Back to GetFilings.com
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended Commission file number
December 31, 1998 1-12338
VESTA INSURANCE GROUP, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
Delaware 63-1097283
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
3760 River Run Drive, 35243
Birmingham, AL
(ADDRESS OF PRINCIPAL (ZIP CODE)
EXECUTIVE OFFICES)
Registrant's telephone number, including area code:
(205) 970-7000
Securities registered pursuant to Section 12(b) of the Act:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS CUSIP NUMBER: ON WHICH REGISTERED:
Common Stock, $.01 Par 925391104 New York Stock Exchange
Value
Securities registered pursuant to Section 12(g) of the Act:
None
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) 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 ((S)229.405 OF THIS CHAPTER) IS NOT CONTAINED HEREIN, AND
WILL NOT BE CONTAINED, TO THE BEST OF REGISTRANT'S KNOWLEDGE, IN DEFINITIVE
PROXY OR INFORMATION STATEMENTS INCORPORATED BY REFERENCE IN PART III OF THIS
FORM 10-K OR ANY AMENDMENT TO THIS FORM 10-K. [_]
THE AGGREGATE MARKET VALUE OF THE VOTING STOCK HELD BY NON-AFFILIATES OF THE
REGISTRANT AS OF MARCH 23, 1999 $63,027,605
THE NUMBER OF SHARES OUTSTANDING OF THE REGISTRANT'S COMMON STOCK, AS OF MARCH
23, 1999 is 18,653,404
DOCUMENTS INCORPORATED BY REFERENCE
PORTIONS OF THE VESTA INSURANCE GROUP, INC. PROXY STATEMENT FOR ITS 1999
ANNUAL MEETING OF STOCKHOLDERS ARE INCORPORATED BY REFERENCE INTO PART III
HEREOF.
Table of Contents
Part I Page
------ ----
Item 1 Business
Overview..................................................... 1
Business Strategy............................................ 3
Lines of Business............................................ 4
Reinsurance.................................................. 4
Primary Insurance Business................................... 6
Reinsurance Ceded............................................ 11
Claims....................................................... 11
Reserves..................................................... 12
Investments.................................................. 15
Regulation................................................... 16
A.M. Best.................................................... 20
Competition.................................................. 20
Relationship with Torchmark.................................. 21
Employees.................................................... 21
Item 2 Properties................................................... 21
Item 3 Legal Proceedings............................................ 21
Item 4 Submission of Matters to a Vote of Security Holders.......... 23
Part II
-------
Item 5 Market for Registrants' Common Equity and Related Stockholder 23
Matters.....................................................
Item 6 Selected Financial Data...................................... 24
Item 7 Management's Discussion and Analysis of Results of Operations
and Financial Condition..................................... 26
Item 8 Financial Statements and Supplementary Data.................. 38
Part III
--------
Item 10 Directors and Executive Officers of the Registrants.......... 67
Item 11 Executive Compensation....................................... 67
Item 12 Security Ownership of Certain Beneficial Owners and 67
Management..................................................
Item 13 Certain Relationships and Related Transactions............... 67
Part IV
-------
Item 14 Exhibits, Financial Statement Schedules, and Reports on Form 68
8-K.........................................................
i
Special Note Regarding Forward-Looking Statements
Any statement contained in this report which is not a historical fact, or
which might otherwise be considered an opinion or projection concerning the
Company or its business, whether express or implied, is meant as and should be
considered a forward-looking statement as that term is defined in the Private
Securities LItigation Reform Act of 1996. Forward-looking statements are based
on assumptions and opinions concerning a variety of known and unknown risks,
including but not necessarily limited to changes in market conditions, natural
disasters and other catastrophic events, increased competition, changes in
availability and cost of reinsurance, changes in governmental regulations, and
general economic conditions, as well as other risks more completely described
in the Company's filings with the Securities and Exchange Commission including
this Report of Form 10-K. If any of these assumptions or opinions prove
incorrect, any forward-looking statements made on the basis of such
assumptions or opinions may also prove materially incorrect in one or more
respects.
ii
PART I
BUSINESS
Overview
Vesta Insurance Group, Inc. (the "Company" or "Vesta") is a holding company
for a group of property/casualty insurance companies ("Vesta Group"),
including Vesta Fire Insurance Corporation ("Vesta Fire"), which offers treaty
reinsurance and primary insurance on personal and commercial risks. The
Company was incorporated in Delaware on July 9, 1993 to be the holding company
for the property and casualty insurance subsidiaries of Torchmark Corporation
("Torchmark"). Prior to its initial public offering of common stock in
November 1993, the Company was a wholly owned subsidiary of Torchmark. As of
December 31, 1998, Torchmark held approximately 23.9% of the outstanding
common stock of the Company. The Company's principal property and casualty
subsidiary is Vesta Fire. The Company's principal executive offices are at
3760 River Run Drive, Birmingham, Alabama 35243, and its telephone number is
(205) 970-7000.
In its reinsurance and personal insurance operations, the Company focuses
primarily on private passenger automobile and property coverages. Gross
premiums written by the Company in 1998 totalled $759 million. At December 31,
1998, the Company's stockholders' equity was $158.0 million.
The Company has historically provided treaty reinsurance, principally
through reinsurance intermediaries, for small and medium-sized companies and
regional specific reinsurance for larger insurance companies located
throughout the United States. The principal lines of business reinsured by the
Company include homeowner and commercial property coverages, non-standard
automobile insurance and collateral protection insurance. In 1996, prior to
the acquisition of Shelby and Vesta County Mutual, as discussed below, assumed
reinsurance represented 76 percent of gross premiums. As a result of these
acquisitions, assumed reinsurance represented 62 percent of 1997 gross
premiums. Primarily as a result of these acquisitions and pricing pressures in
the reinsurance market place, assumed reinsurance represented 38 percent of
1998 gross premiums. This shift to increased personal and commercial writings
is consistent with the Company's strategy to focus on personal auto and
property coverages in all of its lines of business while adjusting the mix and
volume of its writings and retentions to respond to change in market
conditions. In light of the recent downgrade in the A.M. Best rating to B++,
and given the increasingly competitive market conditions in the reinsurance
marketplace, the Company determined to focus on primary insurance and to exit
the reinsurance marketplace. Accordingly, in March of 1999, the Company
transferred a significant portion of its reinsurance operations to another
reinsurer exclusive of certain treaties for which the underlying policies are
being converted to direct business and certain other contracts. See, Business
Strategy section and Reinsurance Strategy section.
In its personal and commercial insurance operations, the Company has
developed insurance products and programs to meet particular market needs.
Personal and commercial insurance products offered by the Company have
included from time to time a variety of homeowner and dwelling insurance
products, private passenger automobile, specialty commercial transportation
products, commercial business coverages and certain financial services
products designed to protect the interests of financial institutions in real
and personal property collateral. Personal and commercial insurance products
are distributed through independent agents brokers and managing general
agents.
Recently, however, the Company determined the competitiveness of the
commercial marketplaces and the recent A.M. Best downgrade (See A.M. Best
section) will cause the corrective actions necessary to return the commercial
segment to profitability not to be justifiable. Therefore, the Company decided
to withdraw from a major part of its commercial segment effective June 1999
for new business and renewal policies. The Company will continue to write the
Partners, BOP and Transportation lines of business in States that have been
historically profitable. The Company has also
1
determined that the A.M. Best downgrade and the increased competition in the
reinsurance marketplace will cause a significant loss of reinsurance premiums
in 1999. The Company has decided to sell a significant portion of its
reinsurance book of business. See the Business-Strategy section and Note T of
the Notes to the Consolidated Financial Statements for further discussion.
Effective December 31, 1997, Vesta Fire entered into a business transfer and
management agreement with CIGNA Property and Casualty Insurance Company
("CIGNA"). The agreement calls for Vesta Fire to reinsure selected personal
lines (covered business) written by CIGNA through a 100% Quota Share
Reinsurance Treaty. The agreement also calls for CIGNA and Vesta Fire to
cooperate to effect the transfer of the covered business from CIGNA to Vesta
Fire as the issuing carrier. While CIGNA does not own "renewal rights" under
agreements with agents and brokers, CIGNA will use good faith efforts, working
with Vesta Fire, to encourage agents and brokers to enter into similar
agreements with Vesta Fire.
After the close of business on June 30, 1997, the Company completed its
acquisition of all the issued and outstanding stock of the operating
subsidiaries of Anthem Casualty Insurance Group, Inc., each of which are
property and casualty insurance companies, for an aggregate purchase price,
including expenses of $260.9 million. Anthem Casualty Insurance Company has
been renamed Shelby Casualty Insurance Company and all the subsidiaries
acquired are collectively referred to as "Shelby."
Shelby is a regional property and casualty insurer with approximately
$260 million in annual premiums. Shelby markets its insurance product through
approximately 2,200 independent agencies, located in the midwest and mid-
atlantic states. The majority of the business acquired consists of auto
insurance and homeowners insurance in small towns and suburbs. The remainder
of the acquired business consists primarily of small and medium sized
commercial insurance much of which the Company has recently determined not to
renew.
Effective December 31, 1996, the Company acquired control of Ranger County
Mutual Insurance Company through its acquisition of all of the issued and
outstanding capital stock of Ranger General Agency, Inc. from Ranger Insurance
Company ("Ranger"), located in Houston, Texas, for $7.5 million in cash.
Ranger County Mutual Insurance Company has moved its operations to Dallas, and
changed its name to Vesta County Mutual Insurance Company ("Vesta County
Mutual"). All of Vesta County Mutual's business at December 31, 1996, as well
as certain additional business which the Company permitted Ranger to write
through Vesta County Mutual for a period of two years thereafter, is reinsured
100% by Ranger, and the Company does not assume any risk associated with this
business.
Vesta County Mutual is a county mutual insurance company organized under
Chapter 17 of the Texas Insurance Code, and, as such, enjoys certain
regulatory advantages, including the ability to establish rates without the
approval of the Texas Insurance Commission. Prior to the acquisition, Vesta
Fire had historically reinsured certain automobile and associated lines of
business in Texas written by a similar mutual company for which it paid
commissions. Vesta Fire now writes the majority of these lines of business
through Vesta County Mutual and, by doing so, recognizes significant savings.
2
Business Strategy
The Company was confronted with three major challenges during 1998. In June
1998, the Company completed an internal investigation, which resulted in a
reduction of net income of approximately $13.6 million in the fourth quarter
of 1997 and first quarter of 1998. The internal investigation focused on
accounting irregularities in the fourth quarter of 1997 and the first quarter
of 1998. The Company also corrected the methodology by which it recognized
earned premiums in its reinsurance segment. This resulted in a restatement of
its historical financial statements and a decrease in reported net income of
approximately $49 million for the years 1993 through 1997. Finally, the
insurance industry experienced one of the worst years for catastrophe losses
and continued to endure pricing pressures in the reinsurance market.
During the last quarter of 1998 and the first two months of 1999, the
Company analyzed the profitability of the reinsurance, personal lines and
commercial lines segments. The goal of the analysis was to determine which
segments would fit into the Company's strategy for 1999 and beyond. As a
result of the analysis, the Company decided to withdraw from a major part of
its commercial and reinsurance segments. The Company determined the
competitiveness of the commercial and reinsurance marketplace and the recent
A.M. Best downgrade (See A.M. Best section) will cause the corrective actions
necessary to return the commercial segments to profitability not to be
justifiable and the potential for maintaining its reinsurance portfolio to be
significantly impaired.
As discussed elsewhere in this report, the Company's current strategy is to
focus principally on personal auto and property coverages in all of its lines
of business while adjusting the mix and volume of its writings and retentions
to respond to changes in market prices and to manage its risk exposures. The
Company will also continue to write certain commercial risks on a limited
basis. The commercial risks, including transportation and BOP, will only be
written in areas that have historically produced profitable business.
Historically, the Company has made substantial use of reinsurance to reduce
its exposure to risks and the variability of its earnings. The Company plans
to continue to cede a portion of its insurance risks while increasing its
retentions of certain lines of business based on market conditions.
3
Lines of Business
The following table provides selected historical information on a Generally
Accepted Accounting Principles (GAAP) basis concerning the business written by
the Company and the associated underwriting results. This data should be read
in conjunction with the Company's Consolidated Financial Statements and
related notes thereto. For additional information on the Company's business
segments, see "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and Notes O to the Consolidated Financial Statements.
Year Ended December 31,
------------------------------------------------
1994 1995 1996 1997 1998
-------- -------- -------- -------- --------
(In thousands, except ratio data)
Reinsurance
Gross Premiums Written....... $214,430 $353,988 $497,537 $535,427 $287,617
Net Premiums Written......... 165,536 289,565 373,486 351,811 157,729
Net Premiums Earned.......... 164,101 221,933 342,452 335,360 194,261
Loss Ratio................... 55.5% 68.1% 59.9% 53.5% 90.5%
Personal
Gross Premiums Written....... $ 63,658 $105,643 $109,661 $244,719 346,992
Net Premiums Written......... 28,626 52,157 69,769 141,165 264,839
Net Premiums Earned.......... 39,223 44,796 63,206 139,425 247,064
Loss Ratio................... 67.2% 43.6% 40.5% 68.3% 66.7%
Commercial
Gross Premiums Written....... 49,018 58,428 44,573 85,905 124,412
Net Premiums Written......... 37,948 48,782 24,801 33,499 69,022
Net Premiums Earned.......... 29,028 46,349 33,678 42,873 68,368
Loss Ratio................... 59.1% 61.3% 62.8% 55.9% 80.0%
Combined
Gross Premiums Written....... $327,106 $518,059 $651,771 $866,051 759,021
Net Premiums Written......... 232,110 390,504 468,056 526,475 491,590
Net Premiums Earned.......... 232,352 313,078 439,336 517,658 509,693
Loss Ratio................... 57.9% 63.6% 57.3% 57.7% 77.6%
Expense Ratio................ 35.4% 30.0% 33.2% 34.9% 50.2%
Combined Ratio............... 93.3% 93.6% 90.5% 92.6% 127.8%
Reinsurance
Reinsurance is a contractual arrangement under which one insurer (the ceding
company) transfers to another insurer (the reinsurer) all or a portion of a
risk or risks that the ceding company has assumed under the insurance policy
or policies it has issued. A ceding company may purchase reinsurance for any
number of reasons including, to obtain, through the reduction of its
liabilities, greater underwriting capacity than its own capital resources
would support, to stabilize its underwriting results, to protect against
catastrophic loss, to withdraw from a line of business, and to manage risk
when entering a new line of business.
Reinsurance can be written on either a pro rata or excess of loss basis.
Under pro rata reinsurance, the reinsurer, in return for a predetermined
portion or share of the insurance premium charged by the ceding company,
indemnifies the ceding company against a predetermined portion or share of the
losses and loss adjustment expenses ("LAE") of the ceding company under the
covered primary policy or policies. Under excess of loss reinsurance, the
reinsurer indemnifies the ceding company against all or a specified portion of
losses and LAE on underlying insurance policies in excess of a specified
dollar amount, known as the ceding company's retention, subject to a
negotiated policy limit. Catastrophe reinsurance is a form of excess of loss
reinsurance which indemnifies the ceding company for losses resulting from a
particular catastrophic event. Excess of loss reinsurance
4
is often written in layers, with one or a group of reinsurers taking the risk
from the ceding company's retention layer up to a specified amount, at which
point either another reinsurer or a group of reinsurers takes the excess
liability or it remains with the ceding company. The reinsurer acquiring the
risk immediately above the ceding company's retention layer is said to write
working or low layer reinsurance. A loss that reaches just beyond the primary
insurer's retention layer will create a loss for the working layer reinsurer,
but not necessarily for the reinsurers on the higher layers.
Premiums that the ceding company pays to the reinsurer for excess of loss
coverage are not directly proportional to the premiums that the ceding company
receives because the reinsurer does not assume a proportionate risk. Excess of
loss coverage is priced separately and distinctly from the pricing employed by
the ceding company in connection with its risk since the probability of loss
is different for the reinsurer than the ceding company. In contrast, in pro
rata reinsurance, premiums that the ceding company pays to the reinsurer are
proportional to the premiums that the ceding company receives, consistent with
the proportional sharing of risk, and the reinsurer generally pays the ceding
company a ceding commission. Generally, the ceding commission is based upon
the ceding company's cost of obtaining the business being reinsured (i.e.,
commissions, premium taxes, assessments and miscellaneous administrative
expenses).
Substantially all of the reinsurance that the Company currently has written
is on personal (including automobile) and commercial property risks.
Management believes there are certain advantages in emphasizing the writing of
property reinsurance over casualty reinsurance, the most significant of which
is that ultimate property claims losses generally can be determined more
quickly than ultimate casualty claims losses. Long-tail reinsurance, such as
certain casualty coverages, frequently are slower to be reported and finally
determined. However, the earnings of property insurers are affected by
unpredictable catastrophic events. In addition, a continuing increase in the
severity of catastrophic losses as well as various other market forces could
affect the availability of adequate retrocessional coverage.
The Company's mix of reinsurance business on a gross premiums written basis
is set forth in the following table for the periods indicated:
Year Ended December 31,
----------------------------------------------
Type of Reinsurance 1996 1997 1998
- ------------------- -------------- -------------- --------------
(in thousands, except ratio data)
Property Reinsurance
Pro Rata....................... $383,637 77.1% $443,164 82.8% $213,877 74.3%
Catastrophe.................... 46,485 9.4 51,287 9.6 37,042 12.9
Excess Risk.................... 3,135 0.6 3,289 0.6 5,393 1.9
-------- ----- -------- ----- -------- -----
Total Property.................. 433,257 87.1 497,740 93.0 256,312 89.1
Casualty Reinsurance
Auto Liability................. 60,912 12.2 32,696 6.1 29,534 10.3
Other Casualty(1).............. 3,368 0.7 4,991 0.9 1,771 0.6
-------- ----- -------- ----- -------- -----
Total Casualty.................. 64,280 12.9 37,687 7.0 31,305 10.9
-------- ----- -------- ----- -------- -----
Total Reinsurance.............. $497,537 100.0% $535,427 100.0% $287,617 100.0%
======== ===== ======== ===== ======== =====
- --------
(1) Estimated casualty portion of total reinsurance excluding Auto Liability.
In 1998, the Company's pro rata reinsurance writings of private passenger
automobile decreased significantly over 1997. The acquisition of Vesta County
Mutual resulted in a further shift of a large portion of private passenger
automobile writings which had been recorded on the reinsurance line to
personal line. Additionally, the reinsurance market experienced increased
market capacity accompanied by increased price competition in the private
passenger automobile line of business. The
5
Company continued to terminate certain accounts, which reduced its writings of
pro rata reinsurance of private passenger automobile.
The principal lines of business reinsured by the Company include homeowner
and commercial property coverages and non-standard automobile insurance. For
1998, homeowner and commercial business comprised approximately 68% of gross
reinsurance premiums written, non-standard automobile insurance comprised
approximately 26% of gross reinsurance premiums written, and other lines
comprised approximately 6% of gross reinsurance premiums written. The Company
writes a small amount of casualty reinsurance for a certain number of its
property reinsurance clients. Casualty reinsurance risks assumed by the
Company consist largely of non-standard automobile liability insurance as well
as liability coverages provided under homeowner and commercial multi-peril
policies.
Marketing. The Company has historically provided reinsurance to small and
medium-sized regional insurance companies and regional specific reinsurance
for larger insurance companies located throughout the United States. Most of
the Company's reinsurance business was produced through major reinsurance
intermediaries in the United States. In 1996 the Company began writing
international reinsurance business with an emphasis on catastrophe
reinsurance. This was enhanced in September 1996 with the establishment of a
branch office in Copenhagen, Denmark, which improved access to the European
reinsurance market. Until recently, the Company's reinsurance division did
business through approximately 40 intermediaries, five of which were
responsible for approximately 85% of the division's premium volume during
1998.
Underwriting. Management's underwriting strategy is to practice strict
discipline in carrying out its major operating functions, risk selection and
retention. For selecting and managing its portfolio of reinsurance contracts,
the authority to bind the Company is limited to five employees whose duties
are concentrated primarily on identifying and accessing desirable business.
The Company utilizes computers and analytical software to assist underwriters
in evaluating and selecting risks and determining appropriate retention
levels. It has been the Company's practice to have direct contact, either by
underwriting audits or periodic visits of a more general nature, with ceding
companies with whom the Company has working pro rata and layer relationships,
both to enhance the quality of its underwriting process and to develop and
retain its business relationships.
Strategy. Given current market conditions in the reinsurance arena, the
Company determined that the recent downgrade in the A.M. Best rating to B++
(see A.M. Best section) will have a negative impact on its reinsurance
operations. Although the company enjoys an excellent relationship with its
reinsurance customers the potential for maintaining its reinsurance portfolio
has been hampered by the recent change in rating. The Company determined that
the A.M. Best downgrade and the increased competition in the reinsurance
marketplace would cause a significant loss of reinsurance premiums in 1999.
Therefore, the Company sold a significant portion of its reinsurance renewal
rights to Hartford Fire Insurance Company ("Hartford Fire") for $15 million
effective March 24, 1999. See Business Strategy (above) and Note T of the
Notes to the Consolidated Financial Statements for further discussion.
Primary Insurance Business
In its primary insurance operations, the Company has sought to identify
market opportunities and develop insurance products to meet particular market
needs. Prior to 1997, the Company's primary insurance operations focused on
selected personal and commercial property insurance lines as well as on
financial services products consisting of certain collateral protection
insurance policies for financial institutions. In 1997, however, the
acquisitions of the Shelby Insurance Companies and Vesta County Mutual
increased the personal automobile premiums significantly, making it the
Company's largest primary lines of business. The 1997 acquisition of the CIGNA
personal property book of
6
business, representing over $80 million in annual written premium, essentially
balanced the Company's personal lines writings evenly between automobile and
property coverages.
In the past, the Company has emphasized writing property coverages more than
liability. With the addition of the liability portions of the Shelby
automobile line, the Company's writings are also now fairly evenly balanced
between property and liability exposures. This balancing between liability and
property exposures provides better protection against severe impacts of
natural catastrophes, and thus more consistency to the Company's results.
The Company's independent agents may bind insurance coverages only in
accordance with guidelines established by the Company. The Company promptly
reviews all coverages bound by its agents and a decision is made as to whether
to continue such coverages. Because of the broad base of the Company's
independent agency force, the contractual limitation on their authority to
bind coverage and the Company's review procedures, the Company does not
believe that the authority of its agents to bind the Company presents any
material risk to the Company and its operations.
Personal Lines
Prior to 1997, the Company's personal lines business related primarily to
the insurance of residential properties and their contents. The purchase of
Shelby and Vesta County Mutual significantly increased the Company's direct
writings of personal automobile lines. The following table sets forth the
principal line of business distribution of the Company's gross premiums
written in its personal lines business for the three years indicated.
Year Ended December 31,
----------------------------------------------
1996 1997 1998
-------------- -------------- --------------
(in thousands, except percentage)
Personal Auto................... $ 8,379 7.6% $112,394 45.9% $223,425 64.4%
Homeowners...................... 66,954 61.1 88,599 36.2 93,762 27.0%
Financial Services.............. 25,945 23.7 37,344 15.3 20,682 6.0%
Other........................... 8,383 7.6 6,382 2.6 9,123 2.6%
-------- ----- -------- ----- -------- -----
$109,661 100.0% $244,719 100.0% $346,992 100.0%
======== ===== ======== ===== ======== =====
The Company offers personal auto insurance for preferred, standard and non-
standard drivers. In its standard auto line, the Company targets drivers over
age 45 with above average driving records. The non-standard auto line covers
the full spectrum of non-standard drivers.
Liability limits up to $500,000 are written on standard auto policies, with
an additional $5 million personal umbrella limit also available. However, the
vast majority of the personal umbrellas are written at limits of $1 million or
$2 million. For non-standard auto, the Company typically writes minimum basic
limits that vary by state.
The Company's personal property insurance products cover the full range of
homes starting with lower-valued dwellings in the $10,000 to $50,000 range,
through the middle-valued homes from $50,000 to $150,000, as well as higher
valued homes up to $10,000,000. The majority of homes insured are valued
between $40,000 and $250,000.
The Company also provides specialty products protecting collateral and
repossessed property of financial institutions. Certain of these products are
designed to protect the interests of financial institutions against physical
damage to private passenger automobiles and other personal property in those
cases where the borrower fails to insure the collateral in accordance with a
loan agreement. The Company also has mortgage security products that are
designed to protect the interest of the mortgagee and the mortgagor (borrower)
caused by the mortgagor's failure to obtain property insurance on the
mortgaged property. Coverage is also provided for the properties that are in
the process of foreclosure.
7
Marketing. Prior to 1997, the Company marketed personal lines in 15 states
through approximately 870 agencies, with premium concentrated in the property
lines in the Southeast. With the Shelby and CIGNA acquisitions, the Company
increased its marketing force to approximately 3800 agencies in 42 states.
Within certain parameters, the agents of the Company are authorized to write
policies without prior approval from the Company. However, all policies are
reviewed by Company's underwriting staff upon receipt of the application by
the Company.
The following table sets forth the principal geographic distribution of the
Company's gross premiums written in its personal lines business for the three
years indicated. The states listed below comprise the ten states with the
largest gross premiums written for 1998.
Year Ended December 31,
----------------------------------------------
1996 1997 1998
-------------- -------------- --------------
(in thousands, except percentages)
Texas........................... $ 4,588 4.2% $ 50,660 20.7% $ 77,567 22.3%
Pennsylvania.................... 20 0.0 24,455 10.0 50,185 14.4
West Virginia................... 358 0.3 12,823 5.3 27,593 8.0
Hawaii.......................... 41,927 38.2 35,686 14.6 25,175 7.3
Tennessee....................... 4,367 4.0 15,890 6.5 24,924 7.2
Illinois........................ 1,482 1.4 12,118 4.6 20,029 5.8
Ohio............................ 541 0.5 10,865 4.5 17,942 5.2
Alabama......................... 15,348 14.1 18,032 7.4 14,641 4.2
North Carolina.................. 1,354 1.2 5,186 2.2 11,966 3.4
Mississippi..................... 3,950 3.6 7,773 3.2 11,398 3.3
All Other....................... 35,726 32.5 51,231 21.0 65,572 18.9
-------- ----- -------- ----- -------- -----
Total......................... $109,661 100.0% $244,719 100.0% $346,992 100.0%
===== ===== =====
The geographic balance reflected above allows for greater profit protection
and more cost effective management of the property catastrophe exposures. The
Company employs marketing representatives to maintain and expand its agency
relationships in its personal lines business. In addition, the Company pays
competitive commission rates to its agents and utilizes a profit sharing plan
for agencies which is based on volume of premiums and loss ratios for business
written.
Underwriting. Underwriting of personal lines business is conducted in four
locations and performed by the Company's underwriting staff in accordance with
specific underwriting authority related to the acceptability of each risk for
the appropriate program profile. Management information reports are utilized
to measure risk selection and pricing in order to control underwriting
performance. The principal underwriting criteria for personal property
coverages is a financially stable owner with a well-maintained property. Rates
for lower valued properties are surcharged to reflect risk characteristics.
Within certain parameters, the agents of the Company are authorized to write
policies without prior approval from the Company.
It has been the Company's policy generally not to underwrite personal
property business in the Southeast within one hundred miles of a coastline
(except for Florida which is 10 miles) in order to limit its exposure to
typical coastal occurrences such as hurricanes and other types of storms. In
the Northeast and West, the Company does not impose as restrictive a criteria
for property location, but does endeavor to utilize high wind deductibles
whenever possible in order to limit its catastrophe exposure. The Company
continually monitors and controls its production in order to prudently manage
its risk in areas with significant exposure to natural disasters.
Future Plans. A significant potential for internal, organic growth exists in
personal lines through expansion of the Company's existing products to its
existing agency force. The largest potential exists
8
with both standard and non-standard auto, which are currently marketed in only
13 and 8 of the Company's active states, respectively. There are many of the
Company's appointed agencies in additional states to whom it plans to market
these products in the next several years, thus enabling them to cross-sell the
Company's current personal property policyholders. This cross-selling activity
will not only increase premium production, but should also improve renewal
retention, and therefore the Company's loss ratio and expenses.
In addition to the expansion of the Company's auto products to other active
states, the Company also plans to expand its Low-Valued Dwelling and High-
Valued Homeowners products to other active states, as appropriate, based on
state demographics. The Company recognizes that to be a successful personal
lines carrier, it is essential that the Company makes it as easy as possible
for its agents to do business with the Company. Therefore, the Company is
currently pursuing three key technological developments in personal lines to
accomplish its goal.
First, the Company is well along in its efforts to make its underwriting and
processing systems paperless, through the implementation of an imaging system.
This system enables the Company to service its agents and policyholders more
quickly and effectively by having policy information readily available on its
computer. The Company anticipates this will improve its policy processing
time.
Second, the Company continues to expand the number of agencies utilizing its
SEMCI agency download system, updating the agencies' management systems with
current policy data. Currently over 600 agencies utilize this service, and the
number of agencies continues to grow.
Third, the Company is currently developing an Internet-based interactive
inquiry, application, and endorsement service for its agents. The Company
anticipates introducing this service in the second or third quarter of 1999.
This inquiry service will put policy, billing, and claims information at the
agents' fingertips, thus enabling them to better serve their customers. In
addition, the application and endorsement service will enable the agents to
have direct access to the Company's policy issuance system, thus further
improving turnaround time for policy and endorsement processing.
Commercial Lines
The Company provides insurance products covering a select group of target
classes for which it has developed specific commercial industry expertise. The
Company typically provides a full spectrum of property, liability, and auto
coverage for these target classes, with the focus on small accounts. These
target classes include typical small office, service, and retail
businessowners, mini-storage facilities, artisan contractors, and small
service garages.
Until recently, the Company pursued a broader range of target classes which
focused on other classes such as hotels, manufacturers, restaurants,
motorcycle dealers, broadcasters and publishers. The Company concluded,
however, that in the continuing competitive marketplace, the Company could not
achieve adequate pricing for these classes of business as required for
profitability. Therefore, these classes of business will be discontinued in
the second quarter of 1999 (see the Business Strategy section), as the Company
elected to focus on the expansion of its small commercial Partners Program,
offering its Businessowners, Artisan Contractors, and small Service Garage
programs.
These continuing programs offer the advantages to the Company of more
controlled pricing, better renewal retention, greater growth potential due to
changing demographics, better opportunities for developing internal processing
efficiencies, and a better match with the marketing needs of our personal
lines agents.
In recognition of the need to make it easy for agents to do commercial
business with the Company, agents have been provided with personal computer
rating disks that enable the agents to
9
quote eligible small accounts and conduct initial underwriting screening. In
the future, once the commercial policy issuance systems are further developed,
the Company will utilize the personal lines Internet-based inquiry,
application and endorsement system to also improve the service and
efficiencies of the Partners Program.
The Company has also designed a complementary group of insurance products
for the trucking industry. These products are offered to independent owner-
operators of trucks and small fleets to cover physical damage, non-trucking
liability (non-business use of the vehicle), and cargo risks. Physical damage
protection is the principal product written by the Company in this line of
business.
Marketing. The Company's standard commercial lines products had been offered
in 29 states, but has now been narrowed to 14 states to enable the Company to
focus on the aforementioned Partners Program. In the next few years, the
Company will expand its Partners Program into other personal lines states. The
Company uses marketing representatives to market it's commercial lines
products to independent agents. These marketing representatives are employees
of the Company and are located in areas which the Company operates and targets
business development. Commercial business products are now being marketed
directly through approximately 2,000 independent agencies. Transportation
products are marketed through approximately 60 agencies which specialize in
this line of business. The Company believes that the commissions and profit
sharing arrangements it provides to contracted agents have been important
factors in the Company's ability to access and maintain profitable commercial
property-casualty and transportation business.
The following table sets forth the principal geographic distribution of the
Company's direct premiums written in its commercial lines of business for the
years indicated. The states listed below comprise the ten states with the
largest gross premiums written for 1998. As noted above, the volume of
premiums written in the Company's commercial lines of business are expected to
decrease significantly in 1999 as a result of the Company's decision to
withdraw from a major part of its commercial segment.
Year Ended December 31,
---------------------------------------------
1996 1997 1998
-------------- -------------- ---------------
(in thousands, except percentages)
North Carolina.................... $1,337 3.0% $10,869 12.4% $19,226 15.5%
Ohio.............................. 846 1.9 4,673 5.3 12,325 9.9
Texas............................. 11,035 24.8 11,804 13.5 9,222 7.4
Missouri.......................... 6,554 14.7 5,429 6.2 8,748 7.0
Connecticut....................... -- 0.0 4,131 4.7 8,608 6.9
Tennessee......................... 1,447 3.2 5,336 6.2 8,255 6.6
Indiana........................... 81 0.2 4,415 5.1 7,675 6.2
Georgia........................... 1,410 3.2 4,933 5.6 6,471 5.2
Kentucky.......................... 1,787 4.0 3,828 4.4 5,767 4.7
Rhode Island...................... 0 0.0 3,490 4.0 5,650 4.5
All Other......................... 20,076 45.0 26,997 32.6 32,465 26.1
------- ------ ------- ------ -------- ------
Total........................... $44,573 100.0% $85,905 100.0% $124,412 100.0%
======= ====== ======= ====== ======== ======
Underwriting. Underwriting of the Company's commercial business and
transportation products had been centralized in two locations (the Company's
home office and the Shelby office). The Company plans to consolidate all
commercial lines underwriting in the home office by the end of 1999. All
underwriting is performed by the Company's underwriting staff in accordance
with specific underwriting authority based upon the experience and knowledge
level of each underwriter. Risks that are perceived to be more difficult and
complex risk exposures are underwritten by the more experienced staff and
reviewed by management. Many underwriting factors are examined for the
commercial business line, such as quality of construction, occupancy,
protection against fire and other hazards, and financial condition of the
owners.
10
Transportation underwriting is heavily concentrated on a review of the
driver, including the driver's record and experience. However, other factors
are also considered, such as, in the case of cargo insurance, damageability
and theft exposure.
Limited binding authority is provided to contracted agents, but only for
risks which have been underwritten, priced and accepted by an authorized
underwriter of the Company or risks which qualify under specific and pre-set
guidelines and rate parameters established for a specified class of products.
Reinsurance Ceded
The Company seeks to manage its risk exposure through the purchase of
reinsurance, including retrocessional placements for its reinsurance business.
The Company obtains reinsurance principally to reduce its net liability on
individual risks and to provide protection for individual loss occurrences,
including catastrophic losses, in order to stabilize its underwriting results.
In exchange for reinsurance, the Company pays to its reinsurers a portion of
the premiums received under the reinsured policies. While the assuming
reinsurer is liable for losses to the extent of the coverage ceded,
reinsurance does not legally discharge the Company from primary liability for
the full amount of the policies ceded.
The Company generally purchases reinsurance separately for its primary
insurance business lines and its reinsurance business. Gross written premiums
ceded for 1997 were $339.6 million, which constituted 39.2% of the gross
premiums written, in order for 1998, were $267.4 million, which constituted
35.1% of the gross premiums written. The decrease in 1998 was primarily due to
the decrease in gross written premiums in 1998 and the cancellation of a
certain reinsurance treaty effective July 1, 1998. While the Company seeks to
reinsure a significant portion of its property catastrophe risks, there can be
no assurance that losses experienced by the Company will be within the
coverage limits of the Company's reinsurance and retrocessional programs.
The availability and cost of reinsurance and retrocessional coverage may
vary significantly over time and are subject to prevailing market conditions.
The Company seeks to evaluate the credit quality of the reinsurers and
retrocessionaires to which it cedes business. No assurance can be given
regarding the future ability of any of the Company's reinsurers to meet their
obligations.
Claims
Claims arising under the policies issued by the Company are managed by the
Company's Claims Department. When the Company receives notice of a loss, its
claims personnel open a claim file and establish a reserve with respect to the
loss. All claims are reviewed and all payments are made by the Company's
employees, with the exception of claims on certain products, which are
adjusted by a managing general agency and periodically audited by the
Company's claims personnel.
Most personal lines claims are adjusted and paid by staff claims adjusters.
Management believes that utilizing the Company's trained employee adjusters
permits faster, more efficient service at a lower cost.
Claims settlement authority levels are established for each adjuster or
manager based upon each employee's ability and level of experience. Upon loss
notification, each claim is reviewed and assigned to an adjuster or manager
based upon the type of claim. Claims-related litigation is monitored by home
office litigation supervisors. The Company emphasizes prompt, fair and
equitable settlement of meritorious claims, adequate reserving for claims and
controlling of claims adjustment and legal expenses.
11
Reserves
The Company's insurance subsidiaries maintain reserves to cover their
estimated ultimate liability for losses and loss adjustment expenses ("LAE")
with respect to reported and unreported claims incurred. To the extent that
reserves prove to be inadequate in the future, the Company would have to
increase such reserves and incur a charge to earnings in the period such
reserves are increased, which could have a material adverse effect on the
Company's results of operations and financial condition. The establishment of
appropriate reserves is an inherently uncertain process, and there can be no
assurance that ultimate losses will not materially exceed the Company's loss
and LAE reserves. Reserves are estimates involving actuarial and statistical
projections at a given time of what the Company expects to be the cost of the
ultimate settlement and administration of claims based on facts and
circumstances then known, estimates of future trends in claims severity and
other variable factors such as inflation. The inherent uncertainties of
estimating reserves generally are greater with respect to reinsurance
liabilities due to the diversity of development patterns among different types
of reinsurance contracts, the necessary reliance on ceding companies for
information regarding reported claims and differing reserving practices among
ceding companies.
With respect to reported claims, reserves are established on a case-by-case
basis. The reserve amounts on each reported claim are determined by taking
into account the circumstances surrounding each claim and policy provision
relating to the type of loss. Loss reserves are reviewed on a regular basis,
and as new data becomes available, appropriate adjustments are made to
reserves.
For incurred but not reported ("IBNR") losses, a variety of methods have
been developed in the insurance industry for determining estimates of loss
reserves. One common method of actuarial evaluation, which is used by the
Company, is the loss development method. This method uses the pattern by which
losses have been reported over time and assumes that each accident year's
experience will develop in the same pattern as the historical loss
development. The Company also relies on industry data to provide the basis for
reserve analysis on newer lines of business (lines written less than 3 years).
Provisions for inflation are implicitly considered in the reserving process.
The Company's reserves are carried at the total estimate for ultimate expected
loss without any discount to reflect the time value of money.
Reserves are computed by the Company based upon actuarial principles and
procedures applicable to the lines of business written by the Company. These
reserve calculations are reviewed regularly by management, and, as required by
state law, the Company periodically engages an independent actuary to render
opinions as to the adequacy of statutory reserves established by management.
The actuarial opinions are filed with the various jurisdictions in which the
Company is licensed. Based on the practice and procedures employed by the
Company management believes that the Company's reserves are adequate as of the
valuation date.
12
The following table provides a reconciliation of beginning and ending
liability balances on a GAAP basis for the years indicated:
Year Ended December 31,
------------------------------
1996 1997 1998
-------- --------- ---------
(in thousands)
Gross Losses and LAE reserves at beginning of
year......................................... $168,502 $ 173,275 $ 596,797
Reinsurance Receivable........................ (24,384) (60,343) (204,336)
-------- --------- ---------
Net Losses and LAE reserves at beginning of
year......................................... 144,118 112,932 392,461
Increases (decreases) in provisions for losses
and LAE for claims incurred:
Current year................................. 242,454 311,089 396,091
Prior year................................... 9,329 (12,451) (769)
Acquisition of Shelby......................... -- 300,315 --
Losses and LAE payments for claims incurred:
Current year................................. (158,409) (166,447) (269,369)
Prior year................................... (124,560) (152,977) (219,642)
-------- --------- ---------
Net Losses and LAE reserves at end of year ... 112,932 392,461 298,772
Reinsurance Receivable........................ 60,343 204,336 206,139
-------- --------- ---------
Gross loss and LAE Reserves................... $173,275 $ 596,797 $ 504,911
======== ========= =========
The reconciliation between statutory basis and GAAP basis reserves for each
of the three years in the period ended December 31, 1998 is shown on the
following page:
Year Ended December 31,
----------------------------
1996 1997 1998
-------- -------- --------
(in thousands)
Statutory reserves............................... $115,360 $391,069 $363,139
Adjustments for salvage and subrogation.......... (2,376) (15,553) (11,250)
Retroactive reinsurance amounts.................. -- 16,945 (53,117)
Gross-up of amounts netted against reinsurance
recoverable..................................... 60,291 204,336 206,139
-------- -------- --------
Reserves on a GAAP basis......................... $173,275 $596,797 $504,911
======== ======== ========
13
The following table shows the development of the reserves for unpaid losses
and loss adjustment expenses from 1988 through 1998 for the Company's
insurance subsidiaries on a GAAP basis net of reinsurance recoveries. The top
line of the table shows the liabilities at the balance sheet date for each of
the indicated years. This reflects the estimated amounts of losses and loss
adjustment expenses for claims arising in that year and all prior years that
are unpaid at the balance sheet date, including losses incurred but not yet
reported to the Company. The upper portion of the table shows the cumulative
amounts subsequently paid as of successive years with respect to the
liability. The lower portion of the table shows the reestimated amount of the
previously recorded liability based on experience as of the end of each
succeeding year. The estimates change as more information becomes known about
the frequency and severity of claims for individual years. A redundancy
(deficiency) exists when the reestimated liability at each December 31 is less
(greater) than the prior liability estimate. The "cumulative redundancy
(deficiency)" depicted in the table, for any particular calendar year,
represents the aggregate change in the initial estimates over all subsequent
calendar years.
Year Ended December 31,
---------------------------------------------------------------------------------------------------
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
------- ------- ------- ------- ------- ------- ------- -------- -------- -------- --------
(in thousands)
Liability for unpaid
losses and LAE..... $40,837 $32,861 $27,823 $21,919 $21,976 $29,688 $66,648 $118,733 $112,932 $392,461 $298,772
Paid (cumulative) as of
One year later..... 19,730 19,611 11,864 13,166 20,517 20,761 51,527 88,377 86,978 197,477
Two years later.... 28,475 24,063 14,949 17,054 20,272 28,766 65,360 116,388 114,704
Three years later.. 32,443 27,199 17,096 16,810 20,281 34,776 66,490 125,299
Four years later... 34,628 29,235 18,093 16,622 23,272 33,139 72,273
Five years later... 36,703 29,960 19,206 18,140 20,994 38,222
Six years later.... 37,535 30,976 20,683 16,218 22,964
Seven years later.. 38,602 32,303 20,391 17,922
Eight years later.. 40,150 31,856 22,284
Nine years later... 39,524 33,171
Ten years later.... 40,268
Liability
reestimated as of
End of year....... 40,837 32,861 27,823 21,919 21,976 29,688 66,648 118,733 112,932 392,461 298,772
One year later..... 42,097 34,078 28,779 21,853 28,530 28,930 61,033 127,790 99,708 391,692
Two years later.... 42,702 33,304 29,431 19,009 27,914 34,219 66,582 110,437 144,986
Three years later.. 42,665 33,851 29,130 19,817 26,120 38,940 66,713 118,657
Four years later... 42,493 32,097 29,578 16,470 30,435 41,517 76,863
Five years later... 40,132 34,549 26,291 19,862 33,845 50,993
Six years later.... 42,973 31,205 29,493 23,760 40,317
Seven years later.. 39,464 34,280 36,400 29,574
Eight years later.. 42,525 38,955 40,568
Nine years later... 46,648 44,587
Ten years later.... 52,146
Cumulative
redundancy/
(deficiency)....... (11,309) (11,726) (12,745) (7,655) (18,341) (21,305) (10,215) 76 (32,054) 769
The table above was significantly affected by the 1998 restatement of Vesta
Fire's statutory loss development (Schedule P) required by the Alabama
Department of Insurance, which corrected the assignment of certain losses to
accident years and is reflected above. The table differs significantly from
statutory loss development tables due to GAAP adjustments (see Note D of the
Notes to Consolidated Financial Statements) and the 1997 acquisitions of
Shelby and VCM.
The Company reinsured a number of casualty risks in the early 1980's which
could result in claims for coverage of asbestos related and other
environmental impairment liabilities to the extent that such liabilities were
not excluded from the underlying policies. The attachment points in
reinsurance treaties relating to these risks are relatively high, and the
Company's percentage participation in the layers of reinsurance in which it
participates is relatively low. In addition, the Company carries reinsurance
which would mitigate the effect of any losses under these treaties. While
there exists a possibility that the Company could suffer material loss in the
event of a high number of large losses under these treaties, this is unlikely
in management's judgment.
14
Investments
The Company's investment portfolio consists primarily of investment grade
fixed income securities. Waddell & Reed Asset Management Company ("WRAMCO")
provides investment advisory services to the Company subject to investment
policies and guidelines established by management and the Board of Directors.
The Company's investments at December 31, 1998 totaled approximately $634.7
million and were classified as follows:
Amount at which % of
Type of Investment Shown on Balance Sheet Portfolio
- ------------------ ---------------------- ---------
(in thousands)
Cash and short-term investments................ $156,350 24.6%
United States Government securities............ 75,416 11.9%
Asset-backed securities........................ 88,760 14.0%
Corporate bonds................................ 161,582 25.5%
Foreign government............................. 3,717 .6%
Municipal bonds................................ 127,744 20.1%
Equity securities.............................. 21,099 3.3%
-------- -----
Total........................................ $634,668 100.0%
======== =====
The value of the fixed maturities portfolio, classified by category, as of
December 31, 1998, was as follows:
Amortized Cost Fair Value
-------------- ----------
(in thousands)
United States Government.............................. $ 72,935 $ 75,416
Asset-backed securities............................... 87,773 88,760
Municipal............................................. 124,358 127,744
Foreign government.................................... 3,619 3,717
Corporate............................................. 157,831 161,582
-------- --------
Total............................................... $446,516 $457,219
======== ========
The composition of the fixed maturities portfolio, classified by Moody's
rating as of December 31, 1998 was as follows:
Amortized Cost % of Total
-------------- ----------
(in thousands)
Aaa................................................... $240,083 53.8%
Aa.................................................... 61,758 13.8%
A..................................................... 130,167 29.2%
Baa................................................... 14,508 3.2%
-------- -----
Total............................................... $446,516 100.0%
======== =====
The NAIC has a bond rating system that assigns securities to classes called
"NAIC designations" that are used by insurers when preparing their annual
statutory financial statements. The NAIC assigns designations to publicly-
traded as well as privately-placed securities. The designations assigned by the
NAIC range from class 1 to class 6, with a rating in class 1 being of the
highest quality. As of December 31, 1998, 100% of the Company's fixed
maturities portfolio, measured on a statutory carrying value basis, was
invested in securities rated in class 1 or 2 by the NAIC, which are considered
investment grade. The weighted average maturity of the Company's fixed income
portfolio at December 31, 1998 was 6.1 years. The weighted average duration of
the Company's fixed income portfolio was 3.1 years.
15
As of December 31, 1998, none of the Company's fixed maturities portfolio
was invested in securities that were rated below investment grade. Less than
5% of the Company's assets were invested in equity securities, and less than
20% of the Company's assets were invested in collateralized mortgage
obligations secured by residential mortgages.
Regulation
The Company's insurance companies are subject to regulation by governmental
agencies in the states in which they do business. The nature and extent of
such regulation varies by jurisdiction, but typically involves prior approval
of the acquisition of control of an insurance company or of any company
controlling an insurance company, regulation of certain transactions entered
into by an insurance company with any of its affiliates, approval of premium
rates for many lines of insurance, standards of solvency and 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, licensing of insurers and agents, deposits of securities
for the benefit of policyholders, and reports with respect to financial
condition and other matters. In addition, state regulatory examiners perform
periodic examinations of insurance companies. Such regulation is generally
intended for the protection of policyholders rather than security holders.
For its assumed reinsurance business, the Company has historically made
estimates for its reinsurance reports received subsequent to a period end on a
combined underwriting and accident year basis for both statutory and GAAP
purposes. As a result of a routine examination by the Alabama Department of
Insurance, the Company agreed to revise the accounting for its reinsurance
business for statutory purposes. Effective with its year end 1997 statutory
filings, Vesta Fire revised its statutory accounting for its assumed
reinsurance business to reflect only accident/calendar year information. The
adjustments essentially reversed, in the form of a one-time charge, the
cumulative effect of the accounting practice consistently applied over prior
years. On a GAAP basis, the correction was accounted for by restating prior
financial statements.
In addition to the regulatory supervision of the Company's insurance
subsidiaries, the Company is also subject to regulation under the Alabama,
Ohio, Indiana, Hawaii and Texas Insurance Holding Company System Regulatory
Acts (the "Holding Company Acts"). The Holding Company Acts contain certain
reporting requirements including those requiring the Company, as the ultimate
parent company, to file information relating to its capital structure,
ownership, and financial condition and general business operations of its
insurance subsidiaries. The Holding Company Acts contain special reporting and
prior approval requirements with respect to transactions among affiliates. The
Alabama Holding Company Act is generally the most significant to the Company
since it governs the Company's relationship with Vesta Fire, the Company's
principal insurance subsidiary.
During 1998, the Alabama Department of Insurance completed its examination
of Vesta Fire's December 31, 1997 Annual Statement. The examination resulted
in certain adjustments to the as-filed Annual Statement. The adjustments
reduced the previously reported 1997 capital and surplus of $355.3 million to
$100.8 million. The Alabama Department did not require the Company to refile
Vesta Fire's 1997 Annual Statement. The examination changes have been taken
into account in preparation of Vesta Fire's 1998 Annual Statement. Using the
basis of accounting established in the examination, Vesta Fire's 1998
statutory capital and surplus was $217.3 million after giving effect in 1998
to $125.8 million of adjustments arising from the 1997 examination. The
Alabama Department of Insurance is currently performing a follow-up target
examination on selected financial information. Management does not expect that
any adjustment that may result from the target examination to have a material
impact on the Company's financial position, results of operations or cash
flows.
On February 11, 1999, the Connecticut Department of Insurance informed the
Company that it intended to restrict the Vesta Fire's Certificate of
Authority. Management of the Company is engaged in discussions with the
Connecticut Department of Insurance to reach a mutual agreement on the scope
and extent of the restriction, should it be formally imposed. If this
Certificate of Authority is fully
16
restricted, Vesta Fire will no longer be able to write new policies of
insurance in the State of Connecticut.
On March 3, 1999, the North Carolina Department of Insurance unilaterally
restricted the Vesta Fire's and its insurance subsidiaries (the Group)
Certificates of Authority, which restriction effectively prohibited the Group
from writing new policies of insurance in the State of North Carolina.
Following meetings with management of the Company and submission of additional
data the North Carolina Department of Insurance agreed to temporarily defer
the effectiveness of these restrictions pending their review of the additional
data submitted by the Company. The Group is engaged in ongoing discussions
with the North Carolina Department of Insurance to reach an agreement on the
scope and extent of any restrictions, if any, which will be finally imposed on
the Group's Certificates of Authority. If the restriction originally imposed
is reinstated, the Group will no longer be able to write new policies of
insurance in the State of North Carolina.
The federal government does not directly regulate the insurance business.
However, federal legislation and administrative policies in several areas,
including pension regulation, age and sex discrimination, financial services
regulation and federal taxation, do affect the insurance business. Recently, a
number of state legislatures have considered or have enacted legislative
proposals that alter, and in many cases increase, the authority of state
agencies to regulate insurance companies and holding company systems. In
addition, legislation has been introduced from time to time in recent years
which, if enacted, could result in the federal government assuming a more
direct role in the regulation of the insurance industry.
In 1998, the NAIC adopted the Codification of Statutory Accounting
Principles guidance which will replace the current NAIC Annual Statement
Instructions and Accounting Practices and Procedures manual as the NAIC's
primary guidance on statutory accounting. The Codification provides guidance
for areas where statutory accounting has been silent and changes current
statutory accounting in some areas. The implementation date established by the
NAIC is January 1, 2001; however, the effective date will be specified by each
insurance company's state of domicile. The Company is currently evaluating the
potential effect of the Codification guidance, but does not expect it to have
a material impact on the Company's statutory surplus.
State insurance regulators and the NAIC periodically re-examine existing
laws and regulations and their application to insurance companies. In recent
years, the NAIC has approved, the recommended to the states for adoption and
implementation, several regulatory initiatives designed to decrease the risk
of insolvency of insurance companies. These initiatives include risk based
capital ("RBC")
requirements for determining the levels of capital and surplus an insurer must
maintain in relation to its insurance and investment risks. Other NAIC
regulatory initiatives impose restrictions on an insurance company's ability
to pay dividends to its stockholders. These initiatives may be adopted by the
various states in which the Company's subsidiaries are licensed; the ultimate
content and timing of any statutes and regulations adopted by the states
cannot be determined at this time. 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 existing insurance related laws and
regulations will not become more restrictive in the future or that laws and
regulations enacted in the future will not be more restrictive.
The NAIC's RBC requirements are intended to be used as an early warning tool
to help insurance regulators identify deteriorating or weakly capitalized
companies in order to initiate regulatory action. Such requirements are not
intended as a mechanism for ranking adequately capitalized companies. The
formula defines a new minimum capital standard which supplements the low,
fixed minimum capital and surplus requirements previously implemented on a
state-by-state basis.
The NAIC adopted risk-based capital requirements that require insurance
companies to calculate and report information under a risk-based formula which
attempts to measure statutory capital and surplus needs based on the risks in
a company's mix of products and investment portfolio. The formula
17
is designed to allow state insurance regulators to identify potential weakly
capitalized companies. Under the formula, a company determines its "risk-based
capital" ("RBC") by taking into account certain risks related to the insurer's
assets (including risks related to its investment portfolio and ceded
reinsurance) and the insurer's liabilities (including underwriting risks
related to the nature and experience of its insurance business). Risk-based
capital rules provide for different levels of regulatory attention depending
on the ratio of a company's total adjusted capital to its "authorized control
level" ("ACL") of RBC.
At December 31, 1998 the total RBC as a percentage of authorized control
level were as follows for the Company's insurance subsidiaries:
Vesta Fire Insurance Corporation...................................... 275%
The Hawaiian Insurance & Guaranty Company, Limited.................... 9900%
Shelby Casualty Insurance Company..................................... 2663%
The Shelby Insurance Company.......................................... 6221%
Insura Property and Casualty Company.................................. 2591%
Affirmative Insurance Company......................................... 17029%
Sheffield Insurance Corporation....................................... 2225%
Vesta Insurance Corporation........................................... 4988%
Vesta County Mutual Insurance Company................................. 844%
Vesta Lloyds Insurance Company........................................ 9643%
Restrictions on Dividends to Stockholders. The Company's insurance
subsidiaries are subject to various state statutory and regulatory
restrictions, generally applicable to each insurance company in its state of
incorporation, which limit the amount of dividends or distributions by an
insurance company to its stockholders. The restrictions are generally based on
certain levels of surplus, investment income and operating income, as
determined under statutory accounting practices. Alabama, Ohio, Indiana and
Texas law permits dividends in any year which, together with other dividends
or distributions made within the preceding 12 months, do not exceed the
greater of (i) 10% of statutory surplus as of the end of the preceding year or
(ii) the net income for the preceding year, with larger dividends payable only
after receipt of prior regulatory approval. Hawaii law limits dividends to the
lesser of (i) and (ii) without prior approval. Certain other extraordinary
transactions between an insurance company and its affiliates, also are subject
to prior approval by the Department of Insurance. Future dividends from the
Company's subsidiaries may be limited by business and regulatory
considerations. In 1998 Vesta Fire voluntarily agreed that it will not pay any
dividends to the Company, except those required to service certain
indebtedness of the Company, until December 31, 1999, without the prior
written approval of the Alabama Department of Insurance. See Note D of the
Notes to the Consolidated Financial Statements.
Insurance Regulation Concerning Change or Acquisition of Control. Certain
subsidiaries of the Company are domestic property and casualty insurance
companies organized under the insurance codes of Alabama, Ohio, Indiana,
Hawaii and Texas (the "Insurance Codes"). The Insurance Codes contain a
provision to the effect that the acquisition or change of "control" of a
domestic insurer or of any person that controls a domestic insurer cannot be
consummated without the prior approval of the relevant insurance regulatory
authority. A person seeking to acquire control, directly or indirectly, of a
domestic insurance company or of any person controlling a domestic insurance
company must generally file with the relevant insurance regulatory authority
an application for change of control (commonly known as a "Form A") containing
certain information required by statute and published regulations and provide
a copy of such Form A to the domestic insurer. In Alabama, control is presumed
to exist if any person, directly or indirectly, owns, controls, holds with the
power to vote or holds proxies representing 5% or more of the voting
securities of any other person. In Texas and Hawaii, control is presumed to
exist if any person, directly or indirectly, or with members of the person's
immediate family, owns, controls, or holds with the power to vote, or if any
person other than
18
a corporate officer or director of a person holds proxies representing, 10% or
more of the voting securities of any other person.
In addition, many state insurance regulatory laws contain provisions that
require pre-notification to state agencies of a change in control of a non-
domestic admitted insurance company in that state. While such prenotification
statutes do not authorize the state agency to disapprove the change of
control, such statutes do authorize issuance of a cease and desist order with
respect to the non-domestic admitted insurer if certain conditions exist, such
as undue market concentration.
Any future transactions that would constitute a change in control of the
Company would also generally require prior approval by the Insurance
Departments of Alabama, Ohio, Indiana, Hawaii and Texas and would require
preacquisition notification in those states which have adopted preacquisition
notification provisions and wherein the insurers are admitted to transact
business. Such requirements may deter, delay or prevent certain transactions
affecting the control of the Company or the ownership of the Company's common
stock, including transactions that could be advantageous to the stockholders
of the Company.
Membership in Insolvency Funds and Associations; Mandatory Pools. Most
states require property and casualty insurers to become members of insolvency
funds or associations which generally protect policyholders against the
insolvency of an insurer writing insurance in the state. Members of the fund
or association must contribute to the payment of certain claims made against
insolvent insurers. Maximum contributions required by law in any one year vary
between 1% and 2% of annual premiums written by a member in that state.
The Company is also required to participate in various mandatory insurance
facilities or in funding mandatory pools, which are generally designed to
provide insurance coverage for consumers who are unable to obtain insurance in
the voluntary insurance market. Among the pools in which the Company
participates are those established in coastal states to provide windstorm and
other similar types of property coverage. These pools typically require all
companies writing property insurance in the state for which the pool has been
established to fund deficiencies experienced by the pool based upon each
company's relative premium writings in that state, with any excess funding
typically distributed to the participating companies on the same basis. To the
extent that these assessments are not covered by the Company's reinsurance
treaties, they may have an adverse effect on the Company.
Total assessments from insolvency funds, associations and mandatory pools
were $.5 million, $.3 million and $2.9 million for 1996, 1997 and 1998,
respectively. Some of these payments are recoverable through future policy
surcharges and premium tax reductions.
Various states in which the Company is doing business have established
certain shared market facilities with respect to the coverage of windstorm and
hurricane losses in the state. The Company is subject to assessments under
these facilities up to certain prescribed limits (which are generally based on
its share of the property insurance market in the state) if funds in the state
facility are inadequate to pay such losses on insured risks. The Company
believes that such assessments generally would be treated as a catastrophic
loss under the Company's catastrophe reinsurance programs.
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 "markets assistance
plans" under which insurers are induced to provide certain coverages, (ii)
restrictions on the ability of insurers to 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.
Effect of Federal Legislation. Although the federal government does not
directly regulate the business of insurance, federal initiatives often affect
the insurance business in a variety of ways.
19
Current and proposed federal measures which may significantly affect the
insurance business include federal government participation in asbestos and
other product liability claims, pension regulation (ERISA), examination of the
taxation of insurers and reinsurers, minimum levels of liability insurance and
automobile safety regulations.
NAIC-IRIS Ratios. The NAIC has developed its Insurance Regulatory
Information System ("IRIS") to assist state insurance departments in
identifying significant changes in the operations of an insurance company,
such as changes in its product mix, large reinsurance transactions, increases
or decreases in premiums received and certain other changes in operations.
Such changes may not result from any problems with an insurance company but
merely indicate changes in certain ratios outside ranges defined as normal by
the NAIC. When an insurance company has four or more ratios falling outside
"normal ranges," state regulators may investigate to determine the reasons for
the variance and whether corrective action is warranted. In 1996, Vesta Fire
had no ratios which varied unfavorably from the "usual value" range. In 1997,
Vesta Fire's IRIS ratios may be negatively impacted by the one-time statutory
charge. In 1998, Vesta Fire had 6 ratios which varied unfavorably from the
"usual value" range. The unfavorable ratios were primarily due to 1998
operating results and the Company's overall reserve strengthening during the
year.
A.M. Best Rating
A.M. Best, which rates insurance companies based on factors of concern to
policyholders, recently lowered its rating on the Company's insurance
subsidiaries to "B++" (Very Good, its fifth highest rating category) from "A-"
(Excellent, its fourth highest rating category). Some of the factors noted by
A.M. Best as contributing to the downgrade include the Company's operating
performance, which was affected in part by heavy catastrophe losses, the
Company's debt level, and the uncertainty associated with the Company's then
ongoing negotiations with its lenders to amend its credit agreement in light
of then existing covenant defaults. See, Managements Discussion and Analysis--
Liquidity. The Company does not believe the downgrade will have a material
impact on its personal lines. The Company has determined that the impact of
the A.M. Best downgrade on the commercial line of business will necessitate
corrective actions in excess of what the marketplace will accept. Therefore,
the Company will withdraw from certain commercial lines of business in the
second quarter of 1999. The Company has also determined that the impact of the
downgrade on the reinsurance segment has significantly impaired the Company's
ability to compete effectively in the current reinsurance marketplace.
Therefore, effective March 24, 1999 the Company transferred a significant
portion of its reinsurance operations to another reinsurer in exchange for $15
million.
Competition
The property and casualty insurance industry is highly competitive on the
basis of both price and service. The Company competes for direct business with
other stock companies, specialty insurance organizations, mutual insurance
companies and other underwriting organizations, some of which are
substantially larger and have greater financial resources than the Company. In
recent years there has been a trend in the property and casualty industry
toward consolidation which could result in even more competitive pricing. The
Company also faces competition from foreign insurance companies and from
"captive" insurance companies and "risk retention" groups (i.e., those
established by insureds to provide insurance for themselves.) In the future,
the industry, including the Company, may face increasing insurance
underwriting competition from banks and other financial institutions.
The property and casualty reinsurance business is also highly competitive.
Competition in the types of reinsurance in which the Company is engaged is
based on many factors, including the perceived overall financial strength of
the reinsurer, premiums charged, contract terms and conditions, services
offered, speed of claims payment, reputation and experience. Competitors
include independent reinsurance companies, subsidiaries or affiliates of
established domestic or worldwide
20
insurance companies, reinsurance departments of certain primary insurance
companies and underwriting syndicates.
Relationship with Torchmark
Prior to the initial public offering of its common stock in November 1993,
the Company was a wholly owned subsidiary of Torchmark. As of December 31,
1998, Torchmark owned approximately 23.9% of the issued and outstanding common
stock of the Company. Prior to its initial public offering, the Company
entered into several agreements with Torchmark and certain of its subsidiaries
regarding the future relationship of the Company and Torchmark. Among these
are a lease agreement, pursuant to which the Company leases its headquarters
building, and an investment services agreement, pursuant to which the Company
receives investment advice and services in connection with the management of
the Company's investment portfolio. Prior to May of 1995, the Company marketed
lower value personal dwelling insurance in six states through agents of
Liberty National Life Insurance Company (LNF), pursuant to a written marketing
agreement between the Company and LNL. However, LNL terminated this agreement
in 1995 and will no longer market these products through its agents.
Employees
As of December 31, 1998, the Company employed 655 persons. The Company's
employees are neither represented by labor unions nor are they subject to any
collective bargaining agreements. Management knows of no current efforts to
establish labor unions or collective bargaining agreements.
Item 2. Properties
The Company leases approximately 111,099 square feet for its home office at
3760 River Run Drive, Birmingham, Alabama under a long-term operating lease
from Torchmark Development Corporation, a wholly owned subsidiary of Torchmark
Corporation. The Company considers the office facilities to be suitable and
adequate for its current level of operations.
HIG leases approximately 8,140 square feet for its operations at 1001 Bishop
Street Pacific Tower, Honolulu, Hawaii under a long-term operating lease. The
Company considers the office facilities to be suitable and adequate for HIG's
current and anticipated level of operations.
The Company owns an office building with approximately 175,000 square feet
located at 175 Mansfield Avenue, Shelby, Ohio for its Shelby operations.
Item 3. Legal Proceedings
Subsequent to the filing of its quarterly report on Form 10-Q for the period
ended March 31, 1998 with the Securities and Exchange Commission, the Company
became aware of certain accounting irregularities consisting of inappropriate
reductions of reserves and overstatements of premium income in the Company's
reinsurance business that had been recorded in the fourth quarter of 1997 and
the first quarter of 1998. The Company promptly commenced an internal
investigation to determine the exact scope and amount of such reductions and
overstatements. This investigation concluded that inappropriate amounts had,
in fact, been recorded and the Company determined it should restate its
previously issued 1997 financial statements and first quarter 1998 Form 10-Q.
Additionally, during its internal investigation the Company re-evaluated the
accounting methodology being utilized to recognize earned premium income in
its reinsurance business. The Company had historically reported certain
assumed reinsurance premiums as earned in the year in which the related
reinsurance contracts were entered even though the terms of those contracts
frequently bridged two years. The Company determined that reinsurance premiums
should be recognized as earned over the contract period and corrected the
error in its accounting methodology by restating previously issued financial
21
statements. The Company issued press releases, which were filed with the
Securities and Exchange Commission, on June 1, 1998 and June 29, 1998
announcing its intention to restate its historical financial statements.
The Company restated its previously issued financial statements for 1995,
1996 and 1997 and its first quarter 1998 Form 10-Q for the above item by
issuance of a current report on Form 8-K dated August 19, 1998. These
restatements resulted in a cumulative decrease to stockholder' equity of $75.2
million through March 31, 1998.
Commencing in June, 1998, the Company and several of its current and former
officers and directors were named in several purported class action lawsuits
in the United States District Court for the Northern District of Alabama and
in one purported class action lawsuit in the Circuit Court of Jefferson
County, Alabama. Several of Vesta's officers and directors also have been
named in a derivative action lawsuit in the Circuit Court of Jefferson County,
Alabama, in which Vesta is a nominal defendant.
The class action lawsuit filed in the Circuit Court of Jefferson County,
Alabama has been dismissed and the derivative case has been placed on the
administrative docket. The class actions filed in the United States District
Court for the Northern District of Alabama have been consolidated into a
single action in that district. The purported class representatives in that
action have filed (a) a consolidated amended complaint alleging that the
defendants violated the federal securities laws and (b) a motion for class
certification. The consolidated amended complaint also added as defendants
Torchmark Corporation and the Company's predecessor auditors, KPMG Peat
Marwick, LLP. The time for the defendants to respond to the complaint and the
motion for class certification has not yet run. The consolidated amended
complaint alleges various violations of the federal securities law and seeks
unspecified but potentially significant damages.
The Company has notified its directors and officers liability insurance
companies of these lawsuits and the consolidated amended compliant. The
litigation is still in the preliminary stages and there has been no discovery
or class certification. The Company intends to vigorously to defend this
litigation and intends to explore all available rights and remedies it may
have under the circumstances. In related litigation, in September, 1998,
Cincinnati Insurance Company ("Cincinnati"), one of the Company's directors
and officers liability insurance carriers, filed a lawsuit in the United
States District Court for the Northern District of Alabama seeking to avoid
coverage under its directors and officers liability and other policies. The
Company filed a motion to dismiss Cincinnati's complaint on jurisdictional
grounds in federal court (which was granted), and filed a lawsuit against
Cincinnati in the Circuit Court of Jefferson County, Alabama seeking damages
arising out of Cincinnati's actions. Cincinnati has filed an answer and
counterclaim in that case again seeking to avoid coverage. The Company intends
to vigorously resist Cincinnati's efforts to avoid coverage. Because these
matters are in their early stages, their ultimate outcome cannot be
determined. Accordingly, no provision for any liability that may result
therefrom has been made in the accompanying consolidated financial statements.
As discussed above, the Company corrected its accounting for assumed
reinsurance business through restatement of its previously issued financial
statements. Similar corrections were made on a statutory accounting basis
through recording cumulative adjustments in Vesta Fire's 1997 statutory
financial statements. The impact of this correction has been reflected in
amounts ceded under the Company's 20 percent whole account quota share treaty
which was terminated on June 30, 1998 on a run-off basis. The Company believes
such treatment is appropriate under the terms of this treaty and has
calculated the quarterly reinsurance billings presented to the treaty
participants accordingly. The aggregate amount included herein as recoverable
from such reinsurers totalled $60.4 million at December 31, 1998. Two of the
three participants have notified the Company that they wish to audit the
treaty computations as allowed by the terms of the treaty. The other
participant, through various correspondence, has also expressed an interest in
obtaining additional data. While management believes its interpretation of the
treaty's terms and computations based thereon, are correct, the effects, if
any, of participant audits or other actions cannot be determined at this time.
22
The Company, through its subsidiaries, is routinely a party to pending or
threatened legal proceedings and arbitrations. These proceedings involve
alleged breaches of contract, torts, including bad faith and fraud claims and
miscellaneous other causes of action. These lawsuits may include claims for
punitive damages in addition to other specified relief. Based upon information
presently available, and in light of legal and other defenses available to the
Company and its subsidiaries, management does not consider liability from any
threatened or pending litigation or arbitration to be material.
Item 4. Submission of Matters to a Vote of Security Holders
None.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matter
(a) Market Information
Since November 11, 1993, the Common Stock has been traded on the New York
Stock Exchange under the symbol "VTA". Prior to November 11, 1993, there was
no established public trading market for the Common Stock. The stock began
trading on November 11, 1993, at $16.67 per share.
Quarterly high and low market prices of the Company's common stock in 1997
were as follows:
Quarter Ended High Low
------------- ------ ------
March 31.................................................... $41.50 $30.88
June 30..................................................... 49.00 32.75
September 30................................................ 59.00 43.63
December 31................................................. 64.50 54.88
Quarterly high and low market prices of the Company's common stock in 1998
were as follows:
Quarter Ended High Low
------------- ------ ------
March 31.................................................... $64.75 $52.13
June 30..................................................... 59.00 20.00
September 30................................................ 22.13 6.75
December 31................................................. 9.88 5.00
(b) Number of Holders of Common Stock
There were 178 shareholders of record on January 15, 1999 including
shareholder accounts held in nominee form.
(c) Dividend History and Restrictions
The declaration and payment of dividends will be at the discretion of the
Company's Board of Directors and will depend upon many factors, including the
Company's financial condition and earnings, the capital requirements of the
Company's operating subsidiaries, legal requirements and regulatory
constraints. The Company has agreed not to pay dividends to its common
stockholders until it satisfies certain financial commitment to its commercial
lenders. See Management Discussion and Analysis--Liquidity Section.
The dividends paid by the Company on its common stock for the past two years
were as follows (in thousands):
Quarter 1997 1998
------- ---- ----
First............................. $697 $691
Second............................ 697 687
Third............................. 701 695
Fourth............................ 702 697
Alabama imposes restrictions on the payment of dividends to the Company by
the Company's insurance subsidiary in excess of certain amounts without prior
regulatory approval (see the "Restrictions on Dividends to Stockholders"
section in Item 1).
23
Item 6. Selected Financial Data
The following information should be read in conjunction with the Company's
Consolidated Financial Statements and related notes reported elsewhere in this
Form 10-K.
(Amounts in Thousands Except Per Share and Percentage Data)
Year Ended December 31,
------------------------------------------------------
1994 1995 1996 1997 1998
-------- -------- -------- ------------- ----------
(restated)(4)
Statement of Operations
Data*
Gross Premiums Written. $327,106 $518,059 $651,771 $ 866,051 759,021
Net Premiums Written... 232,110 390,504 468,056 526,475 491,590
Net Premiums Earned.... 232,352 313,078 439,336 517,658 509,693
Net Investment Income.. 12,999 17,972 23,148 35,960 35,058
Investment Gains
(Losses).............. (695) 276 32 3,283 3,272
Other.................. 100 216 188 2,094 5,473
-------- -------- -------- ---------- ----------
Total Revenues......... 244,756 331,542 462,704 558,995 553,496
-------- -------- -------- ---------- ----------
Losses and LAE
Incurred.............. 134,557 198,962 251,783 298,638 395,322
Policy Acquisition and
Other Underwriting
Expenses.............. 82,264 93,983 145,703 180,464 255,994
Loss on Asset
Impairment............ -- -- -- -- 74,496
Amortization of
Goodwill.............. -- 264 484 4,007 6,609
Interest Expense....... 1,708 5,273 10,059 10,859 14,054
-------- -------- -------- ---------- ----------
Total Losses and
Expenses.............. 218,529 298,482 408,029 493,968 746,475
-------- -------- -------- ---------- ----------
Income (Loss) From
Operations Before
Income Tax............ 26,227 33,060 54,675 65,027 (192,979)
Income Taxes (benefit). 7,352 10,468 17,862 23,116 (57,244)
Deferrable capital
securities interest,
net of income tax..... -- -- -- 5,051 5,449
-------- -------- -------- ---------- ----------
Net income (loss)...... $ 18,875 $ 22,592 $ 36,813 $ 36,860 $ (141,184)
Basic Earnings Per
Share (2)(3).......... $ 1.00 $ 1.20 $ 1.95 $ 1.98 $ (7.61)
Shares used in per
share calculation
(2)(3)................ 18,812 18,842 18,860 18,600 18,548
Diluted Earnings Per
Share continuing
operations (2)(3)..... $ 1.00 $ 1.19 $ 1.92 $ 1.93 $ (7.61)
Shares used in per
share calculation
(2)(3)................ 18,834 18,970 19,157 19,053 18,548
Cash dividends per
share................. .15 .13 .20 .15 .15
Balance Sheet Data (at
end of period)
Total Investments and
Cash.................. $300,186 $422,516 $427,276 $ 656,816 $ 634,668
Total Assets........... 479,325 735,758 871,385 1,636,859 1,347,702
Reserves For Losses and
LAE................... 110,297 168,502 173,275 596,797 504,911
Long Term Debt......... 28,000 98,163 98,279 98,602 98,302
Total Liabilities...... 258,703 488,499 599,466 1,239,523 1,089,675
Deferrable Capital
Securities............ -- -- -- 100,000 100,000
Stockholders' Equity... 220,622 247,259 271,919 297,336 158,027
Certain Financial Ratios
and Other Data
GAAP
Loss and LAE Ratio..... 57.9% 63.6% 57.3% 57.7% 77.6%
Underwriting Expense
Ratio................. 35.4 30.0 33.2 34.9 50.2
-------- -------- -------- ---------- ----------
Combined Ratio......... 93.3% 93.6% 90.5% 92.6% 127.8%
======== ======== ======== ========== ==========
SAP (1)
Loss and LAE Ratio..... 54.0% 57.2% 57.9% 65.6% 90.4%
Underwriting Expense
Ratio................. 35.4 33.4 31.8 51.7 42.1
-------- -------- -------- ---------- ----------
Combined Ratio......... 89.4% 90.6% 89.7% 117.3% 132.5%
======== ======== ======== ========== ==========
Net Premiums Written to
Surplus Ratio......... 1.18x 1.44x 1.53x 1.49x 2.81x
Surplus................ $212,507 $318,997 $352,695 $317,875 $ 220,210
- --------
* As a result of an internal investigation begun in the second quarter of
1998, the Company determined that certain inappropriate reductions of
reserves and overstatements of premium income in the Company's reinsurance
business had been recorded in the fourth quarter of 1997 and the first
quarter of 1998. Based on the information discovered in that investigation,
the Company has restated its previously issued financial statements in
August 1998 to make the necessary
24
corrections. In addition, the Company has revised its statutory accounting
for its assumed reinsurance business to reflect only accident/calendar year
information. Effective with its year end 1997 statutory filings, the
adjustments reversed, in the form of a one-time charge, the cumulative
effect of the Company's prior practice of making estimates for reinsurance
assumed on a combined underwriting and accident year basis, the accounting
practice consistently applied over prior years. On a GAAP basis, the
correction was accounted for by restating prior financial statements.
(1) Statutory data have been derived from the financial statements of the
Company prepared in accordance with SAP and filed with insurance
regulatory authorities.
(2) Restated for 3-for-2 stock split paid on January 22, 1996.
(3) Effective as of December 31, 1997, the Company adopted FASB 128. The prior
periods have been restated. See Note R of Notes to Consolidated Financial
Statements.
(4) The Company determined, subsequent to the issuance of the 1997 financial
statements, that a specific reinsurance ceded contract entered into in
1997 contains retroactive elements as defined in FAS 113. The Company
erroneously recorded the initial gain on this contract in 1997 and must
adjust its previously issued financial statements to appropriately defer
and recognize such gain. See Note B for further discussion.
25
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Overview
The Company writes treaty reinsurance and primary insurance on selected
personal and commercial lines risks. In its reinsurance operations, the
Company focuses principally on property coverages, for which ultimate losses
generally can be more promptly determined than on casualty risks. In the past,
the Company's primary operations have emphasized writing property coverages
more than liability. With the addition of the liability portions of the Shelby
automobile lines, the Company's writings are also now more evenly balanced
between property and liability exposures. The Company's revenues from
operations are derived primarily from net premiums earned on risks written or
reinsured by the Company, investment income and investment gains or losses,
while expenses consist primarily of payments for claims losses and
underwriting expenses, including agents' commissions and operating expenses.
Significant factors influencing results of operations include the supply and
demand for property and casualty insurance and reinsurance, as well as the
number and magnitude of catastrophic losses such as hurricanes, windstorms,
fires and severely cold weather. Premium rate levels are affected by the
availability of insurance coverage which is influenced by levels of surplus in
the industry and other factors. Increases in surplus have generally been
accompanied by increased price competition among property and casualty
insurers. Pricing in this business has weakened due to increased reinsurance
market capacity.
For its assumed reinsurance business, the Company had historically made
estimates for its reinsurance reports received subsequent to a period end on a
combined underwriting and accident year basis for both statutory and GAAP
purposes. As a result of a routine examination by the Alabama Department of
Insurance, the Company agreed to revise the accounting for its reinsurance
business for statutory purposes. Effective with its year end 1997 statutory
filings, Vesta Fire revised its statutory accounting for its assumed
reinsurance business to reflect only accident/calendar year information. The
adjustments essentially reversed, in the form of a one-time charge, the
cumulative effect of the accounting practice consistently applied over prior
years. On a GAAP basis, the correction was accounted for by restating prior
financial statements.
The Company determined, subsequent to the issuance of the 1997 financial
statements, that a specific reinsurance ceded contract entered into in 1997
contains retroactive elements as defined in Financial Accounting Standards
Board ("FASB") Statement 113. The Company erroneously recorded a gain on this
contract in the fourth quarter of 1997 and must adjust its previously issued
financial statements to appropriately defer and recognize such gain in future
periods. See Note B of the consolidated financial statements for further
discussion.
The Company seeks to manage its risk exposure by adjusting the mix and
volume of business written in response to changes in price, maintaining
extensive reinsurance and retrocessional programs and applying the Company's
knowledge of primary insurance markets to its reinsurance business.
The Company has historically followed a practice of maintaining low
retentions in its primary and reinsurance business to reduce the variability
of its earnings. The Company's loss reserve levels historically have remained
relatively stable from year to year despite changes in premium volume. The
Company is continuing to cede portions of insurance risks while using its
capital base to gradually increase, on a selective basis, its retention of
certain property risks.
Because catastrophe loss events are by their nature unpredictable,
historical results of operations may not be indicative of expected results of
future operations. The Company markets its primary personal insurance products
throughout the United States. While the Company seeks to reduce its exposure
to catastrophic events through the purchase of reinsurance, the occurrence of
one or more major catastrophes in any given period could have a material
adverse impact on the Company's results of operations and financial condition
and could result in substantial outflows of cash as losses are paid. In
addition, the increased underwritings of catastrophe
26
related reinsurance, and potential residual market assessments may also lead
to increased variability in the Company's loss ratio.
Prior to the Shelby and Vesta County Mutual acquisitions, assumed
reinsurance was the dominant line of business, representing 78 percent of 1996
net premiums. As a result of these acquisitions, assumed reinsurance
represented 62 percent of 1997 gross premiums. In 1998, assumed reinsurance
represented 38 percent of 1998 gross premiums. This shift to increase primary
writing is consistent with the Company's strategy to focus on property
coverages in all of its lines of business while adjusting the mix and volume
of its writings and retentions to respond to change in market conditions.
On December 31, 1996 the Company terminated the 75% pro rata reinsurance
contract on its homeowners and dwelling lines of business (excluding HIG)
produced through independent agents and also on its homeowners and dwelling
lines of business in the financial services business. The cancellation enabled
the Company to increase its net writings in the personal lines of business.
In July of 1996, Vesta Fire entered into a pro rata reinsurance facility
covering substantially all primary and assumed business in order to provide
capital flexibility to take advantage of growth opportunities in the future.
This reinsurance facility had the effect of reducing net premiums written in
the second half of 1996 by $98.0 million. In 1997, the reinsurance facility
had the effect of reducing net written premiums by $155.1 million, including
reducing Shelby net written premiums by $37.5 million. In 1998, the
reinsurance facility had the effect of reducing net premiums written by $70.2
million. Effective July 1, 1998, the reinsurance facility was cancelled on a
run-off basis.
Comparison of Fiscal Year 1998 to Fiscal Year 1997
Premiums, Loss and LAE--Reinsurance
Gross premiums written for reinsurance decreased by $247.8 million, or
46.3%, to $287.6 million for the year ended December 31, 1998, from $535.4
million for the year ended December 31, 1997. The main contributors to the
reduction of reinsurance gross premiums written were the continuation of
increased competition in the market place coupled with the Company's
unwillingness to follow the market price, the modification of one large treaty
and the cancellation of another large treaty. The acquisition of Vesta County
Mutual resulted in the further shift of $27 million of private passenger
automobile writings which had been recorded on the reinsurance line in 1997 to
personal lines in 1998. Net premiums written for reinsurance decreased $194.1
million, or 55.2%, to $157.7 million for the year ended December 31, 1998,
from $351.8 million for the year ended December 31, 1997. Net premiums earned
for reinsurance decreased $141.1 million, or 42.1% to $194.3 million for the
year ended December 31, 1998, from $335.4 million for the year ended December
31, 1997.
Loss and LAE for reinsurance decreased by $3.8 million, or 2.1% to $175.7
million for the year ended December 31, 1998, from $179.5 for the year ended
December 31, 1997. The dollar amount of loss and loss adjustment expenses
incurred decreased during 1998 due to the decline in net premiums earned. The
loss and LAE ratio for reinsurance for the year ended December 31, 1998 was
90.5% as compared to 53.5% for the year ended December 31, 1997. The increase
in the loss ratio was primarily attributable to the decreases in earned
premiums due to pricing pressures and market competition, higher ceded
reinsurance costs in 1998 versus 1997 and an increase of $18.7 million in
catastrophe losses.
Given current market conditions in the reinsurance arena the Company
anticipates that the recent change in its A.M. Best rating to B++ will have a
negative impact on its reinsurance operations. Although the company enjoys an
excellent relationship with its reinsurance customers the potential for growth
in its reinsurance portfolio has been hampered by the recent change in rating.
The Company has determined that the A.M. Best downgrade and the increased
competition in the reinsurance
27
marketplace will cause a significant loss of reinsurance premiums in 1999.
Therefore, the Company has entered into an agreement to sell a significant
portion of its reinsurance book of business. See the Business Strategy section
and Note T of the Notes to the Consolidated Financial Statements for further
discussion.
Included in the reinsurance results for 1998, were two large 100% Quota
share reinsurance treaties for CIGNA and Homeplus which cover selected
homeowners lines. As the covered business is renewed it will be transferred to
Vesta Fire as the issuing carrier. These treaties were not included in the
sale of the reinsurance book of business. In 1998, these treaties accounted
for $107.4 million in gross written premiums.
Premiums, Loss and LAE--Personal lines
Gross premiums written for personal lines increased by $102.3 million, or
41.8%, to $347.0 million for the year ended December 31, 1998, from $244.7
million for the year ended December 31, 1997. Included in the $102.3 increase
in gross premiums written for personal lines was a $101.0 million increase in
gross premiums written due to a full year of Shelby premiums in 1998 versus
six months of Shelby premiums in 1997. The remaining increase of $1.3 million
was primarily due to the transfer of business from assumed reinsurance to
personal lines following the acquisition of Vesta County Mutual partially
offset by premium reductions in the Financial Services lines and the Hawaiian
Insurance and Guaranty Company Limited ("HIG").
Net premiums written for personal lines increased by $123.6 million, or
87.5%, to $264.8 million for the year ended December 31, 1998, from $141.2
million for the year ended December 31, 1997. The increase in net premiums
written was largely attributable to the writings from Shelby and the transfer
of business from assumed reinsurance to personal lines following the
acquisition of Vesta County Mutual. Net premiums earned for personal lines
increased $107.7 million, or 77.3% to $247.1 million for the year ended
December 31, 1998, from $139.4 million for the year ended December 31, 1997.
Loss and LAE for personal lines increased by $69.7 million, or 73.2% to
$164.9 million for the year ended December 31, 1998, from $95.2 million for
the year ended December 31, 1997. The increase in loss and loss adjustment
expenses was primarily attributable to a full year of losses for Shelby
included in 1998 versus only six months of losses for Shelby in 1997. The loss
and LAE ratio for personal lines for the year ended December 31, 1998 was
66.7% as compared to 68.3% at December 31, 1997.
Premiums, Loss and LAE--Commercial Lines
Gross premiums written for commercial lines increased $38.5 million, or
44.8%, to $124.4 for the year ended December 31, 1998, from $85.9 million for
the year ended December 31, 1997. The increase in gross premiums written is
primarily attributable to the $37.5 million increase in premiums related to a
full year of Shelby premiums in 1998 versus six months of Shelby premiums in
1997. Net premiums written increased $35.5 million, or 106.0% to $69.0 million
for the year ended December 31, 1998, from $33.5 million for the year ended
December 31, 1997. Net premiums earned increased $25.5 million, or 59.4%, to
$68.4 million for the year ended December 31, 1998, from $42.9 million for the
year ended December 31, 1997.
Loss and LAE for commercial lines increased $30.7 million, or 127.9% from
$24.0 million for the year ended December 31, 1997 to $54.7 million for the
year ended December 31, 1998. The loss and LAE ratio for commercial lines for
the year ended December 31, 1998 was 80.0% as compared to 55.9% for the year
ended December 31, 1997. The increase in loss ratio was primarily attributable
to increased market competition and catastrophe losses for the year ended
December 31, 1998.
28
Until recently, the Company pursued a broader range of target commercial
classes which focused on hotels, manufacturers, restaurants, motorcycle
dealers, broadcasters and publishers. The Company concluded, however, that in
the continuing competitive marketplace, the Company could not achieve adequate
pricing for these classes of business as required for profitability.
Therefore, in the second June of 1999, the Company will withdraw from these
classes of business, as the Company elected to focus on the expansion of its
small commercial Partners program, offering its Businessowners, Artisan
Contractors, and small Service Garage programs. See the Business Strategy
section and Note T of the Notes to the Consolidated Financial Statements for
further discussion.
Policy Acquisition Expenses and Other Operating Expenses
Policy acquisition expenses increased by $23.0 million, or 17.2% to $156.0
million for the year ended December 31, 1998, from $133.0 million for the year
ended December 31, 1997. The increase in policy acquisition costs is primarily
attributable to additional marketing staff salaries and additional agents
incentives. Other operating expenses include administrative costs not directly
related to the generation of premium revenue, premium taxes and fees, interest
on debt and goodwill amortization. Administrative costs (designated as
operating expenses on the statement of operations) increased $52.5 million.
The increase in administration costs is primarily attributable to $42.0
million in increased costs related to the Shelby operations. The remaining
$10.5 million in increased costs is related primarily to increases in
information systems costs and professional fees. The increase in premium taxes
and fees is directly related to the increase in direct premiums written. The
increase in goodwill amortization is attributable to a full year of
amortization of the goodwill related to the Shelby acquisition versus six
months of amortization in 1997.
Net Investment Income. Net investment income decreased by $.9 million, or
2.5%, to $35.1 million for the year ended December 31, 1998, from $36.0
million for the year ended December 31, 1997. The weighted average yield on
invested assets (excluding realized and unrealized gains) was 6.0% for the
year ended December 31, 1998, compared with 5.8% for the year ended December
31, 1997.
Loss on asset impairment. During the fourth quarter of 1998, management
evaluated goodwill impairment pursuant to the Company's existing policies. The
evaluation indicated an impairment of goodwill acquired as part of the Shelby
acquisition. The events that led to this conclusion include the Company's
inability to integrate the Shelby acquisition as planned and the resulting
high level of expenses, and the recording of significant operating losses in
1998. As a result of these evaluations, the unamortized goodwill attributable
to the Shelby acquisition was reduced by $74.5 million. See Note C of the
Notes of the Consolidated Financial Statements.
Federal Income Taxes. Federal income taxes decreased by $80.4 million to a
benefit of $57.3 million for the year ended December 31, 1998 from $23.1
million for the year ended December 31, 1997. This decrease was primarily due
to the decrease in operating income.
Net Income (loss). For the reasons discussed above, net income decreased by
$178.1 million, to a loss of $141.2 million for the year ended December 31,
1998, from $36.9 million for the year ended December 31, 1997.
Comparison of Fiscal Year 1997 to Fiscal Year 1996
On December 31, 1996 the Company terminated the 75% pro rata reinsurance
contract on its homeowners and dwelling lines of business (excluding HIG)
produced through independent agents and also on its homeowners and dwelling
lines of business in the financial services business. The cancellation enable
the Company to increase its net writings in the personal lines of business.
In July of 1996, Vesta Fire entered into a pro rata reinsurance facility
covering substantially all primary and assumed business in order to provide
capital flexibility to take advantage of growth opportunities in the future.
This reinsurance facility had the effect of reducing net premiums written in
29
the second half of 1996 by $98.0 million. In 1997, the reinsurance facility
had the effect of reducing net written premiums by $155.1 million, including
reducing Shelby net written premiums by $37.5 million.
Premiums, Loss and LAE--Reinsurance
Gross premiums written for reinsurance increased by $37.9 million, or 7.6%,
to $535.4 million for the year ended December 31, 1997, from $497.5 million
for the year ended December 31, 1996. In 1997, the Company significantly
increased its reinsurance writings of homeowners lines through several large
contracts including the CIGNA 100% Quota Share Reinsurance Treaty. The
increased reinsurance writings of homeowners lines was partially offset by a
decrease in reinsurance writings of private passenger automobile lines from
1997 to 1996. The acquisition of Vesta County Mutual resulted in the shift of
$47 million of private passenger automobile writings which had been recorded
on the reinsurance line to primary insurance. Additionally, the reinsurance
market experienced increased market capacity accompanied by increased price-
competition in the private passenger automobile line of business. As a result
of these factors, the Company elected to terminate certain accounts. Net
premiums written for reinsurance decreased $21.7 million, or 5.8%, to $351.8
million for the year ended December 31, 1997, from $373.5 million for the year
ended December 31, 1996. Net premiums earned for reinsurance decreased $7.1
million, or 2.1% to $335.4 million for the year ended December 31, 1997, from
$342.5 million for the year ended December 31, 1996. The decreases in net
premiums written and net premiums earned are attributable to the pro-rata
reinsurance facility being in place for 12 months in 1997 versus six months in
1996.
Loss and LAE for reinsurance decreased by $25.5 million, or 12.4% to $179.5
million for the year ended December 31, 1997, from $205.0 for the year ended
December 31, 1996. The dollar amount of loss and loss adjustment expenses
incurred decreased during 1997 due to the decline in net premiums earned. The
loss and LAE ratio for reinsurance for the year ended December 31, 1997 was
53.5% as compared to 59.9% for the year ended December 31, 1996. The decrease
in the loss ratio was primarily attributable to the increased reinsurance
writings of homeowners' lines of business which generally incurs a lower loss
ratio than automobile lines.
Premiums, Loss and LAE--Personal Lines
Gross premiums written for personal lines increased by $135.0 million, or
123.1%, to $244.7 million for the year ended December 31, 1997, from $109.7
million for the year ended December 31, 1996. The increase in personal lines
gross premiums is primarily due to the acquisition of Shelby and the transfer
of business from assumed reinsurance to personal lines following the
acquisition of Vesta County Mutual.
Net premiums written for personal lines increased by $71.4 million, or
102.3%, to $141.2 million for the year ended December 31, 1997, from $69.8
million for the year ended December 31, 1996. Net premiums earned for personal
lines increased $76.2 million, or 120.6% to $139.4 million for the year ended
December 31, 1997, from $63.2 million for the year ended December 31, 1996.
Loss and LAE for personal lines increased by $69.6 million, or 271.9% to
$95.2 million for the year ended December 31, 1997, from $25.6 million for the
year ended December 31, 1996. Included in the increase in loss and loss
adjustment expenses was $56.8 million in losses incurred by Shelby. The loss
and LAE ratio for personal lines for the year ended December 31, 1997 was
68.3% as compared to 40.5% at December 31, 1996. The increase in the loss
ratio was primarily due to a shift in writing more automobile lines because of
the acquisition of Shelby and the increased writings from Vesta County Mutual.
Automobile lines generally incur higher loss ratios than homeowners lines.
30
Premiums, Loss and LAE--Commercial Lines
Gross premiums written for commercial lines increased by $41.3 million, or
92.7%, to $85.9 million for the year ended December 31, 1997, from $44.6
million for the year ended December 31, 1996. The increase in gross premiums
written for commercial lines is primarily attributable to the acquisition of
Shelby.
Net premiums written for commercial lines increased by $8.7 million, or
35.1%, to $33.5 million for the year ended December 31, 1997, from $24.8
million for the year ended December 31, 1996. Net premiums earned for
commercial lines increased 9.2 million, or 27.3% to $42.9 million for the year
ended December 31, 1997, from $33.7 million for the year ended December 31,
1996.
Loss and LAE for commercial lines increased by $2.8 million, or 13.2% to
$24.0 million for the year ended December 31, 1997, from $21.1 million for the
year ended December 31, 1996. The loss and LAE ratio for primary insurance for
the year ended December 31, 1997 was 55.9% as compared to 62.8% at December
31, 1996.
Policy Acquisition Expenses and Other Operating Expenses.
Policy acquisition expenses increased by $14.4 million, or 12.1% to $133.0
million for the year ended December 31, 1997, from $118.6 million for the year
ended December 31, 1996. The increase in policy acquisition expenses is
primarily attributable to the increase in net written premiums. Other
operating expenses include administrative costs not directly related to the
generation of premium revenue, premium taxes and fees, interest on debt and
goodwill amortization. Administrative costs (designated as operating expenses
on the statement of operations) increased $17.7 million. The increase in
administration costs is primarily attributable to the assimilation and
administration of the Shelby operations. The increase in premium taxes and
fees is directly related to the increase in direct premiums written. The
increase in goodwill amortization is attributable to the $83 million of
goodwill acquired on June 30, 1997 in connection with the Shelby acquisition.
Net Investment Income. Net investment income increased by $12.9 million, or
55.4%, to $36.0 million for the year ended December 31, 1997, from $23.1
million for the year ended December 31, 1996. The weighted average yield on
invested assets (excluding realized and unrealized gains) was 5.8% for the
year ended December 31, 1997, compared with 5.6% for the year ended December
31, 1996. The increase in net investment income is primarily attributable to
an increase in average invested assets relating to the Shelby acquisition.
Federal Income Taxes. Federal income taxes increased by $5.2 million, or
29.1%, to $23.1 million for the year ended December 31, 1997 from $17.9
million for the year ended December 31, 1996. The effective rate on pre-tax
income increased from 32.7% to 35.4% for the year ended December 31, 1997.
Net Income. For the reasons discussed above, net income increased by $.1
million, or .3%, to $36.9 million for the year ended December 31, 1997, from
$36.8 million for the year ended December 31, 1996.
Liquidity and Capital Resources
The Company is a holding company whose principal asset is its investment in
the capital stock of the companies constituting the Vesta Group, a group of
wholly owned property and casualty insurance companies including Vesta Fire.
The insurance company subsidiaries comprising Vesta Group are individually
supervised by various state insurance regulators. Vesta Fire is the principal
operating subsidiary of the Company.
31
As a holding company with no other business operations, the Company relies
primarily upon dividend payments from Vesta Fire to meet its cash requirements
(including its debt service) and to pay dividends to its stockholders.
Transactions between Vesta Fire, and the Company, including the payment of
dividends by Vesta Fire, are subject to certain limitations under the
insurance laws of Alabama. Specifically, Alabama law permits the payment of
dividends in any year which, together with other dividends or distributions
made within the preceding 12 months, do not exceed the greater of 10% of
statutory surplus as of the end of the preceding year or the net income for
the preceding year, with larger dividends payable only after receipt of prior
regulatory approval. In 1998, Vesta Fire voluntarily agreed that it will not
declare any dividends, except for those required to service the Company's
debt, until December 31, 1999, without the prior written approval of the
Alabama Department of Insurance.
The principal uses of funds at the holding company level are to pay
operating expenses, interest on outstanding indebtedness and dividends to
stockholders. During the last three years, the insurance subsidiaries of the
Company have produced operating results sufficient to fund the needs of the
Company. However, there can be no assurance as to the ability of the Company's
insurance subsidiaries to continue to pay dividends at current levels. Except
for the regulatory restrictions described above, the Company is not aware of
any demands or commitments of the insurance subsidiaries that would prevent
the payment of dividends to the Company sufficient to meet the anticipated
needs (including debt service) of the Company over the next twelve months. See
"Business--Regulation."
During 1998, the Company paid approximately $2.8 million in dividends on its
common stock. However, the Company will not pay any common stock dividends in
1999. The Company is also required to make semi-annual interest payments of
$4.4 million on its $100 million of 8.75% Senior Debentures due 2025 (the
"Senior Notes"). As required by the Company's amended bank facility, the
Company will defer the semi-annual interest payments of $4.3 million on its
$100 million of 8.525% Junior Subordinated Deferrable Interest Debentures (the
"Trust Debentures") issued to Vesta Capital Trust I in connection with its
sale of $100 million of 8.525% Capital Securities.
As of December 31, 1998, the Company had borrowed $70 million under its $200
million line of credit for general corporate purposes and for a capital
contribution of $25 million to the Company's principal insurance subsidiary,
Vesta Fire. The credit agreement related to this line of credit contains
certain covenants that require, among other things, the Company to maintain a
certain consolidated net worth ("Consolidated Net Worth Covenant"), maintain a
certain amount of earnings before interest and taxes available for the payment
of interest and dividend expense, ("Fixed Charge Coverage Ratio"), cause each
insurance subsidiary to maintain a certain total adjusted statutory capital,
("Adjusted Statutory Capital Covenant"), and that limits the amount of
indebtedness of the companies. As of December 31, 1998, the Company was not in
compliance with all of its financial covenants.
Subsequent to December 31, 1998, the Company's banks agreed to amend the
covenants and waive any event of default arising from non-compliance with the
covenants as of December 31, 1998. The amended credit facility was
restructured into a $70 million senior revolving credit facility, maturing
July 31, 2000 ("the "Amended Facility"). The interest rate on the Amended
Facility will be the prime rate plus 1%, provided that from and after
September 30, 1999 the rate shall be increased to the prime rate plus 3% if
the Company has not made permanent principal prepayments on the Amended
Facility aggregating at least $25 million. The Company will also pay the banks
a 1% Commitment Fee on all of the used and unused commitments under the
Amended Facility.
The Amended Facility requires the Company to make a closing principal
prepayment of $15 million less transaction expenses the net amount of which
reduces the obligation to make permanent principal payment aggregating $25
million. The amended Facility also provides for warrants equal to
approximately 6.6% of the Company's outstanding shares being issued to the
banks participating on
32
the Amended Facility, which become exercisable in the event the Company does
not make $25 million of permanent principal prepayments on the facility by
March 15, 2000.
The Amended Facility requires the Company to suspend dividends on its common
stock and defer payments of interest on its Trust Debentures unless the
Company has made $25 million of permanent principal prepayments on the Amended
Facility by March 15, 2000. The Amended Facility contains certain covenants
that require the Company to maintain minimum statutory surplus levels, minimum
cumulative statutory net income levels and minimum cumulative GAAP net income
levels.
The principal sources of funds for the Company's insurance subsidiaries are
premiums, investment income and proceeds from the sale or maturity of invested
assets. Such funds are used principally for the payment of claims, operating
expenses, commissions and the purchase of investments. On a consolidated
basis, net cash used in operations for the year ended December 31, 1998 and
1997, was $47.1 million and $59.2 million, respectively. The negative cash
flow from operations in 1998 related primarily to the net loss incurred in
1998. The negative cash flow from operations in 1997 related primarily to the
return of a loss reserve portfolio relating to a pro rata reinsurance contract
commuted at the end of 1996 and the Shelby unearned premium portfolio transfer
to the reinsurance facility. These transactions had the combined effect of
reducing cash flow from operations by $73.2 million in 1997.
As of December 31, 1998, the Company's investment portfolio consisted of
cash and short-term investments (24.6%), U.S. Government securities (11.9%),
mortgage-backed securities (14.0%), corporate bonds (25.5%), foreign
government securities (0.6%), municipal bonds (20.1%) and equity securities
(3.3%). According to Moody's, 95.4% of the Company's portfolio is rated A or
better. The Company expects current cash flow to be sufficient to meet
operating needs, although invested assets have been categorized as available
for sale in the event short-term cash needs exceed available resources. The
Company adjusts its holdings of cash, short-term investments and invested
assets available for sale according to its seasonal cash flow needs. Beginning
in June of each year, the Company begins to increase its holdings of cash and
short-term investments. This practice facilitates the Company's ability to
meet its higher short-term cash needs during the hurricane season. See
"Business--Investments."
On November 1, 1996, the Company instituted a stock repurchase program under
which the Company may purchase up to two million shares of its common stock in
the open market at prevailing prices or in privately negotiated transactions,
depending on market conditions, stock price and other factors. In 1996, the
Company purchased a total of 375,000 shares of its common stock under this
program for an aggregate purchase price of $10.2 million (average cost of
$27.31 per share). In 1997, the Company purchased a total of 370,900 shares of
its common stock for an aggregate purchase price of $21.1 million (average
cost of $57.06 per share). Purchases to date have been funded from available
working capital and the repurchased shares are being held in treasury to be
used for ongoing stock issuances such as issuances under the Company's
incentive compensation and stock option programs.
On January 31, 1997, Vesta Capital Trust I, a Delaware business trust
controlled by the Company, sold $100 million of its 8.525% Capital Securities.
These securities have a 30 year maturity and are not redeemable except in
certain limited circumstances. These securities were sold in a private
placement transaction to qualified institutional buyers and were not
registered under Securities Act of 1933 pursuant to an exemption from
registration provided by Rule 144A promulgated thereunder. A portion of the
proceeds from the sale of these capital securities were used to repay
indebtedness under the Company's existing lines of credit and the remainder is
for general corporate purposes. As noted earlier, the Company has agreed,
pursuant to the Amended Facility, to defer distributions on these Capital
Securities pending satisfaction of certain financial commitments to its
lenders.
33
After the close of business on June 30, 1997, the Company completed its
acquisition of Shelby, which are property and casualty insurance companies
headquartered in Ohio for $260.9 million. The acquired subsidiaries had $648
million of assets and approximately $217 million of stockholders' equity at
June 30, 1997. The Company funded the payment of the purchase price for this
acquisition with available cash on hand, short term investments, cash
available from its insurance subsidiaries and with funds available under its
line of credit.
Known Trends and Uncertainties
The financial position, results of operations, and cash flows of property
and casualty insurers have historically been subject to significant
fluctuations due to competition, insurance ratings, and other factors. Certain
known trends and uncertainties which may affect future results of the Company
are discussed more fully below.
Competition: The property and casualty insurance industry is highly
competitive on the basis of both price and service. In recent years there has
been a trend in the property and casualty industry toward consolidation which
could result in even more competitive pricing. The Company also faces
competition from foreign insurance companies captive insurance companies and
risk retention groups. In the future, the industry, including the Company, may
face increasing insurance underwriting competition from banks and other
financial institutions.
Insurance Ratings: A.M. Best, which rates insurance companies based on
factors of concern to policy holders, recently lowered its rating on the
Company's insurance subsidiaries to "B++" from "A-". The Company has
determined that the downgrade will have a material impact on the commercial
and reinsurance lines. See "A.M. Best Rating" for further discussion.
Litigation: See "Item 3. Legal Proceedings" and "Note J to the Consolidated
Financial Statements" for discussion of current status of litigation.
Reliance on Performance of Reinsurers: The Company evaluates the credit
quality of the reinsurers and retrocessionaires to which it cedes business. No
assurance can be given regarding the future ability of any of the Company's
reinsurers to meet their obligations.
Year 2000: The failure to correct a material Year 2000 ("Y2K") problem could
result in an interruption in, or failure of, the normal business operations of
the Company including the delay in premium or claim processing and the
disruption of service to its customers.
Inflation
The Company does not believe its results have been materially affected by
inflation due in part to the predominantly short-tail nature of its business.
The potential adverse impacts of inflation include: (i) a decline in the
market value of the Company's fixed maturity investment portfolio; (ii) an
increase in the ultimate cost of settling claims which remain unresolved for a
significant period of time; and (iii) an increase in the Company's operating
expenses. Historically, the effect of inflation on the Company's reserves has
not been material.
Market Risk of Financial Instruments
Vesta's principal assets are financial instruments, which are subject to the
market risk of potential losses from adverse changes in market rates and
prices. The Company's primary risk exposures are interest rate risk on fixed
maturity investments and equity price risk for domestic stocks.
Vesta manages its exposure to market risk by selecting investment assets
with characteristics such as duration, yield, and liquidity to reflect the
underlying characteristics of the related insurance.
34
The following table sets forth the estimated market values of the Company's
fixed maturity investments and equity investments resulting from a
hypothetical immediate 100 bases point increase in interest rates and a 10%
decline in market prices for equity exposures, respectively from levels
prevailing at December 31, 1998.
Amount
--------------
(in thousands)
Fixed Maturity Investments...................................... $ 445,538
Equity Investments.............................................. $ 18,989
The decrease in fair values based on an increase in interest rates was
determined by estimating the present value of future cash flows using various
models, primarily duration modeling.
The decrease in fair value of equity securities based on a decrease in the
market prices of all equity securities was estimated as 10% of the fair value.
Year 2000
The Company and it subsidiaries are proceeding on schedule with efforts to
convert its computer systems to be Y2K compliant. The Company has implemented
a phased approach to transition computer systems to be Y2K compliant.
The Company has completed the first six of seven phases of the transition
for its defined mission critical systems. Extraneous systems are either being
discontinued or are in the remediation phase at this time. Implementation of
Y2K compliance for these remaining systems is scheduled for completion by
third quarter of 1999.
The Company began the assessment phase in October, 1996. From that time
forward, system development and major enhancements to existing systems took
Y2K process requirements into consideration. During the Assessment Phase, a
comprehensive inventory of systems was completed and all date related fields
and code that handled these dates were identified. The Assessment Phase was
completed in December, 1996.
Once the Company had an understanding of the lines of code and number of
date fields that must be addressed to ensure systems would be made Y2K
compliant, the second phase, Methodology Development, began. The purpose of
this phase was to develop a methodology that would ensure the Company's
systems would be made Y2K compliant and at the same time allow the Company to
continue to address the day-to-day business needs. This phase was completed in
March, 1997.
Part of the Methodology Development Phase was the selection of a business
partner (BP) to assist the Company in the Y2K Compliance effort. This BP had
proven experience in the migration of applications to becoming Y2K compliant
and would provide project management leadership and a team of programming
resources to perform the actual migration.
The third phase of the Y2K effort was the Pilot Project Phase the purpose of
which was to test/prove the Y2K methodology developed in the prior phase. The
Company selected the reinsurance system as the application to be made Y2K
compliant as the Pilot System. This effort began in March, 1997 and was
completed in June, 1997.
The fourth phase of the Y2K effort was the Accounting Project Phase the
purpose of which was to verify that the methodology would support the
integration of Y2K compliant systems with non-Y2K compliant systems. Since the
accounting systems interface with the core insurance processing systems in the
transfer of information, the development of interface modules to correctly
handle the translation of dates in both formats was begun and was completed in
October, 1997.
35
The fifth phase of the Y2K effort was the All Systems Project Phase the
purpose of which was to convert the core insurance processing systems to Y2K
compliance. Additioinal personnel were added to the effort for the primary
purpose of testing and validating results. This effort, which was completed on
August 3, 1998 completed the conversion/migration of all of the Company's in-
house developed system to Y2K compliance.
The Post-Implementation Support and Assurance Phase includes continued
monitoring of Y2K compliance and executing programs to test compliance.
The Shelby Insurance Companies (SIC) had migrated its commercial lines,
claims, and billing applications to Policy Management Systems Corporation
(PMSC) Y2K compliant systems prior to its acquisition in 1999. SIC's personal
lines and other miscellaneous internally developed systems renamed to be
converted to their Y2K counterpart. The migration effort was completed in
October, 1998. Presently, the core insurance processing systems for SIC are
Y2K compliant while work remains with respect to miscellaneous in-house
developed systems. PMSC will continue to test all systems through 1999.
As of December 31, 1998, the Company had spent approximately $5.5 million to
bring its systems to Y2K compliance. The Company estimates it will incur an
additional $2.0 million to complete Y2K readiness efforts (i.e., upgrade PC
hardware, servers, routers, PC related software, etc.). These costs do not
include contingency planning and implementation of contingency plans.
In January, 1999, the Company began its Non-Application Y2K Compliance
Phase. This phase consists of the activities for identifying, evaluating, and
remediating/replacing non mission critical hardware and software.
As of the first of March, inventories have been completed for hardware and
corresponding systems. External service providers have been identified and
letters requesting the status of their Y2K compliance level have been sent and
responses are currently being received.
The Company is currently developing its Y2K contingency plans for its
business areas by developing detailed plans to allow the Company to process
its business should one or more systems, internal and/or external, cause a
disruption in the normal daily processing. Such plans are scheduled to be
completed by June, 1999, and tested by the user community in the third quarter
of 1999.
Conclusion
The failure to correct a material Y2K problem could result in an
interruption in, or a failure of, the normal business operations of the
Company including the disruption or delay in premium or claim processing and
the disruption in service to its customers. Also the inability to be Y2K
compliant of significant third-party providers of the Company and SIC could
result in an interruption in the normal business operations. Due to the
general uncertainty inherent in the Y2K problem, such failures could
materially and adversely affect the Company's financial position, results of
operations and liquidity.
The Y2K issue is also a concern from an underwriting standpoint regarding
the extent of liability for coverage under various general liability, property
and directors and officers liability and product policies. The Company
believes that minimal coverage could exist under some current liability and
product policies. This exposure should be minimal as commercial lines business
has historically excluded any manufacturing risks which produce computer and
computer dependent products.
The Insurance Services Office (ISO) recently developed policy language that
clarifies that there is no coverage for certain Y2K occurrences. The liability
exclusion has been accepted in over 40 states and a companion filing for
property has been accepted in at least 20 states at this time. Several states
36
have not adopted or approved the property exclusion form citing specifically
that there is no coverage under the current property contracts and therefore,
there is no reason to accept a clarifying endorsement. The Company is
currently addressing the Y2K issue by attaching the ISO exclusionary language
to all general liability policies with a rating classification the Company
believes could potentially have Y2K losses. The ISO exclusionary language
endorsement is included on all property policies. These actions should
minimize the Company's exposure to Y2K losses.
Item 7a. Market Risk of Financial Instruments
Vesta's principal assets are financial instruments, which are subject to the
market risk of potential losses from adverse changes in market rates and
prices. The Company's primary risk exposures are interest rate risk on fixed
maturity investments and equity price risk for domestic stocks.
Vesta manages its exposure to market risk by selecting investment assets
with characteristics such as duration, yield, and liquidity to reflect the
underlying characteristics of the related insurances.
The following table sets forth the estimated market values of the Company's
fixed maturity investments and equity investments resulting from a
hypothetical immediate 100 bases point increase in interest rates and a 10%
decline in market prices for equity exposures, respectively from levels
prevailing at December 31, 1998.
Amount
--------------
(in thousands)
Fixed Maturity Investments...................................... $ 445,538
Equity Investments.............................................. $ 18,989
The decrease in fair values based on an increase in interest rates was
determined by estimating the present value of future cash flows using various
models, primarily duration modeling.
The decrease in fair value of equity securities based on a decrease in the
market prices of all equity securities was estimated as 10% of the fair value.
Special Note Regarding Forward-Looking Statements
Any statement contained in this report which is not a historical fact, or
which might otherwise be considered an opinion or projection concerning the
Company or its business, whether express or implied, is meant as and should be
considered a forward-looking statement as that term is defined in the Private
Securities Litigation Reform Act of 1996. Forward-looking statements are based
on assumptions and opinions concerning a variety of known and unknown risks,
including but not necessarily limited to changes in market conditions, natural
disasters and other catastrophic events, increased competition, changes in
availability and cost of reinsurance, changes in governmental regulations, and
general economic conditions, as well as other risks more completely described
in the Company's filings with the Securities and Exchange Commission,
including its most recent Annual Report of Form 10-K. If any of these
assumptions or opinions prove incorrect, any forward-looking statements made
on the basis of such assumptions or opinions may also prove materially
incorrect in one or more respects.
37
Item 8. Financial Statements and Supplementary Data
Page
-----
Report of Independent Accountants........................................ 39
Independent Auditors' Report............................................. 40
Consolidated Balance Sheets at December 31, 1997 and 1998................ 41
Consolidated Statements of Operations and Comprehensive Income (loss) for
each of the years in the three-year period ended December 31, 1998...... 42
Consolidated Statements of Stockholders' Equity for each of the years in
the three-year
period ended December 31, 1998.......................................... 43
Consolidated Statements of Cash Flows for each of the years in the three-
year period
ended December 31, 1998................................................. 44
Notes to Consolidated Financial Statements............................... 45-66
38
Report of Independent Accountants
To the Stockholders of
Vesta Insurance Group, Inc.
In our opinion, the consolidated financial statements listed in the index
appearing under Item 14(a)(1) present fairly, in all material respects, the
financial position of Vesta Insurance Group., Inc. and its subsidiaries at
December 31, 1998, and the results of their operations and their cash flows
for the year then ended in conformity with generally accepted accounting
principles. In addition, in our opinion, the financial statement schedules
listed in the index appearing under Item 14(a)(2) present fairly, in all
material aspects, the information set forth therein at December 31, 1998 and
the year then ended when read in conjunction with the related consolidated
financial statements. These financial statements and financial statement
schedules are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements. We
conducted our audit of these statements in accordance with generally accepted
auditing standards which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles and estimates made by management, and evaluating the
overall financial statement presentation. We believe that our audit provides a
reasonable basis for the opinion expressed above.
Birmingham, Alabama
April 15, 1999
39
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Vesta Insurance Group, Inc.
Birmingham, Alabama:
We have audited the consolidated balance sheet of Vesta Insurance Group,
Inc. and subsidiaries as of December 31, 1997 and the related consolidated
statements of operations, comprehensive income, stockholders' equity and cash
flow for each of the years in the two-year period ended December 31, 1997. In
connection with our audits of the consolidated financial statements, we also
have audited the 1997 and 1996 financial statement schedules as listed in the
accompanying index. These financial statements and financial statement
schedules are the responsibility of Vesta's management. Our responsibility is
to express an opinion on these financial statements and financial statement
schedules based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Vesta
Insurance Group, Inc. and subsidiaries at December 31, 1997, and the results
of their operations and their cash flows for each of the years in the two-year
period ended December 31, 1997, in conformity with generally accepted
accounting principles. Also in our opinion, the related financial statement
schedules, when considered in relation to the basic consolidated financial
statements taken as a whole, present fairly, in all material respects, the
information set forth therein.
As discussed in Note B, the Company has restated its financial statements as
of and for the year ended December 31, 1997.
KPMG PEAT MARWICK LLP
Birmingham, Alabama
March 27, 1998, except
as to the statements of
comprehensive income
and Note B and Note O
which are as of
April 19, 1999
40
VESTA INSURANCE GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands except share and per share data)
At December 31,
-----------------------
1997 1998
---------- -----------
(Restated)
Assets:
Investments:
Fixed maturities available for sale--at fair value
(cost: 1997--$488,923; 1998--$446,516)............ $ 495,566 $ 457,219
Equity securities--at fair value: (cost: 1997--
$10,921; 1998--$18,127)............................... 20,424 21,099
Short-term investments.............................. 119,025 131,029
---------- -----------
Total investments.................................. 635,015 609,347
Cash................................................. 21,801 25,321
Accrued investment income............................ 8,419 7,194
Premiums in course of collection (net of allowances
for losses of
$654 in 1997 and $1,712 in 1998).................... 252,193 121,948
Reinsurance balances receivable...................... 315,534 265,903
Reinsurance recoverable on paid losses............... 136,640 111,577
Deferred policy acquisition costs.................... 102,124 100,957
Property and equipment............................... 18,093 18,442
Income tax receivable................................ 4,231 17,950
Deferred income taxes................................ 7,310 19,090
Other assets......................................... 39,358 35,681
Goodwill............................................. 96,141 14,292
---------- -----------
Total assets....................................... $1,636,859 $ 1,347,702
========== ===========
Liabilities:
Reserves for:
Losses and loss adjustment expenses................. 596,797 504,911
Unearned premiums................................... 365,052 309,515
---------- -----------
961,849 814,426
Deferred gain on retroactive reinsurance............. 16,945 9,848
Reinsurance balances payable......................... 56,897 49,028
Other liabilities.................................... 60,230 48,071
Short term debt...................................... 45,000 70,000
Long term debt....................................... 98,602 98,302
---------- -----------
Total liabilities.................................. 1,239,523 1,089,675
Commitments and contingencies: See Note J
Deferrable Capital Securities......................... 100,000 100,000
Stockholders' equity
Preferred stock, 5,000,000 shares authorized, none
issued................................................ -- --
Common stock, $.01 par value, 32,000,000 shares
authorized,
issued: 1997--18,970,695 shares; 1998--18,964,322... 190 190
Additional paid-in capital........................... 162,550 156,465
Accumulated other comprehensive income, net of
applicable taxes...................................... 9,829 8,889
Retained earnings.................................... 154,074 10,120
Receivable from issuance of restricted stock......... (3,891) (2,045)
Treasury stock....................................... (25,416) (15,592)
---------- -----------
Total stockholders' equity......................... 297,336 158,027
---------- -----------
Total liabilities, Deferrable Capital Securities
and stockholders' equity.............................. $1,636,859 $ 1,347,702
========== ===========
See accompanying Notes to Consolidated Financial Statements.
41
VESTA INSURANCE GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(Amounts in thousands except per share data)
STATEMENTS OF OPERATIONS
For the Year Ended
December 31,
------------------------------
1996 1997 1998
-------- ---------- ---------
(Restated)
Revenues:
Net premiums written.......................... $468,056 $526,475 $ 491,590
Decrease (increase) in unearned premium....... (28,720) (8,817) 18,103
-------- -------- ---------
Net premiums earned........................... 439,336 517,658 509,693
Net investment income......................... 23,148 35,960 35,058
Realized investment gains (losses)............ 32 3,283 3,272
Other......................................... 188 2,094 5,473
-------- -------- ---------
Total Revenue................................ 462,704 558,995 553,496
Expenses:
Losses incurred............................... 229,953 273,774 337,564
Loss adjustment expense incurred.............. 21,830 24,864 57,758
Policy acquisition expenses................... 118,608 132,984 155,952
Operating expenses............................ 21,167 38,913 91,394
Premium taxes and fees........................ 5,928 8,567 8,648
Interest on debt.............................. 10,059 10,859 14,054
Loss on asset impairment...................... -- -- 74,496
Goodwill amortization......................... 484 4,007 6,609
-------- -------- ---------
Total expenses............................... 408,029 493,968 746,475
Net income (loss) before taxes................ 54,675 65,027 (192,979)
Income taxes (benefit)........................ 17,862 23,116 (57,244)
Deferred capital security interest, net of
tax........................................... -- 5,051 5,449
-------- -------- ---------
Net Income (loss)............................ $ 36,813 $ 36,860 $(141,184)
======== ======== =========
Basic net income (loss) per common share...... $ 1.95 $ 1.98 $ (7.61)
======== ======== =========
Diluted net income (loss) per common share.... $ 1.92 $ 1.93 $ (7.61)
======== ======== =========
STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
Net income (loss).............................. $ 36,813 $ 36,860 $(141,184)
Other comprehensive income, net of tax:
Unrealized holding gains (losses) on
available-for-sale securities net of
applicable taxes of $(422), $2,778 and $2,676
in 1996, 1997 and 1998, respectively......... (742) 7,521 1,187
Less realized gains on available-for-sale
securities net of applicable taxes of $11,
$1,149 and 1,145 in 1996, 1997 and 1998,
respectively................................. 21 2,134 2,127
-------- -------- ---------
(763) 5,387 (940)
Comprehensive income (loss).................... $ 36,050 $ 42,247 $(142,124)
======== ======== =========
See accompanying Notes to Consolidated Financial Statements.
42
VESTA INSURANCE GROUP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Amounts in thousands)
Accumulated Receivable
Additional Other From
Common Paid-in Comprehensive Retained Treasury Restricted
Stock Capital Income (Loss) Earnings Stock Stock
------ ---------- ------------- --------- -------- ----------
Balance, December 31,
1995 ................. $189 $159,449 $5,205 $ 86,098 $ (520) $(3,162)
Net income.............. -- -- -- 36,813 --
Issuance of stock....... 1 1,188 -- -- -- --
Change in restricted
stock receivable....... -- -- -- -- -- (45)
Treasury stock
acquisitions........... -- -- -- -- (10,597) --
Treasury stock issued
for options exercised.. -- 63 -- (64) 563 --
Common dividends
declared
(0.20 per share)....... -- -- -- (2,836) -- --
Net change in unrealized
gains net of tax of
$(411)................. -- -- (763) -- -- --
Tax Benefit from
exercise of stock
options................ -- 337 -- -- -- --
---- -------- ------ --------- -------- -------
Balance, December
31,1996............... 190 161,037 4,442 120,011 (10,554) (3,207)
Net income as restated.. -- -- -- 36,860 -- --
Change in restricted
stock receivable....... -- -- -- -- -- (684)
Treasury stock
acquisitions........... -- -- -- -- (21,164) --
Treasury stock issued
for options exercised.. -- (1,061) -- -- 6,302 --
Common dividends
declared (0.15 per
share)................. -- -- -- (2,797) -- --
Net change in unrealized
gains net of tax of
$3,927................. -- -- 5,387 -- -- --
Tax benefit from
exercise of stock
options................ -- 2,574 -- -- -- --
---- -------- ------ --------- -------- -------
Balance, December
31,1997 as restated... 190 162,550 9,829 154,074 (25,416) (3,891)
Net loss................ -- -- -- (141,184) -- --
Change in restricted
stock receivable....... -- -- -- -- -- 1,846
Treasury stock issued
for options exercised.. -- (6,833) -- -- 9,824 --
Common dividends
declared (0.15 per
share)................. -- -- -- (2,770) -- --
Net change in unrealized
gains net of tax of
$(1,531)............... -- -- (940) -- -- --
Tax benefit from
exercise of stock
options................ -- 748 -- -- -- --
---- -------- ------ --------- -------- -------
Balance, December
31,1998............... $190 $156,465 $8,889 $ 10,120 $(15,592) $(2,045)
==== ======== ====== ========= ======== =======
See accompanying Notes to Consolidated Financial Statements
43
VESTA INSURANCE GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOW
(Dollar amounts in thousands)
For the Year Ended
December 31,
--------------------------------
1996 1997 1998
------- ---------- -----------
(Restated)
Operating Activities:
Net income (loss).......................... $36,813 $ 36,860 $ (141,184)
Adjustments to reconcile net income (loss)
to cash provided from
operations:
Changes in:
Loss and LAE reserves.................... 4,773 140,152 (91,886)
Unearned premium reserves................ 59,813 38,350 (55,537)
Deferred income taxes.................... -- 3,959 9,434
Accrued income taxes..................... (3,326) (18,354) (34,933)
Reinsurance balances payable............. (18,201) 5,735 (7,869)
Other liabilities........................ 14,126 18,617 (26,633)
Premiums in course of collection......... (10,877) (285,188) 179,874
Reinsurance recoverable on paid losses... (25,363) (8,515) 25,063
Other assets............................. (39,632) 15,519 12,505
Policy acquisition costs deferred......... (60,797) (112,981) (163,433)
Policy acquisition costs amortized........ 53,096 105,209 164,600
Investment gains.......................... (32) (3,283) (3,272)
Amortization and depreciation............. 3,562 4,803 11,647
Goodwill impairment....................... -- -- 74,496
Gain on disposition of property, plant, (115) (38) --
equipment...................................
------- --------- -----------
Net cash provided from (used in) 13,840 (59,155) (47,128)
operations..................................
Investing Activities:
Investments sold, matured, and called:
Fixed maturities available for sale-- 43,811 283,723 156,377
matured, called and sold...............
Equity securities.......................... -- 2,291 3,822
Investments acquired:
Fixed maturities available for sale........ (37,239) (52,871) (116,007)
Equity securities.......................... (7,326) -- (4,323)
Net cash paid for acquisition.............. -- (245,811) --
Net increase in short-term investments..... (9,490) (13,610) (12,005)
Additions to property and equipment........ (1,754) (4,182) (5,659)
Dispositions of property and equipment..... 236 289 1,677
------- --------- -----------
Net cash provided from (used in) (11,762) (30,171) 23,882
investing activities........................
Financing Activities:
Issuance of long and short term debt and 7,116 123,321 24,700
deferrable capital securities...............
Issuance of treasury stock................. 563 6,302 --
Acquisition of treasury stock.............. (10,597) (21,164) --
Dividends paid............................. (2,836) (2,797) (2,770)
Capital contributions from exercising stock 1,481 828 4,836
options.....................................
------- --------- -----------
Net cash provided from (used in) (4,273) 106,490 26,766
financing activities........................
------- --------- -----------
Increase (decrease) in cash................. (2,195) 17,164 3,520
Cash at beginning year...................... 6,832 4,637 21,801
------- --------- -----------
Cash at end of year......................... $ 4,637 $ 21,801 $ 25,321
======= ========= ===========
- --------
See accompanying Notes to Consolidated Financial Statements.
44
VESTA INSURANCE GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar amounts in thousands)
Note A--Significant Accounting Policies
Financial Statement Presentation: Vesta Insurance Group, Inc. (Vesta) and
subsidiaries (the Company) was incorporated by Torchmark Corporation
("Torchmark") on July 9, 1993 and capitalized on July 16, 1993 with a $50
million contribution from Torchmark and the contribution from Torchmark of all
of the outstanding common stock of J. Gordon Gaines, Inc., Liberty National
Reinsurance Company, Ltd, and Vesta Fire Insurance Corporation (Vesta Fire)
and its wholly-owned subsidiaries. On November 18, 1993, the Company completed
an initial public offering of common stock which resulted in proceeds to the
Company of approximately $51 million. At year-end 1998, Torchmark held
approximately 23.9% of the outstanding common stock of the Company with the
balance publicly traded.
Nature of Operations: The Company is a holding company for a group of
property and casualty insurance companies (the "Vesta Group") that offer
treaty reinsurance and primary insurance on personal and commercial risks. The
lead insurer in the Vesta Group is Vesta Fire. In both its reinsurance and
primary insurance operations, the Company focuses primarily on private
passenger auto and property coverages. Gross premiums written by the Company
in 1998 totaled $759.0 million. Gross premiums written in the reinsurance line
were $287.6 million in 1998, substantially all of which were on personal
(including automobile) risks and commercial property risks. Also, property
(including auto physical damage) risks accounted for approximately 62% of the
Company's gross premiums written in all lines in 1998.
The availability and cost of reinsurance and retrocessional coverage may
vary significantly over time and are subject to prevailing market conditions.
Pricing on both assumed and ceded reinsurance weakened slightly in 1997 and
1998 due to increased availability of reinsurance market capacity.
Use of Estimates in the Preparation of the Financial Statements: The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ materially from those estimates. These estimates
and assumptions are particularly important in determining the premiums in
course of collection, reserves for losses and loss adjustment expenses and
deferred policy acquisition costs.
Investments: Investment securities are classified in three categories at
date of purchase and accounted for as follows: (i) Debt securities which are
purchased with the positive intent and ability to hold to maturity are
classified as held-to-maturity and reported at amortized cost; (ii) Debt and
equity securities which are bought and held principally for the purpose of
selling them in the near term are classified as trading securities and
reported at fair value, with unrealized gains and losses included in earnings;
and (iii) Debt and equity securities which are not classified as either held-
to-maturity or trading securities are classified as available for sale and
reported at fair value, with unrealized gains and losses excluded from
earnings and reported in a separate component of stockholders' equity.
Short-term investments are carried at cost and include investments in
certificates of deposit and other interest-bearing time deposits with original
maturities of one year or less. If an investment becomes permanently impaired,
such impairment is treated as a realized loss and the investment is adjusted
to net realizable value.
Gains and losses realized on the disposition of investments are recognized
as revenues and are determined on a specific identification basis. Unrealized
gains and losses on equity securities and fixed maturities available for sale,
net of deferred income taxes, are reflected directly in stockholders' equity.
45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar amounts in thousands)
Note A--Significant Accounting Policies (continued)
Determination of Fair Values of Financial Instruments: Fair values for cash,
short-term investments, short-term debt, receivables and payables approximate
their carrying value. Fair values for investment securities and long-term debt
are based on quoted market prices where available. Otherwise, fair values are
based on quoted market prices of comparable instruments.
Cash: Cash consists of balances on hand and on deposit in banks and
financial institutions.
Recognition of Premium Revenue: Earned premiums on primary business are
generally recognized as revenue on a pro rata basis over the policy term.
Earned premiums on assumed reinsurance are recognized as revenue when reported
by the cedant. Also, due to the delay in reporting from its reinsurance
cedants, the Company accrues unreported premium revenue on its assumed
reinsurance business based on historical experience. The company estimates for
its reinsurance reports received subsequent to a period end on a combined
calendar/accident year basis. These accrued premiums are necessarily based on
estimates and, while management believes that the accruals are reasonable, the
ultimate reported premium may be less than or in excess of the amounts
accrued.
Losses and Loss Adjustment Expenses: The liability for losses and loss
adjustment expenses ("LAE") includes an amount determined from loss reports
and individual cases. It also includes an amount for losses incurred but not
reported which is based on past experience. Such liabilities are necessarily
based on estimates and, while management believes that the amount is adequate,
the ultimate liability may be in excess of or less than the amounts provided.
The methods for making such estimates and for establishing the resulting
liabilities are continually reviewed, and any adjustments are reflected in
earnings currently. These reserves are established on an undiscounted basis
and are reduced for estimates of salvage and subrogation.
Deferred Acquisition Costs: Commissions and other costs of acquiring
insurance that vary with and are primarily related to the production of new
and renewal business are deferred and amortized over the terms of the policies
or reinsurance treaties to which they relate. Anticipated investment income is
considered in determining recoverability of deferred acquisition costs on
certain lines.
Reinsurance: Reinsurance enables an insurance company, by assuming or ceding
reinsurance, to diversify its risk and limit its financial exposure to risk
and catastrophic events. However, reinsurance does not ordinarily relieve the
primary insurer from its obligations to the insured. In the ordinary course of
business, Vesta assumes business from other insurance organizations and also
reinsures certain risks with other insurance organizations.
Income Taxes: Vesta accounts for income taxes using the asset and liability
method under which deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases.
Property and Equipment: Property and equipment is reported at cost less
allowances for depreciation. Depreciation is recorded primarily on the
straight line method over the estimated useful lives of these assets which
range from 2 to 5 years for equipment. Ordinary maintenance and repairs are
charged to income as incurred.
Goodwill: The company amortizes goodwill on a straight-line basis over a
period of 15 years.
Reclassification: Certain amounts in the financial statements presented have
been reclassified from amounts previously reported in order to be comparable
between years. These reclassifications have no effect on previously reported
stockholders' equity or net income during the period involved.
46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar amounts in thousands)
Note A--Significant Accounting Policies (continued)
Income Per Share: The Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 128, "Earnings per share," effective for the year ended
1997. This standard requires the dual presentation of basic and diluted
earnings per share ("EPS") on the face of the income statement and a
reconciliation of basic EPS to diluted EPS. As required by SFAS 128, prior-
period EPS data has been restated for comparability. Basic EPS is computed by
dividing income available to common stockholders by the weighted average
common shares outstanding for the period. Weighted average common shares
outstanding for each period are as follows: 1998-18,548,612, 1997-18,600,000,
1996-18,860,000. Diluted EPS is calculated by adding to shares outstanding the
additional net effect of potentially dilutive securities or contracts which
could be exercised or converted into common shares. Weighted average diluted
shares outstanding for each period are as follows: 1998-18,548,612, 1997-
19,053,000, 1996 19,157,000.
Year Ended December 31,
-------------------------
1996 1997 1998
------- ------- ---------
(restated)
(in thousands except per
share data)
BASIC NET INCOME PER SHARE:
Weighted average common shares outstanding......... 18,860 18,600 18,548
Net income (loss).................................. $36,813 $36,860 $(141,184)
Basic net income per share......................... $ 1.95 $ 1.98 $ (7.61)
DILUTED NET INCOME PER SHARE:
Weighted average common shares outstanding......... 18,860 18,600 18,548
Net effect of the assumed exercise of stock options
and nonvested restricted stock--based on the
treasury stock method using average market price
for the year...................................... 297 453 --
------- ------- ---------
Total weighted average common shares and common
stock equivalents outstanding..................... 19,157 19,053 18,548
Net income......................................... $36,813 $36,860 $(141,184)
Diluted net income per share....................... $ 1.92 $ 1.93 $ (7.61)
Long lived assets: The Company evaluates long-lived assets and certain
identifiable intangibles held and used by an entity for impairment whenever
events or changes in circumstances indicate that the carrying amount of an
asset may not be recoverable. This evaluation is based on undiscounted future
projected cash flows of the asset or asset group. If an impairment exists, the
amount of such impairment is calculated based on the estimated fair value of
the assets. Fair value is generally determined by discounting future projected
cash flows of the asset or asset group under review.
In accordance with Accounting Principles Board Opinion (APB) No. 17,
"Intangible Assets," the recoverability of goodwill not identified with assets
subject to an impairment loss is reviewed for impairment, on an acquisition by
acquisition basis, whenever events or changes in circumstances indicate that
it may not be recoverable. If such an event occurred, the Company would
prepare projections of future discounted cash flows for the applicable
acquisition. The projections are for the remaining term of the goodwill using
a discount rate and terminal value that would be customary for evaluating
insurance company transactions. The Company believes this discounted cash flow
approach approximates fair market value.
New Accounting Standards: In 1998, the Company implemented SFAS No. 130,
"Reporting Comprehensive Income," SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information," and SFAS No. 132, "Employers
Disclosures about Pensions and Other Postretirement Benefits." These financial
statements have been prepared with the expanded disclosures required by these
standards.
47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar amounts in thousands)
Note A--Significant Accounting Policies (continued)
In March 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position (SOP)
98-1 "Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use." This pronouncement is effective for periods beginning January
1, 1999 with early application encouraged. The Company implemented SOP 98-1 in
1998. The adoption of this standard did not have a material impact on the
Company's financial position, results of operations or cash flows.
Note B--Restatement
The Company determined, subsequent to the issuance of the 1997 financial
statements, that a specific reinsurance ceded contract entered into in 1997
contains retroactive elements as defined in SFAS 113. A contract is deemed
retroactive when an assuming enterprise agrees to reimburse a ceding
enterprise for liabilities incurred as a result of past insurable events. For
such contracts, SFAS 113 requires that any initial gain and any benefit due
from a reinsurer as a result of subsequent covered losses be deferred in the
financial statements of the ceding enterprise and recognized into income over
the settlement period of the underlying claims. The Company erroneously
recorded a gain on this contract in the fourth quarter of 1997 and has
adjusted its previously issued financial statements to appropriately defer and
recognize such gain. Analysis of this contract under the recovery method
resulted in the following adjustments to the 1997 financial statements
included herein:
As Previously
Reported Restatement As Restated
------------- ----------- -----------
Losses incurred........... $256,829 $ 16,945 $273,774
Income taxes.............. 29,048 (5,932) 23,116
Net income.............. 47,873 (11,013) 36,860
Basic net income per
common share............. $ 2.57 (.59) 1.98
Diluted net income per
common share............. $ 2.51 (.58) 1.93
Deferred income taxes..... 1,378 5,932 7,310
Deferred gain on
retroactive reinsurance.. 0 16,945 16,945
Retained earnings......... 165,087 (11,013) 154,074
The deferred gain, which is included in the accompanying balance sheet,
associated with this contract at December 31, 1997 and 1998 is $16.9 million
and $9.8 million, respectively.
Note C--Asset Impairment
During the fourth quarter of 1998, management evaluated goodwill
recoverability pursuant to the Company's existing policies. The evaluation
indicated an impairment of goodwill acquired as part of the Shelby Acquisition
(See Note Q). The events that led to this conclusion include the Company's
inability to integrate the Shelby acquisition as planned and the resulting
high level of expenses, and the recording of significant operating losses in
1998.
The Company's measurement of this impairment was based on cash flow analysis
using projections for the remaining term of the goodwill and a weighted
average cost of capital and terminal value deemed appropriate for evaluating
companies similar to Vesta. The weighted average cost of capital and future
premium growth rates used were 12% and 5% respectively. The assumptions used
in this analysis represent management's best estimate of future results.
However, actual results could differ from these estimates.
As a result of this measurement, the unamortized goodwill attributable to
the Shelby Acquisition was reduced by $74.5 million.
48
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands)
Note D--Statutory Accounting and Regulation
Insurance subsidiaries of Vesta are required to file statutory financial
statements with state insurance regulatory authorities. Accounting principles
used to prepare these statutory financial statements differ from GAAP. The
most significant differences between statutory accounting principles and GAAP
are as follows: (a) acquisition costs of obtaining new business are deferred
and amortized over the policy period rather than charged to operations as
incurred; (b) loss and loss adjustment expense are reduced for the benefits of
salvage and subrogation; (c) deferred income taxes are provided for temporary
differences between financial and taxable earnings; (d) certain items are
reported as assets (property and equipment, agents' balances, prepaid
expenses) rather than being charged directly to surplus as non admitted items;
(e) statutory accounting disallows reserve credits for reinsurance in certain
circumstances; (f) bonds are recorded at their market values instead of
amortized costs. The tables set forth below reflect the Company's revision of
its accounting for its assumed reinsurance business to reflect only
accident/calendar year information. Effective with its year end 1997 statutory
filings, the adjustments reversed, in the form of a one-time charge, the
cumulative effect of the Company's prior practice of making estimates for
reinsurance assumed on a combined underwriting and accident year basis, the
accounting practice consistently applied over prior years. On a GAAP basis,
the revision was accounted for by retroactively restating prior financial
statements.
A reconciliation of Vesta's insurance subsidiaries' reported statutory net
income (loss) to Vesta's consolidated GAAP net income (loss) is as follows:
Year Ended December 31,
---------------------------------
1996 1997 1998
-------- --------- ---------
Statutory net income (loss)........... $ 46,745 $ (44,941) $(107,074)
Accounting Irregularities (2)......... -- -- 7,715
Deferral of acquisition costs......... 60,797 112,981 163,433
Amortization of acquisition costs..... (53,096) (105,210) (164,600)
Effects of retroactive reinsurance.... -- (16,945) 7,097
Differences in insurance policy
liabilities........................... 1,104 13,177 14,910
Reinsurance premium and loss accrual.. (13,424) 46,785 (1) --
Deferred income taxes................. 1,621 2,732 39,294
Income (loss) of non-insurance
entities and other ................... (6,450) 32,012 (20,854)
Investment gains...................... -- 276 --
Goodwill amortization................. (484) (4,007) (6,609)
Loss on asset impairment.............. -- -- (74,496)
-------- --------- ---------
GAAP net income (loss)................ $ 36,813 $ 36,860 $(141,184)
======== ========= =========
49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar amounts in thousands)
Note D--Statutory Accounting and Regulation (continued)
A reconciliation of Vesta's insurance subsidiaries' reported statutory
stockholders' equity to Vesta's consolidated GAAP stockholders' equity is as
follows:
Year Ended December 31,
-----------------------------
1996 1997 1998
-------- --------- --------
Statutory stockholder's equity............ $352,695 $ 317,875 $220,210
Deferred gain on retroactive reinsurance.. -- (16,945) (9,848)
Differences in insurance policy
liabilities............................... 2,376 15,554 55,343
Deferred policy acquisition costs......... 75,532 102,124 100,957
Deferred income taxes..................... (21,463) 7,310 19,090
Nonadmitted assets........................ 1,267 297 22,131
Goodwill.................................. 7,339 96,141 14,292
Net liabilities of non-insurance
entities.................................. (101,914) (231,204) (274,850)
Reinsurance premium and loss accrual(1)... (46,785) --
Unrealized gain on investments............ 2,872 6,184 10,702
-------- --------- --------
GAAP stockholders' equity................. $271,919 $ 297,336 $158,027
======== ========= ========
- --------
(1) Vesta Fire has revised its statutory and GAAP accounting for its assumed
reinsurance business to reflect only accident/calendar year information in
1997. On a GAAP basis, the correction was accounted for by restating prior
financial statements. On a statutory basis, the correction was made on a
cumulative basis to the 1997 statutory filings.
(2) In June 1998, the Company completed an internal investigation which
resulted in a reduction of net income of approximately $13.6 million
relating to the fourth quarter of 1997 and the first quarter of 1998. For
GAAP purposes, the amounts relating to 1997 were corrected in 1997, while
for statutory purposes, the amounts related to the fourth quarter of 1997
were recorded in the 1998 statutory reports as the 1997 statutory reports
had been filed prior to such discovery.
The excess, if any, of stockholders' equity of the insurance subsidiaries on
a GAAP basis over that as reported on a statutory basis is not available for
distribution to its stockholders without regulatory approval.
The Company's insurance subsidiaries are subject to regulation by the
insurance departments of states in which they are licensed and undergo
examinations by those departments. The Alabama Department of Insurance
("ADOI") completed its examination of Vesta Fire's 1997 statutory report and
issued its report on December 18, 1998. The examination resulted in
adjustments to decrease reported statutory surplus by $255 million. Management
believes that it has appropriately recorded such adjustments in Vesta Fire's
1998 statutory report or that other remedies have been executed to render
certain adjustments inappropriate for 1998 (for example, corrections of
technical violations of reinsurance security letters of credit). The ADOI is
currently conducting a target examination on Vesta Fire's 1998 filing. This
examination could result in adjustments to Vesta Fire's statutory statements,
including policyholder surplus. Management does not believe that such
adjustments, if any, would have a material impact on the Company's financial
position or results of operations or cash flows.
50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands)
Note D--Statutory Accounting and Regulation (continued)
Restrictions on Dividends to Stockholders. The Company's insurance
subsidiaries are subject to various state statutory and regulatory
restrictions, generally applicable to each insurance company in its state of
incorporation, which limit the amount of dividends or distributions by an
insurance company to its stockholders. The payment of dividends by Vesta Fire
is subject to certain limitations imposed by the insurance laws of the State
of Alabama. The restrictions are generally based on certain levels of surplus,
investment income and operating income, as determined under statutory
accounting practices. Alabama and most other states that regulate Vesta Fire's
operations permit dividends in any year which together with other dividends or
distributions made within the preceding 12 months, do not exceed the greater
of (i) 10% of statutory surplus as of the end of the preceding year or (ii)
the statutory net income for the preceding year, with larger dividends payable
only upon prior regulatory approval. Certain other extraordinary transactions
between an insurance company and its affiliates, including sales, loans or
investments which in any twelve-month period aggregate at least 3% of its
admitted assets or 25% of its statutory capital and surplus, also are subject
to prior approval by the Department of Insurance. In 1998, the Company
voluntarily agreed that it will not pay any dividends, except those required
to service "indebtedness" as defined under the $200 million Revolving Credit
Facility Agreement (Note P), until December 31, 1999, without the prior
written approval of the ADOI.
Risk-Based Capital Requirements. The NAIC adopted risk-based capital
requirements that require insurance companies to calculate and report
information under a risk-based formula which attempts to measure statutory
capital and surplus needs based on the risks in a company's mix of products
and investment portfolio. The formula is designed to allow state insurance
regulators to identify potential weakly capitalized companies. Under the
formula, a company determines its "risk-based capital" ("RBC") by taking into
account certain risks related to the insurer's assets (including risks related
to its investment portfolio and ceded reinsurance) and the insurer's
liabilities (including underwriting risks related to the nature and experience
of its insurance business). Risk-based capital rules provide for different
levels of regulatory attention depending on the ratio of a company's total
adjusted capital to its "authorized control level" ("ACL") of RBC. Based on
calculations made by the Company, the RBC levels for each of the Company's
insurance subsidiaries did not trigger regulatory attention.
Note E--Investment Operations
Investment income is summarized as follows:
Year Ended December 31,
-------------------------
1996 1997 1998
------- ------- -------
Fixed maturities............................... $16,668 $23,876 $27,930
Equity securities.............................. 199 248 422
Short-term investments......................... 6,982 12,763 9,323
------- ------- -------
23,849 36,887 37,675
Less investment expense........................ (701) (927) (2,617)
------- ------- -------
Net investment income.......................... $23,148 $35,960 $35,058
======= ======= =======
51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands)
Note E--Investment Operations (continued)
An analysis of gains (losses) from investments is as follows:
Year Ended December 31,
--------------------------
1996 1997 1998
-------- ------- --------
Realized investment gains (losses) from:
Fixed maturities........................... $ (139) $ 3,000 $ 159
Equity securities.......................... 171 283 3,113
-------- ------- --------
32 3,283 3,272
======== ======= ========
Net change in unrealized investment gains
(losses) on:
Fixed maturities available for sale........ $((2,523) $ 3,772 $ 4,060
Equity securities available for sale....... 1,349 5,542 (6,531)
Applicable tax (benefit)................... (411) 3,927 (1,531)
-------- ------- --------
Net change in unrealized gains (losses)..... $ (763) $ 5,387 $ (940)
======== ======= ========
A summary of fixed maturities and equity securities by amortized cost and
estimated fair value at December 31, 1997 and 1998 is as follows:
Gross Gross
Amortized Unrealized Unrealized Fair
1997: Cost Gains Losses Value
- ----- --------- ---------- ---------- --------
Fixed maturities available for sale:
United States Government............. $ 84,896 $ 1,348 $ 96 $ 86,148
States, municipalities and political
subdivisions........................ 145,567 2,891 0 148,458
Foreign governments.................. 3,643 102 0 3,745
Corporate............................ 194,672 1,844 107 196,409
Mortgage-backed securities, GNMA
collateral.......................... 60,145 743 82 60,806
-------- ------- ------ --------
Total Fixed Maturities.............. 488,923 6,928 285 495,566
Equity securities..................... 10,921 9,503 0 20,424
-------- ------- ------ --------
Total portfolio..................... $499,844 $16,431 $ 285 $515,990
======== ======= ====== ========
1998:
- -----
Fixed maturities available for sale:
United States Government............. $ 72,935 $ 2,509 $ 28 $ 75,416
States, municipalities and political
subdivisions........................ 124,358 3,386 -- 127,744
Foreign governments.................. 3,619 128 30 3,717
Corporate............................ 157,831 3,931 180 161,582
Mortgage-backed securities, GNMA
collateral.......................... 87,773 1,058 71 88,760
-------- ------- ------ --------
Total Fixed Maturities.............. 446,516 11,012 309 457,219
Equity securities..................... 18,127 4,079 1,107 21,099
-------- ------- ------ --------
Total portfolio..................... $464,643 $15,091 $1,416 $478,318
======== ======= ====== ========
52
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar amounts in thousands)
Note E--Investment Operations (continued)
A schedule of fixed maturities held for investment by contractual maturity
at December 31, 1998 is shown below on an amortized cost basis and on a fair
value basis. Actual maturities could differ from contractual maturities due to
call or prepayment provisions.
Amortized Fair
Cost Value
--------- --------
Due in one year or less................................ $ 49,029 $ 50,929
Due from one to five years............................. 209,811 216,029
Due from five to ten years............................. 79,983 81,482
Due in ten years or more............................... 19,920 20,019
-------- --------
358,743 368,459
Mortgage backed securities, including
GNMA's and GNMA collateral............................ 87,773 88,760
-------- --------
Total.................................................. $446,516 $457,219
======== ========
Proceeds from sales, maturities and calls of fixed maturities were $44
million in 1996, $284 million in 1997 and $156 million in 1998. Gross gains
realized on those sales were $23 thousand in 1996, $3,386 thousand in 1997 and
$178 thousand in 1998. Gross losses on those sales were $162 thousand in 1996,
$329 thousand in 1997 and $19 thousand in 1998.
Note F--Property and Equipment
A summary of property and equipment used in the business is as follows:
December 31, 1997 December 31, 1998
-------------------- --------------------
Accumulated Accumulated
Cost Depreciation Cost Depreciation
------- ------------ ------- ------------
Building and real $16,518 $ 8,415 $15,664 $ 8,993
estate..................
Data processing 7,383 2,557 10,603 5,079
equipment...............
Furniture and office 3,952 1,776 4,271 2,443
equipment...............
Other................... 3,744 756 5,910 1,491
------- ------- ------- -------
$31,597 $13,504 $36,448 $18,006
======= ======= ======= =======
Depreciation expense on property and equipment used in the business was $1.4
million, $2.9 million and $4.2 million each of the years 1996, 1997, 1998.
Note G--Deferred Policy Acquisition Costs
Deferred policy acquisition costs for the years ended December 31, 1996,
1997 and 1998 are summarized as follows:
Year Ended December 31,
-----------------------------
1996 1997 1998
-------- --------- --------
Balance at beginning of year.............. $ 67,831 $ 75,532 $102,124
Deferred policy acquisition costs acquired
from Anthem Casualty Group............... -- 18,820 --
Deferred during period.................... 60,797 112,981 163,433
Amortized during period................... (53,096) (105,209) (164,600)
-------- --------- --------
Balance at end of year.................... $ 75,532 $ 102,124 $100,957
======== ========= ========
Commissions comprise the majority of the additions to deferred policy
acquisition costs in each year.
53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar amounts in thousands)
Note H--Reserves for Losses and Loss Adjustment Expenses
The table below presents a reconciliation of beginning and ending loss and
LAE reserves for the last three years:
Year Ended December 31,
-------------------------------
1996 1997 1998
--------- --------- ---------
Gross Losses and LAE reserves at beginning
of year.................................. $ 168,502 $ 173,275 $ 596,797
Reinsurance Recoverable................... (24,384) (60,343) (204,336)
--------- --------- ---------
Net Losses and LAE reserves at beginning
of year.................................. 144,118 112,932 392,461
Increases (decreases) in provisions for
losses and LAE for claims incurred:
Current year............................. 242,454 311,089 396,091
Prior year............................... 9,329 (12,451) (769)
Acquisition of Shelby..................... -- 300,315 --
Losses and LAE payments for claims in-
curred:
Current year............................. (158,409) (166,447) (269,369)
Prior year............................... (124,560) (152,977) (219,642)
--------- --------- ---------
Net Losses and LAE reserves at end of 112,932 392,461 298,772
year......................................
Reinsurance Recoverable................... 60,343 204,336 206,139
--------- --------- ---------
Gross loss and LAE Reserves............... $ 173,275 $ 596,797 $ 504,911
========= ========= =========
Note I--Related Party Transactions
Vesta leases office space from Torchmark Development Corporation, a wholly
owned subsidiary of Torchmark. Rent expense of $.6 million, $.7 million and
$1.2 million was charged to operations for the years ended December 31, 1996,
1997 and 1998, respectively, related to this lease agreement.
Waddell & Reed Asset Management Company, ("WRAMCO"), provides investment
advice and services to the Company and its subsidiaries in connection with the
management of their respective portfolios pursuant to an Investment Services
Agreement. The Company paid $.4 million, $.4 million and $.6 million in fees
to WRAMCO pursuant to the Investment Services Agreement in 1996, 1997 and
1998, respectively.
On September 13, 1993, Vesta Fire Insurance Corporation, a wholly owned
subsidiary of the Company ("Vesta Fire"), and Liberty National Life Insurance
Company ("Liberty National"), a wholly owned subsidiary of Torchmark, entered
into a Marketing and Administrative Services Agreement, pursuant to which
Vesta Fire marketed certain of its industrial fire insurance products through
agents of Liberty National. Under this agreement, Liberty National pays to
Vesta Fire an amount equal to all premiums collected by Liberty National after
deducting all expenses incurred by Liberty National which are directly
attributable to the industrial fire insurance products and after deducting a
fee for administrative services. Such fee for 1996, 1997 and 1998 was $1.7
million, $1.4 million and $.9 million, respectively. This agreement was
terminated effective April 30, 1995, and these products are no longer marketed
through Liberty National agents. However, Liberty National continues to
service the existing business.
54
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands)
Note J--Commitments and Contingencies
Litigation: Subsequent to the filing of its quarterly report on Form 10-Q
for the period ended March 31, 1998 with the Securities and Exchange
Commission, the Company became aware of certain accounting irregularities
consisting of inappropriate reductions of reserves and overstatements of
premium income in the Company's reinsurance business that had been recorded in
the fourth quarter of 1997 and the first quarter of 1998. The Company promptly
commenced an internal investigation to determine the exact scope and amount of
such reductions and overstatements. This investigation concluded that
inappropriate amounts had, in fact, been recorded and the Company determined
it should restate its previously issued 1997 financial statements and first
quarter 1998 Form 10-Q. Additionally, during its internal investigation the
Company re-evaluated the accounting methodology being utilized to recognize
earned premium income in its reinsurance business. The Company had
historically reported certain assumed reinsurance premiums as earned in the
year in which the related reinsurance contracts were entered even though the
terms of those contracts frequently bridged two years. The Company determined
that reinsurance premiums should be recognized as earned over the contract
period and corrected the error in its accounting methodology by restating
previously issued financial statements. The Company issued press releases,
which were filed with the Securities and Exchange Commission, on June 1, 1998
and June 29, 1998 announcing its intention to restate its historical financial
statements.
The Company restated its previously issued financial statements for 1995,
1996 and 1997 and its first quarter 1998 Form 10-Q for the above item by
issuance of a current report on Form 8-K dated August 19, 1998. These
restatements resulted in a cumulative decrease to stockholder' equity of $75.2
million through March 31, 1998.
Commencing in June, 1998, the Company and several of its current and former
officers and directors were named in several purported class action lawsuits
in the United States District Court for the Northern District of Alabama and
in one purported class action lawsuit in the Circuit Court of Jefferson
County, Alabama. Several of Vesta's officers and directors also have been
named in a derivative action lawsuit in the Circuit Court of Jefferson County,
Alabama, in which Vesta is a nominal defendant.
The class action lawsuit filed in the Circuit Court of Jefferson County,
Alabama has been dismissed and the derivative case has been placed on the
administrative docket. The class actions filed in the United States District
Court for the Northern District of Alabama have been consolidated into a
single action in that district. The purported class representatives in that
action have filed (a) a consolidated amended complaint alleging that the
defendants violated the federal securities laws and (b) a motion for class
certification. The consolidated amended complaint also added as defendants
Torchmark Corporation and the Company's predecessor auditors, KPMG Peat
Marwick, LLP. The time for the defendants to respond to the complaint and the
motion for class certification has not yet run. The consolidated amended
complaint alleges various violations of the federal securities law and seeks
unspecified but potentially significant damages.
The Company has notified its directors and officers liability insurance
companies of these lawsuits and the consolidated amended complaint. The
litigation is still in the preliminary stages and there has been no discovery
or class certification. The Company intends to vigorously defend this
litigation and intends to explore all available rights and remedies it may
have under the circumstances. In related litigation, in September, 1998,
Cincinnati Insurance Company ("Cincinnati"), one of the Company's directors
and officers liability insurance carriers, filed a lawsuit in the United
States District Court for the Northern District of Alabama seeking to avoid
coverage under its directors and officers liability and other policies. The
Company filed a motion to dismiss Cincinnati's complaint on jurisdictional
grounds in federal court (which was granted), and filed a lawsuit against
Cincinnati in the Circuit Court of Jefferson County, Alabama seeking damages
arising out of Cincinnati's actions. Cincinnati has filed an answer
55
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands)
Note J--Commitment and Contingencies (continued)
and counterclaim in that case again seeking to avoid coverage. The Company
intends to vigorously resist Cincinnati's efforts to avoid coverage. Because
these matters are in their early stages, their ultimate outcome cannot be
determined. Accordingly, no provision for any liability that may result
therefrom has been made in the accompanying consolidated financial statements.
As discussed above, the Company corrected its accounting for assumed
reinsurance business through restatement of its previously issued financial
statements. Similar corrections were made on a statutory accounting basis
through recording cumulative adjustments in Vesta Fire's 1997 statutory
financial statements. The impact of this correction has been reflected in
amounts ceded under the Company's 20 percent whole account quota share treaty
which was terminated on June 30, 1998 on a run-off basis. The Company believes
such treatment is appropriate under the terms of this treaty and has
calculated the quarterly reinsurance billings presented to the treaty
participants accordingly. The aggregate amount included herein as recoverable
from such reinsurers totalled $60.4 million at December 31, 1998. Two of the
three participants have notified the Company that they wish to audit the
treaty computations as allowed by the terms of the treaty. The other
participant, through various correspondence, has also expressed an interest in
obtaining additional data. While management believes its interpretation of the
treaty's terms and computations based thereon, are correct, the effects, if
any, of participant audits or other actions cannot be determined at this time.
The Company, through its subsidiaries, is routinely a party to other pending
or threatened legal proceedings and arbitrations. These proceedings involve
alleged breaches of contract, torts, including bad faith and fraud claims and
miscellaneous other causes of action. These lawsuits may include claims for
punitive damages in addition to other specified relief. Based upon information
presently available, and in light of legal and other defenses available to the
Company and its subsidiaries, management does not consider liability from any
threatened or pending litigation or arbitration to be material.
Leases: The Company leases office space for its home office and HIG under
operating lease arrangements. These leases contain various renewal options and
escalation clauses. Rental expense for operating leases was $1.1 million, $1.2
million, and $1.8 million, for the years ending December 31, 1996, 1997, and
1998, respectively. Future minimum rental commitments required under these
leases are approximately $1.5 million per year.
Concentrations of Credit Risk: Vesta maintains a highly-diversified
investment portfolio with limited concentrations in any given region,
industry, or economic characteristic. At December 31, 1998, the investment
portfolio consisted of securities of the U.S. government or U.S. government
backed securities (11.9%); mortgage backed securities, GNMA collateral
(14.0%); investment grade corporate bonds (25.5%); cash and short-term
investments (24.6%); securities of state and municipal governments (20.1%);
securities of foreign governments (.6%); and corporate common stocks (3.3%).
Corporate equity and debt investments are made in a wide range of industries.
All of Vesta's investments at year-end 1998 were rated investment-grade.
At December 31, 1998, the Company has unsecured reinsurance recoverables
from reinsurers that are in excess of 3% of statutory surplus, the largest of
which is $31 million.
Note K--Supplemental Disclosures for Cash Flow Statement
The following table summarizes Vesta's non-cash investing and financing
activities and amounts recorded for interest and income taxes paid.
Year Ended December 31,
-------------------------
1996 1997 1998
------- --------- -------
Paid in capital from tax benefit of stock $ 337 $ 2,574 $ 748
option exercises...............................
56
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands)
Note K--Supplemental Disclosures for Cash Flow Statement (continued)
The following table summarizes certain amounts paid during the period:
Year Ended December 31,
-----------------------
1996 1997 1998
------- ------- -------
Interest paid...................................... $ 9,494 $15,113 $11,193
Income taxes paid.................................. $21,500 $22,571 $ --
Note L--Reinsurance
Vesta engages in reinsurance ceded transactions as part of its overall
underwriting and risk management strategy. Vesta's reinsurance ceded programs
include coverages which limit the amount of individual claims to a fixed
amount or percentage and which limit the amount of claims related to
catastrophes.
The effect on premiums earned and losses and loss adjustment expenses
incurred of reinsurance ceded transactions are as follows:
Year Ended December 31,
--------------------------
1996 1997 1998
-------- -------- --------
Reinsurance ceded:
Premiums ceded................................ $149,964 $300,799 $310,652
Losses and LAE recovered
and recoverable.............................. 134,756 345,780 199,026
The amounts of reserves for unpaid losses and loss adjustment expenses and
unearned premiums that Vesta would remain liable for should reinsuring
companies be unable to meet their obligations are as follows:
Year Ended December 31,
-----------------------
1997 1998
----------- -----------
Losses and loss adjustment expense................ $ 204,336 $ 206,139
Retroactive Reinsurance Receivable................ 16,945 9,848
Unearned premiums................................. 94,253 49,916
----------- -----------
$315,534 $265,903
=========== ===========
Vesta engages in assumed reinsurance transactions as part of its overall
business strategy. The effect on premiums earned and losses and loss
adjustment expenses of all assumed reinsurance transactions, including
involuntary pools, are as follows:
Year Ended December 31,
--------------------------
1996 1997 1998
-------- -------- --------
Premiums assumed................................ $427,476 $495,063 $341,956
Losses and loss adjustment expenses assumed..... 288,835 333,488 230,497
The effect of reinsurance on premiums written and earned is as follows:
1996 1997 1998
-------------------- -------------------- --------------------
Written Earned Written Earned Written Earned
--------- --------- --------- --------- --------- ---------
Direct.................. $ 154,235 $ 161,824 $ 330,624 $ 323,394 $ 471,404 $ 478,389
Assumed................. 497,537 427,476 535,427 495,063 287,617 341,956
Ceded................... (183,716) (149,964) (339,576) (300,799) (267,431) (310,652)
--------- --------- --------- --------- --------- ---------
Net premiums.......... $ 468,056 $ 439,336 $ 526,475 $ 517,658 $ 491,590 $ 509,693
========= ========= ========= ========= ========= =========
57
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands)
Note M--Income Taxes
Income tax expense (benefit) for the years ended December 31, 1996, 1997 and
1998 was allocated as follows:
1996 1997 1998
------- ------- --------
Operating income.................................. $17,862 $23,116 $(57,244)
Deferrable Capital Securities..................... -- (2,719) (3,076)
Stockholder's equity, for unrealized gains (413) 3,927 (1,531)
(losses)..........................................
Stockholder's equity, for compensation expense for
tax purposes in excess of amounts recognized for
financial reporting purposes..................... 337 (2,574) (748)
------- ------- --------
$17,786 $21,750 $(62,599)
======= ======= ========
Income tax expense benefit attributable to income from operations consists
of:
Year Ended December 31,
--------------------------
1996 1997 1998
------- ------- --------
Current tax expense (benefit)................. $19,483 $25,848 $(17,951)
Deferred tax expense (benefit)................ (1,621) (2,732) (39,293)
------- ------- --------
Total........................................ $17,862 $23,116 $(57,244)
======= ======= ========
Vesta's effective income tax rate differed from the statutory income tax
rate as follows:
Year Ended December 31,
------------------------------------------
1996 1997 1998
------------ ------------ --------------
Amount % Amount % Amount %
------- --- ------- --- -------- ----
Statutory federal income tax $19,136 35% $22,759 35% $(67,543) (35%)
rate.........................
Increases (reductions) in tax
resulting from:
Tax exempt investment (2,240) (3) (2,019) (2) (2,246) (2)
income.......................
State income tax............ -- -- 337 -- -- --
Goodwill.................... 13,109 8
Other....................... 966 1 2,039 2 (564) --
------- --- ------- --- -------- ----
$17,862 33% $23,116 35% $(57,244) (29%)
======= === ======= === ======== ====
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities included in
other liabilities at December 31, 1997 and 1998 are presented below:
1997 1998
------- -------
Deferred tax assets:
Unearned and advance premiums............................ $19,439 $20,312
Reinsurance recoverables................................. 26,321 --
Discounted unpaid losses................................. 9,795 13,615
Net operating loss carryforward.......................... -- 38,049
Goodwill................................................. -- 7,983
Retroactive Reinsurance.................................. 5,931 3,447
Deferred Compensation.................................... 750 775
------- -------
Total deferred tax assets................................. $62,236 $84,181
======= =======
58
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar amounts in thousands)
Note M--Income Taxes (continued)
1997 1998
------- -------
Deferred tax liabilities:
Deferred acquisition costs............................ $35,455 $35,335
Contingent commissions................................ 6,008 4,005
Unrealized gains...................................... 6,317 6,446
Fixed assets.......................................... 1,470 2,606
Contingent receivables................................ 2,467 4,764
Goodwill.............................................. 2,252 --
Salvage and subrogation............................... 875 248
Reinsurance Recoverables.............................. 10,982
Other................................................. 82 705
------- -------
Total deferred tax liabilities......................... $54,926 $65,091
------- -------
Net deferred tax asset................................. $ 7,310 $19,090
======= =======
Deferred tax assets are to be reduced by a valuation allowance if it is more
likely than not that some portion or all of the deferred tax assets will not
be realized. The Company is able to demonstrate that the benefits of its
deferred tax assets are realizable and accordingly, no valuation allowance has
been recorded at December 31, 1998 and 1997.
Note N--Retirement Plans
Vesta has a defined contribution retirement and savings plan and a
supplemental executive retirement plan. These plans are fully funded at year-
end 1998. Vesta's total cost for benefits under these plans was $.3 million
for 1996, $.7 million for 1997 and $.1 million for 1998.
Note O--Segment Information
During 1998, the Company adopted SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information," which requires companies to report
financial and descriptive information about their reportable operating
segments. The Company writes personal and commercial insurance products
throughout the United States and reinsurance for companies located throughout
the United States. All revenues are generated from external customers and the
Company does not have a reliance on any major customer.
The Company evaluates segment profitability based on pre-tax operating
profit. Net investment income, interest expense and operating expenses are
allocated based on certain assumptions and estimates; stated segment operating
results would change if different methods were applied. The accounting
policies of the operating segments are the same as those described in Note A.
59
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands)
Year Ended December 31,
--------------------------------
1996 1997 1998
-------- ---------- ----------
Revenues
Reinsurance Operations
Net premiums earned....................... $342,452 $ 335,360 $ 194,261
Net investment income and realized
gain/(loss)................................ 18,864 18,578 14,045
-------- ---------- ----------
Total reinsurance........................ 361,316 353,938 208,306
Personal insurance operations
Net premiums earned....................... 63,206 139,425 247,064
Net investment income and realized
gain/(loss)................................ 3,263 13,501 15,727
Other .................................... 123 1,602 4,287
-------- ---------- ----------
Total personal........................... 66,592 154,528 267,078
Commercial insurance operations
Net premiums earned....................... 33,678 42,873 68,368
Net investment income and realized
gain/(loss)................................ 1,053 7,164 8,558
Other .................................... 65 492 1,186
-------- ---------- ----------
Total commercial......................... 34,796 50,530 78,112
-------- ---------- ----------
Total revenues........................... $462,704 $ 558,995 $ 553,496
======== ========== ==========
Total pretax income from operations
Reinsurance Operations
Underwriting gain (loss).................. $ 37,318 $ 38,774 $ (84,662)
Net investment income and realized
gain/(loss)................................ 18,864 18,578 14,045
Interest expense.......................... 7,841 7,036 5,377
-------- ---------- ----------
Total reinsurance........................ 48,342 50,316 (75,994)
Personal Operations
Underwriting gain (loss).................. 7,773 (2,470) (35,688)
Net investment income and realized
gain/(loss)................................ 3,263 13,501 15,727
Other income ............................. 123 1,602 4,287
Loss on asset impairment.................. -- -- 65,496
Goodwill.................................. 316 3,065 5,177
-------- ---------- ----------
Total personal........................... 10,843 9,568 (86,347)
Commercial Operations
Underwriting gain (loss).................. (3,242) 2,252 (21,279)
Net investment income and realized
gain/(loss)................................ 1,053 7,164 8,558
Other income ............................. 65 492 1,186
Loss on asset impairment.................. -- -- 9,000
Goodwill.................................. 168 942 1,432
-------- ---------- ----------
Total commercial......................... (2,292) 8,966 (21,967)
-------- ---------- ----------
Other Operations
Interest expense........................... 2,218 3,823 8,671
-------- ---------- ----------
Total pretax income (loss) from $ 54,675 $ 65,027 $ (192,979)
operations..................................
======== ========== ==========
Total identifiable assets
Reinsurance operations
Investments and other assets.............. $644,954 $ 681,273 $ 451,667
Deferred acquisition costs................ 55,870 52,742 57,764
Personal operations
Investments and other assets.............. 111,564 580,809 520,200
Deferred acquisition costs................ 16,437 38,772 35,465
Commercial operations
Investments and other assets.............. 39,335 272,653 274,878
Deferred acquisition costs................ 3,225 10,610 7,728
-------- ---------- ----------
Total assets............................. $871,385 $1,636,859 $1,347,702
======== ========== ==========
60
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands)
Note P--Debt
On July 19, 1995, the Company issued $100 million of its 8.75% Senior
Debentures due July 15, 2025. The Debentures are not subject to redemption or
any sinking fund prior to maturity. The Debentures are unsecured and rank on
parity with all of its other unsecured and unsubordinated indebtedness. The
Debentures contain covenants that limit the ability of the Company or its
subsidiaries to issue, sell or otherwise dispose of shares of voting common
stock of any Restricted Subsidiary and limit the ability of the Company or its
subsidiaries to pledge the shares of capital stock of any subsidiary. The
Debentures also place certain limitations on the Company's ability to
consolidate or merge with or sell its assets substantially as an entirety. The
Company used the proceeds from the sale to repay a $28 million loan from a
Torchmark affiliate, and to increase the capital and surplus of Vesta Fire.
On January 31, 1997, Vesta Capital Trust I, a Delaware business trust
controlled by the Company, sold $100 million of its 8.525% Deferrable Capital
Securities. These securities have a 30 year maturity and are not redeemable
except in certain limited circumstances. These securities were sold in a
private placement transaction to qualified institutional buyers and were not
registered under Securities Act of 1933 pursuant to an exemption from
registration provided by Rule 144A promulgated thereunder. A portion of the
proceeds from the sale of these securities were used to repay indebtedness
under the Company's existing lines of credit and for general corporate
purposes. As required by the Company's amended bank facility, the Company will
defer interest under the Indenture dated January 31, 1997 which will result in
the deferral of distributions under the amended and restated Declaration of
Trust dated January 31, 1997.
At December 31, 1998, the Company had borrowed $70 million under its $200
million line of credit for general corporate purposes and for a capital
contribution of $25 million to the Company's principal insurance subsidiary,
Vesta Fire Insurance Corporation. The credit agreement related to this line of
credit contains certain covenants that require, among other things, the
Company to maintain a certain consolidated net worth ("Consolidated Net Worth
Covenant"), maintain a certain amount of earnings before interest and taxes
available for the payment of interest and dividend expense, ("Fixed Charge
Coverage Ratio"), cause each insurance subsidiary to maintain a certain total
adjusted statutory capital, ("Adjusted Statutory Capital Covenant"), and that
limits the amount of indebtedness of the companies. As of December 31, 1998,
the Company was not in compliance with all of its financial covenants.
Subsequent to December 31, 1998, the Company's banks agreed to amend the
covenants and waive any event of default arising from non-compliance with the
covenants as of December 31, 1998. The amended credit facility was
restructured into a $70 million senior revolving credit facility, maturing
July 31, 2000 ("the "Amended Facility"). The interest rate on the Amended
Facility will be the prime rate plus 1%, provided that from and after
September 30, 1999 the rate shall be increased to the prime rate plus 3% if
the Company has not made permanent principal prepayments on the Amended
Facility aggregating at least $25 million. The Company will also pay the banks
a 1% Commitment Fee on all of the used and unused commitments under the
Amended Facility.
The Amended Facility requires the Company to make a closing principal
prepayment of $15 million less transaction expenses the net amount of which
reduces the obligation to make permanent principal payments aggregating $25
million. The amended Facility also provides for warrants equal to
approximately 6.6% of the Company's outstanding shares being issued to the
banks participating on the Amended Facility, which become exerciseable in the
event the Company does not make $25 million of permanent principal prepayments
on the facility by March 15, 2000.
61
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands)
Note P--Debt (continued)
The Amended Facility requires the Company to suspend dividends on its common
stock and defer payments of interest on its junior subordinated debentures due
January 31, 2027 unless the Company has made $25 million of permanent
principal prepayments on the Amended Facility by March 15, 2000. The Amended
Facility contains certain covenants that require the Company to maintain
minimum statutory surplus levels, minimum cumulative statutory net income
levels and minimum cumulative GAAP net income levels.
Note Q--Stock Options
During 1995, the Financial Accounting Standards Board issued Financial
Accounting Statement No. 123, Accounting for Stock-Based Compensation ("SFAS
123"). The Statement defines a fair value based method of accounting for an
employee stock option. It also allows an entity to continue using the
intrinsic valued based accounting method prescribed by Accounting Principles
Board Opinion No. 25, Accounting for Stock Issued to Employees. The Company
has continued to use this method to account for its stock options. However,
SFAS 123 requires entities electing to remain with the intrinsic method of
accounting to provide pro forma disclosures of net income and earnings per
share as if the fair value based method of accounting had been applied as well
as other disclosures about the Company's stock-based employee compensation
plans. Information about the Company's stock option plans and the related
required disclosures follow.
Prior to completion of the Company's initial public offering, the Company's
stockholders approved the Vesta Insurance Group, Inc. Long Term Incentive Plan
("Plan"), which provided for grants to the Company's executive officers of
restricted stock, stock options, stock appreciation rights, and deferred stock
awards, and in certain instances grants of options to directors. The Company's
stockholders approved certain amendments to the Plan effective May 16, 1995,
including an amendment to increase
the shares of the Company's common stock available for awards under the Plan
from 1,091,400 shares to 2,221,998 shares and an amendment to delete the
provision for the grant of options to non-employee directors. The Company's
stockholders also approved the Vesta Insurance Group, Inc. Non-Employee
Director Stock Plan ("Director Plan") effective May 16, 1995, which provides
for grants to the Company's non-employee directors of stock options and
restricted stock.
Pro forma information regarding net income and earnings per share is
required by FAS 123, and has been determined as if the Company had accounted
for its employee stock options under the fair value method of that Statement.
The fair value for these options was estimated at the date of grant using a
Black-Scholes option pricing model with the following weighted average
assumptions for 1997 and 1998, respectively; risk-free interest rates of 5.75
percent and 5.16 percent; dividend yields of 0.27 and 0.44 percent; volatility
factor of the expected market price of the Company's common stock of 38.75 and
44.70; and a weighted-average expected life of the options of ten years for
both years.
The Company's actual and pro forma information follows (in thousands except
for earnings per share information):
Year Ended
December 31,
--------------------
1997 1998
---------- ---------
(restated)
Net income:
As reported....................................... $36,860 $(141,184)
Pro forma......................................... 33,576 (144,684)
Basic net income per common share:
As reported....................................... $ 1.98 $ (7.61)
Pro forma......................................... 1.81 (7.80)
Diluted net income per common share:
As reported....................................... $ 1.93 $ (7.61)
Pro forma......................................... 1.76 (7.80)
62
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands)
Note Q--Stock Options (continued)
The following summary sets forth activity under the Plan for the years ended
December 31:
1996 1997 1998
------------------- ------------------- -----------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
--------- --------- --------- --------- ------- ---------
Outstanding--beginning
of the year............ 1,055,699 $18.37 1,022,872 $20.38 937,451 $25.65
Granted................. 129,394 31.93 135,085 51.64 101,500 21.30
Exercised............... 55,667 15.51 220,506 17.15 237,000 17.16
Forfeited............... 106,554 16.99 -- -- 237,903 35.14
--------- ------ --------- ------ ------- ------
Outstanding--end of the
year................... 1,022,872 $20.38 937,451 $25.65 564,048 $24.43
========= ====== ========= ====== ======= ======
Weighted-average fair
value of options
granted during the
year................... $ 25.85 $ 36.89 $ 12.56
Of the 564,048 outstanding options at December 31, 1998, 125,389 were
exercisable with the remaining having varying vesting periods. Exercise prices
for options outstanding as of December 31, 1998 ranged from $9.56 to $59.19.
Unexercised options with exercise prices of less than $25.00 for 375,623
shares had a weighted average contractual life of 6.9 years and a weighted
average exercise price of $18.13 while unexercised options with exercise
prices greater than $25.00 for 188,425 shares had a weighted average
contractual life of 9.2 years and a weighted average exercise price of $38.42.
In 1993, the Company entered into restricted stock agreements under which
Vesta granted 153,300 shares of common stock at $10.26 per share to officers
of the Company in exchange for promissory notes. In 1994, an additional 60,000
shares of Common Stock at $18.92 per share were issued to an officer of the
Company under a restricted stock agreement in exchange for a promissory note.
The common stock is being held by the Company as security for repayment of the
notes. A portion of the shares will be released to the officers annually as
they repay the promissory notes. The Company intends to pay cash bonuses each
year in amounts sufficient to reduce the notes by the amount of the purchase
price for the shares which are earned in that year. During 1996 the Company
acquired 19,564 shares of its common stock with respect to previously granted
awards of restricted stock in exchange for release of indebtedness of
$169 thousand. The balance of the notes at December 31, 1996 was $3,207
thousand. During 1997 and 1998 the Company did not acquire any shares of its
common stock with respect to previously granted awards of restricted stock.
The balance of the notes at December 31, 1997 and 1998 was $3,891 thousand and
$2,045 thousand, respectively. The promissory notes and the unearned
compensation are shown as deductions from stockholders equity.
In 1995, the Company entered into restricted stock agreements under which
the Company granted 23,333 shares of restricted common stock to certain
officers of the Company. The Company entered into restricted stock agreements
under which the Company granted 20,915 and 30,000 shares of restricted common
stock to certain employees of the Company and 9,632 and 5,399 shares of
restricted common stock to certain directors of the Company in 1997 and 1998,
respectively. The common stock with respect to all awards of restricted stock
is being held by the Company until the restrictions lapse.
63
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands)
Note R--Quarterly Financial Information (Unaudited)
The following is a summary of quarterly financial data, in thousands except
per share data:
Three Months Ended
-------------------------------------------------------------------------------
March 31, 1998 June 30, 1998 September 30, 1998 December 31, 1998
------------------- ------------------- ------------------- -----------------
As As As
previously As previously As previously As
reported restated reported restated reported restated
---------- -------- ---------- -------- ---------- --------
Gross premiums written.. $233,217 $233,217 $253,374 $253,374 $196,400 $112,882 $ 159,549
Net premiums written.... 131,885 131,885 169,292 169,292 118,892 52,047 138,367
Premiums earned......... 139,292 139,292 164,076 164,076 131,278 65,352 140,972
Net investment income... 9,300 9,300 8,800 8,800 8,362 8,362 8,596
Operating costs and
expenses............... 144,639 139,693 189,910 194,905 162,076 102,098 214,619
Loss on asset
impairment............. -- -- -- -- -- -- (74,496)
Net Income (loss)....... (1,146) 2,071 (13,839) (17,185) (26,305) (24,773) (101,297)
======== ======== ======== ======== ======== ======== =========
Per share data:
Net income.............. (0.06) 0.11 (0.75) (0.93) (1.41) (1.34) (5.45)
Stockholder's equity per
share.................. 16.56 16.73 15.89 15.72 14.55 14.63 8.47
Cash dividends per
share.................. 0.04 0.04 0.04 0.04 0.04 0.04 0.04
Three Months Ended
------------------------------------------------------------
March 31, June 30,
1997 1997 September 30, 1997 December 31, 1997
---------- -------- ------------------- -------------------
As As
previously As previously As
reported restated reported restated
---------- -------- ---------- --------
Gross premiums written.. $171,187 $203,043 $239,794 $239,794 $252,025 $252,025
Net premiums written.... 105,736 137,186 114,405 114,405 169,148 169,148
Premiums earned......... 100,040 133,717 153,287 153,287 130,614 130,614
Net investment income... 6,147 7,178 12,251 12,251 10,384 10,384
Operating costs and
expenses............... 94,504 112,673 136,544 145,684 118,414 126,341
Net income (loss)....... 6,353 15,088 18,261 12,320 8,171 3,099
======== ======== ======== ======== ======== ========
Per share data:
Basic net income........ 0.34 0.81 0.98 0.66 0.44 0.17
Diluted net income...... 0.34 0.80 0.96 0.65 0.43 0.16
Stockholder's equity per
share.................. 14.87 15.78 16.90 16.58 16.71 16.12
Cash dividends per
share.................. 0.04 0.04 0.04 0.04 0.04 0.04
The Company determined, subsequent to the issuance of the 1997 financial
statements, that a specific reinsurance ceded contract entered into in 1997
contains retroactive elements as defined in FAS 113. The Company erroneously
recorded a gain on this contract in the fourth quarter of 1997 and must adjust
its previously issued financial statements to appropriately defer and
recognize such gain. The first three quarters of 1998 and the fourth quarter
of 1997 have been restated to reflect the recognition of the deferred gain in
1998 (See Note B). The third and fourth quarter of 1997 have also been
restated to reflect adjustments for salvage and subrogation related to the
Shelby loss reserves.
Revenues, losses and expenses for the 1998 third quarter have been restated
to reflect changes in presentation. Amounts are restated to present
adjustments recorded in the Company's reinsurance assumed business on gross
basis rather than on a net basis as previously presented. Net income and
earnings per share for the quarters and year to date periods ending
September 30, 1998 were not affected by this change.
64
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands)
Note S--Business Acquisition
After the close of business on June 30, 1997, the Company completed its
acquisition of all the issued and outstanding stock of the operating
subsidiaries of Anthem Casualty Insurance Group, Inc., each of which are
property and casualty insurance companies headquartered in Ohio, for $260.9
million. The acquired subsidiaries had $648 million of assets and
approximately $217 million of stockholders' equity at June 30, 1997. The
acquisition was accounted for as a purchase and the results of operations
since the acquisition date were consolidated. Goodwill from the transaction
was being amortized straight line over 15 years. This goodwill was deemed
impaired in 1998.
A summary of net assets acquired follows:
Assets acquired:
Investments....................................................... $419,271
Cash.............................................................. 15,069
Goodwill.......................................................... 83,341
Other Assets...................................................... 166,944
--------
Total............................................................ 684,625
Liabilities Assumed
Loss and loss adjustment expenses................................. 300,315
Unearned premiums................................................. 98,378
Other............................................................. 25,052
--------
Total............................................................ $423,745
Purchase price.................................................... $238,750
Acquisition expenses.............................................. 22,130
Less cash acquired................................................ (15,069)
--------
Aggregate purchase price.......................................... $245,811
========
The above table represents the purchase price plus acquisition costs through
December 31, 1997.
The table below presents supplemental pro forma information for 1996 and
1997 as if the Anthem acquisition were made at January 1, 1996, based on
estimates and assumptions considered appropriate:
Twelve months ended
December 31,
-------------------
1996 1997
--------- ---------
Revenues.................................................. 784,858 709,643
Net income................................................ 42,351 44,131
Basic net income per common share......................... 2.25 2.38
Diluted net income per common share....................... 2.21 2.31
Note T--Subsequent Events (Unaudited)
On March 15, 1999 the Company adopted a plan to discontinue its Commercial
Lines business with the exception of its' Partners program, Transportation
program and BOP programs in the States of Alabama, Alaska, Arizona, and Texas.
Implementation of the plan will begin in June of 1999
65
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands)
Note T--Subsequent Events (continued)
On March 24, 1999 the Company sold its reinsurance assumed business with the
exception of the homeowner's reinsurance business that is currently being
converted to primary operations. The Company received $15 million in exchange
for its commitment to (a) enter into a 100% quota share treaty, effective
January 1, 1999 for all business written on or after that date; (b) use its
best efforts to novate to the purchaser or renew on the purchaser's paper, all
assumed treaties except those currently being converted to primary business
and; (c) facilitate the hiring by the purchaser of several of the Company's
reinsurance employees.
Summarized pro-forma results of the discontinued commercial and reinsurance
segments for the last three years are as follows:
Year Ended December 31,
-----------------------------------
1996 1997 1998
----------- ----------- -----------
(unaudited) (unaudited) (unaudited)
(in thousands)
Commercial Line
Gross Premiums Written................... $ 32,016 $ 47,466 $ 85,662
-------- -------- --------
Income (Loss) from Operations before
income
tax (expense) benefit .................. (295) 2,850 (13,615)
Income tax (expense) Benefit............. 97 (1,036) 5,434
-------- -------- --------
Income (Loss) from Operations............ $ (198) $ 1,814 $ (8,180)
======== ======== ========
Reinsurance Line
Gross premiums written................... $570,113 $474,981 $183,065
-------- -------- --------
Income (loss) from operations before
income
tax (expense) benefit................... 53,866 55,591 (67,817)
Income tax (expense) benefit............. (17,793) (19,683) 26,950
-------- -------- --------
Income (loss) from operations............ $ 36,073 $ 35,908 $(40,867)
======== ======== ========
66
[Performance Graph Appears Here]
ITEM 9. CHANGES IN REGISTRANT'S CERTIFYING ACCOUNTANT
During 1998, the Board of Directors of the Company adopted a resolution
authorizing the Chairman of the Audit Committee, in his discretion, (i) to
dismiss KPMG Peat Marwick LLP ("KPMG") as the Company's independent
accountants, effective upon management's notification of KPMG of such
dismissal and (ii) concurrently with such dismissal, to engage
PricewaterhouseCoopers LLP ("PwC") as the Company's independent accountants
for the fiscal year ending December 31, 1998.
On December 18, 1998, the Company notified KPMG of the dismissal. Also on
December 18, 1998, the Company engaged PwC as the Company's independent
accountants, subject to PwC's normal client acceptance procedures. This
process was completed and PwC's engagement commenced on January 26, 1999.
During the two most recent fiscal years, and during the subsequent interim
period preceding the decision to change independent accountants, neither the
Company nor anyone on its behalf consulted PwC regarding either the
application of accounting principles to a specified transaction, either
completed or proposed, or the type of audit opinion that might be rendered on
the Company's financial statements, and neither a written report nor oral
advice was provided to the Company by PwC with respect to any such
consultation.
KPMG audited the Company's annual consolidated financial statements as of
and for each of the fiscal years ended December 31, 1993, 1994, 1995, 1996 and
1997 (the "Historical Financial Statements"). KPMG's auditors reports on these
Historical Financial Statements did not contain any adverse opinion or
disclaimer of opinion and were not qualified or modified as to uncertainty,
audit scope, or accounting principles. However, in connection with the
Company's decision to restate the Historical Financial Statements in June,
1998, KPMG advised the Company that it could no longer be associated with
these Historical Financial Statements. The Company subsequently issued
restated financial statements as of and for the fiscal years ended December
31, 1996 and 1997 (the "Restated Financial Statements"), which were filed with
the Securities and Exchange Commission as a current report on Form 8-K on
August 20, 1998. KPMG issued an auditors report on the Restated Financial
Statements which did not contain any adverse opinion or disclaimer of opinion
and were not qualified or modified as to uncertainty, audit scope, or
accounting principles.
By a current report on Form 8-K filed on December 28, 1998 in connection
with KPMG's dismissal, the Company reported that during the Company's two most
recent fiscal years, and in the subsequent interim period, there had been no
disagreements between the Company's management and KPMG on any matters of
accounting principles or practices, financial statement disclosure, or
auditing scope and procedures which, if not resolved to the satisfaction of
KPMG, would have caused KPMG to make reference to the matter in an auditors
report. However, KPMG subsequently clarified its view that certain issues
regarding the financial presentation set forth in the Company's Form 10-Q
filed with the Securities and Exchange Commission on November 16, 1998
constituted reportable disagreements. Accordingly, the Company amended its
Form 8-K on January 12, 1999 to reflect these unresolved issues as reportable
disagreements and filed copies of letters from KPMG summarizing these
unresolved issues as Exhibits 16.1 and 16.2 to that amendment. The Audit
Committee discussed these matters with KPMG and authorized KPMG to respond
fully to the inquiries of PwC concerning these matters. The Company did not
consult PwC, prior to its engagement as the Company's successor auditors,
regarding such matters.
As noted above, KPMG audited the Company's consolidated financial statements
for the period ended December 31, 1997, which audit was completed March 27,
1998, except as to Note B, which is as of August 19, 1998. By letter dated
December 3, 1998, KPMG informed the Audit Committee of the Company's Board of
Directors that, in connection with said audit and their reviews of the 1998
quarterly financial statements, it had noted certain matters involving
internal controls that it considered to be reportable conditions under
applicable auditors' reporting standards.
67
PART III
Item 10. Directors and Executive Officers of Registrant
Information required by this item is incorporated by reference from the
sections entitled "Election of Directors," "Profiles of Directors and
Nominees," "Profiles of Executive Officers who are not directors" and
"Compensation and Other Transactions with Executive Officers and Directors" in
the Proxy Statement for the Annual Meeting of Stockholders to be held May 18,
1999 (the "Proxy Statement"), which is to be filed with the Securities and
Exchange Commission prior to May 1, 1999.
Item 11. Executive Compensation
Information required by this item is incorporated by reference from the
section entitled "Compensation and Other Transactions with Executive Officers
and Directors" in the Proxy Statement.
Item 12. Security Ownership of Certain Beneficial Owners and Management
(a)Security ownership of certain beneficial owners:
Information required by this item is incorporated by reference from the
section entitled "Principal Stockholders" in the Proxy Statement.
(b)Security ownership of management:
Information required by this item is incorporated by reference from the
section entitled "Stock Ownership of Management" in the Proxy Statement.
(c)Changes in control:
The Company knows of no arrangements, including any pledges by any person
of its securities, the operation of which may at a subsequent date result
in a change of control.
Item 13. Certain Relationships and Related Transactions
Information required by this item is incorporated by reference from the
section entitled "Compensation Committee Interlocks and Insider Participation;
Other Transactions" in the Proxy Statement.
68
PART IV
Item 14. Exhibits, Financial Statements Schedules, and Reports on Form 8-K
(a) Index of documents filed as a part of this report:
Page of
this
Report
-------
(1) Financial Statements:
Vesta Insurance Group, Inc.
Report of Independent Accountants.................................... 39
Independent Auditors' Report......................................... 40
Consolidated Balance Sheets at December 31, 1997 and 1998............ 41
Consolidated Statements of Operations and Comprehensive Income for
each of the years in the three-year period ended December 31, 1998.. 42
Consolidated Statements of Stockholders' Equity for each of the years
in the three-year
period ended December 31, 1998...................................... 43
Consolidated Statements of Cash Flow for each of the years in the
three-year period ended December 31, 1998........................... 44
Notes to Consolidated Financial Statements........................... 45-66
(2) Schedules Supporting Financial Statements for the three years
ended December 31, 1998:
II.Condensed Financial Information of Registrant (Parent Company)..... 73
III.Supplemental Insurance Information (Consolidated)................. 76
IV.Reinsurance (Consolidated)......................................... 78
V.Valuation and Qualifying Accounts (Consolidated).................... 79
Schedules not referred to have been omitted as inapplicable or not required by
Regulation S-X.
(3) Exhibits
Exhibits are listed in the index of Exhibits at page 67.
(b) Reports on Form 8-K: No reports on Form 8-K were filed during the
last quarter of the period covered by this report.
69
EXHIBITS INDEX
Exhibit
No. Description
------- -----------
3.1 Restated Certificate of Incorporation of the Company, dated
September 1, 1993 (filed as an exhibit to the Company's Form
10-Q for the quarter ended June 30, 1998, filed on June 16,
1998 and incorporated herein by reference (File No. 1-12338))
3.2 By-Laws of the Company (Amended and Restated as of October 1,
1993) (filed as an exhibit to Amendment No. 1 to the
Registration Statement on Form S-1 (Registration No. 33-68114)
of Vesta Insurance Group, Inc., filed on October 18, 1993 and
incorporated herein by reference (File No. 1-12338))
4.1 Indenture between the Company and Southtrust Bank of Alabama,
National Association, dated as of July 19, 1995 (filed as an
exhibit to the Company's Form 10-K for the year ended December
31, 1995, filed on March 28, 1996 and incorporated herein by
reference (File No. 1-12338))
4.2 Supplemental Indenture between the Company and Southtrust Bank
of Alabama, National Association, dated July 19, 1995 (filed
as an exhibit to the Company's Form 10-K for the year ended
December 31, 1995, filed on March 28, 1996 and incorporated
herein by reference (File No. 1-12338))
4.3 Indenture dated as of January 31, 1997, between the Company
and First Union National Bank of North Carolina, as trustee
(filed as an exhibit to the Company's Form 10-Q for the
quarter ended March 31, 1997, filed on May 13, 1997 and
incorporated herein by reference (File No. 1-12338))
4.4 Amended and Restated Declaration of Trust, dated as of January
31, 1997, of Vesta Capital Trust I (filed as an exhibit to the
Company's Form 10-Q for the quarter ended March 31, 1997,
filed on May 13, 1997 and incorporated herein by reference
(File No. 1-12338))
4.5 Capital Securities Guarantee Agreement, dated as of January
31, 1997, between the Company and First Union National Bank of
North Carolina, as trustee (filed as an exhibit to the
Company's Form 10-Q for the quarter ended March 31, 1997,
filed on May 13, 1997 and incorporated by reference (File No.
1-12338))
10.1 Separation and Public Offering Agreement between Torchmark
Corporation and the Company dated September 13, 1993 (filed as
an exhibit to the Company's Form 10-K for the year ended
December 31, 1993, filed on March 28, 1994 and incorporated
herein by reference (File No. 1-2338))
10.2 Marketing and Administrative Services Agreement between
Liberty National Fire Insurance Company, Liberty National
Insurance Corporation and Liberty National Life Insurance
Company dated September 13, 1993 (filed as an exhibit to the
Company's Form 10-K for the year ended December 31, 1993,
filed on March 28, 1994 and incorporated herein by reference
(File No. 1-2338))
10.3 Investment Services Agreement between Waddell & Reed Asset
Management Company and the Company (filed as an exhibit to
Amendment No. 1 to the Registration Statement on Form S-1
(Registration No. 33-68114) of Vesta Insurance Group, Inc.,
filed on October 18, 1993 and incorporated herein by reference
(File No. 1-12338)) dated September 13, 1993.
10.5 Management Agreement between J. Gordon Gaines, Inc., Liberty
National Fire Insurance Company, Sheffield Insurance
Corporation, Liberty National Insurance Corporation and Vesta
Insurance Corporation dated November 15, 1994 (filed as an
exhibit to the Company's Form 10-K for the year ended December
31, 1993, filed on March 28, 1994 and incorporated herein by
reference (File No. 1-2338))
70
Exhibit
No. Description
------- -----------
10.6 Form of Restricted Stock Agreement (filed as an exhibit to the
Registration Statement on Form S-1 (Registration No. 33-68114)
of Vesta Insurance Group, Inc., filed on August 31, 1993 and
incorporated herein by reference (File No. 1-12338))
10.7* The Company's Long Term Incentive Plan as amended effective as
of May 16, 1995 (filed as an exhibit to the Company's Form 10Q
for the quarter ended June 30, 1995, filed on August 14, 1995
and incorporated herein by reference (File No. 1-12338))
10.8* Form of Non-Qualified Stock Option Agreement entered into by
and between the Company and certain of its executive officers
and directors (filed as an exhibit to the Company's Form 10-K
for the year ended December 31, 1995, filed on March 28, 1996
and incorporated herein by reference (File No. 1-12338))
10.9* Cash Bonus Plan of the Company (filed as an exhibit to the
Company's Form 10-K for the year ended December 31, 1993,
filed on March 28, 1994 and incorporated herein by reference
(File No. 1-2338))
10.10* J. Gordon Gaines, Inc. Post Retirement Benefits Plan (filed as
an exhibit to the Company's Form 10-K for the year ended De-
cember 31, 1994, filed on March 29, 1995 and incorporated
herein by reference (File No. 1-12338))
10.11* J. Gordon Gaines, Inc. Retirement Savings Plan (filed as an
exhibit to the Company's Form 10-K for the year ended December
31, 1994, filed on March 29, 1995 and incorporated herein by
reference (File No. 1-12338))
10.12* The Company's Non-Employee Director Stock Plan (filed as an
exhibit to the Company's 10-Q for the quarter ended June 30,
1995, filed on August 14, 1995 and incorporated herein by ref-
erence (File No. 1-12338))
10.13 Office Lease between the Company and Torchmark Development
Corporation, dated as of April 20, 1992 (filed as an exhibit
to the Company's Form 10-K for the year ended December 31,
1993, filed on March 28, 1994 and incorporated herein by ref-
erence (File No. 1-12338))
10.14 Agency Agreement between Liberty National Fire Insurance Com-
pany, Vesta Insurance Corporation, Sheffield Insurance Corpo-
ration, and Overby-Seawell Company (filed as an exhibit to
Amendment No. 1 to the Registration Statement on Form S-1
(Registration No. 33-68114) of Vesta Insurance Group, Inc.,
filed on October 18, 1993 and incorporated herein by reference
(File No. 1-12338))
10.15 Commercial/Personal Property Risk Excess Reinsurance Con-
tracts, dated July 1, 1993, constituting the Company's Direct
Per Risk Treaty Program, between Vesta Fire Insurance Corpora-
tion and its subsidiary and affiliated companies and various
reinsurers (filed as an exhibit to Amendment No. 1 to the Reg-
istration Statement on Form S-1 (Registration No. 33-68114) of
Vesta Insurance Group, Inc., filed on October 18, 1993 and in-
corporated herein by reference (File No. 1-12338)) Renewed
July 1, 1997.
10.17 Specific Regional Catastrophe Excess Contracts, dated January
1, 1996, constituting the Company's Regional Property Catas-
trophe Program, between Vesta Fire Insurance Corporation and
various reinsurers (filed as an exhibit to the Company's Form
10-K for the year ended December 31, 1995, filed on March 28,
1996 and incorporated herein by reference (File No. 1-12338)).
Renewed January 1, 1998.
10.18 Casualty Excess of Loss Reinsurance Agreements, dated January
1, 1998, constituting the Company's Casualty Excess of Loss
Reinsurance Program, between Vesta Fire Insurance Corporation,
Vesta Insurance Corporation, Sheffield Insurance Corporation,
Vesta Lloyds Insurance Company and Employers Reinsurance
Corporation, (filed as an exhibit to the Company's Form 10-Q
for the quarter ended March 31, 1998, filed on May 13, 1998
and incorporated herein by reference (File No. 1-12338)).
71
Exhibit
No. Description
------- -----------
10.19 Amendment to Catastrophe Reinsurance Contracts, dated July 1,
1995, constituting the Company's Direct Property Catastrophe
Program, between Vesta Fire Insurance Corporation, Vesta
Insurance Corporation, Sheffield Insurance Corporation, Vesta
Lloyds Insurance Company, Hawaiian Insurance & Guaranty
Company, Limited and various reinsurers. (Filed as an exhibit
to the Company's Form 10-Q for the quarter ended September 30,
1995, filed on November 14, 1995 and incorporated herein by
reference (File No. 1-12338)). Renewed July 1, 1997.
10.20 Amendment to Catastrophe Reinsurance Contracts, dated January
1, 1996, constituting the Company's Direct Property
Catastrophe Program, between Vesta Fire Insurance Corporation,
Vesta Insurance Corporation, Sheffield Insurance Corporation,
Vesta Lloyds Insurance Company, Hawaiian Insurance & Guaranty
Company, Limited and various reinsurers (filed as an exhibit
to the Company's Form 10-K for the year ended December 31,
1995, filed on March 28, 1996 and incorporated herein by
reference (File No. 1-12338)). Renewed January 1, 1997.
10.21 Amended and Restated Credit Agreement between Vesta Insurance
Group, Inc. and Southtrust Bank of Alabama, N.A., ABN Amro
Bank B.V., Bank of Tokyo-Mitsubishi Trust Company, The First
National Bank of Chicago, Wachovia Bank of Georgia, N.A. and
First Union National Bank of North Carolina (as agent), dated
April 8, 1997 (filed as an exhibit to the Company's Form 10-Q
for the quarter ended March 31, 1997, filed on May 13, 1997,
and incorporated herein by reference (File No. 1-12338))
10.22 First amendment, dated April 14, 1999, to amended and Restated
Credit Agreement between Vesta Insurance Group, Inc. and
Southtrust Bank of Alabama, N.A., ABN Amro Bank B.V., Bank of
Tokyo-Mitsubishi Trust Company, The First National Bank of
Chicago, Wachowia Bank of Georgia, N.A. and First Union
National Bank of North Carolina (as agent), dated April 8,
1997.
10.23 Stock Purchase Agreement between Anthem Casualty Insurance
Group, Inc., and Vesta Insurance Group, Inc., dated April 23,
1997 (filed as an exhibit to the Company's Form
10-Q for the year ended September 30, 1997, filed on November
13, 1997 and incorporated herein by reference (File No. 1-
12338))
10.24 Business Transfer and Management Agreement between Vesta Fire
Insurance Corporation and its affiliated companies and CIGNA
Property and Casualty Insurance Company and its affiliated
companies, dated January 28, 1998 (filed as an exhibit to the
Company's Form 10-K for the year ended December 31, 1997,
filed on March 27, 1998 and incorporated herein by reference
(File No. 1-12338))
10.25 Agreement for Data Processing Services between Shelby
Insurance Company and Policy Management Systems Corporation,
dated January 1, 1998 (filed as an exhibit to the Company's
Form 10-Q for the period from June 30, 1998, filed on August
20, 1998 and incorporated herein by reference (File No. 1-
12338)).
23.1 Consent of KPMG Peat Marwick LLP.
23.2 Consent of PricewaterhouseCoopers LLP.
- --------
*These are the Company's compensatory plans.
72
Exhibit 11. Statement re computation of per share earnings
VESTA INSURANCE GROUP, INC. COMPUTATION OF EARNINGS PER SHARE
Year Ended December 31,
-------------------------
1996 1997 1998
------- ------- ---------
(In thousands except per
share data)
BASIC EARNINGS PER SHARE:
Weighted average common shares outstanding......... 18,860 18,600 18,549
Net income......................................... $36,813 $36,860 $(141,184)
Basic earnings per share........................... $ 1.95 $ 1.98 $ (7.61)
DILUTED EARNINGS PER SHARE:
Weighted average common shares outstanding......... 18,860 18,600 18,549
Net effect of the assumed exercise of stock options
and nonvested restricted stock--based on the trea-
sury stock method using average market price for
the year.......................................... 297 453 --
------- ------- ---------
Total weighted average common shares and common
stock equivalents outstanding..................... 19,157 19,053 18,549
Net income......................................... $36,813 $36,860 $(141,184)
Diluted earnings per share......................... $ 1.92 $ 1.93 $ (7.61)
======= ======= =========
- --------
Exhibit 21. Subsidiaries of the Registrant
The following table lists subsidiaries of the registrant which meet the
definition of "significant subsidiary" according to Regulation S-X:
Name Under Which
Company State of Incorporation Company Does Business
------- ---------------------- ---------------------
Vesta Fire Alabama Vesta Fire
Insurance Corporation Insurance Corporation
All other exhibits required by Regulation S-K are listed as to location in
the Exhibits Index on pages 47 through 49 of this report. Exhibits not referred
to have been omitted as inapplicable or not required.
73
VESTA INSURANCE GROUP, INC.
(PARENT COMPANY)
SCHEDULE II--CONDENSED BALANCE SHEETS
(Amounts in thousands except share and per share data)
At December 31,
-------------------
1997 1998
---------- --------
(restated)
Assets
Investment in affiliates................................ $547,575 $430,910
Short-term investments.................................. 7,015 4,791
-------- --------
Total investments..................................... 554,590 435,701
Cash.................................................... 8 10,523
Other assets............................................ 9,507 11,179
-------- --------
Total assets.......................................... $564,105 $457,403
======== ========
Liabilities
Other liabilities....................................... $ 20,351 $ 27,981
Long term debt.......................................... 246,418 271,395
-------- --------
Total liabilities..................................... 266,769 299,376
Stockholders' equity
Preferred stock, 5,000,000 shares authorized, none -- --
issued....................................................
Common stock, $.01 par value, 32,000,000 shares
authorized,
issued: 1997--18,970,695 shares; 1998--18,964,322
shares............................................... 190 190
Additional paid-in capital.............................. 162,550 156,465
Unrealized investment gains, net of applicable taxes.... 9,829 8,889
Retained earnings....................................... 154,074 10,120
Receivable from issuance of restricted stock............ (3,891) (2,045)
Treasury stock.......................................... (25,416) (15,592)
-------- --------
Total stockholders' equity............................ 297,336 158,027
-------- --------
Total liabilities and stockholders' equity............ $564,105 $457,403
======== ========
74
VESTA INSURANCE GROUP, INC.
(PARENT COMPANY)
SCHEDULE II--CONDENSED STATEMENTS OF OPERATIONS
(Dollar amounts in thousands)
For the Year Ended December 31,
----------------------------------
1996 1997 1998
--------- -----------------------
(restated)
Revenues:
Net other income (loss)................... $ 213 $ (5,224) 8,457
--------- ---------- ----------
Total revenues.......................... 213 (5,224) 8,457
Expenses:
Interest expenses......................... 10,059 10,901 22,579
Operating expenses........................ (6,745) (10,327) 2,384
--------- ---------- ----------
Total expenses.......................... 3,314 574 24,963
--------- ---------- ----------
Net loss before income tax and equity
in earnings of affiliates................. (3,101) (5,798) (16,506)
Income tax benefit......................... 1,330 1,932 5,698
--------- ---------- ----------
Income before equity in earnings of (1,771) (3,866) (10,808)
affiliates.................................
Equity in earnings of affiliates........... 38,584 40,726 (130,376)
--------- ---------- ----------
Net income (loss).......................... $ 36,813 $ 36,860 (141,184)
========= ========== ==========
75
VESTA INSURANCE GROUP, INC.
(PARENT COMPANY)
SCHEDULE II--CONDENSED STATEMENTS OF CASH FLOWS
(Dollar amounts in thousands)
For the Year Ended December 31,
-----------------------------------
1996 1997 1998
---------- ----------- ----------
Cash provided from operations............. $ 11,181 $ 48,163 $ 6,526
Cash used in investing activities:
Contribution to investments in -- (154,616) (25,000)
affiliates................................
Net (increase) decrease in short-term (6,980) (35) 2,224
investments...............................
---------- ----------- ----------
Cash used in investing activities......... (6,980) (106,488) (22,776)
Cash (used in) provided from financing
activities:
Dividends paid........................... (2,836) (2,797) (2,770)
Acquisition of treasury stock............ (10,597) (21,164) --
Issuance of treasury stock............... 563 6,302 --
Capital Contributions from exercising 1,481 828 4,836
stock options............................
Issuance of debt and deferrable capital 7,116 123,321 24,700
securities................................
---------- ----------- ----------
Cash (used in) provided from financing (4,273) 106,490 26,766
activities................................
Net increase (decrease) in cash........... (72) 2 10,516
Cash balance at beginning of period....... 77 5 7
---------- ----------- ----------
Cash balance at end of period............. $ 5 $ 7 $ 10,523
========== =========== ==========
76
VESTA INSURANCE GROUP, INC.
SCHEDULE III--SUPPLEMENTAL INSURANCE INFORMATION (CONSOLIDATED)
As of December 31, 1997 and 1998
(Dollar amounts in thousands)
Reserves for
Deferred Unpaid Claims
Policy and Claim
Acquisition Adjustment Unearned
Costs Expenses Premiums
----------- ------------- --------
As of December 31, 1997:
Reinsurance................................ $ 52,742 $238,799 $192,922
Commercial................................. 10,610 130,702 47,731
Personal................................... 38,772 227,296 124,399
-------- -------- --------
$102,124 $596,797 $365,052
======== ======== ========
As of December 31, 1998:
Reinsurance................................ $ 57,764 $148,021 $139,663
Commercial................................. 7,728 178,511 42,759
Personal................................... 35,465 178,379 127,093
-------- -------- --------
$100,957 $504,911 $309,515
======== ======== ========
77
VESTA INSURANCE GROUP, INC.
SCHEDULE III--SUPPLEMENTARY INSURANCE INFORMATION--(continued)
(CONSOLIDATED)
For the Years Ended December 31, 1996, 1997 and 1998
(Dollar amounts in thousands)
Claim and
Claim
Net Net Adjustment Amortization Other Net
Earned Investment Expenses of Operating Premium
Premium Income Incurred DAC Expenses Written
-------- ---------- ---------- ------------ --------- --------
As of December 31, 1996:
Reinsurance............ $342,452 $18,838 $205,005 $ 40,104 $60,025 $373,486
Commercial............. 33,678 1,051 21,148 4,285 11,487 24,801
Personal............... 63,206 3,259 25,630 8,707 21,095 69,769
-------- ------- -------- -------- ------- --------
$439,336 $23,148 $251,783 $ 53,096 $92,607 $468,056
======== ======= ======== ======== ======= ========
As of December 31, 1997:
Reinsurance............ $335,360 $17,023 $193,473 $ 65,725 $51,377 $351,811
Commercial............. 42,873 6,565 16,812 12,088 4,545 33,499
Personal............... 139,425 12,372 88,353 27,396 19,333 141,165
-------- ------- -------- -------- ------- --------
$517,658 $35,960 $298,638 $105,209 $75,255 $526,475
======== ======= ======== ======== ======= ========
As of December 31, 1998:
Reinsurance............ $194,261 $12,846 $175,633 $ 77,706 $20,838 $157,728
Commercial............. 68,368 7,827 54,712 24,717 6,461 69,022
Personal............... 247,064 14,385 164,977 62,177 51,595 264,840
-------- ------- -------- -------- ------- --------
$509,693 $35,058 $395,322 $164,600 $78,894 $491,590
======== ======= ======== ======== ======= ========
78
VESTA INSURANCE GROUP, INC.
SCHEDULE IV--REINSURANCE (CONSOLIDATED)
For the Years Ended December 31, 1996, 1997 and 1998
(Dollar amounts in thousands)
Gross Ceded to Assumed Percentage of
Direct Other from Other Net Amount Assumed
Premiums Earned Amount Companies Companies Amount to Net
- --------------- -------- --------- ---------- -------- --------------
1996...................... $161,824 $149,964 $427,476 $439,336 97.3%
1997...................... 323,394 300,799 495,063 517,658 95.6%
1998...................... 478,389 310,652 341,956 509,693 67.1%
79
VESTA INSURANCE GROUP, INC.
SCHEDULE V--VALUATION AND QUALIFYING ACCOUNTS (CONSOLIDATED)
For the Years Ended December 31, 1996, 1997 and 1998
(Dollar amounts in thousands)
Balance Additions-- Balance
at Charged at End
Beginning to Costs and of
Description of Period Expenses Deductions Period
- ----------- --------- ------------ ---------- -------
Allowance for premiums in course of
collection:
1996............................... 70 168 168 70
1997............................... 70 797 213 654
1998............................... 654 13,688 130 14,212
80
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
VESTA INSURANCE GROUP, INC.
/s/ Norman W. Gayle, III
By___________________________________
Norman W. Gayle, III
Its President and Chief Executive
Officer
Pursuant to the requirements of the Securities Act of 1934, as amended, this
report has been signed by the following persons in the capacities and on the
dates indicated.
Signature Title Date
--------- ----- ----
/s/ Ehney A. Camp, III
- ------------------------------------
Ehney A. Camp, III Director, Chairman of the
Board April 12, 1999
/s/ Norman W. Gayle, III
- ------------------------------------
Norman W. Gayle, III Director, President and April 12, 1999
Chief Executive Officer
(Principal Executive
Officer)
/s/ James E. Tait
- ------------------------------------
James E. Tait Director, Executive Vice April 12, 1999
President and Chief
Financial Officer
(Principal Financial
Officer)
/s/ William P. Cronin
- ------------------------------------
William P. Cronin Senior Vice President, April 12, 1999
Controller (Principal
Accounting Officer)
/s/ Walter M. Beale, Jr.
- ------------------------------------
Walter M. Beale, Jr. Director April 12, 1999
/s/ Robert A. Hershbarger, PhD
- ------------------------------------
Robert A. Hershbarger, PhD Director April 12, 1999
/s/ Clifford F. Palmer
- ------------------------------------
Clifford F. Palmer Director April 12, 1999
/s/ Jarvis W. Palmer
- ------------------------------------
Jarvis W. Palmer Director April 12, 1999
81