SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
Form 10-Q
[X] Quarterly report pursuant to Section 13 or 15 (d)
of the Securities Exchange Act of 1934 for the
quarterly period ended September 30, 1999 or
[ ] Transition report pursuant to Section 13 or 15 (d)
of the Securities Exchange Act of 1934 for the
transition period from _________ to _________.
0-16533
(Commission File Number)
Old Guard Group, Inc.
(Exact Name of Registrant as Specified in its Charter)
Pennsylvania 23-2852984
(State of Incorporation) (IRS Employer ID Number)
2929 Lititz Pike, Lancaster, PA 17604
(Address of Principal Executive Offices) (Zip Code)
717-569-5361
(Registrant's Telephone Number)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15 (d) of the
Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to
file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
Number of Shares Outstanding as of October 31, 1999:
Common Stock (No Par Value) 3,705,665
(Title of Class) (Outstanding Shares)
OLD GUARD GROUP, INC.
Form 10-Q
For the Quarter Ended September 30, 1999
Contents
Page
No.
Part I FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of
September 30, 1999 and December 31, 1998 3
Consolidated Statements of Income and
Comprehensive Income for the Three
Months Ended September 30, 1999 and 1998 4
Consolidated Statements of Income and
Comprehensive Income for the Nine Months
Ended September 30, 1999 and 1998 5
Consolidated Statement of Shareholders'
Equity for the Nine Months Ended
September 30, 1999 6
Consolidated Statements of Cash Flows for
the Nine Months Ended September 30, 1999
and 1998 7
Notes to Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of
Operations 12
PART II OTHER INFORMATION
Item 1. Legal Proceedings 18
Item 2. Change in Securities 18
Item 3. Defaults upon Senior Securities. 18
Item 4. Submission of Matters to a Vote of Security
Holders 18
Item 5. Other Information 18
Item 6. Exhibits and Reports on Form 8 - K 18
OLD GUARD GROUP, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(Unaudited)
As of As of
September 30, December 31,
1999 1998
ASSETS
Investments:
Fixed income securities
Held to maturity, at
amortized cost $ 35,306,460 $ 36,615,905
Available for sale, at fair
value 58,217,071 59,249,118
Preferred stocks, available for
sale, at fair value 5,564,235 5,979,443
Common stocks, available for
sale, at fair value 15,335,605 15,620,659
Other invested assets 4,652,959 4,412,378
Total investments 119,076,330 121,877,503
Cash and cash equivalents 17,547,110 6,121,983
Receivables:
Premiums 14,117,259 9,354,449
Reinsurance 13,904,922 15,138,801
Investment income 1,345,935 1,194,031
Affiliates 712,714 479,989
Prepaid reinsurance premiums 434,158 983,630
Deferred policy acquisition costs 11,327,051 9,423,124
Deferred income taxes 850,509 -
Property and equipment 17,045,488 16,941,129
Title plant 2,227,767 -
Intangible assets 675,521 716,879
Other assets 3,004,884 3,752,624
Total assets $202,269,648 $185,984,142
LIABILITIES AND SHAREHOLDERS'
EQUITY
Liabilities:
Losses and loss adjustment
expenses 57,987,936 52,707,951
Unearned premiums 46,557,753 39,812,585
Accrued expenses 4,702,451 4,250,938
Deferred income taxes - 420,654
Long-term debt 9,277,778 3,402,778
ESOP liability 3,314,490 3,547,448
Other liabilities 4,506,526 3,362,831
Total liabilities 126,346,934 107,505,185
Minority Interest 985,169 703,220
Shareholders' Equity:
Preferred stock (5,000,000
shares authorized; 0 issued
and outstanding) - -
Common stock (15,000,000
shares authorized; 4,257,327
and 4,248,417 shares issued;
3,889,859 and 3,933,401
shares outstanding; no par) 38,865,703 38,776,603
Additional paid-in capital 4,284,687 4,370,606
Deferred compensation (5,081,350) (5,330,718)
Retained earnings 40,544,384 40,175,219
Net unrealized investment gains,
net of deferred income taxes 2,071,293 4,997,299
Treasury stock, at cost (367,468
and 315,016 shares) (5,747,172) (5,213,272)
Total shareholders' equity 74,937,545 77,775,737
Total liabilities and
shareholders' equity $202,269,648 $185,984,142
The accompanying notes are an integral part of the
consolidated financial statements.
OLD GUARD GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Income and Comprehensive Income
(Unaudited)
<TABLE>
<CAPTION>
For the Three For the Three
Months Ended Months Ended
September 30, 1999 September 30, 1998
<S> <C> <C>
Revenue:
Net premiums written $32,273,127 $22,102,373
Change in unearned premiums (3,175,850) (2,263,023)
Net premiums earned 29,097,277 19,839,350
Investment income, net of expenses 1,573,089 1,302,936
Net realized investment gains 127,158 (461,848)
Realized gain on sale of property 210,507 -
Other revenue 1,170,441 616,858
Total revenue 32,178,472 21,297,296
Expenses:
Losses and loss adjustment
expenses incurred 19,600,075 12,514,531
Operating expenses 13,378,583 9,808,831
Interest expense 253,329 145,935
Total expenses 33,231,987 22,469,297
Loss before income tax and
minority interest (1,053,515) (1,172,001)
Income tax benefit (516,043) (543,849)
Loss before minority interest (537,472) (628,152)
Minority interest in income of
consolidated subsidiary 115,507 7,856
Net loss (652,979) (636,008)
Other comprehensive loss, before
tax:
Unrealized holding losses (3,353,596) (2,646,799)
Less: Reclassification
adjustment for gains (losses)
included in net income 127,158 (209,618)
Other comprehensive loss, before tax (3,480,754) (2,437,181)
Income tax benefit related to
items of other comprehensive income (1,162,814) (828,642)
Other comprehensive loss, net of tax (2,317,940) (1,608,539)
Comprehensive loss $(2,970,919) $(2,244,547)
Earnings per share
Basic (0.18) (0.17)
Diluted (0.18) (0.17)
<FN>
The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>
OLD GUARD GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Income and Comprehensive Income
(Unaudited)
<TABLE>
<CAPTION>
For the Nine For the Nine
Months Ended Months Ended
September 30, 1999 September 30, 1998
<S> <C> <C>
Revenue:
Net premiums written $88,514,521 $65,241,517
Change in unearned premiums (7,294,640) (9,225,402)
Net premiums earned 81,219,881 56,016,115
Investment income, net of expenses 4,507,723 4,354,760
Net realized investment gains 1,841,602 1,282,351
Realized gain on sale of property 210,507 -
Other revenue 3,456,159 1,825,071
Total revenue 91,235,872 63,478,297
Expenses:
Losses and loss adjustment
expenses incurred 50,865,819 36,329,102
Operating expenses 38,480,747 26,488,876
Interest expense 675,390 361,148
Total expenses 90,021,956 63,179,126
Income before income tax and
minority interest 1,213,916 299,171
Income tax expense (benefit) 164,109 (43,736)
Income before minority interest 1,049,807 342,907
Minority interest in income of
consolidated subsidiaries 312,119 50,761
Net income 737,688 292,146
Other comprehensive loss, before tax:
Unrealized holding gains
(losses) (2,520,323) 640,943
Less: Reclassification
adjustment for gains
included in net income 1,841,602 1,534,581
Other comprehensive loss, before tax (4,361,925) (893,638)
Income tax benefit related to items of
other comprehensive income (1,435,919) (304,313)
Other comprehensive loss, net
of tax (2,926,006) (589,325)
Comprehensive loss $(2,188,318) $(297,179)
Earnings per share
Basic 0.21 0.08
Diluted 0.20 0.07
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
OLD GUARD GROUP, INC. AND SUBSIDIARIES
Consolidated Statement of Shareholders' Equity
For the Nine Months Ended September 30, 1999
(Unaudited)
<TABLE>
<CAPTION>
Net Unrealized
Additional Investment Gains
Common Stock Paid-In Deferred Retained Net of Deferred Treasury
Shares Amount Capital Compensation Earnings Income Taxes Stock Total
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance January 1,
1999 3,933,401 $38,776,603 $4,370,606 $(5,330,718) $40,175,219 $ 4,997,299 $(5,213,272) $77,775,737
Comprehensive income:
Net income 737,688 737,688
Unrealized losses on
investments, net of
reclassification
adjustment (2,926,006) (2,926,006)
Comprehensive loss (2,188,318)
Dividends ($.05 per
share) (368,523) (368,523)
Purchase of treasury
stock (61,300) (851,044) (851,044)
Reissuance of treasury
stock 5,284 (12,939) 79,920 66,981
Exercise of common
stock options 8,910 89,100 89,100
Stock-based
compensation 3,564 (72,980) 249,368 237,224 413,612
Balance, September 30,
1999 3,889,859 $38,865,703 $4,284,687 $(5,081,350) $40,544,384 $2,071,293 $(5,747,172) $74,937,545
<FN>
The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>
OLD GUARD GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
For the Nine For the Nine
Months Ended Months Ended
September 30, 1999 September 30, 1998
<S> <C> <C>
Cash flows from operating activities:
Net income $ 737,688 $ 292,146
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 1,892,244 912,841
Net realized investment gains (1,841,602) (1,534,581)
Deferred income tax expenses 64,366 (191,694)
Non-cash compensation expense 711,514 817,597
Other 94,776 47,761
(Increase) decrease in assets:
Receivables (2,683,853) (3,246,237)
Prepaid reinsurance premiums 549,472 4,146,641
Deferred policy acquisition costs (1,903,927) (2,273,573)
Other assets 875,494 (2,365,927)
Increase (decrease) in liabilities:
Losses and loss adjustment expenses 3,789,161 (850,654)
Unearned premiums 6,745,168 5,078,761
Accrued expenses 73,042 1,358,155
Other liabilities (170,942) 23,398
Net cash provided by operating activities 8,932,601 2,214,634
Cash flows from investing activities:
Cost of purchases of fixed income securities
Held to maturity (5,337,279) (9,690,924)
Available for sale (22,006,604) (15,981,005)
Proceeds from sales of fixed income securities
Available for sale 18,197,206 17,946,190
Proceeds from maturities of fixed income securities
Held to maturity 6,607,435 11,543,645
Available for sale 3,856,011 3,036,032
Cost of equity securities acquired (3,711,470) (5,741,691)
Proceeds from sales of equity securities 4,497,095 4,433,771
Change in receivable/payable for securities 1,475,940 -
Cost of purchases of other invested assets (139,695) (1,250,000)
Proceeds from sales of other invested assets 18,000 -
Acquisition of subsidiary, net of cash acquired (3,661,465) -
Cost of purchases of property and equipment (2,415,208) (5,966,497)
Proceeds from sales of property and equipment 1,394,011 3,000
Net cash used by investing activities (1,226,023) (1,667,479)
Cash flows from financing activities:
Exercise of common stock options 89,100 402,570
Purchase of treasury stock (1,148,947) (3,226,564)
Proceeds from reissuance of treasury stock 66,981 16,932
Distributions to minority interest (205,414) -
Payment of dividends (368,523) (363,797)
Proceeds from issuance of long-term debt 6,067,273 3,500,000
Repayment of long-term debt (781,921) (1,054,999)
Net cash provided (used) by financing activities 3,718,549 (725,858)
Net increase (decrease) in cash and cash
equivalents 11,425,127 (178,703)
Cash and cash equivalents at beginning of period 6,121,983 10,214,908
Cash and cash equivalents at end of period $17,547,110 $10,036,205
<FN>
The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>
OLD GUARD GROUP, INC. AND SUBSIDIARIES
(UNAUDITED)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization
The consolidated financial statements include the accounts
of Old Guard Group, Inc. and its wholly-owned subsidiaries
(OGGI), Old Guard Insurance Company (Old Guard), Old Guard Fire
Insurance Company (Old Guard Fire), First Patriot Insurance
Company (First Patriot), New Castle Insurance Company of
Delaware (New Castle), Investors Southern Corporation
(Southern), Old Guard Insurance Management Company (OGIM), 2929
Service Corporation and OGGI's 80% owned subsidiary, First
Delaware Insurance Company (First Delaware).
OGGI is a regional insurance holding company that provides
property and casualty insurance throughout Pennsylvania,
Maryland and Delaware and title insurance and related services
in Virginia, North Carolina, Washington D.C., Ohio, Pennsylvania
and Maryland.
Effective January 1, 1999, OGGI acquired Southern and its
principal operating subsidiary, Southern Title Insurance
Corporation. Pursuant to the stock purchase agreement, OGGI paid
$6,750,000 in cash for 100% of Southern's capital stock. In
addition, OGGI will make additional payments equal to 25% of
Southern's pretax profits in 1999, 2000, and 2001. Effective
October 1, 1998, New Castle Mutual Insurance Company converted
from mutual to stock form and changed its name to New Castle
Insurance Company of Delaware. New Castle's conversion was
pursuant to a plan of conversion approved by the Delaware
Insurance Department and New Castle's policyholders. Along with
the conversion, OGGI's $2.5 million surplus note investment in
New Castle was converted to 1,500 shares of common stock and
OGGI became the sole shareholder of New Castle. Pro forma
results for the three and nine months ended September 30, 1998,
including Southern and New Castle as if they had been a wholly-
owned subsidiary for that period are as follows:
Three Months Ended Nine Months Ended
September 30, 1998 September 30, 1998
Total revenue $25,242,608 $73,794,167
Income (loss) before
income tax (1,241,209) 386,932
Net income (loss) (591,415) 383,571
Earnings (loss) per
share - diluted (0.16) 0.10
2. Basis of Presentation
The financial information for the interim periods included
herein is unaudited; however, such information reflects all
adjustments, consisting of normal recurring adjustments, which
are, in the opinion of management, necessary to a fair
presentation of the financial position, results of operations,
and cash flows for the interim periods. The results of
operations for interim periods are not necessarily indicative of
results to be expected for the full year.
These consolidated financial statements should be read in
conjunction with the consolidated financial statements and notes
for the year ended December 31, 1998 included in OGGI's 1998
Annual Report on Form 10-K filed with the Securities and
Exchange Commission.
Certain amounts in the 1998 financial statements have been
reclassified to conform with the current year presentation.
3. Earnings Per Share
The following table reconciles the numerator and
denominator used in basic earnings per share to diluted earnings
per share for the nine months ended:
September 30, September 30,
1999 1998
Net income for basic
and diluted earnings per share $737,688 $292,146
Common shares outstanding 3,569,000 3,727,011
Dilutive shares:
Treasury stock in MRP trust 134,065 123,288
Outstanding stock options 43,766 89,761
Total common and dilutive shares 3,746,831 3,940,060
4. Supplemental Cash Flow Disclosure
Interest paid for the nine months ended September 30, 1999
and 1998 was $676,400 and $361,148, respectively. Net income
taxes paid (recovered) for the nine months ended September 30,
1999 and 1998 was $(661,224) and $1,480,328, respectively.
5. Business Segments
The following table indicates OGGI's total revenue and pre-
tax income by principal business segment.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1999 1998 1999 1998
<S> <C> <C> <C> <C>
Revenue:
P & C operations $27,630,374 $22,101,525 $76,877,729 $60,055,137
Title operations 4,059,578 - 11,816,954 -
Net realized investment gains
(losses) 127,158 (461,848) 1,841,602 1,282,351
Other 361,362 (342,381) 699,587 2,140,809
Total revenue $32,178,472 $21,297,296 $91,235,872 $63,478,297
Pretax income (loss):
P & C operations $(1,510,092) $(1,351,493) $(1,383,484) $(1,300,844)
Title operations 294,894 - 918,718 -
Net realized investment gains
(losses) 127,158 (461,848) 1,841,602 1,282,351
Other 34,525 641,340 (162,920) 317,664
Income (loss) before income
taxes and minority interest (1,053,515) (1,172,001) 1,213,916 299,171
Income tax expense (benefit) (516,043) (543,849) 164,109 (43,736)
Income (loss) before minority
interest (537,472) (628,152) 1,049,807 342,907
Minority interest in earnings
of consolidated subsidiaries 115,507 7,856 312,119 50,761
Net income (loss) $(652,979) $(636,008) $ 737,688 $ 292,146
</TABLE>
6. New Accounting Pronouncements
In June 1998, SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," was issued. SFAS No. 133
establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded
in other contracts (collectively referred to as "derivatives")
and for hedging activities. SFAS No. 133 requires that an
entity recognize all derivatives as either assets or liabilities
in the statement of financial position and measure those
instruments at fair value. If certain conditions are met, a
derivative may be specifically designated as (i) a hedge of the
exposure to changes in the fair value of a recognized asset or
liability or an unrecognized firm commitment, (ii) a hedge of
the exposure of variable cash flows of a forecasted transaction,
or (iii) a hedge of the foreign currency exposure of a net
investment in a foreign operation, an unrecognized firm
commitment, an available-for-sale security, or a foreign-
currency-denominated forecasted transaction. The accounting for
changes in the fair value of a derivative (that is, gains and
losses) depends on the intended use of the derivative and the
resulting designation. In June 1999, SFAS No. 137, "Accounting
for Derivative Instruments and Hedging Activities-Deferral of
the Effective Date of FASB Statement No. 133," was issued which
defers the effective date of SFAS No. 133 to fiscal years
beginning after June 15, 2000. While OGGI is presently
evaluating the impact of SFAS No. 133, the adoption of SFAS No.
133 is not expected to have a material impact on OGGI's
financial condition, results of operations or liquidity.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.
Premiums. Gross premiums written increased $7.8 million,
or 31.1%, to $32.8 million, and $15.7 million, or 20.8%, to
$91.4 million for the three and nine months ended September 30,
1999 compared to the three and nine months ended September 30,
1998. The primary cause of these increases was growth in
property and casualty (P&C) direct premiums written of $4.5
million and $9.5 million for the three and nine months ended
September 30, 1999, respectively, versus the comparable periods
in 1998. Workers' compensation, personal and commercial
automobile and commercial multi-peril were the lines
contributing to the growth. In addition, $3.1 million and $8.9
million of title insurance premiums written were generated by
Southern in the three and nine months ended September 30, 1999,
respectively. Offsetting the impact of growth during the nine
months ended September 30, 1999 was a one-time transfer of $3.0
million of unearned premiums from New Castle as of January 1,
1998. The unearned premium transfer resulted from a 100% quota
share reinsurance agreement between Old Guard and New Castle.
Written premiums ceded to reinsurers decreased $2.4
million, or 82.7%, to $0.5 million and $7.5 million, or 72.6%,
to $2.8 million for the three and nine months ended September
30, 1999 compared to the three and nine months ended September
30, 1998. The decrease in ceded written premiums was
attributable to changes in the reinsurance program as of January
1, 1999 including reductions in rates. Changes in the
reinsurance program included elimination of the first layers of
the property and casualty excess of loss reinsurance agreements
which covered losses in excess of $150,000 up to $500,000. This
layer of reinsurance required premium payments equal to losses
incurred plus a load subject to a maximum and minimum premium.
OGGI's experience had generally been such that the actual
premium paid was within the minimum and maximum. As a result,
OGGI's effective retention was already at $500,000. OGGI also
eliminated its 95% quota share reinsurance agreement on the
first $1 million of umbrella liability coverage and included
this risk in its casualty excess of loss reinsurance agreement.
In addition, during the third quarter of 1999, OGGI commuted its
aggregate excess of loss reinsurance agreement. This
commutation resulted in the return of $579,000 previously ceded
under this agreement during 1999.
Net premiums written increased $10.2 million, or 46.0%, to
$32.3 million, and $23.3 million, or 35.7%, to $88.5 million for
the three and nine months ended September 30, 1999 compared to
the three and nine months ended September 30, 1998. Net
premiums earned increased $9.3 million, or 46.7%, to $29.1
million, and $25.2 million, or 45.0%, to $81.2 million during
the three and nine months ended September 30, 1999 compared to
the three and nine months ended September 30, 1998. The
increases in net premiums written and earned were directly
attributable to the effects of the changes instituted in OGGI's
reinsurance program and increases in gross premiums written as
previously discussed.
Net Investment Income. Net investment income increased
20.7% or $270,000 for the three months ended September 30, 1999
and 3.5% or $153,000 for the nine months ended September 30,
1999. Average cash and invested assets increased $7.4 million
or 6.2% for the nine months ended September 30, 1999 compared to
the average cash and invested assets for the twelve months
ending December 31, 1998. The increase in average invested
assets is primarily related to the acquisition of Southern
effective January 1, 1999. For the nine months ended
September 30, 1999, the yield on average cash and invested
assets was 4.7% compared to 4.9% for the nine months ended
September 30, 1998.
Net Realized Investment Gains. Net realized investment
gains (losses) were $127,000 and $1.8 million for the three and
nine months ended September 30, 1999, respectively, compared to
$(462,000) and $1.3 million for the comparable periods in 1998.
The realized loss in 1998 can be attributed to a charge of
$707,000 related to the acquisition of New Castle. OGGI
completed its acquisition of New Castle in October of 1998 and
recognized a loss in the third quarter of 1998 as a result of
writing down the carrying value of its surplus note investment
in New Castle, forgiveness of interest on the note, and costs
related to the transaction.
Other Revenue. Other revenue increased $554,000, or 89.7%,
to $1.2 million and $1.6 million, or 89.4%, to $3.5 million for
the three and nine months ended September 30, 1999 compared to
the three and nine months ended September 30, 1998. Southern
accounted for an increase of $867,000 and $2.8 million in the
three and nine months periods, respectively. Offsetting the other
revenue from Southern was a decrease in OGIM's management fee
income from New Castle of $420,000 and $1.3 million in the three
and nine months ended September 30, 1999, respectively. In 1998,
management fee income from New Castle was included in
consolidation until its conversion on October 1, 1998.
Losses and Loss Adjustment Expenses. Net losses and loss
adjustment expenses incurred increased by $7.1 million, or
56.6%, to $19.6 million, and $14.5 million, or 40.0%, to $50.9
million for the three and nine months ended September 30, 1999
compared to the three and nine months ended September 30, 1998.
The increase in losses and loss adjustment expenses can be
attributed to the changes in OGGI's reinsurance program
increases in net earned premium enumerated previously. The loss
and loss adjustment expense ratio for P&C operations was 74.8%
and 69.6% for the three and nine months ended September 30,
1999, respectively, versus 63.1% and 64.9% for the comparable
periods in 1998. The increase in the loss and loss adjustment
expense ratio for the three months ended September 30, 1999
versus the comparable period in 1998 can be attributed to nearly
$2.6 million of losses from Hurricane Floyd and several large
fire losses on commercial properties. The loss and loss
adjustment expense ratio for title operations was 4.9% and 4.7%
for the three and nine months ended September 30, 1999,
respectively.
Operating Expenses. Operating expenses increased by $3.6
million, or 36.4%, to $13.4 million and $12.0 million, or 45.3%,
to $38.5 million for the three and nine months ended
September 30, 1999 compared to the three and nine months ended
September 30, 1998. Excluding title operations, operating
expenses decreased $33,000, or 0.3%, for the three months ended
September 30, 1999 and increased $1.5 million, or 5.8% for the
nine months ended September 30, 1999 compared to the comparable
periods in 1998. Included in September 1998 operating expenses is
a $1.5 million charge for the Pennsylvania Insurance Guaranty
Association (PIGA) assessment related to January 1997 through June
1998. Absent this charge, the increase in 1999 operating expenses
is attributable to an increase in expenses, e.g., commissions,
that vary with changes in gross earned premiums. The expense
ratio for P&C operations was 36.5% and 37.9% for the three and
nine months ended September 30, 1999, respectively, versus 46.3%
and 44.0% for the comparable periods in 1998. The reductions in
the expense ratio can be attributed to increases in net premiums
earned without commensurate increases in expenses.
Federal Income Tax Expense. Federal income tax as a
percentage of pre-tax income was 49.0% and 13.5% for the three
and nine months ended September 30, 1999, respectively, versus
46.4% and (14.6%) for the comparable periods in 1998. Changes
in the effective tax rate are attributable to income from
minority interests earned by Southern which is not taxed and
lower levels of pretax income versus the magnitude of tax
preference items (primarily tax exempt income and dividends).
Liquidity and Capital Resources
The principal sources of OGGI's cash flow are premiums,
investment income, maturing investments and proceeds from sales
of invested assets. In addition to the need for cash flow to
meet operating expenses, the liquidity requirements of OGGI
relate primarily to the payment of losses and loss adjustment
expenses. The short and long-term liquidity requirements of
OGGI vary because of the uncertainties regarding the settlement
dates for liabilities for unpaid claims and because of the
potential for large losses, either individually or in the
aggregate.
OGGI and its subsidiaries have in place unsecured lines of
credit with a local financial institution under which they may
borrow up to an aggregate of $1.5 million. As of September 30,
1999, no amounts were borrowed against these lines of credit.
Net cash provided by operating activities was $8.9 million
and $2.2 million during the first nine months of 1999 and 1998,
respectively. The increase in cash flow from operating
activities in 1999 versus 1998 can be attributed to increased
profitability and an increase in gross premiums written.
In 1999, cash used by investing activities was $1.2 million
as OGGI funded the acquisition of Southern. In 1998, cash used
by operating activities was $1.7 million as OGGI invested in new
computer systems and its home office expansion.
In 1999, cash provided by financing activities was $3.7
million primarily as a result of OGGI obtaining a $6.0 million
loan to help it finance its acquisition of Southern. The $6.0
million loan has a term of five years and an interest rate of
LIBOR plus 1.5%. OGGI has entered into an interest rate swap
agreement to fix the interest rate on the loan at 7.05%. In
1998, cash used by financing activities was $726,000 resulting
from OGGI's purchase of treasury stock offset by mortgage
financing obtained on OGGI's newly constructed office building.
The $3.5 million mortgage requires principal payments over
fifteen years and interest floating monthly at LIBOR plus 1.5%.
$2.0 million of the mortgage has been converted to a fixed rate
of 7.7% through the use of an interest rate swap
As a holding company, the principal source of liquidity for
Old Guard Group, Inc. will be dividend payments and other fees
received from its subsidiaries. Insurance companies are
restricted by the insurance laws of the state of domicile as to
the amount of dividends or other distributions they may pay
without the prior approval of the state regulatory authority.
Under Pennsylvania law, the maximum amount that may generally be
paid by an insurance company during any twelve-month period
after notice to, but without prior approval of, the Pennsylvania
Insurance Department, cannot exceed the greater of 10% of the
insurance company's statutory surplus as reported on the most
recent annual statement filed with the Department, or the net
income of the insurance company for the period covered by such
annual statement. However, Old Guard, Old Guard Fire and First
Patriot are further restricted as to the amount of dividends
that they may pay. These restrictions do not allow the payment
of any dividend without prior approval of the Pennsylvania
Insurance Department until February of 2000.
In 1997, OGGI's Employee Stock Ownership Plan (ESOP)
borrowed $4.1 million from an unaffiliated lender and $100,000
from Old Guard Group, Inc. to purchase 10% of the common stock
issued in OGGI's subscription offering. The loans bear an 8.45%
interest rate, and will require the ESOP to make monthly
payments of $50,417 for a term of 10 years. The loans are
secured by the shares of common stock and the earnings thereon.
Shares purchased with such loan proceeds will be held in a
suspense account for allocation among participants as the loans
are repaid. OGGI expects to contribute sufficient funds as
necessary to the ESOP to repay such loans, plus such other
amounts as the OGGI's Board of Directors may determine at its
discretion.
Effects of Inflation
The effects of inflation on OGGI are implicitly considered
in estimating reserves for unpaid losses and loss adjustment
expenses, and in the premium rate-making process. The actual
effects of inflation on OGGI's results of operations cannot be
accurately known until the ultimate settlement of claims.
However, based upon the actual results reported to date, it is
management's opinion that the liability for losses and LAE,
including losses that have been incurred but not yet reported,
make adequate provision for the effects of inflation.
Year 2000 Issue
General:
As the year 2000 approaches, concerns arise involving
business interruptions or failures of specific operations
performed by computer chips as a result of date sensitive
information. The problem results because some current
information technology ("IT") systems and non-IT systems with
embedded computer chips are not prepared to recognize the year
change from 1999, to 2000. Absent remediation of non-compliant
systems, there is a substantial risk to OGGI of business
interruption or failure. Therefore, it is important to prepare
a contingency plan whereby all affected areas within OGGI have
been reviewed.
Project:
OGGI has developed an enterprise-wide year 2000 Readiness
Initiative Program to identify the enterprise-wide business
impact(s) of the arrival of the year 2000. A plan was developed
to ensure all applicable systems, equipment, vendors and
external agents are compliant. OGGI has utilized the
recommendations from an outside consultant as a tool for project
management.
In the process of identifying assets affected by the year
2000 problem, a year 2000 representative was selected from each
department within OGGI. Each representative completed an
inventory of year 2000 affected assets utilized by their
department. The inventory included: infrastructure, including
non-IT assets such as elevators and security systems,
applications software, computer hardware, third-party suppliers
and customers (external agents).
The representatives prioritized assets by assigning a
criticality factor. These factors consisted of "fatal,"
"critical," "marginal" and "desirable." "Fatal" is defined as
an asset that is necessary for uninterrupted operations of OGGI
and will fail or terminate if there were year 2000 date
processing errors. "Critical" is defined as an asset that is
necessary for the operation of the business, and year 2000-
related failures will produce an inaccurate or incorrect result.
"Marginal" is defined as an asset that is necessary for the
operation of the business, but year 2000-related failures will
cause minor inconveniences, annoyances, or irritations.
"Desirable" is defined as an asset that is not mandatory for
operating the business. All assets have been evaluated to
determine whether they need to be replaced, repaired or are
compliant.
OGGI's most "fatal" asset is older personal computers.
OGGI implemented a plan to ensure that these computers were
compliant by the first quarter of 1999. Information regarding
BIOS upgrades and recommendations have been received from the
manufacturers of each of the different computer systems that
were not year 2000 compliant. Software programs identified as
not compliant were reviewed and remediation plans were
implemented according to manufacturer recommendations. Other
computer software programs identified as non compliant were
replaced by compliant programs.
Vendors and external agents also have been contacted to
request information regarding their year 2000 status. OGGI has
received responses confirming year 2000 compliance from all
agents and vendors considered fatal or critical. For other
agents or vendors from whom responses have not been received,
contingency plans have been developed.
Costs:
OGGI presently expects that substantially all future costs
associated with the year 2000 compliance will be internal and
are estimated to be less than $10,000. Costs incurred to date
have been approximately $190,000.
Contingency Plans:
Although OGGI has confirmed that all of its fatal and
critical systems are year 2000 compliant, it has considered
contingencies in case any of these assets experience unforeseen
problems related to the year 2000 issue. For such assets, OGGI
has identified alternatives that will not cause significant
interruptions to service or operation.
Policy Coverage:
Many experts now believe that the year 2000 problem may
have a material adverse impact on the national and global
economies. In addition, it seems likely that if businesses are
materially damaged as a result of the year 2000 problems, at
least some such businesses may attempt to recoup their losses by
claiming coverage under various types of insurance policies.
And, although management has concluded that under a fair reading
of the various policies of insurance issued by it, no coverage
for year 2000 problems should be considered to exist and has
included exclusionary language on certain policies beginning in
1998, it is not possible to predict whether or to what extent
any such coverage could ultimately be found to exist by courts
in the various jurisdictions. Accordingly, important factors
which could cause actual results to differ materially from those
expressed in the forward looking statements include, but are not
limited to, the inability of OGGI to accurately estimate the
impact of the year 2000 problem on the insurance issued by, or
other business operations of OGGI.
Forward-Looking Statements
Certain statements contained in the Management's Discussion
and Analysis of Financial Condition and Results of Operations
and other statements made throughout this report constitute
"forward-looking statements" (as such term is defined in the
Private Securities Litigation Reform Act of 1995). Such
forward-looking statements involve certain assumptions, risks
and uncertainties that could cause actual results to differ
materially from those included in or contemplated by the
statements. These assumptions, risks and uncertainties include,
but are not limited to those associated with factors affecting
the property-casualty and title insurance industries generally,
including price competition, size and frequency of claims,
escalating damage awards, natural disasters, fluctuations in
interest rates and general business conditions; OGGI's
dependence on investment income; the geographic concentration of
OGGI's business in the Northeast United States, the adequacy of
OGGI's liability for losses and loss adjustment expenses;
government regulation of the insurance industry; the inability
of the Company or third parties to achieve Y2K compliance and
the other risks and uncertainties discussed or indicated in all
documents filed by OGGI with the Securities and Exchange
Commission. OGGI expressly disclaims any obligation to update
any forward-looking statements as a result of developments
occurring after the release of this report.
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings - In February 1997, four
policyholders, purportedly on behalf of all policyholders, filed
an action against OGGI, Old Guard, Old Guard Fire, First Patriot
and their directors in the United States District Court for the
Eastern District of Pennsylvania. Plaintiffs seek damages for the
loss of their alleged equity interest in the Insurance Companies
as a result of the conversion, based on numerous theories,
including breach of fiduciary duty and civil rights claims. In
April 1997, defendants filed a motion to dismiss for failure to
state a cause of action. The motion to dismiss was granted as to
two counts and denied as to the remaining nine counts. In January
1998, plaintiffs filed a motion for class certification which was
granted in September 1998. In July 1998, defendants filed a
motion for summary judgment with respect to the remaining
constitutional claims. In March 1999, the Court granted the
motion with respect to the two remaining counts under the U.S.
Constitution and retained supplemental jurisdiction over the
remaining state law claims. In June 1999, the plaintiffs filed an
amended complaint alleging additional theories of liability
arising from the same facts. In October 1999, defendants filed a
motion for summary judgment with respect to all remaining claims.
ITEM 2. Change in Securities - None
ITEM 3. Defaults Upon Senior Securities - None
ITEM 4. Submission of Matters to a Vote of Security Holders
- None
ITEM 5. Other Information - None
ITEM 6. Exhibits and Reports on Form 8-K
(A) Exhibit 27 - Financial Data Schedule
(B) Reports on Form 8-K - None
SIGNATURE
Pursuant to the requirements 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.
OLD GUARD GROUP, INC.
Date: November 15, 1999 /s/ Henry J. Straub
Henry J. Straub,
Chief Financial Officer and
Treasurer (principal financial
officer and principal accounting
officer)
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