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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------------
FORM 10-K
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<S> <C>
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 0-8636
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AMERICAN INDEMNITY FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 510119643
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
ONE AMERICAN INDEMNITY PLAZA 77550
GALVESTON, TEXAS (Zip Code)
(Address of principal executive offices)
</TABLE>
Registrant's telephone number, including area code: (409) 766-4600
Securities registered pursuant to Section 12(b) of the Act:
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<CAPTION>
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
------------------- ---------------------
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None None
</TABLE>
Securities registered pursuant to Section 12(g) of the Act:
Common Stock ($3.33 1/3 par value)
(TITLE OF CLASS)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting and non-voting common equity of
the Registrant held by non-affiliates as of March 16, 1998 was $15,358,249 based
upon the closing price as of such date.
As of March 16, 1998, there were outstanding 1,962,410 shares of Common
Stock, $3.33 1/3 par value, of the Registrant.
DOCUMENTS INCORPORATED BY REFERENCE:
(1) Annual Report to Stockholders for the fiscal year ended December 31,
1997 (portions of which are incorporated into Parts II and IV hereof).
(2) The Registrant's definitive Proxy Statement with respect to the
Registrant's Annual Meeting of Stockholders proposed to be held April 27, 1998
(portions of which are incorporated into Part III hereof).
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TABLE OF CONTENTS
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PAGE
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PART I
ITEM 1. Business.................................................... 2
General Development of Business............................. 2
Distribution of Business.................................... 2
Financial Information....................................... 3
Net Premiums Written........................................ 3
Underwriting Results........................................ 3
Loss and Loss Adjustment Expense Reserves................... 4
Narrative Description of Business........................... 7
General..................................................... 7
Reinsurance................................................. 7
Investments................................................. 8
Regulation and Other Restrictions........................... 8
ITEM 2. Properties.................................................. 9
ITEM 3. Legal Proceedings........................................... 10
ITEM 4. Submission of Matters to a Vote of Security Holders......... 10
PART II
ITEM 5. Market for the Registrant's Common Equity and Related
Stockholder Matters......................................... 10
ITEM 6. Selected Financial Data..................................... 10
ITEM 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 10
ITEM 8. Financial Statements and Supplementary Data................. 10
ITEM 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 10
PART III
ITEM 10. Directors and Executive Officers of the Registrant.......... 10
ITEM 11. Executive Compensation...................................... 11
ITEM 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 11
ITEM 13. Certain Relationships and Related Transactions.............. 11
PART IV
ITEM 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K......................................................... 11
SIGNATURES................................................................ 14
INDEPENDENT AUDITORS' REPORT.............................................. 15
SCHEDULE I Summary of Investments -- Other than Investments in Related
Parties, December 31, 1997.................................. S-1
SCHEDULE II Condensed Financial Information of Registrant............... S-2
</TABLE>
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ITEM 1. BUSINESS.
GENERAL DEVELOPMENT OF BUSINESS
American Indemnity Financial Corporation (the "Company"), an insurance
holding company, was organized in June 1973 under the laws of Delaware for the
purpose of acquiring the outstanding shares of common stock of American
Indemnity Company. The Company currently owns 99.9% of the common stock of
American Indemnity Company, its principal operating subsidiary. American
Indemnity Company, incorporated in 1913, is the oldest Texas stock company
engaged in the general casualty insurance business in the state. The insurance
written by American Indemnity Company and its two wholly owned subsidiaries,
American Fire and Indemnity Company and Texas General Indemnity Company, and its
affiliate, American Indemnity Lloyds, includes automobile, homeowners multiple
peril, workers' compensation, fire and allied lines, commercial multiple peril,
inland marine and general casualty lines.
In this report, the term "American Indemnity" refers to American Indemnity
Company, its subsidiaries, and its affiliate, American Indemnity Lloyds, unless
the context indicates otherwise.
The principal business of the Company is carried on through American
Indemnity; however, the Company does provide advice and services to American
Indemnity and coordinates its activities in the areas of accounting,
investments, public relations, business development, data processing and
automation, asset and liability management, budgetary planning, compliance with
governmental regulations and procedures, financing arrangements, and other such
matters. American Indemnity and each of its subsidiaries operate under the
day-to-day management of their own officers and directors.
DISTRIBUTION OF BUSINESS
The Company writes the majority of its business in Texas. In general,
American Indemnity has avoided writing business in those jurisdictions where
regulators are most reluctant to grant rate adjustments. The following table
shows the geographic distribution of gross premiums written.
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<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------
1997 1996 1995
------ ------ ------
<S> <C> <C> <C>
Texas....................................................... 68.9% 71.9% 73.4%
Florida..................................................... 7.8 6.6 6.4
Louisiana................................................... 7.3 7.3 6.9
Alabama..................................................... 4.8 3.5 2.7
Mississippi................................................. 3.8 3.8 3.8
Tennessee................................................... 2.7 2.5 2.4
Kentucky.................................................... 2.5 2.1 2.0
All other................................................... 2.2 2.3 2.4
----- ----- -----
Total............................................. 100.0% 100.0% 100.0%
</TABLE>
The following table provides the distribution of the Company's business on
the basis of net premiums written between personal lines (primarily insurance
for private passenger automobiles and residential property) and commercial
lines.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------
1997 1996 1995
------ ------ ------
<S> <C> <C> <C>
Personal Lines.............................................. 38% 37% 38%
Commercial Lines............................................ 62 63 62
----- ----- -----
Total............................................. 100% 100% 100%
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FINANCIAL INFORMATION
NET PREMIUMS WRITTEN
The following table summarizes, by major classes of policies written, the
amounts and percentages of net premiums written by American Indemnity during the
periods indicated.
NET PREMIUMS WRITTEN
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------------------
1997 1996 1995
--------------- --------------- ---------------
<S> <C> <C> <C> <C> <C> <C>
Personal automobile........................ $15,598 25.3% $17,844 25.9% $19,764 29.4%
Commercial automobile...................... 14,974 24.4 16,272 23.6 14,543 21.6
Commercial multiple peril.................. 13,911 22.6 15,973 23.2 16,097 23.9
Homeowners multiple peril.................. 6,133 10.0 5,506 8.0 4,154 6.2
Other liability............................ 5,786 9.4 7,646 11.1 6,626 9.8
Fire and allied lines...................... 3,667 6.0 3,506 5.1 3,285 4.9
Inland marine.............................. 1,361 2.2 1,366 2.0 1,439 2.1
All other.................................. 58 0.1 750 1.1 1,407 2.1
------- ----- ------- ----- ------- -----
Net premiums written............. $61,488 100.0% $68,863 100.0% $67,315 100.0%
======= ===== ======= ===== ======= =====
</TABLE>
In April 1997, A. M. Best Company assigned the Company a rating of B
(Adequate). The Company cannot predict whether this rating will eventually be
changed. Although some mortgage lenders will not accept property insurance
written by B rated insurers, the Company has not seen any reduction in the
number of its property policies which can be attributed to this rating. In the
event that any mortgage lenders take exception to any American Indemnity
property policies, the Company has arranged for a cut-through endorsement
(guaranty bond) from Munich American Reinsurance Company which will meet the
standards of mortgage lenders.
UNDERWRITING RESULTS
A common industry measurement of property-casualty insurance underwriting
results is the "statutory combined ratio." This ratio is the sum of (1) the
ratio of losses and loss adjustment expenses to premiums earned ("loss and loss
adjustment expense ratio"); (2) the ratio of underwriting expenses to premiums
written ("underwriting expense ratio"); and (3) the ratio of statutory
retrospective premium adjustments on workers' compensation policies to premiums
written ("retrospective premium adjustment ratio"). When the statutory combined
ratio is under 100%, underwriting results are profitable. Federal income taxes,
investment income, deferred policy acquisition costs and other non-underwriting
income and expenses are not reflected in the statutory combined ratios.
3
<PAGE> 5
The following table sets forth the Company's statutory combined ratios for
the periods indicated.
STATUTORY COMBINED RATIOS
(DOLLARS IN THOUSANDS)
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YEARS ENDED DECEMBER 31,
---------------------------
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Premiums earned............................................. $64,052 $64,579 $67,858
Statutory losses incurred................................... 41,025 38,505 40,784
Loss adjustment expenses incurred........................... 13,411 7,360 8,752
Loss ratio................................................ 64.0% 59.6% 60.1%
Loss and loss adjustment expense ratio.................... 84.8 70.9 73.0
Underwriting expense ratio................................ 36.4 36.4 37.4
Retrospective premium adjustment ratio.................... (0.9) 0.8 3.0
------- ------- -------
Statutory combined ratio.......................... 120.3% 108.1% 113.4%
======= ======= =======
</TABLE>
LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
RESERVES FOR INSURED EVENTS. American Indemnity maintains a provision for
losses and loss adjustment expenses to cover the ultimate net cost of losses on
reported and unreported claims. The estimation of unpaid losses and loss
adjustment expenses is perhaps the most crucial and important aspect affecting
underwriting results of the Company and the industry as a whole. The Company
follows the practice of reserving for losses for reported and unreported claims
and for related loss adjustment expenses, in each case based on the terms and
limits of liability as specified in the Company's policies. There has not been a
significant change in reserving assumptions or methodologies during the year,
nor a material change in the geographic locations of business produced.
With respect to reported claims, the Company establishes reserves on a
case-by-case basis, based on the best available evidence as to the cost of the
claim. When the reserve for a particular case is set initially, it is based on
current estimated costs, such as automobile or home repair costs for property
damage claims and, in the case of liability claims, the Company's claims
adjuster's and the handling attorney's best estimate of the settlement costs, as
well as such attorney's judgment as to the climate of the courts with respect to
the size of judgments. While there is no explicit provision made for inflation,
these reserves are reviewed periodically on a case-by-case basis to determine
if, for example, updated cost information on property claims or revised
estimates based on new information received in the course of settling or
litigating a claim require the reserve to be adjusted. In this manner, the
reserve is updated implicitly to reflect additional costs resulting from
inflation or from changing social conditions, such as changes in the size of
judgments for liability claims.
In addition to reserving for reported claims, the Company establishes
reserves for incurred but unreported claims. These reserves are based on
historical experience with respect to the probable number and nature of claims
arising from losses not yet reported. In addition, if an event occurs with
respect to which the Company believes that all losses have not been reported,
the Company adjusts the reserve for losses incurred but not reported. This
adjustment of the reserve for incurred but unreported claims is based on the
average severity of claims reported with respect to such an event, historical
experience with respect to the average claim severity of like occurrences, the
judgment of the Company's claims adjusters and an estimate of the probable
number of claims that will arise from such an event.
Loss adjustment expense reserves are established based on the Company's
historical experience with respect to loss adjustment expenses paid and
incurred, as well as an experience-based provision for those loss adjustment
expenses not directly assignable to specific claims which are known as
unallocated loss adjustment expenses. Unallocated loss adjustment expenses are
the overhead costs associated with claim handling and administration, such as
salaries of clerical personnel.
For each year end since 1987, the Company has obtained an independent
actuarial review of its reserves for insured events. As of December 31, 1997,
the Company's independent actuary performed its analysis using
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1997 calendar year data. The results of this analysis indicated unexpected
development in loss and loss adjustment expenses for the commercial multiple
peril and other liability lines of business and that the Company's reserves were
below the reserve range called for by such development. After review of the data
and subsequent discussions with the actuary, management believed it to be
prudent to further increase reserves. Loss and loss adjustment expenses were
impacted by a total of approximately $7,700,000 during 1997 as a result of these
reserve increases and other changes in reserves during the year.
One factor influencing the predictability of loss reserves, as well as the
underwriting results of the Company, is the amount of net property losses
incurred resulting from weather-related catastrophes. Weather-related
catastrophe losses are an ever present aspect of the property-casualty insurance
business. The cost to the Company of such losses in 1997 was approximately
$470,000, compared with $3,525,000 for 1996 and $6,281,000 for 1995.
With respect to losses for insured events, the Company continues to limit
the effects of large losses on underwriting results by maintaining what it
believes to be adequate treaty, facultative and catastrophe reinsurance. See
Note 6 of "Notes to Consolidated Financial Statements" in the Company's 1997
Annual Report to Stockholders (the "Annual Report") incorporated herein by
reference.
The following table presents the changes in loss reserves for the three
most recent years.
RECONCILIATION OF CONSOLIDATED LOSS RESERVES
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Beginning reserve, net...................................... $36,833 $39,191 $40,293
------- ------- -------
Provision for:
Insured events of the current year........................ 44,016 44,431 47,159
Insured events of prior years............................. 7,820 1,777 2,407
------- ------- -------
Incurred loss and loss adjustment expenses................ 51,836 46,208 49,566
------- ------- -------
Payments for losses and loss adjustment expenses:
Attributable to insured events of the current year........ 21,708 24,941 27,910
Attributable to insured events of prior years............. 21,521 23,625 22,758
------- ------- -------
Total payments............................................ 43,229 48,566 50,668
------- ------- -------
Ending reserve, net......................................... $45,440 $36,833 $39,191
======= ======= =======
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The following table presents the Company's loss reserve development for the
ten years ended December 31, 1997:
CONSOLIDATED LOSS AND LOSS ADJUSTMENT EXPENSE DEVELOPMENT
(DOLLARS IN THOUSANDS)
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<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------------------------------------------------------------
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
------ ------ ------ ------ ------ ------ ------ ------- ------ ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
LIABILITY FOR UNPAID CLAIMS AND
CLAIM ADJUSTMENT
EXPENSE(1)..................... 49,214 51,624 54,449 47,643 43,407 40,841 40,293 39,191 36,833 45,440
PAID (CUMULATIVE) AS OF:
One year later................. 25,848 26,186 25,009 25,514 21,184 20,375 22,759 23,625 21,521 --
Two years later................ 38,054 36,055 39,030 35,756 29,795 31,375 32,389 33,613 -- --
Three years later.............. 43,278 44,317 45,892 40,170 36,068 36,407 37,503 -- -- --
Four years later............... 48,484 48,515 48,736 42,984 39,180 38,909 -- -- -- --
Five years later............... 51,069 50,044 50,500 44,914 40,438 -- -- -- -- --
Six years later................ 52,212 51,324 51,824 45,772 -- -- -- -- -- --
Seven years later.............. 53,138 52,491 52,538 -- -- -- -- -- -- --
Eight years later.............. 54,324 52,935 -- -- -- -- -- -- -- --
Nine years later............... 54,623 -- -- -- -- -- -- -- -- --
LIABILITY RE-ESTIMATED AS OF (1):
One year later................. 50,185 52,934 53,674 48,803 44,183 42,135 42,700 40,968 44,653 --
Two years later................ 54,145 54,949 57,612 51,887 46,609 45,516 46,267 48,576 -- --
Three years later.............. 55,397 56,414 59,599 52,202 48,749 47,640 50,242 -- -- --
Four years later............... 56,082 57,264 59,693 52,947 50,016 50,017 -- -- -- --
Five years later............... 56,511 57,112 60,474 53,737 51,085 -- -- -- -- --
Six years later................ 56,234 57,552 60,995 54,681 -- -- -- -- -- --
Seven years later.............. 56,571 57,957 61,788 -- -- -- -- -- -- --
Eight years later.............. 56,974 58,475 -- -- -- -- -- -- -- --
Nine years later............... 57,455 -- -- -- -- -- -- -- -- --
REDUNDANCY (DEFICIENCY).......... (8,241) (6,851) (7,339) (7,038) (7,678) (9,176) (9,949) (9,385) (7,820) --
Gross liability -- end of year... 51,165 55,602 71,055
Reinsurance recoverable.......... 11,974 18,769 25,615
Net liability -- end of year..... 39,191 36,833 45,440
Gross re-estimated
liability -- latest............ 64,181 65,234
Re-estimated recoverable --
latest......................... 15,605 20,581
Net re-estimated liability --
latest......................... 48,576 44,653
Gross cumulative deficiency...... (13,016) (9,632)
</TABLE>
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(1) The re-estimated liability shown above has been reduced (increased) by
retrospective premium adjustments which were subsequently collected from
(paid to) workers' compensation policyholders as follows (dollars in
thousands): 1988, $1,852; 1989, $(294); 1990, $(3,470); 1991, $(2,275);
1992, $(3,725); 1993, $(3,229); 1994, $(3,494); 1995, $(401); and 1996,
$(750). Since these amounts are reported separately from incurred losses in
the Company's financial statements prepared in accordance with generally
accepted accounting principles and its statutory financial statements, they
are reconciling items between this table and Schedule P of the statutory
financial statements. Additionally, in accordance with generally accepted
accounting principles, accruals have been made for the Company's estimated
assessments from the Texas Workers' Compensation Insurance Facility, and the
liability for unpaid claims and claim adjustment expenses has been increased
by the following amounts (dollars in thousands): 1988, $2,817; 1989, $4,060;
1990, $4,958; 1991, $2,415; and 1992, $603, and the re-estimated liability
shown above has been increased (decreased) by the following amounts (dollars
in thousands): 1988, $752; 1989, $751; 1990, $401; 1991, $(366); 1992,
$(642); 1993, $(214); 1994, $42; 1995, $54; and 1996, $91. Such amounts are
also reconciling items between this table and Schedule P of the statutory
financial statements.
6
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In evaluating the above table, it should be noted that each amount includes
the effects of all changes in amounts for prior periods. For example, the amount
of the deficiency related to losses settled in 1991, but incurred in 1988, will
be included in the cumulative deficiency amount for years 1988, 1989 and 1990.
Conditions and trends that have affected development of the reserves in the past
may not necessarily occur in the future. Accordingly, it is not appropriate to
extrapolate future redundancies or deficiencies based on this table.
Loss reserves amounted to approximately $45,440,000 at December 31, 1997.
In view of the variability inherent in the calculation of loss reserves, should
the ultimate net cost of American Indemnity's losses prove to be substantially
greater than its loss reserves, its operations, earnings and surplus could be
adversely affected. The Company believes, however, that its aggregate loss and
loss adjustment expense reserves are reasonable and adequate to cover the
ultimate net cost of losses and loss adjustment expenses on reported and
unreported claims.
NARRATIVE DESCRIPTION OF BUSINESS
General
The Company, through American Indemnity, is a multiple-line property and
casualty insurer. The lines of insurance written by American Indemnity include
automobile, homeowners multiple peril, workers' compensation, fire and allied
lines, commercial multiple peril, inland marine and general casualty lines.
American Indemnity does not write certain high-risk specialty lines, such as
medical and other professional malpractice and directors' and officers'
liability, although it is exposed to a certain extent to such risks through
pooling arrangements required of insurance companies by various state regulatory
authorities.
The insurance written by American Indemnity is produced through
approximately 519 agencies. All such agencies are permitted to, and usually do,
represent other insurance companies. In the past, workers' compensation
insurance was principally written directly by American Indemnity's internal
marketing department. As of January 1, 1997, American Indemnity no longer writes
this line of business. In addition, American Indemnity maintains four service
offices in two states to service its agencies and policyholders. In five other
states, the Company has a marketing representative.
American Indemnity competes with individual companies and with groups of
affiliated companies, many of which have nationwide organizations, more
diversified lines of insurance coverage, greater financial resources, larger
sales forces and more widespread agency relationships. Competitors include both
stock and mutual companies and other underwriting organizations.
As of December 31, 1997, the Company and American Indemnity had 151 home
office employees and 65 employees in the field.
Reinsurance
American Indemnity follows the customary practice of reinsuring with other
insurance companies a portion of certain risks under the policies it has
written. This practice is referred to as "ceding." Such reinsurance is
maintained to protect American Indemnity against the severity of individual
claims as well as against unusually serious occurrences in which a number of
claims produce an aggregate extraordinary loss. Although reinsurance does not
discharge American Indemnity from its primary liability for the full amount of
the policies, it does make the assuming reinsurer liable to American Indemnity
to the extent of the reinsured portion of risks. The statutes and regulations of
various states permit the primary insurer, in its financial statements, to treat
risks, to the extent properly reinsured, as though they were risks for which the
primary insurer is not liable.
American Indemnity has reinsurance contracts, known as reinsurance
"treaties," under which certain types of policies are automatically reinsured
without the need for individual approval by the reinsurer of each risk covered.
Other reinsurance contracts provide for "facultative" reinsurance which is
handled on an individual policy or risk basis and requires the specific
agreement of the reinsurer as to each risk insured.
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Property insurance risks are reinsured under treaty arrangements whereby
$900,000 of losses in excess of $100,000 are automatically reinsured. American
Indemnity has additional automatic property facultative reinsurance agreements
for losses in excess of $1,000,000 up to a maximum of $2,300,000. Therefore, the
liability of American Indemnity on property risks is effectively limited to a
maximum of $100,000. In addition, American Indemnity currently carries excess
catastrophe reinsurance which covers 95% of all losses with respect to
windstorm, hurricane and hail suffered within any two separate 72 hour periods
within a 12 month interval up to $36,000,000 in excess of $4,000,000. American
Indemnity carries excess property and automobile catastrophe reinsurance which
covers 95% of catastrophe losses up to $4,000,000 incurred in excess of
$2,000,000, subject to a $200,000 per occurrence retention. The Company has
never had an individual catastrophe loss in excess of $6,300,000; however, there
can be no assurance that a greater loss could not occur in the future.
All claims on automobile liability and casualty insurance over $150,000 up
to $2,000,000 are automatically reinsured under a treaty. Effective January 1,
1998, American Indemnity's retention for these claims will increase to $175,000
from $150,000.
INVESTMENTS
American Indemnity invests its capital surplus and reserve funds in
securities and other investments authorized by applicable state laws and
regulations and receives income from such investments in the form of interest,
dividends and capital gains. The principal objective of the Company's investment
portfolio is to provide capital for American Indemnity's insurance underwriting
operations. The securities comprising American Indemnity's investment portfolio
consist primarily of taxable government and government agencies and authorities
bonds, tax-exempt state and municipal bonds, corporate bonds, and preferred and
common stocks.
The invested assets of the Company at December 31, 1997 are set forth on
Schedule I hereto.
The following table sets forth the investment results of the Company,
exclusive of investments in subsidiaries, for each of the three years ended
December 31, 1997 (dollars in thousands).
<TABLE>
<CAPTION>
ANNUAL PERCENTAGE
EARNED ON
AVERAGE CASH ------------------------- NET CAPITAL
AND INVESTMENTS NET GAINS (LOSSES)
--------------------------------- INVESTMENT INVESTMENTS INVESTMENTS ---------------------
YEAR CASH INVESTMENTS(1) TOTAL INCOME(2) AND CASH ONLY REALIZED UNREALIZED
---- ------ -------------- ------- ---------- ----------- ----------- -------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1995................. $4,860 $83,125 $87,985 $4,010 4.56% 4.82% $ (276) $12,737
1996................. 4,566 86,388 90,954 4,592 5.05 5.32 658 (304)
1997................. 6,262 87,902 94,164 4,368 4.64 5.00 1,482 4,445
</TABLE>
- ---------------
(1) The average of amounts at beginning and end of year with securities valued
at market value.
(2) Net investment income is after deduction of investment expenses and before
net realized gains and losses.
REGULATION AND OTHER RESTRICTIONS
American Indemnity, similar to other insurance companies, is subject to
regulation and supervision by the insurance regulatory authority of each state
or other jurisdiction in which it is licensed to do business. These regulatory
authorities have broad administrative powers relating to the granting and
revocation of licenses to transact business, the licensing of agents, the
approval of policy forms and rates, the form and content of mandatory financial
statements, reserve requirements and the types of investments which may be made.
Detailed annual reports must be filed with the appropriate regulatory
authorities and the books and records of American Indemnity are subject to their
examination.
In 1971, the Texas Legislature enacted the Insurance Holding Company System
Regulatory Act (the "Texas Act") which regulates insurance companies authorized
to do business in the State of Texas which are members of an insurance holding
company system. Under the Texas Act, no insurance company may pay dividends
within any twelve-month period which exceed the greater of 10% of such insurer's
statutory surplus as regards policyholders, as reported at the end of the
preceding calendar year, or the statutory net investment
8
<PAGE> 10
income of such insurer for such year, without the consent of the Commissioner of
Insurance of the State of Texas. Furthermore, only such earnings of American
Indemnity determined on the statutory basis, exclusive of restricted surplus and
special surplus funds, are available for distribution as cash dividends and are
subject to declaration by American Indemnity's Board of Directors and to such
restrictions imposed by law or regulation on the payment of dividends. For
amounts available for payment of dividends by American Indemnity, see Note 7 of
"Notes to Consolidated Financial Statements" in the Annual Report.
The National Association of Insurance Commissioners (the "NAIC") has
established various model laws, regulations and guidelines as part of its
regulatory oversight of insurance companies. A state must adopt these laws in
order to maintain its accreditation from the NAIC. The NAIC Model Insurance
Company System Regulatory Act (the "NAIC Model Act") contains restrictions
regarding payment of dividends which differ from restrictions under Texas law.
Although the state of Texas has not yet adopted these restrictions, the Texas
Department of Insurance has given notice it will vigorously scrutinize any
dividends deemed extraordinary under this act and may take a variety of actions.
The NAIC Model Act requires that no insurance company may pay any extraordinary
dividend or make any other extraordinary distribution to its shareholders until
thirty days after the commissioner of insurance has received notice of the
declarations thereof and has not within that period disapproved the payment, or
until the commissioner of insurance has approved the payment within the
thirty-day period. An extraordinary dividend or distribution includes any
dividend or distribution of cash or other property, whose fair market value
together with that of other dividends or distributions made within the preceding
twelve months exceeds the lesser of 10% of its statutory surplus as regards to
policyholders as of the end of the preceding calendar year or the net income,
not including realized capital gains, for such year. An insurance company may
carry forward net income from the previous two calendar years that has not
already been paid out as dividends.
Additionally, under the Texas Act, a Texas insurance company may not enter
into transactions with any member of its holding company system involving sales,
purchases, exchanges, loans or extensions of credit, or investment, involving
either more than 5% of its admitted assets or 25% of its surplus, whichever is
the lesser, as of the end of the prior calendar year, without the approval of
the Commissioner of Insurance of the State of Texas. Certain other states in
which American Indemnity is authorized to do business have enacted statutes
similar to the Texas Act, but such statutes typically provide that they are
inapplicable, in whole or in part, to insurance companies which are subject to
similar regulations in their state of domicile.
American Indemnity, similar to other insurance companies, maintains its
accounts in accordance with statutory insurance practices, which differ in some
respects from generally accepted accounting principles followed by other
business enterprises in determining financial position and results of
operations. Since these differences have been adjusted to present the Company's
consolidated financial statements filed as a part of this report in conformity
with generally accepted accounting principles (see Notes 1 and 7 of "Notes to
Consolidated Financial Statements" in the Annual Report), such consolidated
financial statements do not necessarily disclose American Indemnity's financial
position for purposes of regulation and supervision by the supervising agencies
of each state or jurisdiction in which American Indemnity is licensed to do
business.
In accordance with the insurance laws of Texas and the rules and practices
of the NAIC, American Indemnity is examined periodically by examiners of the
state of Texas and (on an "association" or "zone" basis) by representatives of
the other states in which it is licensed to do business. The most recently
completed examination was made by the state of Texas as of December 31, 1996.
ITEM 2. PROPERTIES.
The home office facilities consist of two adjacent and connected buildings
owned by American Indemnity with an aggregate of 152,000 square feet located in
the business section of Galveston, Texas. The Company's home office facilities
are 99.9% occupied by the Company and 0.1% leased to other parties.
All other facilities of the Company consist of a total of four service
offices in two states that are leased by American Indemnity for terms of one to
five years.
The Company believes that its leased and owned properties are adequate for
its current needs.
9
<PAGE> 11
ITEM 3. LEGAL PROCEEDINGS.
None, except in the ordinary course of business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
The information set forth under the captions "Per Share Market and Dividend
Information" and "Common Stock" on the page 2 and the inside back cover,
respectively, of the Annual Report, is incorporated herein by reference.
Reference is also made to "Regulation and Other Restrictions" under Item 1 of
this Form.
ITEM 6. SELECTED FINANCIAL DATA.
The information set forth under the caption "Five Year Comparative Summary
of Selected Financial Data" on page 13 of the Annual Report is incorporated
herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The information set forth under the caption "Management's Discussion and
Analysis of Financial Condition and Results of Operations" on pages 14 through
19, inclusive, of the Annual Report is incorporated herein by reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The information set forth under the captions "Consolidated Balance Sheets",
"Consolidated Statements of Income", "Consolidated Statements of Cash Flows",
"Consolidated Statements of Stockholders' Equity", "Notes to Consolidated
Financial Statements" and "Independent Auditors' Report" on pages 20 through 35,
inclusive, of the Annual Report, and under the caption "Selected Quarterly
Financial Data" on page 13 of the Annual Report, is incorporated herein by
reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information set forth under the captions "Election of Directors" and
"Executive Officers" on pages 4 through 7, inclusive, and the information under
the caption "Compliance with Section 16(a) of the Securities Exchange Act of
1934" on page 14 of the Company's Proxy Statement with respect to the Company's
1998 Annual Meeting of Stockholders (the "Proxy Statement"), is incorporated
herein by reference.
10
<PAGE> 12
ITEM 11. EXECUTIVE COMPENSATION.
The information set forth under the caption "Executive Compensation" on
pages 7 through 13, inclusive, of the Proxy Statement is incorporated herein by
reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information set forth under the captions "Principal Stockholders",
"Election of Directors" and "Executive Officers" on pages 2 through 7,
inclusive, of the Proxy Statement is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information set forth under the caption "Other Transactions" on page 13
of the Proxy Statement is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) Documents Filed as a Part of this Report.
1. FINANCIAL STATEMENTS
The financial statements listed below appear on pages 20 through 34 of the
Annual Report. Such financial statements are incorporated herein by reference.
Consolidated Balance Sheets, December 31, 1997 and 1996
Consolidated Statements of Income for the Three Years Ended December 31,
1997
Consolidated Statements of Cash Flows for the Three Years Ended December
31, 1997
Consolidated Statements of Stockholders' Equity for the Three Years Ended
December 31, 1997
Notes to Consolidated Financial Statements
2. FINANCIAL STATEMENT SCHEDULES
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
Schedule I -- Summary of Investments -- Other Than Investments in Related S-1
Parties, December 31, 1997..................................
Schedule II-- Condensed Financial Information of Registrant:
Balance Sheets, December 31, 1997 and 1996.................. S-2
Statements of Income for the Three Years Ended December 31, S-3
1997........................................................
Statements of Cash Flows for the Three Years Ended December S-4
31, 1997....................................................
</TABLE>
All other schedules are omitted because they are not required or because
the required information is included in the financial statements or related
footnotes.
11
<PAGE> 13
3. EXHIBITS
The Company undertakes to furnish to any stockholder so requesting a copy
of any of the following exhibits upon payment to the Company of the reasonable
costs incurred by the Company in furnishing any such exhibit.
<TABLE>
<C> <S>
3.1 -- Certificate of Incorporation of the Company, as amended
(Exhibit 3.1 to the Company's Annual Report on Form 10-K
for the year ended December 31, 1989, is incorporated by
reference herein).
3.2. -- By-Laws of the Company, as amended (Exhibit 3.2 to the
Company's Annual Report on Form 10-K for the year ended
December 31, 1992 is incorporated by reference herein).
4.1 -- See Exhibit Nos. 3.1 and 3.2 for provisions of the
Certificate of Incorporation, as amended, and the ByLaws,
as amended, of the Company defining the rights of the
holders of the Common Stock.
+10.1. -- The Company's 1982 Incentive Stock Option Plan (Exhibit
10.1 to the Company's Annual Report on Form 10-K for the
year ended December 31, 1990, is incorporated by
reference herein).
+10.2. -- Form of 1982 Incentive Stock Option Plan Agreement
(Exhibit 10.2 to the Company's Annual Report on Form 10-K
for the year ended December 31, 1990, is incorporated by
reference herein).
+10.3. -- The Company's Key Executive Severance Plan (Exhibit 10.3
to the Company's Annual Report on Form 10-K for the year
ended December 31, 1990, is incorporated by reference
herein).
+10.4. -- Form of Key Executive Severance Agreement (Exhibit 10.4
to the Company's Annual Report on Form 10-K for the year
ended December 31, 1990, is incorporated by reference
herein).
+10.5. -- The Company's 1992 Employee Stock Option Plan (Exhibit
4.4 to the Company's Registration Statement on Form S-8
(No. 33-47359), is incorporated by reference herein).
+10.6. -- Form of the Company's Non-Incentive Stock Option
Agreement (Exhibit 4.5 to the Company's Registration
Statement on Form S-8 (No. 33-47359), is incorporated by
reference herein).
+10.7. -- Form of the Company's Incentive Stock Option Agreement
(Exhibit 4.6 to the Company's Registration Statement on
Form S-8 (No. 33-47359), is incorporated by reference
herein).
+10.8. -- The Company's 1992 Non-Employee Director Stock Option
Plan (Exhibit 4.4 to the Company's Registration Statement
on Form S-8 (No. 33-47546), is incorporated by reference
herein).
+10.9. -- Form of the Company's Non-Employee Director Stock Option
Agreement (Exhibit 4.5 to the Company's Registration
Statement on Form S-8 (No. 33-47546), is incorporated by
reference herein).
+10.10. -- The Company's 1997 Non-Employee Director Stock Option
Plan (Exhibit 4.4 to the Company's Registration Statement
on Form S-8 (No. 333-42439), is incorporated by reference
herein).
+10.11. -- Form of the Company's Non-Employee Director Stock Option
Agreement (Exhibit 4.5 to the Company's Registration
Statement on Form S-8 (No. 333-42439), is incorporated by
reference herein).
*13.1. -- Page 2 and pages 13 through 35, inclusive, of the
Company's Annual Report to Stockholders for the fiscal
year ended December 31, 1997.
</TABLE>
12
<PAGE> 14
<TABLE>
<C> <S>
21.1. -- List of the Company's Subsidiaries (Exhibit 22.1 to the Company's Annual Report on Form
10-K for the year ended December 31, 1990, is hereby incorporated by reference herein).
*23.1. -- Consent of Independent Auditors.
*24.1. -- Powers of Attorney.
*27.1 -- Financial Data Schedule
</TABLE>
- ---------------
* Filed herewith.
+ Management contract or compensatory plan or arrangement required to be filed
pursuant to Item 14 of Form 10-K.
(b) Reports on Form 8-K.
None.
13
<PAGE> 15
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.
AMERICAN INDEMNITY FINANCIAL
CORPORATION
By /s/ PHILLIP E. APGAR
-----------------------------------
Phillip E. Apgar
Vice President, Treasurer and
Dated March 26, 1998 Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below on the 26th day of March, 1998, by the following
persons on behalf of the Registrant and in the capacities indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE
--------- -----
<C> <S>
/s/ J. FELLMAN SEINSHEIMER, III President, Chief Executive Officer and
- ----------------------------------------------------- Director (Principal Executive Officer)
(J. Fellman Seinsheimer, III)
/s/ PHILLIP E. APGAR Vice President, Treasurer and Chief
- ----------------------------------------------------- Financial Officer (Principal Financial
(Phillip E. Apgar) Officer and Principal Accounting
Officer)
WILLIAM C. LEVIN, M.D.* Director
- -----------------------------------------------------
(William C. Levin, M.D.)
HARRIS L. KEMPNER, JR.* Director
- -----------------------------------------------------
(Harris L. Kempner, Jr.)
MARVIN L. WEST* Director
- -----------------------------------------------------
(Marvin L. West)
JACK T. CURRIE* Director
- -----------------------------------------------------
(Jack T. Currie)
HENRY W. HOPE* Director
- -----------------------------------------------------
(Henry W. Hope)
SYNOTT L. MCNEEL* Director
- -----------------------------------------------------
(Synott L. McNeel)
JAMES W. MCFARLAND, Ph.D.* Director
- -----------------------------------------------------
(James W. McFarland, Ph.D.)
FRED C. BURNS* Director
- -----------------------------------------------------
(Fred C. Burns)
*By /s/ PHILLIP E. APGAR
- -----------------------------------------------------
(Phillip E. Apgar, pursuant to Power of Attorney)
</TABLE>
14
<PAGE> 16
INDEPENDENT AUDITORS' REPORT
American Indemnity Financial Corporation:
We have audited the consolidated financial statements of American Indemnity
Financial Corporation and subsidiaries as of December 31, 1997 and 1996, and for
each of the three years in the period ended December 31, 1997, and have issued
our report thereon dated March 13, 1998; such consolidated financial statements
and report are included in your 1997 Annual Report to Stockholders and are
incorporated herein by reference. Our audits also included the financial
statement schedules of American Indemnity Financial Corporation and
subsidiaries, listed in Item 14. These financial statement schedules are the
responsibility of the Company's management. Our responsibility is to express an
opinion based on our audits. In our opinion, such 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.
DELOITTE & TOUCHE LLP
Houston, Texas
March 13, 1997
15
<PAGE> 17
SCHEDULE I
AMERICAN INDEMNITY FINANCIAL CORPORATION AND SUBSIDIARIES
SUMMARY OF INVESTMENTS -- OTHER THAN
INVESTMENTS IN RELATED PARTIES
<TABLE>
<CAPTION>
DECEMBER 31, 1997
-------------------------------------------
AMOUNT
AT WHICH
MARKET SHOWN IN THE
TYPE OF INVESTMENT COST(A) VALUE BALANCE SHEET
------------------ ----------- ----------- -------------
<S> <C> <C> <C>
Fixed maturities:
Bonds
United States government and government
agencies and authorities..................... $18,688,192 $18,857,867 $18,857,867
Mortgage-backed securities issued by U.S.
government agencies and authorities.......... 29,274,280 28,624,538 28,624,538
Collateralized mortgage obligations............ 13,963,442 14,017,082 14,017,082
States, municipalities and political
subdivisions................................. 1,326,375 1,405,738 1,405,738
All other...................................... 8,083,586 8,308,594 8,308,594
----------- ----------- -----------
Total fixed maturities.................... 71,335,875 71,213,819 71,213,819
----------- ----------- -----------
Equity securities:
Common stocks Public utilities.................... $ 4,783,094 $ 6,862,277 $ 6,862,277
Banks, trusts and insurance companies.......... 1,958,834 4,415,805 4,415,805
Industrial, miscellaneous and all other........ 4,323,337 6,411,993 6,411,993
Nonredeemable preferred stocks.................... 949,905 972,407 972,407
----------- ----------- -----------
Total equity securities................... 12,015,170 18,662,482 18,662,482
----------- ----------- -----------
Total investments......................... $83,351,045 $89,876,301 $89,876,301
=========== =========== ===========
</TABLE>
- ---------------
(a) Original cost of equity securities and, as to fixed maturities, original
cost, reduced by repayments and adjusted for amortization of premium or
accrual of discount.
S-1
<PAGE> 18
SCHEDULE II
AMERICAN INDEMNITY FINANCIAL CORPORATION
(PARENT COMPANY ONLY)
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1997 1996
----------- -----------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Bonds..................................................... $ 298,331 $ 113,676
Cash and cash equivalents................................. 37,704 47,555
Accrued investment income................................. 596
Receivable from affiliate................................. 37,037 27,288
----------- -----------
Total current assets.............................. 373,072 189,115
INVESTMENTS IN SUBSIDIARIES AND AFFILIATE -- At equity,
including unrealized appreciation in market value of
investments held by subsidiaries.......................... 39,292,839 41,430,749
----------- -----------
TOTAL ASSETS...................................... $39,665,911 $41,619,864
=========== ===========
LIABILITIES
Accounts Payable............................................ $ 1,010 $ 891
----------- -----------
EQUITY
STOCKHOLDERS' EQUITY:
Common stock, $3.33 1/3 par value, authorized 2,500,000
shares; outstanding shares, 1,962,410 in 1997 and
1,951,910 in 1996...................................... $ 6,541,351 $ 6,506,351
Preferred stock, authorized 2,000,000 shares; none
outstanding............................................
Paid-in surplus........................................... 13,097,668 13,061,709
Unrealized appreciation in market value of investments
held by subsidiaries and affiliate..................... 6,525,256 2,080,388
Retained earnings (substantially all of which represent
equity in undistributed earnings of subsidiaries and
affiliate)............................................. 13,500,626 19,970,525
----------- -----------
TOTAL............................................. $39,664,901 $41,618,973
----------- -----------
TOTAL LIABILITIES AND EQUITY................................ $39,665,911 $41,619,864
=========== ===========
</TABLE>
S-2
<PAGE> 19
SCHEDULE II
AMERICAN INDEMNITY FINANCIAL CORPORATION
(PARENT COMPANY ONLY)
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------
1997 1996 1995
----------- ---------- -----------
<S> <C> <C> <C>
INCOME:
That portion of the equity in earnings of wholly
owned subsidiaries which is equal to the amount of
dividends received during the year................ $ 725,583 $ 215,876 $ 347,801
Investment income...................................... 16,896 21,110 35,018
----------- ---------- -----------
Total........................................ 742,479 236,986 382,819
EXPENSES............................................... 50,624 46,938 66,560
----------- ---------- -----------
INCOME BEFORE FEDERAL INCOME TAX AND EQUITY IN EARNINGS
OF WHOLLY OWNED SUBSIDIARIES......................... 691,855 190,048 316,259
CREDIT FOR FEDERAL INCOME TAX -- CURRENT............... (12,950) (702) (10,724)
----------- ---------- -----------
INCOME BEFORE EQUITY IN EARNINGS OF WHOLLY OWNED
SUBSIDIARIES......................................... 704,805 190,750 326,983
INCOME (LOSS) OF WHOLLY OWNED SUBSIDIARIES AND
AFFILIATE, IN EXCESS OF DIVIDENDS RECEIVED........... (6,585,979) 1,757,203 (5,420,738)
----------- ---------- -----------
NET INCOME (LOSS)...................................... $(5,881,174) $1,947,953 $(5,093,755)
=========== ========== ===========
EARNINGS (LOSS) PER SHARE.............................. $ (3.00) $ 1.00 $ (2.62)
=========== ========== ===========
</TABLE>
S-3
<PAGE> 20
SCHEDULE II
AMERICAN INDEMNITY FINANCIAL CORPORATION
(PARENT COMPANY ONLY)
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------------
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income (loss)................................. $(5,881,174) $ 1,947,953 $(5,093,755)
Adjustments to reconcile net income to net cash
flows from operating activities:
Excess of equity in income of subsidiaries and
affiliate over dividends received
therefrom.................................... 6,585,979 (1,757,203) 5,420,738
Realized investment gains (losses)............. (7,911) 2,807
Decrease (Increase) in accrued investment
income....................................... 596 6,299 2,040
Increase in receivable from affiliate.......... (9,749) (702) (10,724)
Other.......................................... (3,082) 127 764
----------- ----------- -----------
Net cash flow from operating activities... 692,570 188,563 321,870
----------- ----------- -----------
INVESTING ACTIVITIES:
Sale of bonds..................................... 715,000 929,898 248,430
Purchase of bonds................................. (899,655) (558,626) (74,629)
----------- ----------- -----------
Net cash flow from investing activities... (184,655) 371,272 173,801
----------- ----------- -----------
FINANCING ACTIVITIES:
Cash dividends paid to stockholders............... (588,725) (584,650) (554,845)
Proceeds received from exercise of stock
options........................................ 70,959 30,624 2,552
----------- ----------- -----------
Net cash flow from financing activities... (517,766) (554,026) (552,293)
----------- ----------- -----------
Net Increase (Decrease) in Cash and Cash
Equivalents.................................... (9,851) 5,809 (56,622)
Cash and Cash Equivalents -- January 1............ 47,555 41,746 98,368
----------- ----------- -----------
Cash and Cash Equivalents -- December 31.......... $ 37,704 $ 47,555 $ 41,746
=========== =========== ===========
</TABLE>
S-4
<PAGE> 21
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
3.1 -- Certificate of Incorporation of the Company, as amended
(Exhibit 3.1 to the Company's Annual Report on Form 10-K
for the year ended December 31, 1989, is incorporated by
reference herein).
3.2. -- By-Laws of the Company, as amended (Exhibit 3.2 to the
Company's Annual Report on Form 10-K for the year ended
December 31, 1992 is incorporated by reference herein).
4.1 -- See Exhibit Nos. 3.1 and 3.2 for provisions of the
Certificate of Incorporation, as amended, and the
By-Laws, as amended, of the Company defining the rights
of the holders of the Common Stock.
+10.1. -- The Company's 1982 Incentive Stock Option Plan (Exhibit
10.1 to the Company's Annual Report on Form 10-K for the
year ended December 31, 1990, is incorporated by
reference herein).
+10.2. -- Form of 1982 Incentive Stock Option Plan Agreement
(Exhibit 10.2 to the Company's Annual Report on Form 10-K
for the year ended December 31, 1990, is incorporated by
reference herein).
+10.3. -- The Company's Key Executive Severance Plan (Exhibit 10.3
to the Company's Annual Report on Form 10-K for the year
ended December 31, 1990, is incorporated by reference
herein).
+10.4. -- Form of Key Executive Severance Agreement (Exhibit 10.4
to the Company's Annual Report on Form 10-K for the year
ended December 31, 1990, is incorporated by reference
herein).
+10.5. -- The Company's 1992 Employee Stock Option Plan (Exhibit
4.4 to the Company's Registration Statement on Form S-8
(No. 33-47359), is incorporated by reference herein).
+10.6. -- Form of the Company's Non-Incentive Stock Option
Agreement (Exhibit 4.5 to the Company's Registration
Statement on Form S-8 (No. 33-47359), is incorporated by
reference herein).
+10.7. -- Form of the Company's Incentive Stock Option Agreement
(Exhibit 4.6 to the Company's Registration Statement on
Form S-8 (No. 33-47359), is incorporated by reference
herein).
+10.8. -- The Company's 1992 Non-Employee Director Stock Option
Plan (Exhibit 4.4 to the Company's Registration Statement
on Form S-8 (No. 33-47546), is incorporated by reference
herein).
+10.9. -- Form of the Company's Non-Employee Director Stock Option
Agreement (Exhibit 4.5 to the Company's Registration
Statement on Form S-8 (No. 33-47546), is incorporated by
reference herein).
+10.10. -- The Company's 1997 Non-Employee Director Stock Option
Plan (Exhibit 4.4 to the Company's Registration Statement
on Form S-8 (No. 333-42439), is incorporated by reference
herein).
+10.11. -- Form of the Company's Non-Employee Director Stock Option
Agreement (Exhibit 4.5 to the Company's Registration
Statement on Form S-8 (No. 333-42439), is incorporated by
reference herein).
*13.1. -- Page 2 and pages 13 through 35, inclusive, of the
Company's Annual Report to Stockholders for the fiscal
year ended December 31, 1997.
</TABLE>
<PAGE> 22
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
21.1. -- List of the Company's Subsidiaries (Exhibit 22.1 to the
Company's Annual Report on Form 10-K for the year ended
December 31, 1990, is hereby incorporated by reference
herein).
*23.1. -- Consent of Independent Auditors.
*24.1. -- Powers of Attorney.
*27.1 -- Financial Data Schedule
</TABLE>
- ---------------
* Filed herewith.
+ Management contract or compensatory plan or arrangement required to be filed
pursuant to Item 14 of Form 10-K.
<PAGE> 1
Consolidated Financial Highlights
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------
For the Years Ended December 31,
1997 1996 1995
- --------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Income Statement Data:
Net premiums earned $ 64,052,155 $ 66,961,281 $ 67,136,782
Net investment income 4,367,807 4,591,651 4,009,564
Realized investment gains (losses) 1,481,695 657,875 (276,311)
Net income (loss) (5,881,173 1,947,953 (5,093,755)
Per share (3.00) 1.00 (2.62)
Dividends declared per share .30 .30 .285
Balance Sheet Data:
Total assets $ 161,648,714 $ 144,899,748 $ 138,113,936
Stockholders' equity 39,664,901 41,618,973 40,529,114
Per share 20.21 21.32 20.82
Average investment yield 5.00% 5.32% 4.82%
Statutory Ratios:
Statutory combined ratio 120.3% 108.1% 113.4%
Net premiums written/statutory surplus ratio 2.0 to 1 2.1 to 1 2.3 to 1
</TABLE>
Per Share Market and Dividend Information
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------
Price of Common Stock Dividends
High Low Paid
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
1997 QUARTER ENDED:
MARCH 31 14 10 1/8 .075
JUNE 30 13 1/2 12 .075
SEPTEMBER 30 15 1/2 12 1/8 .075
DECEMBER 31 15 11 1/4 .075
1996 Quarter Ended:
March 31 11 1/4 9 3/8 .075
June 30 13 3/8 9 5/8 .075
September 30 13 9 3/4 .075
December 31 11 2/8 9 1/2 .075
</TABLE>
As of February 9, 1998 there were approximately 431 stockholders, not including
shares held beneficially in nominee accounts.
Net Premiums Written (In thousands of dollars)
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------
For the Years Ended December 31,
1997 1996 1995
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Personal automobile $15,598 25.3% $17,844 25.9% $19,764 29.4%
Commercial automobile 14,974 24.4 16,272 23.6 14,543 21.6
Commercial multiple peril 13,911 22.6 15,973 23.2 16,097 23.9
Homeowners multiple peril 6,133 10.0 5,506 8.0 4,154 6.2
Other liability 5,786 9.4 7,646 11.1 6,626 9.8
Fire and allied lines 3,667 6.0 3,506 5.1 3,285 4.9
Inland marine 1,361 2.2 1,366 2.0 1,439 2.1
All other 58 0.1 750 1.1 1,407 2.1
- -------------------------------------------------------------------------------------------------------
Net premiums written $61,488 100.0% $68,863 100.0% $67,315 100.0%
- -------------------------------------------------------------------------------------------------------
</TABLE>
2
<PAGE> 2
FIVE YEAR COMPARATIVE SUMMARY OF SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------
For the Years Ended December 31,
1997 1996 1995 1994 1993
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Income Statement Data:
Premiums earned $ 64,052,155 $ 66,961,281 $ 67,136,782 $ 65,346,464 $ 64,081,902
Net investment income 4,367,807 4,591,651 4,009,564 4,703,398 5,252,684
Realized investment gains (losses) 1,481,695 657,875 (276,311) (31,355) 1,274,693
Net income (loss) (5,881,173) 1,947,953 (5,093,755) 8,249,105 5,722,617
Net Income (loss) per share (3.00) 1.00 (2.62) 4.24 2.95
Dividends declared per share .30 .30 .285 .21 .10
Balance Sheet Data:
Total assets $161,648,714 $144,899,748 $138,113,936 $131,201,491 $135,803,519
Stockholders' equity 39,664,901 41,618,973 40,529,114 33,438,366 37,842,559
Equity per share 20.21 21.32 20.82 17.18 19.44
Average investment yield 5.00% 5.32% 4.82% 5.58% 6.16%
Statutory Ratios:
Loss and loss adjustment expenses
to premiums earned 84.8% 70.9% 73.0% 66.8% 66.9%
Underwriting expenses to
premiums written 36.4 36.4 37.4 36.1 33.0
Retrospective premium adjustments
to premiums written (.9) .8 3.0 .4 2.2
- -----------------------------------------------------------------------------------------------------------------------
Statutory combined ratio 120.3% 108.1% 113.4% 103.3% 102.1%
- -----------------------------------------------------------------------------------------------------------------------
Net premiums written/statutory
surplus ratio 2.0 TO 1 2.1 to 1 2.3 to 1 2.1 to 1 2.2 to 1
</TABLE>
SELECTED QUARTERLY FINANCIAL DATA
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------
Net Premiums Premiums Net Earnings
Written Earned Income Per Share
- ---------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1997
FIRST QUARTER $16,408,628 $15,944,356 $ (258,833) $ (.13)
SECOND QUARTER 15,872,624 15,736,393 387,907 .20
THIRD QUARTER 16,959,852 16,904,968 337,056 .17
FOURTH QUARTER 12,246,999 15,466,438 (6,347,303) (3.23)
1996
First Quarter $18,119,163 $16,875,476 $ 1,065,799 $ .55
Second Quarter 18,389,001 16,765,029 (1,166,984) (.60)
Third Quarter 16,064,232 16,527,013 696,931 .36
Fourth Quarter 16,290,161 16,793,763 1,352,207 .69
</TABLE>
13
<PAGE> 3
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with
the consolidated financial statements and related notes found on pages 20 to 34,
since they contain important information which is helpful in evaluating the
Company's financial position and results of operations.
LIQUIDITY
The Company has consistently been able to generate adequate amounts of cash to
meet its needs and management is unaware of any trends, demands or commitments
which will or are reasonably likely to have a significant effect on the
Company's liquidity.
OPERATING ACTIVITIES. Operating activities during 1997 produced positive net
cash flow despite a decrease in net premiums written and unfavorable
underwriting results during 1997 compared with 1996. The positive cash flow was
primarily the result of a decrease in the amount of funds required for claim
payments during 1997 compared with 1996.
Net premiums written decreased approximately $7,375,000, or 10.7%, during
1997 compared with 1996 primarily as a result of a decrease in direct premiums
written and an increase in ceded premiums written. Direct premiums written
decreased $2,983,000, or 3.6%, during 1997 compared with 1996. This decrease
resulted primarily from soft market conditions during 1997, as the Company has
tried to remain competitive without engaging in severe price competition or
compromising its underwriting guidelines. The Company continually monitors its
rates on all lines of business and takes corrective actions when underwriting
results indicate it is justified. Although the number of policies in force have
decreased 2.3% in 1997 compared with 1996, the average premium per policy
remained essentially the same, which indicates that the Company maintained
consistent, conservative pricing for policies in all lines of business. The
increase in ceded premiums written was due to unanticipated unfavorable loss
experience under the first layer of the Company's multiple year retrospectively
rated casualty reinsurance contract. Retrospective premium adjustments due the
reinsurer under this contract, increased to $7,714,000 during 1997 compared with
$1,333,000 during 1996. The 1997 accruals reflect loss experience during the
year as well as an estimate of the future losses anticipated in the layer. The
Company has negotiated a fixed price contract for its casualty excess of loss
program for 1998. As a result of these accruals in 1997 and the use of a fixed
price contract for 1998, and while no assurances can be given, the Company
anticipates that the overall cost for this segment of our reinsurance program
will decline during 1998.
Despite unfavorable underwriting results, which are discussed below, the
amount of funds required for claim payments, net of reinsurance, decreased
approximately $2,856,000, or 7.0%, during 1997 compared with 1996, primarily
attributable to the Company's personal and commercial automobile liability lines
of business. Underwriting results during 1997 were adversely impacted by an
increase of approximately $7,700,000 in the Company's loss and loss adjustment
expense reserves during 1997 as more fully discussed in the "Results of
Operations" section of this discussion.
As a result of this increase in reserves, the Company announced in February
1998 the suspension of regular quarterly cash dividends to stockholders. It is
not anticipated that dividends to stockholders will resume within the
foreseeable future. Future dividends, if any, will be dependent upon future
favorable operating results of the Company.
The underwriting results improved significantly during 1996 compared with
1995. Nevertheless, these underwriting results produced negative net cash flow
during 1996. The negative effect on cash flow from the underwriting results was
partially offset by a decrease in policy acquisition costs and an increase in
net investment income during 1996 compared with 1995. The Company's total net
loss resulting from weather-related catastrophes during 1996 decreased
significantly compared with 1995. Nevertheless, the negative cash flow from
underwriting results during 1996 was caused primarily by several weather-related
natural catastrophes. During 1996, the Company's total net loss resulting from
weather-related catastrophes was approximately $3,525,000 compared with
$6,281,000 during 1995. Policy acquisition costs decreased 2.6% during 1996
compared with 1995. This decrease resulted primarily from decreased overhead
expenses during 1996 compared with 1995. Overhead expenses decreased primarily
as a result of a decrease in legal expense. Net investment income increased
14.5% during 1996 compared with 1995, primarily as a result of increased yields
on the Company's derivative investments.
14
<PAGE> 4
Operating activities provided negative cash flow during 1995 primarily as a
result of an increase in the severity of weather-related natural catastrophes,
the settlement of several large liability claims in the Company's commercial
automobile and other liability lines of business, an increase in policy
acquisition costs and a decrease in net investment income.
INVESTING ACTIVITIES. During 1997, the Company invested a portion of
available cash balances and the proceeds received from disposition of
investments into investment grade bonds and common stocks. The net cash flow
from investing activities was positive for 1997 because total investment sales
and maturities purchases exceeded total investment purchases.
As shown in the Company's consolidated balance sheets, the unrealized
appreciation in market value of investments was approximately $6,525,000 at
December 31, 1997, compared to an unrealized appreciation of approximately
$2,080,000 at December 31, 1996, resulting in unrealized gains for 1997 of
approximately $4,445,000. Of that amount, unrealized gains in the Company's bond
portfolio were approximately $1,366,000 with unrealized gains on equity
securities constituting the balance of $3,079,000. These unrealized investment
gains were primarily the result of favorable bond and stock markets which
resulted in significant price appreciation in the Company's debt and equity
portfolios during 1997.
Approximately $788,000 of the total $1,366,000 in unrealized investment
gains on bonds in 1997 were related to five issues of derivative securities
purchased by the Company in 1993. The Company's debt and equity securities are
reported on the Company's balance sheet at their respective market values which
fluctuate based upon a variety of market factors. Such fluctuations will result
in changes to the Company's unrealized investment gains or losses and will have
a corresponding impact on the Company's stockholders' equity. Substantially all
of the derivative securities mentioned above are known as inverse floaters as
their yields, which are adjusted periodically, vary inversely to certain LIBOR
rates. These derivative securities will probably exacerbate swings in unrealized
investment gains and losses and stockholders' equity in the event of significant
movement in interest rates, particularly LIBOR rates. Additionally, the yield
formulas for these securities will result in commensurate swings in investment
income. On various dates during 1998, $13,350,000 par value of the total
$19,850,000 of these derivative issues will mature, including the Guaranteed
Yield Security discussed below. As a result, net investment income in 1998 for
these derivative securities should decrease by approximately $487,000 compared
with 1997. However, management believes that the reinvestment of the proceeds
from these maturities should yield comparable investment returns, depending on
the portion of such proceeds available for reinvestment and future investment
market conditions. Any unrealized investment gains or losses and changes in
investment income will be reflected in the Company's financial reports. For the
year ended December 31, 1997, the average yield of these derivative investments,
including the guaranteed yield on one such issue discussed below, was
approximately 4.3%, their average term to maturity was one year, and the market
value carried on the Company's balance sheet was approximately $19,172,000. At
the date of the maturity of the Guaranteed Yield Security in March 1998, the
average yield of the remaining derivative investments will be approximately 2.6%
subject to future resets and their average term to maturity will be less that
two years. The market value of the remaining derivative securities as of
December 31, 1997 was approximately $8,184,000.
Because the derivative securities were issued by government agencies, the
Company believes that their principal is assured at maturity. Barring unforeseen
circumstances, the Company has the ability to hold these debt securities until
their stated maturity. However, if conditions are favorable for their
disposition, the Company may dispose of all or a portion of these securities
prior to maturity. As a matter of investment policy, the Company no longer
invests in inverse floating rate securities.
In connection with the settlement of an arbitration proceeding in 1995, the
Company received an agreement, effective December 8, 1995, guaranteeing the
yield rate on the largest derivative issue held by it ("Guaranteed Yield
Security"). The Guaranteed Yield Security has a par value of $11,000,000 and
matures in March 1998. The yield rate that is guaranteed equals the weekly
average yield rate for three month treasury bills during each interest period of
the security. The maximum amount guaranteed was $1,500,000 and the guarantee
will terminate no later than the security's maturity date at which time the
final guaranteed payment under the settlement agreement will be due to the
Company. At December 31, 1997, the stated interest rate for the Guaranteed Yield
Security was .063% and the guaranteed yield rate was 5.11%. Based on such
guaranteed yield rate, and assuming no change in the yield rate that determines
the guaranteed yield rate, net investment income earned by this security during
1998 should be approximately $128,000. This guarantee was originally secured by
two letters of credit which both expired prior to December 31, 1997.
15
<PAGE> 5
As a result of this guarantee, the yield of the Guaranteed Yield Security
is similar to that of a floating rate instrument whose coupon yield resets
weekly to the average three month treasury bill yield rate during each interest
period. The market value of this security at December 31, 1997 was determined
based upon the market values of other securities with similar yield resets and
similar maturities. As a result, the market value for this security as carried
on the Company's balance sheet at December 31, 1997 was approximately
$10,987,000.
The net cash flow from investing activities was positive for 1996 because
total investment sales and maturities exceeded total investment purchases.
During 1996, the Company's cash flow from operating activities was negative. As
a result, additional funds were raised through the sale of investments. However,
whenever possible during 1996, management invested a portion of available cash
balances and the proceeds received from disposition of investments into
investment grade bonds and common stocks.
The unrealized appreciation in market value of investments was
approximately $2,080,000 at December 31, 1996, compared to an unrealized
appreciation of approximately $2,384,000 at December 31, 1995, resulting in
unrealized losses for 1996 of approximately $304,000. Of these amounts,
unrealized losses in the Company's bond portfolio were approximately $1,067,000,
offset by unrealized gains on equity securities constituting the balance of
$763,000. The unrealized investment losses were primarily the result of the
negative effects of increased interest rates on the market value of the
Company's debt securities during 1996. Approximately $297,000 of the total
$1,067,000 in unrealized investment losses on bonds in 1996 were related to the
derivative securities purchased by the Company in 1993.
The net cash flow from investing activities was positive for 1995. Due to
unfavorable underwriting results during 1995, the Company's cash flow from
operating activities was insufficient to cover the payment of claims and
underwriting expenses. As a result, additional funds were raised through the
sale of investments. However, whenever possible during 1995, management invested
a portion of available cash balances and the proceeds received from disposition
of investments into investment grade bonds and common stocks.
During 1995, the overall returns in bond and stock markets were quite
favorable. As a result, there was significant price appreciation in the
Company's portfolio of equity securities and this, combined with the positive
effects of decreased interest rates on the market value of the Company's fixed
maturity bond portfolio and yield increases in certain derivative investments
held by the Company, resulted in significant unrealized investment gains during
1995. The unrealized appreciation in market value of investments was
approximately $2,384,000 at December 31, 1995, compared to an unrealized decline
of approximately $10,352,000 at December 31, 1994, resulting in unrealized gains
for 1995 of approximately $12,736,000. The unrealized gains in the Company's
bond portfolio constituted approximately $9,275,000 of this total with
unrealized gains on equity securities constituting the balance of $3,461,000.
Approximately $5,176,000 of the total $9,275,000 in unrealized investment gains
on bonds in 1995 were related to the derivative securities purchased by the
Company in 1993.
FINANCING ACTIVITIES. During 1997, the Company and United States National Bank,
Galveston, Texas, renewed and amended an existing line of credit in the
principal amount of $5,000,000, which was entered into on January 1, 1995.
Pursuant to the line of credit agreement, the Company can draw on this line of
credit at any time. The Company entered into this agreement in order to reduce
the need to dispose of investments during unfavorable market conditions in order
to meet potentially significant cash demands that could result, for example,
from a major catastrophic event such as a hurricane. The Company did not borrow
against this line of credit during 1997, 1996 or 1995. According to the terms of
the amended agreement, the collateral securing the line of credit was released
and collateral is only required when the Company has amounts outstanding under
the line of credit.
In January 1996, the Company received $580,500 proceeds from a loan from
United States National Bank. The Company is required to make monthly payments at
an interest rate of 8.75% until the maturity date of February 1, 2002. The
Company may pre-pay without penalty all or a portion of the principal. These
funds were obtained to finance the purchase of computer software designed to
provide policy processing, claims administration, billing and collection,
reinsurance and management reporting needed as part of the Company's ongoing
effort to enhance its technology and re-engineer its business processes.
16
<PAGE> 6
YEAR 2000 COMPLIANCE. During 1997, the Company upgraded its policy processing
and claims system to the PMSC Point system as a part of its technology
enhancement and Year 2000 compliance initiatives. A migration plan has been
developed and is being implemented to move by October 1, 1998 from the current
release of the PMSC Point system to a subsequent release which, the Company has
been advised by PMSC, is fully Year 2000 compliant. Other Company systems have
been addressed as to Year 2000 compliance and are, or are expected to be, Year
2000 compliant by the second or third quarter of 1998. The Company has received
information from and has been in contact with certain of its vendors to assure
their systems compliance as well, or alternatively, to determine to the extent
possible the extent the Company is vulnerable to those third parties' failure to
achieve Year 2000 compliance and if necessary to develop alternatives. As a
result of the Company's ongoing efforts to reengineer its business processes and
assuming compliance by third parties with whom the Company conducts business,
management believes that the impact on future earnings from efforts to achieve
Year 2000 compliance will not be significant. However, there can be no assurance
that the systems of other companies on which the Company's systems and
operations rely will be timely converted, or that a failure to convert by
another company would not have a material adverse effect on the Company's future
operations.
CAPITAL RESOURCES
The activities of insurance companies are regulated by state authorities and
adequate levels of reserves and equity capital are required to be maintained to
ensure that enough capital is retained in the business to provide sufficient
funds to meet its obligations. Management believes that the Company is in
compliance with all statutory and regulatory requirements and that sufficient
funds have been retained to meet its obligations. The Company has no current
commitments or plans for any new debt or equity financing.
RESULTS OF OPERATIONS
Premiums earned decreased during 1997 compared to 1996 primarily as a result of
soft market conditions experienced during the year. Despite such conditions, the
Company endeavored to remain competitive without engaging in severe price
competition or compromising its underwriting guidelines. Reinsurance costs,
which reduce premiums earned, increased as a result of unfavorable loss
experience under the first layer of the Company's casualty excess of loss
reinsurance contract. When unfavorable loss experience occurs, it creates a
retrospective premium adjustment due the reinsurer, and the total of such
adjustments increased during 1997 compared with 1996. Management believes that
the use of a fixed price excess loss reinsurance contract in 1998 should reduce
the overall cost of the Company's reinsurance program during the coming year.
Management intends to continue conservative expansion of all lines of business
at prices that reflect its experience.
Net investment income decreased during 1997 compared with 1996 due to a
reduction in invested assets as well as lower portfolio yields. During 1997,
proceeds from the sale of certain investments were used to fund operating
activities of the Company, which resulted in net dispositions of invested
assets, as reflected in the Consolidated Statements of Cash Flows contained in
this report. The portfolio's average investment yield also declined to 5.00% in
1997 from 5.32% in 1996 as a result of increased allocations to lower yielding
common stocks and a decline in the yields offered on new purchases of fixed
maturity investments.
In an effort to maximize the overall return on the Company's investment
portfolio, the Company elected to take advantage of favorable market conditions
and sold several issues of common and preferred stocks and fixed maturity bonds
which were held in the investment portfolio. As a result, realized investment
gains were approximately $1,482,000 during 1997 compared with $658,000 during
1996.
Underwriting results were adversely impacted as a result of increases made
during 1997 in the Company's loss and loss adjustment expense reserves
("reserves"). As a result, the loss and loss adjustment expense ratio was 80.9%
for 1997 compared with 69.0% for 1996.
The Company's independent actuary performed its analysis using 1997
calendar year data. The results of this analysis indicated unexpected
development in loss and loss adjustment expenses for the commercial multiple
peril and other liability lines of business and that the Company's reserves were
below the reserve range called for by such development. After extensive review
of the data and
17
<PAGE> 7
subsequent discussions with the actuary, management believed it to be prudent to
further increase reserves. Loss and loss adjustment expenses were impacted by a
total of approximately $7,700,000 during 1997 as a result of these reserve
increases and other changes in reserves during the year. Management believes
that the Company's loss and loss adjustment expense reserves are reasonable and
adequate to cover the cost of all losses and loss adjustment expenses.
Management has taken steps which it believes will help to improve loss and
loss adjustment expense development in the future. During 1995 and 1996, the
Company reduced the cost of its claims operations by severing relationships with
the more expensive alternative of independent claims adjusters and replacing
them with in-house staff claims adjusters. One of the largest components of
claims expense is litigation costs. During 1996, the Company instituted a
litigation management plan, which is essentially intended to set Company
standards for legal counsel to use in handling claim litigation for the Company
and acceptable cost standards for all aspects of claims investigation and
litigation performed by attorneys. The Company ceased doing business with those
firms that could not comply with the new standards and have since monitored
litigation activities and billing to assure compliance with the program. As with
any such changes, it will take time to reflect the benefits of these in the
Company's loss and loss adjustment expense payment patterns and the resulting
reserve range.
Also, as a matter of normal business practice, the Company's reinsurers
conduct both operational and reserve audits of the Company's claims operations.
During the second half of 1997, the Company's reinsurers conducted an
operational review of the Company's claims function with an emphasis on the
casualty lines of business. There were two such audits, which reached
essentially the same conclusions and provided similar improvement suggestions.
The Company's claims function was rated as average and the Company undertook a
number of actions to implement the suggestions made in the audits, as well as
other actions, in order to improve this portion of its operation.
During 1997, the Company upgraded it's policy processing and claims system
to the PMSC Point system as a part of its technology enhancement and Year 2000
compliance initiatives. During 1998, management intends to take full advantage
of the Company's improved database to get more timely and pertinent information
regarding loss and loss adjustment expenses.
The policy acquisition cost ratio was 38.1% for 1997 compared with 36.6%
for 1996. This increase was primarily the result of the Company's costs
remaining essentially flat while, as discussed above, its premiums earned
decreased due primarily to the impact on premiums of soft market conditions
during 1997 and increased reinsurance premiums. Certain costs associated with
acquiring new business vary directly with premium volume while others remain
essentially fixed. While advances have been made in 1997 and 1996 in reducing
fixed costs of operating the Company, the costs associated with the Company's
strategic technology initiatives have resulted in fixed costs remaining flat
during 1997 when compared with 1996. When such fixed costs do not decline at the
same time as premiums earned decline, the policy acquisition cost ratio is
increased.
The Company discontinued writing workers' compensation business in 1997,
however this business was written in previous years on a participation and
assessment basis, whereby the policyholder participated directly in the loss
experience of the policy through retrospective premium adjustments. If loss and
loss adjustment expenses incurred plus the Company's charge against premiums
earned was less than premiums earned under the policy, the difference was
refunded to the insured. Conversely, if the same total exceeded premiums earned
under the policy, the insured was assessed for the excess. As there were no
premiums earned for workers' compensation during 1997 and will not be in future
years, this expense will vary with loss experience under the expired workers'
compensation policies. Such loss experience during 1997 created an assessment
due from insureds compared with 1996 in which loss experience created a refund.
The Company's deferred tax asset is projected based on the existence of
net operating loss carryforwards available to the Company and its projection of
future taxable income. As a result of the additions made to the Company's
reserves during 1997, the loss and loss adjustment expense ratios used in the
projection of future taxable income increased. As such, this reduced projected
future taxable income and also the total deferred tax asset, which resulted in a
deferred tax provision for 1997 compared with a deferred tax credit
18
<PAGE> 8
during 1996.
The net loss of the Company was approximately $5,881,000 for 1997 compared
with net income of approximately $1,948,000 during 1996. This resulted primarily
from the increase in the Company's reserves during 1997 as discussed above.
Primarily as a result of strong competition in a soft market and the
Company's conservative pricing and strict underwriting standards, net premiums
earned decreased slightly during 1996 compared with 1995. Management intends to
continue conservative expansion of the Company's commercial lines of business
and to maintain current levels of premium writings in the personal lines of
business.
As discussed above, net investment income increased 14.5% during 1996
compared with 1995, resulting in an increase in the Company's average investment
yield to 5.32% for 1996 compared with 4.82% for 1995.
In an effort to maximize the overall return on the Company's investment
portfolio, management elected to take advantage of favorable market conditions
and in 1996 sold several issues of common and preferred stocks and fixed
maturity bonds which were held in the investment portfolio. As a result,
realized investment gains were approximately $658,000 during 1996 compared with
realized investment losses of approximately $276,000 during 1995.
The underwriting results improved significantly during 1996 compared with
1995, as reflected in the decrease in loss and loss adjustment expenses
incurred. The loss and loss adjustment expense ratio was 68.3% for 1996 compared
with 73.8% for 1995. This decrease was primarily the result of a smaller number
and decreased severity of weather-related natural catastrophes during 1996
compared with 1995. Claims from weather-related natural catastrophes resulted in
approximately $3,525,000 in net losses during 1996 compared with approximately
$6,281,000 during 1995.
The policy acquisition cost ratio was 36.6% for 1996 compared with 37.5%
for 1995. The decrease in this ratio resulted primarily from decreased overhead
expenses during 1996 compared with 1995. Overhead expenses decreased primarily
as a result of a decrease in legal expenses. Legal expenses incurred during 1995
included non-recurring expenses in connection with legal assistance used in
obtaining the guarantee of the yield on the Guaranteed Yield Security.
Management has established strategic initiatives to significantly reduce
overhead expense and policy acquisition costs in the long term.
As a result of favorable loss experience during 1996 on workers'
compensation policies, retrospective premium adjustments on workers'
compensation policies were 0.7% of premiums earned for 1996 compared with 3.0%
for 1995.
The net income of the Company was approximately $1,948,000 during 1996
compared with net loss of $5,094,000 during 1995. This improvement resulted
primarily from the decrease in claims from weather-related natural catastrophes,
the increase in net investment income, and the realized investment gains during
1996 compared with 1995.
RECENT ACCOUNTING PRONOUNCEMENTS. In June 1997, the Financial Accounting
Standards Board ("FASB") issued SFAS No. 130, "Reporting Comprehensive Income"
which establishes standards for reporting and displaying comprehensive income
and its components. Comprehensive income includes all changes in equity during a
period except those resulting from investments by owners and distributions to
owners. SFAS No. 130 is effective for the Company beginning in 1998. In February
1998, the FASB issued SFAS No. 132, "Employers' Disclosures about Pensions and
Other Postretirement Benefits" which revises required disclosures relating to
pensions and postretirement benefit plans. SFAS No. 132 is also effective for
the Company beginning in 1998. The Company will analyze these pronouncements
during 1998 to determine what, if any, additional disclosures will be required
thereunder.
FORWARD-LOOKING STATEMENTS. Certain statements made herein and in other public
filings and releases by the Company contain "forward-looking" information (as
defined in the Private Securities Litigation Reform Act of 1995) that involve
risk and uncertainty including, but not limited to changes in interest rates;
changes in premium volumes; the frequency and severity of catastrophic events;
increased competition; regulatory and legislative changes; changes in loss
payment patterns; changes in estimated overall adequacy of loss and loss
adjustment expense reserves; changes in key management personnel; changes in
general market or economic conditions; and other risk factors. Although the
Company believes that the expectations reflected in such forward-looking
statements are based upon reasonable assumptions, the Company can give no
assurance that these expectations will be achieved. Actual results and trends in
the future may differ materially depending on a variety of factors including,
but not limited to, the factors that are disclosed in conjunction with the
forward-looking statements included herein and in other public filings and
releases by the Company.
19
<PAGE> 9
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------
December 31,
1997 1996
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Investments:
Fixed maturities - bonds:
Available for sale - at market value (amortized cost $71,335,875
in 1997 and $73,598,053 in 1996) $ 71,213,819 $ 72,110,261
Equity securities:
Preferred stocks - at market value (cost $949,905 in 1997
and $1,390,189 in 1996) 972,407 1,377,438
Common stocks - at market value (cost $11,065,265 in 1997
and $8,839,325 in 1996) 17,690,075 12,420,256
Mortgage loans on real estate 19,710
- -------------------------------------------------------------------------------------------------------------
Total investments 89,876,301 85,927,665
Cash and Cash Equivalents 8,174,074 4,349,953
Accrued Investment Income 761,421 826,791
Premiums in Course of Collection 4,615,040 4,093,476
Direct Premium Bills Receivable, Net 11,855,079 9,659,722
Reinsurance Balances Receivable 26,280,329 18,689,412
Prepaid Reinsurance Premiums 1,803,202 651,050
Property and Equipment, Net 3,888,399 4,072,394
Deferred Policy Acquisition Costs 8,562,238 9,375,133
Deferred Income Taxes 3,889,000 4,743,000
Other Assets 1,943,631 2,511,152
- -------------------------------------------------------------------------------------------------------------
Total $161,648,714 $144,899,748
- -------------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Losses and Loss Adjustment Expenses:
Unpaid losses $ 54,291,620 $ 47,476,034
Unpaid loss adjustment expenses 16,763,162 8,125,895
Unearned Premiums 34,913,172 36,325,073
Reinsurance Balances Held or Payable 6,703,466 1,657,874
Notes Payable to Bank 432,473 515,981
Accounts Payable and Other Accrued Liabilities 8,879,920 9,179,918
- -------------------------------------------------------------------------------------------------------------
Total Liabilities 121,983,813 103,280,775
- -------------------------------------------------------------------------------------------------------------
Contingencies
Stockholders' Equity:
Preferred stock, authorized 2,000,000 shares; none outstanding
Common stock, $3.33 1/3 par value; authorized, 2,500,000 shares;
outstanding shares 1,962,410 in 1997 and 1,951,910 in 1996 6,541,351 6,506,351
Paid-in surplus 13,097,668 13,061,709
Unrealized appreciation in market value of investments 6,525,256 2,080,388
Retained earnings 13,500,626 19,970,525
- -------------------------------------------------------------------------------------------------------------
Total Stockholders' Equity 39,664,901 41,618,973
- -------------------------------------------------------------------------------------------------------------
Total $161,648,714 $144,899,748
- -------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes to consolidated financial statements
are an integral part of these financial statements.
20
<PAGE> 10
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------
For the Years Ended December 31,
1997 1996 1995
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Premiums and Other Income
Premiums earned $ 64,052,155 $ 66,961,281 $ 67,136,782
Net investment income 4,367,807 4,591,651 4,009,564
Realized investment gains (losses) 1,481,695 657,875 (276,311)
Interest on premium bills receivable and other income 723,319 743,892 730,211
- -------------------------------------------------------------------------------------------------------
Total 70,624,976 72,954,699 71,600,246
- -------------------------------------------------------------------------------------------------------
Expenses
Losses and loss adjustment expenses:
Losses incurred 38,532,416 38,916,069 40,862,977
Loss adjustment expenses 13,303,194 7,292,287 8,703,295
Policy acquisition costs 24,400,724 24,531,623 25,188,691
Retrospective premium adjustments on workers'
compensation policies (580,984) 511,767 2,020,126
- -------------------------------------------------------------------------------------------------------
Total 75,655,350 71,251,746 76,775,089
- -------------------------------------------------------------------------------------------------------
Income (Loss) Before Federal Income Tax (5,030,374) 1,702,953 (5,174,843)
Provision (Credit) for Federal Income Tax
Current (3,201) (13,088)
Deferred 854,000 (245,000) (68,000)
- -------------------------------------------------------------------------------------------------------
Total 850,799 (245,000) (81,088)
- -------------------------------------------------------------------------------------------------------
Net Income (Loss) $ (5,881,173) $ 1,947,953 $ (5,093,755)
- -------------------------------------------------------------------------------------------------------
Net Income (Loss) Per Share $ (3.00) $ 1.00 $ (2.62)
- -------------------------------------------------------------------------------------------------------
Dividends Declared Per Share $ .30 $ .30 $ .285
- -------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes to consolidated financial statements
are an integral part of these financial statements.
21
<PAGE> 11
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------
For the Years Ended December 31,
1997 1996 1995
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Operating Activities
Net income (loss) $ (5,881,173) $ 1,947,953 $ (5,093,755)
Adjustments to reconcile net income (loss) to net cash
flow from operating activities:
Decrease (Increase) in:
Premiums in course of collection (521,564) 200,093 1,669,215
Direct premium bills receivable (2,195,357) (1,391,982) (358,847)
Reinsurance balances receivable (7,590,917) (6,521,653) (1,379,088)
Prepaid reinsurance premiums (1,152,152) 65,582 610,852
Deferred policy acquisition costs 812,895 (533,428) 255,759
Deferred income taxes 854,000 (245,000) (68,000)
Other assets 567,521 274,116 34,031
Increase (Decrease) in:
Unpaid losses and loss adjustment expenses 15,452,853 4,436,505 248,648
Unearned premiums (1,411,901) 1,835,695 (432,877)
Reinsurance balances held or payable 5,045,592 (1,186,824) (932,849)
Accounts payable and other accrued liabilities (299,998) 94,596 938,775
Realized investment (gains) or losses (1,481,695) (657,875) 276,311
Depreciation 412,396 455,274 419,714
Other 160,478 73,634 109,127
- --------------------------------------------------------------------------------------------------------
Net cash flow from operating activities 2,770,978 (1,153,314) (3,702,984)
- --------------------------------------------------------------------------------------------------------
Investing Activities
Sale of bonds 5,215,019 9,848,321 9,252,615
Maturity of bonds 5,567,344 9,304,151 5,761,836
Sale of preferred stocks 184,396 49,338
Redemption of preferred stocks 455,302 705,368 170,018
Sale of common stocks 3,230,021 2,936,366 6,234,399
Maturity of long-term certificates of deposit 0 60,000
Purchase of bonds (8,307,715) (19,746,127) (16,018,351)
Purchase of common stocks (3,973,749) (2,090,731) (496,370)
Purchase of property and equipment (250,632) (446,893) (858,616)
Other (281,172) 4,895 4,430
- --------------------------------------------------------------------------------------------------------
Net cash flow from investing activities 1,654,418 759,746 4,099,299
- --------------------------------------------------------------------------------------------------------
Financing Activities
Proceeds received from bank loan 580,500
Payments on bank loan (83,508) (64,519)
Cash dividends paid to stockholders (588,726) (584,650) (554,845)
Proceeds received from exercise of stock options 70,959 30,624 2,552
- --------------------------------------------------------------------------------------------------------
Net cash flow from financing activities (601,275) (38,045) (552,293)
- --------------------------------------------------------------------------------------------------------
Net Increase (Decrease) in Cash and Cash Equivalents 3,824,121 (431,613) (155,978)
- --------------------------------------------------------------------------------------------------------
Cash and Cash Equivalents, January 1 4,349,953 4,781,566 4,937,544
- --------------------------------------------------------------------------------------------------------
Cash and Cash Equivalents, December 31 $ 8,174,074 $ 4,349,953 $ 4,781,566
- --------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes to consolidated financial statements
are an integral part of these financial statements.
22
<PAGE> 12
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------------------
For the Three Years Ended December 31, 1997
- -------------------------------------------------------------------------------------------------------------------------------
Unrealized
Appreciation
Common Stock (Decline) in
Issued Paid-in Market Value Retained
Shares Par Value Surplus of Investments Earnings
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance, January 1, 1995 1,946,710 $ 6,489,018 $ 13,045,866 $ (10,352,340) $ 24,255,822
Net loss (5,093,755)
Cash dividends ($.285 per share) (554,845)
Change in market value of investments 12,736,796
Common Stock issued in connection
with stock option plans 400 1,333 1,219
- -------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1995 1,947,110 6,490,351 13,047,085 2,384,456 18,607,222
Net income 1,947,953
Cash dividends ($.30 per share) (584,650)
Change in market value of investments (304,068)
Common stock issued in connection
with stock option plans 4,800 16,000 14,624
- -------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1996 1,951,910 6,506,351 13,061,709 2,080,388 19,970,525
Net loss (5,881,173)
Cash dividends ($ .30 per share) (588,726)
Change in market value of investments 4,444,868
Common stock issued in connection
with stock option plans 10,500 35,000 35,959
- -------------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1997 1,962,410 $ 6,541,351 $ 13,097,668 $ 6,525,256 $ 13,500,626
- -------------------------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes to consolidated financial statements
are an integral part of these financial statements.
23
<PAGE> 13
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
For the Three Years Ended December 31, 1997
1. SUMMARY OF SIGNIFICANT ACCOUNTING AND REPORTING POLICIES
CONSOLIDATION. The consolidated financial statements include the accounts of
American Indemnity Financial Corporation (the "Company"), American Indemnity
Company ("American Indemnity") and American Indemnity's wholly-owned
subsidiaries, American Fire and Indemnity Company, Texas General Indemnity
Company and American Computing Company and American Indemnity's affiliate,
American Indemnity Lloyds. All material intercompany balances and transactions
have been eliminated in consolidation.
BASIS OF PRESENTATION. The consolidated financial statements have been prepared
in conformity with generally accepted accounting principles ("GAAP"). These
principles differ from practices prescribed or permitted by regulatory
authorities (the "statutory method") in the following material respects:
(a) Under GAAP, commissions, salaries, premium taxes and other costs associated
with writing new business are deferred and amortized against the related
earned premiums, whereas under the statutory method those costs are
expensed as incurred.
(b) Under GAAP, the cost of furniture, fixtures and automobiles is capitalized
and depreciation is recorded thereon; while under the statutory method
certain assets are depreciated over different lives and certain costs are
expensed as incurred.
(c) Under GAAP, a deferred federal income tax asset is recorded which is
attributable to the estimated recognition of the tax benefit of a portion
of the Company's net operating loss carryforward. No deferred federal
income tax is recorded under the statutory method.
(d) Under GAAP, certain reserves required for statutory purposes are recorded
as restrictions of retained earnings; such reserves, under the statutory
method, are classified as liabilities on the balance sheet.
USE OF ESTIMATES. 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 revenue and expenses during the reported
periods. Actual results could differ from those estimates.
PERMITTED STATUTORY ACCOUNTING PRACTICES. American Indemnity, domiciled in
Texas, prepares its statutory financial statements in accordance with accounting
practices prescribed or permitted by the Texas Department of Insurance.
Prescribed statutory accounting practices include a variety of publications of
the National Association of Insurance Commissioners ("NAIC"), as well as state
laws, regulations, and general administrative rules. Permitted statutory
accounting practices encompass all accounting practices not so prescribed.
In all material respects, the Company does not use any permitted statutory
accounting practices in preparing its statutory financial statements which
differ from prescribed statutory accounting practices. Also, no material
transactions have arisen which prescribed statutory accounting practices do not
address.
INVESTMENTS. Fixed maturities are purchased to support the investment strategies
of the Company, which are based on many factors including rate of return,
maturity, credit risk, tax considerations and regulatory requirements. The
Company's investments in fixed maturities are recorded entirely as available for
sale and are stated at market value, accordingly.
Investments in equity securities are stated at market value.
Unrealized gains or losses on investments which are reported at market
value are credited or charged to stockholders' equity, net of a provision for
federal income tax, if any. Gains or losses on disposition are computed by the
identified certificate method and are recorded in the income statement at the
date of disposition.
24
<PAGE> 14
DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS. In preparing disclosures
about the fair value of financial instruments, the Company has assumed that the
carrying amount approximates fair value for cash and cash equivalents,
receivables and payables because of the short maturities of those instruments.
The fair value of investments is estimated based on quoted market values when
available, independent pricing services, or on the current interest rates
available to the Company for investments with similar terms and remaining
maturities. At December 31, 1997 and 1996, the fair market value of all of the
Company's financial instruments approximated their reported values.
CASH AND CASH EQUIVALENTS. For purposes of reporting cash flows, the Company
considers all highly liquid debt instruments, purchased with a maturity of three
months or less, and all money market investments to be cash equivalents.
PROPERTY AND DEPRECIATION. Property and equipment is stated at cost.
Depreciation is computed principally using the straight-line method over the
estimated useful lives of the related assets ranging from three to forty years.
UNEARNED PREMIUMS. Insurance premiums are included in income as earned on the
semi-monthly pro-rata basis over the term of the related policies. The Company
considers anticipated investment income in determining whether a premium
deficiency exists.
UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES. The liability for unpaid losses is
based upon the aggregate of estimates for losses reported prior to the end of
the accounting period and estimates for unreported losses based on experience.
Unpaid loss adjustment expenses are based on historical ratios of adjustment
expenses to losses paid.
RETROSPECTIVE PREMIUMS. Retrospective premium adjustments on workers'
compensation policies represent refunds to (assessments due from) insureds which
reflect the difference between the premiums earned, net of American Indemnity's
charge against premiums earned, and losses and loss adjustment expenses
incurred.
INCOME TAXES. The provision or credit for federal income tax is based on
reported income, adjusted for differences arising in revenue or expense items,
per applicable tax laws and regulations, between reported income and taxable
income. The deferred portion relates to the change in the deferred tax asset or
liability, which arises from the current year's change in temporary differences
between the tax and book basis of assets or liabilities and the valuation
allowance related to the deferred tax asset.
The deferred tax asset recorded in the Company's balance sheets is
attributable to the estimated recognition of the tax benefit of a portion of its
net operating loss carryforward.
PER SHARE DATA. In 1997, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 128, "Earnings per Share." This statement requires that
basic and diluted earnings per share be presented. All prior period per share
amounts have been restated in accordance with the new requirements. The weighted
average number of shares outstanding was 1,961,602 for 1997, 1,948,710 for 1996,
and 1,946,843 for 1995. The weighted average number of shares outstanding on the
diluted basis was 1,963,407 for 1997, 1,954,067 for 1996 and 1,954,421 for 1995.
As the effect of the diluted shares was immaterial, all per share amounts
presented represent both basic and diluted earnings per share.
RECENT ACCOUNTING PRONOUNCEMENTS. In June 1997, the Financial Accounting
Standards Board ("FASB") issued SFAS No. 130, "Reporting Comprehensive Income"
which establishes standards for reporting and displaying comprehensive income
and its components. Comprehensive income includes all changes in equity during a
period except those resulting from investments by owners and distributions to
owners. SFAS No. 130 is effective for the Company beginning in 1998. In February
1998, the FASB issued SFAS No. 132, "Employers' Disclosures about Pensions and
Other Postretirement Benefits" which revises required disclosures relating to
pensions and postretirement benefit plans. SFAS No. 132 is also effective for
the Company beginning in 1998. The Company will analyze these pronouncements
during 1998 to determine what, if any, additional disclosures will be required
thereunder.
25
<PAGE> 15
2. INVESTMENTS AND INVESTMENT INCOME
FIXED MATURITIES - BONDS. The amortized cost and estimated market values of
investments in fixed maturities - bonds are as follows:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------------
December 31, 1997
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
United States Government and Government Agencies and Authorities $ 18,688,192 $ 208,941 $ 39,266 $ 18,857,867
Mortgage-backed Securities issued by U. S.
Government Agencies and Authorities 29,274,280 74,247 723,989 28,624,538
Collateralized Mortgage Obligations 13,963,442 80,478 26,838 14,017,082
States, Municipalities and Political Subdivisions 1,326,375 80,272 909 1,405,738
All Other 8,083,586 225,008 8,308,594
- ---------------------------------------------------------------------------------------------------------------------------------
Totals $ 71,335,875 $ 668,946 $ 791,002 $ 71,213,819
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------------
December 31, 1996
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
United States Government and Government Agencies and Authorities $ 21,954,272 $ 151,756 $ 145,278 $ 21,960,750
Mortgage-backed Securities issued by U. S.
Government Agencies and Authorities 27,627,789 13,084 1,599,173 26,041,700
Collateralized Mortgage Obligations 15,975,313 62,260 99,233 15,938,340
States, Municipalities and Political Subdivisions 2,529,867 67,026 5,234 2,591,659
All Other 5,510,812 67,000 5,577,812
- ---------------------------------------------------------------------------------------------------------------------------------
Totals $ 73,598,053 $ 361,126 $ 1,848,918 $ 72,110,261
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
The market value on one inverse floating rate derivative issue, which
matures in March 1998, with a par value of $11,000,000 is determined based on an
agreement the Company received in connection with an arbitration proceeding in
1995. The agreement provided a minimum guaranteed yield and effectively
converted the security into a floating rate instrument whose coupon yield resets
weekly to the average three month treasury bill rate during each interest
period. The market value of this security at December 31, 1997 was determined
based upon the market values of other securities with similar yield resets and
similar maturities. As a result, the market value carried on the Company's
balance sheet at December 31, 1997 for this security was approximately
$10,987,000. The market value of this security, exclusive of the guaranteed
yield agreement was approximately $10,890,000 at December 31, 1997.
At December 31, 1997, bonds with an amortized cost of approximately
$8,663,000 were on deposit with regulatory authorities.
The amortized cost and estimated market value of fixed maturities at
December 31, 1997, by estimated maturity are shown below. Actual maturities will
differ from estimated maturities because borrowers may have the right to call or
prepay obligations with or without call or prepayment penalties.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------
December 31, 1997
Estimated
Amortized Market
Maturity Distribution Cost Value
- -----------------------------------------------------------------------------
<S> <C> <C>
Due in one year or less $ 21,993,148 $ 21,959,061
Due after one year through five years 38,812,399 38,350,346
Due after five years through ten years 7,900,750 8,211,144
Due after ten years 2,629,578 2,693,268
- -----------------------------------------------------------------------------
Totals $ 71,335,875 $ 71,213,819
- -----------------------------------------------------------------------------
</TABLE>
26
<PAGE> 16
INVESTMENT GAINS AND LOSSES. Realized investment gains and losses and unrealized
appreciation or decline in market value of investments are as follows:
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------
Years Ended December 31,
1997 1996 1995
- ----------------------------------------------------------------------------------
<S> <C> <C> <C>
Realized Investment Gains (Losses):
Fixed maturities-Bonds $ (15,535) $ 72,391 $ (213,516)
Equity securities 1,497,230 585,484 (62,795)
- ----------------------------------------------------------------------------------
Total 1,481,695 657,875 (276,311)
Unrealized Appreciation (Decline)
in Market Value of Investments:
Fixed maturities-Bonds 1,365,736 (1,068,353) 9,288,407
Equity Securities 3,079,132 772,620 3,461,895
- ----------------------------------------------------------------------------------
Total 4,444,868 (295,733) 12,750,302
Total $ 5,926,563 $ 362,142 $ 12,473,991
- ----------------------------------------------------------------------------------
</TABLE>
Proceeds from sales of investments during 1997, 1996 and 1995 were
$7,721,611, $13,012,386, and $15,706,370, respectively. The gross realized
investment gains and losses for such sales were as follows: Realized investment
gains: 1997 - $1,487,300; 1996 - $803,138; and 1995 - $1,061,546. Realized
investment losses: 1997 - $20,773; 1996 - $160,025; and 1995 - $1,415,132. The
gross unrealized gains and losses on equity securities at December 31, 1997 were
approximately $6,942,000 and $295,000, respectively.
NET INVESTMENT INCOME. Investment income and expenses are as follows:
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------
Years Ended December 31,
1997 1996 1995
- ----------------------------------------------------------------------------
<S> <C> <C> <C>
Fixed Maturities - Bonds $ 3,909,666 $ 4,150,909 $ 3,376,965
Equity Securities:
Common stocks 537,601 464,839 639,790
Preferred stocks 90,547 146,513 188,101
Mortgage Loans on Real Estate 1,313 2,199 2,634
Other Short-Term Investments 214,857 227,643 191,259
- ----------------------------------------------------------------------------
Total Investment Income 4,753,984 4,992,103 4,398,749
Less Investment Expenses (386,177) (400,452) (389,185)
- ----------------------------------------------------------------------------
Net Investment Income $ 4,367,807 $ 4,591,651 $ 4,009,564
- ----------------------------------------------------------------------------
</TABLE>
3. PROPERTY AND EQUIPMENT
Property and equipment and accumulated depreciation are as follows:
- ---------------------------------------------------------------------------
December 31,
1997 1996
- ---------------------------------------------------------------------------
Land $ 263,503 $ 263,503
Building and Improvements 5,862,085 5,835,467
Furniture, Fixtures and Equipment 2,838,240 2,588,784
Automobiles 261,575 398,884
- ---------------------------------------------------------------------------
Total 9,225,403 9,086,638
Less Accumulated Depreciation 5,337,004 5,014,244
- ---------------------------------------------------------------------------
Property and Equipment, Net $ 3,888,399 $ 4,072,394
- ---------------------------------------------------------------------------
27
<PAGE> 17
4. LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
Reserving for all property and casualty claims continues to be a complex and
uncertain process, requiring the use of informed estimates and judgments. As
additional experience and other data become available and are reviewed or as new
or improved methodologies are developed or as current law changes, estimates and
judgments may be revised. Any such revisions could result in future changes in
estimates of losses or reinsurance recoverables, and would be reflected in
results of operations for the period in which the estimates are changed. While
the effect of any such changes in estimates of losses or reinsurance
recoverables could be material to future results of operations, management does
not expect such changes to have a material effect on the Company's liquidity or
financial condition. In management's judgment, information currently available
has been appropriately considered in estimating loss reserves and reinsurance
recoverables.
The table below is a reconciliation of beginning and ending reserve
balances for loss and loss adjustment expenses for the years ended December 31:
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------
1997 1996 1995
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Gross reserves, beginning of year $55,602,000 $51,165,000 $50,917,000
Reinsurance recoverable, beginning of year 18,769,000 11,974,000 10,624,000
- ----------------------------------------------------------------------------------------------------
Net reserves, beginning of year 36,833,000 39,191,000 40,293,000
Net incurred loss and loss adjustment expenses related to:
Current year 44,016,000 44,431,000 47,159,000
Prior years 7,820,000 1,777,000 2,407,000
- ----------------------------------------------------------------------------------------------------
Total net incurred 51,836,000 46,208,000 49,566,000
Net paid loss and loss adjustment expenses related to:
Current year 21,708,000 24,941,000 27,910,000
Prior years 21,521,000 23,625,000 22,758,000
- ----------------------------------------------------------------------------------------------------
Total net paid 43,229,000 48,566,000 50,668,000
Net reserves, end of year 45,440,000 36,833,000 39,191,000
Reinsurance recoverable, end of year 25,615,000 18,769,000 11,974,000
- ----------------------------------------------------------------------------------------------------
Gross reserves at December 31 $71,055,000 $55,602,000 $51,165,000
- ----------------------------------------------------------------------------------------------------
</TABLE>
As a result of changes in estimates of insured events in prior years, the
provision of loss and loss adjustment expenses increased by $7,820,000 in 1997
and $1,777,000 in 1996. The Company's loss and loss adjustment expense reserves
were reviewed by the Company's independent actuary. Based on this analysis the
Company strengthened its reserves to a level deemed appropriate (approximately
$7,700,000) in view of unexpected development in losses and loss adjustment
expenses in several major lines.
The Company's exposure to environmental type claims has been insignificant.
However, liabilities have been recognized for known claims when sufficient
information has been developed to indicate the involvement of a specific
insurance policy and management can reasonably estimate its liability.
5. FEDERAL INCOME TAX
Deferred income taxes reflect the net tax effects of (a) temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes and (b) operating loss
carryforwards. The tax effects of significant items comprising the Company's net
deferred income taxes as of December 31, 1997 and December 31, 1996 are as
follows:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------
December 31,
1997 1996
- -----------------------------------------------------------------------------------
<S> <C> <C>
Deferred tax liabilities:
Deferred policy acquisition costs $ (2,911,161) $ (3,187,545)
Differences between book and tax basis of property (301,974) (320,161)
Unrealized investments gains (2,218,587) (707,332)
Other (303,863) (341,959)
- -----------------------------------------------------------------------------------
(5,735,585) (4,556,997)
- -----------------------------------------------------------------------------------
Deferred tax assets:
Reserves not currently deductible 5,355,530 5,167,237
Operating loss carryforwards 14,230,288 12,189,198
- -----------------------------------------------------------------------------------
19,585,818 17,356,435
Net asset 13,850,233 12,799,438
Valuation allowance (9,961,233) (8,056,438)
- -----------------------------------------------------------------------------------
Net deferred tax assets $ 3,889,000 $ 4,743,000
- -----------------------------------------------------------------------------------
</TABLE>
28
<PAGE> 18
The Company is required to establish a valuation allowance for any portion
of the deferred tax asset that management believes will not be realized. The net
change in the total valuation allowance for the year ended December 31, 1997,
was an increase of $1,904,795. Based on a review of anticipated future earnings
and all other available evidence, both positive and negative, management has
concluded that it is "more likely than not" that the Company's deferred tax
asset recognized of $3,889,000 will be realized.
The variance from federal statutory tax rates for each of the years
indicated below consisted of the following elements:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------
Years Ended December 31,
1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Federal income tax provision (credit) computed at statutory rate (34%) $(1,710,327) $ 579,004 $(1,759,445)
Increase in tax credit, or decrease in tax
provision, resulting from:
Tax exempt bond interest (37,303) (75,135) (99,375)
Tax exempt dividends (70% of amount
received from domestic corporations) (149,499) (145,502) (178,595)
Reduction (recognition) of deferred tax asset 854,000 (245,000) (68,000)
Other 37,285 33,102 44,320
Reduction in tax provision (credit) for
current year net operating loss limitation 1,856,643 (391,469) 1,980,007
- ------------------------------------------------------------------------------------------------------------------
Provision (credit) for federal income tax $ 850,799 $ (245,000) $ (81,088)
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
The Company has a net operating loss carryforward for tax purposes of
$41,853,788, which expires if not previously utilized, in 1998 - $3,163,998;
1999 - $7,384,546; 2000 - $5,712,421; 2001 - $4,927,522; 2002 - $2,271,256; 2003
- - $621,205; 2004 - $4,596,950; 2005 - $1,246,728; 2006 - $118,137; 2007 -
$43,352; 2008 - $13,450; 2009 - $13,410; 2010 - $4,604,277; 2011 - $989,347; and
2012 - $6,147,189.
The Company received a federal income tax refund of $3,201 in 1997, paid
federal income tax of $15,000 in 1996 and received a federal income tax refund
of $36,779 in 1995.
6. REINSURANCE AND CONTINGENCIES
Property insurance risks are reinsured under treaty arrangements whereby
$900,000 of losses in excess of $100,000 are automatically reinsured. American
Indemnity has additional automatic property facultative reinsurance agreements
for losses in excess of $1,000,000 up to a maximum of $2,300,000. Therefore, the
liability of American Indemnity on property risks is effectively limited to a
maximum of $100,000.
American Indemnity carries excess catastrophe reinsurance which covers 95%
of all losses up to $36,000,000 in excess of $4,000,000. Additionally, American
Indemnity carries aggregate excess property and automobile catastrophe
reinsurance which covers 95% of all losses up to $4,000,000 in excess of
$2,000,000, subject to a $200,000 per occurrence retention.
All claims on automobile liability and casualty insurance over $150,000 up
to $2,000,000 are automatically reinsured under a treaty.
29
<PAGE> 19
Effective January 1, 1998, American Indemnity's retention for these claims will
increase to $175,000 from $150,000.
American Indemnity, however, is contingently liable if the reinsurance
companies are unable to meet their obligations since such obligations would
become a direct liability of American Indemnity.
Premiums earned, losses and loss adjustment expenses incurred, and unpaid
losses and loss adjustment expenses have been reduced by transactions with
reinsurance companies as follows:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------
Years Ended December 31,
1997 1996 1995
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C>
Premiums Earned:
Catastrophe reinsurance $ 3,862,049 $ 4,216,768 $ 3,996,420
Other reinsurance 14,017,891 10,488,973 10,846,861
- ---------------------------------------------------------------------------------------
Total 17,879,940 14,705,741 14,843,281
- ---------------------------------------------------------------------------------------
Losses and Loss Adjustment Expenses Incurred:
Catastrophe reinsurance 2,700,000
Other reinsurance 15,779,541 13,025,638 8,167,619
- ---------------------------------------------------------------------------------------
Total 15,779,541 13,025,638 10,867,619
- ---------------------------------------------------------------------------------------
Unpaid Losses and Loss Adjustment
Expenses at December 31 $25,614,536 $18,768,740 $11,974,375
- ---------------------------------------------------------------------------------------
</TABLE>
American Indemnity maintains loss reserves to cover the ultimate net cost
of losses on reported and unreported claims and loss adjustment expenses. In
view of the variability inherent in the estimation of such loss reserves, should
the ultimate net cost of such items prove to be substantially greater than the
loss reserves, the Company's operations, earnings and surplus could be adversely
affected. Management believes, however, that the Company's aggregate loss
reserves are reasonable and adequate to cover such ultimate net costs.
7. STOCKHOLDERS' EQUITY
American Indemnity may pay cash dividends only from statutory basis retained
earnings, exclusive of special surplus funds and restricted reserves.
Furthermore, under Texas law, American Indemnity may not pay a dividend without
the consent of the Texas Insurance Commissioner if such dividend and all other
dividends paid during the preceding twelve months would exceed the greater of
(i) 10% of its statutory surplus as regards to policyholders as of the end of
the preceding calendar year or (ii) its statutory net investment income for such
year.
The NAIC has established various model laws, regulations and guidelines as
part of its regulatory oversight of insurance companies. A state must adopt
these laws in order to maintain its accreditation from the NAIC. The NAIC Model
Insurance Company System Regulatory Act ("NAIC Model Act") contains restrictions
regarding payment of dividends which differ from restrictions under Texas law.
Although the state of Texas has not yet adopted these restrictions, the Texas
Department of Insurance has given notice it will vigorously scrutinize any
dividends deemed extraordinary under this act and may take a variety of actions.
The NAIC Model Act requires that American Indemnity may not pay any
extraordinary dividend or make any other extraordinary distribution to its
shareholders until thirty days after the Commissioner has received notice of the
declaration thereof and has not within that period disapproved the payment, or
until the Commissioner has approved the payment within the thirty-day period. An
extraordinary dividend or distribution includes any dividend or distribution of
cash or other property, whose fair market value together with that of other
dividends or distributions made within the
30
<PAGE> 20
preceding twelve months exceeds the lesser of (i) ten percent of its statutory
surplus as regards to policyholders as of the end of the preceding calendar year
or (ii) the net income, not including realized capital gains or losses, for such
year. American Indemnity may carry forward net income from the previous two
calendar years that has not already been paid out as dividends. This
carryforward shall be computed by taking the net income from the second and
third preceding calendar years, not including realized capital gains or losses,
less dividends paid in the second and immediate preceding calendar years.
The Company announced in February 1998 the suspension of regular quarterly
cash dividends to stockholders. It is not anticipated that dividends to
stockholders will resume within the foreseeable future. Future dividends, if
any, will be dependent upon future favorable operating results of the Company.
At December 31, 1997, American Indemnity had no statutory retained earnings
available for payment of cash dividends. At December 31, 1997, American
Indemnity's reported statutory surplus as regards to policyholders was
$28,148,654. For the year ended December 31, 1997, American Indemnity's
unconsolidated statutory net investment income (including realized capital
gains) was $5,282,537 and its unconsolidated net income (loss) (excluding
realized capital gains) was $(7,054,493). The Company's stockholders' equity at
December 31, 1997, 1996 and 1995 and net income for the years then ended, as
reported under the statutory method, are as follows:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------
Statutory Statutory
Years Ended December 31, Stockholders' Equity Net Income (Loss)
- ------------------------------------------------------------------------------
<S> <C> <C>
1997 $ 30,407,297 $(3,755,332)
1996 $ 32,556,876 $ 2,159,102
1995 $ 30,682,608 $ 310,914
</TABLE>
8. EMPLOYEE AND NON-EMPLOYEE DIRECTOR STOCK OPTION PLANS
In 1982, the Company adopted an incentive stock option plan providing for the
grant of options to purchase its common stock by certain employees. The exercise
price of the options granted may not be less than the fair market value of
shares of its common stock on the date the option is granted. All options
granted may be exercised six months from the date of the grant and expire five
years from the date of the grant. Proceeds from options exercised are credited
to capital accounts. No amounts have been charged to income or expense in
connection with the issuance or exercise of options. No options may be granted
under this plan subsequent to March 1992. In 1992, the Company adopted the 1992
Employee Stock Option Plan, which includes similar provisions. No options may be
granted under the 1992 plan subsequent to January 2002.
Activity of shares under the plans was as follows:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------
Number of Exercise Average
Shares Price Price
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Options outstanding, January 1, 1995 21,200 $ 6.38 - 8.50 $ 7.93
Options exercised in 1995 (400) (6.38) (6.38)
- -----------------------------------------------------------------------------------------------------
Options outstanding, December 31, 1995 20,800 6.38 - 13.50 7.99
Options exercised in 1996 (4,800) (6.38) (6.38)
- -----------------------------------------------------------------------------------------------------
Options outstanding, December 31, 1996 16,000 6.38 - 13.50 8.47
Options exercised in 1997 (10,500) (6.38 - 7.01) (6.76)
Options forfeited in 1997 (1,500) (7.01) (7.01)
- -----------------------------------------------------------------------------------------------------
Options outstanding and exercisable, December 31, 1997 4,000 $ 13.50 $13.50
- -----------------------------------------------------------------------------------------------------
</TABLE>
At December 31, 1997, 108,500 shares of common stock were reserved for
issuance pursuant to the terms of the Company's employee stock option plans. At
December 31, 1997, the weighted average remaining contractual life for
outstanding options was 1.4 years.
Also in 1992, the Company adopted a Non-Employee Director Stock Option Plan
providing for the grant of options to purchase its common stock by Directors who
are not employees of the Company or its subsidiaries. The exercise price of the
options granted shall be equal to the fair market value of shares of its common
stock on the date the option is granted and all options expire ten years from
the date of grant. In 1997, the Company adopted the 1997 Non-Employee Director
Stock Option Plan, which includes similar provisions. Proceeds from options
exercised are credited to capital accounts. No amounts have been charged to
income or expense in connection with
31
<PAGE> 21
the issuance or exercise of options.
Activity of shares under the Non-Employee Director Stock Option Plan was as
follows:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------
Number of Exercise Average
Shares Price Price
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Options outstanding, January 1, 1995 11,000 $ 7.75 - 14.00 $11.59
- -------------------------------------------------------------------------------------------------------
Options outstanding, December 31, 1995 11,000 7.75 - 14.00 11.59
Options granted, April 1996 8,000 11.50 - 12.75 12.59
- -------------------------------------------------------------------------------------------------------
Options outstanding, December 31, 1996 19,000 7.75 - 14.00 12.01
Options granted, February 1997 1,000 12.50 12.25
- -------------------------------------------------------------------------------------------------------
Options outstanding and exercisable, December 31, 1997 20,000 $ 7.75 - 14.00 $12.03
- -------------------------------------------------------------------------------------------------------
</TABLE>
At December 31, 1997, 25,000 shares of common stock were reserved for
issuance pursuant to the terms of the Company's 1997 Non-Employee Director Stock
Option Plan. At December 31, 1997, the weighted average remaining contractual
life for outstanding options was 6.9 years.
The Company accounts for stock-based compensation in accordance with SFAS
No. 123, "Stock Based Compensation." Under this statement, a company may elect
to continue its previous method of accounting for stock-based compensation and
include additional disclosure in its financial statements or record expenses for
such compensation based on the fair value of the instruments on the date of
grant. The Company has elected to continue accounting for stock-based
compensation in accordance with Accounting Principles Board Opinion No. 25,
under which no compensation costs have been recognized for stock awards.
Accordingly, the consolidated financial statements do not include any charge for
the fair value of grants for stock-based compensation instruments. Had
compensation expense been determined under SFAS No. 123, the Company's pro forma
net income (loss) would have been ($5,884,173), $1,923,953 and ($5,093,755) for
1997, 1996 and 1995, respectively.
9. RETIREMENT PLANS
American Indemnity sponsors a defined contribution plan (the "Plan"), whereby
eligible employees may elect to contribute a portion of their annual salary,
subject to limitation, to the plan. American Indemnity contributes an additional
amount, subject to limitation, based on the voluntary contribution of the
employee. American Indemnity's contributions charged to expense with respect to
the plan during the years ended December 31, 1997 and 1996 were approximately
$142,000 and $153,000, respectively.
On January 1, 1996, American Indemnity converted its defined benefit plan
to a Cash Balance Pension Plan. Employees who were participants of the plan on
December 31, 1995 received credits for benefits earned under the defined
benefits plan as an opening balance in the Cash Balance Pension Plan. At the end
of each plan year, American Indemnity credits each eligible participant's
account with five percent of each participant's compensation earned that year
plus interest at a rate of six percent. Pension benefits are fully vested after
five years of service.
The following table sets forth the defined benefit plan's funded status:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------
December 31,
1997 1996
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Actuarial Present Value of Benefit Obligations:
Accumulated plan benefits, including vested benefits
of $2,325,361 in 1997 and $2,156,658 in 1996 $ 2,399,191 $ 2,220,951
- --------------------------------------------------------------------------------------------------------------
Projected benefit obligations for services rendered to date $(2,956,617) $(2,785,203)
Plan assets at fair value, consisting primarily of equity securities 3,238,901 2,941,658
- --------------------------------------------------------------------------------------------------------------
Plan assets in excess of projected benefit obligations 282,284 156,455
Unrecognized net gain (364,711) (394,525)
Unrecognized net obligations, at adoption of plan, being recognized over 15 years 704,269 847,573
Unrecognized Prior Service Cost (1,014,033) (1,084,828)
- --------------------------------------------------------------------------------------------------------------
Accrued pension cost $ (392,191) $ (475,325)
- --------------------------------------------------------------------------------------------------------------
</TABLE>
The weighted-average discount rate and rate of the increase in future
compensation levels used in determining the actuarial present
32
<PAGE> 22
value of the projected benefit obligation were seven and one-half percent and
four percent, respectively, for 1997 and eight percent and four percent,
respectively, for 1996. The expected long-term rate of return on assets was nine
percent for 1997 and eight percent for 1996.
Net pension cost included the following components:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------
Years Ended December 31,
1997 1996 1995
- ------------------------------------------------------------------------------------
<S> <C> <C> <C>
Service cost-benefits earned during the period $ 141,269 $ 152,401 $ 131,609
Interest cost on projected benefit obligations 206,248 199,882 215,042
Return on plan assets (474,800) (462,436) (388,691)
Net amortization and deferral 274,046 343,021 339,845
- ------------------------------------------------------------------------------------
Net periodic pension cost $ 146,763 $ 232,868 $ 297,805
- ------------------------------------------------------------------------------------
</TABLE>
American Indemnity's funding policy is to contribute annually an amount at
least sufficient to fund pension cost accrued. Contributions have been intended
to provide not only for benefits attributed to services to date but also those
expected to be earned in the future.
10. POSTRETIREMENT HEALTH CARE AND LIFE INSURANCE BENEFITS
The Company accrues the cost of providing postretirement benefits to employees
during the employees' service period. The benefits provided to retired employees
are principally health care and life insurance. All of these benefits are funded
by the Company on a cash basis.
The following table sets forth the unfunded status and amounts recognized
in the Company's consolidated financial statements:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------
For the years ended December 31,
1997 1996
- --------------------------------------------------------------------------------------
<S> <C> <C>
Accumulated postretirement benefit obligation:
Retirees $ 1,190,000 $ 1,082,000
Fully eligible active participants 204,000 274,000
Other active participants 490,000 716,000
- --------------------------------------------------------------------------------------
Total accumulated postretirement benefit obligation 1,884,000 2,072,000
Unrecognized net obligation, at adoption of plan,
being recognized over 20 years (373,000) (1,215,000)
Prior service cost 55,000
Unrecognized net gain (loss) (430,000) 79,000
- --------------------------------------------------------------------------------------
Accrued postretirement benefit liability $ 1,136,000 $ 936,000
- --------------------------------------------------------------------------------------
</TABLE>
Net postretirement benefit costs include the following components:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
For the years ended December 31,
1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Service cost $ 49,000 $ 57,000 $ 59,000
Interest cost 170,000 155,000 187,000
Net amortization and deferral 75,000 75,000 107,000
- --------------------------------------------------------------------------------
Net postretirement costs $294,000 $287,000 $353,000
- --------------------------------------------------------------------------------
</TABLE>
For measurement purposes, the assumed health care cost trend rate is 8
percent in 1998 and gradually declines to 4.5 percent in 2002 and thereafter.
Increasing the health care cost trend rate by one percentage point in each year
would have no significant effect on the accumulated postretirement benefit
obligation as of December 31, 1997 or on the net periodic postretirement benefit
cost. The calculation assumes a long-term rate of increase in compensation of
four percent for December 31, 1997 and 1996. The weighted-average discount rate
used in determining the accumulated postretirement benefit obligation was seven
and one-half percent and eight percent for 1997 and 1996, respectively.
11. POLICY ACQUISITION COSTS
Policy acquisition costs incurred and expensed and policy acquisition costs
amortized to expense were as follows:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
Years Ended December 31,
1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Costs Incurred and Expensed $ 5,694,425 $ 6,538,408 $ 7,545,615
Costs Amortized to Expense 18,706,299 17,993,215 17,643,076
- --------------------------------------------------------------------------------
Total $24,400,724 $24,531,623 $25,188,691
- --------------------------------------------------------------------------------
</TABLE>
12. LEASE COMMITMENTS
The Company has several operating leases for office space and equipment. Total
lease expense was approximately $577,000 for 1997, $682,000 for 1996, and
$688,000 for 1995. Future minimum lease commitments for the Company are
approximately $478,000 for 1998, $415,000 for 1999, $322,000 for 2000, $31,000
for 2001 and $20,000 for 2002.
13. NOTE PAYABLE TO BANK AND LINE OF CREDIT
In January 1997, the Company received $580,500 proceeds from a loan used to
purchase computer software. The Company is required to make monthly installments
of $10,447 including interest. The interest rate is fixed at 8.75% and the loan
maturity date is February 1, 2002. At December 31, 1997 the principal balance of
the loan was $432,473. The future principal payments of the note payable to bank
are as follows: 1998 - $91,116; 1999 - $99,416; 2000 - $108,472; 2001 -
$118,353; and 2002 - $15,116.
The Company and United States National Bank, Galveston, Texas, renewed and
amended an existing line of credit in the principal amount of $5,000,000 which
was entered into on January 1, 1995. Pursuant to the line of credit agreement,
the Company can draw on this line of credit at any time. The Company did not
borrow against this line of credit during 1997, 1996 or 1995. According to the
terms of the amended agreement, the collateral securing the line of credit was
released and collateral is only required when the Company has amounts
outstanding under the line of credit.
33
<PAGE> 23
INDEPENDENT AUDITORS' REPORT
[DELOITTE & TOUCHE LLP LETTERHEAD]
To The Stockholders of American Indemnity Financial Corporation:
We have audited the accompanying consolidated balance sheets of American
Indemnity Financial Corporation and subsidiaries as of December 31, 1997 and
1996 and the related consolidated statements of income, cash flows and
stockholders' equity for each of the three years in the period ended December
31, 1997. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements 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
misstatements. 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, such consolidated financial statements present fairly, in
all material respects, the financial position of American Indemnity Financial
Corporation and subsidiaries at December 31, 1997 and 1996 and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1997 in conformity with generally accepted accounting
principles.
/s/ DELOITTE & TOUCHE LLP
March 13, 1998
34
<PAGE> 24
AMERICAN INDEMNITY FINANCIAL CORPORATION
COMMON STOCK
American Indemnity Financial Corporation
common stock is traded over the counter
through the National Market System with
the NASDAQ symbol AIFC.
Should stockholders holding common
stock beneficially in "street name" wish to
receive corporate reports directly from the
Company, please write:
Mr. William H. Felts, Jr.
Stockholders' Relations Department
American Indemnity Financial
Corporation
P. O. Box 8985
Wilmington, Delaware 19899-8985
36
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in Registration Statement No.
2-78856, Registration Statement No. 33-47359, Registration Statement No.
333-47546 and Registration Statement No. 333-42439 of American Indemnity
Financial Corporation on Form S-8 of our reports dated March 13, 1998 appearing
in and incorporated by reference in the Annual Report on Form 10-K of American
Indemnity Financial Corporation for the year ended December 31, 1997.
DELOITTE & TOUCHE LLP
Houston, Texas
March 26, 1998
<PAGE> 1
EXHIBIT 24.1
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that the undersigned director of
American Indemnity Financial Corporation, a Delaware corporation (the
"Company"), hereby constitutes and appoints J. Fellman Seinsheimer, III and
Phillip E. Apgar and each of them (with full power to each of them to act
alone), his true and lawful attorney-in-fact and agent, for him and on his
behalf and in his name, place and stead, in any and all capacities, to sign,
execute and file any of the documents relating to the Company's Annual Report
of Form 10-K for the year ended December 31, 1997, to be filed with the
Securities and Exchange Commission, together with all exhibits and any and all
documents required to be filed with respect thereto with any regulatory
authority, granting unto said attorneys, and each of them, full power and
authority to do and perform each and every act and thing requisite and
necessary to be done in and about the premises in order to effectuate the same
as fully to all intents and purposes as the undersigned might or could do if
personally present, hereby ratifying and confirming all that said
attorney-in-facts and agents, or either of them, may lawfully do or cause to be
done by virtue hereof.
IN WITNESS WHEREOF, the undersigned has hereunto set his hand this
24th day of March, 1998.
/s/ Jack T. Currie
-----------------------------------------
Jack T. Currie
<PAGE> 2
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that the undersigned director of
American Indemnity Financial Corporation, a Delaware corporation (the
"Company"), hereby constitutes and appoints J. Fellman Seinsheimer, III and
Phillip E. Apgar and each of them (with full power to each of them to act
alone), his true and lawful attorney-in-fact and agent, for him and on his
behalf and in his name, place and stead, in any and all capacities, to sign,
execute and file any of the documents relating to the Company's Annual Report
of Form 10-K for the year ended December 31, 1997, to be filed with the
Securities and Exchange Commission, together with all exhibits and any and all
documents required to be filed with respect thereto with any regulatory
authority, granting unto said attorneys, and each of them, full power and
authority to do and perform each and every act and thing requisite and
necessary to be done in and about the premises in order to effectuate the same
as fully to all intents and purposes as the undersigned might or could do if
personally present, hereby ratifying and confirming all that said
attorney-in-facts and agents, or either of them, may lawfully do or cause to be
done by virtue hereof.
IN WITNESS WHEREOF, the undersigned has hereunto set his hand this
24th day of March, 1998.
/s/ Henry W. Hope
-----------------------------------------
Henry W. Hope
<PAGE> 3
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that the undersigned director of
American Indemnity Financial Corporation, a Delaware corporation (the
"Company"), hereby constitutes and appoints J. Fellman Seinsheimer, III and
Phillip E. Apgar and each of them (with full power to each of them to act
alone), his true and lawful attorney-in-fact and agent, for him and on his
behalf and in his name, place and stead, in any and all capacities, to sign,
execute and file any of the documents relating to the Company's Annual Report
of Form 10-K for the year ended December 31, 1997, to be filed with the
Securities and Exchange Commission, together with all exhibits and any and all
documents required to be filed with respect thereto with any regulatory
authority, granting unto said attorneys, and each of them, full power and
authority to do and perform each and every act and thing requisite and
necessary to be done in and about the premises in order to effectuate the same
as fully to all intents and purposes as the undersigned might or could do if
personally present, hereby ratifying and confirming all that said
attorney-in-facts and agents, or either of them, may lawfully do or cause to be
done by virtue hereof.
IN WITNESS WHEREOF, the undersigned has hereunto set his hand this
30th day of March, 1998.
/s/ Harris L. Kempner, Jr.
-----------------------------------------
Harris L. Kempner, Jr.
<PAGE> 4
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that the undersigned director of
American Indemnity Financial Corporation, a Delaware corporation (the
"Company"), hereby constitutes and appoints J. Fellman Seinsheimer, III and
Phillip E. Apgar and each of them (with full power to each of them to act
alone), his true and lawful attorney-in-fact and agent, for him and on his
behalf and in his name, place and stead, in any and all capacities, to sign,
execute and file any of the documents relating to the Company's Annual Report
of Form 10-K for the year ended December 31, 1997, to be filed with the
Securities and Exchange Commission, together with all exhibits and any and all
documents required to be filed with respect thereto with any regulatory
authority, granting unto said attorneys, and each of them, full power and
authority to do and perform each and every act and thing requisite and
necessary to be done in and about the premises in order to effectuate the same
as fully to all intents and purposes as the undersigned might or could do if
personally present, hereby ratifying and confirming all that said
attorney-in-facts and agents, or either of them, may lawfully do or cause to be
done by virtue hereof.
IN WITNESS WHEREOF, the undersigned has hereunto set his hand this
19th day of March, 1998.
/s/ William C. Levin, M.D.
-----------------------------------------
William C. Levin, M.D.
<PAGE> 5
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that the undersigned director of
American Indemnity Financial Corporation, a Delaware corporation (the
"Company"), hereby constitutes and appoints J. Fellman Seinsheimer, III and
Phillip E. Apgar and each of them (with full power to each of them to act
alone), his true and lawful attorney-in-fact and agent, for him and on his
behalf and in his name, place and stead, in any and all capacities, to sign,
execute and file any of the documents relating to the Company's Annual Report
of Form 10-K for the year ended December 31, 1997, to be filed with the
Securities and Exchange Commission, together with all exhibits and any and all
documents required to be filed with respect thereto with any regulatory
authority, granting unto said attorneys, and each of them, full power and
authority to do and perform each and every act and thing requisite and
necessary to be done in and about the premises in order to effectuate the same
as fully to all intents and purposes as the undersigned might or could do if
personally present, hereby ratifying and confirming all that said
attorney-in-facts and agents, or either of them, may lawfully do or cause to be
done by virtue hereof.
IN WITNESS WHEREOF, the undersigned has hereunto set his hand this
20th day of March, 1998.
/s/ James W. McFarland, Ph.D.
-----------------------------------------
James W. McFarland, Ph.D.
<PAGE> 6
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that the undersigned director of
American Indemnity Financial Corporation, a Delaware corporation (the
"Company"), hereby constitutes and appoints J. Fellman Seinsheimer, III and
Phillip E. Apgar and each of them (with full power to each of them to act
alone), his true and lawful attorney-in-fact and agent, for him and on his
behalf and in his name, place and stead, in any and all capacities, to sign,
execute and file any of the documents relating to the Company's Annual Report
of Form 10-K for the year ended December 31, 1997, to be filed with the
Securities and Exchange Commission, together with all exhibits and any and all
documents required to be filed with respect thereto with any regulatory
authority, granting unto said attorneys, and each of them, full power and
authority to do and perform each and every act and thing requisite and
necessary to be done in and about the premises in order to effectuate the same
as fully to all intents and purposes as the undersigned might or could do if
personally present, hereby ratifying and confirming all that said
attorney-in-facts and agents, or either of them, may lawfully do or cause to be
done by virtue hereof.
IN WITNESS WHEREOF, the undersigned has hereunto set his hand this
22nd day of March, 1998.
/s/ Synott L. McNeel
-----------------------------------------
Synott L. McNeel
<PAGE> 7
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that the undersigned director of
American Indemnity Financial Corporation, a Delaware corporation (the
"Company"), hereby constitutes and appoints J. Fellman Seinsheimer, III and
Phillip E. Apgar and each of them (with full power to each of them to act
alone), his true and lawful attorney-in-fact and agent, for him and on his
behalf and in his name, place and stead, in any and all capacities, to sign,
execute and file any of the documents relating to the Company's Annual Report
of Form 10-K for the year ended December 31, 1997, to be filed with the
Securities and Exchange Commission, together with all exhibits and any and all
documents required to be filed with respect thereto with any regulatory
authority, granting unto said attorneys, and each of them, full power and
authority to do and perform each and every act and thing requisite and
necessary to be done in and about the premises in order to effectuate the same
as fully to all intents and purposes as the undersigned might or could do if
personally present, hereby ratifying and confirming all that said
attorney-in-facts and agents, or either of them, may lawfully do or cause to be
done by virtue hereof.
IN WITNESS WHEREOF, the undersigned has hereunto set his hand this
23rd day of March, 1998.
/s/ Marvin L. West
-----------------------------------------
Marvin L. West
<PAGE> 8
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that the undersigned director of
American Indemnity Financial Corporation, a Delaware corporation (the
"Company"), hereby constitutes and appoints J. Fellman Seinsheimer, III and
Phillip E. Apgar and each of them (with full power to each of them to act
alone), his true and lawful attorney-in-fact and agent, for him and on his
behalf and in his name, place and stead, in any and all capacities, to sign,
execute and file any of the documents relating to the Company's Annual Report
of Form 10-K for the year ended December 31, 1997, to be filed with the
Securities and Exchange Commission, together with all exhibits and any and all
documents required to be filed with respect thereto with any regulatory
authority, granting unto said attorneys, and each of them, full power and
authority to do and perform each and every act and thing requisite and
necessary to be done in and about the premises in order to effectuate the same
as fully to all intents and purposes as the undersigned might or could do if
personally present, hereby ratifying and confirming all that said
attorney-in-facts and agents, or either of them, may lawfully do or cause to be
done by virtue hereof.
IN WITNESS WHEREOF, the undersigned has hereunto set his hand this
23rd day of March, 1998.
/s/ Fred C. Burns
-----------------------------------------
Fred C. Burns
<TABLE> <S> <C>
<ARTICLE> 7
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<DEBT-HELD-FOR-SALE> 71,213,819
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 18,662,482
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 89,876,301
<CASH> 8,174,074
<RECOVER-REINSURE> 26,280,329
<DEFERRED-ACQUISITION> 8,562,238
<TOTAL-ASSETS> 161,648,714
<POLICY-LOSSES> 71,054,782
<UNEARNED-PREMIUMS> 34,913,172
<POLICY-OTHER> 0
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