicative of results for any future
period. The underwriting results of the crop insurance business are recognized
throughout the year with a reconciliation for the current crop year in the
fourth quarter.
The Company expects that for the foreseeable future a majority of its
crop insurance will continue to be derived from MPCI business. The MPCI program
is federally regulated and supported by the federal government by means of
premium subsidies to farmers, expense reimbursement and federal reinsurance
pools for private insurers. As such, legislative or other changes affecting the
MPCI program could impact the Company's business prospects. The MPCI program has
historically been subject to modification at least annually since its
establishment in 1980, and some of these modifications have been significant. No
assurance can be given that future changes will not significantly affect the
MPCI program and the Company's crop insurance business.
Total MPCI Premium for each farmer depends upon the kinds of crops
grown, acreage planted and other factors determined by the FCIC. Each year, the
FCIC sets, by crop, the maximum per unit commodity price ("Price Election") to
be used in computing MPCI Premiums. Any reduction of the Price Election by the
FCIC will reduce the MPCI Premium charged per policy, and accordingly will
adversely impact MPCI Premium volume.
AgPI is a new insurance product for 1998 and the Company expects to
significantly expand this new product in future years. While the Company
believes there is adequate information to establish pricing and little
competition exits, there is no assurance such pricing will be adequate and
competition will not develop.
The Company's crop insurance business is also affected by market
conditions in the agricultural industry which vary depending on such factors as
federal legislation and administration policies, foreign country policies
relating to agricultural products and producers, demand for agricultural
products, weather, natural disasters, technologic advances in agricultural
practices, international agricultural markets and general economic conditions
both in the United States and abroad. For example, the number of MPCI Buy-up
Coverage policies written has historically tended to increase after a year in
which a major natural disaster adversely affecting crops occurs, and to decrease
following a year in which favorable weather conditions prevail.
Highly Competitive Businesses
Both the nonstandard automobile insurance and crop insurance businesses
are highly competitive. Many of the Company's competitors in both the
nonstandard automobile insurance and crop insurance business segments have
substantially greater financial and other resources than the Company, and there
can be no assurance that the Company will be able to compete effectively against
such competitors in the future.
34
In its nonstandard automobile business, the Company competes with both
large national writers and smaller regional companies. The Company's competitors
include other companies which, like the Company, serve the independent agency
market, as well as companies which sell insurance directly to customers. Direct
writers may have certain competitive advantages over agency writers, including
increased name recognition, loyalty of the customer base to the insurer rather
than an independent agency and, potentially, reduced acquisition costs. In
addition, certain competitors of the Company have from time to time decreased
their prices in an apparent attempt to gain market share. Also, in certain
states, state assigned risk plans may provide nonstandard automobile insurance
products at a lower price than private insurers.
In the crop insurance business, the Company competes against other crop
insurance companies and, with respect to CAT Coverage, USDA field service
offices in certain areas. In addition the crop insurance industry has become
increasingly consolidated. From the 1985 crop year to the 1996 crop year, the
number of insurance companies that have entered into agreements with the FCIC to
sell and service MPCI policies has declined from 50 to 17. The Company believes
that to compete successfully in the crop insurance business it will have to
market and service a volume of premiums sufficiently large to enable the Company
to continue to realize operating efficiencies in conducting its business. No
assurance can be given that the Company will be able to compete successfully if
this market consolidates further.
Importance of Ratings
A.M. Best has currently assigned Superior a B+ (Very Good) rating and
Pafco a B- (Adequate) rating. Subsequent to the Acquisition, the rating of
Superior was reduced from A- to B+ as a result of the leverage of GGS Holdings
resulting from indebtedness in connection with the Acquisition. A "B+" and a
"B-" rating are A.M. Best's sixth and eighth highest rating classifications,
respectively, out of 15 ratings. A "B+" rating is awarded to insurers which, in
A.M. Best's opinion, "have demonstrated very good overall performance when
compared to the standards established by the A.M. Best Company" and "have a good
ability to meet their obligations to policyholders over a long period of time".
A "B-" rating is awarded to insurers which, in A.M. Best's opinion, "have
demonstrated adequate overall performance when compared to the standards
established by the A.M. Best Company" and "generally have an adequate ability to
meet their obligations to policyholders, but their financial strength is
vulnerable to unfavorable changes in underwriting or economic conditions." IGF
recently received an "NA-2" rating (a "rating not assigned" category for
companies that do not meet A.M. Best's minimum size requirement) from A.M. Best.
IGF intends to seek a revised rating in 1999, although there can be no assurance
that a revised rating will be obtained or as to the level of any such rating.
A.M. Best bases its ratings on factors that concern policyholders and agents and
not upon factors concerning investor protection. Such ratings are subject to
change and are not recommendations to buy, sell or hold securities. One factor
in an insurer's ability to compete effectively is its A.M. Best rating. The A.M.
Best ratings for the Company's rated Insurers are lower than for many of the
Company's competitors. There can be no assurance that such ratings or future
changes therein will not affect the Company's competitive position.
Geographic Concentration
The Company's nonstandard automobile insurance business is concentrated
in the states of Florida, California, Georgia, Indiana and Virginia;
consequently the Company will be significantly affected by changes in the
regulatory and business climate in those states. The Company's crop insurance
business is concentrated in the states of Texas, North Dakota, Iowa, Minnesota,
Illinois, California, Nebraska, Mississippi, Arkansas and South Dakota and the
Company will be significantly affected by weather conditions, natural perils and
other factors affecting the crop insurance business in those states.
Future Growth and Continued Operations Dependent on Access to Capital
Property and casualty insurance is a capital intensive business. The
Company must maintain minimum levels of surplus in the Insurers in order to
continue to write business, meet the other related standards established by
insurance regulatory authorities and insurance rating bureaus and satisfy
financial ratio covenants in loan agreements.
Historically, the Company has achieved premium growth as a result of
both acquisitions and internal growth. It intends to continue to pursue
35
acquisition and new internal growth opportunities. Among the factors which may
restrict the Company's future growth is the availability of capital. Such
capital will likely have to be obtained through debt or equity financing or
retained earnings. There can be no assurance that the Company's insurance
subsidiaries will have access to sufficient capital to support future growth and
also satisfy the capital requirements of rating agencies, regulators and
creditors. In addition, the Company will require additional capital to finance
future acquisitions.
The Company's ability to borrow additional funds has been limited under
the terms of the Indenture for the Preferred Securities.
Uncertainty Associated with Estimating Reserves for Unpaid Losses and LAE
The reserves for unpaid losses and LAE established by the Company are
estimates of amounts needed to pay reported and unreported claims and related
LAE based on facts and circumstances then known. These reserves are based on
estimates of trends in claims severity, judicial theories of liability and other
factors.
Although the nature of the Company's insurance business is primarily
short-tail, the establishment of adequate reserves is an inherently uncertain
process, and there can be no assurance that the ultimate liability will not
materially exceed the Company's reserves for losses and LAE and have a material
adverse effect on the Company's results of operations and financial condition.
Due to the inherent uncertainty of estimating these amounts, it has been
necessary, and may over time continue to be necessary, to revise estimates of
the Company's reserves for losses and LAE. The historic development of reserves
for losses and LAE may not necessarily reflect future trends in the development
of these amounts. Accordingly, it may not be appropriate to extrapolate
redundancies or deficiencies based on historical information.
Reliance Upon Reinsurance
In order to reduce risk and to increase its underwriting capacity, the
Company purchases reinsurance. Reinsurance does not relieve the Company of
liability to its insureds for the risks ceded to reinsurers. As such, the
Company is subject to credit risk with respect to the risks ceded to reinsurers.
Although the Company places its reinsurance with reinsurers, including the FCIC,
which the Company generally believes to be financially stable, a significant
reinsurer's insolvency or inability to make payments under the terms of a
reinsurance treaty could have a material adverse effect on the Company's
financial condition or results of operations.
The amount and cost of reinsurance available to companies specializing
in property and casualty insurance are subject, in large part, to prevailing
market conditions beyond the control of such companies. The Company's ability to
provide insurance at competitive premium rates and coverage limits on a
continuing basis depends upon its ability to obtain adequate reinsurance in
amounts and at rates that will not adversely affect its competitive position.
Due to continuing market uncertainties regarding reinsurance capacity,
no assurances can be given as to the Company's ability to maintain its current
reinsurance facilities, which generally are subject to annual renewal. If the
Company is unable to renew such facilities upon their expiration and is
unwilling to bear the associated increase in net exposures, the Company may need
to reduce the levels of its underwriting commitments.
Risks Associated with Investments
The Company's results of operations depend in part on the performance
of its invested assets. Certain risks are inherent in connection with fixed
maturity securities including loss upon default and price volatility in reaction
to changes in interest rates and general market factors. Equity securities
involve risks arising from the financial performance of, or other developments
affecting, particular issuers as well as price volatility arising from general
stock market conditions.
Comprehensive State Regulation
The Company's insurance subsidiaries are subject to comprehensive
regulation by government agencies in the states in which they operate. The
nature and extent of that regulation vary from jurisdiction to jurisdiction but
typically involve prior approval of the acquisition of control of an insurance
36
company or of any company controlling an insurance company, regulation of
certain transactions entered into by an insurance company with any of its
affiliates, limitations on dividends, approval or filing of premium rates and
policy forms for many lines of insurance, solvency standards, minimum amounts of
capital and surplus which must be maintained, limitations on types and amounts
of investments, restrictions on the size of risks which may be insured by a
single company, limitation of the right to cancel or non-renew policies in some
lines, regulation of the right to withdraw from markets or agencies,
requirements to participate in residual markets, licensing of insurers and
agents, deposits of securities for the benefit of policyholders, reporting with
respect to financial condition, and other matters. In addition, state
insurance department examiners perform periodic financial and market
conduct examinations of insurance companies. Such regulation is generally
intended for the protection of policyholders rather than security holders. No
assurance can be given that future legislative or regulatory changes will not
adversely affect the Company.
Holding Company Structure; Dividend And Other Restrictions; Management Fees
Holding Company Structure. The Company is a holding company whose
principal asset is the capital stock of the subsidiaries. The Company relies
primarily on dividends and other payments from its subsidiaries, including its
insurance subsidiaries, to meet its obligations to creditors and to pay
corporate expenses. The Insurers are domiciled in the states of Indiana and
Florida and each of these states limits the payment of dividends and other
distributions by insurance companies. The Company's reinsurance subsidiary,
Granite Re is also limited in its ability to make payments to the Company as a
result of restrictions imposed by the regulatory bodies that govern the
companies that ceded business to it.
Dividend and Other Restrictions. Indiana law defines as "extraordinary"
any dividend or distribution which, together with all other dividends and
distributions to shareholders within the preceding twelve months, exceeds the
greater of: (i) 10% of statutory surplus as regards policyholders as of the end
of the preceding year, or (ii) the prior year's net income. Dividends which are
not "extraordinary" may be paid ten days after the Indiana Department of
Insurance ("Indiana Department") receives notice of their declaration.
"Extraordinary" dividends and distributions may not be paid without the prior
approval of the Indiana Commissioner of Insurance (the "Indiana Commissioner")
or until the Indiana Commissioner has been given thirty days' prior notice and
has not disapproved within that period. The Indiana Department must receive
notice of all dividends, whether "extraordinary" or not, within five business
days after they are declared. Notwithstanding the foregoing limit, a domestic
insurer may not declare or pay a dividend from any source of funds other than
"Earned Surplus" without the prior approval of the Indiana Department. "Earned
Surplus" is defined as the amount of unassigned funds set forth in the insurer's
most recent annual statement, less surplus attributable to unrealized capital
gain or re-evaluation of assets. Further, no Indiana domiciled insurer may make
payments in the form of dividends or otherwise to its shareholders unless it
possesses assets in the amount of such payments in excess of the sum of its
liabilities and the aggregate amount of the par value of all shares of capital
stock; provided, that in no instance shall such dividend reduce the total of (I)
gross paid-in and contributed surplus, plus (ii) special surplus funds, plus
(iii) unassigned funds, minus (iv) treasury stock at cost, below an amount equal
to 50% of the aggregate amount of the par value of all shares of the insurer's
capital stock.
Under Florida law, a domestic insurer may not pay any dividend or
distribute cash or other property to its stockholders except out of that part of
its available and accumulated surplus funds which is derived from realized net
operating profits on its business and net realized capital gains. A Florida
domestic insurer may make dividend payments or distributions to stockholders
without prior approval of the Florida Department of Insurance ("Florida
Department") if the dividend or distribution does not exceed the larger of: (i)
the lesser of (a) 10% of surplus or (b) net investment income, not including
realized capital gains, plus a 2-year carryforward, (ii) 10% of surplus with
dividends payable constrained to unassigned funds minus 25% of unrealized
capital gains, or (iii) the lesser of (a) 10% of surplus or (b) net investment
income plus a 3-year carryforward with dividends payable constrained to
unassigned funds minus 25% of unrealized capital gains. Alternatively, a Florida
domestic insurer may pay a dividend or distribution without the prior written
approval of the Florida Department if (1) the dividend is equal to or less than
the greater of (i) 10% of the insurer's surplus as regards policyholders derived
from net operating profits on its business and net realized capital gains, or
(ii) the insurer's entire net operating profits (including unrealized gains or
losses) and realized net capital gains derived during the immediately preceding
calendar year; (2) the insurer will have policyholder surplus equal to or
exceeding 115% of the minimum required statutory surplus after the dividend or
distribution; (3) the insurer files a notice of the dividend or distribution
with the Florida Department at least ten business days prior to the dividend
payment or distribution; and (4) the notice includes a certification by an
officer of the insurer attesting that, after the payment of the dividend or
distribution, the insurer will have at least 115% of required statutory surplus
37
as to policyholders. Except as provided above, a Florida domiciled insurer may
only pay a dividend or make a distribution (i) subject to prior approval by the
Florida Department, or (ii) thirty days after the Florida Department has
received notice of such dividend or distribution and has not disapproved it
within such time. In the consent order approving the Acquisition (the "Consent
Order"), the Florida Department has prohibited Superior from paying any
dividends (whether extraordinary or not) for four years from date of acquisition
without the prior written approval of the Florida Department.
Although the Company believes that funds required for it to meet its
financial and operating obligations will be available, there can be no assurance
in this regard. Further, there can be no assurance that, if requested, the
Indiana Department will approve any request for extraordinary dividends from
Pafco or IGF or that the Florida Department will allow any dividends to be paid
by Superior during the four year period described above.
The maximum dividends permitted by state law are not necessarily
indicative of an insurer's actual ability to pay dividends or other
distributions to a parent company, which also may be constrained by business and
regulatory considerations, such as the impact of dividends on surplus, which
could affect an insurer's competitive position, the amount of premiums that can
be written and the ability to pay future dividends. Further, state insurance
laws and regulations require that the statutory surplus of an insurance company
following any dividend or distribution by such company be reasonable in relation
to its outstanding liabilities and adequate for its financial needs.
Management Fees. The management agreement originally entered into
between SIG and Pafco was assigned as of April 30, 1996 by SIG to GGS
Management, a wholly-owned subsidiary of GGS Holdings. This agreement provides
for an annual management fee equal to 15% of gross premiums written. A similar
management agreement with a management fee of 17% of gross premiums written has
been entered into between GGS Management and Superior. Employees of SIG relating
to the nonstandard automobile insurance business and all Superior employees
became employees of GGS Management effective April 30, 1996. In the Consent
Order approving the Acquisition, the Florida Department has reserved, for a
period of three years, the right to re-evaluate the reasonableness of fees
provided for in the Superior management agreement at the end of each calendar
year and to require Superior to make adjustments in the management fees based on
the Florida Department's consideration of the performance and operating
percentages of Superior and other pertinent data. There can be no assurance that
either the Indiana Department or the Florida Department will not in the future
require a reduction in these management fees.
Y2K
Please refer to the section, "Impact of Year 2000 Issue", in "Management's
Discussion and Analysis of Results and Operations" in the 1998 Annual Report for
a discussion on this topic.
ITEM 2 - PROPERTIES
The headquarters for the Company is leased space at 181 University Avenue,
Suite 1101, Toronto, Ontario, while SIG, GGS Holdings and Pafco are located at
4720 Kingsway Drive, Indianapolis, Indiana. The Indianapolis building is an
80,000 square foot multilevel structure approximately 50% of which is utilized
by Pafco. The remaining space is leased to third parties at a price of
approximately $10 per square foot.
Pafco also owns an investment property located at 2105 North Meridian,
Indianapolis, Indiana. The property is a 21,700 square foot, multilevel building
leased out entirely to third parties.
Superior's operations are conducted at leased facilities located in
Atlanta, Georgia; Tampa, Florida; and Orange, California. Under a lease term
which extends through February 2003, Superior leases office space at 280
Interstate North Circle, N.W., Suite 500, Atlanta, Georgia. Superior occupies
43,448 square feet at this location. Superior also has an office located at 3030
W. Rocky Pointe Drive, Suite 770, Tampa, Florida consisting of 18,477 square
feet of space leased for a term extending through February 2000. In addition,
Superior occupies an office at 1745 West Orangewood, Orange, California
consisting of 3,264 square feet under a lease extending through May 1999.
IGF owns a 57,799 square foot office building located at 6000 Grand
Avenue, Des Moines, Iowa which serves as its corporate headquarters. The
building is fully occupied by IGF.
38
ITEM 3 - LEGAL PROCEEDINGS
The Company's insurance subsidiaries are parties to litigation arising
in the ordinary course of business. The Company believes that the ultimate
resolution of these lawsuits will not have a material adverse effect on its
financial condition or results of operations. The Company, through its claims
reserves, reserves for both the amount of estimated damages attributable to
these lawsuits and the estimated costs of litigation.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted during 1998 to a vote of security holders of
the Registrant, through the solicitation of proxies or otherwise.
SEPARATE ITEM, EXECUTIVE OFFICERS OF THE REGISTRANT
Presented below is certain information regarding the executive officers
of the Company who are not also directors. Their respective ages and their
respective positions with the Company are listed as follows:
Name Age Position
David L. Bates 40 Vice President, General Counsel and
Secretary of the Company
Gary P. Hutchcraft 37 Vice President, Chief Financial Officer
and Treasurer of the Company
Mr. Bates, J.D., C.P.A., has served as Vice President, General Counsel
and Secretary of SIG since November, 1995 after having been named Vice President
and General Counsel of the Company in April, 1995. Mr. Bates served as a member
of the Fort Howard Corporation Legal Department from September, 1988 through
March, 1995. Prior to that time, Mr. Bates served as a Tax Manager with Deloitte
& Touche.
Mr. Hutchcraft, C.P.A., has served as Vice President, Chief Financial
Officer and Treasurer of SIG and the Company since July, 1996. Prior to that
time, Mr. Hutchcraft served as an Assurance Manager with KPMG Peat Marwick, LLP.
ITEM 5 - MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Information regarding the trading market for the Company's Common
Shares, the range of selling prices for each quarterly period for the years
ended December 31, 1998 and 1997 with respect to the Common Shares and the
approximate number of holders of Common Shares as of December 31, 1998 the
Common Shares and other matters is included under the caption Market Information
on Page 42 of the 1998 Annual Report, included as Exhibit 13, which information
is incorporated herein by reference.
The Company currently intends to retain earnings for use in the
operation and expansion of its business and therefore does not anticipate paying
cash dividends on its Common Stock in the foreseeable future. The payment of
dividends is within the discretion of the Board of Directors and will depend,
among other things, upon earnings, capital requirements, any financing agreement
covenants and the financial condition of the Company. In addition, regulatory
restrictions and provisions of the Preferred Securities limit distributions to
shareholders.
ITEM 6 - SELECTED FINANCIAL DATA
Selected Financial Data of the Company follows:
39
GORAN CAPITAL INC.
Selected Financial Data
As of the Year Ended December 31,
(In Thousands of U.S. Dollars)
1994 1995 1996 1997 1998
Gross Premium Revenue $126,978 $146,603 $299,376 $448,982 $546,771
Net Earnings (Loss)-Continuing Operations - CDN GAAP 3,940 7,171 14,127 15,983 (8,999)
Net Earnings (Loss) - CDN GAAP 3,940 7,171 31,296 12,438 (11,936)
U.S./Canada GAAP Differences:
Discounting on Outstanding Claims 88 (161) 62 (504) --
Deferred Income Taxes 1,180 (344) (64) 177 --
Minority Interest -- -- (177) 107 --
Net Earnings (Loss)-Continuing Operations - US GAAP 5,208 6,666 14,125 15,763 (8,999)
Net Earnings (Loss) - US GAAP 5,208 6,666 31,117 12,218 (11,936)
Basic Earnings Per Share-Continuing Operations - US GAAP $0.96 $1.33 $2.67 $2.82 $(1.54)
Basic Earnings Per Share - US GAAP $0.96 $1.33 $5.87 $2.19 $(2.04)
EPS Continuing Operations-Fully Diluted - US GAAP $0.96 $1.20 $2.47 $2.68 $(1.54)
EPS-Fully Diluted - US GAAP $0.96 $1.20 $5.44 $2.08 $(2.04)
Dividends Per Share $0.00 $0.00 $0.00 $0.00 $0.00
Total Assets - CDN GAAP 115,240 160,816 381,342 560,848 570,989
U.S./Canada GAAP Differences:
Loans to Purchase Shares (593) (563) (595) (346) (1,377)
Deferred Income Taxes 1,742 1,466 1,798 1,975 --
Outstanding Claims Ceded -- -- -- -- --
Unearned Premiums Ceded -- -- -- -- --
Unrealized Gain (Loss) on Investments (1,383) (221) 820 1,336 1,630
Total Assets - US GAAP 115,006 161,498 383,365 563,813 571,242
Long Term Bonds and Debentures 10,787 9,237 -- -- --
Shareholders' Equity - CDN GAAP 5,067 12,622 47,258 60,332 49,725
U.S./Canada GAAP Differences:
Deferred Income Taxes 1,742 1,466 1,798 1,975 --
Discounting on Claims (1,134) (1,327) (1,260) (1,765) --
Unrealized Gain (Loss) on Investments (1,383) (221) 820 1,336 1,176
Minority Interest Portion -- -- (177) (70) --
Loans to Purchase Shares (593) (563) (595) (346) (1,377)
Shareholders' Equity - US GAAP 3,699 11,977 47,843 61,462 49,524
Shares Outstanding-Fully Diluted - US GAAP 5,399,463 5,567,644 5,724,476 5,886,211 5,841,329
40
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF 0PERATIONS
The discussion entitled "Management Discussion and Analysis of Financial
Condition and Results of Operations" in the 1998 Annual Report on pages 5
through 19 included as Exhibit 13 is incorporated herein by reference.
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements included in the 1998 Annual Report,
included as Exhibit 13, and listed in Item 14 of this Report are incorporated
herein by reference.
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item regarding Directors of the Company is
incorporated herein by reference to the Company's definitive proxy statement for
its 1999 annual meeting of common stockholders filed with the Commission
pursuant to Regulation 14A (the "1999 Proxy Statement").
ITEM 11 - EXECUTIVE COMPENSATION
The information required by this Item is incorporated herein by reference
to the Company's 1999 Proxy Statement.
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated herein by reference
to the Company's 1999 Proxy Statement.
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated herein by reference
to the Company's 1999 Proxy Statement.
41
PART IV
ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
The documents listed below are filed as a part of this Report except as
otherwise indicated:
1. Financial Statements. The following described consolidated financial
statements found on the pages of the 1998 Annual Report indicated below
are incorporated into Item 8 of this Report by reference.
Description of Financial Statement Item Page
Report of Independent Auditors 41
Consolidated Balance Sheets, December 31, 1998 and 1997 20
Consolidated Statements of Earnings,
Years Ended December 31, 1998, 1997 and 1996 21
Consolidated Statements of Changes in Shareholders' Equity,
Years Ended December 31, 1998, 1997 and 1996 22
Consolidated Statements of Cash Flows,
Years Ended December 31, 1998, 1997 and 1996 23
Notes to Consolidated Financial Statements,
Years Ended December 31, 1998, 1997 and 1996 24-39
2. Financial Statement Schedules.
The following financial statement schedules are included herein.
Description of Financial Statement Item Page
Schedule II - Condensed Financial Information Of Registrant 43
Schedule IV - Reinsurance 46
Schedule V - Valuation And Qualifying Accounts 47
Schedule VI - Supplemental Information Concerning
Property-Casualty Insurance Operations 48
Schedules other than those listed above have been omitted because the
required information is contained in the financial statements and notes thereto
or because such schedules are not required or applicable.
3. Exhibits. The Exhibits set forth on the Index to Exhibits are incorporated
herein by reference.
4. Reports on Form 8-K. None
42
GORAN CAPITAL INC.
SCHEDULE II - CONDENSED FINANCIAL INFORMATION
OF REGISTRANT (PARENT COMPANY)
BALANCE SHEET
As At December 31,
(In Thousands U.S. Dollars)
(Unaudited)
1997 1998
Assets:
Cash and Short-term Investments $1,166 $233
Loans to Related Parties 334 1,982
Capital and Other Assets 597 503
Investment in Subsidiaries, at Cost 10,321 9,636
------ ------
Total Assets $12,418 $12,354
====== ======
Liabilities and Shareholders' Equity:
Loans from Related Parties 9,324 9,937
------ ------
Total Liabilities 9,324 9,937
------ ------
Shareholders' Equity:
Common Shares 18,010 19,317
Cumulative Translation Adjustment 1,597 1,367
Deficit (16,513) (18,267)
------ ------
Total Shareholders' Equity 3,094 2,417
------ ------
Total Liabilities and Shareholders' Equity $12,418 $12,354
====== ======
43
GORAN CAPITAL INC.
SCHEDULE II - CONDENSED FINANCIAL INFORMATION
OF REGISTRANT
STATEMENT OF EARNINGS (LOSS)
For The Years Ended December 31,
(In Thousands of U.S. Dollars)
(Unaudited)
1996 1997 1998
Revenues:
Management Fees $352 $336 $108
Dividend Income 3,500 -- --
Other Income -- 52 --
Net Investment Income 264 15 40
------ ----- ------
Total Revenues 4,116 403 148
------ ----- ------
Expenses:
Debenture Interest Expense 868 -- --
Amortization 199 -- --
General, Administrative and Acquisition Expenses 1,879 (234) 1,380
------ ----- ------
Total Expenses 2,946 (234) 1,380
------ ----- ------
Net Income (Loss) 1,170 637 (1,232)
Other - Purchase of Common Shares -- -- (522)
Deficit, Beginning of Year (18,320) (17,150) (16,513)
------ ------ ------
Deficit, End of Year $(17,150) (16,513) (18,267)
====== ====== ======
44
GORAN CAPITAL INC.
SCHEDULE II - CONDENSED FINANCIAL INFORMATION
OF REGISTRANT
STATEMENT OF CASH FLOWS
For The Years Ended December 31,
(In Thousands of U.S. Dollars)
(Unaudited)
Cash Flows from Operations 1996 1997 1998
Net Income (Loss) $1,170 $637 $(1,232)
Items Not Involving Cash:
Amortization and Depreciation 199 -- --
Gain on Sale of Capital Assets (4) -- --
Decrease (Increase) in Accounts Receivable (1) (40) 86 (471)
Decrease (Increase) in Other Assets (3) (54) 779
Increase (Decrease) in Accounts Payable 8,749 (867) 613
Translation Adjustment -- -- (230)
------ --- ---
Net Cash Provided (Used) by Operations 10,071 (198) (541)
------ --- ---
Cash Flows From Financing Activities:
Proceeds on Sale of Capital Assets 14 -- --
Purchase of Common Shares -- -- (748)
Issue of Common Shares (1) 599 594 356
--- --- ---
Net Cash Provided by Financing Activities 613 594 (392)
--- --- ---
Cash Flows From Investing Activities:
Other, net (93) 451 --
Reduction of Debentures (11,084) -- --
------ --- ---
Net Cash Used by Investing Activities (11,177) 451 --
------ --- ---
Net Increase (Decrease) in Cash (493) 847 (933)
Cash at Beginning of Year 812 319 1,166
--- --- -----
Cash at End of Year $319 $1,166 $233
=== ===== ===
Cash Resources are Comprised of:
Cash 187 78 104
Short-Term Investments 132 1,088 129
--- ----- ---
$319 $1,166 $233
=== ===== ===
(1) Amounts for 1998 exclude consideration of $1, 177 for the issuance of common
shares received in the form of share purchase loans.
45
GORAN CAPITAL INC. - CONSOLIDATED
SCHEDULE II - CONDENSED FINANCIAL INFORMATION
OF REGISTRANT
For The Years Ended December 31, 1998, 1997 and 1996
Basis of Presentation
The condensed financial information should be read in conjunction with the
consolidated financial statements of Goran Capital Inc. The condensed financial
information includes the accounts and activities of the Parent Company which
acts as the holding company for the insurance subsidiaries.
GORAN CAPITAL INC. - CONSOLIDATED
SCHEDULE IV - REINSURANCE
For The Years Ended December 31,
(In Thousands of U.S. Dollars)
Premiums Written (1) 1996 1997 1998
Direct Amount $290,355 $420,443 $419,966
Assumed from Other Companies $9,021 $28,539 $126,805
Ceded to Other Companies $(85,598) $(167,086) $(184,665)
Net Amount $213,778 $281,896 $362,106
Percentage of Amount Assumed to Net 4.2% 10.1% 35.0%
(1) Excludes premiums written with respect to discontinued operations.
46
GORAN CAPITAL INC. - CONSOLIDATED
SCHEDULE V - VALUATION AND
QUALIFYING ACCOUNTS
For The Years Ended December 31,
(In Thousands of U.S. Dollars)
1996 1997 1998
Allowance for Allowance for Allowance for
Doubtful Doubtful Doubtful
Accounts Accounts Accounts
Additions:
Balance at Beginning of Period $927 $1,480 $1,993
Reserves Acquired in the Superior
Acquisition 500 -- --
Charged to Costs and Expenses (1) 5,034 9,519 12,690
Charged to Other Accounts -- -- --
Deductions from Reserves (4,981)(2) (9,006) (8,290)
----- ----- -----
Balance at End of Period $1,480 $1,993 $6,393
===== ===== =====
(1) The Company continually monitors the adequacy of its allowance for doubtful
accounts and believes the balance of such allowance at December 31, 1998,
1997 and 1996 was adequate.
(2) Uncollectible accounts written off, net of recoveries.
47
GORAN CAPITAL INC. - CONSOLIDATED
SCHEDULE VI - SUPPLEMENTAL
INFORMATION CONCERNING PROPERTY -
CASUALTY INSURANCE OPERATIONS
For The Years Ended December 31,
(In Thousands of U.S. Dollars)
1996 1997 1998
Deferred Policy Acquisition Costs $13,860 $11,849 $16,332
Reserves for Losses and Loss Adjustment Expenses 127,045 152,871 218,233
Unearned Premiums 91,207 118,616 110,665
Earned Premiums 208,883 276,540 342,177
Net Investment Income 7,745 12,777 13,401
Losses and Loss Adjustment Expenses Incurred Related to:
Current Years 146,844 201,483 268,750
Prior Years (570) 9,516 12,142
Paid Losses and Loss Adjustment Expenses 139,441 203,012 236,179
Amortization of Deferred Policy Acquisition Costs 27,657 19,356 51,558
Premiums Written 299,376 448,982 546,771
Note: All amounts in the above table are net of the effects of reinsurance
and related commission income, except for net investment income regarding
which reinsurance is not applicable, premiums written, liabilities for
losses and loss adjustment expenses, and unearned premiums which are stated
on a gross basis. The amounts in the above table exclude amounts with
respect to discontinued operations.
48
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Registrant has duly caused this report to
be signed on its behalf by the undersigned, thereto duly authorized.
GORAN CAPITAL INC.
April 13, 1999 By: /s/ Alan G. Symons
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on April 13, 1999, on
behalf of the registrant in the capacities indicated:
(1) Principal Executive Officer:
/s/ Alan G. Symons
Chief Executive Officer
(2) Principal Financial/Accounting Officer:
/s/Gary P. Hutchcraft
Vice President and Chief Financial Officer
(3) The Board of Directors:
/s/G. Gordon Symons /s/David B. Shapira
Chairman of the Board Director
/s/John K. McKeating /s/James G. Torrance
Director Director
/s/J. Ross Schofield /s/Douglas H. Symons
Director Director
/s/Alan G. Symons
Director
49
EXHIBIT INDEX
Reference to
Regulation S-K
Exhibit No. Document
1 Final Draft of the Underwriting Agreement dated November 4,
1996 among Registrant, Symons International Group, Inc.,
Advest, Inc. and Mesirow Financial, Inc. is incorporated by
reference in the Registrant's 1996 Form 10-K.
2.1 The Strategic Alliance Agreement by and between Continental
Casualty Company and IGF Insurance Company, IGF Holdings, Inc.
and Symons International Group, Inc. dated February 28, 1998
is incorporated by reference to Exhibit 2.1 of the
Registrant's 1997 Form 10-K.
2.2 The MPCI Quota Share Reinsurance Contract by and between
Continental Casualty Company and IGF Insurance Company, IGF
Holdings, Inc. and Symons International Group, Inc. dated
February 28, 1998 is incorporated by reference to Exhibit 2.2
of the Registrant's 1997 Form 10-K.
2.3 The MPCI Quota Share Reinsurance Agreement by and between
Continental Casualty Company and IGF Insurance Company, IGF
Holdings, Inc. and Symons International Group, Inc. dated
February 28, 1998 is incorporated by reference to Exhibit 2.3
of the Registrant's 1997 Form 10-K.
2.4 The Crop Hail Insurance Quota Share Contract by and between
Continental Casualty Company and IGF Insurance Company, IGF
Holdings, Inc. and Symons International Group, Inc. dated
February 28, 1998 is incorporated by reference to Exhibit 2.4
of the Registrant's 1997 Form 10-K.
2.5 The Crop Hail Insurance Quota Share Agreement by and between
Continental Casualty Company and IGF Insurance Company, IGF
Holdings, Inc. and Symons International Group, Inc. dated
February 28, 1998 is incorporated by reference to Exhibit 2.5
of the Registrant's 1997 Form 10-K.
2.6 The Crop Hail Insurance Services and Indemnity Agreement by
and between Continental Casualty Company and IGF Insurance
Company, IGF Holdings, Inc. and Symons International Group,
Inc. dated February 28, 1998 is incorporated by reference to
Exhibit 2.6 of the Registrant's 1997 Form 10-K.
2.7 The Multiple Peril Crop Insurance Service and Indemnity
Agreement by and between Continental Casualty Company and IGF
Insurance Company, IGF Holdings, Inc. and Symons International
Group, Inc. dated February 28, 1998 is incorporated by
reference to Exhibit 2.7 of the Registrant's 1997 Form 10-K.
2.8 The Stock Purchase Agreement between Symons International
Group, Inc. and GS Capital Partners II, L.P. dated July 23,
1997 is incorporated by reference to Exhibit 2.8 of the
Registrant's 1997 Form 10-K.
2.9 The Stock Purchase Agreement between IGF Holdings, Inc. and
1911 CORP. dated July 7, 1998.
2.10 The Asset Purchase Agreement between the Registrant and
Florida International Underwriters dated January 1, 1999.
3.1 The Registrant's Articles of Incorporation are incorporated
by reference to Exhibit 1 of the Registrant's Form 20-F,
filed October 31, 1994.
3.2 Registrant's Restated Bylaw 1 is incorporated by reference in
the Registrant's 1996 Form 10-K.
4.1 Sample Share Certificate and Articles of Amalgamation defining
rights attaching to common shares are incorporated by
reference to Exhibit 2 of Registrant's Form 20-F filed
October 31, 1994.
4.2(1) The Senior Subordinated Indenture between Symons
International Group, Inc. as issuer and Wilmington
Trust Company as trustee for SIG Capital Trust I
dated August 12, 1997 is incorporated by reference in
the Registrant's Registration Statement on Form S-4,
Reg. No. 333-35713.
4.2(2) First Supplemental Senior Subordinated Indenture between
Symons International Group, Inc. and Wilmington Trust Company
Related to SIG Capital Trust I dated January 15, 1998.
10.1 The Stock Purchase Agreement among Registrant, Symons
International Group, Inc., Fortis, Inc. and Interfinancial,
Inc. dated January 31, 1996 is incorporated by reference to
Exhibit 10.1 of Symons International Group, Inc.'s
Registration Statement on Form S-1, Reg. No. 333-9129.
10.2 The Management Agreement among Superior Insurance Company,
Superior American Insurance Company, Superior Guaranty
Insurance Company and GGS Management, Inc. dated April 30,
1996 is incorporated by reference to Exhibit 10.5 of Symons
International Group, Inc.'s Registration Statement on
Form S-1, Reg. No. 333-9129.
10.3 The Management Agreement between Pafco General Insurance
Company and Symons International Group, Inc. dated May 1,
1987, as assigned to GGS Management, Inc. effective April 30,
1996, is incorporated by reference to Exhibit 10.6 of Symons
International Group, Inc.'s Registration Statement on
Form S-1, Reg. No. 333-9129.
10.4 The Administration Agreement between IGF Insurance Company and
Symons International Group, Inc. dated February 26, 1990, as
amended, is incorporated by reference to Exhibit 10.7 of the
Symons International Group, Inc.'s Registration Statement on
Form S-1, Reg. No. 333-9129.
10.5 The Agreement between IGF Insurance Company and Symons
International Group, Inc. dated November 1, 1990 is
incorporated by reference to Exhibit 10.8 of Symons
International Group, Inc.'s Registration Statement on
Form S-1, Reg. No. 333-9129.
10.6 The Registration Rights Agreement between Registrant and
Symons International Group, Inc. dated May 29, 1996 is
incorporated by reference to Exhibit 10.13 of Symons
International Group, Inc.'s Registration Statement on
Form S-1, Reg. No. 333-9129.
10.7(1) The Employment Agreement between GGS Management Holdings, Inc.
and Alan G. Symons dated January 31, 1996 is incorporated by
reference to Exhibit 10.16(1) of Symons International Group,
Inc.'s Registration Statement on Form S-1, Reg. No. 333-9129.
10.7(2) The Employment Agreement between GGS Management Holdings, Inc.
and Douglas H. Symons dated January 31, 1996 is
incorporated by reference to Exhibit 10.16(2) of Symons
International Group, Inc.'s Registration Statement on
Form S-1, Reg. No. 333-9129.
10.8(1) The Employment Agreement between IGF Insurance Company and
Dennis G. Daggett effective February 1, 1996 is incorporated
by reference to Exhibit 10.17(1) of Symons International
Group, Inc.'s Registration Statement on Form S-1,
Reg. No. 333-9129.
10.8(2) The Employment Agreement between IGF Insurance Company and
Thomas F. Gowdy effective February 1, 1996 is incorporated by
reference to Exhibit 10.17(2) of Symons International Group,
Inc.'s Registration Statement on Form S-1, Reg. No. 333-9129.
10.9 The Employment Agreement between Superior Insurance Company
and Roger C. Sullivan, Jr. effective April 23, 1997 is
incorporated by reference to Exhibit 10.9 of the
Registrant's 1997 Form 10-K.
10.10 The Employment Agreement between Registrant and Gary
P. Hutchcraft effective May 1, 1997 is incorporated
by reference to Exhibit 10.10 of the Registrant's
1997 Form 10-K.
10.11 The Employment Agreement between Registrant and David
L. Bates effective April 1, 1997 is incorporated by
reference to Exhibit 10.11 of the Registrant's 1997
Form 10-K.
10.12 The Employment Agreement between Symons International Group,
Inc. and Carl F. Schnaufer effective August 14, 1998.
10.13 The Goran Capital Inc. Stock Option Plan is incorporated by
reference to Exhibit 10.20 of Symons International Group,
Inc.'s Registration Statement of Form S-1,
Reg. No. 333-9129.
10.14 The GGS Management Holdings, Inc. 1996 Stock Option Plan is
incorporated by reference to Exhibit 10.21 of Symons
International Group, Inc.'s Registration Statement on
Form S-1, Reg. No. 333-9129.
10.15 The Symons International Group, Inc. 1996 Stock Option Plan is
incorporated by reference to Exhibit 10.22 of Symons
International Group, Inc.'s Registration Statement on
Form S-1, Reg. No. 333-9129.
10.16 The Symons International Group, Inc. Retirement Savings Plan
is incorporated by reference to Exhibit 10.24 of Symons
International Group, Inc.'s Registration Statement on
Form S-1, Reg. No. 333-9129.
10.17 The Insurance Service Agreement between Mutual Service
Casualty Company and IGF Insurance Company dated May 20, 1996
is incorporated by reference to Exhibit 10.25 of Symons
International Group, Inc.'s Registration Statement on
Form S-1, Reg. No. 333-9129.
10.18(1) The Automobile Third Party Liability and Physical Damage Quota
Share Reinsurance. Contract between Pafco General Insurance
Company and Superior Insurance Company is incorporated by
reference to Exhibit 10.27(1) of Symons International Group,
Inc.'s Registration Statement on Form S-1, Reg. No. 333-9129.
10.18(2) The Crop Hail Quota Share Reinsurance Contract and Crop
Insurance Service Agreement between Pafco General Insurance
Company and IGF Insurance Company is incorporated by reference
to Exhibit 10.27(2) of Symons International Group, Inc.'s
Registration Statement on Form S-1, Reg. No. 333-9129.
10.18(3) The Automobile Third Party Liability and Physical Damage Quota
Share Reinsurance Contract between IGF Insurance Company and
Pafco General Insurance Company is incorporated by reference
to Exhibit 10.27(3) of Symons International Group, Inc.'s
Registration Statement on Form S-1, Reg. No. 333-9129.
10.18(4) The Multiple Line Quota Share Reinsurance Contract between IGF
Insurance Company and Pafco General Insurance Company is
incorporated by reference to Exhibit 10.27(4) of Symons
International Group, Inc.'s Registration Statement on Form
S-1, Reg. No.
333-9129.
10.18(5) The Standard Revenue Agreement between Federal Crop Insurance
Corporation and IGF Insurance Company is incorporated by
reference to Exhibit 10.27(5) of Symons International Group,
Inc.'s Registration Statement on Form S-1, Reg. No. 333-9129.
10.18(6) The Automobile Variable Quota Share Reinsurance Agreement
between The Superior Group and IGF Insurance Company dated
October 1, 1998.
10.18(7) The Automobile Variable Quota Share Reinsurance Agreement
between The Pafco Group and IGF Insurance Company dated
October 1, 1998.
10.18(8) The Automobile Variable Quota Share Reinsurance Agreement
between The Pafco Group and Granite Reinsurance Company, Ltd.
dated October 1, 1998.
10.19 The Commitment Letter, effective October 24, 1996, between
Fifth Third Bank of Central Indiana and Symons International
Group, Inc. is incorporated by reference to Exhibit 10.28 of
Symons International Group, Inc.'s Registration Statement on
Form S-1, Reg. No. 333-9129.
10.20 The Reinsurance Agreement No. 1000-91 (Quota Share Agreement)
and Reinsurance Agreement No. 1000-90 (Stop Loss Reinsurance
and Reserves Administration Agreement) are incorporated by
reference to Exhibit 3(c) of Registrant's Form 20-F filed
October 31, 1994.
10.21 The Form of Share Option Agreement is incorporated by
reference to Exhibit 10.05 of Registrant's Form 10-K for the
year ended December 31, 1994.
10.22 The Share Pledge Agreement between Symons International Group,
Ltd and Registrant is incorporated by reference to Exhibit
10.06 of Registrant's Form 10-K for the year ended
December 31, 1994.
10.23(1) The SIG Capital Trust I 91/2% Trust Preferred Securities
Purchase Agreement dated August 7, 1997 is incorporated by
reference in the Registrant's Registration Statement on
Form S-4, Reg. No. 333-35713.
10.23(2) The Registration Rights Agreement among Symons International
Group, Inc., SIG Capital Trust I and Donaldson, Lufkin &
Jenrette Securities Corporation, Goldman, Sachs & Co., CIBC
Wood Gundy Securities Corp. and Mesirow Financial, Inc. dated
August 12, 1997 is incorporated by reference in the
Registrant's Registration Statement on Form S-4,
Reg. No. 333-35713.
10.23(3) The Declaration of Trust of SIG Capital Trust 1 dated
August 4, 1997 is incorporated by reference in the
Registrant's Registration Statement on Form S-4,
Reg. No. 333-35713.
10.23(4) The Amended and Restated Declaration of Trust of SIG Capital
Trust I dated August 12, 1997 is incorporated by reference in
the Registrant's Registration Statement on Form S-4,
333-35713.
11 Statement re Computation of Per Share Earnings
13 Annual Report to Security Holders, 1998, 1997 and 1996
21 The Subsidiaries of the Registrant are incorporated
by reference to Footnote 1 of the Registrant's
consolidated financial statements contained in its
Annual Report to Security Holders filed hereunder as
Exhibit 13.
99 Management Proxy Circular with respect to 1998 Annual Meeting
of Shareholders of Registrant