<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the Fiscal Year Ended December 31, 1994
Commission File Number 1-7461
ACCEPTANCE INSURANCE COMPANIES INC.
(Exact Name of Registrant As Specified in Its Charter)
DELAWARE 31-0742926
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
222 S. 15TH STREET, SUITE 600 NORTH
OMAHA, NEBRASKA 68102
(Address of Principal Executive Offices)
Registrant's Telephone Number, Including Area Code: (402) 344-8800
Securities Registered Pursuant to Section 12(b) of the Act:
Title of Each Class Name of Each Exchange on Which Registered
-------------------------- -----------------------------------------
Common Stock $.40 Par Value New York Stock Exchange, Inc.
Securities Registered Pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant has been 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 Registrant's voting stock held by
non-affiliates (10,252,593 shares) on March 29, 1995 was $153,788,895.
The number of shares of each class of the Registrant's common stock outstanding
on March 17, 1995 was:
<TABLE>
<CAPTION>
Class of Common Stock No. of Shares Outstanding
--------------------- -------------------------
<S> <C>
Common Stock, $.40 Par Value 15,093,819
</TABLE>
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Registrant's 1995 Annual Meeting of
Shareholders are incorporated by reference into Part III.
<PAGE> 2
GLOSSARY OF INSURANCE TERMS
Admitted insurer: An insurance company licensed by a state regulatory
authority to transact insurance business in that state. An admitted insurer is
subject to the rules and regulations of each state in which it is licensed
governing virtually all aspects of its insurance operations and financial
condition. A non-admitted insurer, also known as an excess and surplus lines
insurer, is not licensed to transact insurance business in a given state but may
be permitted to write certain business in that state in accordance with the
provisions of excess and surplus lines insurance laws which generally involve
less rate, form and operational regulation.
Basic Coverage: The minimum available level of Multi-Peril Crop Insurance,
providing coverage for 50% of a farmer's historical yield for eligible crops at
60% of the price per bushel for such crop set by the CFSA. This coverage is
offered through private insurers and USDA field offices.
Buy-up Coverage: Multi-Peril Crop Insurance policy providing coverage in
excess of that provided by Basic Coverage. Buy-up Coverage is offered only
through private insurers.
Combined ratio: The sum of the expense ratio and the loss ratio determined
in accordance with GAAP or SAP.
Consolidated Farm Service Agency ("CFSA"): A division of the USDA which
administers and provides reinsurance for the federally-regulated MPCI program,
formerly known as the Federal Crop Insurance Corporation.
Direct written premiums: Total premiums collected in respect of policies
issued by an insurer during a given period without any reduction for premiums
ceded to reinsurers.
Excess and surplus lines insurance: The business of insuring risks for
which insurance is unavailable from admitted insurers in whole or in part. Such
business is placed by the broker or agent with nonadmitted insurers in
accordance with the excess and surplus lines provisions of state insurance laws.
Excess of loss reinsurance: A form of reinsurance whereby the reinsurer,
subject to a specified limit, agrees to indemnify the ceding company for the
amount of each loss, on a defined class of business, that exceeds a specified
retention.
Expense ratio: Under statutory accounting, the ratio of underwriting
expenses to net premiums written. Under GAAP accounting, the ratio of
underwriting expenses to net premiums earned.
Generally Accepted Accounting Principles ("GAAP"): Accounting practices as
set forth in opinions and pronouncements of the Accounting Principles Board of
the American Institute of Certified Public Accountants and statements and
pronouncements of the Financial Accounting Standards Board and which are
applicable in the circumstances as of the date in question.
Gross written premiums: Direct written premiums plus premiums collected in
respect of policies assumed, in whole or in part, from other insurance carriers.
Incurred but not reported ("IBNR") reserves: The liability for future
payments on losses which have already occurred but have not yet been reported to
the insurer. IBNR reserves include LAE (as hereinafter defined) related to such
losses and may also provide for future adverse loss development on reported
claims.
Insurance Regulatory Information System ("IRIS"): A system of ratio
analysis developed by the NAIC primarily intended to assist state insurance
departments in executing their statutory mandates to oversee the financial
condition of insurance companies.
Loss adjustment expenses ("LAE"): Expenses incurred in the settlement of
claims, including outside adjustment expenses, legal fees and internal
administrative costs associated with the claims adjustment process, but not
including general overhead expenses.
Loss ratio: The ratio of losses and LAE incurred to premiums earned.
Loss reserves: Liabilities established by insurers to reflect the ultimate
estimated cost of claim payments as of a given date.
MPCI Imputed Premium: For purposes of the profit/loss sharing arrangement
with the federal government, the amount of premiums credited to the Company for
all Basic Coverages it sells, as such amount is determined by formula.
MPCI Premium: For purposes of the profit/loss sharing arrangement with the
federal government, the amount of premiums credited to the Company for all
Buy-up Coverages paid by farmers, plus the amount of any related federal premium
subsidies.
MPCI Retention: The aggregate amount of MPCI Premium and MPCI Imputed
Premium on which the Company retains risk after allocating farms to the three
federal reinsurance pools.
Multi-Peril Crop Insurance ("MPCI"): A federally-regulated and subsidized
crop insurance program that insures a producer of crops with varying levels of
protection against substantially all natural perils to growing crops.
NAIC: The National Association of Insurance Commissioners.
Net earned premiums: The portion of net written premiums applicable to the
expired period of policies and, accordingly, recognized as income during a given
period.
Net written premiums: Total premiums for insurance written (less any return
premiums) during a given period, reduced by premiums ceded in respect of
liability reinsured by other carriers.
Policyholders' or Statutory surplus: As determined under SAP (hereinafter
defined), the excess of total admitted assets over total liabilities.
Quota share reinsurance: A form of reinsurance whereby the reinsurer agrees
to indemnify the cedent for a stated percentage of each loss, subject to a
specified limit the cedent pays, on a defined class of business.
Reinsurance: The practice whereby a company called the "reinsurer" assumes,
for a share of the premium, all or part of a risk originally undertaken by
another insurer called the "ceding" company or "cedent." Reinsurance may be
affected by "treaty" reinsurance, where a standing agreement between the ceding
and reinsuring companies automatically covers all risks of a defined category,
amount and type, or by "facultative" reinsurance where reinsurance is negotiated
and accepted on a risk-by-risk basis.
Retention: The amount of liability, premiums or losses which an insurance
company keeps for its own account after application of reinsurance.
Stop loss reinsurance: A form of reinsurance, similar to Excess of Loss
Reinsurance, whereby the primary insurer caps its loss on a particular risk by
purchasing reinsurance in excess of such cap.
Statutory Accounting Principles ("SAP"): Accounting practices which consist
of recording transactions and preparing financial statements in accordance with
the rules and procedures prescribed or permitted by state regulatory
authorities. Statutory accounting emphasizes solvency rather than matching
revenues and expenses during an accounting period.
ITEM 1. BUSINESS
COMPANY STRATEGY
Acceptance is engaged in the property and casualty insurance business
concentrating on writing specialty coverages not generally emphasized by
standard insurance carriers. The Company selects underwriting specialties within
the property and casualty insurance industry that provide a diversified
portfolio of products, with the goal of producing underwriting results better
than the industry average.
The Company has expanded its business through internal growth and
through acquisitions. The Company regularly explores opportunities, including
through acquisition, where it believes it can achieve profitable results, often
by taking advantage of capacity shortages or other dislocations in the market.
The Company's most significant recent acquisition was its purchase in July 1993
of The Redland Group, Inc. ("Redland"), a leading writer of multi-peril crop
insurance and of crop hail insurance.
Acceptance's strategy is to develop perceived market opportunities by
attracting and supporting underwriters and other managers with proven expertise
who have dedicated their careers to understanding a particular segment of the
insurance industry. The Company allocates its capital among its product lines
depending on where it believes the best underwriting opportunities exist at any
given time. In 1993, the Company expanded its General Agency segment by
hiring four experienced executives who previously served a large national
specialty insurer.
The Company underwrites its products through its five wholly-owned insurance
company subsidiaries: (i) Acceptance Insurance Company ("Acceptance
Insurance"), Acceptance Indemnity Insurance Company ("Acceptance Indemnity")
and American Growers Insurance Company ("American Growers"), each domiciled in
Nebraska; (ii) Redland Insurance Company ("Redland Insurance"), domiciled in
Iowa; and (iii) Phoenix Indemnity Insurance Company ("Phoenix Indemnity"),
domiciled in Arizona (the Company's insurance subsidiaries are collectively
referred to herein as the "Insurance Companies"). Each of the Insurance
Companies is rated A- (Excellent) by A.M. Best, with the exception of American
Growers to which the A.M. Best rating system does not apply. A.M. Best bases
its ratings upon factors that concern policyholders and agents, and not upon
factors concerning investor protection.
The Company positions itself as both an admitted (licensed) and
non-admitted (excess and surplus lines) carrier in order to afford the
flexibility to operate through various distribution channels and react to
different market conditions and opportunities. The Insurance Companies operate
on an admitted carrier basis in 44 states and the District of Columbia and on a
non-admitted carrier basis in 42 states, the District of Columbia and the
Virgin Islands.
The Company seeks to structure reinsurance programs to reduce volatility in
its business segments as well as to mitigate catastrophic or large loss
exposure.
INSURANCE SEGMENTS
The Company's principal business segments are:
A. General Agency which includes specialty automobile, surplus lines
liability and substandard property, and complex products and professional
liability coverages. These business lines are marketed through the
Company's general agency system which includes approximately 120 general
agents.
B. Rural America which includes crop insurance programs and property
and casualty coverages for the rural marketplace. These business lines are
marketed by over 9,000 independent insurance agents.
C. Program, which includes transportation, focused workers'
compensation and used automobile dealer programs. This business is marketed
primarily through independent insurance agents.
D. Non-Standard Automobile which provides coverages for private
passenger automobiles and is written principally in the southwestern United
States. This business is marketed through independent insurance agents.
The following table reflects the amount of net written premium for these
four insurance segments for the periods set forth below.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------
1994 1993(1) 1992
-------- -------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
General Agency................................................. $117,175 $ 75,613 $51,302
Rural America(2)............................................... 42,807 6,589 --
Program........................................................ 39,315 24,100 15,231
Non-Standard Auto.............................................. 29,879 31,203 17,552
-------- -------- -------
Total..................................................... $229,176 $137,505 $84,085
======== ======== =======
</TABLE>
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(1) Premiums for Redland operations are included beginning July 1, 1993.
Redland's operations include auto liability, crop hail, commercial
multi-peril, fire and other allied lines and farmowners coverage, as well
as Multi-Peril Crop Insurance.
(2) For a discussion of the accounting treatment of MPCI premiums, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- General."
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With respect to the business written in the Company's four business
segments, the following table sets forth the Company's gross written premium and
net written premium by principal lines of business. Certain lines of business
are written in more than one of the Company's business segments.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------------------------------
1994 1993 1992
------------------- ------------------- ------------------
GROSS NET GROSS NET GROSS NET
WRITTEN WRITTEN WRITTEN WRITTEN WRITTEN WRITTEN
PREMIUM PREMIUM PREMIUM PREMIUM PREMIUM PREMIUM
-------- -------- -------- -------- -------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Auto Liability......................... $ 89,943 $ 76,844 $ 69,644 $ 64,066 $ 57,590 $40,348
General Liability...................... 74,725 54,502 43,598 31,791 39,098 20,104
Auto Physical Damage................... 24,154 22,486 17,653 17,504 15,715 11,579
Crop Hail.............................. 49,548 21,349 30,411 3,776 -- --
Commercial Multi-Peril................. 22,631 13,561 6,834 3,735 4,201 2,193
Workers' Compensation.................. 16,339 10,285 15,658 7,360 20,615 6,334
Products Liability..................... 20,537 5,753 17,310 4,733 12,904 2,350
Fire & Other Allied Lines.............. 12,920 3,221 7,379 1,700 882 155
Farmowners............................. 10,029 3,237 4,242 1,205 -- --
Other(1)............................... 9,667 2,946 2,203 1,946 1,041 1,012
Homeowners............................. 7,250 1,833 1,311 308 45 10
-------- -------- -------- -------- -------- -------
Subtotal.......................... 337,743 216,017 216,243 138,124 152,091 84,085
Multi-Peril Crop
Insurance(2)......................... 109,740 13,159 39,799 (619) -- --
-------- -------- -------- -------- -------- -------
Total............................. $447,483 $229,176 $256,042 $137,505 $152,091 $84,085
======== ======== ======== ======== ======== =======
</TABLE>
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(1) Principally comprised of inland marine and surety coverages.
(2) For MPCI, gross written premium consists of the aggregate amount of MPCI
premiums paid by farmers, and does not include any related federal premium
subsidies. For 1994, net written premium included in this table consists of
the profit share of $17.0 million earned by the Company, net of $3.9
million in third party reinsurance costs. Since no MPCI profit share was
earned in 1993, net premium written for MPCI shown for that year consists
solely of the cost of third party reinsurance. For further discussion of
the accounting treatment of MPCI premiums, see "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- General."
The increase in the Company's gross written premiums in 1994 compared to
1993 as shown in the table above was primarily the result of its acquisition of
Redland, effective July 1, 1993. Redland's operations include auto liability,
crop hail, commercial multi-peril, farmowners, fire and other allied lines, as
well as MPCI. The increase in gross written premiums was also due in part to an
increase in premiums in the General Agency segment, primarily in the general
liability and commercial multi-peril lines, as a result of increased volume
following the hiring in August 1993 of four experienced executives from another
insurer. See "-- General Agency" below.
The principal factors behind the increase in net written premiums include
the Company's retention of a higher proportion of its gross written premiums in
several lines (principally auto liability and general liability) in 1993 as
compared to 1992 as a result of improved capitalization of the Insurance
Companies, which permitted them to cede less of their gross premiums written to
reinsurers. In addition, the Company retained a higher proportion of its crop
hail gross premiums written in 1994 than in 1993 due to substantial increases in
the cost of third party reinsurance following unfavorable results from this
business in 1993 and 1992.
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GENERAL AGENCY
Products. Specialty insurance coverages written by the General Agency
segment include the following principal lines:
Specialty Automobile, including liability and physical damage
coverages for local haulers of specialized freight, public livery and other
classes of motor vehicles not normally underwritten by standard carriers.
Excess and Surplus Lines Liability and Substandard Property Coverages,
including general liability and commercial multi-peril coverages for small
businesses which normally do not satisfy the underwriting criteria of
standard carriers, such as small contractors, day care centers, automobile
service centers and older apartment buildings, offices and motels.
Complex General Liability Risks, including products and professional
liability which primarily are written on a non-admitted basis and a
substantial amount of which the Company reinsures.
Marketing. General Agency business is written through a system of
approximately 120 general agents who have received binding authority from the
Company for specific lines of business. Insureds are generally small-to-medium
sized businesses, and the Company provides agents with manuals which provide
specific rules for quoting, binding and issuing insurance policies to these
insureds. Risks that are too large or involve more complex coverages are
submitted to the home office and quoted by the home office underwriters. The
Company believes that a key to profitability in this division is in the choice
of general agents within each geographic area. The Company seeks out general
agents with top reputations and long standing relationships with independent
insurance agents in a specific geographic area.
General agents are compensated primarily through commissions and to a
lesser extent through a profit sharing plan based on the accident year
experience of each agency, under which profits are paid out over a four-year
period beginning in the year immediately following the accident year. The
Company's agency agreements with its general agents may generally be terminated
by either party without cause on 30 days' notice.
In August 1993, the Company expanded the General Agency segment by hiring
four experienced executives who previously managed a division of a large
national specialty property and casualty insurer which underwrote a substantial
book of specialty insurance. This group brought significant underwriting
expertise and agency contacts to the Company, especially in excess and surplus
lines liability and substandard property coverages. Since joining the Company,
this group has been responsible for the appointment of 28 new general agents and
an increase in gross premiums written in these lines to approximately $65
million in 1994 from approximately $25 million in 1993.
A subdivision within the General Agency segment consists of the complex
general liability risks underwritten through Acceptance Risk Managers, Inc.
("ARM"), an independent general agent formed under Company sponsorship. This
segment writes larger, long-tail risks, all of which are processed by ARM with
respect to premium quotation, binding and policy issuance. ARM works with
approximately 30 general agents who operate principally as wholesale
intermediaries between the retail agent and ARM. These wholesalers, which do not
have binding authority, tend to be well acquainted with the larger retail
agencies which generally handle these types of risks, as well as the ways in
which coverages can be structured to properly underwrite them.
The Company has structured its general agency relationship with ARM so that
ARM's business incentives are consistent with the profitability goals of the
Company. ARM is paid a flat fee on the first $10 million of gross premium it
writes each year, and an additional variable fee equal to a percentage of gross
premiums written in excess of the first $10 million, the percentage of which
diminishes as premium volume increases. In addition, the Company has structured
a profit sharing plan with ARM under which the first profit sharing adjustment
in respect of an underwriting year is not paid until four years after the
underwriting year
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has begun, and includes reserves for losses and loss adjustment expenses,
including those which have been incurred but not yet reported.
In 1994, the Company wrote through ARM gross written premiums of $42.6
million and net written premiums of $12.8 million. To reduce the potential
volatility of ARM's long-tail business, the Company cedes 70% of this business
to domestic reinsurers rated "A" or better by A.M. Best.
Although ARM currently writes business exclusively for the Company, the
Company's contract with ARM does not prohibit it from writing for other insurers
and can be terminated by either party without cause upon one year's notice.
RURAL AMERICA
Products. The Company's Rural America segment is comprised of its crop
insurance programs and standard property and casualty coverages for the rural
market.
Crop Insurance. The two principal lines of the Company's crop insurance
business are Multi-Peril Crop Insurance and crop hail insurance. Multi-Peril
Crop Insurance is a federally-subsidized program established in 1980 under the
Federal Crop Insurance Act which provides farmers who suffer insured crop damage
during a growing season with funds needed to continue operating and plant crops
for the next season. Under the MPCI program, private insurance companies, in
conjunction with the federal government, offer farmers coverage against
substantially all natural perils, including droughts, freezes, floods, tornados,
insects, hail and other storm damage, excess rainfall, and plant diseases.
Farmers purchase crop insurance, including MPCI, to meet risk management needs
and are often encouraged or required to do so by their lenders. In 1994,
approximately 811,000 MPCI policies were sold by private insurance companies to
U.S. farmers, generating approximately $948 million in MPCI Premiums. For the
year ended December 31, 1994, the Company was the third largest writer of MPCI
business in the United States based on MPCI Premium with a market share of
approximately 14%.
The size of the national MPCI market is poised to increase in 1995 due to
recent changes in law. In response to the substantial costs incurred by the
federal government under traditional disaster relief programs due to
unprecedented flooding in 1993, in October 1994 Congress adopted significant
reforms in the funding and structure of the MPCI program. Among other changes,
the Reform Act now requires farmers for the first time to purchase MPCI coverage
in order to be eligible for a number of other federally-sponsored farm benefits,
including acreage set aside programs, in which farmers are paid to leave a
portion of their land unplanted, and crop price supports. As a result, the
federal Consolidated Farm Service Agency, which administers the MPCI program,
has estimated that the number of acres insured under the MPCI program will
increase substantially in 1995. However, there can be no assurance that such an
increase will in fact occur or, if such an increase were to occur, that it would
result in profitable growth for the Company.
Although the Company writes MPCI business in 37 states, a significant
portion (approximately 34% for 1994) of the business upon which the Company
retains risk after federal reinsurance is written in Iowa and Nebraska. These
states have historically had more consistent crop yields due in part to
advantageous weather conditions and the high percentage of farm acres with
irrigation systems. In addition, the two leading crops in these states are corn
and soybeans, which the Company believes may be less likely to suffer losses
than other, less hardy crops. The Company has crop yield history information on
over 100,000 farms in the United States which it utilizes in its MPCI business.
For a more detailed description of the Company's MPCI business, see
"Business -- Multi-Peril Crop Insurance Program."
In addition to Multi-Peril Crop Insurance, the Company offers stand alone
crop hail insurance, which insures growing crops against damage resulting from
hail storms and which involves no federal participation. The Company generally
sells crop hail insurance in conjunction with Multi-Peril Crop Insurance.
Although both crop hail and MPCI provide insurance against hail damage, under
crop hail coverages farmers can receive payments for hail damage which would not
be severe enough to require a payment under an MPCI policy. The Company believes
that offering crop hail insurance enables it to sell more MPCI policies than it
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otherwise would. In addition to crop hail insurance, the Company also sells a
small volume of insurance against crop damage from other specific named perils.
Other Coverages. The Rural America segment also offers to rural agents a
line of standard property and casualty coverages, e.g., farmowners, automobile
and limited commercial coverages which are marketed to farmers and other
customers in rural areas. The Company has found that many rural agencies
experience difficulty in finding standard property and casualty coverages for
their insureds because many larger insurance companies concentrate on high
volume insurance agencies.
Marketing. The Company markets its crop insurance through approximately
3,800 agencies employing over 7,600 independent agents primarily in the
traditional grain belt of the Midwest. The Company believes its success in
writing crop business is directly related to its investment in quality sales and
service personnel, particularly because there is no price competition with
respect to the MPCI product. The Company's agents, who are in many cases farmers
themselves, often travel from farm to farm to discuss the benefits of crop
insurance in informal, "kitchen table" conversations. A substantial number of
agencies are equipped with laptop computers and proprietary software which
agents use to make presentations to farmers to help them budget their insurance
premium dollars and understand the relative benefits of purchasing different
levels and combinations of MPCI and crop hail insurance policies. The Company
has been an industry leader in the development of this type of marketing
software, which permits the agent to directly transmit orders to the Company's
on-line computer system and strengthens the relationship between the agent and
the Company.
The Company markets its other Rural America coverages primarily through the
same agents which market its crop insurance. The Company believes it can
successfully underwrite this business because it focuses on smaller communities
and outlying farms where certain losses tend to occur less frequently than in
urban areas.
Rural America agents are primarily compensated based on a percentage of
premiums produced. To a lesser degree, agents are also eligible for contingent
commissions generally based upon their production volume and profitability.
PROGRAM
Products. The two largest programs are trucking and workers' compensation.
Other programs include insurance for temporary help agencies, greyhound race
tracks and used car dealers. Trucking coverages include property and casualty
coverages for long haul truckers and upper Midwest regional and national
trucking companies hauling rural products. The workers' compensation program is
based principally in Minnesota and focuses on larger companies, writing policies
with minimum annual premiums of $50,000. The Company's workers' compensation
strategy is to control voluntary and involuntary costs through the application
of intensive claims management techniques which enable clients to improve their
loss frequency experience over time.
Marketing. The Program segment writes insurance generally through highly
focused independent agents who specialize in one particular line of business.
The Company's workers' compensation program is marketed directly to independent
insurance agents who write larger insurance risks. Although the Company's long
haul trucking business has historically been written through general agents, the
Company generally finds that most of its long haul trucking business is received
from a few highly specialized independent insurance agents. In 1991, the Company
purchased Seaboard Underwriters, Inc., a national specialist in long haul
trucking which also receives its business directly from specialized independent
insurance agents. The Company believes that capitalizing on the expertise of
specialized agents may provide more consistent results from this line of
business. In 1993, with the acquisition of Redland, the Company combined all of
its trucking-related business into the Program segment.
With respect to agents in the Program segment, commissions are the primary
form of compensation. Profit sharing plans have been used sparingly to date, but
competitive pressures may induce the Company to offer incentives to producers
based on the profitability of their books of business.
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<PAGE> 7
Additionally, the Company also provides general agency functions for
unaffiliated insurers primarily in the trucking business for which it receives
commission income.
NON-STANDARD AUTOMOBILE
Products. The Company writes non-standard private passenger automobile
coverages principally in the southwestern United States. This product is
designed for drivers who are unable to obtain coverage from standard carriers
due to prior driving records, other underwriting criteria or market conditions.
Such drivers normally are charged higher premium rates than the rates charged
for preferred or standard risk drivers and are offered only basic limits of
liability in order to meet state financial responsibility laws.
Marketing. The Company's book of business was developed by a general
agency, Statewide, over a period beginning in the mid-1960's. In 1988, the
Company formed a joint venture with Statewide to write this book of business
through Phoenix Indemnity, which was originally owned 80% by the Company and 20%
by Statewide. In 1994, the Company purchased Statewide, thereby acquiring at the
same time the remaining 20% of Phoenix Indemnity.
The Company currently writes this business through approximately 600
independent agents. The Company's agents in general do not specialize in
non-standard automobile coverage and, therefore, the Company may be less likely
to compete directly with specialized non-standard automobile companies. The
Company's strategy in this segment is to write additional business when
attractive opportunities arise; however, the Company is not actively seeking
increased market share.
With respect to agents in the Non-Standard Automobile segment, commissions
are the primary form of compensation. Profit sharing commissions have been used
sparingly to date, but competitive pressures may induce the Company to offer
incentives to producers based on the profitability of their books of business.
MULTI-PERIL CROP INSURANCE PROGRAM
DESCRIPTION OF MPCI PROGRAM
Multi-Peril Crop Insurance is a federally-subsidized program which is
designed to provide participating farmers who suffer insured crop damage with
funds needed to continue operating and plant crops for the next growing season.
All of the material terms of the MPCI program and of the participation of
private insurers such as the Company in the program are set by the federal
Consolidated Farm Service Agency (or "CFSA") under applicable law.
Multi-Peril Crop Insurance provides coverage for insured crops against
substantially all natural perils. Purchasing an MPCI policy permits a farmer to
ensure that his crop yield for any growing season will be at least 50% to 75%
(as selected by the farmer at the time of policy issuance) of his historic crop
yield. If a farmer's crop yield for the year is greater than the yield coverage
he selected, no payment is made to the farmer under the MPCI program. However,
if a farmer's crop yield for the year is less than the yield coverage selected,
MPCI entitles the farmer to a payment equal to the yield shortfall multiplied by
60% to 100% (as selected by the farmer at the time of policy issuance) of the
price for such crop for that season as set by the CFSA.
In order to encourage farmers to participate in the MPCI program and
thereby reduce dependence on traditional disaster relief measures, the Reform
Act establishes a new minimum level of MPCI coverage ("Basic Coverage"), which
farmers may purchase upon payment of a minimal fixed administrative fee instead
of any premium. Basic Coverage insures 50% of historic crop yield at 60% of the
CFSA-set crop price per bushel. Basic Coverage can be obtained from private
insurers such as the Company or from USDA field offices.
In addition to Basic Coverage, MPCI policies that provide a greater level
of protection than Basic Coverage are also offered (such policies, "Buy-up
Coverage"). Most farmers purchasing MPCI historically have purchased at
Buy-up Coverage levels, with the most frequently sold policy providing coverage
for 65% of historic crop yield at 100% of the CFSA-set crop price per bushel.
Buy-up Coverages require payment
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<PAGE> 8
of a premium in an amount determined by formula set by the CFSA. Buy-up Coverage
can only be purchased from private insurers. The Company focuses its marketing
efforts on Buy-up Coverages, which have higher premiums and which the Company
believes will continue to appeal to farmers who desire, or whose lenders
encourage or require, revenue protection.
The number of MPCI policies written has historically tended to increase
after a year, such as 1993, in which many natural disasters adversely affecting
crops have occurred, and decrease following a year, such as 1994, in which
favorable weather conditions prevail. Although management believes that this
historical pattern will be significantly altered by the provisions of the Reform
Act which now require farmers to purchase MPCI in order to receive certain other
federal benefits, no assurance can be given as to the foregoing.
REVENUES
The Company, like other private insurers participating in the MPCI program,
generates revenues from the MPCI program in two ways. First, it markets, issues
and administers policies, for which it receives administrative fees; and second,
it participates in a profit sharing arrangement in which it receives from the
government a portion of the aggregate profit, or pays a portion of the aggregate
loss, in respect of the business it writes.
PROFIT SHARING ARRANGEMENT
The Company's share of profit or loss on the MPCI business it writes is
determined under a formula established by the CFSA. Under this formula, the
primary factors that determine the Company's MPCI profit or loss share are (i)
the gross premiums the Company is credited with having written; (ii) the amount
of such credited premiums retained by the Company after ceding premiums to
certain federal reinsurance pools; and (iii) the loss experience of the
Company's insureds. The following discussion provides more detail about the
implementation of this profit sharing formula.
Gross Premiums. For each year, the CFSA sets the formulas for determining
premiums for different levels of Buy-up Coverage. Premiums are based on the type
of crop, acreage planted, farm location, price per bushel for the insured crop
as set by the CFSA for that year, and other factors. The federal government will
generally subsidize a portion of the total premium set by the CFSA and require
farmers to pay the remainder. Cash premiums received by the Company from farmers
after the end of a growing season are promptly remitted to the federal
government. Although applicable federal subsidies change from year to year, such
subsidies will range up to approximately 42% of the Buy-up Coverage premium for
1995 depending on the crop insured and the level of Buy-up Coverage purchased.
Federal premium subsidies are recorded on the Company's behalf by the
government. For purposes of the profit sharing formula, the Company is credited
with having written the full amount of premiums paid by farmers for Buy-up
Coverages, plus the amount of any related federal premium subsidies (such total
amount, its "MPCI Premium").
As previously noted, farmers are not required to pay any premium for Basic
Coverage. However, for purposes of the profit sharing formula, the Company will
be credited with an imputed premium (its "MPCI Imputed Premium") for all Basic
Coverages it sells. The amount of such MPCI Imputed Premium credited is
determined by formula. In general, such MPCI Imputed Premium will be less than
50% of the premium that would be payable for a Buy-up Coverage policy that
insured 65% of historic crop yield at 100% of the CFSA-set crop price per
bushel, historically the most frequently sold Buy-up Coverage.
Reinsurance Pools. Under the MPCI program, the Company must allocate its
MPCI Premium or MPCI Imputed Premium in respect of a farm to one of three
federal reinsurance pools, at its discretion. These pools provide private
insurers with different levels of reinsurance protection from the CFSA on the
business they have written. For insured farms allocated to the "Commercial
Pool," the Company generally retains 100% of the risk and the CFSA assumes none
of the risk; for those allocated to the "Developmental Pool," the Company
generally retains 35% of the risk and the CFSA assumes 65%; and for those
allocated to the "Assigned Risk Pool," the Company retains 20% of the risk and
the CFSA assumes 80%.
-8-
<PAGE> 9
Although the Company in general must agree to insure any eligible farm, it
is not restricted in its decision to allocate a risk to any of the three pools,
subject to a minimum aggregate retention of 35% of its MPCI Premiums and MPCI
Imputed Premiums written. Based upon the production histories of each farm for
which the Company writes MPCI policies, as well as other underwriting criteria,
the Company assigns each farm to one of the pools. The Company has crop yield
history information with respect to over 100,000 farms in the United States.
Generally, farms or crops which, based on historical experience, location and
other factors, appear to be less likely to suffer an insured loss, are placed in
the Commercial Pool. Farms or crops which appear to be more likely to suffer a
loss are placed in the Developmental Pool or Assigned Risk Pool. The Company has
historically allocated the bulk of its insured risks to the Commercial Pool.
The Company's share of profit or loss depends in part on the aggregate
amount of MPCI Premium and MPCI Imputed Premium on which the Company retains
risk after allocating farms to the foregoing pools (its "MPCI Retention").
Loss Experience of Insureds. The Company pays insured losses to farmers as
they are incurred during the growing season, with the full amount of such
payments reimbursed to the Company by the federal government within three
business days. After a growing season ends, the aggregate loss experience of the
Company's insureds in each state for risks allocated to each of the three
reinsurance pools is determined. If, for all risks allocated to a particular
pool in a particular state, the Company's share of losses incurred is less than
its aggregate MPCI Retention, the Company shares in the gross amount of such
profit according to a schedule set by the CFSA for each year. As an example, if
the Company's MPCI Retention in respect of risks allocated to the Commercial
Pool in Nebraska in 1995 was, for instance, $1 million, it would receive 94% of
the first $350,000 of the gross amount of such profit, 65% of the next $100,000
of such gross profit, and 11% of any portion of the remaining $550,000 of such
gross profit, for a maximum potential profit share to the Company on such $1
million of Nebraska Commercial Pool MPCI Retention of approximately $455,000,
assuming no losses were incurred.
A similar calculation would be performed if the Company's share of losses
incurred were greater than its MPCI Retention to determine the Company's
participation in such gross loss. The profit and loss sharing percentages and
maximum potential gain or loss are different for profits and losses in each pool
and are different for risks allocated to each of the three reinsurance pools.
Private insurers will receive or pay the greatest percentage of profit or loss
for risks allocated to the Commercial Pool.
The percentage split between private insurers and the federal government of
any profit or loss which emerges from an MPCI Retention is set by the CFSA and
generally is adjusted from year to year. For 1995 and 1996, the CFSA has
increased the maximum potential profit share of private insurers for risks
allocated to the Commercial Pool above the maximum potential profit share set
for 1994, without increasing the maximum potential share of loss for risks
allocated to that pool for 1995. This change increases the potential
profitability of risks allocated to the Commercial Pool by private insurers. To
illustrate, in the example relating to Nebraska above, in 1994 the Company would
have received 92.5% of the first $150,000 of gross profit, 65% of the next
$150,000 of gross profit, and 11% of the remaining $700,000 of gross profit, for
a maximum potential profit share of approximately $313,000, assuming no losses
were incurred. However, no assurance can be given that the profitability of the
Company's MPCI business will increase in 1995, since such profitability is also
affected by a number of other factors.
THIRD PARTY REINSURANCE
In order to reduce the Company's potential loss exposure under the MPCI
program, the Company generally purchases stop loss reinsurance from other
private insurers. The amount purchased varies yearly depending on market
conditions and other factors. Such reinsurance would not eliminate the Company's
potential liability in the event a reinsurer was unable to pay or losses
exceeded the limits of the stop loss coverage. In addition, in 1993, 1992 and
1991 the Company also purchased certain pro rata reinsurance from third parties.
-9-
<PAGE> 10
ADMINISTRATIVE PAYMENTS
Buy-up Coverage. The Company receives an administrative payment from the
CFSA for writing and administering Buy-up Coverage policies. These payments
provide funds to compensate the Company for its expenses, including agents'
commissions and the costs of administering policies and adjusting claims. In
1994, the administrative payments were set at 31% of the MPCI Premium. In 1995
and 1996, this payment has also been set at 31% of the MPCI Premium, but it is
scheduled to be reduced to 29% in 1997, 28% in 1998, and 27.5% in 1999.
Basic Coverage. Farmers are required to pay a minimal fixed administrative
fee in order to obtain Basic Coverage. A portion of this fee is retained by the
Company to defray the cost of administration, with the balance remitted to the
government. The Company will also receive, from the CFSA, a separate minimal
claims administration fee in respect of each Basic Coverage policy it writes. In
general, administrative fees payable to the Company in respect of Basic Coverage
are significantly lower than for Buy-up Coverage.
REDLAND HISTORICAL RESULTS
The tables below provide supplemental unaudited GAAP financial information
with respect to the historical results of Redland for the five year period
ending December 31, 1994. Before its purchase by Acceptance effective July 1993,
Redland operated as a private company with different objectives and requirements
than those of the Company, particularly concerning expense levels and
reinsurance programs.
MULTI-PERIL CROP INSURANCE(1)
<TABLE>
<CAPTION>
MPCI MPCI PROFIT (LOSS) PROFIT (LOSS)
YEAR PREMIUM RETENTION SHARE(2) PERCENT
----------------------------------- -------- --------- ------------- -------------
(IN THOUSANDS, EXCEPT PERCENTAGES)
<S> <C> <C> <C> <C>
1990............................... $ 82,444 $45,490 $ 5,057 11.1%
1991............................... 79,153 58,299 6,768 11.6
1992............................... 85,611 48,186 1,572 3.3
1993............................... 90,290 48,346 (1,029)(3) (2.1)
1994............................... 128,412 77,402 17,007 22.0
</TABLE>
-------------------------
(1) Prior to 1992, the MPCI program only had one government-sponsored
reinsurance pool, rather than the three reinsurance pools currently in
place. Other changes over time in the MPCI program may affect the
comparability of the results shown.
(2) Represents profit (loss) share received from or payable to the federal
government. Amounts exclude third party reinsurance expenses of $0.4
million, $2.1 million, $1.3 million, $1.2 million and $3.9 million in 1990,
1991, 1992, 1993 and 1994, respectively, which are included in "Total
Expenses" shown in the "Total Redland Operations" table which follows, and
exclude certain intercompany items for 1994.
(3) Net of recoveries from third party reinsurance of $7.2 million.
As the table shows, Redland has recognized profit from its MPCI business in
four of the last five years. The profits in each of 1994, 1991 and 1990 resulted
primarily from favorable weather during the growing season in Redland's
principal geographic regions. In 1993, excessive cloudy, wet and cold weather in
those regions, together with severe flooding, resulted in a net loss. The 1993
net loss was mitigated by third party reinsurance coverage. Results in 1992 were
adversely affected by severe hailstorms.
-10-
<PAGE> 11
CROP HAIL AND OTHER CROP INSURANCE
<TABLE>
<CAPTION>
GROSS PREMIUMS UNDERWRITING LOSS
YEAR PREMIUMS EARNED GAIN (LOSS)(1) RATIO
----------------------------------- -------- -------- -------------- ------
(IN THOUSANDS, EXCEPT PERCENTAGES)
<S> <C> <C> <C> <C>
1990............................... $30,550 $ 4,510 $ 321 92.9%
1991............................... 42,396 5,787 1,198 79.3
1992............................... 41,862 9,735 (913) 109.4
1993............................... 50,867 6,883 (1,572) 122.8
1994............................... 53,373 22,933 (19) 100.1
</TABLE>
-------------------------
(1) Excluding underwriting and other expenses which are included in "Total
Expenses" shown in the "Total Redland Operations" table which follows.
Redland's crop hail and other crop results were adversely affected by
significant hail damage suffered in 1994, 1993 and 1992. Crop hail results in
those years were also impacted by significant price competition. The Company
generally sells crop hail insurance in conjunction with MPCI and believes that
offering crop hail insurance allows it to sell more MPCI policies than it
otherwise would. The Company retained a higher proportion of its crop hail
gross premiums written in 1994 than in 1993 due to substantial increases in the
cost of third party reinsurance following the unfavorable results in 1993 and
1992.
OTHER REDLAND P&C OPERATIONS
<TABLE>
<CAPTION>
PREMIUMS UNDERWRITING LOSS
YEAR EARNED GAIN(1) RATIO
------------------------------------------------- ------- ------------ -----
(IN THOUSANDS, EXCEPT PERCENTAGES)
<S> <C> <C> <C>
1990............................................. $ 5,291 $1,148 78.3%
1991............................................. 8,242 768 90.7
1992............................................. 17,207 5,230 69.6
1993............................................. 22,606 2,669 88.2
1994............................................. 26,017 8,409 67.7
</TABLE>
-------------------------
(1) Excluding underwriting and other expenses which are included in "Total
Expenses" shown in the "Total Redland Operations" table which follows.
Other Redland property and casualty lines include auto liability, auto
physical damage, farmowners, commercial multi-peril lines, and fire and allied
lines. Results in 1993 were adversely affected by a $3.0 million strengthening
of reserves prior to Redland's acquisition by the Company in mid-1993.
TOTAL REDLAND OPERATIONS
<TABLE>
<CAPTION>
TOTAL
UNDERWRITING TOTAL UNDERWRITING
YEAR GAIN(1) EXPENSES(2) PROFIT (LOSS)(3)
------------------------------------------------- ------------ ----------- ----------------
(IN THOUSANDS)
<S> <C> <C> <C>
1990............................................. $ 6,526 $ 2,384 $ 4,142
1991............................................. 8,734 5,415 3,319
1992............................................. 5,889 9,053 (3,164)
1993............................................. 68 7,145 (7,077)
1994............................................. 25,397 11,766 13,631
</TABLE>
-------------------------
(1) Represents the totals of the amounts shown for "Profit (Loss) Share" in the
"Multi-Peril Crop Insurance" table above, "Underwriting Gain (Loss)" in the
"Crop Hail and Other Crop Insurance" table, and "Underwriting Gain" in the
"Other Redland P&C Operations" table.
(2) Net of federal reimbursements for the administration of MPCI policies.
-11-
<PAGE> 12
(3) Represents "Total Underwriting Gain" less "Total Expenses."
The increase in Redland's expenses in 1994 over 1993 primarily resulted
from the Company's increased retention in 1994 of its crop hail gross premiums
written as described above, and consequently the receipt of an additional $3.8
million of ceding commissions from reinsurers of the Company's crop hail
business in 1993 as compared to 1994. The remainder of the increase in
expenses in 1994 was primarily the result of growth in premiums written.
COMBINED RATIOS
The statutory combined ratio, which reflects underwriting results before
taking into account investment income, is a traditional measure of underwriting
performance of a property and casualty insurer. A combined ratio of less than
100% indicates underwriting profitability whereas a combined ratio in excess of
100% indicates unprofitable underwriting. The following table reflects the loss
ratios, expense ratios and combined ratios of the Company (separately stated to
include and exclude MPCI and other crop insurance) and the property and casualty
insurance industry, computed in accordance with SAP, for each of the years in
the three-year period ending December 31, 1994.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------
1994(1) 1993(1) 1992
----- ----- -----
<S> <C> <C> <C>
The Company (including crop insurance)
Loss Ratio...................................................... 70.8% 78.4% 75.8%
Expense Ratio................................................... 25.6 28.8 29.3
----- ----- -----
Combined Ratio.................................................. 96.4% 107.2% 105.1%
===== ===== =====
The Company (excluding crop insurance)
Loss Ratio...................................................... 72.2% 74.9% 75.8%
Expense Ratio................................................... 30.4 30.1 29.3%
----- ----- -----
Combined Ratio.................................................. 102.6% 105.0% 105.1%
===== ===== =====
Industry Average(2)
Loss Ratio...................................................... 82.0% 79.5% 88.1%
Expense Ratio................................................... 27.4 27.4 27.5
----- ----- -----
Combined Ratio.................................................. 109.4% 106.9% 115.6%
===== ===== =====
</TABLE>
-------------------------
(1) For information with respect to the effect of MPCI on the Company's
historical combined ratios, see "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- General." 1993 data
includes Redland for the entire calendar year.
(2) Source: Best's Aggregates & Averages -- Property Casualty (1994 Edition).
Ratios for 1994 are preliminary and are from Best's Review,
Property-Casualty, January 1995 Edition.
UNDERWRITING
The Company's underwriting staff is organized by specific lines of
insurance. This enables the Company to take advantage of its underwriters'
expertise and experience in underwriting a particular type of insurance risk on
a consistent basis. In accepting risks, each underwriter is required to comply
with risk parameters, retention limits and rates prescribed by the Company.
Generally, in order to deliver prompt service while ensuring consistent
underwriting, the Company grants general agents the authority to sell and bind
insurance coverages in accordance with detailed procedures and limitations
established by the Company. The Company promptly reviews coverages bound by
agents, decides whether the insurance is written in accordance with such
procedures and limitations, and, subject to state law limits and policy terms,
may cancel coverages that are not in compliance. Regulations of each state vary
regarding cancellation of insurance policies and often depend upon whether they
are written on an admitted or non-admitted basis. Additionally, the policies
written by the Company provide that they may generally be canceled with 30 to 60
day notices, subject to state law limits.
-12-
<PAGE> 13
The Company's underwriting staff attempts to visit general agents and
independent agents not less than annually. Additionally, the Company provides
seminars in certain lines of business for its general agents and independent
agents to discuss, among other things, new procedures and policies, new
coverages and new regulatory requirements.
The Company grants limited binding authority to certain independent agents
in certain lines of business, and provides that all other agents submit all
quotes to the Company's underwriting staff in order for such coverages to be
bound. Each line of business has detailed procedures and limitations established
by the Company. Business that is outside a general agent's or an independent
agent's binding authority must be submitted to the Company's underwriting staff
to obtain approval to bind such coverages.
ARM's operations are subject to contractual and operational controls
designed to maintain proper underwriting standards. The authority of ARM to bind
the Company is limited to specific types of insurance detailed in reinsurance
treaties written for this business unit and is limited to risks under which the
Company's ultimate net retention does not exceed $150,000. Further, the Company
and each of the four reinsurers participating in this business periodically
audit the underwriting operations of ARM, and each has conducted at least two
audits during 1994.
The Company writes insurance in 44 states and the District of Columbia as
an admitted carrier and in 42 states, the District of Columbia and the Virgin
Islands as an approved non-admitted carrier. Non-admitted carriers normally are
restricted to writing lines of business not regularly written in the standard
admitted market, although they have greater freedom to design policy provisions
and charge appropriate premiums on an unregulated basis. The Company generally
seeks to have an insurance subsidiary licensed as an admitted carrier, as well
as another insurance subsidiary operating as an approved non-admitted carrier,
in each state in which it writes insurance in order to have the flexibility to
offer insurance products in both the admitted as well as the non-admitted
market. For the year ended December 31, 1994, the Company wrote 66% of its
direct written premiums as an admitted carrier and 34% as a non-admitted
carrier.
CLAIMS
The Company's claims department administers all claims and directs all
legal and adjustment aspects of the claims handling process. Independent
adjusters are utilized regularly to assist in settling claims. The Company
maintains an active approach to claims management which is designed to
investigate claims as soon as practicable in order to manage and anticipate
developments throughout the claims process.
The specialized nature of the Company's business segments requires specific
skills to settle claims successfully, and accordingly the Company maintains a
staff of experienced claim examiners. These claim examiners specialize in
individual segments of the Company's business, which provides greater
consistency and depth of experience in settling claims.
LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
The Company maintains reserves for estimates of liability for reported
losses, losses which have occurred but which have not yet been reported, and for
the expenses of investigating, processing and settling claims under outstanding
policies. Such reserves are estimates by the Company primarily based on Company
and industry experience with the types of risks involved, knowledge of the
circumstances surrounding individual claims, and Company and industry experience
with respect to the probable number and nature of claims arising from losses not
yet reported. The effects of inflation are implicitly reflected in these loss
reserves through the industry data utilized in establishing such reserves. The
Company does not discount its reserves to estimated present value for financial
reporting purposes. The Company annually obtains an independent review of its
loss reserving process and reserve estimates by a professional actuary as part
of the annual audit of its financial statements.
-13-
<PAGE> 14
The following table presents an analysis of the Company's reserves,
reconciling beginning and ending reserve balances for the periods indicated:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------
1994 1993 1992
--------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Net loss and loss adjustment expense reserves at beginning of
year....................................................... $ 115,714 $ 77,627 $ 66,132
--------- -------- --------
Net loss and loss adjustment expense reserves of Redland at
date of acquisition........................................ -- 13,499 --
--------- -------- --------
Provisions for net losses and loss adjustment expenses for
claims occurring in the current year....................... 137,881 90,250 57,678
Increase in net reserves for claims occurring in prior
years...................................................... 5,070 2,555 2,347
--------- -------- --------
142,951 92,805 60,025
--------- -------- --------
Net losses and loss adjustment expenses paid for claims
occurring during:
The current year........................................... (60,375) (40,209) (18,328)
Prior years................................................ (56,776) (28,008) (30,202)
--------- -------- --------
(117,151) (68,217) (48,530)
--------- -------- --------
Net loss and loss adjustment expense reserves at end of
year....................................................... 141,514 115,714 77,627
Reinsurance recoverable on unpaid losses and loss adjustment
expenses................................................... 79,811 95,886 50,039
--------- -------- --------
Gross loss and loss adjustment expense reserves.............. $ 221,325 $211,600 $127,666
========= ======== ========
</TABLE>
-14-
<PAGE> 15
The following table presents the development of balance sheet loss reserves
from calendar years 1984 through 1994. The top line of the table shows the loss
reserves at the balance sheet date for each of the indicated years. These
amounts are the estimates of losses and loss adjustment expenses for claims
arising in all prior years that are unpaid at the balance sheet date, including
losses that had been incurred but not yet reported to the Company. The middle
section of the table shows the cumulative amount paid with respect to previously
recorded reserves as of the end of each succeeding year. The lower section of
the table shows the re-estimated amount of the previously recorded reserves
based on experience as of the end of each succeeding year. The "Net cumulative
redundancy (deficiency)" caption represents the aggregate cumulative change in
the estimates over all prior years. The Company computes the cumulative
redundancy (deficiency) annually on a calendar year basis.
The establishment of reserves is an inherently uncertain process. The
Company underwrites both property and casualty coverages in a number of
specialty areas of business which may involve greater risks than standard
property and casualty lines, including the risks associated with the absence of
a long-term, reliable historical claims experience. These risk components may
make more difficult the task of estimating reserves for losses, and cause the
Company's underwriting results to fluctuate. Further, conditions and trends
that have affected the development of loss reserves in the past may not
necessarily occur in the future. Accordingly, it may not be appropriate to
extrapolate future redundancies or deficiencies based on this information.
The Company adopted Statement of Financial Accounting Standards No.
113 ("SFAS #113"), "Accounting and Reporting for Reinsurance of Short-Duration
and Long-Duration Contracts," effective January 1, 1993. The effect of the
application of SFAS #113 resulted in the reclassification of amounts ceded to
reinsurers, which amounts were previously reported as a reduction in unearned
premium and unpaid losses and loss adjustment expenses, to assets on the
consolidated balance sheet. The table below includes a reconciliation of net
loss and loss adjustment expense reserves to amounts presented on the
consolidated balance sheet after reclassifications related to the adoption of
SFAS #113. The gross cumulative deficiency is presented for 1992 and 1993, the
only years on the table for which the Company has restated amounts in
accordance with SFAS #113.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------------------------------------------------------------------------------
1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994
------- ------- ------- ------- ------- ------- ------- -------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net reserves for
unpaid losses
and loss
adjustment
expenses...... $ 2,764 $ 7,894 $17,373 $27,730 $34,092 $43,380 $58,439 $ 66,132 $ 77,627 $115,714 $141,514
Cumulative
amount of net
liability paid
through:
One year
later........ 2,475 3,857 5,641 8,490 10,413 13,026 23,737 30,202 28,008 56,776
Two years
later........ 4,510 6,408 10,955 15,710 17,765 25,790 41,391 47,803 57,140
Three years
later........ 5,463 8,609 14,721 20,207 23,436 33,005 51,703 63,862
Four years
later........ 6,193 9,868 16,229 22,691 26,254 36,676 59,125
Five years
later........ 6,514 9,970 17,385 23,486 27,802 38,677
Six years
later........ 6,563 10,123 17,464 24,153 29,087
Seven years
later........ 6,658 10,113 17,521 24,449
Eight years
later........ 6,624 10,137 17,751
Nine years
later........ 6,652 10,167
Ten years
later........ 6,652
Net reserves
reestimated as
of:
One year
later........ 5,221 8,720 17,260 26,778 33,360 42,969 58,637 68,479 80,182 120,784
Two years
later........ 6,020 9,490 18,196 27,066 31,482 41,307 59,775 72,712 85,160
Three years
later........ 6,378 10,589 18,648 25,326 29,761 39,670 62,752 77,305
Four years
later........ 6,775 10,606 17,894 24,885 28,936 40,132 64,715
Five years
later........ 6,647 10,224 17,996 24,431 29,081 40,790
Six years
later........ 6,618 10,256 17,802 24,619 29,516
Seven years
later........ 6,686 10,183 17,845 24,651
Eight years
later........ 6,663 10,179 17,890
Nine years
later........ 6,674 10,233
Ten years
later........ 6,662
Net cumulative
redundancy
(deficiency)(1)... $(3,898) $(2,339) $ (517) $ 3,079 $ 4,576 $ 2,590 $(6,276) $(11,173) $ (7,533) $ (5,070)
Gross reserves
for unpaid
loss and loss
adjustment
expenses....... $127,666 $211,600 $221,325
Reinsurance
recoverable on
unpaid loss and
loss adjustment
expenses....... 50,039 95,886 79,811
-------- -------- --------
Net reserves for
unpaid loss and
loss adjustment
expenses....... 77,627 115,714 $141,514
==========
Reestimated
gross reserves
for unpaid loss
and loss
adjustment
expenses....... 129,950 220,244
Reestimated
reinsurance
recoverable on
unpaid
loss and loss
adjustment
expenses....... 44,790 99,460
-------- --------
Reestimated net
reserves for
unpaid loss and
loss adjustment
expenses....... 85,160 120,784
-------- --------
Gross cumulative
deficiency..... $ (2,284) $ (8,644)
========== ==========
</TABLE>
-------------------------
(1) Cumulative deficiencies appearing in the Company's reserve estimates for
years 1990 through 1993 principally resulted from adverse loss and loss
adjustment expense development occurring in the 1990 and 1991 accident years
in its general liability and commercial multi-peril lines of business, and
to a lesser extent its workers' compensation and liquor liability lines. The
actual experience of these lines differed from the historical patterns
causing the deficiencies. The Company has reviewed and adjusted its
reserving practices and actuarial techniques to adjust for these reserve
deficiencies.
-15-
<PAGE> 16
For further information about the Company's loss reserves, see "Certain
Investment Considerations -- Loss Reserves."
REINSURANCE
A significant component of the Company's business strategy involves the
structuring of reinsurance tailored to the needs of its business lines.
Insurance companies purchase reinsurance to spread risk on individual exposures,
protect against catastrophic losses and increase their capacity to write
insurance. Reinsurance involves an insurance company transferring, or ceding,
all or a portion of its exposure on insurance to a reinsurer. The reinsurer
assumes the exposure in return for a portion of the premium received by the
insurance company. Reinsurance does not discharge the insurer from its
obligations to its insured. If the reinsurer fails to meet its obligations, the
ceding insurer remains liable to pay the insured, but the reinsurer is liable to
the ceding insurer to the extent of the reinsured portion of any loss.
The Company limits its exposure under individual policies by purchasing
excess of loss and quota share reinsurance from other insurance companies, as
well as maintaining catastrophe reinsurance to protect against catastrophic
occurrences where claims can arise under several policies from a single event,
such as a hurricane, earthquake, wind storm, riot, tornado or other
extraordinary event.
The Company generally retains the first $500,000 of risk under its casualty
lines, ceding the next $2,500,000 to reinsurers; and 25% of the first $500,000
of risk under its property lines, ceding the other 75% to quota share reinsurers
and the next $1,500,000 per risk to other reinsurers. The foregoing reinsurance
coverage does not apply to business written through ARM, for which the Company
maintains a separate 70% quota share treaty. To the extent that individual
policies in any line exceed reinsurance treaty limits, it is the Company's
customary policy to purchase reinsurance on a facultative (specific policy)
basis.
The Company maintains catastrophe reinsurance for its casualty lines which
provides coverages of $7 million in excess of $3 million of aggregate risk per
occurrence, and for its property lines, which provides catastrophe coverage of
95% of $17,500,000 in excess of $2,500,000 per catastrophe.
In its Minnesota workers' compensation business, the Company buys
catastrophe coverage on an unlimited basis from the Minnesota Workers
Compensation Reinsurance Association in excess of $450,000 retention per
occurrence. In other states the Company purchases $49.5 million of coverage in
excess of $500,000 per occurrence and $9.5 million of coverage in excess of
$500,000 per person through private insurers.
The Company reinsures its MPCI business with various federal reinsurance
pools administered by the CFSA. Under the CFSA's reinsurance program, the
Company may (at the Company's election) cede to the CFSA a portion of the
Company's gross exposure under MPCI policies, ranging from 0% to 80% of such
exposure. In 1994, the Company ceded to the CFSA an aggregate of 39.7% of such
gross exposure. The Company's net exposure on MPCI business is further reduced
by privately placed stop loss reinsurance purchased from private carriers. See
"Business -- Multi-Peril Crop Insurance Program."
Approximately 50% of the Company's crop hail business is reinsured through
quota share agreements, which is also supplemented by surplus and stop loss
contracts purchased from private reinsurers. Surplus agreements generally limit
the Company's quota share exposure to $1,500,000 per county or township. Stop
loss reinsurance is purchased to cover 90% of net retained losses exceeding 90%
up to 130% of retained premiums.
Reinsurance treaties are renegotiated and renewed annually by the
Company, generally by March 31st. Although the Company may determine to make
changes in its reinsurance facilities for the next renewal year, it is
currently anticipated that its reinsurance program will remain substantially
the same.
The Company seeks to mitigate exposure to adverse reinsurance pricing
conditions and to credit risk by maintaining a diversity of reinsurers. The
Company closely monitors the quality and performance of its reinsurers. At
December 31, 1994, 94% of the Company's outstanding reinsurance recoverables
were from
-16-
<PAGE> 17
domestic reinsurance companies or the federal government, 98% of which was from
domestic reinsurance companies rated A- (Excellent) or better by A.M. Best or
from the federal government. The balance of the Company's reinsurance was
primarily placed with major international reinsurers.
The following table sets forth the principal domestic reinsurers of the
Company and their A.M. Best ratings, ranked in order of outstanding reinsurance
recoverables at December 31, 1994.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1994
----------------------------------------------
OUTSTANDING REINSURANCE
REINSURANCE PREMIUMS A.M. BEST'S
DOMESTIC REINSURER RECOVERABLES CEDED 1993 RATING
---------------------------------------------------------------- --------------- ----------- ------------
(IN THOUSANDS)
<S> <C> <C> <C>
Consolidated Farm Service Agency................................ $ 35,515 $92,744 Government
Constitution Reinsurance Corporation............................ 15,607 18,113 A+
Reliance Reinsurance Corporation................................ 6,955 14,223 A-
Re Capital Reinsurance Company.................................. 6,803 5,379 A
Cologne Reinsurance Company of America.......................... 5,755 42 A+
Skandia America Reinsurance Corporation......................... 5,113 6,116 A
PMA Reinsurance Corporation..................................... 4,704 4,952 A+
Signet Star Reinsurance Corporation............................. 4,659 2,358 A
------------
Subtotal.................................................... 85,111
------------
Other Reinsurance Recoverables from Domestic Reinsurers
Rated A- or Better by A.M. Best........................... 19,178
------------
Total Outstanding Reinsurance recoverables from Domestic
Reinsurers Rated A- or Better by A.M. Best................ $ 104,289
Total Outstanding Reinsurance Recoverables
from Domestic Reinsurers.................................. $ 106,000
------------
Percentage of Total Outstanding Domestic Reinsurance
Recoverables from Reinsurers which are Rated A- or
Better.................................................... 98%
=============
</TABLE>
INVESTMENTS
The Company's investment policy is to maximize the after-tax yield of the
portfolio while emphasizing the stability and preservation of the Company's
capital base. Further, the portfolio is invested in types of securities and in
an aggregate duration which reflect the nature of the Company's liabilities and
expected liquidity needs. The Company manages its portfolio internally.
Effective January 1, 1994, all of the Company's fixed maturity securities were
classified as available for sale and carried at market value. At December 31,
1993, the fixed maturity securities which the Company classified as available
for sale were carried at the lower of aggregate cost or market and the fixed
maturity securities classified as held for investment were carried at cost. The
investment portfolio at December 31, 1994 and December 31, 1993, consisted of
the following:
<TABLE>
<CAPTION>
DECEMBER 31, 1994 DECEMBER 31, 1993
--------------------- ---------------------
CARRYING CARRYING
TYPE OF INVESTMENT COST VALUE COST VALUE
------------------------------------------------ -------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Fixed maturity securities
U.S. government obligations................... $ 68,308 $ 66,087 $ 26,455 $ 26,455
Obligations of states and political
subdivisions............................... 39,544 37,595 33,874 33,874
Foreign corporations.......................... 1,499 1,430 499 499
Public utilities.............................. 4,904 4,693 3,218 3,218
All other corporate bonds..................... 21,796 21,300 9,789 9,789
Collateral-backed securities.................. 73,024 59,075 73,757 73,757
-------- -------- -------- --------
Total fixed maturity securities....... 209,075 190,180 147,592 147,592
Common stocks................................... 5,960 5,772 5,439 5,427
Preferred stocks................................ 7,803 6,758 8,367 8,445
Commercial mortgages............................ 1,869 1,869 2,852 2,852
Real estate..................................... 3,891 3,891 4,266 4,266
Short-term investments(1)....................... 56,273 56,273 19,404 19,404
-------- -------- -------- --------
Total................................. $284,871 $264,743 $187,920 $187,986
======== ======== ======== ========
</TABLE>
-------------------------
(1) Due to the short-term nature of crop insurance, the Company must maintain
short-term investments to fund amounts due. Historically, these short-term
funds are highest in the Fall corresponding to the cash flow of the
agricultural industry.
-17-
<PAGE> 18
The following table sets forth, as of December 31, 1994, the composition of
the Company's fixed maturity securities portfolio by time to maturity.
<TABLE>
<CAPTION>
CARRYING
MATURITY: VALUE PERCENT
------------------------------------------------------------------- -------- -------
(IN THOUSANDS,
EXCEPT
PERCENTAGES)
<S> <C> <C>
1 year or less..................................................... $ 5,713 3.0%
More than 1 year through 5 years................................... 72,909 38.3
More than 5 years through 10 years................................. 22,050 11.6
More than 10 years................................................. 30,433 16.0
Collateral backed securities....................................... 59,075 31.1
-------- -----
Total.................................................... $190,180 100.0%
======== =====
</TABLE>
The following table sets forth, as of December 31, 1994, the ratings
assigned to the Company's fixed maturity securities.
<TABLE>
<CAPTION>
CARRYING
RATING:(1) VALUE PERCENT
------------------------------------------------------------------- -------- -------
(IN THOUSANDS,
EXCEPT
PERCENTAGES)
<S> <C> <C>
Aaa................................................................ $156,399 82.3%
Aa................................................................. 6,847 3.6
A.................................................................. 20,221 10.6
Baa................................................................ 3,807 2.0
Below investment grade............................................. 2,906 1.5
-------- -----
Total.................................................... $190,180 100.0%
======== =====
</TABLE>
-------------------------
(1) Ratings are assigned by Moody's Investors Service, Inc. when available, with
the remaining ratings assigned by Standard & Poor's Corporation.
The Company's investment results for the periods indicated are set forth
below:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------
1994 1993 1992
-------- -------- --------
(IN THOUSANDS, EXCEPT PERCENTAGES)
<S> <C> <C> <C>
Net investment income...................................... $ 13,276 $ 10,844 $ 8,220
Average investment portfolio(1)............................ 220,125 173,182 113,024
Pre-tax return on average investment portfolio............. 6.0% 6.3% 7.3%
Net realized gains......................................... $ 554 $ 2,250 $ 1,046
</TABLE>
-------------------------
(1) Average investment portfolio represents the average of the beginning and
ending investment portfolio (excluding real estate) computed on a quarterly
basis.
-18-
<PAGE> 19
The Company's collateral backed securities portfolio consists of
mortgage-backed securities, all of which are collateralized mortgage obligations
("CMOs"). The following table sets forth as of December 31, 1994 the categories
of the Company's CMOs, which at such date had an average life of approximately
six years.
<TABLE>
<CAPTION>
CARRYING
TYPE OF CMO PAR VALUE(1) AMORTIZED COST(1) VALUE
--------------------------------------------------------- ------------ ----------------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Fixed coupon............................................. $ 18,547 $18,795 $ 17,581
Floating rate(2)......................................... 18,460 18,354 17,838
Inverse floating rate(2)................................. 38,037 35,875 23,656
-------- ------- --------
Total CMOs(3).................................. $ 75,044 $73,024 $ 59,075
======== ======= ========
</TABLE>
-------------------------
(1) Par value is the face amount of the underlying mortgage collateral. Any cost
in excess of par value is a "premium" whereas cost lower than par value is a
"discount." The Company's aggregate CMO portfolio has been purchased at a
discount.
(2) Floating rate CMOs provide an increased interest rate when a specified index
interest rate increases and a lower interest rate when such index rate
decreases, while inverse floating rate CMOs provide a lower interest rate
when the index rate increases and a higher rate when the index rate
decreases. Generally, the Company's floating rate and inverse floating rate
securities are tied to the one month LIBOR. The market values of the
Company's floating rate and inverse floating rate CMOs are significantly
impacted by various factors, including the outlook for future interest rate
changes and such securities' relative liquidity under current market
conditions. In certain cases, carrying values presented are determined by
modeling techniques for securities not actively traded. See Note 1 to the
Consolidated Financial Statements.
(3) All of the CMO portfolio collateral is guaranteed by a government agency.
The yield characteristics of mortgage-backed securities differ from those
of traditional fixed maturity securities. Interest and principal payments occur
more frequently, often monthly, and mortgage-backed securities are subject to
risks associated with variable prepayments. Prepayment rates are influenced by a
number of factors which cannot be predicted with certainty, including the
relative sensitivity of the underlying mortgages backing the assets to changes
in interest rates, a variety of economic, geographic and other factors and the
prepayment priority of the securities in the overall securitization structures.
In general, prepayments on the underlying mortgage loans, and the
securities backed by these loans, increase when the level of prevailing interest
rates decline significantly below the interest rates on such loans.
Mortgage-backed securities purchased at a discount to par will experience an
increase in yield when the underlying mortgages prepay faster than expected
because the faster prepayment results in accelerated recognition of the discount
as income. Those securities purchased at a premium that prepay faster than
expected will incur a reduction in yield because the faster prepayment results
in accelerated amortization of the premium. When declines in interest rates
occur, the proceeds from the prepayment of mortgage-backed securities are likely
to be reinvested at lower rates than the Company was earning on the prepaid
securities.
As the level of prevailing interest rates increases, which occurred during
1994, prepayments on mortgage-backed securities decelerate as fewer underlying
mortgages are refinanced. When this occurs, the average maturity and duration of
the mortgage-backed securities increase, which decreases the yield on mortgage-
backed securities purchased at a discount because the discount is realized as
income at a slower rate and increases the yield on those purchased at a premium
as a result of a decrease in annual amortization of the premium.
REGULATION
As a general rule, an insurance company must be licensed to transact
insurance business in each jurisdiction in which it operates, and almost all
significant operations of a licensed insurer are subject to regulatory scrutiny.
Licensed insurance companies are generally known as "admitted" insurers. Most
states provide a limited exemption from licensing for insurers issuing insurance
coverages that generally are not
-19-
<PAGE> 20
available from admitted insurers. Their coverages are referred to as "surplus
lines" insurance and these insurers as "surplus lines" or "non-admitted"
companies.
The Company's admitted insurance businesses are subject to comprehensive,
detailed regulation throughout the United States, under statutes which delegate
regulatory, supervisory and administrative powers to state insurance
commissioners. The primary purpose of such regulations and supervision is the
protection of policyholders and claimants rather than stockholders or other
investors. Depending on whether the insurance company is domiciled in the state
and whether it is an admitted or non-admitted insurer, such authority may extend
to such things as (i) periodic reporting of the insurer's financial condition;
(ii) periodic financial examination; (iii) approval of rates and policy forms;
(iv) loss reserve adequacy; (v) insurer solvency; (vi) the licensing of insurers
and their agents; (vii) restrictions on the payment of dividends and other
distributions; (viii) approval of changes in control; and (ix) the type and
amount of permitted investments.
The Company also is subject to laws governing insurance holding companies
in Nebraska, Iowa and Arizona, where the Insurance Companies are domiciled.
These laws, among other things, require the Company to file periodic information
with state regulatory authorities including information concerning its capital
structure, ownership, financial condition and general business operations;
regulate certain transactions between the Company, its affiliates and the
Insurance Companies, including the amount of dividends and other distributions
and the terms of surplus notes; and restrict the ability of any one person to
acquire certain levels of the Company's voting securities without prior
regulatory approval.
The insurance holding company laws of Nebraska, Iowa and Arizona limit
dividends and other distributions from the Insurance Companies to the Company.
Under Nebraska law, dividends or distributions may not be paid by an insurance
company without prior regulatory approval, unless such dividend, together with
any dividends paid within the preceding 12 months, does not exceed the lesser of
(a) 10% of the policyholders' surplus of the insurer as of the preceding
December 31 or (b) the insurer's net income, excluding realized capital gains,
for the preceding calendar year, all as computed in accordance with SAP. In
determining net income available for dividends in Nebraska, an insurer may carry
forward net income from the second and third full calendar years preceding the
date of determination, again excluding realized capital gains, less dividends
paid in such prior calendar years. Under Iowa law, dividends or distributions
may not be paid by an insurance company without prior regulatory approval,
unless such dividend, together with any dividends paid within the preceding
twelve months, does not exceed the greater of (a) 10% of the policyholders'
surplus of the insurer as of the preceding December 31 or (b) the insurer's net
income for the preceding calendar year, all as computed in accordance with SAP.
Under Arizona law, dividends or distributions may not be paid by an insurance
company without prior regulatory approval, unless such dividend, together with
any dividends paid within the preceding twelve months, does not exceed the
lesser of (a) 10% of the policyholders' surplus of the insurer as of the
preceding December 31 or (b) the insurer's net investment income (including
realized capital losses and excluding realized capital gains) for the preceding
calendar year, all as computed in accordance with SAP.
Other regulatory and business considerations may further limit the
willingness of the Insurance Companies to pay dividends. For example, the impact
of dividends on surplus could affect an insurer's competitive position, the
amount of premiums that it can write and its ability to pay future dividends.
Further, the insurance laws and regulations of Nebraska, Iowa and Arizona
require that the statutory surplus of an insurance company domiciled therein,
following any dividend or distribution by such company, be reasonable in
relation to its outstanding liabilities and adequate for its financial needs.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."
While the non-insurance company subsidiaries are not subject directly to
the dividend and other distribution limitations, insurance holding company
regulations govern the amount which a subsidiary within the holding company
system may charge any of the Insurance Companies for services (e.g., agents'
commissions).
The Company's MPCI program is federally regulated and supported by the
federal government by means of premium subsidies to farmers, expense
reimbursement and federal reinsurance pools for private insurers. Consequently,
the MPCI program is subject to oversight by the legislative and executive
branches of the
-20-
<PAGE> 21
federal government, including the CFSA, a division of the USDA. The MPCI program
regulations generally require compliance with federal guidelines with respect to
underwriting, rating and claims administration. The Company is required to
perform continuous internal audit procedures and is subject to audit by several
federal government agencies.
The MPCI program has historically been subject to change by the federal
government at least annually since its establishment in 1980, some of which
changes have been significant. The most recent significant changes to the MPCI
program came as a result of the passage by Congress of the Reform Act of 1994.
See "Business -- Multi-Peril Crop Insurance Program."
Certain provisions of the Reform Act, if implemented by the CFSA, may
increase competition among private insurers in the pricing of Buy-up Coverage.
The Reform Act authorizes the CFSA to implement regulations permitting insurance
companies to pass on to farmers in the form of reduced premiums certain cost
efficiencies related to any excess expense reimbursement over the insurer's
actual cost to administer the program, which could result in increased price
competition. To date, the CFSA has not enacted regulations implementing these
provisions.
During the past several years, various regulatory and legislative bodies
have adopted or proposed new laws or regulations to deal with the cyclical
nature of the insurance industry, catastrophic events and insurance capacity and
pricing. These regulations include (i) the creation of "market assistance plans"
under which insurers are induced to provide certain coverages, (ii) restrictions
on the ability of insurers to cancel certain policies in mid-term, (iii) advance
notice requirements or limitations imposed for certain policy non-renewals and
(iv) limitations upon or decreases in rates permitted to be charged.
Governmental regulators and the NAIC re-examine from time to time existing
laws and regulations and their application to insurance companies. For example,
the NAIC recently approved and recommended that states adopt and implement
several regulatory initiatives designed to be used by regulators as an early
warning tool to identify deteriorating or weakly capitalized insurance companies
and to decrease the risk of insolvency of insurance companies. These initiatives
include the implementation of the RBC standards for determining adequate levels
of capital and surplus to support four areas of risk facing property and
casualty insurers: (a) asset risk (default on fixed income assets and market
decline), (b) credit risk (losses from unrecoverable reinsurance and inability
to collect agents' balances and other receivables), (c) underwriting risk
(premium pricing and reserve estimates), and (d) off-balance sheet/growth risk
(excessive premium growth and unreported liabilities). The RBC standards require
regulators to analyze the ratio of an insurance company's total adjusted capital
(defined as the total of its statutory capital and surplus, as adjusted) to its
required RBC. Insurers having less statutory surplus than that required by the
RBC formula will be subject to varying degrees of regulatory attention, from
submission of a comprehensive plan to improve its capital position, to special
examinations, to being placed under supervision.
The RBC formula provides a mechanism for the calculation of an insurance
company's authorized control level RBC and its total adjusted capital. The
formula sets forth the points at which a commissioner of insurance is authorized
and expected to take regulatory action. The first level is known as the company
action level RBC, which is set at twice the authorized control level RBC. The
second level is the regulatory action level RBC, set at 1.5 times the authorized
control level RBC. The third is the authorized control level RBC, and the fourth
is the mandatory control level RBC, set at 70 percent of the authorized control
level RBC.
If an insurance company's adjusted capital is higher than or equal to the
regulatory action level RBC but below the company action level RBC, the
insurance company must submit to its commissioner of insurance an RBC plan which
shall contain, among other things, proposals for corrective action. If an
insurance company's adjusted capital is higher than or equal to the authorized
control level RBC but lower than the regulatory action level RBC, the
commissioner of insurance shall perform any examination or analysis as deemed
necessary of the insurer's business and operations and issue any appropriate
corrective orders to address the insurance company's financial problems. If an
insurer's adjusted capital is higher than or equal to the mandatory control
level RBC but lower than the authorized control level RBC, the commissioner may
place the insurer under regulatory control. If the insurance company's adjusted
capital falls below the mandatory
-21-
<PAGE> 22
control level RBC, the commissioner will be required to place the insurer under
regulatory control. Of the states in which the Insurance Companies are
domiciled, Nebraska is the first state to adopt, effective January 1, 1994, RBC
rules into law, although the RBC results must be reported to the states in which
the Insurance Companies do business. The Nebraska RBC statute is similar to the
NAIC initiative set forth above. Management believes the implementation of RBC
will not have a material adverse effect on the operations of the Insurance
Companies, each of which has exceeded the RBC requirements for the 1994 year.
The NAIC has developed its Insurance Regulatory Information System ("IRIS")
to assist state insurance departments in identifying significant changes in the
operations of an insurance company, such as changes in its product mix, large
reinsurance transactions, increases or decreases in premiums received and
certain other changes in operations. Such changes may not result from any
problems with an insurance company but merely indicate changes in certain ratios
outside ranges defined as normal by the NAIC. When an insurance company has four
or more ratios falling outside "normal ranges," state regulators may investigate
to determine the reasons for the variance and whether corrective action is
warranted.
For the year ended December 31, 1993, Redland Insurance was outside the
normal range specified by IRIS in six out of the twelve IRIS ratios for property
and casualty insurers. The Company has taken action to improve certain of these
ratio results, and, during 1994, the Company contributed a total of $24 million
to the surplus of Redland Insurance, including the $18 million described below.
As a result primarily of the foregoing IRIS results, the Iowa insurance
regulatory authorities conducted a special examination of Redland Insurance for
the year ended December 31, 1993. Since the results of this examination have not
yet been disclosed to the Company, no assurance can be given that such
examination will not result in regulatory action that could have an adverse
impact on the business or results of operations of Redland Insurance.
For the year ended December 31, 1994, Redland Insurance was outside the
normal range specified by IRIS in four out of the twelve IRIS ratios. Of these
four ratios, the investment yield ratio was outside the normal range as a result
of the high proportion of short-term investments held by Redland due to its
short-term crop insurance business and the change in surplus ratio was outside
the normal range due to surplus contributions to Redland Insurance from its
parent company. Although the Company does not believe that these ratios will
result in regulatory action having a material effect on the Company, there can
be no assurance as to the foregoing.
The insurance laws of Michigan require non-domiciliary insurance
companies that undergo a change of control to requalify for their certificates
of authority to write insurance. On May 29, 1994, the Michigan Insurance Bureau
(the "Bureau") revoked Redland Insurance's certificate of authority after it
failed to requalify under such law following its acquisition by the Company.
The Bureau cited as its reason concerns about Redland Insurance's
capitalization, operating ratios and 1993 IRIS ratios. The Company has since
improved the capitalization of Redland Insurance. Redland Insurance plans to
seek requalification in Michigan in 1996. For 1994, gross premiums written by
Redland in Michigan were $4.5 million, 90% of which consisted of MPCI and crop
hail insurance. The Company does not believe that the action by Michigan will
have a material adverse effect on the Company's financial condition and results
of operations since management believes that the Company has been able to write
through Acceptance Insurance substantially all of the Michigan business it
would have written through Redland Insurance.
On August 29, 1994, after a review of the Company's six month financial
statements, A.M. Best placed the current A- (Excellent) rating of three of the
rated Insurance Companies under review, with negative implications, citing as
the reason the Company's growth in written premiums without a corresponding
growth in surplus. Subsequently, the Company increased the statutory surplus of
Redland Insurance and Acceptance Insurance by an additional $18 million and $20
million, respectively, with the proceeds from the exercise of the Warrants. A.M.
Best then affirmed the Insurance Companies' A- (Excellent) rating.
The eligibility of the Company's insurance subsidiaries to write insurance
on a surplus lines basis in most jurisdictions is dependent on their compliance
with certain financial standards, including the maintenance of a requisite level
of capital and surplus and the establishment of certain statutory deposits.
State surplus lines laws typically: (i) require the insurance producer placing
the business to show that he or she was unable to
-22-
<PAGE> 23
place the coverage with admitted insurers; (ii) establish minimum financial
requirements for surplus lines insurers operating in the state; and (iii)
require the insurance producer to obtain a special surplus lines license. In
recent years, many jurisdictions have increased the minimum financial standards
applicable to surplus lines eligibility.
The Insurance Companies also may be required under the solvency or guaranty
laws of most states in which they are licensed to pay assessments (up to certain
prescribed limits) to fund policyholder losses or liabilities of insolvent or
rehabilitated insurance companies. These assessments may be deferred or forgiven
under most guaranty laws if they would threaten an insurer's financial strength
and, in certain instances, may be offset against future premium taxes. Some
state laws and regulations further require participation by the Insurance
Companies in pools or funds to provide some types of insurance coverages which
they would not ordinarily accept.
It is not possible to predict the future impact of changing state and
federal regulation on the Company's operations, and there can be no assurance
that existing insurance-related laws and regulations will not become more
restrictive in the future or that laws and regulations enacted in the future
will not be more restrictive than existing laws.
EMPLOYEES
At March 15, 1995 the Company and its subsidiaries employed 17 salaried
executives and 775 other personnel. Acceptance believes that relations with its
employees are good.
-23-
<PAGE> 24
ITEM 2. PROPERTIES.
The following table sets forth certain information regarding the
principal properties of the Company.
<TABLE>
<CAPTION>
Location General Character Size Leased/Owned
----------------------- --------------------- ------------------------- ------------
<S> <C> <C> <C>
Omaha, NE . . . . . . . Office 44,000 sq. ft. Leased(1)
Council Bluffs, IA. . . Office 63,000 sq. ft. Leased(1)
Burlington, NC. . . . . Office 15,000 sq. ft. Leased(1)
Phoenix, AZ . . . . . . Office 33,000 sq. ft. Leased(1)
Scottsdale, AZ. . . . . Office 11,000 sq. ft. Leased(1)
</TABLE>
---------------------
(1) The range of expiration dates for these leases is November 30, 2001
(Omaha), June 30, 1997 (Council Bluffs), February 1, 1996 (Burlington),
February 21, 2000 (Phoenix), and December, 1998 (Scottsdale).
ITEM 3. LEGAL PROCEEDINGS.
There are no material legal proceedings pending involving the Company or
any of its subsidiaries which require reporting pursuant to this Item.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended December 31, 1994.
-24-
<PAGE> 25
ITEM 5. MARKET FOR REGISTRANT'S EQUITY AND RELATED STOCKHOLDER MATTERS.
The Common Stock is listed and traded on the NYSE. The following table sets
forth the high and low sales prices per share of Common Stock as reported on the
NYSE Composite Tape for the fiscal quarters indicated.
<TABLE>
<CAPTION>
HIGH LOW
---- ----
<S> <C> <C>
Year Ended December 31, 1993
First Quarter................................................ $13 1/4 $8 1/4
Second Quarter............................................... 14 1/8 12
Third Quarter................................................ 15 1/4 12 1/2
Fourth Quarter............................................... 15 5/8 11 1/4
Year Ended December 31, 1994
First Quarter................................................ 13 3/4 11 1/8
Second Quarter............................................... 13 5/8 11 3/8
Third Quarter................................................ 15 1/8 12 3/4
Fourth Quarter............................................... 18 12 5/8
Year Ending December 31, 1995
First Quarter (through March 29, 1995)....................... 16 5/8 14 1/8
</TABLE>
The closing sales price of the Common Stock on March 29, 1995, as reported
on the NYSE Composite Tape, was $15 per share. As of March 29, 1995, there
were approximately 1,900 holders of record of the Common Stock.
The Company has not paid cash dividends to its stockholders during the
periods indicated above and does not anticipate that it will pay cash dividends
in the foreseeable future. The Revolving Credit Facility prohibits the payment
of cash dividends to stockholders. See "Business -- Regulation" for a
description of restrictions on payment of dividends to the Company from the
Insurance Companies.
-25-
<PAGE> 26
ITEM 6. SELECTED FINANCIAL DATA.
SELECTED CONSOLIDATED FINANCIAL DATA
The following table sets forth certain selected consolidated financial data
and should be read in conjunction with, and is qualified in its entirety by, the
Consolidated Financial Statements and the notes thereto and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
appearing elsewhere herein. This selected consolidated financial
data has been derived from the audited Consolidated Financial Statements of the
Company and its subsidiaries. The information set forth below with respect to
insurance operations does not present information for Acceptance Insurance's
operations for periods prior to its acquisition by the Company in April 1990.
<TABLE>
<CAPTION>
FOUR MONTHS
YEARS ENDED DECEMBER 31, ENDED YEAR ENDED
------------------------------------------------ DECEMBER 31, AUGUST 31,
1994(1) 1993(1) 1992 1991 1990(2) 1990
-------- -------- -------- -------- ------------ -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA AND RATIOS)
<S> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Insurance Revenues:
Gross premiums written.......... $447,483 $256,042 $152,091 $104,853 $ 25,563 $38,985
======== ======== ======== ======== ======== =======
Net premiums written............ $229,176 $137,505 $ 84,085 $ 62,982 $ 16,627 $36,940
======== ======== ======== ======== ======== =======
Net premiums earned............. $202,659 $128,082 $ 79,164 $ 65,164 $ 23,362 $27,948
Net investment income........... 12,864 10,467 8,220 6,103 2,367 3,145
Net realized capital gains...... 554 2,250 1,046 1,953 1,155 616
Agency income................... 3,629 4,119 3,992 1,645 -- --
-------- -------- -------- -------- -------- -------
Insurance revenues............ 219,706 144,918 92,422 74,865 26,884 31,709
Non-insurance revenues(3).......... 412 377 2,610 5,824 1,498 1,870
-------- -------- -------- -------- -------- -------
Total revenues..................... 220,118 145,295 95,032 80,689 28,382 33,579
Insurance expenses:
Losses and loss adjustment
expenses...................... 142,951 92,805 60,025 46,917 16,928 19,746
Underwriting and other
expenses...................... 52,627 36,905 23,523 19,433 6,371 8,389
Agency expenses................. 3,180 3,794 3,736 1,624 -- --
-------- -------- -------- -------- -------- -------
Insurance expenses............ 198,758 133,013 86,793 67,483 23,095 27,971
Non-insurance expenses(3).......... 1,684 1,225 3,107 11,533 4,020 7,867
-------- -------- -------- -------- -------- -------
Total expenses..................... 200,442 134,729 90,391 79,507 27,319 36,002
-------- -------- -------- -------- -------- -------
Operating profit (loss)............ 19,676 10,566 4,641(4) 1,182 1,063 (2,423)
Other income (expense):
Interest expense................ (1,693) (2,235) (4,428) (5,712) (2,092) (3,987)
Other income (expense),
net(3)........................ (271) (340) (823) (18,728) (312) 394
-------- -------- -------- -------- -------- -------
Income (loss) from continuing
operations before income taxes
and minority interests........ 17,712 7,991 (610) (23,258) (1,341) (6,016)
Provision (benefit) for income
taxes(5)........................ (3,443) 167 -- -- -- --
Minority interests in net income
(loss)
of consolidated subsidiaries.... 80 238 216 (148) (509) (358)
-------- -------- -------- -------- -------- --------
Net income (loss) from continuing
operations(6)................... $ 21,075 $ 7,586 $ (826)(4) $(23,110)(7) $ (832) $(5,658)
======== ======== ======== ======== ======== =======
Net income (loss) from continuing
operations per share:
-- Primary...................... $ 1.71 $ 0.86 $ (0.24) $ (6.78) $ (0.25) $ (1.82)
-- Fully diluted................ 1.68 0.85 (0.24) (6.78) (0.25) (1.82)
GAAP Ratios:
Loss ratio......................... 70.5% 72.5% 75.8%(4) 72.0% 72.4% 70.7%
Expense ratio...................... 26.0 28.8 29.7 29.8 27.3 30.0
-------- -------- -------- -------- -------- -------
Combined loss and expense ratio.... 96.5% 101.3% 105.5% 101.8% 99.7% 100.7%
======== ======== ======== ======== ======== =======
</TABLE>
-26-
<PAGE> 27
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1994 1993
-------- --------
(IN THOUSANDS)
<S> <C> <C>
BALANCE SHEET DATA:
Investments.................................................................... $264,743 $187,986
Total assets................................................................... 543,087 409,385
Loss and loss adjustment expense reserves...................................... 221,325 211,600
Unearned premiums.............................................................. 97,170 60,114
Borrowings and term debt....................................................... 29,000 18,951
Stockholders' equity........................................................... 159,754 95,717
Statutory surplus of Insurance Companies(8).................................... 126,272 73,910
</TABLE>
-------------------------
(1) For a discussion of the accounting treatment of the Company's MPCI business,
the results of which are included in the periods indicated, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- General."
(2) Effective September 1, 1990, the Company changed its fiscal year end from
August 31 to December 31.
(3) For further information with respect to amounts shown in these lines, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- General -- Effects of Non-Insurance Operations."
(4) Operating profit was reduced in 1992 by the strengthening of reserves in the
amount of approximately $2.1 million on two lines of insurance and $1.7
million of incurred losses relating to Hurricanes Andrew and Iniki. The
strengthening of reserves and hurricane losses accounted for 4.8% of the
loss ratio for 1992.
(5) Results for 1994 and 1993 reflect the utilization of tax loss carryforwards
and other temporary differences resulting from prior non-insurance
operations.
(6) Does not include amounts relating to discontinued operations recorded
primarily in 1991. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- General -- Effects of Non-Insurance
Operations."
(7) Included in other income (expense), net and loss from continuing operations
for the year ended December 31, 1991, is a non-cash charge of $15.3 million,
or $4.49 per share, to reduce the Company's equity investment in real estate
operations to estimated net realizable value, incurred as part of the
restructuring of certain prior non-insurance operations.
(8) Statutory data have been derived from the separate financial statements of
the Insurance Companies prepared in accordance with SAP.
-27-
<PAGE> 28
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
The following discussion and analysis of financial condition and results of
operations of the Company and its consolidated subsidiaries should be read in
conjunction with the Company's Consolidated Financial Statements and the notes
thereto included elsewhere herein.
GENERAL
INSURANCE OPERATIONS
Over the past five years, premiums written in the Company's insurance
operations have consistently increased, both as the result of acquisitions and
through internal growth. The Company has reported operating profits in each
quarter beginning with the third quarter of 1992, when the phasing out of its
prior non-insurance operations was substantially completed. For information
about the effects of these prior operations on the Company's financial results,
see "-- Effects of Non-Insurance Operations" below.
Although the property and casualty insurance industry in general has been
experiencing soft market conditions for the past several years, the Company
nonetheless has been able to increase premium volumes in recent periods while
maintaining combined ratios better than the ratios of the industry as a whole.
This growth has been the result of the Company's strategy of acquiring niche
businesses and increasing premiums written in selected lines. The Company's most
significant recent acquisition was its purchase in July 1993 of Redland, which
provides MPCI, crop hail and other named peril crop insurance and certain
standard property and casualty coverages to the rural market. Following its
acquisition by the Company, Redland increased the volume of its MPCI Premium by
42% in 1994 over 1993. The Company was the third largest MPCI writer in the
United States in 1994.
MPCI is a government-sponsored program with accounting treatment which
differs from more traditional property and casualty insurance lines. For income
statement purposes under GAAP and under SAP, gross premiums written consist of
the aggregate amount of MPCI premiums paid by farmers, and do not include any
related federal premium subsidies. The Company's profit or loss from its MPCI
business is determined after the crop season ends on the basis of a profit
sharing formula established by law and the CFSA. For income statement purposes,
any such profit share earned by the Company, net of the cost of third party
reinsurance, is shown as net premiums written, which equals net premiums earned
for MPCI business; however, any share of losses payable by the Company is
charged to losses and loss adjustment expenses. All expense reimbursements
received are credited to underwriting expenses. The foregoing are the principal
entries that are made in respect of net premiums written, net premiums earned,
losses paid and underwriting expenses. See "Business -- Multi-Peril Crop
Insurance Program."
As a result of this accounting treatment, the MPCI business may tend to
affect comparisons of the Company's results and operating ratios for periods
after the Redland acquisition with prior periods and affect comparisons of the
Company's operating ratios with industry averages. For information about the
Company's operating ratios excluding the results of its MPCI and other crop
business, see "Business -- Combined Ratios." Certain other characteristics of
the Company's crop business also may affect comparisons, including: (i) the
seasonal nature of the business whereby profits are generally recognized
predominantly in the second half of the year; (ii) the short-term nature of crop
business whereby losses are known within a short time period; and (iii) the
limited amount of investment income associated with crop business. In addition,
cash flows from such business differ from cash flows from certain more
traditional lines. See "-- Liquidity and Capital Resources" below. The seasonal
and short term nature of the Company's crop business, as well as the impact on
such business of weather and other natural perils, may produce more volatility
in the Company's operating results on a quarter to quarter or year to year basis
than has historically been present in the operations of the Company.
-28-
<PAGE> 29
EFFECTS OF NON-INSURANCE OPERATIONS
Prior to June 1992, the Company also was engaged in certain citrus and real
estate businesses. These operations encountered difficulties beginning in 1990
and the Company commenced a restructuring in 1991. This restructuring was
substantially completed by the third quarter of 1992, and since then the
Company's insurance operations have been its sole business focus. The impact of
these prior non-insurance operations and their restructuring and of certain
related items in the Company's historical results of operations is described
more fully below through an analysis of certain line items appearing in the
"Selected Consolidated Financial Data" appearing elsewhere herein.
<TABLE>
<CAPTION>
YEARS ENDED FOUR MONTHS
DECEMBER 31, ENDED YEAR ENDED
--------------------------------------- DECEMBER 31, AUGUST 31,
LINE ITEM 1994 1993 1992 1991 1990 1990
-------------------------------------------- ------ ------ ------- -------- ------------ -----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Non-insurance revenues:
Holding company interest income........... $ 412 $ 377 $ 0 $ 0 $ 0 $ 0
Real estate revenues...................... 0 0 2,610 5,824 1,498 1,870
------ ------ ------- -------- ------ -------
Total non-insurance revenues.......... $ 412 $ 377 $ 2,610 $ 5,824 $1,498 $ 1,870
====== ====== ======= ======== ====== =======
Non-insurance expenses:
Holding company general and administrative
expenses................................ $1,684 $1,182 $ 1,427 $ 6,128 $1,922 $ 4,875
Real estate expenses...................... 0 43 1,680 5,405 2,098 2,992
------ ------ ------- -------- ------ -------
Total non-insurance expenses.......... $1,684 $1,225 $ 3,107 $ 11,533 $4,020 $ 7,867
====== ====== ======= ======== ====== =======
Other income (expense), net:
Major Realty valuation adjustment......... $ 0 $ 0 $ 0 $(15,300) $ 0 $ 0
Share of net loss of Major Realty......... (297) (301) (1,165) (1,179) (470) (1,018)
Other real estate write-down.............. 0 0 0 (2,520) 0 0
Other, net................................ 26 (39) 342 271 158 1,412
------ ------ ------- -------- ------ -------
Total other income (expense), net..... $ (271) $ (340) $ (823) $(18,728) $ (312) $ 394
====== ====== ======= ======== ====== =======
</TABLE>
Non-Insurance Revenues. Amounts shown as holding company interest income
consisted of interest earned on investment assets held at the holding company
level which were primarily acquired with a portion of the net proceeds of the
Company's equity rights offering. Amounts shown as real estate revenues reflect
income from prior real estate operations which were restructured in 1992 as
described under "Other Income (Expense), Net" below.
Non-Insurance Expenses. Included in holding company general and
administrative expenses are directors' fees, legal and accounting expenses,
shareholder-related costs including annual report, proxy and annual meeting
expenses, New York Stock Exchange fees and similar expenses related to operation
of the holding company. For consistency of presentation, the full amounts of
these items have been included in non-insurance expenses for each of the periods
shown.
Real estate expenses relate to miscellaneous costs associated with the
remaining real estate owned by the Company as well as costs from the Company's
restructured real estate operations. All such real estate interests were
contributed by the holding company to Acceptance Insurance prior to the third
quarter of 1992.
Other Income (Expense), Net. The Company owns an approximate 33% interest
in Major Realty Corporation ("Major Realty"), a publicly-traded real estate
company focusing on the ownership of land, principally in Florida (Nasdaq
symbol: "MAJR"). The Company recorded a non-cash charge to continuing operations
of $15.3 million for the year ended December 31, 1991, to reduce its equity
investment in Major Realty to estimated net realizable value. At December 31,
1994, the carrying value of the Company's investment in Major Realty was $5.1
million. The Company continues to recognize its equity share of net operating
losses recorded by Major Realty.
In 1991, the Company recognized an additional $2.5 million loss on the
write-down of a real estate investment not owned by Major Realty. This
investment has since been sold.
-29-
<PAGE> 30
Prior Citrus Operations. No effects from the discontinuation and sale of
the Company's prior citrus operations are shown above since those effects were
recorded as loss from discontinued operations for all relevant periods. The
Company recorded a provision for the expected loss on disposal of its investment
in the citrus operations of approximately $19.6 million, or $5.75 per share, in
1991 which is excluded from loss and loss per share from continuing operations.
Upon the sale of such operations in 1992, the Company recognized an additional
loss of approximately $0.1 million.
Certain Tax Benefits. As a result of these prior non-insurance operations,
the Company generated significant tax loss carryforwards and other temporary
differences, all of which were used by the end of 1994. Utilization of these
carryforwards and other temporary differences resulted in the Company recording
a net income tax benefit of $3.4 million instead of any income tax expense in
respect of its pretax net income in 1994, and no income tax expense in 1993
other than approximately $0.2 million representing applicable Alternative
Minimum Tax amounts. The elimination of these tax benefits will result in an
increase in taxes reported by the Company in its operations in future periods
beginning in the first quarter of 1995.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1994
COMPARED TO YEAR ENDED DECEMBER 31, 1993
The Company's net premiums earned increased 58.2% for the year ended
December 31, 1994 to $202.7 million from $128.1 million in 1993. The principal
components of this increase were an increase of $30.0 million and $14.4 million
in earned premium in Redland's crop and standard property and casualty lines of
business, respectively, following the acquisition of Redland in the third
quarter of 1993, and an increase of $32.9 million in General Agency earned
premium primarily resulting from the expansion of this segment following the
hiring of four new managers in August 1993.
Included in the $30.0 million increase in net earned premiums for crop
business for 1994 was $17.0 million in profit sharing (before deducting the cost
of third party reinsurance) earned on the Company's MPCI business, compared to
no profit sharing earned for such business for 1993 when the Company recorded a
loss share of $0.9 million (net of recoveries from third party reinsurers).
Because of its accounting treatment, such 1993 loss share is not reflected as a
reduction in net premiums earned but instead as an increase in the Company's
losses and loss adjustment expenses for the 1993 period. The 1994 profit
resulted primarily from increases in the Company's MPCI Premiums and MPCI
Retention (as defined herein) after ceding risk to federal reinsurance pools, as
well as the occurrence of fewer insured losses, as adverse weather conditions in
1993 gave way to favorable weather conditions in 1994.
The Company's net investment income increased 22.4% to $13.3 million in
1994 versus $10.8 million during the prior year. The average size of the
investment portfolio increased from approximately $173 million during the year
ended December 31, 1993 to approximately $220 million during 1994. This increase
resulted primarily from internally-generated cash flows and the ownership of
Redland for a full year. The investment yield decreased from 6.3% to 6.0%
primarily as a result of Redland's portfolio generally being invested in
short-term investments due to the nature of its business.
Net realized capital gains were approximately $0.6 million for 1994 versus
$2.3 million for 1993. The higher amount in 1993 resulted from the Company's
decision to reposition its portfolio in a higher concentration of tax-exempt
securities during 1993 when market values of the Company's fixed income
securities in many cases exceeded cost due to lower prevailing interest rates.
Losses and loss adjustment expenses increased to $143.0 million versus
$92.8 million in 1993 or a 54.0% increase, consistent with the increase in net
premiums earned. The 1994 results were affected by adverse loss and loss
adjustment expense development of approximately $5.1 million, primarily from the
Company's general liability and commercial multi-peril lines. This adverse
development principally related to the 1990 and 1991 accident years, and to a
lesser extent to the 1992 and 1993 years, when actual experience differed from
historical patterns. In 1994 the Company reviewed and adjusted its reserving
practices to adjust for these developments.
-30-
<PAGE> 31
The Company's underwriting and other expenses increased 42.6% to $52.6
million in 1994 versus $36.9 million in 1993. The primary causes for this
increase were the increase in premium volume, and to a lesser extent, the need
to increase the staff and systems at the Insurance Companies in order to monitor
the larger operations of the Company during 1994 and the expenses associated
with the establishment of an office for General Agency business in Scottsdale,
Arizona. Partially offsetting this increase was the full year impact of the
Company's book of crop insurance, which typically has a lower expense ratio than
most of the Company's other businesses.
The Company's interest expense for the year decreased 24.3% to $1.7 million
versus $2.2 million in the prior year. This decrease in interest expense was
principally caused by the retirement during 1993 of $16.5 million of higher
interest rate debt issued in connection with the restructuring in 1992, which
was partially offset by a $10.0 million increase in the outstanding debt of the
Company during 1994.
The Company's net income benefitted from the recognition during the year
ended December 31, 1994 of a deferred tax benefit of $9.5 million, which offset
taxes that otherwise would have been accrued and resulted in a net income tax
benefit of $3.4 million. This net income benefit resulted from the release of a
valuation allowance established for a deferred tax asset upon the Company
meeting the realizability tests for such asset under Statement of Financial
Accounting Standards ("SFAS") #109, "Accounting for Income Taxes", adopted by
the Company in January 1993.
The Company's net income increased 177.8% to $21.1 million for the year
ended December 31, 1994 compared to $7.6 million for the year ended December 31,
1993 because of the factors discussed above.
YEAR ENDED DECEMBER 31, 1993
COMPARED TO YEAR ENDED DECEMBER 31, 1992.
Net premiums earned increased 61.8% to $128.1 million in 1993 from $79.2
million in 1992. The increase in premiums earned was due primarily to the
Company's ability to retain more premiums as a result of increased capital from
a portion of the $31.2 million proceeds of an offering of the Company's Common
Stock completed in January 1993. The two business lines in which the increase in
retentions was the most significant were the auto liability line, in which net
premiums written increased $23.7 million, and the general liability line, in
which net premiums written increased $11.7 million.
Redland operations added $16.2 million to the Company's net premiums earned
for 1993, consisting primarily of premiums from auto liability, auto physical
damage and crop hail insurance, following the Redland acquisition in July of
that year. The Company's MPCI business recorded a loss share of $0.9 million
(net of recoveries from third party reinsurers) for 1993, and such loss is
included in losses and loss adjustment expenses.
The Company's net investment income increased 31.9% to $10.8 million in
1993 from $8.2 million in 1992. This increase is attributable primarily to the
increase in the size of the Company's investment portfolio from an average of
$113 million during 1992 to an average of $173 million during 1993. This
increase was principally a result of the investment of approximately $20 million
of funds derived from the Company's Common Stock offering completed in January
1993, the Company's ability to retain more of its premiums written as a result
of this additional capital, and approximately $21 million in additional
investment assets acquired in the Redland acquisition. The impact of the
increase in the average size of the investment portfolio was offset by a
reduction in the average yield on the invested assets from 7.3% during 1992 to
6.3% during 1993. The reduction in the average yield primarily was due to the
addition to the Company's portfolio of tax-exempt securities which in general
have lower yields than equivalent taxable securities, the short term nature of
Redland's portfolio, the amortization of premiums paid for certain of the
Company's mortgage-backed securities caused by an acceleration in the rate of
prepayments of the underlying mortgages, and a general decline in interest
rates.
The Company's net realized capital gains increased to $2.3 million in 1993
from $1.0 million in the prior year. The increase in the net realized capital
gains was primarily a result of sales related to the repositioning of
-31-
<PAGE> 32
the Company's portfolio into a higher concentration in tax-exempt securities
during the strong market for fixed income securities in 1993.
Losses and loss adjustment expenses increased 54.6% to $92.8 million in
1993 from $60.0 million in the prior year, consistent with the increase in net
premiums earned. Losses and loss adjustment expenses in 1993 were adversely
impacted by the Company's MPCI results, which generated a net loss share of $0.9
million due primarily to losses resulting from adverse weather conditions in the
1993 growing season. The 1992 results were adversely affected by $1.7 million in
losses from Hurricanes Andrew and Iniki as well as $2.1 million in reserve
strengthening in the Company's workers' compensation and liquor liability lines.
The Company's underwriting and other expenses increased 56.9% to $36.9
million in 1993 from $23.5 million in the prior year, consistent with the
increase in net premiums earned.
The Company's interest expense declined to $2.2 million during 1993 from
$4.4 million in 1992 primarily due to a decrease in the average amount of
outstanding debt as well as a reduction in the average interest rate. In May
1992, the Company completed the sale of its citrus operations permitting a $22
million principal amount reduction in bank debt, which accounted for
approximately $1.1 million of the reduction in interest expense, and in January
1993, completed a Common Stock offering permitting the retirement of $9.5
million of higher interest rate notes issued in 1992, which accounted for
approximately $800,000 of the reduction in interest expense.
Income taxes were approximately $200,000 in 1993 whereas none was recorded
in 1992. The $200,000 recorded in 1993 represented applicable Alternative
Minimum Tax amounts as no other tax was recorded in either year due to the
availability of net operating loss carryforwards.
The Company's net income increased by $8.5 million from 1992 to 1993 as net
income improved from a loss of $900,000 for the year ended December 31, 1992 to
income of $7.6 million for the year ended December 31, 1993 because of the
factors discussed above.
LIQUIDITY AND CAPITAL RESOURCES
The Company has included a discussion of the liquidity and capital
resources requirements of the Company and the Insurance Companies.
THE COMPANY -- PARENT ONLY
As an insurance holding company, the Company's assets consist primarily of
the capital stock of its subsidiaries, a surplus note issued by Acceptance
Insurance and investment assets held at the holding company level. Following the
Offering, the Company's primary sources of liquidity will be the receipt of
dividends or other distributions from subsidiaries, interest payments on such
surplus note (and any additional surplus note that Acceptance Insurance may
issue), tax sharing payments from its subsidiaries and net investment income
from, and proceeds from the sale of, holding company investments. The Company
needs liquidity primarily to service debt, pay operating expenses and taxes and
make investments in subsidiaries.
The three domiciliary states of the Insurance Companies limit the payment
of dividends and other distributions by such companies. For example, under
Nebraska law, dividends or distributions may not be paid by an insurance company
unless such dividends, together with any dividends paid within the preceding 12
months, do not exceed the lesser of (a) 10% of the policyholders' surplus of the
insurer as of the preceding December 31 or (b) the insurer's net income,
excluding realized capital gains, for the preceding calendar year, both computed
in accordance with statutory accounting principles applicable to insurance
companies. In determining net income available for dividends in Nebraska, an
insurer may carry forward net income, again excluding realized capital gains,
from the second and third full calendar years preceding the date of
determination, less dividends paid in such prior calendar years. See "Business
-- Regulation" for a description of the dividend restrictions applicable to
insurers domiciled in Iowa and Arizona. Under these laws, the maximum
aggregate amount of dividend payments permitted to be made by the Insurance
Companies in 1995 without prior regulatory approval will be approximately
$6.0 million, none of which has been paid.
-32-
<PAGE> 33
The Company currently holds a surplus note issued by Acceptance
Insurance in the principal amount of $20 million, bearing interest at the rate
of 9% per annum, payable quarterly. Although the principal of surplus
notes issued by a Nebraska domiciled company such as Acceptance Insurance may
not be repaid without the prior approval of the Nebraska insurance regulators,
under current law, no prior approval is required for interest payments.
The maximum dividend permitted by law is not necessarily indicative of an
insurer's actual ability to pay dividends or other distributions to a parent
company, which may be constrained by business and regulatory considerations such
as the impact of such payments on surplus and certain leverage and operating
ratios, which could affect an insurer's competitive position, the amount of
premiums that can be written and the ability to pay future dividends. Further,
state insurance laws and regulations require that the statutory surplus of
insurance companies following any dividend or distribution by such company be
reasonable in relation to its outstanding liabilities and adequate for its
financial needs.
Statutory accounting practices differ in many respects from those governing
the preparation of financial statements under generally accepted accounting
principles. Accordingly, statutory operating results and statutory surplus may
differ substantially from amounts reported in the GAAP basis financial
statements for comparable items. Information as to statutory surplus and
statutory net income for the Insurance Companies is included in the footnotes to
the Consolidated Financial Statements of the Company included elsewhere herein.
In addition to dividends from the Insurance Companies, the Company also may
receive distributions from its non-insurance subsidiaries which are engaged in
agency, premium finance and claims service operations.
The Company is currently a party to a tax sharing agreement with its
subsidiaries, under which such subsidiaries pay the Company amounts in general
equal to the federal income tax that would be payable by such subsidiaries on a
stand-alone basis. These tax payments may provide cash flow for the Company in
the future.
On December 1, 1994, pursuant to a call by the Company to redeem certain
outstanding Warrants, approximately 4.85 million of such Warrants were exercised
to purchase shares of Common Stock, resulting in net proceeds to the Company of
approximately $53.4 million. Of such amount, $18 million was contributed as
surplus to Redland Insurance, $20 million was used to purchase the surplus note
of Acceptance Insurance described above and thereby increase its surplus and the
remainder was used for working capital and general corporate purposes.
At December 31, 1994, after receipt of the proceeds of exercise of the
Warrants, approximately $9.4 million was held by the Company at the holding
company level.
-33-
<PAGE> 34
The Company is also a party to the Revolving Credit Facility with a
group of bank lenders which is secured by substantially all of the Company's
assets. The maximum amount that may be borrowed under the facility is $35
million. Interest is payable quarterly at a rate selected by the Company equal
to either the prime rate or LIBOR plus a margin of 1% to 1.75% depending on the
Company's debt-to-equity ratio. At December 31, 1994, the outstanding balance
under the facility was $29 million, bearing interest at 7.375%. Borrowings
under the facility were used to provide capital for the Insurance Companies and
to repay other debt. The Revolving Credit Facility expires on March 31, 1998,
and may be extended for an additional year with the consent of the lenders. The
Company is currently discussing with its bank lenders an increase in the
principal amount available under the Company's Revolving Credit Facility,
although there can be no assurance that such an increase will occur.
The Company's history is one of continuing premium growth as a result both
of acquisitions and other equity investments and of internal growth, and it
intends to continue to pursue additional opportunities in the insurance
business. Such growth requires capital, and as a result the Company may seek
additional debt or equity financing in the future to provide capital for the
Insurance Companies, to fund further acquisitions or for other purposes. There
can be no assurance that the Insurance Companies will have access to sufficient
capital in future periods to continue their growth and also satisfy the capital
requirements of rating agencies and regulators.
INSURANCE COMPANIES
The principal liquidity needs of the Insurance Companies are to fund losses
and loss adjustment expense payments and to pay underwriting expenses, including
commissions and other expenses. The available sources to fund these requirements
are net premiums received and, to a lesser extent, cash flows from the Company's
investment activities, which together have been adequate to meet such
requirements on a timely basis. The Company monitors the cash flows of the
Insurance Companies and attempts to maintain sufficient cash to meet current
operating expenses, and to structure its investment portfolio at a duration
which approximates the estimated cash requirements for the payment of loss and
loss adjustment expenses.
Cash flows from the Company's MPCI and crop hail businesses differ in
certain respects from cash flows associated with more traditional property and
casualty lines. MPCI premiums are not received from farmers until the covered
crops are harvested, and when received are promptly remitted by the Company in
full to the government. Covered losses are paid by the Company during the
growing season as incurred, with such expenditures reimbursed by the government
within three business days. Policy acquisition and administration expenses are
paid by the Company as incurred during the year. The Company periodically
throughout the year receives a payment in reimbursement of its policy
administration expenses.
The Company's profit or loss from its MPCI business is determined after the
crop season ends on the basis of a profit sharing formula established by law and
the CFSA. At such time, the Company receives a profit share in cash, with any
amount in excess of 15% of its MPCI Retention in any year carried forward to
future years, or it must pay its share of losses. The profit sharing formula
takes into consideration the amount of federal premium subsidies credited to the
Company in respect of the MPCI business it has written. These federal subsidies
are non-cash items, which for 1994 ranged as high as 30% of MPCI Premiums for
certain policies and for 1995 may range up to approximately 42% of such MPCI
Premiums.
In the crop hail insurance business, premiums are generally not received
until after the harvest, while losses and other expenses are paid throughout the
year.
CHANGES IN FINANCIAL CONDITION
On August 29, 1994, A.M. Best placed under review with negative
implications the A- (Excellent) ratings of Acceptance Insurance, Acceptance
Indemnity and Redland Insurance due to their rapid growth in premiums without a
corresponding growth in surplus. Subsequently, the Company agreed to increase
the
-34-
<PAGE> 35
statutory capital of Redland Insurance and Acceptance Insurance by an additional
$18 million and $20 million, respectively. A.M. Best then affirmed the A-
(Excellent) ratings of Acceptance Insurance, Acceptance Indemnity and Redland
Insurance.
The NAIC has released its proposed RBC formula for property and casualty
insurance companies. The RBC initiative is designed to enhance the current
regulatory framework for the evaluation of the capital adequacy of a property
and casualty insurer. The formula requires an insurer to compute the amount of
capital necessary to support four areas of risk facing property and casualty
insurers: (a) asset risk (default on fixed income assets and market decline),
(b) credit risk (losses from unrecoverable reinsurance and inability to collect
agents' balances and other receivables), (c) underwriting risk (premium pricing
and reserve estimates), and (d) off balance sheet/growth risk (excessive premium
growth and unreported liabilities). The Insurance Companies have reviewed and
applied the proposed RBC formula for the 1994 year and have exceeded these
requirements. Of the states in which the Insurance Companies are domiciled,
Nebraska is the first state to adopt the RBC rules into law, although the RBC
results must be reported to the states in which the Insurance Companies do
business. See "Business -- Regulation."
The Company's unrealized gain or loss on marketable equity securities and
fixed maturities available for sale, net of tax, changed from a $66,000 gain as
of December 31, 1993 to an approximate $13.7 million loss as of December 31,
1994. Such change was caused by the loss in value related to the general upward
movement in interest rates. Although the Company believes that it has adequate
sources of liquidity to avoid being required to realize any of the foregoing
unrealized losses, there can be no assurance in this regard. See "Recent
Statements of Financial Accounting Standards" below.
CONSOLIDATED CASH FLOWS
Cash flows from operations for the year ended December 31, 1994 were a
positive $42.7 million as compared to a positive $24.6 million for the 1993
year. The 1994 cash flows were positively impacted by premium growth in casualty
lines of business and changes in the Company's reinsurance structure whereby the
Company retained more of its business for its own account. Cash flows from
financing activities for 1994 were positively impacted primarily by the exercise
of the Warrants in December 1994, and to a lesser extent the restructuring of
the Company's bank borrowings upon its entering into the Revolving Credit
Facility in March 1994.
INFLATION
The Company does not believe that inflation has had a material impact on
its financial condition or results of operations.
RECENT STATEMENTS OF FINANCIAL ACCOUNTING STANDARDS
On January 1, 1994, the Company adopted SFAS #115, "Accounting for Certain
Investments in Debt and Equity Securities." In conjunction with the adoption of
SFAS #115, the Company reclassified its debt and equity securities to meet the
requirements of the statement. SFAS #115 requires investments in debt and equity
securities to be classified at acquisition into one of three categories: held to
maturity, available for sale, or trading.
At December 31, 1994, all debt and equity securities were classified as
available for sale. Available for sale securities are stated at fair market
value with the unrealized gains and losses, net of tax, reported as a separate
component of stockholders' equity. At December 31, 1994, the Company had an
unrealized loss on these securities, net of taxes, of approximately $13.7
million. See "Business -- Investments."
-35-
<PAGE> 36
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
See Item 14 hereof and the Consolidated Financial Statements attached
hereto.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
There have been no disagreements with the Registrant's independent
accountants of the nature calling for disclosure under Item 9.
PART III.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by Item 10 with respect to the Registrant's
executive officers and directors will be set forth in the Company's 1995 Proxy
Statement included as Exhibit 99.6 hereto and incorporated herein by reference.
-36-
<PAGE> 37
ITEM 11. EXECUTIVE COMPENSATION.
The information required by Item 11 will be set forth in the Company's
1995 Proxy Statement included as Exhibit 99.6 hereto and incorporated herein by
reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by Item 12 will be set forth in the Company's
1995 Proxy Statement included as Exhibit 99.6 hereto and incorporated herein
by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The Company beneficially owns 33.1% of the common stock of Major Realty
Corporation ("Major Realty"). Messrs. Bielfield, Coon, McCarthy & Treadwell are
directors of both the Company and Major Realty. George F. Valassis, beneficial
owner of approximately 13% of the Company's common stock, owns beneficially
approximately 9.8% of the Major Realty common stock. Mr. Valassis is the
father of Doug T. Valassis, a director of the Company.
During the fiscal year ended December 31, 1994, the Company employed
McCarthy & Co., d/b/a Long View Capital Management, a wholly-owned subsidiary
of McCarthy Group, Inc., to furnish investment advisory services to the Company
and paid McCarthy & Co. $132,000 for such services. Michael R. McCarthy, a
director of the Company, is Chairman and a principal shareholder of McCarthy
Group, Inc.
During the fiscal year ended December 31, 1994, the Company purchased from
an unaffiliated insurer health insurance for its employees through Mammel &
Associates, Inc., a third-party administrator, which receives certain
commissions from the unaffiliated insurer. Mammel & Associated, Inc., is an
81% subsidiary of Redland & Associates, Inc. John P. Nelson, a director of the
Company is Chairman of the Board and a principal shareholder of Redland &
Associates, Inc.
PART IV.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) The following documents are filed as a part of this Report:
1. Financial Statements. The Company's audited Consolidated Financial
Statements for the years ended December 31, 1994 and 1993 consisting
of the following:
Reports of Independent Accountants
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Cash Flows
Consolidated Statements of Stockholders' Equity
Notes to Consolidated Financial Statements
2. Financial Statement Schedules
SCHEDULE II. CONDENSED FINANCIAL INFORMATION OF REGISTRANT
SCHEDULE V. VALUATION ACCOUNTS
3. The Exhibits filed herewith are set forth in the Exhibit Index
attached hereto.
(b) No Current Reports on Form 8-K have been filed during the last fiscal
quarter of the period covered by this Report.
-37-
<PAGE> 38
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Audited Consolidated Financial Statements for the Years Ended December 31, 1994 and
December 31, 1993:
Independent Auditors' Report........................................................ F-2
Consolidated Balance Sheets......................................................... F-3
Consolidated Statements of Operations............................................... F-4
Consolidated Statement of Stockholders' Equity...................................... F-5
Consolidated Statements of Cash Flows............................................... F-6
Notes to Consolidated Financial Statements.......................................... F-7
</TABLE>
F-1
<PAGE> 39
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders
of Acceptance Insurance Companies Inc.
We have audited the accompanying consolidated balance sheets of Acceptance
Insurance Companies Inc. and its subsidiaries as of December 31, 1994 and 1993,
and the related consolidated statements of operations, stockholders' equity and
cash flows for each of the three years in the period ended December 31, 1994.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these 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
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of Acceptance Insurance Companies
Inc. and subsidiaries as of December 31, 1994 and 1993, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1994, in conformity with generally accepted accounting principles.
As discussed in Note 1 to the consolidated financial statements, in 1994
the Company adopted Statement of Financial Accounting Standards No. 115,
Accounting for Certain Investments in Debt and Equity Securities.
DELOITTE & TOUCHE LLP
Omaha, Nebraska
March 17, 1995
F-2
<PAGE> 40
ACCEPTANCE INSURANCE COMPANIES INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1994 AND 1993
(IN THOUSANDS EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
1994 1993
-------- --------
<S> <C> <C>
ASSETS
Investments (Note 4):
Fixed maturities available for sale................................... $190,180 $ 95,836
Fixed maturities held for investment.................................. -- 51,756
Marketable equity securities.......................................... 12,530 13,872
Mortgage loans and other investments.................................. 1,869 2,852
Real estate........................................................... 3,891 4,266
Short-term investments, at cost, which approximates market............ 56,273 19,404
-------- --------
264,743 187,986
Cash.................................................................... 9,339 2,894
Equity investment in Major Realty Corporation (Note 6).................. 5,079 5,376
Receivables, net (Note 5)............................................... 76,993 48,166
Reinsurance recoverable on unpaid loss and loss adjustment expenses..... 79,811 95,886
Prepaid reinsurance premiums............................................ 25,988 15,448
Property and equipment, net of accumulated depreciation of $2,830 and
$1,557, respectively.................................................. 4,572 3,200
Deferred policy acquisition costs....................................... 19,834 11,815
Excess of cost over acquired net assets................................. 38,142 33,254
Deferred income tax (Note 8)............................................ 13,025 --
Other assets............................................................ 5,561 5,360
-------- --------
$543,087 $409,385
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Losses and loss adjustment expenses..................................... $221,325 $211,600
Unearned premiums....................................................... 97,170 60,114
Amounts payable to reinsurers........................................... 19,309 7,186
Accounts payable and accrued liabilities................................ 16,529 13,343
Bank borrowings, term debt and other borrowings (Note 7)................ 29,000 18,951
-------- --------
Total liabilities................................................ 383,333 311,194
-------- --------
Contingencies (Note 15)
Minority interests...................................................... -- 2,474
-------- --------
Stockholders' equity (Note 2):
Preferred stock, no par value, 5,000,000 shares authorized, none
issued............................................................. -- --
Common stock, $.40 par value, 20,000,000 shares authorized; 15,128,846
and 9,976,415 shares issued........................................ 6,052 3,991
Capital in excess of par value........................................ 194,674 140,002
Unrealized gain (loss) on available-for-sale securities, net of tax... (13,705) 66
Accumulated deficit................................................... (23,003) (44,078)
-------- --------
164,018 99,981
Less:
Treasury stock, at cost, 35,559 shares............................. (1,564) (1,564)
Contingent stock, 240,000 shares (Note 3).......................... (2,700) (2,700)
-------- --------
Total stockholders' equity....................................... 159,754 95,717
-------- --------
$543,087 $409,385
======== ========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-3
<PAGE> 41
ACCEPTANCE INSURANCE COMPANIES INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992
(IN THOUSANDS EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
1994 1993 1992
-------- -------- -------
<S> <C> <C> <C>
Revenues:
Insurance premiums earned (Note 12).......................... $202,659 $128,082 $79,164
Insurance agency commissions................................. 3,629 4,119 3,992
Real estate revenues......................................... -- -- 2,610
Net investment income (Note 4)............................... 13,276 10,844 8,220
Net realized capital gains................................... 554 2,250 1,046
-------- -------- -------
220,118 145,295 95,032
-------- -------- -------
Costs and expenses:
Cost of revenues:
Insurance losses and loss adjustment expenses (Note 12)... 142,951 92,805 60,025
Insurance agency costs.................................... 3,180 3,794 3,736
Insurance underwriting expenses........................... 52,627 36,905 23,523
Real estate costs......................................... -- -- 818
General and administrative expenses.......................... 1,684 1,225 2,289
-------- -------- -------
200,442 134,729 90,391
-------- -------- -------
Operating profit........................................ 19,676 10,566 4,641
-------- -------- -------
Other income (expense):
Interest expense............................................. (1,693) (2,235) (4,428)
Share of net loss of investee (Note 6)....................... (297) (301) (1,165)
Other, net................................................... 26 (39) 342
-------- -------- -------
(1,964) (2,575) (5,251)
-------- -------- -------
Income (loss) from continuing operations before income
taxes and minority interests......................... 17,712 7,991 (610)
Income tax (expense) benefit (Note 8):
Current...................................................... (2,487) (167) --
Deferred..................................................... 5,930 -- --
-------- -------- -------
3,443 (167) --
Minority interests in net income of consolidated
subsidiaries................................................. (80) (238) (216)
-------- -------- -------
Income (loss) from continuing operations................ 21,075 7,586 (826)
Loss on disposal of discontinued operations.................... -- -- (83)
-------- -------- -------
Net income (loss)....................................... $ 21,075 $ 7,586 $ (909)
======== ======== =======
Net income (loss) per share:
Primary:
Continuing operations..................................... $1.71 $0.86 $(0.24)
Discontinued operations................................... -- -- (0.02)
Net income (loss) per share............................. $1.71 $0.86 $(0.26)
Fully diluted:
Continuing operations..................................... $1.68 $0.85 $(0.24)
Discontinued operations................................... -- -- (0.02)
Net income (loss) per share............................. $1.68 $0.85 $(0.26)
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-4
<PAGE> 42
ACCEPTANCE INSURANCE COMPANIES INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992
(IN THOUSANDS)
<TABLE>
<CAPTION>
UNREALIZED
GAIN
CAPITAL (LOSS) ON RETAINED
IN MARKETABLE EARNINGS TOTAL
COMMON EXCESS OF EQUITY (ACCUMULATED TREASURY CONTINGENT STOCKHOLDERS'
STOCK PAR VALUE SECURITIES DEFICIT) STOCK STOCK EQUITY
------ --------- ---------- ------------ -------- ---------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1992... $1,383 $ 86,731 $ (477) $ (50,755) $(1,840) $ -- $ 35,042
Issuance of common stock
under employee benefit
plans.................... 3 27 -- -- -- -- 30
Issuance of common stock in
connection with Major
Group merger............. 21 -- -- -- -- -- 21
Issuance of common stock in
settlement of expenses... -- (231) -- -- 276 -- 45
Change in unrealized gain
(loss) on marketable
equity securities........ -- -- 294 -- -- -- 294
Net loss................... -- -- -- (909) -- -- (909)
------ -------- -------- -------- ------- -------- ---------
Balance at December 31,
1992....................... 1,407 86,527 (183) (51,664) (1,564) -- 34,523
Issuance of common stock
from rights offering..... 1,597 29,568 -- -- -- -- 31,165
Issuance of common stock
from note payable
conversion............... 350 6,650 -- -- -- -- 7,000
Issuance of common stock in
connection with Redland
acquisition.............. 632 17,132 -- -- -- (2,700) 15,064
Issuance of common stock
under employee benefit
plans.................... 5 125 -- -- -- -- 130
Change in unrealized gain
(loss) on marketable
equity securities........ -- -- 249 -- -- -- 249
Net income................. -- -- -- 7,586 -- -- 7,586
------ -------- -------- -------- ------- -------- ---------
Balance at December 31,
1993....................... 3,991 140,002 66 (44,078) (1,564) (2,700) 95,717
Issuance of common stock on
exercise of warrants..... 1,946 51,467 -- -- -- -- 53,413
Issuance of common stock in
connection with Statewide
acquisition.............. 107 2,993 -- -- -- -- 3,100
Issuance of common stock
under employee benefit
plans.................... 8 212 -- -- -- -- 220
Change in unrealized gain
(loss) on
available-for-sale
securities, net of income
taxes of $6,424.......... -- -- (13,771) -- -- -- (13,771)
Net income................. -- -- -- 21,075 -- -- 21,075
------ -------- -------- -------- ------- -------- ---------
Balance at December 31,
1994....................... $6,052 $194,674 $(13,705) $(23,003) $(1,564) $ (2,700) $ 159,754
====== ======== ======== ========= ======== ======== =========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-5
<PAGE> 43
ACCEPTANCE INSURANCE COMPANIES INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992
(IN THOUSANDS)
<TABLE>
<CAPTION>
1994 1993 1992
--------- --------- --------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) from continuing operations....................... $ 21,075 $ 7,586 $ (826)
Adjustments to reconcile net income (loss) from continuing
operations to net cash provided by (used for) operating
activities:
Depreciation and amortization.................................. 3,522 3,533 1,552
Deferred tax benefit........................................... (5,930) -- --
Share of net loss of investee.................................. 297 301 1,165
Minority interests............................................. 80 238 216
Policy acquisition costs incurred.............................. (55,234) (37,147) (21,785)
Amortization of policy acquisition costs....................... 47,215 31,484 21,033
Gain on sale of investments.................................... (554) (2,250) (1,046)
Increase (decrease) in cash attributable to changes in assets
and liabilities, net of effects of purchase of companies:
Receivables............................................... (28,855) 8,138 (6,784)
Net losses and loss adjustment expenses................... 25,800 24,588 11,495
Net unearned premiums..................................... 26,515 9,424 4,921
Amounts payable to reinsurers............................. 12,123 (25,600) (4,068)
Accounts payable and accrued liabilities.................. (2,402) 3,137 (6,227)
Other, net..................................................... (978) 1,141 (379)
--------- --------- --------
Net cash provided by (used for) operating activities...... 42,674 24,573 (733)
--------- --------- --------
Cash flows from investing activities:
Proceeds from sales of investments................................. 640 22,230 18,962
Proceeds from sales of investments available-for-sale.............. 24,179 115,339 60,351
Proceeds from maturities of investments............................ 37,483 13,441 8,086
Proceeds from maturities of investments available-for-sale......... 15,437 17,906 6,058
Proceeds from maturities of investments held-to-maturity........... -- 6,507 1,758
Purchases of investments........................................... (48,162) (36,124) (65,082)
Purchases of investments available-for-sale........................ (101,243) (173,695) (88,494)
Proceeds from sale of discontinued operations...................... -- -- 28,970
Purchase of companies, net of cash and short-term investments
acquired......................................................... -- (4,165) --
Other, net......................................................... (2,022) (794) (764)
--------- --------- --------
Net cash provided by (used for) investing activities...... (73,688) (39,355) (30,155)
--------- --------- --------
Cash flows from financing activities:
Proceeds from bank borrowings...................................... 29,000 6,597 16,000
Repayments of bank borrowings...................................... (18,597) (8,086) (40,320)
Proceeds from term debt, other borrowings and notes payable to
affiliates....................................................... -- -- 16,519
Repayments of term debt, other borrowings and notes payable to
affiliates....................................................... (354) (10,764) (8,918)
Proceeds from issuance of common stock............................. 53,633 31,295 32
Minority interests................................................. 7 830 47
--------- --------- --------
Net cash provided by (used for) financing activities...... 63,689 19,872 (16,640)
--------- --------- --------
Net increase (decrease) in cash and short-term investments........... 32,675 5,090 (47,528)
Cash and short-term investments at beginning of period............... 17,561 12,471 59,999
--------- --------- --------
Cash and short-term investments at end of period..................... $ 50,236 $ 17,561 $ 12,471
========== ========== =========
Non-cash financing activities:
Note payable to affiliate converted to equity...................... $ -- $ 7,000 $ --
========== ========== =========
Issuance of common stock for acquisition of Redland................ $ -- $ 15,064 $ --
========== ========== =========
Issuance of common stock for acquisition of Statewide.............. $ 3,100 $ -- $ --
========== ========== =========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-6
<PAGE> 44
ACCEPTANCE INSURANCE COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF OPERATIONS
Acceptance Insurance Companies Inc. (the "Company") is primarily engaged in
the specialty property and casualty insurance business through its wholly-owned
subsidiaries, Acceptance Insurance Holdings Inc. ("Acceptance") and The Redland
Group, Inc. ("Redland"), which the Company acquired on April 11, 1990 and August
13, 1993, respectively. The Company previously conducted citrus operations
through its approximate 52% owned subsidiary, Orange-co, Inc. ("Orange-co"). In
December 1991, the Company decided to sell its interest in Orange-co and in May
1992 its interest was sold. As a result, the Company's loss on its disposal of
Orange-co is presented separately on the consolidated statements of operations.
The Company holds a 33% equity investment in Major Realty Corporation
("Major Realty"), a Florida based real estate company.
PRINCIPLES OF CONSOLIDATION
The Company's consolidated financial statements include the accounts of its
majority-owned subsidiaries. All significant intercompany transactions have been
eliminated.
INSURANCE ACCOUNTING
Generally, premiums are recognized as income ratably over the terms of the
related policies. Crop insurance premiums are recognized based upon exposure to
related insurance losses. Insurance costs are associated with premiums earned,
resulting in the recognition of profits over the term of the policies. This
association is accomplished through amortization of deferred policy acquisition
costs and provisions for unearned premiums and loss reserves.
The liability for unearned premiums represents the portion of premiums
written which relates to future periods and is calculated generally using the
pro rata method. The Company also provides a liability for policy claims based
on its review of individual claim cases and the estimated ultimate settlement
amounts. This liability also includes estimates of claims incurred but not
reported based on Company and industry paid and reported claim and settlement
expense experience. Differences which arise between the ultimate liability for
claims incurred and the liability established will be reflected in the statement
of operations of future periods as additional claim information becomes
available.
Certain costs of acquiring new insurance business, principally commissions,
premium taxes, and other underwriting expenses, have been deferred. Such costs
are being amortized as related premiums are earned. Anticipated investment
income is considered in evaluating recoverability of deferred acquisition costs.
STATEMENTS OF CASH FLOWS
The Company aggregates cash and short-term investments with maturity dates
of three months or less from the date of purchase for purposes of reporting cash
flows. As of December 31, 1994 and 1993, approximately $15,376,000 and
$4,737,000 of short-term investments had maturity dates at acquisition of
greater than three months.
INVESTMENTS
On January 1, 1994, the Company adopted Statement of Financial Accounting
Standards No. 115 (SFAS 115), Accounting for Certain Investments in Debt and
Equity Securities. As a result of adoption of this statement, $2,912,000 was
credited to stockholders' equity at January 1, 1994. In conjunction with the
adoption of SFAS 115, the Company reclassified its investment in fixed maturity
securities to meet the
F-7
<PAGE> 45
ACCEPTANCE INSURANCE COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
requirements of the statement. SFAS 115 requires investments in fixed maturity
securities to be classified at acquisition into one of three categories:
held-to-maturity, available-for-sale, or trading. Securities are classified as
trading when they are bought and held principally for the purpose of selling
them in the near future. Securities are classified as available-for-sale when
the securities may be sold from time to time to effectively manage interest rate
exposure and liquidity needs. Securities are classified as held-to-maturity
securities when the Company has the positive intent and ability to hold these
securities until maturity.
Since adoption of SFAS 115, all debt and equity securities were classified
as available-for-sale. Available-for-sale securities are stated at fair value
with the unrealized gains and losses reported as a separate component of
stockholders' equity, net of tax.
Mortgage loans are carried at the lower of their unpaid principal balance
or their estimated net realizable value. Real estate is stated at the lower of
cost or estimated net realizable value and is non-income producing.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost, net of accumulated depreciation.
Depreciation is recognized principally using the straight-line method over a
period of five to ten years.
EXCESS OF COST OVER ACQUIRED NET ASSETS
The excess of cost over equity in acquired net assets is being amortized
principally using the straight-line method over periods not exceeding 40 years.
Accumulated amortization approximated $3,299,000 and $2,185,000 at December 31,
1994 and 1993, respectively.
Recoverability of this asset is evaluated periodically based on
management's estimate of future undiscounted earnings of the businesses
acquired.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Estimated fair values of financial instruments have been determined by the
Company, using available market information and valuation methodologies.
However, judgment is necessarily required in interpreting market data to develop
the estimates of fair value. Accordingly, the estimates presented herein are not
necessarily indicative of the amounts that the Company could realize in a
current market exchange. The use of different valuation methodologies or market
assumptions may have an effect on the estimated fair value amounts presented.
The fair value of fixed maturity and equity securities disclosed in Note 4
to the financial statements are determined by the quoted market price or
modeling techniques for asset-backed securities not actively traded. The book
value of mortgage loans, short-term investments, other investments, cash,
receivables, equity investment in Major Realty Corporation, accounts payable and
borrowings approximate fair value.
PER SHARE DATA
Primary and fully diluted earnings per share are based on weighted average
shares outstanding of approximately 13.4 million and 13.6 million, respectively,
for the year ended December 31, 1994; approximately 11.6 million and 11.9
million, respectively, for the year ended December 31, 1993; and approximately
3.4 million for the year ended December 31, 1992. Included in weighted average
shares outstanding in 1994 and 1993 is the assumed conversion of all outstanding
options and warrants utilizing the modified treasury stock method, since average
outstanding options and warrants during those periods exceeded 20% of the
outstanding stock. Under this method, appropriate adjustment to net income is
made to reflect the assumed use of the proceeds of the conversion.
F-8
<PAGE> 46
ACCEPTANCE INSURANCE COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
RECLASSIFICATIONS
Certain prior period accounts have been reclassified to conform with
current year presentation.
2. COMMON STOCK ISSUED
On December 1, 1994, pursuant to a call by the Company to redeem certain
outstanding warrants, approximately 4.85 million of such warrants were exercised
to purchase shares of common stock, resulting in net proceeds to the Company of
approximately $53.4 million.
On January 27, 1993, the Company completed a Common Stock Rights Offering
to raise additional equity capital. The Rights Offering was fully subscribed
resulting in the issuance of 3,992,480 units, at $8.00 per unit, consisting of
one share of common stock and a warrant for the purchase of one share of common
stock exercisable at $11.00. Net proceeds of approximately $31.2 million were
used in part to retire $9.5 million of Secured Subordinated Notes (see Note 7).
Effective April 15, 1993, the holder of a $7,000,000 Secured Subordinated
Note of one of the Company's subsidiaries, which had been assumed by the
Company, exchanged such note for 875,000 shares of common stock and warrants to
purchase 875,000 additional shares of common stock. The shares of common stock
and warrants were identical to the shares and warrants issued in the Company's
Rights Offering.
3. ACQUISITIONS
On March 31, 1994, the Company entered into an Agreement and Plan of Merger
with Statewide Insurance Corporation (Statewide), the exclusive general agent
for the Company's non-standard automobile insurance program underwritten by
Phoenix Indemnity Insurance Company (Phoenix Indemnity), pursuant to which the
Company acquired Statewide. Statewide owned 20% of the outstanding common stock
of Phoenix Indemnity which was a previously 80% owned subsidiary of the Company.
The acquisition was effective April 1, 1994 and was accounted for as a purchase.
The purchase price of approximately $3.1 million, comprised of
approximately 266,000 shares of the Company's common stock, was allocated based
upon the estimated fair market value of assets acquired and liabilities assumed.
The purchase price in excess of the fair market value of the net assets acquired
is being amortized using the straight-line method over 40 years.
On August 13, 1993, the Company acquired all of the outstanding common
stock, warrants to purchase common stock, and preferred stock of Redland
pursuant to an Exchange Agreement. Redland underwrites multi-peril crop, crop
hail, specialty automobile, and farmowner insurance coverages. The acquisition
of Redland was accounted for as a purchase transaction. The purchase price of
approximately $15.4 million, comprised of 1,339,000 shares of the Company's
common stock and acquisition related costs of $306,000, was allocated based upon
the estimated fair market value of assets acquired and liabilities assumed. The
purchase price in excess of the fair market value of the net assets acquired is
being amortized using the straight-line method over 40 years.
The results of operations for Redland are included in the accompanying
financial statements effective July 1, 1993. The purchase price does not reflect
240,000 shares issued by the Company and held in escrow pursuant to the Exchange
Agreement, as a fund against which the Company may assert certain claims. The
primary contingency under which claims may be asserted is the ultimate
development of Redland's liability for losses and loss adjustment expenses. Upon
resolution of contingencies related to the acquisition, such shares will be
returned to the Company or released to former Redland stockholders.
F-9
<PAGE> 47
ACCEPTANCE INSURANCE COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
The pro forma financial data, which gives effect to the acquisition of
Redland as though it had been completed January 1, 1993, for the year ended
December 31, 1993, is as follows (in thousands, except per share data):
<TABLE>
<CAPTION>
1993
--------
<S> <C>
Revenues.......................................................................... $157,299
========
Loss from continuing operations................................................... $ (1,292)
========
Net loss.......................................................................... $ (1,292)
========
Earnings per share:
Primary and fully diluted:
Continuing operations........................................................ $ (0.14)
Discontinued operations...................................................... --
--------
Net loss per share......................................................... $ (0.14)
========
</TABLE>
The pro forma financial data for the year ended December 31, 1993, is not
necessarily indicative of the results had the Company actually acquired Redland
on January 1, 1993, as the financial data includes $3.9 million of charges to
earnings taken by Redland in the first and second quarters of 1993. The charges
were comprised of a $900,000 write-down of a marketable equity security and a
$3.0 million strengthening of reserves, both of which would have been adjusted
to their fair market value on January 1, 1993, and thus would have been excluded
from the 1993 results of operations.
4. INVESTMENTS
A summary of net investment income earned on the investment portfolio for
the years ended December 31, 1994, 1993 and 1992 is as follows (in thousands):
<TABLE>
<CAPTION>
1994 1993 1992
------- ------- ------
<S> <C> <C> <C>
Interest on fixed maturities...................................... $10,357 $ 9,177 $7,339
Interest on short-term investments................................ 2,101 711 659
Other............................................................. 1,420 1,338 391
------- ------- ------
13,878 11,226 8,389
Investment expenses............................................... (602) (382) (169)
------- ------- ------
Net investment income............................................. $13,276 $10,844 $8,220
======= ======= ======
</TABLE>
F-10
<PAGE> 48
ACCEPTANCE INSURANCE COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
The amortized cost and related market values of fixed maturities in the
accompanying balance sheets are as follows (in thousands):
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
--------- ---------- ---------- --------
<S> <C> <C> <C> <C>
December 31, 1994:
Fixed maturities available for sale:
U.S. Treasury and government securities........ $ 68,308 $ 4 $ 2,225 $ 66,087
States, municipalities and political
subdivisions................................. 39,544 8 1,957 37,595
Mortgage-backed securities..................... 73,024 -- 13,949 59,075
Other debt securities.......................... 28,199 100 876 27,423
--------- ---------- ---------- --------
$ 209,075 $ 112 $ 19,007 $190,180
======== ======== ======== ========
Marketable equity securities -- preferred stock... $ 7,803 $ 4 $ 1,049 $ 6,758
======== ======== ======== ========
Marketable equity securities -- common stock...... $ 5,960 $ 530 $ 718 $ 5,772
======== ======== ======== ========
December 31, 1993:
Fixed maturities held for investment:
U.S. Treasury and government securities........ $ 9,076 $ 360 $ -- $ 9,436
States, municipalities and political
subdivisions................................. 504 26 -- 530
Mortgage-backed securities..................... 33,070 1,330 81 34,319
Other debt securities.......................... 9,106 663 -- 9,769
--------- ---------- ---------- --------
$ 51,756 $2,379 $ 81 $ 54,054
======== ======== ======== ========
Fixed maturities available for sale:
U.S. Treasury and government securities........ $ 17,379 $ 241 $ 206 $ 17,414
States, municipalities and political
subdivisions................................. 33,370 407 4 33,773
Mortgage-backed securities..................... 40,687 302 203 40,786
Other debt securities.......................... 4,400 88 11 4,477
--------- ---------- ---------- --------
$ 95,836 $1,038 $ 424 $ 96,450
======== ======== ======== ========
Marketable equity securities -- preferred stock..... $ 8,367 $ 179 $ 101 $ 8,445
======== ======== ======== ========
Marketable equity securities -- common stock........ $ 5,439 $ 347 $ 359 $ 5,427
======== ======== ======== ========
</TABLE>
The amortized cost and related market values of the fixed maturity
securities as of December 31, 1994 are shown below by stated maturity dates.
Actual maturities may differ from stated maturities because the borrowers may
have the right to call or prepay obligations with or without call or prepayment
penalties.
<TABLE>
<CAPTION>
AMORTIZED CARRYING
COST VALUE
--------- --------
(IN THOUSANDS)
<S> <C> <C>
Fixed maturities available for sale:
Due in one year or less............................................... $ 5,738 $ 5,713
Due after one year through five years................................. 75,250 72,909
Due after five years through ten years................................ 23,088 22,050
Due after ten years................................................... 31,975 30,433
--------- --------
136,051 131,105
Mortgage-backed securities............................................ 73,024 59,075
--------- --------
$ 209,075 $190,180
======== ========
</TABLE>
F-11
<PAGE> 49
ACCEPTANCE INSURANCE COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
The Company's collateral backed securities portfolio consists of
mortgage-backed securities, all of which are collateralized mortgage obligations
(CMOs). The following table sets forth as of December 31, 1994 the categories of
the Company's CMOs, which at such date had an average expected life of
approximately six years.
<TABLE>
<CAPTION>
PAR AMORTIZED CARRYING
TYPE OF CMO VALUE(1) COST(1) VALUE
---------------------------------------------------------------- --------- --------- ---------
<S> <C> <C> <C>
Fixed coupon.................................................... $18,547 $18,795 $ 17,581
Floating rate(2)................................................ 18,460 18,354 17,838
Inverse floating rate(2)........................................ 38,037 35,875 23,656
--------- --------- ---------
Total CMOs(3)......................................... $75,044 $73,024 $ 59,075
======= ======= =======
</TABLE>
-------------------------
(1) Par value is the face amount of the underlying mortgage collateral. Any cost
in excess of par value is a "premium" whereas cost lower than par value is
a "discount". The Company's aggregate CMO portfolio has been purchased at a
discount.
(2) Floating rate CMOs provide an increased interest rate when a specified index
interest rate increases and a lower interest rate when such index rate
decreases, while inverse floating rate CMOs provide a lower interest rate
when the index increases and a higher rate when the index rate decreases.
Generally, the Company's floating rate and inverse floating rate securities
are tied to the one month LIBOR. The market values of the Company's
floating rate and inverse rate CMOs are significantly impacted by various
factors, including the outlook for future interest rate changes and such
securities' relative liquidity under current market conditions.
(3) All of the CMO portfolio collateral is guaranteed by a government agency.
Proceeds from sales of fixed maturity securities during the years ended
December 31, 1994, 1993 and 1992 were approximately $21,729,000, $115,339,000
and $76,457,000, respectively. There were no sales of fixed maturity securities
held for investment. Gross realized gains on sales of fixed maturity securities
were approximately $55,000, $2,023,000 and $1,362,000, and gross realized losses
on sales of fixed maturity securities were approximately $13,000, $17,000 and
$85,000 during the years ended December 31, 1994, 1993 and 1992, respectively.
As required by insurance regulatory laws, certain bonds with an amortized
cost of approximately $15,942,000 and short-term investments of approximately
$376,000 at December 31, 1994 were deposited in trust with regulatory agencies.
5. RECEIVABLES
The major components of receivables at December 31 are summarized as
follows (in thousands):
<TABLE>
<CAPTION>
1994 1993
------- -------
<S> <C> <C>
Insurance premiums and agents' balances due............................... $40,308 $33,801
Amounts recoverable from reinsurers....................................... 33,058 10,978
Accrued interest.......................................................... 2,648 2,126
Installment notes receivable.............................................. 1,916 1,768
Other..................................................................... 384 1,586
Less allowance for doubtful accounts...................................... (1,321) (2,093)
------- -------
$76,993 $48,166
======= =======
</TABLE>
F-12
<PAGE> 50
ACCEPTANCE INSURANCE COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
6. EQUITY INVESTMENT IN MAJOR REALTY CORPORATION
As of December 31, 1994 and 1993, the Company held an approximate 33%
equity investment in Major Realty, a publicly traded real estate company engaged
in the ownership and development of its undeveloped land in Orlando, Florida.
At December 31, 1994, the carrying value of the Company's investment in
Major Realty approximated $5.1 million or $2.23 per share. Additionally at that
date, Major Realty had a stockholders' equity of approximately $1,102,000 and
the quoted market price of Major Realty was $2.00 per share. The Company expects
to realize a minimum of its carrying value in Major Realty based on the
estimated net realizable values of Major Realty's underlying assets. The
Company's estimate of net realizable value is based upon several factors
including estimates from Major Realty's management, asset appraisals and sales
to date of Major Realty's assets. Commencing in 1992, the Company has not
recognized its share of net gains realized by Major Realty on sales of real
estate but continues to recognize its share of general and administrative
expenses recorded by Major Realty.
The following summary financial data for Major Realty as of and for the
years ended December 31, 1994 and 1993 was obtained from Major Realty's
consolidated financial statements (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1994 1993
------- -------
<S> <C> <C>
Land held for sale or development......................................... $ 7,038 $ 7,283
Other assets.............................................................. 3,713 3,621
------- -------
Total assets......................................................... $10,751 $10,904
======= =======
Mortgage and other notes payable.......................................... $ 8,038 $ 9,438
Other liabilities......................................................... 1,611 1,452
Stockholders' equity...................................................... 1,102 14
------- -------
Total liabilities and stockholders' equity........................... $10,751 $10,904
======= =======
Total revenues............................................................ $ 4,087 $55,199
======= =======
Gross profit.............................................................. $ 2,697 $ 2,895
======= =======
Net income................................................................ $ 1,089 $ 891
======= =======
</TABLE>
7. BANK BORROWINGS, TERM DEBT AND OTHER BORROWINGS AND NOTES PAYABLE TO
AFFILIATES
On March 31, 1994, the Company amended its borrowing arrangements with its
bank lenders providing a $35 million line of credit with interest payable
quarterly at the prime rate or at LIBOR plus a margin of 1% to 1.75%, depending
on the Company's debt to equity ratio. The line of credit will mature in four
years and may be extended to five years by the bank lenders.
F-13
<PAGE> 51
ACCEPTANCE INSURANCE COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
The following information relates to the debt agreements in effect as of
December 31 (in thousands):
<TABLE>
<CAPTION>
1994 1993
------- -------
<S> <C> <C>
Bank borrowings:
Line of credit, 7.375% interest at December 31, due 1998................ $29,000 $ --
Term loan at the prime rate of interest plus .5% or at the Company's
option, LIBOR plus 2.5%.............................................. -- 12,000
Revolving promissory note at the federal funds rate plus 2.75%.......... -- 6,597
Term debt and other borrowings............................................ -- 354
------- -------
$29,000 $18,951
======= =======
</TABLE>
The Company is considering raising additional debt capital. Use of the
proceeds of any additional borrowing may include a contribution to capital of
the insurance subsidiaries.
At December 31, 1994, the line of credit was collateralized by the
Company's Acceptance and Redland common stock. Borrowings and interest on the
line of credit averaged $20,852,000 and 6.3% during 1994. The line of credit
contains covenants which do not permit the payment of dividends by the Company,
require the Company to maintain certain operating and debt service coverage
ratios, requires maintenance of specified levels of surplus and requires the
Company to meet certain tests established by regulatory authorities.
In August 1993, Redland refinanced its existing notes payable to a bank
with a $7,500,000 revolving promissory note. At December 31, 1993, $6,597,000
was outstanding under this agreement.
The Company issued $9.5 million of Secured Subordinated Notes to certain
directors or stockholders in April 1992 through the exchange of previously
issued secured and unsecured notes aggregating approximately $8.3 million and
cash. Additionally, the Company issued to the holders of the Secured
Subordinated Notes approximately 97,500 common stock warrants exercisable for
five years at a price of $9.50 per share, of which 86,101 warrants remained
outstanding at December 31, 1994. In January 1993, these notes were redeemed.
Cash payments for interest were approximately $1.5 million, $2.5 million
and $4.2 million during the years ended December 31, 1994, 1993 and 1992,
respectively.
8. INCOME TAXES
The Company adopted Statement of Financial Accounting Standards (SFAS) No.
109, "Accounting for Income Taxes", effective January 1, 1993. The prospective
application of SFAS No. 109 resulted in no effect upon net income for the year
ended December 31, 1993.
SFAS No. 109 requires that the Company recognize a net deferred tax asset
or liability for all temporary differences and net operating loss carryforwards
and a related valuation allowance account when realization of the asset is
uncertain. A valuation allowance was recorded for the full amount of the
deferred tax asset at December 31, 1993 because the Company had reported pre-tax
losses from 1989 through 1992. Although the circumstances that generated these
losses were not indicative of operating income, management was uncertain of
future earnings.
As of December 31, 1994, the Company has reported ten consecutive quarters
with pre-tax earnings and the Company has used all of its net operating loss
carryforwards. Accordingly, management believes it is more likely than not that
the Company will realize a portion of the deferred tax asset. The valuation
allowance at
F-14
<PAGE> 52
ACCEPTANCE INSURANCE COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
December 31, 1994 primarily relates to capital loss items whose realization is
uncertain. The net deferred tax asset as of December 31, is as follows (in
thousands):
<TABLE>
<CAPTION>
1994 1993
------- --------
<S> <C> <C>
Unpaid losses and loss adjustment expenses............................... $ 7,263 $ 6,581
Unearned premiums........................................................ 4,840 3,037
Allowances for doubtful accounts......................................... 449 712
Net operating loss carryforward.......................................... -- 3,610
Other.................................................................... 1,599 --
Unrealized loss on marketable equity securities.......................... 419 --
Unrealized loss on fixed maturities available-for-sale................... 6,424 --
Major Realty basis difference............................................ 7,632 7,531
------- --------
Deferred tax asset..................................................... 28,626 21,471
------- --------
Deferred policy acquisition costs........................................ (6,744) (4,017)
Other.................................................................... (681) (23)
------- --------
Deferred tax liability................................................. (7,425) (4,040)
------- --------
21,201 17,431
Valuation allowance...................................................... (8,176) (17,431)
------- --------
Net deferred tax asset................................................... $13,025 $ --
======= ========
</TABLE>
Income taxes computed by applying statutory rates to income before income
taxes are reconciled to the provision for income taxes set forth in the
consolidated financial statements as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
1994
------------
<S> <C>
Computed U.S. federal income taxes.............................................. $ 6,022
Nondeductible amortization of goodwill and other intangibles.................... 514
Tax-exempt interest income...................................................... (400)
Dividends received deduction.................................................... (217)
Recognition of a portion of the deferred tax asset.............................. (9,469)
Other........................................................................... 107
--------
Income taxes provided......................................................... $ (3,443)
========
</TABLE>
The Company recognized a current tax expense of approximately $167,000 for
the year ended December 31, 1993 as a result of amounts due under alternative
minimum taxable income provisions which limit net operating loss carryforwards.
Cash payments for income taxes were approximately $1,478,000 and $232,000
during the years ended December 31, 1994 and 1993.
F-15
<PAGE> 53
ACCEPTANCE INSURANCE COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
9. OPERATING LEASES
The Company leases office space and certain furniture and equipment under
operating leases. Future minimum obligations under these operating leases are as
follows (in thousands):
<TABLE>
<S> <C>
1995............................................................................... $ 2,605
1996............................................................................... 2,470
1997............................................................................... 1,958
1998............................................................................... 1,645
1999............................................................................... 1,384
Thereafter......................................................................... 1,954
-------
$12,016
=======
</TABLE>
Rental expense totaled approximately $2,529,000, $1,169,000 and $1,014,000
for the years ended December 31, 1994, 1993 and 1992, respectively.
10. STOCK OPTIONS
In December 1992, stockholders approved an incentive stock option plan
under which options granted to employees vest over the four years following the
date of grant, options granted to non-employee directors are vested one year
from the date of grant and all options terminate ten years from the date of
grant. A maximum of 500,000 shares are available for the plan and 125,500 and
94,500 options were granted during 1994 and 1993, respectively.
On January 27, 1993, certain executive officers of the Company were awarded
non-qualified options entitling these officers to purchase a total of 72,500
shares of the Company's Common Stock at market value on the date of grant of
$8.75 per share, which are currently exercisable through January 27, 1998.
In connection with consulting agreements entered into in May 1991 with
certain of its directors, the Company incurred approximately $100,000 of expense
during the year ended December 31, 1992. Under the same agreements and in
addition to the above, these directors received a total of 62,210 options to
purchase Company common stock at a price of $10.25 per share which are
exercisable through May 1996.
Changes in stock options are as follows:
<TABLE>
<CAPTION>
NUMBER OF SHARES
------------------- OPTION PRICE
RESERVED GRANTED PER SHARE
-------- ------- -------------
<S> <C> <C> <C>
Balance at January 1, 1992.................................. 260,829 207,006 $ 3.92-$38.50
Reserved.................................................. 500,000 --
Canceled.................................................. (58,455) (4,632)
Exercised................................................. (7,643) (7,643) $3.92
------- -------
Balance at December 31, 1992................................ 694,731 194,731 $12.76-$38.50
Granted................................................... 72,500 167,000 $ 8.75-$13.00
Canceled.................................................. (87,500) (87,500)
------- -------
Balance at December 31, 1993................................ 679,731 274,231 $ 8.75-$38.50
Granted................................................... -- 125,500 $11.38-$12.50
------- -------
Balance at December 31, 1994................................ 679,731 399,731 $ 8.75-$38.50
======= =======
</TABLE>
At December 31, 1994, 211,231 shares were exercisable under stock options.
In December 1992, stockholders approved an employee stock purchase plan
whereby eligible employees will be given the opportunity to subscribe for the
purchase of the Company's common stock for 85% of its fair
F-16
<PAGE> 54
ACCEPTANCE INSURANCE COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
market value as defined. During 1994 and 1993, 19,722 and 12,639 shares were
issued under this plan, respectively.
11. RELATED PARTY TRANSACTIONS
Included in real estate revenues for the year ended December 31, 1992, is
fee income totaling approximately $1,522,000 for real estate advisory services
provided by a subsidiary of the Company to Major Realty. Revenues for the year
ended December 31, 1992 included a non-recurring fee of $925,000 associated with
the settlement and termination of the advisory agreement in March 1992,
effective January 1, 1992. As part of the termination and settlement agreement,
Major Realty issued two promissory notes bearing interest at 12% aggregating
$1,514,581 to the Company's subsidiary representing payment of all deferred fees
and interest thereon and payment of the termination fee, substantially all of
which has been paid at December 31, 1994. Four members of the Board of Directors
of the Company also serve on the Board of Directors of Major Realty.
The Company contracts with a related party to administer health insurance
benefits for its employees whereby the related party receives a commission fee
from the insurance provider.
The Company made payments during 1994 totalling approximately $132,000 to a
related party to provide investment related services.
12. INSURANCE PREMIUMS AND CLAIMS
Insurance premiums written and earned by the Company's insurance
subsidiaries for the years ended December 31, 1994, 1993 and 1992 are as follows
(in thousands):
<TABLE>
<CAPTION>
1994 1993 1992
-------- -------- --------
<S> <C> <C> <C>
Direct premiums written....................................... $410,228 $253,359 $144,464
Assumed premiums written...................................... 37,255 2,683 7,627
Ceded premiums written........................................ (218,307) (118,537) (68,006)
-------- -------- --------
Net premiums written........................................ $229,176 $137,505 $ 84,085
======== ======== ========
Direct premiums earned........................................ $376,624 $250,074 $134,551
Assumed premiums earned....................................... 33,802 3,642 7,048
Ceded premiums earned......................................... (207,767) (125,634) (62,435)
-------- -------- --------
Net premiums earned......................................... $202,659 $128,082 $ 79,164
======== ======== ========
</TABLE>
Five insurance agencies produced direct premiums written aggregating
approximately 22%, 34% and 51% of total direct premiums during the years ended
December 31, 1994, 1993 and 1992, respectively.
F-17
<PAGE> 55
ACCEPTANCE INSURANCE COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
The following table presents an analysis of the Company's reserves,
reconciling beginning and ending reserve balances for the periods indicated (in
thousands):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------
1994 1993 1992
-------- -------- --------
<S> <C> <C> <C>
Net loss and loss adjustment expense reserves at
beginning
of year................................................ $115,714 $ 77,627 $ 66,132
-------- -------- --------
Net loss and loss adjustment expense reserves of Redland
at date of acquisition................................. -- 13,499 --
-------- -------- --------
Provisions for net losses and loss adjustment expenses
for claims occurring in the current year............... 137,881 90,250 57,678
Increase in net reserves for claims occurring in prior
years.................................................. 5,070 2,555 2,347
-------- -------- --------
142,951 92,805 60,025
-------- -------- --------
Net losses and loss adjustment expenses paid for claims
occurring during:
The current year....................................... (60,375) (40,209) (18,328)
Prior years............................................ (56,776) (28,008) (30,202)
-------- -------- --------
(117,151) (68,217) (48,530)
-------- -------- --------
Net loss and loss adjustment expense reserves at end of
year................................................... 141,514 115,714 77,627
Reinsurance recoverable on unpaid loss and loss
adjustment expenses.................................... 79,811 95,886 50,039
-------- -------- --------
Gross loss and loss adjustment expense reserves.......... $221,325 $211,600 $127,666
======== ======== ========
</TABLE>
Insurance loss and loss adjustment expenses have been reduced by recoveries
recognized under reinsurance contracts of $145,451,000 and $216,246,000 for the
years ended December 31, 1994 and 1993, respectively.
13. REINSURANCE
The Company's insurance subsidiaries cede insurance to other companies
under quota share, excess of loss and facultative treaties. The insurance
subsidiaries also maintain catastrophe reinsurance to protect against
catastrophic occurrences where claims can arise under numerous policies due to a
single event. The reinsurance agreements are tailored to the various programs
offered by the insurance subsidiaries. The largest amount retained in any one
risk by the insurance subsidiaries during 1994 was $500,000. The methods used
for recognizing income and expenses related to reinsurance contracts have been
applied in a manner consistent with the recognition of income and expense on the
underlying direct and assumed business (See Note 1).
Three reinsurers, who have an A.M. Best rating of A- (Excellent) or better,
accounted for approximately 30% of the reinsurance recoverables and prepaid
reinsurance premiums at December 31, 1994. No other reinsurer, except for the
Consolidated Farm Service Agency (sponsored by the United States Department of
Agriculture) accounted for more than 5% of these balances.
14. DIVIDEND RESTRICTIONS AND REGULATORY MATTERS
Dividends from the insurance subsidiaries of the Company are regulated by
the state regulatory authorities of the states in which each subsidiary is
domiciled. The laws of such states generally restrict dividends from insurance
companies to parent companies to certain statutorily approved limits. As of
December 31, 1994, the statutory limitations on dividends from insurance company
subsidiaries to the Company without further insurance department approval were
approximately $6.0 million.
F-18
<PAGE> 56
ACCEPTANCE INSURANCE COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
The Company's insurance subsidiaries reported to regulatory authorities
surplus of approximately $126,272,000 and $73,910,000 at December 31, 1994 and
1993, respectively, and total statutory net income of $6,659,000, $682,000, and
$1,304,000 for the years ended December 31, 1994, 1993, and 1992, respectively.
The statutory net income includes Redland insurance subsidiaries effective
July 1, 1993.
15. CONTINGENCIES
The Company is involved in various insurance related claims and other legal
actions arising from the normal conduct of business. Management believes that
the outcome of these proceedings will not have a material effect on the
consolidated financial statements of the Company.
A subsidiary of the Company has guaranteed debt of $775,000 relating to a
real estate partnership in which the subsidiary has a limited partnership
interest.
16. INTERIM FINANCIAL INFORMATION (UNAUDITED)
<TABLE>
<CAPTION>
UNDERWRITING PRIMARY FULLY DILUTED
INCOME NET NET INCOME NET INCOME
QUARTERS ENDED REVENUES (LOSS) INCOME(1) PER SHARE(1) PER SHARE(1)
---------------------------------- -------- ------------ --------- ------------- --------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
1994:
December 31..................... $ 59,631 $ 3,236 $ 7,826 $0.59 $ 0.58
September 30.................... 67,916 3,684 6,326 0.51 0.50
June 30......................... 50,866 300 4,954 0.41 0.40
March 31........................ 41,705 (139) 1,969 0.20 0.19
-------- ------------ --------- ------ ------
$220,118 $ 7,081 $21,075 $1.71 $ 1.68(2)
======== ========= ======== ========== ==========
1993:
December 31..................... $ 43,821 $ (775) $ 2,152 $0.21 $ 0.21
September 30.................... 38,460 153 2,167 0.22 0.22
June 30......................... 32,581 (654) 1,715 0.20 0.20
March 31........................ 30,433 (352) 1,552 0.24 0.23
-------- ------------ --------- ------ ------
$145,295 $ (1,628) $ 7,586 $0.86(2) $ 0.85(2)
======== ========= ======== ========== ==========
</TABLE>
-------------------------
(1) As a result of the acquisition of Redland in July 1993, the Company became
significantly involved in crop insurance programs, including the federal
Multi-Peril Crop Insurance program and the crop hail business. The
Company's operating results from its crop program can vary substantially
from quarter to quarter as a result of various factors, including timing
and severity of losses from storms and other natural perils and crop
production cycles. Therefore, the results for any quarter are not
necessarily indicative of results for any future period. The results of the
crop program business primarily are recognized in the second half of the
calendar year.
(2) Quarterly net income per share numbers do not add to the annual net income
per share due to rounding.
F-19
<PAGE> 57
ACCEPTANCE INSURANCE COMPANIES INC.
SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
DECEMBER 31, 1994 AND 1993
BALANCE SHEETS
(PARENT COMPANY ONLY)
(IN THOUSANDS)
<TABLE>
<CAPTION>
1994 1993
<S> <C> <C>
ASSETS
Fixed maturities available-for-sale $ 2,968 $ --
Cash and short-term investments 6,516 238
Receivables, net 3,618 3,074
Surplus note receivable from subsidiary 20,000 --
Investments in subsidiaries 158,531 95,597
Other assets 1,143 1,043
-------- --------
$192,776 $ 98,952
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable and accrued liabilities $ 374 $ 278
Intercompany payables 3,648 2,957
Term debt and other borrowings 29,000 --
-------- --------
Total liabilities 33,022 3,235
Stockholders' equity:
Preferred stock, no par value, 5,000,000
shares authorized, none issued --
Common stock, $.40 par value, 20,000,000
shares authorized; 15,128,846 and 9,976,415
shares issued 6,052 3,991
Capital in excess of par value 194,674 140,002
Unrealized gain (loss) on available-for-sale
securities, net of tax (13,705) 66
Accumulated deficit (23,003) (44,078)
-------- --------
164,018 99,981
Less:
Treasury stock, at cost, 35,559 shares (1,564) (1,564)
Contingent stock, 240,000 shares (2,700) (2,700)
-------- --------
Total stockholders' equity 159,754 95,717
-------- --------
$192,776 $ 98,952
======== ========
</TABLE>
<PAGE> 58
ACCEPTANCE INSURANCE COMPANIES INC.
SCHEDULE II - (CONTINUED)
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992
STATEMENTS OF OPERATIONS
(PARENT COMPANY ONLY)
(IN THOUSANDS)
<TABLE>
<CAPTION>
1994 1993 1992
<S> <C> <C> <C>
Revenues $ -- $ -- $ --
Costs and expenses:
General and administrative expenses 1,878 1,209 1,403
------- ------- -------
Operating loss (1,878) (1,209) (1,403)
Other income (expense):
Interest expense (1,434) (973) (2,182)
Loss on Settlement Agreement with Major Group -- -- (1,113)
Share of net income (loss) of subsidiaries 19,203 9,257 3,554
Other 724 465 318
------- ------- -------
18,493 8,749 577
------- ------- -------
Income (loss) from continuing operations before
income taxes 16,615 7,540 (826)
Income tax (expense) benefit:
Current 734 46 --
Deferred 3,726 -- --
------- ------- -------
Income (loss) from continuing operations 21,075 7,586 (826)
Loss on disposal of discontinued operations -- -- (83)
------- ------- -------
Net income (loss) $21,075 $ 7,586 $ (909)
======= ======= =======
</TABLE>
<PAGE> 59
ACCEPTANCE INSURANCE COMPANIES INC.
SCHEDULE II - (CONTINUED)
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992
STATEMENTS OF CASH FLOWS (PARENT COMPANY ONLY)
(IN THOUSANDS)
<TABLE>
<CAPTION>
1994 1993 1992
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) from continuing operations $ 21,075 $ 7,586 $ (826)
Adjustments to reconcile net income (loss) from continuing
operations to net cash used for operating activities:
Deferred tax benefit (3,726) -- --
Share of net (income) loss of subsidiaries (19,203) (9,257) (3,554)
Loss on Settlement Agreement with Major Group -- -- 1,113
Increase (decrease) in cash attributable to changes in
assets and liabilities:
Receivables (572) (577) 3,420
Payables (4,564) (1,140) (2,363)
Other, net 291 849 58
-------- -------- --------
Net cash used for operating activities (6,699) (2,539) (2,152)
Cash flows from investing activities:
Proceeds from sale of discontinued operations -- -- 27,550
Contributions to investments in subsidiaries (66,679) (18,489) (3,155)
Purchases of investments (972) -- --
Purchases of investment available-for-sale (2,977) -- --
Costs of acquiring Redland -- (306) --
-------- -------- --------
Net cash provided by (used for) investing activities (70,628) (18,795) 24,395
Cash flows from financing activities:
Proceeds from bank borrowings 29,000 -- --
Repayments of bank borrowings -- -- (23,808)
Proceeds from term debt, other borrowings and notes payable
to affiliates -- -- 9,500
Repayments of term debt, other borrowings and notes payable
to affiliates -- (9,996) (7,796)
Proceeds from issuance of common stock 53,633 31,295 32
-------- -------- --------
Net cash provided by (used for) financing activities 82,633 21,299 (22,072)
-------- -------- --------
Net increase (decrease) in cash and short-term investments 5,306 (35) 171
Cash and short-term investments at beginning of year 238 273 102
-------- -------- --------
Cash and short-term investments at end of year $ 5,544 $ 238 $ 273
======== ======== ========
</TABLE>
<PAGE> 60
ACCEPTANCE INSURANCE COMPANIES INC.
SCHEDULE II - (CONTINUED)
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992
NOTES TO FINANCIAL STATEMENTS (PARENT COMPANY ONLY)
The condensed financial information of Acceptance Insurance Companies Inc. (the
"Company") for the years ended December 31, 1994, 1993, and 1992 should be read
in conjunction with the consolidated financial statements of the Company and
the notes thereto incorporated elsewhere herein by reference.
On December 1, 1994, pursuant to a call by the Company to redeem certain
outstanding warrants, approximately 4.85 million of such warrants were
exercised to purchase shares of common stock, resulting in net proceeds to the
Company of approximately $53.4 million.
In January 1993, the Company assumed a $7 million note from one of its
subsidiaries. In April 1993, this note was exchanged for 875,000 shares of
common stock and warrants to purchase common stock. (See Note 2 to the
Consolidated Financial Statements.)
On March 31, 1994, the Company entered into an Agreement and Plan of Merger
with Statewide Insurance Corporation (Statewide), the exclusive general agent
for the Company's non-standard automobile insurance program underwritten by
Phoenix Indemnity Insurance Company (Phoenix Indemnity), pursuant to which the
Company acquired Statewide. Statewide owned 20% of the outstanding common stock
of Phoenix Indemnity which was a previously 80% owned subsidiary of the
Company. The acquisition was effective April 1, 1994 and was accounted for as a
purchase.
In August 1993, the Company acquired Redland and the purchase price of $15.4
million was comprised of 1,339,000 shares of the Company's common stock and
acquisition related costs of $306,000. (See Note 3 to the Consolidated
Financial Statements.)
The Company aggregates cash and short-term investments with maturity dates of
three months or less from the date of purchase for purposes of reporting cash
flows. As of December 31, 1994, approximately $972,000 of short-term
investments had maturity dates at acquisition of greater than three months.
The deferred tax benefit for the year ended December 31, 1994 is mainly
comprised of $3.6 million of realized net operating loss carryforwards, which
at December 31, 1993 had a valuation allowance for the same amount.
Cash payments for interest were $1,272,000, $1,019,000 and $1,960,000 during
the years ended December 31, 1994, 1993 and 1992, respectively.
<PAGE> 61
ACCEPTANCE INSURANCE COMPANIES INC.
SCHEDULE V
VALUATION ACCOUNTS
YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992
(IN THOUSANDS)
<TABLE>
<CAPTION>
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
BALANCE
AT BALANCE
BEGINNING AT
OF END OF
PERIOD ADDITIONS DEDUCTIONS PERIOD
<S> <C> <C> <C> <C>
Allowance for doubtful accounts:
Year ended December 31, 1994 $2,093 $ 656 $1,428 $1,321
Year ended December 31, 1993 $1,207 $1,000 (A) $ 114 $2,093
Year ended December 31, 1992 $3,586 $ 641 $3,020 (B) $1,207
</TABLE>
(A) Includes allowance for doubtful accounts related to Redland of $663 at
date of acquisition.
(B) Includes $2,993 deductions related to Major Group which is a result of
various write-offs and the conveyance of receivables to Term Sheet
Creditors, in September 1992.
<PAGE> 62
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.
ACCEPTANCE INSURANCE COMPANIES INC.
By /s/ Kenneth C. Coon Dated: March 23, 1995
-------------------------------------
Kenneth C. Coon
Chairman and Chief Executive Officer
By /s/ Georgia M. Mace Dated: March 23, 1995
-------------------------------------
Georgia M. Mace
Chief Financial Officer and Treasurer
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
Dated: March 23, 1995 /s/ Jay A. Bielfield
------------------------------------
Jay A. Bielfield, Director
Dated: March 23, 1995 /s/ Kenneth C. Coon
------------------------------------
Kenneth C. Coon, Director
Dated: March 23, 1995 /s/ Edward W. Elliott, Jr.
------------------------------------
Edward W. Elliott, Jr., Director
Dated: March 23, 1995 /s/ Robert LeBuhn
------------------------------------
Robert LeBuhn, Director
Dated: March 23, 1995 /s/ Michael R. McCarthy
------------------------------------
Michael R. McCarthy, Director
Dated: March 23, 1995 /s/ John P. Nelson
------------------------------------
John P. Nelson, Director
Dated: March 23, 1995 /s/ R. L. Richards
------------------------------------
R. L. Richards, Director
Dated: March 23, 1995 /s/ David L. Treadwell
------------------------------------
David L. Treadwell, Director
Dated: March 23, 1995 /s/ Doug T. Valassis
------------------------------------
Doug T. Valassis, Director
<PAGE> 63
ACCEPTANCE INSURANCE COMPANIES INC.
ANNUAL REPORT ON FORM 10-K
FISCAL YEAR ENDED DECEMBER 31, 1994
EXHIBIT INDEX
NUMBER EXHIBIT DESCRIPTION
3.1 Restated Certificate of Incorporation of Acceptance Insurance
Companies Inc. Incorporated by reference to Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31, 1993.
3.2 Restated By-laws of Acceptance Insurance Companies Inc.
Incorporated by reference to Registrant's Annual Report on Form
10-K for the fiscal year ended December 31, 1993.
4.1 Form of Stock Certificate representing shares of Acceptance
Insurance Companies Inc., Common Stock, $.40 par value.
Incorporated by reference to Exhibit 4.1 to Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31, 1992.
10.1 Office Building Lease dated July 19, 1991, between State of
California Public Employees' Retirement System and Acceptance
Insurance Company. Incorporated by reference to Exhibit 10.7 to
Registrant's Annual Report on Form 10-K for the fiscal year ended
December 31, 1991.
10.2 Intercompany Federal Income Tax Allocation Agreement between
Acceptance Insurance Holdings Inc. and its subsidiaries and
Registrant dated April 12, 1990, and related agreements.
Incorporated by reference to Exhibit 10i to Registrant's Annual
Report on Form 10-K for the fiscal year ended August 31, 1990.
10.3 Employment Agreement dated February 19, 1990 between Acceptance
Insurance Holdings Inc., Registrant and Kenneth C. Coon.
Incorporated by reference to Exhibit 10.65 to Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31, 1991.
10.4 Employment Agreement dated July 2, 1993, between Redland
Insurance Group, Inc., and John P. Nelson. Incorporated by
reference to Exhibit 2 to Registrant's Current Report on Form 8-K
dated July 2, 1993.
10.5 Employment Agreement dated July 2, 1993, between Redland
Insurance Group, Inc., and Richard C. Gibson. Incorporated by
reference to Exhibit 2 to Registrant's Current Report on Form 8-K
dated July 2, 1993.
11 Computation of Income (Loss) per share.
21 Subsidiaries of the Registrant.
23.1 Consent of Deloitte & Touche LLP.
- 1 -
<PAGE> 64
23.2 Report on schedules of Deloitte & Touche LLP.
27 Financial Data Schedule.
28P Schedule P -- Analysis of Losses and Loss Expenses of
Consolidated Annual Statement for the year 1993. Filed in paper
format pursuant to S-T Regulation 311.
99.1 Acceptance Insurance Companies Inc., 1992 Incentive Stock Option
Plan effective as of December 22, 1992. Incorporated by
reference to Exhibit 10.1 to Registrant's Registration Statement
on Form S-1, Registration No. 33-53730.
99.2 Acceptance Insurance Companies Inc., Employee Stock Purchase
Plan, effective as of December 22, 1992. Incorporated by
reference to Exhibit 10.2 to Registrant's Registration Statement
on Form S-1, Registration No. 33-53730.
99.3 Acceptance Insurance Companies Inc., Employee Stock Ownership and
Tax Deferred Savings Plan as merged, amended and restated
effective October 1, 1990. Incorporated by reference as Exhibit
10.4 to Registrant's Quarterly Report on Form 10-Q for the
quarter ended November 30, 1990.
99.4 First Amendment to Acceptance Insurance Companies Inc. Employee
Stock Ownership and Tax Deferred Savings Plan. Incorporated by
reference to Registrant's Annual Report on Form 10-K for the
fiscal year ended December 31, 1993.
99.5 Second Amendment to Acceptance Insurance Companies Inc. Employee
Stock Ownership and Tax Deferred Savings Plan. Incorporated by
reference to Registrant's Annual Report on Form 10-K for the
fiscal year ended December 31, 1993.
99.6 Proxy Statement for 1995 Annual Meeting of Shareholders filed on
or prior to April 30, 1995.
99.7 Acceptance Insurance Companies Inc. Amended 1992 Incentive Stock
Option Plan. Incorporated by reference to Registrant's Proxy
Statement for 1995 Annual Meeting of Shareholders filed on or
prior to April 30, 1995.
99.8 Acceptance Insurance Companies Inc. Amended Employee Stock
Purchase Plan. Incorporated by reference to Registrant's
Proxy Statement for 1995 Annual Meeting of Shareholders filed on
or prior to April 30, 1995.
- 2 -
<PAGE> 1
EXHIBIT 11
ACCEPTANCE INSURANCE COMPANIES INC.
COMPUTATION OF INCOME (LOSS) PER SHARE
Years Ended December 31, 1994, 1993, and 1992
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------
1994(1) 1993(1) 1992
------- ------- -------
<S> <C> <C> <C>
PRIMARY EARNINGS PER SHARE:
Income (loss) from continuing operations $21,075 $ 7,586 $ (826)
Adjustment for interest expense reduction
and interest income from assumed proceeds 1,826 2,403 --
------- ------- -------
Adjusted income (loss) from continuing
operations 22,901 9,989 (826)
Loss on discontinued operations -- -- (83)
------- ------- -------
Adjusted net income (loss) $22,901 $ 9,989 $ (909)
======= ======= =======
Weighted average number of shares
outstanding 10,351 8,335 3,432
Adjustment for shares issuable 3,069 3,227 --
------- ------- -------
Adjusted weighted average number of shares
outstanding 13,420 11,562 3,432
======= ======= =======
Continuing operations $ 1.71 $ 0.86 $ (0.24)
Discontinued operations -- -- (0.02)
------- ------- -------
Net income (loss) per share $ 1.71 $ 0.86 $ (0.26)
======= ======= =======
FULLY DILUTED EARNINGS PER SHARE:
Income (loss) from continuing operations $21,075 $ 7,586 $ (826)
Adjustment for interest expense reduction
and interest income from assumed proceeds 1,757 2,483 --
Adjustment for addback of interest
on convertible notes -- 239(2) 633
------- ------- -------
Adjusted income (loss) from continuing
operations 22,832 10,308 (193)
Loss on discontinued operations -- -- (83)
------- ------- -------
Adjusted net income (loss) $22,832 $10,308 $ (276)
======= ======= =======
Weighted average number of shares
outstanding 10,591 8,427 3,432
Adjustment for effect of outstanding
options and warrants -- -- 6
Adjustment for shares issuable 3,025 3,426 --
Adjustment for convertible notes -- 249(2) 633
------- ------- -------
Adjusted weighted average number of shares
outstanding 13,616 12,102 4,071
======= ======= =======
Continuing operations $ 1.68 $ 0.85 $ (0.05)
Discontinued operations -- -- (0.02)
------- ------- -------
Net income (loss) per share $ 1.68 $ 0.85 $ (0.07)(2)
======= ======= =======
</TABLE>
(1) For the years ended December 31, 1994 and 1993 the number of shares of the
Company's common stock obtainable on exercise of outstanding options and
warrants in the aggregate exceeds 20% of the common shares outstanding.
Therefore, the method of calculating earnings per share has been adjusted
accordingly as provided by APB Opinion No. 15.
(2) This calculation is submitted in accordance with Regulation S-K Item 601
(b) (11) although it is contrary to paragraph 40 of APB Opinion No. 15 because
it produces an anti-dilutive result.
<PAGE> 1
EXHIBIT 21
SUBSIDIARIES OF THE COMPANY
The following is a list of subsidiaries of Registrant as of March 31, 1995,
other than subsidiaries which, considered in the aggregate as a single
subsidiary, would not constitute a significant subsidiary as defined by
Securities and Exchange Commission Regulation S-X.
STATE OF
NAME OF SUBSIDIARY INCORPORATION
Acceptance Insurance Holdings Inc. (1) Nebraska
Radice Lands, Inc. (1) Florida
The Redland Group, Inc. (1) Iowa
Acceptance Insurance Services, Inc. (2) Nebraska
Acceptance Insurance Company (2) Nebraska
Seaboard Underwriters, Inc. (2) North Carolina
Acceptance Indemnity Insurance Company (3) Nebraska
Phoenix Indemnity Insurance Company (4) Arizona
Major Realty Corporation (5) Delaware
American Agrisurance Inc. (6) Iowa
Redland Insurance Company (7) Iowa
Agro International, Inc. (8) Iowa
Crop Insurance Marketing, Inc. (9) Iowa
American Agrijusters, Co. (10) Iowa
American Growers Ins. Company (10) Nebraska
U.S. Ag Insurance Services Inc. (11) Texas
Acceptance Premium Finance Company (12) Arizona
---------------------------------------
(1) A wholly owned subsidiary of Acceptance Insurance Companies Inc.
(2) A wholly owned subsidiary of Acceptance Insurance Holdings Inc.
(3) A wholly owned subsidiary of Acceptance Insurance Company.
(4) An 80% owned subsidiary of Acceptance Insurance Company, 20% of which is
owned by the Registrant.
(5) An approximately 33.1% owned subsidiary of Acceptance Insurance Company.
(6) A wholly owned subsidiary of The Redland Group, Inc.
(7) An approximately 99.99% owned subsidiary of The Redland Group, Inc.
(8) An approximately 80% owned subsidiary of The Redland Group, Inc.
(9) A wholly owned subsidiary of American Agrisurance Inc.
(10) A wholly owned subsidiary of Redland Insurance Company.
(11) An approximately 60% owned subsidiary of Redland Insurance Company.
(12) A 50% owned subsidiary of Registrant.
<PAGE> 1
Exhibit 23.1
INDEPENDENT AUDITORS' CONSENT
To the Board of Directors
Acceptance Insurance Companies Inc.
We consent to the incorporation by reference in Registration Statement No.
33-53001 and No. 33-68856 on Form S-3 and in Registration Statement No.
33-67180 and No. 33-51441 on Form S-8 of Acceptance Insurance Companies Inc. of
our reports dated March 17, 1995 in this Annual Report on Form 10-K of the
Company for the year ended December 31, 1994. Our report referred to above
includes an explanatory paragraph regarding the change in accounting method as
described in Note 1 to the consolidated financial statements.
DELOITTE & TOUCHE LLP
Omaha, Nebraska
March 27, 1995
<PAGE> 1
Exhibit 23.2
INDEPENDENT AUDITORS' REPORT ON SCHEDULES
To the Board of Directors and Stockholders
Acceptance Insurance Companies Inc.
We have audited the consolidated financial statements of Acceptance Insurance
Companies Inc. as of December 31, 1994 and 1993, and for each of the three
years in the period ended December 31, 1994, and have issued our report thereon
dated March 17, 1995 which includes an explanatory paragraph regarding a change
in accounting method as described in Note 1 to consolidated financial
statements; such report is included elsewhere in this Form 10-K. Our audits
also included the consolidated financial statements schedules of Acceptance
Insurance Companies Inc., 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 consolidated 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
Omaha, Nebraska
March 17, 1995
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
AUDITED CONSOLIDATED FINANCIAL STATEMENTS INCLUDED IN THE ANNUAL REPORT ON
FORM 10-K AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1994
<PERIOD-END> DEC-31-1994
<DEBT-HELD-FOR-SALE> 190,180
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 12,530
<MORTGAGE> 1,869
<REAL-ESTATE> 3,891
<TOTAL-INVEST> 264,743
<CASH> 9,339
<RECOVER-REINSURE> 10,902
<DEFERRED-ACQUISITION> 19,834
<TOTAL-ASSETS> 543,087
<POLICY-LOSSES> 221,325
<UNEARNED-PREMIUMS> 97,170
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 29,000
<COMMON> 6,052
0
0
<OTHER-SE> 153,702
<TOTAL-LIABILITY-AND-EQUITY> 543,087
202,659
<INVESTMENT-INCOME> 13,276
<INVESTMENT-GAINS> 554
<OTHER-INCOME> 3,629
<BENEFITS> 142,951
<UNDERWRITING-AMORTIZATION> 47,215
<UNDERWRITING-OTHER> 5,412
<INCOME-PRETAX> 17,712
<INCOME-TAX> (3,443)
<INCOME-CONTINUING> 21,075
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 21,075
<EPS-PRIMARY> 1.71
<EPS-DILUTED> 1.68
<RESERVE-OPEN> 115,714
<PROVISION-CURRENT> 137,881
<PROVISION-PRIOR> 5,070
<PAYMENTS-CURRENT> 60,375
<PAYMENTS-PRIOR> 56,776
<RESERVE-CLOSE> 141,514
<CUMULATIVE-DEFICIENCY> 5,070
</TABLE>
