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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
For the fiscal year ended December 31, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
COMMISSION FILE NUMBER 0-15022
FRONTIER INSURANCE GROUP, INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 14-1681606
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
195 LAKE LOUISE MARIE ROAD, ROCK HILL, NEW YORK 12775-8000
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (914) 796-2100
Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class on which Registered
---------------------------- -----------------------
Common Stock, $.01 par value New York Stock Exchange
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
[x] Yes [ ] No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting stock (Common Stock, $.01 par value)
held by non-affiliates of the Registrant was $637,733,039 on March 18, 1997,
based on the closing sales price of the Common Stock on such date.
The aggregate number of shares of the Registrant's Common Stock, $.01 par value,
outstanding on March 18, 1997, was 14,702,779.
Documents incorporated by reference:
None
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"SAFE HARBOR" STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995: This Annual Report, on Form 10-K, contains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934 which are not historical facts, and
involve risks and uncertainties that could cause actual results to differ
materially from those expected and projected. Such risks and uncertainties
include the following: general economic conditions and conditions specific to
the property and casualty insurance industry including its cyclical nature,
regulatory changes and conditions, rating agency policies and practices,
competitive factors, claims development and the impact thereof on loss reserves
and the Company's reserving policies, the adequacy of the Company's reinsurance
programs, developments in the securities markets and the impact on the Company's
investment portfolio, the success of the Company's acquisition program, changes
in generally accepted accounting principles and the risk factors listed from
time to time in the Company's Securities and Exchange Commission filings.
Accordingly, there can be no assurance that the actual results will conform to
the forward-looking statements in the Annual Report.
-----------------
PART I
Item 1. Business.
General
The Company is an insurance holding company which, through its direct or
indirect wholly-owned subsidiaries, Frontier Insurance Company ("Frontier
Insurance"), Medical Professional Liability Agency, Ltd. ("Med Pro"), Pioneer
Claim Management, Inc. ("Pioneer"), Frontier Pacific Insurance Company
("Frontier Pacific," formerly Contractors' Surety Company), Spencer Douglass
Insurance Associates ("SDIA"), United Capitol Holding Company ("United Capitol
Holding"), United Capitol Insurance Company ("United Capitol"), Olympic
Underwriting Managers, Inc. ("Olympic"), Fischer Underwriting Group, Inc.
("Fischer"), Regency Financial Corporation ("Regency Financial"), Regency
Insurance Company ("Regency") and Emrol Installment Premium Discount, Inc.
("Emrol"), and its 50% ownership of Douglass/Frontier LLC ("Douglass/Frontier"),
conducts business as a specialty property and casualty insurer and reinsurer,
and performs claims adjusting and management services. Frontier Insurance, the
Company's principal insurance company subsidiary, was acquired by the Company in
April 1986. Med Pro, which underwrites the majority of the Company's medical and
dental malpractice programs, was acquired by the Company in June 1987. Pioneer,
which performs claims adjusting and claims management services for the Company's
insurance lines, was organized and commenced business in October 1989 as the
successor to a claims adjusting company. Frontier Pacific, the Company's
California insurance company subsidiary, was acquired by Frontier Insurance in
October 1991 and changed its name from Contractors' Surety Company in September
1993. SDIA was acquired by the Company in April 1994 and is involved in placing
and servicing license and permit bond business in California and other western
states. Douglass/Frontier was formed as a joint venture in May 1995 and is
involved in placing and servicing bail bond business. United Capitol Holding,
which was acquired by Frontier Insurance in May 1996, through its subsidiaries,
United Capitol, Olympic and Fischer, conducts business as an excess and surplus
lines insurer and as an underwriting management company for directors' and
officers' liability and property coverages. Regency Financial was organized by
the Company in June 1996 to acquire Regency, a non-standard automobile insurer
and Emrol, a premium finance company, which were so acquired in September 1996.
In February 1996, the Company acquired a 33% ownership interest in Townsquare
Title Insurance Services, which owns United General Title Insurance Company
("United General"). In October 1996, the Company formed Frontier Financing
Trust, a Delaware statutory business trust, for the sole purpose of issuing
certain convertible preferred securities and investing the proceeds thereof in
an equivalent amount of convertible subordinated debentures of the Company. The
financial statements of Frontier Financing Trust have been consolidated with
those of the Company. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Liquidity and Capital Resources," and NOTE
M of the NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS.
The Company's underwriting strategy is to identify niche markets or programs
that are unattractive to other insurers due to the limited potential market or
perceived excessive risks, which the Company
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believes afford favorable opportunities for profitability due to limited
potential competition and the Company's innovative underwriting and value added
services, principally risk management, coverage enhancements and specialized
claims management. The Company underwrites specialty niche market programs,
including medical and dental malpractice for physicians, social service care
providers, alternative risk physicians, psychiatrists, chiropractors and
dentists, predominantly in New York, Florida, Illinois, Ohio, Texas, and
Michigan. The Company also underwrites a variety of specialty programs under
general liability, together with workers' compensation, surety bonds for small
contractors, contractor license bonds, license and permit bonds, bail bonds,
custom bonds, commercial earthquake and other miscellaneous lines. The medical
and dental malpractice programs are currently produced on a direct basis through
Med Pro and are also marketed, together with all other lines, through a network
of independent general agents and retail brokers.
Frontier Insurance is licensed as a property and casualty insurer in 49 states,
the District of Columbia, Puerto Rico and the Virgin Islands, and is rated A-
(Excellent) by A.M. Best Company, Inc ("A.M. Best"). Additionally, Standard &
Poor's Insurance Rating Services has given Frontier Insurance an Insurer
Claims-Paying Ability Rating of A+ (Excellent). Frontier Pacific is licensed in
California and Nevada and is rated A- (Excellent) by A.M. Best. United Capitol
is licensed as a property and casualty writer in Arizona and Wisconsin, is an
approved excess and surplus lines insurer in 47 states and is rated
A-(Excellent) by A.M. Best; Regency is licensed as a property and casualty
writer in North Carolina and South Carolina and is rated A- (Excellent) by A.M.
Best; and United General is licensed as a title insurer in 30 states and is not
rated by A.M. Best. A.M. Best's and Standard & Poor's ratings are based on an
analysis of the financial condition and operations of an insurance company as
they relate to the industry in general, are not designed for the protection of
investors and do not constitute recommendations to buy, sell or hold any
security.
The following chart provides examples of typical niche markets/programs
underwritten by the Company for specific types of customers:
<TABLE>
<CAPTION>
Customer Type Coverage/Line of Business Hypothetical Claim
- ------------- ------------------------- ------------------
<S> <C> <C>
Doctors and dentists professional liability patient injured
White water raft operators general liability rafter injured through
operator's negligence
Social service agencies professional liability, general client sues agency or
liability, fire professional
Crane operators general liability crane damages a third
party's property
Alarm installers general liability house is burglarized
through faulty alarm
installation
Small-construction contractors surety bonds electrician or plumber
fails to complete job
Self-Insured employers excess worker's compensation/ workers' compensation
employer's liability loss exceeds
employer's self-insured
retention
Importers customs bonds importer fails to pay duty
Commercial property owners earthquake (difference in conditions) earthquake damages
to building or disrupts
operations
</TABLE>
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Insurance Lines
The following table sets forth the gross and net premiums by principal lines of
insurance written by the Company and the related percentages of the total such
premiums represented thereby for the year ended December 31, 1996:
<TABLE>
<CAPTION>
Gross Premiums Written Net Premiums Written
----------------------- ---------------------
Dollars Percentage Dollars Percentage
------- --------- ------- ----------
(dollar amounts in thousands)
<S> <C> <C> <C> <C>
Medical malpractice (Including
dental malpractice and social services) $139,233 34.6% $119,653 38.4%
General liability 113,423 28.2 93,980 30.1
Surety 65,381 16.2 56,632 18.2
Workers' compensation 25,429 6.3 6,253 2.0
Commercial earthquake 16,541 4.1 11,904 3.8
Other 42,792 10.6 23,441 7.5
--------- ------ ---------- -------
Total $402,799 100.0% $311,863 100.0%
======== ===== ======== =====
</TABLE>
Medical Malpractice
The Company commenced underwriting medical malpractice insurance in 1981 under
programs developed for physicians with varied practices, which include part-time
physicians, internists, physicians and other health care professionals providing
medical services to clients of social service care facilities (mental health,
home care, etc.), family practitioners, psychiatrists, chiropractors,
dermatologists, and other specialists. Physicians covered under the Company's
programs generally must be members of a national, state, or county society for
their particular specialty and must limit their practice to such specialty, or
be employed by a social services care facility, or be in practice or employed on
a part-time basis. The Company has implemented strict underwriting guidelines in
an attempt to screen-out undesirable risks and reduce its exposure. Medical
malpractice insurance is written by the Company on both an occurrence and a
claims made basis predominantly in New York, Florida, Illinois, Ohio, Texas, and
Michigan. Additionally, the Company markets a specialty program for physicians
unable to obtain traditional malpractice coverage as a result of excessive
malpractice claims, professional disciplinary proceedings and/or drug or alcohol
abuse. Coverage under this program is written with a deductible and is priced
substantially higher than the Company's standard medical malpractice programs.
At December 31, 1996, approximately 17,500 physicians were insured by the
Company, of whom 600, or 3.4%, were employed as faculty members at medical
schools of the State University of New York ("SUNY"), 12,300, or 70.3%, were
physicians who were members of 19 medical associations which endorsed or
approved the Company's medical malpractice insurance program, and 4,600, or
26.3% were physicians and other health care professionals providing medical
services covered by the Company's social services care insurance program. Since
December 31, 1990, the number of SUNY physicians insured by the Company has
decreased by approximately 430, attributable to increased competition and other
factors, including a 1990 decision by the New York State Court of Claims
relating to SUNY physicians in favor of the Company. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Litigation with the State of New York."
Dental Malpractice
In August 1987, the Company commenced underwriting dental malpractice insurance
for dentists viewed by the Company as preferred risks. Dentists who practice
oral surgery or who utilize anesthesia to render their patients unconscious are,
among others, not viewed as preferred risks and, accordingly,
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are not eligible for coverage. As with medical malpractice, the endorsement of
related professional organizations is a key element in marketing; the
endorsement by the Academy of General Dentistry in 1994 has proven especially
beneficial. Dental malpractice is written by the Company predominantly in New
York, Florida, and Ohio. At December 31, 1996, approximately 4,900 dentists were
insured by the Company under its dental malpractice program.
General Liability
The Company underwrites general liability coverages for day care centers, crane
operators, white water rafting, health and social services programs, pest
control operators, fire protection equipment dealers and installers, security
guards, excess workers' compensation/employer's liability for self-insured
employers, and a variety of other programs. Further, the Company underwrites
umbrella coverage up to $5 million over an underlying $1 million general
liability coverage. The Company's specialty insurance programs include
environmental policies covering enumerated hazards with stated policy limits.
Although the Company believes that such policies, together with the Company's
general, professional and other liability policies, do not subject the Company
to material exposure for environmental pollution claims, there can be no such
assurance in view of the expansion of liability for environmental claims in
recent litigation.
Surety
The Company directly underwrites surety bonds for small contractors, customs
bonds, contractor license bonds, bail bonds, license and permit bonds, and
self-insured employer's workers' compensation bonds.
Workers' Compensation
The Company underwrites workers' compensation coverage for cotton gins, jockeys,
feed lots, and other specialty niches. Additionally, the Company assumes
workers' compensation business as a result of its required participation in the
National Workers' Compensation Reinsurance Pool and other residual market
mechanisms. Due to adverse underwriting results, competitive pricing and
competition, the Company discontinued all workers' compensation business in 1993
except its cotton gin and feedlot programs in Texas, its New Jersey jockey
program, and its social services program. During 1996, the Company established
an alternative risk division and commenced underwriting workers' compensation
coverage in conjunction with other programs.
Commercial Earthquake
In July 1995, the Company commenced underwriting difference in conditions
("DIC") commercial earthquake policies under an agreement with a subsidiary of
Associated International Insurance Company ("Associated"). Pursuant to the
agreement, the Company and Associated underwrite DIC commercial earthquake
policies through a companion carrier facility with combined limits of $7.5
million, with two-thirds of the new and renewal policies being underwritten by
Associated and one-third by the Company. The agreement may be terminated by
either party upon 90 days' notice.
Other
The Company underwrites other lines of insurance, including commercial
multi-peril, inland marine, ocean marine, property, specialty homeowners,
non-standard auto, and excess of loss group accident and health. In 1996 the
Company began to assume, on a quota share basis, homeowners business
underwritten by Omega Insurance Company.
Reinsurance
On July 1, 1996, the Company obtained catastrophe reinsurance coverage for its
homeowners business written, which provides coverage in the amount of $14
million excess of a $1 million retention.
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The Company reinsures its ocean marine and international risks under multiple
layers of excess reinsurance which provides coverage up to $9.95 million excess
of $50,000 per occurrence, excess of an aggregate retention of $200,000 of
loss occurrences in excess of $50,000. Prior to 1997, the Company also
reinsured ocean marine business written by its subsidiary, United Capitol,
retaining the first $250,000 per occurrence and ceding up to $7.75 million
excess of $250,000, per occurrence under a program led by Underwriters at
Lloyds on a losses occurring basis. Effective January 1, 1997, this program was
replaced by a similar program written on a risks attaching basis by Munich
American Reinsurance Company and Munich Reinsurance Company, U.S. branch.
The Company cedes 100% of its environmental liability business to Underwriters
Reinsurance Company. The Company reassumes 10% of this business, together with
10% of the environmental liability business underwritten by Commercial
Underwriters Insurance Company and Underwriters Reinsurance Company. During 1995
and 1996, the Company assumed mobile homeowners business from Omega Insurance
Company, errors and omission business which it acquired from Bankers Multiple
Line Insurance Company ("BMLIC"), in 1995. The Company also assumes reinsurance
from its required participation in residual market pools such as the National
Workers' Compensation Reinsurance Pool.
Effective January 1, 1995, the Company entered into a stop loss reinsurance
contract with Centre Reinsurance Company of New York ("Centre Re") for 1995,
1996 and 1997. Under the terms of the agreement, Centre Re provides reinsurance
protection for losses and LAE in excess of a predetermined ratio of these
expenses to net premiums earned for a given accident year for all lines of
business except certain classes of surety bonds, realtors errors and omissions
and all of the net premiums earned from United Capitol and Regency. The loss and
LAE ratio above which the reinsurance provides coverage is 66%, 65%, and 64% for
accident years 1995 through 1997, respectively. The maximum amount recoverable
for an accident year is 175% of the reinsurance premium paid for that accident
year, or $162.5 million in the aggregate for the three years. The additional
reinsurance coverages described herein are underlying reinsurance coverages
which inure to the benefit of this stop loss contract.
Effective July 15, 1995, the Company implemented a program, with 26 reinsurers
for its commercial Difference in Condition ("DIC") earthquake program, through a
per risk excess of loss agreement and four layers of inuring catastrophe
reinsurance. The catastrophe layers attach at $2.5 million per occurrence up to
$40 million per occurrence and allow one full reinstatement per year. The
Company retains $50,000 per risk, $2.5 million per occurrence.
Effective January 1, 1996, the Company entered into a clash reinsurance
agreement with Mutual Assurance, Inc., the Doctors' Insurance Company, and
Reliance Insurance Company with respect to its medical malpractice business.
Under the agreement, reinsurance is provided to the Company for occurrences
involving multiple physicians for $3 million excess of $2 million per
occurrence, subject to an aggregate of $6 million.
The majority of the Company's ceded business is reinsured by Centre Reinsurance
Company of New York, Swiss Reinsurance America Corporation, and its umbrella
liability business by Munich American Reinsurance Company. During 1996, the
Company reinsured a large workers' compensation program with the Commercial Risk
Re-Insurance Company.
Munich American Reinsurance Company is currently rated A+ (Superior), and Centre
Reinsurance Company of New York and Swiss Reinsurance America Corporation are
currently rated A (Excellent) by A.M. Best Company, Inc.
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The following table is a summary of the maximum amount of loss typically
retained and ceded by the Company's insurance subsidiaries as of December 31,
1996 (exclusive of facultative reinsurance and the Centre Re stop loss
contract):
<TABLE>
<CAPTION>
Maximum Retained Loss Maximum Ceded Loss
Per Occurrence/ Per Occurrence/
Risk/Principal Risk/Principal
---------------------- ------------------------
(dollar amounts in thousands)
<S> <C> <C>
Property lines $ 500 $ 9,500
Casualty lines (excluding medical
malpractice, health specialties,
and social services) 1,000 4,000
Medical malpractice, health
specialties and social services 1,000 (1) 1,000
Workers' compensation 1,000 2,000
Surety 1,000 (3) 4,000 (3)
Custom bonds 3,000 (4) N/A
Umbrella liability 1,000 4,000
Group accident and health 250 750
Excess workers' compensation/
employers' liability 1,000 (5) 9,000 (5)
Earthquake 2,500 (2) 47,500 (2)
Homeowners 1,000 (6) 14,000 (6)
Ocean marine 250 9,750
Directors and officers liability 1,000 4,000
</TABLE>
- ----------
(1) For certain risks and policy years, the maximum retained loss per
occurrence is $.5 million. On a very limited basis, the maximum retained
loss per occurrence is $2 million.
(2) Amounts relate to the contract effective January 1, 1997, which
catastrophe layers in excess of $2.5 million are subject to a 5%
coinsurance.
(3) Effective December 1, 1995, a layer of excess reinsurance was added for a
maximum limit of $10 million per principal on a direct basis, $2.1 million
on a net basis.
(4) Amount indicated is the maximum face amount (limit) on the bond issued,
which represents the value of goods being imported that are subject to
U.S. Customs duty. The actual exposure to the Company is the amount of any
unpaid duty on the goods imported, which is generally approximately 15% of
the face value of the goods, and any penalties associated with the late
payment of the duty.
(5) Subject to a catastrophe retention of $3 million per occurrence and a
maximum ceded loss of $40 million per occurrence.
(6) Excludes the effects of the Company's 5% retention of $14 million in
losses in excess of $1 million.
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Marketing
The Company relies on multiple distribution channels to market its insurance
products. Medical malpractice and dental malpractice insurance are produced on a
direct basis by Med Pro and by independent brokers and agents. License and
permit bonds are marketed directly by Frontier Pacific and SDIA, and through
independent brokers and agents. Bail bonds are produced by Douglass/Frontier
through a nationwide network of bail bondsmen.
The Company relies primarily on independent insurance agencies and insurance
brokerage firms to generate sales of its remaining lines of business. General
liability, workers' compensation, multi-peril and property policies are produced
through general agents, principally in California, Florida, New Jersey, New
York, Pennsylvania, and Texas, and selected small agencies in New York on a
brokerage basis. Surety bonds for small contractors are produced through
independent insurance agents acting as retail brokers and general agents and
several small insurance companies which also act as reinsurers on the business
they produce. Custom bonds are produced through a specialty agency in New York
which derives the business from a nationwide network of customs brokers located
in the various ports of entry.
The following tables set forth for the three years ended December 31, 1996, the
gross and net premiums written produced internally and by independent agencies
and brokerage firms, no one of which accounted for more than 5% of such
premiums:
<TABLE>
<CAPTION>
Year Ended December 31
---------------------------------------------------------------------
1996 1995 1994
-------------------- ----------------------- ---------------
Premiums Percent Premiums Percent Premiums Percent
Written of Total Written of Total Written of Total
---------- -------- -------- -------- --------- --------
(dollar amounts in thousands)
<S> <C> <C> <C> <C> <C> <C>
GROSS PREMIUMS
Internal $ 78,411 19.5% $ 56,118 21.2% $ 48,099 24.2%
All others 324,388 80.5 208,196 78.8 150,793 75.8
--------- ------ --------- ------ --------- ------
Total $402,799 100.0% $264,314 100.0% $198,892 100.0%
======== ===== ======== ===== ======== =====
NET PREMIUMS
Internal $ 56,511 18.1% $ 49,126 22.3% $ 47,050 25.1%
All others 255,352 81.9 171,631 77.7 140,238 74.9
--------- ------ --------- ------ --------- ------
Total $311,863 100.0% $220,757 100.0% $187,288 100.0%
======== ===== ======== ===== ======== =====
</TABLE>
Operating Ratios
Statutory Combined Ratio
The statutory combined ratio is the traditional measure of underwriting
experience for insurance companies. Generally, if the statutory combined ratio
is below 100%, an insurance company has an underwriting profit and if it is
above 100%, the insurer has an underwriting loss.
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The following table reflects the consolidated statutory loss ratios, expense
ratios and combined ratios of the Company's primary insurance operating
subsidiaries, Frontier Insurance, Frontier Pacific and, from May and July
1996, United Capitol and Regency, respectively, determined in accordance with
statutory accounting practices, together with the property and casualty
industry-wide statutory combined ratios after policyholders' dividends as
compiled by A.M. Best, for the years indicated:
<TABLE>
<CAPTION>
Year Ended December 31
-----------------------------------------------
1996 1995 1994 1993 1992
------ ----- ----- ----- ----
<S> <C> <C> <C> <C> <C>
Loss ratio 58.7% 60.0% 69.9% 66.4% 71.9%
Expense ratio 32.2 31.1 28.2 27.8 24.9
---- ----- ----- ----- -----
Combined ratio 90.9% 91.1% 98.1% 94.2% 96.8%
==== ===== ===== ===== =====
Industry combined ratio after
policyholders' dividends 105.9% 106.4% 108.4% 106.9% 115.7%
===== ===== ===== ===== =====
</TABLE>
Premium-to-Surplus Ratio
While there are no statutory provisions governing premium-to-surplus ratios,
regulatory authorities regard this ratio as an important indicator since the
lower the ratio, the greater the insurer's ability to withstand abnormal loss
experience. Guidelines established by the National Association of Insurance
Commissioners provide that an insurer's premium-to-surplus ratio is satisfactory
if it is below 3 to 1.
The following table sets forth the ratio of net premiums written during the year
to policyholders' surplus at the end of the year for Frontier Insurance,
Frontier Pacific, United Capitol and Regency for the years indicated:
<TABLE>
<CAPTION>
Year Ended December 31
--------------------------------------------------
1996 1995 1994 1993 1992
--------- -------- --------- --------- -------
(dollar amounts in thousands)
<S> <C> <C> <C> <C> <C>
Frontier Insurance:
Net premiums written
during the year $255,446 $205,614 $179,058 $115,028 $113,508
Policyholders' surplus
at end of year $262,899 $171,362 $104,871 $101,418 $76,438
Ratio .97/1 1.20/1 1.71/1 1.13/1 1.48/1
Frontier Pacific:
Net premiums written
during the year $32,040 $15,143 $8,230 $3,791 $2,740
Policyholders' surplus
at end of year $25,985 $17,155 $16,127 $15,108 $6,522
Ratio 1.23/1 .88/1 .51/1 .25/1 .42/1
United Capitol:
Net premiums written
during the year $25,930 $10,981 $17,051 $17,708 $17,640
Policyholders' surplus
at end of year $53,355 $68,026 $61,750 $65,676 $62,387
Ratio .49/1 .16/1 .28/1 .27/1 .28/1
Regency:
Net premiums written
during the year $4,489 $4,441 $4,804 $5,587 $6,047
Policyholders' surplus
at end of year $5,105 $4,667 $4,521 $4,308 $4,070
Ratio .88/1 .95/1 1.06/1 1.30/1 1.49/1
</TABLE>
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Loss and LAE Reserves
Significant periods of time, ranging up to several years, may elapse between the
occurrence of an insured loss, the reporting of the loss to the Company and its
payment of such loss. Medical malpractice and general liability usually have a
much longer period of time between occurrence of a loss and payment than
property lines. To recognize liabilities for unpaid losses, the Company
establishes reserves, which are balance sheet liabilities representing estimates
of amounts needed to pay claims and related expenses with respect to insured
events which have occurred, including those not yet reported ("IBNR").
All claims are investigated, supervised and adjusted by personnel of Pioneer,
which selects counsel and outside adjusting firms, if required, and monitors the
case and approves any settlement. Any payment in excess of $50,000 requires
approval by an officer of the Company. The Company believes claims management is
critical to controlling the amount of paid losses and has an internal staff of
experienced claims adjusters and attorneys assigned exclusively to managing and
adjusting claims.
When a claim is reported, the Company's claims adjusting personnel establish a
formula case reserve, which is based on historical average claim costs, for the
estimated amount to be paid. As more pertinent information becomes available on
a claim, adjusting personnel change the reserve from a formula reserve to a case
basis reserve. This case basis reserve is an estimate of the amount of ultimate
payment which reflects the informed judgment of such personnel, based on the
Company's reserving practices and the experience and knowledge of such personnel
regarding the nature and value of the specific type of claim. Additionally,
reserves are established by the Company on an aggregate basis to provide for
IBNR losses and to maintain the overall adequacy of reserves. The Company also
establishes a related loss adjustment expense ("LAE") reserve on an aggregate
basis representing the estimated expense of settling claims, including legal and
other fees and general expenses of administering the claims adjustment process
with respect to reported and unreported losses. Virtually all of the Company's
LAE is classified as allocated LAE as a result of its method of handling claims
through Pioneer. The Company does not discount its reserves either on the basis
of generally accepted accounting practices ("GAAP") or statutory accounting
practices.
The reserves for losses and LAE are estimated using loss evaluations and
actuarial projections and represent estimates of the ultimate net cost of all
unpaid losses and LAE incurred through December 31 of each year. These estimates
are subject to the effect of trends in claims severity and frequency and are
continually reviewed. As part of this process, historical data are reviewed and
consideration is given to the anticipated impact of various factors, such as
legal developments, changes in social attitudes, and economic conditions,
including the effects of inflation and anticipated subrogation recoveries with
respect to the surety line of business. As experience develops and other data
becomes available, these estimates are revised, as required, resulting in
increases or decreases in reserves for insured events of prior years. Future
adjustments, if any, will be reflected in the results of operations in the
period in which recognized.
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The following table sets forth a reconciliation of the beginning and ending loss
and LAE reserve balances, net of reinsurance ceded, for each of the three years
in the period ended December 31, 1996:
<TABLE>
<CAPTION>
Year Ended December 31
----------------------------------------
1996 1995 1994
---- ---- ----
(amounts in thousands)
<S> <C> <C> <C>
Net reserves for losses and LAE, beginning of year $294,393 $263,202 $216,486
Total acquired reserves 53,008 5,500
Incurred losses and LAE for claims relating to:
Current year 160,470 126,769 97,044
Prior years (4,479) (7,514) 13,874
------- ------- -------
Total incurred losses and LAE 155,991 119,255 110,918
------- ------- -------
Loss and LAE payments for claims relating to:
Current year 27,626 13,057 7,216
Prior years 102,160 80,507 56,986
------- ------ ------
Total payments 129,786 93,564 64,202
------- ------ ------
Net reserves for losses and LAE, end of year 373,606 294,393 263,202
Total reinsurance recoverable on unpaid losses
and LAE 165,467 73,043 49,435
------- -------- ---------
Gross reserves for losses and LAE, end of year $539,073 $367,436 $312,637
======== ======== ========
</TABLE>
The Company's net reserves for unpaid losses and LAE, net of related reinsurance
recoverable, at December 31, 1995 and 1994 were decreased in the following year
by approximately $4.5 million and $7.5 million, respectively, and at December
31, 1993 were increased in the following year by approximately $13.9 million,
for claims that had occurred on or prior to the balance sheet dates. No premiums
have been accrued as a result of the changes to prior-year loss and LAE
reserves.
The net $4.5 million decrease in prior years' reserves in 1996 was the result of
favorable claims development on the workers' compensation line of business.
Included in the net development was an increase in prior years' reserves of
approximately $13 million which was entirely offset by subrogation recoverables
recognized in connection with a favorable court ruling in 1995. See NOTE C of
the NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS. The significant increase in
the reinsurance recoverables in 1996 was due to the contribution to the
recoverables as result of the acquisition of United Capitol and Regency, which
were acquired in 1996, and the change in the type of reinsurance from an
aggregate claim excess of loss to a stop loss for the majority of the Company's
losses.
The net $7.5 million decrease in the prior years' reserves in 1995 was the
result of favorable claims development on the general liability and workers'
compensation lines and to subrogation recoveries in the surety line of business
in excess of expectations. Included in the net development was an increase in
prior years' reserves of approximately $19 million which was entirely offset by
subrogation recoverables recognized in connection with a favorable court ruling
in 1995. See NOTE C of the NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS. The
significant increase in the reinsurance recoverable in 1995 was due to a change
in the type of reinsurance from an aggregate claim excess of loss to a stop loss
for the majority of the Company's losses. See "Reinsurance".
The $13.9 million increase in prior years' reserves in 1994 resulted from a
$17.5 million increase in the reserves attributable to adverse medical
malpractice claims development in Florida as a result of higher
11
<PAGE>
<PAGE>
than anticipated dollar settlements and from redundancies in other lines.
The following table reflects the Company's loss and LAE reserves development,
net of estimated subrogation recoverable through December 31, 1996, for each of
the preceding ten years:
<TABLE>
<CAPTION>
Year Ended December 31
------------------------------------------------------------------------------------------------
1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996
------ ------ ------ ------ ------ ------ ------ ------ ------ ------ -----
(amounts in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Reserves for unpaid
losses & LAE $27,271 $ 43,813 $ 64,971 $ 92,384 $120,096 $161,263 $185,074 $216,486 $263,202 $294,393 $373,606
Reserves reestimated
at December 31:
1 year later 28,495 46,385 67,486 93,419 119,875 162,121 188,387 230,360 255,689 289,914
2 years later 29,587 49,495 68,793 91,457 120,550 158,746 196,005 229,334 252,678
3 years later 31,906 50,890 66,532 91,527 115,310 163,537 191,401 214,712 --
4 years later 33,425 49,694 66,656 86,508 114,790 154,217 172,654 -- --
5 years later 32,730 49,895 64,254 87,795 107,907 133,768 -- -- --
6 years later 32,740 49,492 64,700 79,459 88,803 -- -- -- --
7 years later 33,563 48,749 55,300 62,667 -- -- -- -- --
8 years later 32,357 43,099 42,687 -- -- -- -- -- --
9 years later 30,720 32,391 -- -- -- -- -- -- --
10 years later 23,375 -- -- -- -- -- -- -- --
Cumulative redundancy 3,896 11,422 22,284 29,717 31,293 27,495 12,420 1,774 10,524 4,479
Cumulative amount of liability
paid through December 31:
1 year later 3,760 6,208 9,611 16,823 8,129 41,486 38,300 56,986 80,507 102,160
2 years later 7,477 12,946 20,006 13,230 35,864 62,175 74,113 113,471 148,513
3 years later 11,953 20,339 11,196 32,987 45,973 80,888 112,017 154,548 --
4 years later 16,605 14,902 24,825 39,166 58,043 104,672 139,333 -- --
5 years later 12,916 24,426 30,919 50,406 74,659 122,863 -- -- --
6 years later 18,466 27,766 39,664 61,276 86,405 -- -- -- --
7 years later 20,999 32,372 47,784 67,429 -- -- -- -- --
8 years later 23,259 38,271 50,119 -- -- -- -- -- --
9 years later 27,412 39,567 -- -- -- -- -- -- --
10 years later 27,820 -- -- -- -- -- -- -- --
Net reserve - December 31 $263,202 $294,393 $373,606
Reinsurance recoverables 49,435 73,043 165,467
-------- -------- --------
Gross reserve $312,637 $367,436 $539,073
======== ======== ========
</TABLE>
The loss and LAE reserves of Frontier Insurance, Frontier Pacific, United
Capitol and Regency as reported in their Annual Statements prepared in
accordance with statutory accounting practices and filed with state insurance
departments are identical with those reflected in the Company's financial
statements prepared in accordance with GAAP included herein, before elimination
of inter-company transactions and except for a change resulting from the
rescission by Frontier Insurance in April 1986 of an offer to assume reinsurance
under a proposed treaty with another insurer which has been given retroactive
effect herein but was not reflected in the statutory filing with the New York
Insurance Department until the March 31, 1986 quarterly statement, thereby
reducing the GAAP reserves at December 31, 1985, by $861,000 from the statutory
reserves at such date. Further, at December 31, 1986, Frontier Insurance's loss
and LAE reserves under GAAP were lower by $138,000 than its 1986 statutory
reserves as a result of the revision of certain estimates with respect to liquor
law liability claims.
12
<PAGE>
<PAGE>
Investments
Funds, including reserve funds, are invested until required for the Company's
operations, subject to restrictions on permissible investments established by
applicable state insurance codes. The Company's investment strategy is to
maximize after-tax income while generally limiting investments to investment
grade securities with high liquidity. Prior to 1996, the Company's investment
portfolio was managed by Asset Allocation and Management Company ("Asset
Allocation") and General Re New England Asset Management, Inc.("New England"),
registered investment advisors which specialize in insurance company portfolio
management, pursuant to guidelines established by the Company. In 1996, the
Company hired a Chief Investment Officer and the core fixed income portfolio is
now being managed internally. Asset Allocation and New England provide
investment advisory and related services to the Company in asset classes such as
mortgage-backed securities, sinking fund preferred stocks, and other special
classes of securities.
The following table contains information concerning the Company's investment
portfolio at December 31, 1996:
<TABLE>
<CAPTION>
Market Amount Reflected Percent
Cost (1) Value on Balance Sheet of Total
--------- --------- --------------- ----------
(dollar amounts in thousands)
<S> <C> <C> <C> <C>
Available-for-sale securities
Fixed maturity securities:
U.S. Treasury securities and
obligations of U.S. Government
corporations and agencies $ 29,708 $ 29,960 $ 29,960 4.3%
Obligations of states and
political subdivisions 191,311 193,055 193,055 27.5
Foreign governments 30 24 24 .0
Corporate securities 162,336 164,398 164,398 23.4
Mortgage-backed securities 296,896 297,840 297,840 42.5
-------- -------- -------- -----
Total fixed maturity securities 680,281 685,277 685,277 97.7
Equity securities 13,871 16,271 16,271 2.3
-------- -------- -------- -----
Total available-for-sale-securities $694,152 $701,548 $701,548 100.0%
======== ======== ======== =====
</TABLE>
- ----------
(1) Original cost of equity and short-term securities and, as to fixed
maturities, original cost reduced by repayments and adjusted for
amortization of premiums or accrual of discounts.
The following table sets forth a profile of the Company's fixed maturity
investment portfolio by rating at December 31, 1996:
<TABLE>
<CAPTION>
Amount Reflected Percent
Market on of
S&P/Moody's Rating (1) Value Balance Sheet Total
- ---------------------- -------- --------------- --------
(dollar amounts in thousands)
<S> <C> <C> <C>
AAA/Aaa (including U.S. Treasuries of $24,118) $417,650 $417,650 60.9%
AA/Aa 101,460 101,460 14.8
A/A 119,652 119,652 17.5
BBB/Baa 46,491 46,491 6.8
All other 24 24 .0
-------- -------- -----
Total $685,277 $685,277 100.0%
======== ======== =====
</TABLE>
- ----------
(1) Ratings are as assigned primarily by Standard & Poor's Corporation, with
remaining ratings as assigned by Moody's Investors Service Inc.
13
<PAGE>
<PAGE>
The following table sets forth the maturity profile of the Company's portfolio
of fixed maturity investments at December 31, 1996:
<TABLE>
<CAPTION>
Amount Reflected Percent
Market on of
Maturity Value Balance Sheet Total
- -------- -------- ------------------ --------
(dollar amounts in thousands)
<S> <C> <C> <C>
Due in one year or less $ 2,656 $ 2,656 .4%
Due after one year to 5 years 81,800 81,800 11.9
Due after five years to 10 years 119,248 119,248 17.4
Due after 10 years 183,732 183,732 26.8
Mortgage-backed securities 297,841 297,841 43.5
--------- --------- ------
Total $685,277 $685,277 100.0%
======== ======== =====
</TABLE>
The following table summarizes the Company's investment results for the five
years ended December 31, 1996, calculated on the mean of total investments as of
the first and last day of each calendar quarter:
<TABLE>
<CAPTION>
Year Ended December 31
--------------------------------------------------------
1996 1995 1994 1993 1992
-------- -------- ------- ------ ------
(dollar amounts in thousands)
<S> <C> <C> <C> <C> <C>
Total net investment income $38,933 $30,055 $22,975 $22,371 $20,208
Average annual pre-tax yield 6.4% 6.4% 6.6% 7.8% 7.9%
Average annual after-tax yield 4.8% 4.9% 5.4% 6.3% 6.2%
Effective federal income tax rate
on total net investment income 24.8% 23.7% 19.8% 19.3% 21.2%
</TABLE>
Regulation
Frontier Insurance, Frontier Pacific, United Capitol and Regency are subject to
varying degrees of regulation and supervision in the jurisdictions in which they
transact business under statutes which delegate regulatory, supervisory and
administrative powers to state insurance commissioners. Such regulation
generally is designed to protect policyholders rather than investors and relates
to such matters as the standards of solvency which must be met and maintained;
the licensing of insurers and their agents; the nature of and examination of the
affairs of insurance companies, which includes periodic market conduct
examinations by the regulatory authorities; annual and other reports, prepared
on a statutory accounting basis, required to be filed on the financial condition
of insurers or for other purposes; establishment and maintenance of reserves for
unearned premiums and losses; and requirements regarding numerous other matters.
In general, Frontier Insurance, Frontier Pacific, Regency and United Capitol
must file all rates for insurance directly underwritten with the insurance
department of each state in which they operate on an admitted basis; reinsurance
generally is not subject to rate regulation. Medical malpractice rates in New
York are established by the New York State Insurance Department (the
"Department"). Further, state insurance statutes typically place limitations on
the amount of dividends or other distributions payable by insurance companies in
order to protect their solvency. New York, the jurisdiction of incorporation of
Frontier Insurance, requires that dividends be paid only out of earned surplus
and limits the annual amount payable without the prior approval of the
Department to the lesser of 10% of policyholders' surplus or 100% of adjusted
net investment income. California, the jurisdiction of incorporation of Frontier
Pacific, currently limits the annual amount of dividends payable without the
prior approval of the California Insurance Department to the greater of
14
<PAGE>
<PAGE>
10% of policyholders' surplus at the end of the previous calendar year or 100%
of net income for the previous calendar year. Wisconsin, the jurisdiction of
incorporation of United Capitol, precludes the Company from paying dividends
without prior approval of the Commissioner of Insurance. North Carolina, the
jurisdiction of incorporation of Regency, limits the amount payable without
prior approval and is limited to the lesser of 10% of statutory surplus or net
income.
The Company is also subject to statutes governing insurance holding company
systems in various jurisdictions. Typically, such statutes require the Company
to file information periodically with the state insurance regulatory
authorities, including information concerning its capital structure, ownership,
financial condition and general business operations. Under the terms of
applicable state statutes, any person or entity desiring to purchase more than a
specified percentage (commonly 10%) of the Company's outstanding voting
securities is required to obtain regulatory approval for the purchase. Article
15 of the New York Insurance Law relating to holding companies, to which the
Company is subject, requires, inter alia, disclosure of transactions between
Frontier Insurance and the Company or any of its subsidiaries, that such
transactions satisfy certain standards, including that they be fair, equitable
and reasonable and that certain material transactions be specifically
non-disapproved by the Department. Further, prior approval by the Department is
required of affiliated sales, purchases, exchanges, loans or extensions of
credit, or investments, any of which involve 5% or more of Frontier Insurance's
admitted assets as of the preceding December 31st. In addition, any documents
relating to the offering of securities by the Company, the proceeds of which
will be used for Frontier Insurance, must be approved by the Department. With
respect to Frontier Pacific, United Capitol and Regency, California, Wisconsin
and North Carolina law with respect to holding companies is substantially
equivalent to that of New York.
The National Association of Insurance Commissioners ("NAIC") has established
eleven financial ratios to assist state insurance departments in their oversight
of the financial condition of insurance companies operating in their respective
states. The NAIC calculates these ratios based on information submitted by
insurers on an annual basis and shares the information with the applicable state
insurance departments. The ratios relate to leverage, profitability, liquidity
and loss reserve development. Frontier Insurance's percentage increase in
surplus exceeded the acceptable range during 1996 due to a $64 million capital
infusion by the Company. United Capitol's percentage decrease in surplus was
outside the acceptable range during 1996 due to a $49.8 million dividend paid to
its previous parent prior to the acquisition by the Company, partially offset by
net income of $4.9 million and a $27.2 million capital contribution by the
Company. United Capitol's percentage increase in net written premiums exceeded
the acceptable range during 1996 due to the exceptionally low net written
premiums from under utilization of capital in previous years. Frontier Pacific's
percentage increase in surplus exceeded the acceptable range during 1996 due to
a $5.1 million dollar capital infusion by its parent, Frontier Insurance.
Frontier Pacific's increase in net written premiums and percentage of agents
balances were outside the acceptable range due to the increased writings in
California in the majority of the Company's programs, of which approximately
fifty percent was written in the fourth quarter. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
In their ongoing effort to improve solvency regulation, the NAIC and individual
states have enacted certain laws and statutory financial statement reporting
requirements. For example, NAIC rules require audited statutory financial
statements as well as actuarial certification of loss and LAE reserves therein.
Other activities are focused on greater disclosure of an insurer's reliance on
reinsurance and changes in its reinsurance programs and tighter rules on
accounting for certain overdue reinsurance. In addition, the NAIC has
implemented risk-based capital requirements for property and casualty insurance
companies commencing in 1995 (see below). These regulatory initiatives and the
overall focus on solvency may intensify the restructuring and consolidation of
the insurance industry. It is also possible that Congress may enact legislation
regulating the insurance industry. While the impact of these regulatory efforts
on the Company's operations cannot be quantified until enacted, the Company
believes it will be adequately positioned to compete in an environment of more
stringent regulation.
In 1994, the NAIC implemented a risk-based capital measurement formula to be
applied, commencing
15
<PAGE>
<PAGE>
in 1995, to all property/casualty insurance companies, which formula calculates
a minimum required statutory net worth based on the underwriting, investment,
credit loss reserve and other business risks applicable to the insurance
company's operations. An insurance company that does not meet threshold
risk-based capital measurement standards could be required to reduce the scope
of its operations and ultimately could become subject to statutory receivership
proceedings. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations--Regulation."
Competition
The property and casualty insurance business is highly competitive, principally
in terms of price and extent of coverage. In New York State, there are three
major competitors, as well as a number of other insurers, writing medical
malpractice insurance for physicians, the Company's principal insurance program,
and in Florida such coverage is offered by a larger number of insurers. However,
the Company benefits from the endorsement or approval of various medical
associations, many of whose physician members are insured by the Company.
Moreover, the Company's program, unlike those of its competitors, is limited to
specified classes of physicians. Dental malpractice coverage in all
jurisdictions is significantly more competitive than medical malpractice with
respect to rates and terms of coverage. Although the Company's underwriting
strategy is to underwrite specialty programs for niche markets, it nevertheless
encounters competition from carriers engaged in insuring risks in the broader
lines of business which encompass niche programs.
Employees
The Company currently has 749 full-time employees, 7 of whom are executive
management, and 33 part-time employees. The Company is not a party to any
collective bargaining agreement and believes its relationship with its employees
to be good.
Item 2. Properties.
The Company owns a three-story office building at 195 Lake Louise Marie Road,
Rock Hill, New York, in which its executive offices and insurance operations for
Frontier Insurance are located. A 50,000 square foot addition is under
construction and is anticipated to be completed in September 1997. The Company
also owns a one-story building in Rock Hill, New York, which it uses for storage
and a portion of which is rented, and an airplane for which it leases facilities
at a local airport.
The Company owns a one-story 6,000 sq. ft. building in Charlotte, North Carolina
where Regency Financial Corporation conducts its insurance operations.
The Company leases office space at eighteen locations in 11 states at an
aggregate monthly rental of approximately $133,000.
The Company believes that upon completion of the addition at Rock Hill, New
York, it will have adequate space for expansion of its existing operations.
Item 3. Legal Proceedings.
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations- -Shareholder Litigation"
16
<PAGE>
<PAGE>
Item 4. Submission of Matters to a Vote of Security Holders.
On December 30, 1996, the Company held a Special Meeting of Stockholders to vote
upon proposals (i) to approve and ratify a financing transaction involving a
$172,500,000 offering of Convertible Trust Originated Preferred Securities
issued by the Company's financing vehicle, Frontier Financing Trust, and (ii) to
adopt an amendment to the Company's Certificate of Incorporation increasing the
authorized number of shares of Common Stock to 50,000,000 shares.
Present at the Special Meeting in person or by proxy were holders of 13,273,611
shares of the 14,688,064 shares of the Company's Common Stock issued and
outstanding on November 22, 1996, the record date for the Special Meeting.
The vote on the proposals was as follows:
1) To approve and ratify the financing transaction description in the Proxy
Statement:
For Against Abstain Broker Non-Votes
--- ------- ------- ----------------
11,005,986 36,220 13,421 2,217,984
2) To adopt an amendment to the Company's Certificate of Incorporation to
increase the authorized number of shares of Common Stock to 50,000,000
shares:
For Against Abstain Broker Non-Votes
--- ------- ------- ----------------
11,950,398 1,311,789 11,424 -0-
17
<PAGE>
<PAGE>
PART II
Item 5. Market for the Registrant's Common Stock and Related Security Holder
Matters.
The Company's Common Stock is traded on the New York Stock Exchange under the
symbol FTR. The following table sets forth the high and low sales prices for the
Company's Common Stock, as reported by the New York Stock Exchange, for each
calendar quarter during the periods indicated, as adjusted to reflect stock
dividends paid and stock splits:
<TABLE>
<CAPTION>
High Low
---- ---
<S> <C> <C>
1995:
First Quarter $22.50 $18.41
Second Quarter 24.55 21.36
Third Quarter 29.09 22.95
Fourth Quarter 30.68 25.00
1996:
First Quarter $30.11 $25.68
Second Quarter 38.00 30.13
Third Quarter 41.13 32.63
Fourth Quarter 39.87 36.25
1997:
First Quarter (through March 18, 1997) $44.25 $36.63
</TABLE>
On March 18,1997, the Company had approximately 896 holders of record of its
Common Stock, which did not include beneficial owners for shares registered in
nominee or street name.
During 1996, the Company declared three quarterly cash dividends of $.13 per
share and one quarterly cash dividend of $.11 per share (adjusted for stock
dividend), constituting the sixteenth consecutive quarterly cash dividends. (See
"Business-Regulation" for restrictions on the payment of dividends by the
Company's insurance subsidiaries.)
18
<PAGE>
<PAGE>
Item 6. Selected Financial Data
The following selected financial data are derived from the Company's
consolidated financial statements. The data should be read in conjunction with
the consolidated financial statements, related notes, and other financial
information included elsewhere in this report.
<TABLE>
<CAPTION>
Income Statement Data: Year Ended December 31
- ---------------------- ----------------------------------------------------------------------------
1996 1995 1994 1993 1992
---------- ---------- ------------- ------------ -----------
(in thousands, except per share dollar amounts)
<S> <C> <C> <C> <C> <C>
Revenues:
Gross premiums written $ 402,799 $ 264,314 $ 198,892 $ 148,750 $ 149,504
========== ========== ========== ========== ==========
Net premiums written $ 311,863 $ 220,757 $ 187,288 $ 118,819 $ 116,248
========== ========== ========== ========== ==========
Net premiums earned $ 265,989 $ 196,220 $ 156,755 $ 116,372 $ 105,171
Net investment income 37,226 30,035 24,453 22,523 19,875
Realized capital gains (losses) 1,707 20 (1,478) (152) 333
Gross claims adjusting income 55 130 255 424 1,356
---------- ---------- ---------- ---------- ----------
Total revenues 304,977 226,405 179,985 139,167 126,735
Expenses:
Losses and loss adjustment expenses 155,991 119,255 110,918 77,581 74,933
Amortization of policy acquisition costs,
underwriting, and other expenses 88,080 62,975 47,737 31,293 26,604
Minority interest in income of
subsidiary trust 2,277
Interest expense 1,970 895
---------- ---------- ---------- ---------- ----------
Total expenses 248,318 183,125 158,655 108,874 101,537
---------- ---------- ---------- ---------- ----------
Income before income taxes and
cumulative effect of change in
accounting principle 56,659 43,280 21,330 30,293 25,198
Income taxes 16,592 12,069 4,350 7,130 6,236
---------- ---------- ---------- ---------- ----------
Income before cumulative effect
of change in accounting principle 40,067 31,211 16,980 23,163 18,962
Cumulative effect of change in
accounting for income taxes 708
---------- ---------- ---------- ---------- ----------
Net Income $ 40,067 $ 31,211 $ 16,980 $ 23,871 $ 18,962
========== ========== ========== ========== ==========
Net income per share - primary $2.77 $2.18 $1.19 $1.90 $1.60
===== ===== ===== ===== =====
Net income per share - fully diluted $2.73 $2.17 $1.18 $1.88 $1.58
===== ===== ===== ===== =====
Cash dividends declared per share $ .50 $ .48 $ .46 $ .40 $ .40
===== ===== ===== ===== =====
<CAPTION>
Balance Sheet Data: December 31
------------------ ---------------------------------------------------------------------------
1996 1995 1994 1993 1992
----------- ---------- ----------- ---------- -----------
Total investments $ 838,320 $ 552,714 $ 407,618 $ 343,591 $ 262,010
Total assets 1,246,407 773,348 599,117 527,657 406,149
Liabilities for gross unpaid losses and
loss adjustment expenses 539,073 367,436 312,637 274,035 238,941
Total liabilities 810,880 543,615 408,853 341,963 299,400
Guaranteed preferred beneficial interest
in Company's convertible subordinated
debentures 166,953
Total shareholders' equity 268,574 229,733 190,264 185,694 106,749
Supplemental Primary Earnings Per Share Data:
Realized capital gains (losses)-net of tax $ .07 $ $ (.06) $ (.01) $ .02
Federal income tax "Fresh Start" benefits .03
Cumulative effect of accounting change .06
Operating income 2.70 2.18 1.25 1.85 1.55
------ ------ ------ ------ -----
Net income $ 2.77 $ 2.18 $ 1.19 $ 1.90 $1.60
====== ====== ====== ====== =====
Book value $18.28 $15.99 $13.28 $13.04 $8.99
====== ====== ====== ====== =====
Statutory Combined Ratio 90.9% 91.1% 98.1% 94.2% 96.8%
GAAP Combined Ratio 91.8% 92.7% 101.0% 93.2% 95.4%
Ratio of earnings to combined fixed
charges and preferred stock dividends 13.2x 39.1x N/A N/A N/A
</TABLE>
19
<PAGE>
<PAGE>
Management's Discussion and Analysis of Financial Condition and Results of
Operations
The following discussion and analysis should be read in conjunction with the
consolidated financial statements and notes thereto included elsewhere in this
report.
Results of Operations
The following table sets forth the Company's net premiums earned by principal
lines of insurance for the three years indicated and the dollar amount and
percentage of change therein from year to year:
<TABLE>
<CAPTION>
Increase (Decrease)
--------------------------------------------
Year Ended December 31 1995 to 1996 1994 to 1995
------------------------------ ---------------- ----------------
1996 1995 1994 Amount % Amount %
---- ---- ---- ------- -- ------- --
(Dollar amounts in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Medical malpractice
(including dental
malpractice and social services) $105,217 $ 88,295 $ 74,877 $ 16,922 19.2 $ 13,418 17.9
General liability 78,641 50,026 28,631 28,615 57.2 21,395 74.7
Surety 51,369 39,756 30,344 11,613 29.2 9,412 31.0
Workers' compensation 7,025 10,320 16,671 (3,295) (31.9) (6,351) (38.1)
Commercial earthquake 8,257 249 8,008 3,216.1 249 n/a
Other 15,480 7,574 6,232 7,906 104.4 1,342 21.5
-------- -------- -------- -------- -------- ----
Total $265,989 $196,220 $156,755 $ 69,769 35.6 $ 39,465 25.2
======== ======== ======== ======== ======== ====
</TABLE>
The following table sets forth the expense components of the Company's combined
ratio calculated as a percentage of net premiums earned on the basis of
generally accepted accounting principles ("GAAP Combined Ratio") for the three
years indicated:
<TABLE>
<CAPTION>
Year Ended December 31
-------------------------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Losses 36.5% 45.6% 54.1%
Loss adjustment expenses ("LAE") 22.2 15.2 16.7
---- ----- ------
Losses and LAE 58.7 60.8 70.8
Acquisition, underwriting, interest, and other expenses 33.1 31.9 30.2
---- ----- ------
GAAP Combined Ratio 91.8% 92.7% 101.0%
==== ===== =====
</TABLE>
Calendar Year 1996 Compared to Calendar Year 1995
A variety of factors accounted for the 35.6% growth in net premiums earned, the
principal factor being increases in the majority of the Company's core and new
program business, partially offset by a decrease in workers' compensation,
particularly the cotton gin program, and by the increased ceding of net premiums
earned under the Company's aggregate excess of loss reinsurance contract
effective January 1, 1996, pursuant to which 13.5% and 14% of net premiums
earned in 1996 and 1995, respectively, was ceded for all lines of business,
except certain classes of surety bonds, realtors' errors and omissions and all
of the net premiums earned by United Capitol and Regency.
The increase in medical malpractice net premiums earned was primarily
attributable to an increase in the number of physicians insured, principally
those associated with mental health, home care and other social service
organizations, growth in the programs for psychiatrists and alternative risks,
geographical expansion in Ohio, Texas, Michigan and Illinois, growth in the
dental program endorsed by the Academy of General Dentistry, and rate increases
in Florida.
Net premiums earned for the general liability line increased primarily because
of increases in various programs, including social services, alarms and guards,
demolition contractors, pest control, excess employer's liability and asbestos
abatement as a result of the acquisition of United Capitol in May 1996. These
increases were partially offset by a decrease in net premiums earned in the
umbrella and crane
20
<PAGE>
<PAGE>
operator liability programs.
Growth in the surety net premiums earned continued in 1996, primarily
attributable to expanded writings of license and permit bonds, small contractors
bonds, miscellaneous bonds, custom bonds and bail bonds.
Net premiums earned for the workers' compensation line decreased primarily as a
result of decreases in the specialty niche program for cotton gins and feed
lots, decreases in the social services programs due to price competition, and a
lesser required participation in the National Workers' Compensation Reinsurance
Pools. These decreases were partially offset by increases in workers'
compensation from the alternative risk program which the Company initiated in
1996.
Net premiums earned for the commercial earthquake program increased primarily
due to the growth in the number of policies written in 1996 over the comparable
period in 1995, when the program was initiated.
Net premiums earned for the other lines of business increased primarily due to
increased volume in commercial package policies in the social services program,
and in the mobile homeowners program and auto physical damage business as a
result of the acquisition of Regency effective in June 1996. These increases
were partially offset by decreases in other miscellaneous small programs.
Net investment income before realized capital gains and losses increased 23.9%
due principally to increases in invested assets resulting from the proceeds of
the issuance of Convertible Trust Originated Preferred Securities ("Convertible
TOPrS") in October 1996, cash inflow from regular operations, and the
contribution to net investment income by United Capitol and Regency, partially
offset by the interest charge on funds held by the Company for the benefit of
the reinsurer of the Company's aggregate excess of loss reinsurance contract.
Total net investment income increased 29.5% due to the aforementioned increase
in net investment income and an increase in realized capital gains. The average
annual pre-tax yield on investments, excluding the charge for funds held under
the aggregate excess of loss reinsurance contract and realized capital gains and
losses, was 6.4%, unchanged from the previous year. The average annual after-tax
yield on investments, excluding the charge for funds held under the aggregate
excess of loss reinsurance contract and realized capital gains and losses, was
4.8%, as compared to the previous year.
Gross claims adjusting income decreased 57.7% primarily as a result of a
decrease in claim services provided to outside companies, principally Markel
Corporation.
Total revenues increased 34.7% as a result of the above.
Total expenses increased by 35.6%, similar to the 35.6% increase in net premiums
earned. Losses and loss adjustment expenses ("LAE") increased by 30.8% which
included a 8.5% increase in losses and a 97.5% increase in LAE. The increase in
losses was substantially lower than for net premiums earned as a result of a
one-time reallocation of loss reserves to LAE reserves, favorable reserve
development in accident years prior to 1996 for general liability and workers'
compensation and recoveries under the aggregate excess of loss reinsurance
contract which provides coverage for certain losses and LAE in excess of 65% of
the net premiums earned for the 1996 accident year, partially offset by higher
loss and LAE ratios for business written in 1996. The Company also increased
prior years' reserves by approximately $13 million, which was entirely offset by
an increase in the same amount of the subrogation recoverable recognized in
conjunction with the favorable December 1995 ruling in the New York Court of
Appeals, described in Note C of the Notes to Consolidated Financial Statements.
Such increase in the subrogation recoverable resulted from further documentation
and verification in the second quarter of 1996 of claims already paid by the
Company and reserves held by the Company that the Company believes are
reimbursable by the State of New York. The 97.5% increase in LAE resulted from
the increase in loss and LAE ratios, a one-time reallocation of loss reserves to
LAE reserves, partially offset by a change in the line of business mix to those
having a lower percentage relationship
21
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<PAGE>
of LAE to losses and the allocation of recoveries under the aggregate excess of
loss contract. Due to the disproportionate relationship of losses and LAE to net
premiums earned, the loss and LAE component of the GAAP Combined Ratio was 2.1
percentage points lower than in the comparable 1995 period. The 40% increase in
the amortization of policy acquisition costs, underwriting and other expenses
was attributable primarily to an increase in direct commission expense resulting
from growth in programs with higher commission rates, a decrease in reinsurance
contingent commissions, increased staffing and marketing expenses related to
expansion, a reduction in assessment recoveries from the Texas Workers'
Compensation Insurance Facility, and salary increases. The 120% increase in
interest expense was primarily the result of increased interest expense
associated with the borrowing under the line of credit. The Company also
incurred approximately $2,277,000 of expenses in 1996 associated with the
Convertible TOPrS. See NOTE M of the NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS. As the non-claim related component of the GAAP Combined Ratio
increased at a greater rate than premiums earned, the non-claim component was
1.2 percentage points higher than in the comparable 1995 period. The total GAAP
Combined Ratio decreased by .9 percentage points to 91.8% as a result of the
above.
The foregoing changes resulted in income before income taxes of $56.7 million
for the year ended 1996, a 30.9% increase from the comparable 1995 period. Net
income for the year increased by $8.9 million, or 28.4%.
Calendar Year 1995 Compared to Calendar Year 1994
A variety of factors accounted for the 25.2% growth in net premiums earned, the
principal factor being increases in the majority of the Company's core and new
program business, partially offset by a decrease in workers' compensation,
particularly the cotton gin program, and by the increased ceding of earned
premiums under the Company's aggregate excess of loss reinsurance contract
effective January 1, 1995, pursuant to which 14% of earned premium for all lines
of business, except bail, customs, license and permit, and miscellaneous surety
bonds is ceded.
The increase in medical malpractice net premiums earned was primarily
attributable to an increase in the number of physicians insured, principally
those associated with mental health, home care, and other social service
organizations, growth in the program for psychiatrists, greater penetration of
the Ohio physician market, growth in the dental program endorsed by the Academy
of General Dentistry, and rate increases in Florida and other geographic areas.
Net premiums earned for the general liability line increased primarily because
of increases in various programs, including social services, alarms and guards,
pest control and excess employer's liability. These increases were partially
offset by a decrease in net written premiums earned in the umbrella and in the
crane operator liability programs.
Growth in the surety net premiums earned continued in 1995, primarily
attributable to expanded writings of license and permit bonds, with bonds for
small contractors, miscellaneous bonds, and bail bonds also showing substantial
percentage increases. The increase in license and permit bonds was primarily
attributable to the Company's acquisition in April 1994 of the license and
permit bond business of a California insurance agency.
Net premiums earned for the workers' compensation line decreased primarily as a
result of decreases in the specialty niche program for cotton gins caused by a
weather-related reduction in the cotton crop, and decreases in other smaller
programs due to the Company's decision not to renew accounts deemed
unprofitable, and decreased required participation in the National Workers'
Compensation Reinsurance Pools. These decreases were partially offset by
increases in workers' compensation premiums written in the social services
programs.
Net premiums earned for the other lines of business increased primarily due to
increased volume in commercial package policies in the social services program,
and the recent start-up of an earthquake
22
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<PAGE>
program. These increases were partially offset by decreases in other
miscellaneous small programs.
Net investment income before realized capital gains and losses increased 22.8%
due principally to increases in invested assets resulting from the proceeds of
the $25 million borrowing under a line of credit facility, the January 1995
commutation of certain medical malpractice reinsurance treaties, and cash inflow
from regular operations, partially offset by the interest charge on funds held
by the Company for the benefit of the reinsurer of the Company's aggregate
excess of loss reinsurance contract. Total net investment income increased 30.8%
due to the aforementioned increase in net investment income and a decrease in
realized capital losses. The average annual pre-tax yield on investments,
excluding the charge for funds held under the aggregate excess of loss
reinsurance contract and realized capital gains and losses, decreased to 6.4%
from 6.6%. This decrease is primarily the result of generally lower interest
rates available for funds invested in 1994 and 1995, and a decrease in the
Company's holdings of higher yielding investments, as a result of maturities and
calls for redemption. The average annual after-tax yield on investments,
excluding the charge for funds held under the aggregate excess of loss
reinsurance contract and realized capital gains and losses, decreased to 4.9%
from 5.4%, primarily for the reasons described above.
Gross claims adjusting income decreased 49.0% primarily as a result of a
decrease in claim services provided to outside companies, principally Markel
Corporation.
Total revenues increased 25.8% as a result of the above.
Total expenses increased by 15.4% compared to the 25.2% increase in net premiums
earned. Losses and loss adjustment expenses ("LAE") increased by 7.5% as a
result of a 5.5% increase in losses and a 14.1% increase in LAE. The increase in
losses was substantially lower than that for net premiums earned as a result of
the one-time addition of $17.5 million to the 1994 loss reserves applicable to
the Company's medical malpractice business in Florida, subrogation recoveries in
the surety line of business in excess of expectations, favorable reserve
development in accident years prior to 1995 for general liability and workers'
compensation and recoveries under the aggregate excess of loss reinsurance
contract which provides coverage for certain losses and LAE in excess of 66% of
the net earned premium for the 1995 accident year. These decreases were
partially offset by carrying higher loss and LAE ratios to premiums earned for
1995 business. The Company also increased prior years reserves by approximately
$19.0 million, offset by subrogation recoverable of like amount, recognized in
conjunction with the favorable ruling in the New York Court of Appeals as more
fully described in Note--C of the Notes to Consolidated Financial Statements.
The 14.1% increase in LAE resulted from the increase in loss and LAE ratios,
partially offset by a change in the line of business mix to those having a lower
percentage relationship of LAE to losses and the allocation of recoveries under
the aggregate excess of loss contract and the favorable court ruling mentioned
above. Due to the disproportionate relationship of losses and LAE to earned
premium, the loss and LAE component of the GAAP Combined Ratio was 9.6
percentage points lower than in the comparable 1994 period. The 38.7% increase
in the amortization of policy acquisition costs was attributable primarily to an
increase in direct commission expense resulting from growth in programs with
higher commission rates, a decrease in reinsurance contingent commissions,
increased staffing and marketing expenses related to expansion, and salary
increases, partially offset by a decrease in assumed commission expense
resulting from the continued decrease in assumed written premiums. The 25.1%
increase in underwriting, other expenses and interest expense was primarily the
result of the interest expense associated with the borrowing under the line of
credit facility, an increase in the additions to allowance for bad debts,
increased staffing, increased facilities, equipment and materials expense
necessitated by the Company's growth, a reduction in assessment recoveries from
the Texas Workers' Compensation Insurance Facility, and salary increases,
partially offset by a decrease in policyholder dividends. As the non-claim
related component of the GAAP Combined Ratio increased at a greater rate than
premiums earned, the non-claim component was 1.7 percentage points higher than
in the comparable 1994 period. The total GAAP Combined Ratio decreased by 8.3
percentage points to 92.7% as a result of the above.
The foregoing changes resulted in income before income taxes of $43.3 million
for the year ended 1995,
23
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a 102.9% increase from the comparable 1994 period. Net income for the year
increased by $14.2 million, or 83.8%. The comparative results were significantly
impacted by the $17.5 million addition to loss reserves in the third quarter of
1994 reflected above, which resulted in a disproportionately lower net income
for the 1994 period.
Asset Portfolio Review
At December 31, 1996, the Company's total assets of $1.25 billion was
comprised of the following: cash and investments, 67.9%; reinsurance
recoverables, 15.5%; premiums receivable and agents balances, 6.2%; deferred
expenses (policy acquisition costs and deferred federal income taxes), 4.9%;
home office building, property and equipment, 3.0%; and other assets, 2.5%.
The Company generally invests in securities with fixed maturities with the
objective of providing reasonable returns while limiting liquidity and credit
risk. As a result, its investment portfolio consists primarily of government and
governmental agency securities and high-quality marketable corporate securities
which are rated at investment grade levels. At December 31, 1996, the Company
held rated, or better-than-investment grade, fixed income debt securities with a
carrying amount of $ 685.3 million, constituting 100.0% of the Company's fixed
maturity investments.
At December 31, 1996 and 1995, the Company's fixed maturity securities included
mortgage-backed bonds of $297.8 million and $192.1 million, respectively, which
are subject to risks associated with variable prepayments of the underlying
mortgage loans. Prepayments cause those securities to have different actual
maturities than that expected at the time of purchase. Securities that have an
amortized cost greater than par that are backed by mortgages that prepay faster
than expected will incur a reduction in yield or loss, while securities that
have an amortized cost less than par that are backed by mortgages that prepay
faster than expected will generate an increase in yield or gain. The degree to
which a security is susceptible to either gains or losses is influenced by the
difference between its amortized cost and par, the relative sensitivity of the
underlying mortgages backing the assets to prepayments in a changing interest
rate environment and the repayment priority of the securities in the overall
securitization structure.
The Company limits the extent of its credit risk by purchasing securities that
are backed by stable collateral and by concentrating on securities with enhanced
priority in the securitization structure. Such securities with reduced risk
typically have a lower yield (but higher liquidity) than higher-risk
mortgage-backed bonds (i.e., mortgage-backed bonds structured to share in
residual cash flows or which cover interest only payments). At selected times,
higher-risk securities may be purchased if they do not compromise the safety of
the Company's general portfolio. There are negligible default risks in the
Company's mortgage-backed bond portfolio as the vast majority of these bonds are
either guaranteed by U.S. government-sponsored entities or are supported in the
securitization structure by junior securities resulting in the bonds having high
investment grade status.
At December 31, 1996, the following table provides a profile of the Company's
fixed maturity investment portfolio by rating:
<TABLE>
<CAPTION>
Amount Percent
Market Reflected on of
S&P/Moody's Rating Value Balance Sheet Portfolio
------------------ -------- -------------- -----------
(Amounts in thousands)
<S> <C> <C> <C>
AAA/Aaa (including U.S. Treasuries of $24,118) $417,650 $417,650 60.9%
AA/Aa 101,460 101,460 14.8
A/A 119,652 119,652 17.5
BBB/Baa 46,491 46,491 6.8
All other 24 24 .0
------------- ------------- ---------
Total $685,277 $685,277 100.0%
======== ======== =====
</TABLE>
24
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Prior to January 1, 1994, the Company classified fixed maturity securities in
accordance with the then existing accounting standards and, accordingly, those
fixed maturity securities that were not intended to be held-to-maturity were
designated as actively managed, and were carried at fair value with unrealized
holding gains and losses reported in a separate caption in shareholders' equity.
Other fixed maturity securities were carried at amortized cost, since the
Company had both the ability and intent to hold those securities until maturity.
As of January 1, 1994, the Company adopted FASB Statement 115 and reclassified a
portion of its fixed maturity securities portfolio as "available-for-sale," with
the remainder being classified as "held-to-maturity." Under the
reclassification, the fixed maturity securities classified as
"available-for-sale" are carried at fair value and changes in fair values, net
of applicable income taxes, are charged or credited directly to shareholders'
equity. "Held-to-maturity" securities are reported at amortized cost. The
adoption of Statement 115 increased shareholders' equity by $3.65 million at
January 1, 1994.
In December 1995, the Company reclassified all of its previously held securities
classified as held-to-maturity, to available-for-sale as permitted by the FASB's
Special Report, A Guide to Implementation of Statement 115 on Accounting for
Certain Investments in Debt and Equities - Questions and Answers. The
reclassification increased shareholders' equity by $2.75 million at December 31,
1995.
Liquidity and Capital Resources
The Company is a holding company, receiving cash principally through sales of
equities, borrowings, and dividends from its subsidiaries, certain of which are
subject to dividend restrictions described in Note I of the Notes to the
Consolidated Financial Statements. The ability of insurance and reinsurance
companies to underwrite insurance and reinsurance is based on maintaining
liquidity and capital resources sufficient to pay claims and expenses as they
become due. The primary sources of liquidity for the Company's subsidiaries are
funds generated from insurance and reinsurance premiums, investment income,
commission and fee income, capital contributions from the Company and proceeds
from sales and maturities of portfolio investments. The principal expenditures
are for payment of losses and LAE, underwriting and other operating expenses,
commissions, and dividends to shareholders and policyholders.
The Company's subsidiaries maintain liquid operating positions and follow
investment guidelines that are intended to provide for an acceptable return on
investment while preserving capital, maintaining sufficient liquidity to meet
their obligations, and as to the Company's insurance subsidiaries, maintaining a
sufficient margin of capital and surplus to ensure their unimpaired ability to
write insurance and assume reinsurance.
Cash flow generated from operations for 1996, 1995, and 1994 was $116.5 million,
$105.0 million, and $81.9 million, respectively, amounts adequate to meet all of
the Company's obligations.
In January 1994 and 1995, investment funds were increased by $9.0 million and
$3.9 million, respectively, from the commutation of the 1990, and 1991 treaty
years under the medical malpractice reinsurance treaties, resulting in the
receipt of $6.1 million and $3.9 million, respectively, in cash and a
concomitant increase in reserves for unpaid losses and LAE, with the balance
received from the collection of contingent commissions earned by the Company for
the 1994 treaty year.
In April 1994, the Company completed the acquisition of Spencer Douglass
Insurance Associates, Inc., a California license and permit bond insurance
agency, for $3.2 million and entered into a five-year consulting agreement with
the owner/principal of the agency. Personnel of the agency involved in placing
and servicing the acquired business have become employees of the Company,
operating from their respective locations in Phoenix, Arizona; Reno and Las
Vegas, Nevada; and San Jose, Orange County and La Jolla, California. All new and
renewal policies with respect to the approximately $5 million to $6 million of
license and permit bond business acquired are issued by the Company.
25
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In May 1995, the Company and R. Spencer Douglas III ("Douglass") formed a
California limited liability corporation, Douglass/Frontier, LLC
("Douglass/Frontier"), a bail bond insurance agency to which the Company
contributed $2.4 million in cash and Douglass contributed the assets of his
wholly-owned existing bail bond agency. The Company and Douglass share equally
in the ownership of Douglass/Frontier.
On June 29, 1995, the Company obtained a 4 1/2 year, $35 million line of credit
facility from The Bank of New York, under which it borrowed $25 million at an
interest rate of 6.87% per annum, payable quarterly. In June and September 1996,
the Company borrowed an additional $4.2 million and $2.9 million from The Bank
of New York (outside of the line of credit) at annual interest rates of 6.125%
and 6.3125%, respectively, payable quarterly, due October 1996. In the fourth
quarter, the Company repaid all borrowings and terminated the facility.
As a result of a review by AM Best of Frontier Insurance Company's A-
(Excellent) rating, the Company agreed with AM Best to make a $45 million
capital infusion to Frontier Insurance Company by June 30, 1995 in order to fund
its projected growth and retain its A- rating. At June 30, 1995, the Company had
completed the $45 million capital infusion, utilizing a combination of funds
previously held by the Company and loan proceeds from The Bank of New York loan.
In November 1995, the Company acquired the realtors' errors and omissions book
of business from Bankers Multiple Line Insurance Company ("BMLIC") for $400,000.
The personnel of BMLIC involved in placing and servicing the acquired business
have become employees of the Company and will continue to operate from their
location in Louisville, Kentucky.
In May 1996, the Company completed the acquisition of United Capitol Holding
Company ("United Capitol Holding"), the direct or indirect parent of United
Capitol Insurance Company, United Capitol Managers, Inc. (renamed Olympic
Underwriting Mangers, Inc.) and Fischer Underwriting Group, Inc., for $31.0
million. United Capitol Holding, through its subsidiaries, underwrites specialty
risks such as asbestos abatement, environmental liability and directors' and
officers' liability.
Effective June 1996, the Company completed the acquisition of Regency Insurance
Company and Emrol Premium Discount, Inc. in exchange for 238,087 shares of the
Company's Common Stock. Regency underwrites non-standard automobile insurance
principally in North Carolina and Emrol finances premiums primarily for
policyholders of Regency.
In October 1996, the Company completed a $172.5 million offering of Convertible
TOPrS, issued through Frontier Financing Trust, a Delaware business trust formed
by the Company for the purpose of the transaction. The Convertible TOPrS have a
dividend rate of 6 1/4% and are convertible into 1.0663 shares of the Company's
Common Stock, equivalent to a conversion price of $46.89 per share. See NOTE M
of the NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS. Net proceeds to the
Company from this offering were $166.9 million of which $32.1 million was
applied to repay bank debt, $60 million was contributed to the surplus of
Frontier Insurance and the remaining balance was available for general corporate
purposes.
During 1996, the Company expended $1.2 million in connection with the
construction of an addition to its home office building. The Company plans to
occupy the addition in 1997 and will expend approximately $11.3 million to
complete the facility.
In March 1992, the Company commenced quarterly cash dividend payments. Cash
dividends declared in 1996, 1995 and 1994 were $7,300,000, $6,200,000, and
$6,000,000, respectively.
On November 10, 1994, the Company authorized a stock repurchase program to
purchase up to 1,000,000 shares of its Common Stock at such times and prices as
the Company deems advantageous, in compliance with SEC Rule 10b-18 at the
discretion of the Chairman of the Board. There is no commitment or obligation on
the part of the Company to purchase any particular number of shares, and
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the program may be suspended at any time at the Company's discretion. The
Company did not purchase any shares in 1996. In 1995 and 1994, in conjunction
with this repurchase program, the Company purchased 6,600 and 38,940 shares of
its Common Stock at a cost of $134,000 and $654,000, respectively.
On March 31, 1997, the Company announced that it executed a definitive agreement
to acquire 100% of the stock of Lyndon Property Insurance Company and its six
subsidiaries, Lyndon Life Insurance Company, Twin Mercury Life Insurance
Company, Gulfco Life Insurance Company, Lyndon Southern Insurance Company,
Lyndon-DFS Warranty Services, Inc. and Lyndon General Agency of Texas, Inc.,
subject to certain closing conditions and regulatory approval, at a purchase
price of approximately $92,000,000. The purchase price will be financed by
Company funds and bank borrowings.
Reinsurance
Effective January 1, 1995, the Company entered into a stop loss reinsurance
contract with Centre Reinsurance Company of New York ("Centre Re") for accident
years' commencing 1995. Under the agreement, Centre Re provides reinsurance
protection within certain accident year and contract aggregate dollar limits for
losses and LAE in excess of a predetermined ratio of these expenses to net
premiums earned for a given accident year for all lines of business, except
certain classes of surety bonds, and net premiums earned from United Capitol and
Regency. The loss and LAE ratio above which the reinsurance provides coverage is
66%, 65%, and 64% for accident years 1995 through 1997, respectively. The
maximum amount recoverable for an accident year is 175% of the reinsurance
premium paid for the accident year, or $162,500,000 in the aggregate for the
three years.
Litigation with the State of New York
In December 1990, the New York State Court of Claims rendered a decision in
favor of the Company holding that a State University of New York ("SUNY")
medical school faculty member engaged in the clinical practice of medicine at a
SUNY medical facility, corollary to such physician's faculty activities, was
within the scope of such physician's employment by SUNY and was protected
against malpractice claims arising out of such activity by the State of New York
and not under the Company's medical malpractice policy. The decision was
affirmed on appeal by the New York State Appellate Division in November 1991 and
not appealed by the State. In July 1992, the State of New York enacted
legislation eliminating medical school faculty members of SUNY engaged in the
clinical practice of medicine at a SUNY medical facility from indemnification by
the State with respect to malpractice claims arising out of such activity,
retroactive to July 1, 1991. In an opinion filed on September 3, 1993 the Court
of Claims of the State of New York held, inter alia, that the July 1992
legislation by the State of New York eliminating SUNY medical school faculty
members engaged in the clinical practice of medicine, as part of their
employment by SUNY, from indemnification by the State with respect to
malpractice claims arising out of such activity, was not to be applied
retroactively. This decision was affirmed by the New York State Appellate
Division in April 1994. Subsequently, in February 1995, the Appellate Division
granted leave to Frontier and the State of New York to have the issues of
Frontier's entitlement to recover its costs of defense and its costs of
settlement ruled on by the State's highest Court, the New York Court of Appeals.
In December 1995, the New York Court of Appeals ruled on this issue and
concluded that Frontier was entitled to recoveries from the State for such
medical malpractice claims. As a result of this decision, the Company believes
that it will benefit economically by not being ultimately responsible for
certain claims against SUNY physicians for whom it presently carries reserves is
entitled to reimbursement of certain claims previously paid; accordingly,
effective June 30, 1996 and December 31, 1995, Frontier recorded subrogation
recoverables of approximately $13,000,000 and $19,000,000, respectively,
representing the amount of claims already paid and the reserves currently held
by Frontier on open cases that management believes are reimbursable by the State
of New York. In January 1997, the New York Court of Claims rendered a decision
granting summary judgement to the Company on three SUNY cases that were
previously paid by the Company. This decision has been appealed by the State of
New York. To the extent that the amount of the actual recovery varies, such
difference will be reported in the period recognized. The Company is continuing
to defend all SUNY faculty members against malpractice claims that have been
asserted and is maintaining reserves therefor adjusted for the anticipated
recoveries.
27
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Regulation
In its ongoing effort to improve solvency regulation, the National Association
of Insurance Commissioners ("NAIC") and individual states have enacted certain
laws and financial statement changes. The NAIC has adopted Risk-Based Capital
("RBC") requirements for property/casualty insurance companies to evaluate the
adequacy of statutory capital and surplus in relation to investment and
insurance risks such as asset quality, mortality and morbidity, asset and
liability matching, benefit and loss reserve adequacy, and other business
factors. The RBC formula is used by state insurance regulators as an early
warning tool to identify, for the purpose of initiating regulatory action,
insurance companies that potentially are inadequately capitalized. In addition,
the formula defines new minimum capital standards that supplement the current
system of low fixed minimum capital and surplus requirements on a state-by-state
basis. Regulatory compliance is determined by a ratio of the enterprise's
regulatory total adjusted capital, as defined by the NAIC, to its authorized
control level RBC, as defined by the NAIC. Companies below specific trigger
points or ratios are classified within certain levels, each of which requires
specific corrective action. The levels and ratios are as follows:
<TABLE>
<CAPTION>
Ratio of Total Adjusted Capital to
Authorized Control Level RBC
Regulatory Event (Less Than or Equal to)
---------------- -------------------------------
<S> <C>
Company action level 2 *
Regulatory action level 1.5
Authorized control level 1
Mandatory control level 0.7
*Or, 2.5 with negative trend.
</TABLE>
The ratios of total adjusted capital to authorized control level RBC for the
Company's insurance subsidiaries were all in excess of 3:1 at both December 31,
1996 and 1995.
The NAIC currently is in the process of recodifying statutory accounting
practices, the result of which is expected to constitute the only source of
"prescribed" statutory accounting practices. Accordingly, that project, which is
expected to completed in 1997, will likely change, to some extent, prescribed
statutory accounting practices, and may result in changes in the Company's
insurance subsidiaries statutory surplus.
The thrust of these regulatory efforts at all levels is to improve the solvency
of insurers. These regulatory initiatives, and the overall focus on solvency,
may intensify the restructuring and consolidation of the insurance industry.
While the impact of these regulatory efforts on the Company's operations cannot
be quantified until enacted, the Company believes it will be adequately
positioned to compete in an environment of more stringent regulation.
Impact of Inflation
Property and casualty insurance premiums are established before the amount of
losses and LAE, or the extent to which inflation may affect such expenses, are
known. Consequently, the Company attempts, in establishing its premiums, to
anticipate the potential impact of inflation. However, for competitive and
regulatory reasons, the Company may be limited in raising its premiums
commensurate with anticipated inflation, in which event the Company, rather than
its insureds, would absorb inflation costs. Inflation also affects the rate of
investment return on the Company's investment portfolio with a corresponding
effect on the Company's investment income.
28
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Environmental Issues
The Company, through its subsidiary, United Capitol, in the ordinary course of
business, writes insurance on accounts which have hazardous, unique or unusual
risk characteristics. Since United Capitol's organization in 1986, its liability
policies have included an absolute pollution coverage exclusions, except for
policies providing pollution liability coverage to contractors involved in the
remediation of pre-existing pollution. In addition, United Capitol's product
liability and other primary general liability policies contain exclusions for
coverage of claims for bodily injury or property damage caused by exposure to
asbestos, other than for the policies providing coverage to asbestos abatement
contractors for third party claims alleging bodily injury or property damage as
a result of exposure to asbestos. Employees of the insured contractor and others
required to be in the abatement area are excluded from coverage.
Although the Company believes that such policies, together with the Company's
general, professional and other liability policies, do not subject it to
material exposure for environmental pollution claims, there can be no assurance
of the Company's continued protection in view of the expansion of liability for
environmental claims in recent litigation in the insurance industry.
Shareholder Litigation
The Company has been served with several purported class actions alleging
violations of federal securities laws by the Company and, in some cases, by
certain of its officers and directors; certain other actions also allege
violations of the common law. The complaints relate to the Company's November 5,
1994 announcement of its third-quarter financial results and allege that the
Company previously had omitted and/or misrepresented material facts with respect
to its earnings and profits. The Company believes the suits are without merit
and has retained special legal counsel to contest them vigorously and believes
that the Company's exposure to liability under such lawsuits, if any, would not
have a material adverse effect on the Company's financial condition.
Item 8. Financial Statements and Supplementary Data.
See List of Financial Statements and Financial Statement Schedules
on Page F-1.
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.
None.
29
<PAGE>
<PAGE>
PART III
Item 10. Directors and Executive Officers of the Registrant.
The following table lists each director and each executive officer of the
Company, together with their respective age and office(s) held:
Name Age Office
- ------------------- --- --------------------------------------
Walter A. Rhulen 65 President and Chairman of the Board
Peter L. Rhulen 58 Vice President and Director
Harry W. Rhulen 33 Executive Vice President
Peter H. Foley 49 Executive Vice President - M & A
Mark H. Mishler 38 Vice President - Finance and Treasurer
Thomas J. Dietz 55 Vice President
Linda Markovits 48 Vice President - Investor Relations
James E. Kroh 53 Vice President - Human Resources
Lawrence E. O'Brien 56 Director
Douglas C. Moat 65 Director
Alan Gerry 68 Director
Walter A. Rhulen has been the President and Chairman of the Board of the
Company since commencement of its operations in July 1986 and the President of
Frontier Insurance since 1976. Mr. Rhulen was also the President of Rhulen
Agency, a position he held for more than 22 years, which office he resigned in
1986. Mr. Rhulen, a chartered property and casualty underwriter (CPCU), has more
than 40 years experience in the insurance business.
Peter L. Rhulen has been a Vice President and director of the Company
since commencement of its operations in July 1986 and a Vice President of
Frontier Insurance since 1976. Mr. Rhulen was formerly Vice Chairman of
Markel/Rhulen, a position he held from October 1989 to September 1992, and now
acts as an independent insurance consultant. Mr. Rhulen is also Vice Chairman of
the Board and President of RAI Partners, Inc. (formerly Rhulen Agency), a firm
of which he has been an executive officer for more than 25 years. Mr. Rhulen
devotes only minimal time to the affairs of the Company in his capacity as Vice
President.
Harry W. Rhulen was elected Executive Vice President of the Company in
October 1996, having been a Vice President of the Company since June 1990 and an
employee since June 1989. Mr. Rhulen also serves as Chief Executive Officer of
United Capitol from its acquisition in May 1996.
Peter H. Foley was elected Executive Vice President of the Company in
October 1996, having been a Vice President of the Company since June 1995. Prior
thereto, Mr. Foley served as Vice President of Aegis Security Insurance Company
from September 1993 to June 1995, Executive Vice President and co-founder of
Connecticut Surety Insurance Company from May 1993 to September 1993, and Senior
Vice President of E.W. Blanch, Inc. from November 1991 to May 1993. Mr. Foley
has served in various executive officer positions in the insurance industry for
more than 22 years, and has served as principal of his own consulting firm.
Mark H. Mishler was elected Vice President - Finance and Treasurer of the
Company in October 1996, having been the Vice President and Controller of
Frontier Insurance Company since 1995, and an employee of the Company since
1987. Mr. Mishler has more than 15 years experience in the insurance business.
30
<PAGE>
<PAGE>
Thomas J. Dietz has been a Vice President of the Company since July 1990
and the President of Med Pro since its inception in 1986. For more than five
years prior thereto, Mr. Dietz was a Vice President of Medical Quadrangle, Inc.,
an insurance agency which acted as a broker to the Company through February
1987. Mr. Dietz, a CPCU, has more than 29 years' experience in the insurance
business.
Linda Markovits has been an employee of the Company since 1987, was
elected an Assistant Vice President in January 1991 and a Vice President in June
1993. Ms. Markovits has 18 years of experience in the insurance business.
James E. Kroh was elected Vice President - Human Resources of the Company
in May 1996, and joined the Company in 1995. Prior thereto, Mr. Kroh served for
in excess of five years as Vice President for PHICO Insurance Company.
Lawrence E. O'Brien has been a director of the Company since June 1990 and
a member of the Audit Committee since that date. Mr. O'Brien, a CPCU, is the
President of O'Brien Management Company, Inc., an insurance consulting firm, a
position he has held since January 1988, and was a co-founder and a director of
Underwriter Management Associates, a managing general insurance agency with
which he had been associated since its inception in 1983 until its sale in
September 1990. From 1976 to 1987, Mr. O'Brien was Executive Vice President of
Associated Risk Managers, a New York statewide affiliation of independent
insurance agents marketing specialized insurance programs.
Douglas C. Moat has been a director of the Company since August 1991 and a
member of the Audit Committee since that date. Mr. Moat, a JD, CLU, and FLMI, is
Chairman of the Manhattan Group, Inc., an insurance and financial services firm.
Mr. Moat has over 40 years' experience in insurance and financial services sales
and management, including 13 years as a private consultant. During his career,
he has held positions as Executive Vice President, The Home Group; Director
Financial Services Corporate Staff, ITT Corp.; Vice President, USLIFE Corp., and
President of USLIFE's mutual fund subsidiary; Vice President, The Glens Falls
Group and the National Life Assurance Company of Canada. Mr. Moat is a member of
the New York State Bar Association, serves on several insurance and banking
committees, and writes and speaks extensively on insurance topics, often acting
as an expert witness.
Alan Gerry was elected a director of the Company in March 1996. Mr. Gerry
was the founder of Cablevision Industries Corporation, the eighth largest
multiple cable system operator in the United States and its Chairman of the
Board and Chief Executive Officer until its merger with Time Warner
Entertainment in January 1996. Mr. Gerry is a member of the Board of Directors
of Time Warner Entertainment, the National Cable Television Association, and
C-SPAN, the industry public affairs programming network. He was a founding
member of the Board of the Cable Alliance for Education and is a past President
of the New York State Cable Television Association.
----------------------
Messrs. Walter A. Rhulen and Peter L. Rhulen are brothers and Mr. Harry W.
Rhulen is the son of Walter A. Rhulen.
All directors hold office until the next annual meeting of shareholders and
until their successors are elected and qualified. Officers are elected annually
and serve at the pleasure of the Board of Directors, subject to rights, if any,
under contracts of employment.
31
<PAGE>
<PAGE>
Item 11. Executive Compensation
The following table sets forth a summary of the compensation earned by the
Company's Chief Executive Officer and its four other most highly compensated
executive officers during the year ended December 31, 1996 and the two preceding
years.
Summary Compensation Table
<TABLE>
<CAPTION>
Long-Term
Annual Compensation Compensation
Name and ------------------- Awards
Principal Salary Bonus ------ All Other
Position Year ($) ($) Options (#) Compensation ($) (1)
- ----------- ---- ------- ------- ----------- --------------------
<S> <C> <C> <C> <C> <C>
Walter A. Rhulen 1996 500,000 415,500 -- 30,000
President 1995 500,000 296,900 -- 23,400
and Chairman 1994 500,000 -- -- 27,300
Thomas J. Dietz 1996 250,000 75,000 -- 20,000
Vice President 1995 215,000 35,400 -- 16,300
1994 215,000 -- -- 15,000
Peter H. Foley 1996 191,000 157,800 20,000(2) 17,000
Executive 1995 77,900 45,300 11,000(3) 3,600
Vice President 1994 -- -- -- --
Harry W. Rhulen 1996 125,000 65,000 -- 14,000
Executive 1995 105,000 23,900 2,750(4) 10,000
Vice President 1994 90,000 10,000 -- 9,200
Mark H. Mishler 1996 106,000 60,000 -- 11,300
Vice President 1995 87,000 8,900 2,750(4) 8,500
and Treasurer 1994 80,000 7,500 -- 6,700
</TABLE>
- ----------------------
(1) Represents the allocable amount accrued for contribution by the Company to
its profit sharing plan and the allocable amount of the Company's
contribution to its 401K plan. The allocable amount accrued for
contribution to the Company's profit sharing plan for Messrs. W. Rhulen,
Dietz, Foley, H. Rhulen and Mishler was $9,500, $9,500, $9,500, $9,400 and
$6,700, respectively, and the allocable amount contributed to the Company's
401K Plan for Messrs. W. Rhulen, Dietz, Foley, H. Rhulen and Mishler was
$20,500, $10,500, $7,500, $4,600 and $4,600, respectively.
(2) Exercisable cumulatively at the rate of approximately 10% of the underlying
shares per year, commencing June 30, 1997.
(3) Exercisable cumulatively at the rate of 25% of the underlying shares per
year, commencing June 5, 1996.
(4) Exercisable cumulatively at the rate of 25% of the underlying shares per
year, commencing March 3, 1996.
----------------------
32
<PAGE>
<PAGE>
The following table presents the value of unexercised options held at December
31, 1996 by the individuals named in the Summary Compensation Table:
Options Value Table
Value of
Number of Unexercised
Unexercised In-the-Money
Options Options
at Year-End (#) at Year-End ($)*
Exercisable (E)/ Exercisable (E)/
Name Unexercisable (U) Unexercisable (U)
- --------------------- ----------------- ----------------
Walter A. Rhulen -- --
Thomas J. Dietz 74,250 (E) -0- (E)
Peter H. Foley 2,750 (E) 43,938 (E)
28,250 (U) 136,813 (U)
Harry W. Rhulen 105,854 (E)(1) 40,663 (E)
2,744 (U) 49,105 (U)
Mark H. Mishler 2,049 (E) 31,559 (E)
2,516 (U) 46,053 (U)
- ------------
* Values are calculated by subtracting the exercise price from the fair market
value of the Common Stock at year-end.
(1) Includes 103,215 shares purchasable at $45.45 per share upon exercise of
options granted to Mr. Walter A. Rhulen, his father, and gifted to Mr. Harry
W. Rhulen by his father.
----------------------
Mr. Harry W. Rhulen is the son of Mr. Walter A. Rhulen
33
<PAGE>
<PAGE>
Item 12. Security Ownership of Certain Beneficial Owners and Management
The following table sets forth the beneficial ownership of the Company's Common
Stock at December 31, 1996 by (i) each person known by the Company to own
beneficially five percent or more of such shares, (ii) each director, (iii) each
person named in the Summary Compensation Table under "Executive Compensation" on
page 32, and (iv) all directors and executive officers as a group, together with
their respective percentage ownership of the outstanding shares:
Amount and Nature of
Beneficial Ownership
<TABLE>
<CAPTION>
Currently Acquirable Percent of
Name and Address Owned Within 60 Days (1) Outstanding
- ---------------- ------------ -------------- -----------
<S> <C> <C> <C> <C>
Walter A. Rhulen (2)............... 1,083,822(3) -- 7.4
Peter L. Rhulen (2)................ 972,950(4) -- 6.6
Lawrence E. O'Brien................ 34,392 688 *
Douglas C. Moat.................... 4,263 688 *
Alan Gerry ........................ -- -- *
Thomas J. Dietz.................... 69,704 74,250 1.0
Harry W. Rhulen.................... 97,631(5) 105,854(6) 1.4
Peter H. Foley..................... 952 2,750 *
Mark H. Mishler.................... -- 2,049 *
Estate of Jesse M. Farrow (2)...... 859,594 -- 5.9
Denver Investment Advisors LLC
1225 - 17th Street, 26th Floor
Denver, CO 80202................ 1,218,726(7) -- 8.3
Wellington Management Company
75 State Street
Boston, MA 02109................. 1,139,071(8) -- 7.8
All directors and executive
officers as a group (9 persons).. 2,276,314 190,383 16.8
</TABLE>
- ------------------------------------
* Less than 1%
(1) Reflects number of shares of Common Stock acquirable upon exercise of
options.
(2) Address is 195 Lake Louise Marie Road, Rock Hill, NY 12775-8000.
(3) Does not include 5,072 shares of Common Stock owned by the wife of Walter A.
Rhulen, the beneficial ownership of which Mr. Rhulen disclaims.
(4) Does not include 13,216 shares of Common Stock owned by the wife of Peter L.
Rhulen, 245,391 shares owned by the children of Peter L. Rhulen, 26,200
shares of Common Stock owned by The Eileen and Peter Rhulen Foundation of
which Mr. Rhulen is President, and 12,650 shares of Common Stock owned by a
charitable foundation for which Mr. Rhulen acts as trustee. Mr. Rhulen
disclaims beneficial ownership of the aforementioned shares.
(5) Includes 3,394 shares owned by a daughter of Mr. Harry W. Rhulen for whom he
acts as custodian under the Uniform Gifts to Minors Act. Does not include
5,459 shares of Common Stock owned by Mr. Rhulen's wife, as to which Mr.
Rhulen disclaims beneficial ownership.
(6) Includes 103,125 shares purchasable at $45.45 per share upon exercise of
options granted to Mr. Walter A. Rhulen, his father, and gifted to Mr. Harry
W. Rhulen by his father.
(7) Information is from Schedule 13G, dated February 10, 1997, filed by Denver
Investment Advisors, LLC, which reflects shared dispositive power with
respect to 1,218,726 shares.
(8) Information is from a Schedule 13G, dated January 24, 1997, filed by
Wellington Management Company, which reflects shared dispositive power with
respect to 1,139,071 shares.
34
<PAGE>
<PAGE>
Item 13. Certain Relationships and Related Transactions
Not applicable.
PART IV
Item 14. Exhibits, Financial Statements, Schedules, and Reports on Form 8-K
(a) List of documents filed as part of this Report.
(1), (2) Financial Statements and Schedules.
See List of Financial Statements and Financial Statement
Schedules on page F-1.
(3) The list of exhibits required to be filed with this Report
is set forth in the Index to Exhibits herein.
(b) Reports on Form 8-K.
None.
(c) Exhibits.
See Index to Exhibits
35
<PAGE>
<PAGE>
ANNUAL REPORT ON FORM 10-K
ITEM 8, ITEM 14(a)(1) and (2), (c), and (d)
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
LIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
CERTAIN EXHIBITS
FINANCIAL STATEMENT SCHEDULES
YEAR ENDED DECEMBER 31, 1996
FRONTIER INSURANCE GROUP, INC.
ROCK HILL, NEW YORK
<PAGE>
<PAGE>
FORM 10-K--ITEM 14(a)(1) AND (2)
FRONTIER INSURANCE GROUP, INC. AND SUBSIDIARIES
LIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
The following consolidated financial statements and supplemental data of
Frontier Insurance Group, Inc. and subsidiaries are included in Item 8:
Consolidated Balance Sheets--December 31, 1996 and 1995.....................F-3
Consolidated Statements of Income--Years Ended
December 31, 1996, 1995 and 1994........................................F-5
Consolidated Statements of Shareholders' Equity--Three Years Ended
December 31, 1996.......................................................F-6
Consolidated Statements of Cash Flows--Years Ended
December 31, 1996, 1995 and 1994........................................F-7
Notes to the Consolidated Financial Statements..............................F-8
Supplemental Data--Quarterly Results of Operations (Unaudited)..............F-30
The following consolidated financial statement schedules of Frontier Insurance
Group, Inc. and subsidiaries are included in Item 14(a):
Schedule II --Condensed Financial Information of Registrant................F-31
Schedule IV --Reinsurance...................................................F-34
Schedule V --Valuation and Qualifying Accounts.............................F-35
Schedule VI --Supplemental Information Concerning
Property/Casualty Insurance Operations.......................F-36
All other schedules for which provision is made in Article 7 of Regulation S-X
are not required under the related instructions, are inapplicable, or required
information is included in the consolidated financial statements, and therefore,
have been omitted.
F-1
<PAGE>
<PAGE>
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Shareholders
Frontier Insurance Group, Inc.
We have audited the accompanying consolidated balance sheets of Frontier
Insurance Group, Inc. and subsidiaries as of December 31, 1996 and 1995, and the
related consolidated statements of income, shareholders' equity, and cash flows
for each of the three years in the period ended December 31, 1996. Our audits
also included the financial statement schedules listed in the Index at Item
14(a). These financial statements and schedules are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and schedules based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Frontier Insurance Group, Inc. and subsidiaries at December 31, 1996 and 1995,
and the consolidated results of their operations and their cash flows for each
of the three years in the period ended December 31, 1996, in conformity with
generally accepted accounting principles. Also, in our opinion, the related
financial statement schedules, when considered in relation to the basic
financial statements taken as a whole, present fairly in all material respects
the information set forth therein.
As described in Note B to the consolidated financial statements, effective
January 1, 1994, the Company adopted Financial Accounting Standards Board
Statement 115, "Accounting for Certain Investments in Debt and Equity
Securities."
/S/ Ernst & Young LLP
-------------------------
New York, New York
March 26, 1997, except for
Note O, as to which the date
is March 31, 1997
F-2
<PAGE>
<PAGE>
FRONTIER INSURANCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollar amounts in thousands)
ASSETS
<TABLE>
<CAPTION>
December 31
--------------------------
1996 1995
---------- --------
<S> <C> <C>
Investments--Note H:
Securities, available for sale--at fair value:
Fixed maturities (amortized cost:
1996--$680,281; 1995--$510,056) $ 685,277 $521,402
Equity securities (cost: 1996--$13,871;
1995--$20,132) 16,271 21,024
Short-term investments 133,835 7,353
Investment in limited liability corporation 2,937 2,935
---------- --------
TOTAL INVESTMENTS 838,320 552,714
Cash 8,332 5,115
Agents' balances due, less
allowances for doubtful accounts
(1996--$2,225; 1995--$3,346) 50,558 25,779
Premiums receivable from insureds,
less allowances for doubtful accounts
(1996--$60; 1995--$45) 26,225 24,177
Net reinsurance recoverables, less
allowances for possible uncollectible
amounts (1996--$517; 1995--$115)--Notes D and N 192,569 76,955
Accrued investment income 9,364 7,458
Federal income taxes recoverable 3,987 217
Deferred policy acquisition costs 32,871 18,797
Deferred federal income tax asset--Note E 27,620 23,627
Home office building, property and equipment--
at cost, less accumulated depreciation and
amortization (1996--$11,184; 1995--$7,679) 37,167 29,668
Intangible assets, less accumulated amortization
(1996--$3,808; 1995--$2,370) 11,738 3,082
Other assets 7,656 5,759
---------- --------
TOTAL ASSETS $1,246,407 $773,348
========== ========
</TABLE>
See notes to the consolidated financial statements.
F-3
<PAGE>
<PAGE>
FRONTIER INSURANCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS--Continued
(dollar amounts in thousands, except per share data)
LIABILITIES AND SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
December 31
--------------------------
1996 1995
---------- --------
<S> <C> <C>
LIABILITIES
Policy liabilities--Notes C and D:
Unpaid losses $ 429,506 $309,164
Unpaid loss adjustment expenses 109,567 58,272
Unearned premiums 185,728 107,282
---------- --------
TOTAL POLICY LIABILITIES 724,801 474,718
Funds withheld under reinsurance contracts--Note N 64,065 28,226
Cash dividend payable to shareholders 1,904 1,568
Note payable--Note F 25,000
Other liabilities 20,110 14,103
---------- --------
TOTAL LIABILITIES 810,880 543,615
COMMITMENTS AND CONTINGENCIES--Note L
GUARANTEED PREFERRED BENEFICIAL INTEREST
IN COMPANY'S CONVERTIBLE SUBORDINATED
DEBENTURES--Note M 166,953
SHAREHOLDERS' EQUITY--Notes A, G, I, and J
Preferred stock, par value $.01
per share; authorized and
unissued--1,000,000 shares
Common stock, par value $.01 per share;
(shares authorized: 1996--50,000,000;
1995--20,000,000, shares issued:
1996--14,689,552; 1995--13,062,501) 147 130
Additional paid-in capital 221,984 167,587
Net unrealized gains--Note H 4,807 7,955
Retained earnings 42,424 54,849
---------- --------
SUBTOTAL 269,362 230,521
Less treasury stock--at cost (1996--45,540 shares;
1995--41,400 shares) 788 788
---------- --------
TOTAL SHAREHOLDERS' EQUITY 268,574 229,733
---------- --------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $1,246,407 $773,348
========== ========
</TABLE>
See notes to the consolidated financial statements.
F-4
<PAGE>
<PAGE>
FRONTIER INSURANCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(dollar amounts in thousands, except per share data)
<TABLE>
<CAPTION>
Year Ended December 31
---------------------------------------
1996 1995 1994
--------- --------- ---------
<S> <C> <C> <C>
REVENUES--Note D
Premiums written $ 402,799 $ 264,314 $ 198,892
Premiums ceded (90,936) (43,557) (11,604)
--------- --------- ---------
NET PREMIUMS WRITTEN 311,863 220,757 187,288
Increase in net unearned premiums (45,874) (24,537) (30,533)
--------- --------- ---------
NET PREMIUMS EARNED 265,989 196,220 156,755
Net investment income 37,226 30,035 24,453
Realized capital gains (losses) 1,707 20 (1,478)
--------- --------- ---------
TOTAL NET INVESTMENT
INCOME--Note H 38,933 30,055 22,975
Gross claims adjusting income--Note B 55 130 255
--------- --------- ---------
TOTAL REVENUES 304,977 226,405 179,985
EXPENSES
Losses--Notes C and D 97,058 89,422 84,777
Loss adjustment expenses--Notes C and D 58,933 29,833 26,141
Amortization of policy acquisition
costs--Note B 57,540 42,258 30,463
Underwriting and other expenses 30,540 20,717 17,274
Minority interest in income of consolidated
subsidiary trust--Note M 2,277
Interest expense--Note F 1,970 895
--------- --------- ---------
TOTAL EXPENSES 248,318 183,125 158,655
--------- --------- ---------
INCOME BEFORE INCOME TAXES 56,659 43,280 21,330
Income taxes--Note E
State 723 1,173 554
Federal 15,869 10,896 3,796
--------- --------- ---------
TOTAL INCOME TAXES 16,592 12,069 4,350
--------- --------- ---------
NET INCOME $ 40,067 $ 31,211 $ 16,980
========= ========= =========
PER SHARE DATA--Note B
Primary earnings per common share $ 2.77 $ 2.18 $ 1.19
========= ========= =========
Fully diluted earnings per common share $ 2.73 $ 2.17 $ 1.18
========= ========= =========
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING (in thousands):
Primary 14,453 14,313 14,291
Fully diluted 15,219 14,405 14,401
</TABLE>
See notes to the consolidated financial statements.
F-5
<PAGE>
<PAGE>
FRONTIER INSURANCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(dollar amounts in thousands, except per share data)
<TABLE>
<CAPTION>
Three Years Ended December 31, 1996 Net Unrealized
Additional Gains(Losses)
Common Paid-in on Securities Retained Treasury Total
Stock Capital Available-for-Sale Earnings Stock Shareholders' Equity
------ ---------- ------------------ -------- -------- --------------------
<S> <C> <C> <C> <C> <C> <C>
Balances at January 1, 1994 $ 86 $166,663 $ 55 $18,890 $185,694
Add (deduct):
Net income 16,980 16,980
Expenses associated with 1993 issuance
of 1,408,000 shares of common stock (47) (47)
Common stock split (3 for 2) 43 (43)
Purchase of 35,400 shares as treasury stock $(654) (654)
Stock options exercised 1 636 637
Cumulative effect of change in accounting
principle -- Note B 3,651 3,651
Net unrealized losses on securities
available-for-sale (net of tax) (10,013) (10,013)
Cash dividends paid and accrued ($.46 per share) (5,984) (5,984)
---- -------- ------- ------- ----- ---------
Balances at December 31, 1994 130 167,209 (6,307) 29,886 (654) 190,264
---- -------- ------- ------- ----- ---------
Add (deduct):
Net income 31,211 31,211
Purchase of 6,000 shares as treasury stock (134) (134)
Stock options exercised 378 378
Transfer of securities to available-for-sale
(net of tax) - Note B 2,753 2,753
Net unrealized gains on securities
available-for-sale (net of tax) 11,509 11,509
Cash dividends paid and accrued ($.48 per share) (6,248) (6,248)
---- -------- ------- ------- ----- --------
Balances at December 31, 1995 130 167,587 7,955 54,849 (788) 229,733
---- -------- ------- ------- ----- --------
Add (deduct):
Net income 40,067 40,067
Common stock dividend (10%) 14 45,222 (45,236)
Stock options exercised 1 1,102 1,103
Issuance of 238,087 shares of common stock 2 8,073 8,075
Net unrealized losses on securities
available-for-sale (net of tax) (3,148) (3,148)
Cash dividends paid and accrued ($.50 per share) (7,256) (7,256)
---- -------- ------- ------- ----- --------
Balances at December 31, 1996 $147 $221,984 $ 4,807 $42,424 $(788) $268,574
==== ======== ======= ======= ===== ========
</TABLE>
See notes to the consolidated financial statements.
F-6
<PAGE>
<PAGE>
FRONTIER INSURANCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollar amounts in thousands)
<TABLE>
<CAPTION>
Year Ended December 31
-------------------------------------------
1996 1995 1994
-------- -------- --------
OPERATING ACTIVITIES
<S> <C> <C> <C>
Net income $ 40,067 $ 31,211 $ 16,980
Adjustments to reconcile net
income to net cash provided
by operating activities:
Increase in policy liabilities 145,636 80,857 63,274
Decrease (increase) in
reinsurance balances (35,473) 5,403 15,619
Increase in agents' balances
and premiums receivable (21,402) (8,825) (6,950)
Increase in deferred policy
acquisition costs (14,366) (5,584) (6,393)
Increase in accrued investment
income (1,369) (2,380) (161)
Deferred income tax expense (benefit) 2,279 (175) (5,162)
Depreciation and amortization 3,687 2,384 305
Realized capital losses (gains) (1,707) (20) 1,478
Other (895) 2,110 2,871
-------- -------- --------
NET CASH PROVIDED BY
OPERATING ACTIVITIES 116,457 104,981 81,861
INVESTING ACTIVITIES
Proceeds from sales of fixed maturities
available-for-sale 129,523 46,650 26,245
Proceeds from sales of fixed maturities
held-to-maturity 12,534
Proceeds from calls, paydowns and
maturities of fixed maturities
available-for-sale 191,888 77,999 25,250
Proceeds from calls, paydowns and maturities
of fixed maturities held-to-maturity 33,783 19,175
Proceeds from sales of equity securities 15,256 36,465 63,200
Purchases of fixed maturities
available-for-sale (430,713) (294,379) (35,994)
Purchases of fixed maturities
held-to-maturity (33,327) (109,127)
Purchases of equity securities (5,533) (4,559) (68,783)
Purchases of wholly-owned subsidiaries,
net of cash acquired (28,996)
Net (purchases) sales of
short-term investments (108,889) 5,534 4,001
Additions to home office building (1,178) (2,568) (2,191)
Purchases of property and equipment (9,431) (328) (996)
Proceeds from sales of property and equipment 438
Purchase of renewal rights (8) (633) (3,427)
Investment in limited liability corporation (2) (2,400)
-------- -------- --------
NET CASH USED IN
INVESTING ACTIVITIES (247,645) (125,229) (82,647)
FINANCING ACTIVITIES
Proceeds from guaranteed preferred
beneficial interest in Company's
convertible subordinated debentures 166,914
Proceeds from borrowings 7,100 25,000
Repayment of borrowings (33,792)
Issuance of common stock 1,103 378 590
Cash dividends paid (6,920) (6,243) (5,717)
Purchase of treasury stock (134) (654)
-------- -------- --------
NET CASH PROVIDED BY (USED IN)
FINANCING ACTIVITIES 134,405 19,001 (5,781)
-------- -------- --------
INCREASE (DECREASE) IN CASH 3,217 (1,247) (6,567)
Cash at beginning of year 5,115 6,362 12,929
-------- -------- --------
CASH AT END OF YEAR $ 8,332 $ 5,115 $ 6,362
======== ========= ========
</TABLE>
See notes to the consolidated financial statements.
F-7
<PAGE>
<PAGE>
FRONTIER INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE A--OPERATIONS AND ACQUISITIONS
Frontier Insurance Group, Inc., and its subsidiaries (the "Company"), is
principally a specialty property and casualty insurer operating in 50 states.
The Company's principal lines of business are medical malpractice, general
liability, surety, and commercial earthquake accounting for approximately 34.6%,
28.2% , 16.2% and 4.1% of gross premiums written in 1996, respectively. The
medical malpractice programs are marketed principally through the Company's
wholly-owned subsidiary, Medical Professional Liability Agency, Ltd ("Med Pro").
The Company also has a bail bond program, which is marketed through
Douglass/Frontier LLC, a fifty percent owned entity (see below). The Company's
remaining lines of business are marketed primarily through independent agents.
In April 1994, the Company completed the acquisition of certain assets of
Spencer Douglass Insurance Associates, Inc. ("SDIA") constituting that company's
California license and permit bond insurance agency business for $3,200,000 and
entered into a five-year consulting agreement with the owner/principal. This
acquisition was accounted for as a purchase. The purchase price of $3,200,000
exceeded by the same amount the net book value of the business acquired.
In May 1995, the Company and R. Spencer Douglas III ("Douglass") formed a
California limited liability corporation, Douglass/Frontier LLC
("Douglass/Frontier"), a bail bond insurance agency. The Company made an initial
cash investment of $2,400,000, and Douglass contributed the assets and
liabilities of his wholly owned existing bail bond agency. The Company and
Douglass share equally in the ownership of Douglass/Frontier. All of the
Company's bail bond business is written through Douglass/Frontier and for the
years ended December 31, 1996 and 1995, was approximately $7,608,000 and
$4,800,000, respectively. At December 31, 1996 and 1995, Douglass/Frontier had
premium balances due the Company in the normal course of business of $2,358,000
and $1,271,000, and notes payable to the Company of $3,291,000 and $212,000,
respectively. At December 31, 1996, the Company had an interest of $537,000 in
the undistributed earnings of Douglass/Frontier.
In December 1995, the Company purchased certain assets from Bankers Multiple
Line Insurance Company ("BMLIC") constituting BMLIC's realtors' errors and
omissions ("Realtors' E & O") business for $400,000. The purchase agreement
provides that, if certain conditions cease to exist in future years, the
purchase price may be reduced. In addition, the Company was paid approximately
$8,000,000 to assume BMLIC's obligations under its existing Realtors' E & O
policies consisting of $2,287,000 of unearned premium reserves and $5,713,000 of
undiscounted loss and loss adjustment expense ("LAE") reserves at the
acquisition date. The Company's maximum liability relative to its assumption of
the loss and LAE reserves is $7,141,000 with BMLIC retaining the liability for
any losses in excess of this amount. During 1996, the Company earned the
previously assumed unearned premiums and paid $3,948,000 in losses and LAE, and
at December 31, 1996 holds related reserves of $1,765,000.
In May 1996, the Company completed the acquisition of United Capitol Holding
Company ("United Capitol Holding") and its wholly-owned subsidiaries, United
Capitol Insurance Company ("United Capitol"), United Capitol Managers, Inc.
(renamed Olympic Underwriting Managers, Inc.) and Fischer Underwriting Group,
Inc., for $31,020,000, which exceeded the fair value of the net assets acquired
by approximately $7,700,000. From its headquarters in Atlanta, Georgia, these
entities underwrite specialty risks such as asbestos abatement, environmental
liability and directors' and officers' liability. This acquisition was accounted
for as a purchase.
In September 1996, the Company completed the acquisition of Regency Insurance
Company ("Regency") and Emrol Installment Premium Discount, Inc. ("Emrol") in
exchange for 238,087 shares
F-8
<PAGE>
<PAGE>
FRONTIER INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--Continued
NOTE A--OPERATIONS AND ACQUISITIONS--Continued
of the Company's Common Stock, which had a market value per share of $33.92 on
June 11, 1996, the effective date of the agreement. The purchase price, which is
inclusive of $221,000 of capitalized acquisition costs, exceeded the fair value
of the net assets acquired by approximately $2,400,000. Regency, an underwriter
of non-standard automobile insurance is located in Charlotte, North Carolina.
Emrol finances premiums primarily for policyholders of Regency. This acquisition
was accounted for as a purchase.
The assets acquired, liabilities assumed and the related goodwill of the
companies purchased in 1996, are summarized in the following table (in
thousands):
<TABLE>
<CAPTION>
United Capitol Regency and
Holding Emrol Total
-------------- ----------- --------
<S> <C> <C> <C>
Purchase Price $ 31,020 $ 8,296 $ 39,316
Assets acquired:
Invested assets 74,966 4,168 79,134
Other assets 49,797 11,833 61,630
-------- -------- --------
Total assets acquired 124,763 16,001 140,764
Liabilities assumed:
Unpaid losses and LAE 84,823 4,163 88,986
Other liabilities 16,604 5,944 22,548
-------- -------- --------
Total liabilities assumed 101,427 10,107 111,534
-------- -------- --------
Net assets acquired 23,336 5,894 29,230
-------- -------- --------
Excess of purchase price over
net assets acquired $ 7,684 $ 2,402 $ 10,086
======== ======== ========
</TABLE>
F-9
<PAGE>
<PAGE>
FRONTIER INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--Continued
NOTE A--OPERATIONS AND ACQUISITIONS--Continued
The following schedule summarizes the Company's pro forma unaudited results of
operations for the years ended December 31, 1996 and 1995, assuming the purchase
of United Capitol Holding, Regency and Emrol had been consummated as of January
1, 1995 (in thousands, except per share data):
<TABLE>
<CAPTION>
Year Ended December 31
--------------------------
1996 1995
-------- --------
(Unaudited)
<S> <C> <C>
Net premiums earned $271,452 $214,347
Net investment income (including net capital
gains and losses) 41,385 33,831
Other revenues 55 130
-------- --------
Total revenues 312,892 248,308
Losses and LAE 158,963 130,068
Amortization of policy acquisition costs 57,248 43,489
Underwriting and other expenses 32,615 25,991
Minority interest in income of
consolidated subsidiary trust 2,277
Interest expense 1,970 895
-------- --------
Total expenses 253,073 200,443
-------- --------
Income before income taxes 59,819 47,865
Income tax expense 17,831 13,317
-------- --------
Net income $ 41,988 $ 34,548
======== ========
Per share data:
Primary earnings per common share $ 2.87 $ 2.37
======== ========
Fully diluted earnings per common share $ 2.82 $ 2.36
======== ========
</TABLE>
The foregoing pro forma financial information has been prepared for
informational purposes only and includes certain adjustments relating to
investment income, amortization of goodwill, and also for 1995, loss and other
expenses, together with the related income tax effects. The pro forma
financial information is not necessarily indicative of the results of operations
as they would have been had the transactions been consummated on the assumed
dates.
The Company's Preferred Stock may be issued from time to time by the Board of
Directors in one or more series and classes and with such dividend rights,
conversion rights, voting rights, redemption provisions, liquidation
preferences, and other rights and restrictions as the Board of Directors may
determine.
On December 31, 1996, the Company held a Special Meeting of Stockholders and
voted to adopt an amendment to the Company's Certificate of Incorporation to
increase the authorized number of shares of the Company's Common Stock from
20,000,000 to 50,000,000.
NOTE B--SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation and Principles of Consolidation: The accompanying
financial statements have been prepared in accordance with generally accepted
accounting principles ("GAAP"), which, as to insurance companies, differ from
the statutory accounting practices prescribed or permitted by regulatory
authorities. The consolidated financial statements include the accounts and
operations of Frontier Insurance Group, Inc. and all subsidiaries. All
significant intercompany accounts and transactions have been eliminated in
consolidation.
F-10
<PAGE>
<PAGE>
FRONTIER INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--Continued
NOTE B--SIGNIFICANT ACCOUNTING POLICIES--Continued
Use of Estimates: The preparation of financial statements requires management to
make estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Such estimates and assumptions could change
in the future as more information becomes known which could impact the amounts
reported and disclosed herein.
Recognition of Premium Revenues: Direct, assumed, and ceded reinsurance premiums
written are recognized as earned pro rata over the terms of the related
insurance policies.
Investments: Effective January 1, 1994, the Company adopted Financial Accounting
Standards Board ("FASB") Statement 115, "Accounting for Certain Investments in
Debt and Equity Securities" ("FASB 115"). Under FASB 115, investments in fixed
maturities are classified in three categories: held-to-maturity, trading and
available-for-sale; investments in equity securities are classified as either
available-for-sale or trading. Held-to-maturity securities are reported at cost,
adjusted for amortization of premium or discount; trading securities are
reported at fair value, with unrealized gains and losses included in earnings;
and available-for-sale securities are reported at fair value with unrealized
gains and losses excluded from earnings and reported in a separate component of
shareholders' equity, net of applicable income taxes. This change in accounting
had no effect on net income; however, the accounting change increased
shareholders' equity at January 1, 1994 by $3,651,000, net of applicable income
taxes, representing the amount of unrealized gains on fixed-maturity investments
classified as available-for-sale. Under the former rules, debt securities
(principally bonds, notes and redeemable preferred stocks) were carried at cost,
adjusted for the amortization of premium or discount and other-than-temporary
market value declines. Unrealized gains and losses were excluded from both
earnings and shareholders' equity.
In December 1995, the Company reclassified all of its securities classified as
held-to-maturity to the available-for-sale category as permitted by the FASB's
Special Report, "A Guide to Implementation of Statement 115 on Accounting for
Certain Investments in Debt and Equity Securities - Questions and Answers." The
securities reclassified had a carrying value of $190,474,000 and a market value
of $194,709,000 at the date of transfer. This reclassification resulted in a
$2,753,000 increase, net of applicable income taxes, in shareholders' equity.
Fixed maturities available-for-sale (principally bonds and notes) are carried at
fair value. Fair values for available-for-sale fixed maturity securities are
based on quoted market prices, where available.
For fixed maturity securities not actively traded, fair values are estimated
using values obtained from independent pricing services. For mortgage backed
securities, the Company considers estimates of future principal prepayments in
the calculation of the constant effective yield necessary to apply the interest
method. If a difference arises between the prepayments anticipated and actual
prepayments received, the Company recalculates the effective yield to reflect
the actual payments received and the anticipated future payments. Equity
securities (principally common and nonredeemable preferred stocks) are carried
at fair value, based on quoted market prices. Short-term investments are carried
at their principal balances, which approximates their fair value. Realized gains
and losses from the sales or liquidation of investments are determined using the
specific identification basis. Changes in the fair value of available-for-sale
securities are reflected as unrealized gains or losses directly in shareholders'
equity net of federal income tax.
The investment in Douglass/Frontier is accounted for under the equity method
based on Douglas/Frontier's GAAP results of operations.
F-11
<PAGE>
<PAGE>
FRONTIER INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--Continued
NOTE B--SIGNIFICANT ACCOUNTING POLICIES--Continued
Home Office Building, Property and Equipment: Home office building is stated at
cost, net of accumulated depreciation computed, for both financial reporting and
federal income tax purposes, on the straight-line basis over an estimated useful
life of 31.5 years. Property and equipment is stated at cost net of accumulated
depreciation and amortization computed, for financial reporting purposes, on the
straight-line basis over estimated useful lives between three to ten years and,
for federal income tax purposes, using accelerated methods and guideline lives
ranging from three to seven years. During 1996, 1995, and 1994, depreciation and
amortization expense was $3,413,000, $2,440,000, and $1,939,000, respectively.
In April 1993 and in July 1996, the Company put into service and began to occupy
its new home office facility and purchased a corporate jet, respectively. The
cost of the facility's construction and purchase of the jet was financed
internally by the Company. However, to receive favorable tax status, title to
the facility and jet resides with the County of Sullivan Industrial Development
Agency ("IDA") which, in turn, issued to the Company its twenty-year bonds with
a face value equal to the total cost of the facility and jet. Under the
provisions of related agreements, title to the facility and jet reverts to the
Company on maturity of the bonds, or sooner for a nominal fee, should the
Company so desire. Accordingly, as a result of these agreements, the home office
facility and corporate jet are reported in the accompanying financial statements
as, "Home office building, property and equipment." As of December 31, 1996, the
outstanding, par value of the IDA bonds was $24,574,000; which approximates the
carrying values of such assets.
Deferred Policy Acquisition Costs: Recoverable policy acquisition costs that
vary with and are directly related to the production of business, such as
commissions and premium taxes, net of reinsurance allowances, are deferred and
amortized to income as the related premiums are earned. Anticipated losses, LAE,
and policy maintenance expenses, based on historical and current experience, are
considered in determining the recoverability of such deferred policy acquisition
costs. When the anticipated losses, LAE, acquisition and policy maintenance
expenses exceed the related unearned premiums, without considering anticipated
investment income, a provision for the indicated deficiency is recorded.
Intangible Assets: Intangible assets are stated at cost, net of accumulated
amortization computed on a straight-line basis over estimated useful lives
ranging from two to seven years for insurance renewal rights and five to fifteen
years for other intangible assets, including goodwill. The Company assesses the
recoverability of intangible assets by determining whether the amortization of
the balance over its remaining life can be recovered through the undiscounted
future operating cash flows of the acquired operations.
Unpaid Losses and LAE: The liabilities for unpaid losses and LAE represent the
estimated liabilities for reported claims, claims incurred but not yet reported
("IBNR"), and the related LAE. The liabilities for unpaid losses and LAE are
determined using case-basis evaluations and actuarial analyses and represent
estimates of the ultimate expected cost of all losses and LAE unpaid at the
balance sheet dates.
The liabilities for unpaid losses and LAE have been reduced by estimated salvage
and subrogation recoverable and have not been reduced from their ultimate values
by the effects of discounting estimated ultimate payments to their present
value.
Reinsurance: Assumed reinsurance premiums written, commissions, and unpaid
losses are accounted
F-12
<PAGE>
<PAGE>
FRONTIER INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--Continued
NOTE B--SIGNIFICANT ACCOUNTING POLICIES--Continued
for based principally on the reports received from the ceding insurance
companies and in a manner consistent with the terms of the related reinsurance
agreements. Liabilities for unpaid losses, LAE and unearned premiums are stated
gross of ceded reinsurance recoverables. Deferred policy acquisition costs are
stated net of the amounts of reinsurance ceded, as are premiums written and
earned, losses and LAE incurred, and amortized acquisition costs.
Contingent Reinsurance Commissions: Contingent reinsurance commissions are
accounted for on an earned basis and are accrued, in accordance with the terms
of the applicable reinsurance agreement, based on the estimated level of
profitability relating to such reinsured business. Accordingly, the
profitability of the reinsured business is continually reviewed and as
adjustments become necessary, such adjustments are reflected in current
operations. Contingent reinsurance commissions are included in other assets and
other liabilities.
Income Taxes: Income tax provisions are based on income reported for financial
statement purposes, adjusted for permanent differences between financial and
taxable income. Deferred federal income taxes are recognized using the liability
method, whereby tax rates are applied to the temporary differences between the
financial reporting and tax bases of assets and liabilities. Deferred tax assets
and liabilities are adjusted for changes in tax rates or laws, and the
adjustment is reflected in income during the period in which such change is
enacted.
Earnings per Share: Primary earnings per common share are computed by dividing
net income by the weighted average common shares outstanding during the period.
The weighted average shares outstanding have been adjusted retroactively to
reflect the effects of stock splits and stock dividends. The effect of common
stock equivalents (stock options) is excluded from the calculations because
their effect is not material. Fully diluted earnings per common share assume the
conversion of all securities whose contingent issuance would have a dilutive
effect on earnings.
Gross Claims Adjusting Income: Claims adjusting income is accounted for on an
accrual basis, gross of related expenses. During 1996, 1995, and 1994, operating
expenses included with underwriting and other expenses associated with claims
adjusting income amounted to $637,000, and $203,000, and $331,000, respectively.
Impact of Recently Issued Accounting Standards: In June 1996, the Financial
Accounting Standards Board issued Statement 125, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities, which provides
accounting and reporting standards for sales, securitizations, and servicing of
receivables and other financial assets, secured borrowing and collateral
transactions, and the extinguishments of liabilities. The Statement is to be
applied to transactions occurring after December 31, 1996 including transfers of
assets pursuant to securitization structures that previously were entered into.
However, the FASB has issued a proposed amendment that would delay until 1998
the effective date of certain of the statement's provisions that deal with
securities lending, repurchase and dollar repurchase agreements and the
recognition of collateral. The Company will adopt Statement 125 in the first
quarter 1997, excluding the provisions that deal with securities lending,
repurchase and dollar repurchase agreements, and the recognition of collateral,
which will be adopted in 1998 pursuant to the proposed amendment. The Company
does not believe the effect of the adoption will be material to its financial
position or results of operations.
F-13
<PAGE>
<PAGE>
FRONTIER INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--Continued
NOTE B--SIGNIFICANT ACCOUNTING POLICIES--Continued
Reclassifications: Certain prior year amounts have been reclassified to conform
to the 1996 presentation.
NOTE C--UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
The liabilities for unpaid losses and LAE are estimated by management utilizing
methods and procedures which they believe are reasonable. These liabilities are
necessarily subject to the impact of future changes in claim severity and
frequency, as well as numerous other factors. Although management believes that
the estimated liabilities for unpaid losses and LAE are reasonable, because of
the extended period of time over which such losses are reported and settled, the
subsequent development of these liabilities may not conform to the assumptions
inherent in their determination and, accordingly, may vary from the estimated
amounts included in the accompanying financial statements. To the extent that
the actual emerging loss experience varies from the assumptions used in the
determination of these liabilities, they are adjusted to reflect actual
experience. Such adjustments, to the extent they occur, are reported in the
period recognized.
The anticipated effect of inflation is implicitly considered when estimating
reserves for losses and LAE.
Although anticipated price increases due to inflation are considered in
estimating the ultimate claim costs, the increase in average severities of
claims is caused by a number of factors that vary with the types of policies
written. Average severities are projected based on historical trends adjusted
for implemented changes in underwriting standards, policy provisions, and
general economic trends. Those anticipated trends are monitored based on actual
development and are adjusted as necessary. The effects of such adjustments are
reported in the period recognized.
In December 1990, the New York State Court of Claims rendered a decision in
favor of the Company holding that a State University of New York ("SUNY")
medical school faculty member engaged in the clinical practice of medicine at a
SUNY medical facility, corollary to such physician's faculty activities, was
within the scope of such physician's employment by SUNY and was protected
against malpractice claims arising out of such activity by the State of New York
and not under the Company's medical malpractice policy. The decision was
affirmed on appeal by the New York State Appellate Division in November 1991 and
not appealed by the State. In July 1992, the State of New York enacted
legislation eliminating medical school faculty members of SUNY engaged in the
clinical practice of medicine at a SUNY medical facility from indemnification by
the State with respect to malpractice claims arising out of such activity,
retroactive to July 1, 1991. In an opinion filed on September 3, 1993 the Court
of Claims of the State of New York held, inter alia, that the July 1992
legislation by the State of New York eliminating SUNY medical school faculty
members engaged in the clinical practice of medicine, as part of their
employment by SUNY, from indemnification by the State with respect to
malpractice claims arising out of such activity was not to be applied
retroactively. This decision was affirmed by the New York State Appellate
Division in April 1994. Subsequently, in February 1995, the Appellate Division
granted leave to the Company and the State of New York to have the issues of the
Company's entitlement to recover its costs of defense and its costs of
settlement ruled on by the State's highest Court, the New York Court of Appeals.
In December 1995, the New York Court of Appeals ruled on this issue and
concluded that the Company was entitled to recoveries from the State for such
medical malpractice claims. As a result of this decision, the Company believes
that it will benefit economically by not being ultimately responsible for
certain claims against SUNY physicians for whom it presently carries reserves
and be entitled to reimbursement for certain claims previously paid;
accordingly, in 1996 and 1995, the Company recorded subrogation recoverables of
approximately $13,000,000 and
F-14
<PAGE>
<PAGE>
FRONTIER INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--Continued
NOTE C--UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES--Continued
$19,000,000, respectively, representing the amount of claims already paid and
the reserves currently held by the Company on the cases that management believes
are reimbursable by the State of New York. In January 1997, the New York Court
of Claims rendered a decision granting summary judgement to the Company on three
SUNY cases that were previously paid by the Company. This decision has been
appealed by the State of New York. To the extent the amount of the actual
recovery varies, such difference will be reported in the period recognized. The
Company is continuing to defend all SUNY faculty members against malpractice
claims that have been asserted and is maintaining reserves therefor adjusted for
the anticipated recoveries.
The following table sets forth a reconciliation of the beginning and ending loss
and LAE reserve balances, net of reinsurance ceded, for each of the three years
in the period ended December 31, 1996 (in thousands):
<TABLE>
<CAPTION>
Year Ended December 31
-------------------------------------
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Net reserves for losses and LAE, beginning of year $294,393 $263,202 $216,486
Total acquired reserves 53,008 5,500
Incurred losses and LAE for claims relating to:
Current year 160,470 126,769 97,044
Prior years (4,479) (7,514) 13,874
-------- -------- --------
Total incurred losses and LAE 155,991 119,255 110,918
-------- -------- --------
Loss and LAE payments for claims relating to:
Current year 27,626 13,057 7,216
Prior years 102,160 80,507 56,986
-------- -------- --------
Total payments 129,786 93,564 64,202
-------- -------- --------
Net reserves for losses and LAE, end of year 373,606 294,393 263,202
Total reinsurance recoverable on unpaid losses
and LAE 165,467 73,043 49,435
-------- -------- --------
Gross reserves for losses and LAE, end of year $539,073 $367,436 $312,637
======== ======== ========
</TABLE>
The Company's reserves for unpaid losses and LAE, net of related reinsurance
recoverable, at December 31, 1995 and 1994 were decreased in the following year
by approximately $4,479,000 and $7,514,000, respectively, and at December 31,
1993 the reserves were increased in the following year by approximately
$13,900,000, for claims that had occurred prior to the balance sheet dates. No
premiums have been accrued as a result of the changes to prior year loss and LAE
reserves.
The $4,479,000 decrease in prior years' reserves in 1996 was the result of
favorable claims development on the workers' compensation line of business.
Included in the net development is an
F-15
<PAGE>
<PAGE>
FRONTIER INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--Continued
NOTE C--UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES--Continued
increase in prior years' reserves of approximately $13,000,000 which was
entirely offset by subrogation recoverables recognized in connection with a
favorable court ruling in 1995. The significant increase in the reinsurance
recoverable in 1996 was due to the contribution to the recoverable by United
Capitol and Regency, which were acquired in 1996, and the change in the type of
reinsurance from an aggregate claim excess of loss, to a stop loss for the
majority of the Company's losses.
The $7,514,000 decrease in the prior years' reserves in 1995 was the result of
favorable claims development on the general liability and worker's compensation
lines and to subrogation recoveries in the surety line of business in excess of
expectations. Included in the net development, was an increase in prior years'
reserves of approximately $19,000,000, which was entirely offset by additional
subrogation recoverables recognized in connection with the favorable court
ruling in 1995. The significant increase in the reinsurance recoverable in 1995
was due to the change in the type of reinsurance from an aggregate claim excess
of loss, to a stop loss for the majority of the Company's losses.
The $13,874,000 increase in prior years' reserves in 1994 resulted from a
$17,500,000 increase in the reserves attributable to adverse medical malpractice
claims development in Florida from higher than anticipated dollar settlements
and from redundancies in other lines.
Because of the adverse development experienced in 1994, the Company has
significantly restructured the manner in which it adjudicates its claims. The
change in process included, among other things, placing more reliance on
internal claim examiners and in-house attorneys than on third parties,
especially for the Company's medical malpractice claims in Florida. Management
believes that the revised process will result in better control over the
ultimate costs to adjudicate its claims and the related indemnity costs enabling
management to settle such claims for amounts reflected in the accompanying
financial statements. However, management recognizes that many factors could
impact the successful implementation of its revised process, and to the extent,
future claim costs are not reduced from current levels as anticipated in the
implementation plan, actual ultimate claim costs could vary, perhaps
significantly, from those included in the accompanying financial statements.
NOTE D--REINSURANCE
The Company maintains reinsurance with various unrelated insurance companies,
principally for its direct business written, whereby amounts written in excess
of certain retention limits are ceded to those companies generally under
reinsurance treaty arrangements. Beginning in 1995, the Company entered into a
three-year stop loss reinsurance contract with Centre Reinsurance Company of New
York ("Centre Re"). Under the terms of the agreement, Centre Re provides
reinsurance protection within certain accident year and contract aggregate
dollar limits for losses and LAE in excess of a predetermined ratio of these
expenses to earned premiums for a given accident year for all lines of business
except bail, customs, license and permit, and miscellaneous surety bonds. The
loss and LAE ratio above which the reinsurance provides coverage is 66%, 65%,
and 64% for accident years 1995 through 1997, respectively.
Although the reinsurance companies are liable to the Company for the amounts
reinsured, the Company remains liable to its insureds for the full amount of the
policies written whether or not the reinsurance companies meet their
obligations. Consequently, allowances are established for amounts deemed
uncollectible. To minimize its exposure to significant losses from reinsurance
insolvencies, the Company evaluates the financial condition of its reinsurers
and monitors concentration of credit risk from similar geographic regions,
activities or economic characteristics of the reinsurers. At December
F-16
<PAGE>
<PAGE>
FRONTIER INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--Continued
NOTE D--REINSURANCE--Continued
31, 1996, the Company has outstanding gross reinsurance recoverables of
$74,002,000 from its largest reinsurer, Centre Re; however, under the terms of
the reinsurance arrangements, the Company is withholding $63,766,000 of funds
due Centre Re. Accordingly, the net outstanding recoverable from Centre Re is
$10,236,000. Of the remaining net reinsurance recoverables balance,
approximately 43% is due from three reinsurers; one rated A+ (Superior) and two
rated A (Excellent) by A.M. Best Company, Inc.
The following is a summary of the maximum amount of loss retained and ceded by
the Company for new and renewal policies as of December 31, 1996, 1995, and 1994
(exclusive of facultative reinsurance and the Centre Re stop loss contract) (in
thousands):
<TABLE>
<CAPTION>
Maximum Retained Loss Maximum Ceded Loss
Per Occurrence/ Per Occurrence/
Risk/Principal Risk/Principal
---------------------------- --------------------------------
December 31 December 31
---------------------------- --------------------------------
1996 1995 1994 1996 1995 1994
------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
Property lines $ 500 $ 200 $ 200 $ 9,500 $ 800 $ 800
Casualty lines (excluding medical
malpractice, health
specialties and social services) 1,000 1,000 1,000 4,000 1,000 1,000
Medical malpractice, health
specialties and social services 1,000(1) 1,000(1) 1,000(1) 1,000 1,000 1,000
Workers' compensation 1,000 1,000 1,000 2,000 2,000 2,000
Surety 1,000(5) 1,000(5) 1,000 4,000(5) 4,000(5) 500
Custom bonds 3,000(3) 3,000(3) 650(3) N/A N/A N/A
Umbrella liability 1,000 1,000 400 4,000 4,000 4,800
Group accident and health 250 250 250 750 750 750
Excess workers' compensation/
employers' liability 1,000(4) 1,000(4) 1,000(4) 9,000(4) 9,000(4) 9,000(4)
Earthquake 2,500(2) 2,500 47,500(2) 37,500
Homeowners 1,000(6) 14,000(6)
Ocean marine 250 9,750
Directors' and officers' liability 1,000 4,000
</TABLE>
(1) For certain risks and policy years, the maximum retained loss per
occurrence is $500,000. On a very limited basis, the maximum retained loss
per occurrence is $2,000,000.
(2) Amounts relate to the contract effective January 1, 1997, which catastrophe
layers in excess of $2,500,000 are subject to 5% coinsurance.
(3) Amount indicated is the maximum face amount (limit) on the bond issued,
which represents the value of goods being imported that are subject to U.S.
Customs duty. The actual exposure to the Company is the amount of any
unpaid duty on the goods imported, which is generally approximately 15% of
the face value of the goods, and any penalties associated with the late
payment of the duty.
(4) Subject to a catastrophe retention of $3,000,000 per occurrence and a
maximum ceded loss of $40,000,000 per occurrence.
(5) Effective December 1, 1995, two layers of excess reinsurance were added for
a maximum limit of $10,000,000 per principal on a direct basis, $2,100,000
on a net basis.
(6) Excludes the effect of the Company's 5% retention of $14,000,000 in losses
in excess of $1,000,000.
F-17
<PAGE>
<PAGE>
FRONTIER INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--Continued
NOTE D--REINSURANCE--Continued
Prior to 1994, the Company assumed reinsurance under various reinsurance treaty
arrangements and through mandatory participation in various states' residual
market pools and reinsurance facilities. The amount of risk assumed by the
Company varies in amount by treaty and does not exceed $500,000 per
occurrence/risk/surety bond principal after retrocessions. As part of its
acquisition of BMLIC's realtors errors and omissions business, the Company is
reinsuring policies issued by BMLIC until such time as the program is filed and
can be underwritten on the Company's policies. In 1996, the Company began to
assume, on a quota share basis, homeowners business underwritten by Omega
Insurance Company.
The Company also reinsured ocean marine business written by its subsidiary,
United Capitol. The Company retained the first $250,000 per occurrence and ceded
up to $9,750,000 excess of $250,000 per occurrence. The reinsurance program was
led by underwriters at Lloyds on a losses occurring basis. Effective January 1,
1997, this program was replaced by a similar program written on a risks
attaching basis by Munich American Reinsurance Company and Munich Reinsurance
Company, U.S. branch.
On July 1, 1996, the Company implemented a catastrophe reinsurance program for
its homeowners business written in the state of Florida. The program provides
coverage in the amount of $14,000,000 excess of a $1,000,000 retention.
In 1996, the Company began assuming and writing on a direct basis ocean marine
business. The Company reinsures its ocean marine and international risks under
multiple layers of excess reinsurance. Coverage is provided up to $9,950,000
excess of $50,000 per occurrence, excess of an aggregate retention of $200,000
of loss occurrences in excess of $50,000.
The Company cedes 100% of its environmental liability business to Underwriters
Reinsurance Company. The Company reassumes 10% of this business, along with 10%
of environmental liability business underwritten by Commercial Underwriters
Insurance Company and Underwriters Reinsurance Company.
In 1995 and 1994, the Company's medical malpractice reinsurers agreed to a
commutation for treaty years 1991 and 1990, respectively. As a result of
their commutation, the Company recaptured its liability for ceded unpaid losses
and LAE of approximately $3,900,000 and $6,100,000 for treaty years 1991 and
1990, respectively, and received cash of an equal amount, resulting in no gain
or loss. After the commutation, there was no change in the net incurred losses
or loss ratios as a result of these transactions.
In 1996, 1995, and 1994, the Company recognized and accrued (reduced)
reinsurance contingent profit commissions earned of $773,000, ($783,000), and
($337,000), respectively.
The components of the net reinsurance recoverable balances included in the
accompanying balance sheets are as follows (in thousands):
Year Ended December 31
----------------------------
1996 1995
-------- -------
Ceded paid losses & LAE recoverable $ 7,519 $ 2,639
Ceded unpaid losses and LAE 165,467 73,043
Ceded unearned premiums 32,403 5,541
Ceded reinsurance payable (12,820) (4,268)
-------- -------
TOTAL $192,569 $76,955
======== =======
F-18
<PAGE>
<PAGE>
FRONTIER INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--Continued
NOTE D--REINSURANCE--Continued
The reinsurance ceded components of the amounts reflected in the accompanying
statements of income are as follows (in thousands):
Year Ended December 31
-------------------------------------------
1996 1995 1994
------- ------- -------
Ceded premiums earned $73,643 $42,086 $17,562
Ceded incurred losses 56,597 25,557 14,114
Ceded incurred LAE 18,240 11,700 3,664
The effect of reinsurance on premiums written and earned in 1996, 1995 and 1994
was as follows (in thousands):
<TABLE>
<CAPTION>
1996 1995 1994
Premiums Premiums Premiums
------------------- ------------------- -------------------
Written Earned Written Earned Written Earned
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Direct $394,057 $332,345 $259,222 $235,696 $195,614 $169,893
Assumed 8,742 7,287 5,092 2,610 3,278 4,424
Ceded (90,936) (73,643) (43,557) (42,086) (11,604) (17,562)
-------- -------- -------- -------- -------- --------
Net premiums $311,863 $265,989 $220,757 $196,220 $187,288 $156,755
======== ======== ======== ======== ======== ========
</TABLE>
NOTE E--INCOME TAXES
State income taxes represent the amount of current state income taxes incurred.
The Company files a consolidated federal income tax return, which includes the
income and expenses of its subsidiaries from the dates of their acquisition.
The components of federal income tax expense are as follows (in thousands):
<TABLE>
<CAPTION>
Year Ended December 31
-----------------------------------------
1996 1995 1994
------- ------- ------
<S> <C> <C> <C>
Federal income tax expense (benefit):
Current $13,590 $11,071 $8,958
Deferred 2,279 (175) (5,162)
------- ------- ------
TOTAL FEDERAL INCOME TAX EXPENSE $15,869 $10,896 $3,796
======= ======= ======
</TABLE>
F-19
<PAGE>
<PAGE>
FRONTIER INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--Continued
NOTE E--INCOME TAXES--Continued.
A reconciliation of federal income tax, based on the prevailing corporate income
tax rate of 35%, to the federal income tax expense reflected in the accompanying
financial statements is as follows (in thousands):
Year Ended December 31
-------------------------------------
1996 1995 1994
------- ------- -------
Tax rate applied
to pre-tax income $19,831 $15,148 $ 7,465
Add (deduct) tax effect of:
Tax-exempt interest income (3,026) (2,754) (2,726)
Dividend received deduction (752) (634) (805)
State income taxes (253) (410) (194)
Other 69 (454) 56
------- ------- -------
FEDERAL INCOME TAX EXPENSE $15,869 $10,896 $ 3,796
======= ======= =======
Significant components of the Company's deferred tax assets and liabilities at
December 31, 1996, 1995 and 1994 are as follows (in thousands):
December 31
-------------------------------------
1996 1995 1994
------- ------- -------
Deferred tax assets:
Reserve discounting, including
salvage and subrogation $30,515 $26,466 $26,341
Unearned premium reserve 10,732 7,121 5,404
Net unrealized losses on available-
for-sale securities 3,396
Other 2,624 1,879 437
------- ------- -------
Total deferred tax assets 43,871 35,466 35,578
Deferred tax liabilities:
Deferred policy acquisition costs 11,504 6,579 4,625
Net unrealized gains on available-
for-sale securities 2,588 4,284
Other 2,159 976 186
------- ------- -------
Total deferred tax liabilities 16,251 11,839 4,811
------- ------- -------
Net deferred tax assets $27,620 $23,627 $30,767
======= ======= =======
F-20
<PAGE>
<PAGE>
FRONTIER INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--Continued
NOTE E--INCOME TAXES--Continued
Deferred federal income taxes result from timing differences in the recognition
of certain income and expenses for tax and financial statement purposes and are
summarized as follows (in thousands):
Year Ended December 31
-------------------------------------
1996 1995 1994
------- ------- -------
Reserve discounting, including
salvage and subrogation $ 119 $ (125) $(4,997)
Unearned premium reserve (3,211) (1,718) (2,137)
Deferred policy acquisition costs 4,666 1,954 2,258
Excess depreciation expense 120 220 64
Bad debt expense (credit) 279 (404) (354)
Other 306 (102) 4
------- ------- -------
TOTAL DEFERRED FEDERAL
INCOME TAX EXPENSE (BENEFIT) $ 2,279 $ (175) $(5,162)
======= ======= =======
The Company made income tax payments of $17,021,000, $12,829,000 and $9,330,000,
in 1996, 1995, and 1994, respectively.
NOTE F--CREDIT FACILITY AND OTHER DEBT
In 1995, the Company obtained a variable rate line of credit for $35,000,000
with the Bank of New York. Under this arrangement, the Company borrowed
$7,100,000 and $25,000,000 in 1996 and 1995, respectively. The credit facility
agreement was terminated in 1996.
The Company also extinguished approximately $1,700,000 of long-term debt in
1996, which was assumed in conjunction with the acquisition of Emrol.
Interest incurred during 1996 and 1995 is as follows (in thousands):
1996 1995
------ ----
Bank credit facility $1,892 $895
Other long-term debt 78
------ ----
TOTAL $1,970 $895
====== ====
F-21
<PAGE>
<PAGE>
FRONTIER INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--Continued
NOTE G--STATUTORY FINANCIAL INFORMATION
A reconciliation of the consolidated amounts of insurance subsidiaries'
policyholders' surplus as of December 31, 1996 and 1995, and net income for each
of the years ended December 31, 1996, 1995 and 1994, on a statutory accounting
basis ("SAP") as reported to insurance regulatory authorities, to the GAAP
shareholders' equity and net income included in the accompanying consolidated
financial statements, is as follows (in thousands):
<TABLE>
<CAPTION>
1996 1995 1994
------------------------------ ---------------------------- ------
Net Net Net
Surplus/Equity Income Surplus/Equity Income Income
-------------- ------ -------------- ------ ------
<S> <C> <C> <C> <C> <C>
Insurance subsidiaries'
consolidated SAP amounts $268,004 $28,874 $171,362 $26,407 $ 6,623
Add (deduct):
Deferred policy acquisition costs 32,871 14,365 18,797 5,585 8,139
Nonadmitted assets and unauthorized
reinsurance 14,738 15,667
Investment valuation 4,296 48 11,440 (24)
Allowance for doubtful accounts (2,768) 875 (3,506) (1,154) (1,011)
Intangible assets 3,255 (188) 495 (147)
Deferred federal income taxes 28,157 (2,062) 23,805 352 4,551
Other than temporary market decline (715) (225) (490) (490)
Other additions (deductions) (864) (588) 394 393
-------- ------- -------- ------- -------
INSURANCE SUBSIDIARIES'
CONSOLIDATED GAAP AMOUNTS 346,974 41,099 237,469 31,564 18,155
Shareholders' equity and net loss
arising from activities of
the parent company and its
non-insurance subsidiaries (78,400) (1,032) (7,736) (353) (1,175)
-------- ------- -------- ------- -------
CONSOLIDATED AMOUNTS--GAAP BASIS $268,574 $40,067 $229,733 $31,211 $16,980
======== ======= ======== ======= =======
</TABLE>
F-22
<PAGE>
<PAGE>
FRONTIER INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--Continued
NOTE H--INVESTMENTS
The major categories of total net investment income are summarized as follows
(in thousands):
<TABLE>
<CAPTION>
Year Ended December 31
--------------------------------------------
1996 1995 1994
-------------- -------------- ----------
<S> <C> <C> <C>
Interest and dividends:
Fixed maturities $37,623 $28,338 $20,942
Equity securities 1,190 1,745 3,774
Short-term and other investments 3,830 2,529 695
Interest expense on funds held (4,307) (2,174)
Limited liability corporation 2 535
------- ------- -------
Investment income before expenses 38,338 30,973 25,411
Less investment expenses 1,112 938 958
------- ------- -------
Net investment income 37,226 30,035 24,453
------- ------- -------
Realized capital gains (losses):
Securities available-for-sale:
Fixed maturities 1,245 1,265 325
Equity securities 463 (1,920) (1,743)
Short-term investments (1) (1)
Fixed maturities held-to-maturity 675 (59)
------- ------- -------
Total realized capital gains (losses) 1,707 20 (1,478)
------- ------- -------
TOTAL NET INVESTMENT INCOME $38,933 $30,055 $22,975
======= ======= =======
</TABLE>
Gross realized capital gains on available-for-sale securities in 1996, 1995 and
1994 were $3,882,000, $2,509,000, and $987,000, respectively. Gross realized
capital losses on available-for-sale securities in 1996, 1995 and 1994 were
$2,175,000, $3,164,000, and $2,604,000, respectively. Also, gross realized
capital gains in 1995 and 1994 on held-to-maturity securities were $675,000 and
$27,000, respectively, and gross realized capital losses were $86,000 in 1994.
The change in net unrealized gains/(losses) on fixed-maturity securities was
$(6,350,000), $28,490,000 and $(25,177,000) in 1996, 1995 and 1994,
respectively; the corresponding amounts for equity securities were $1,508,000,
$4,704,000 and $(3,896,000).
At December 31, 1996, bonds and notes with an amortized cost of $25,911,000 were
on deposit with various regulatory authorities to meet statutory requirements.
F-23
<PAGE>
<PAGE>
FRONTIER INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--Continued
NOTE H--INVESTMENTS--Continued
Investments in available-for-sale securities are summarized as follows (in
thousands):
<TABLE>
<CAPTION>
Gross Gross
Unrealized Unrealized Fair
Cost Gains Losses Value
---- ---------- ---------- -----
<S> <C> <C> <C> <C>
At December 31, 1996:
Fixed maturity securities:
U.S. Treasury securities and
obligations of U.S. government
corporations and agencies $ 29,708 $ 409 $ 157 $ 29,960
Obligations of states and
political subdivisions 191,311 2,485 741 193,055
Foreign governments 30 6 24
Corporate securities 162,336 3,299 1,237 164,398
Mortgage-backed securities 296,896 3,483 2,539 297,840
-------- ------- --------- --------
Total fixed maturity securities 680,281 9,676 4,680 685,277
Equity securities 13,871 2,702 302 16,271
-------- ------- --------- --------
TOTAL $694,152 $12,378 $4,982 $701,548
======== ======= ====== ========
At December 31, 1995:
Fixed maturity securities:
U.S. Treasury securities and
obligations of U.S. government
corporations and agencies $ 29,602 $ 1,519 $ 3 $ 31,118
Obligations of states and
political subdivisions 189,363 4,154 611 192,906
Foreign governments 20 20
Corporate securities 102,667 3,992 1,395 105,264
Mortgage-backed securities 188,404 5,080 1,390 192,094
-------- ------- --------- --------
Total fixed maturity securities 510,056 14,745 3,399 521,402
Equity securities 20,132 1,191 299 21,024
-------- ------- --------- --------
TOTAL $530,188 $15,936 $ 3,698 $542,426
======== ======= ========= ========
</TABLE>
F-24
<PAGE>
<PAGE>
FRONTIER INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--Continued
NOTE H--INVESTMENTS--Continued
At December 31, 1996, the amortized cost and estimated market value of debt
securities, by contractual maturity, are shown below (in thousands). Expected
maturities will differ from contractual maturities because borrowers may have
the right to call or prepay obligations with or without call or prepayment
penalties.
<TABLE>
<CAPTION>
Estimated
Amortized Market
Cost Value
--------- ----------
<S> <C> <C>
Due in one year or less $ 2,656 $ 2,656
Due after one year to five years 80,741 81,800
Due after five years to ten years 117,429 119,248
Due after ten years 182,559 183,732
Mortgage backed securities 296,896 297,841
-------- --------
TOTAL $680,281 $685,277
======== ========
</TABLE>
NOTE I--DIVIDEND AND CAPITAL RESTRICTIONS
The Company's insurance subsidiaries are subject to certain regulatory
supervision by their respective domiciliary states. Such regulation is generally
designed to protect policyholders and includes such matters as maintenance of
minimum statutory surplus and restrictions on the payments of dividends. At
December 31, 1996, the maximum dividend that may be paid to the Company in 1997
without regulatory approval is approximately $27,000,000.
Additionally, the insurance subsidiaries are subject to certain Risk-Based
Capital ("RBC") requirements as specified by the NAIC. Under those requirements,
the amount of capital and surplus maintained by the insurance companies is to be
determined based on the various risk factors related to it. At December 31,
1996, the Company met the RBC requirements.
NOTE J--STOCK OPTIONS
The Company has elected to follow Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" (APB 25) and related interpretations
in accounting for its employee stock options because, as discussed below, the
alternative fair value accounting provided for under FASB Statement No. 123,
"Accounting for Stock-Based Compensation," requires use of option valuation
models that were not developed for use in valuing employee stock options. Under
APB 25, because the exercise price of the Company's employee stock options
equals the market price of the underlying stock on the date of grant, no
compensation expense is recognized.
The Company has adopted stock option plans (the "Plans") under which 800,051
shares of common stock are reserved for issuance upon exercise of options
granted pursuant to the Plans. Under the Plans, incentive stock options may be
granted to employees and nonqualified stock options may be granted to employees,
directors, and such other persons as the Board of Directors (or a committee
appointed by the Board) determines will assist the Company's business endeavors,
at exercise prices equal to at least 100% of the fair market value of the common
stock on the date of grant. Incentive
F-25
<PAGE>
<PAGE>
FRONTIER INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--Continued
NOTE J--STOCK OPTIONS-- Continued
stock options granted under the Plans are not exercisable until one year after
grant and expire five years after the date of grant. In addition to selecting
the optionees, the Board (or such committee) determines the number of shares
subject to each option, the expiration date and vesting periods of nonqualified
stock options and otherwise administers the Plans. Certain of the Company's
officers are ineligible to participate in the Plans. Incentive stock options
have been granted at various times and for varying amounts.
During 1993, the Company granted the President and Chairman of the Board, and a
Vice President, separate stock options outside of the Plans to purchase 412,500
and 74,250 shares, respectively, of the Company's Common Stock at $45.45 per
share at any time through December 31, 1999, which options were outstanding at
December 31, 1996.
Pro forma information regarding net income and earnings per share is required by
Statement 123, which also requires that the information be determined as if the
Company has accounted for its employee stock options granted subsequent to
December 31, 1994 under the fair value method of that Statement. The fair value
for these options was estimated at the date of grant using a Black-Scholes
option pricing model with the following weighted-average assumptions for 1996
and 1995, respectively; risk-free interest rates of 6.20% and 7.05%; a dividend
yield of 1.25%; volatility factors of the expected market price of the Company's
Common Stock of .25 and .25; and a weighted-average expected life of the option
of 5 years.
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. The Company's pro
forma information follows (in thousands, except per share data):
<TABLE>
<CAPTION>
1996 1995
------- ------
<S> <C> <C>
Pro forma net income $39,813 $31,053
======= =======
Pro forma primary earnings per common share $2.75 $2.17
===== =====
Pro forma fully diluted earnings per common share $2.71 $2.16
===== =====
</TABLE>
For purposes of pro forma disclosure, the estimated fair value of the options is
amortized to expense over the options' vesting period and does not include
grants prior to January 1, 1995. As such, the pro forma net income and earnings
per share are not indications of future years.
F-26
<PAGE>
<PAGE>
FRONTIER INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--Continued
NOTE J--STOCK OPTIONS--Continued
A summary of the Company's stock option activity, and related information for
the years ended December 31 follows:
<TABLE>
<CAPTION>
1996 1995 1994
-----------------------------------------------------------------------------------
Options Weighted-Average Options Weighted-Average Options Weighted-Average
(000) Exercise Price (000) Exercise Price (000) Exercise Price
<S> <C> <C> <C> <C> <C> <C>
Outstanding-beginning of year 349 $20 250 $18 339 $16
Granted 69 34 175 19 2 28
Exercised (83) 13 (46) 8 (81) 8
Canceled (10) 22 (30) 23 (10) 24
--- --- ---
Outstanding-end of year 325 24 349 20 250 18
=== === ===
Exercisable at end of year 108 23 122 17 118 14
</TABLE>
The weighted average fair value of options granted during 1996 and 1995 were
$10.26 and $6.15, respectively. Exercise prices for options outstanding as of
December 31, 1996 ranged from $18.86 to $39.75. The weighted-average contractual
life of those options is 3.8 years.
NOTE K--EMPLOYEE BENEFIT PLANS
The Company sponsors an employee savings plan (401(k)) whereby the Company
contributes a base of 2% of the salary of all full-time employees and matches
50% of the employee's personal contribution up to 2% of the employee's salary.
The maximum Company contribution, base and match, is 4% of an employee's salary.
In addition, the Company has a noncontributory profit sharing plan. At the
discretion of the Board of Directors, the Company may contribute up to 4% of the
eligible salaries of full-time employees who have completed one year of service.
The Company's total expense related to employee benefit plan contributions for
1996, 1995 and 1994 was $1,691,000, $1,221,000 and $1,030,000, respectively.
NOTE L--COMMITMENTS AND CONTINGENCIES
At December 31, 1996, the future minimum rental commitment for operating leases
was as follows: 1997--$1,600,000; 1998--$1,356,000; 1999--$1,298,000;
2000--$857,000; 2001--$563,000, and 2002 and thereafter--$328,000. These leases
are for the rental of office space, the initial terms of which run five years,
with a negotiated renewal option at the end of the term. Total rental expense
for 1996, 1995, and 1994 amounted to $1,112,000, $720,000 and $479,000,
respectively.
In 1996, the Company entered into certain contractual agreements with several
contractors and vendors in connection with the construction of an addition to
its home office building and the purchase of office equipment. The remaining
commitments that will be paid in 1997 total approximately $11,300,000.
The Company has been served with several purported class actions alleging
violations of federal securities laws by the Company and, in some cases, by
certain of its officers and directors; certain other actions also allege
violations of the common law. The complaints relate to the Company's
announcement
F-27
<PAGE>
<PAGE>
FRONTIER INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--Continued
NOTE L--COMMITMENTS AND CONTINGENCIES--Continued
of its third quarter, 1994 financial results and allege that the Company
previously had omitted and/or misrepresented material facts with respect to its
earnings and profits.
The amount of potential loss is not possible to estimate as of the present due
to the fact that these actions allege differing class periods, and until an
actual class is certified in the consolidation action, the number of shares
impacted by the claims cannot be ascertained. The Company believes the suits are
without merit and has retained special legal counsel to contest them vigorously.
The Company is involved in other unrelated litigation which is considered
incidental to its business. The ultimate outcome of all litigation is not
expected to be material in relation to the Company's financial position and
results of operations.
The insurance subsidiaries record guaranty assessments when such assessments are
billed by the respective guaranty funds. In addition, each insurance
subsidiary's policy is to accrue for any significant insolvencies when the loss
is probable and the assessment amount can be reasonably estimated. In the case
of most insurance insolvencies, the ability of each insurance subsidiary to
reasonably estimate the insolvent insurer's liabilities or develop a meaningful
range of the insolvent's liabilities is significantly impaired by inadequate
financial data with respect to the state of the insolvent company as supplied by
the guaranty funds.
On November 10, 1994, the Company authorized a stock repurchase program to
purchase up to 1,000,000 shares of its Common Stock at such times and prices the
Company deems advantageous in compliance with SEC Rule 10b-18 at the discretion
of the Chairman of the Board. There is no commitment or obligation on the part
of the Company to purchase any particular number of shares, and the program may
be suspended at any time at the Company's discretion. In 1995 and 1994, in
conjunction with this repurchase program, the Company acquired 6,600 and 38,940
shares at a cost of $134,000 and $654,000, respectively.
NOTE M--GUARANTEED PREFERRED BENEFICIAL INTEREST IN COMPANY'S CONVERTIBLE
SUBORDINATED DEBENTURES
In October 1996, the Company completed a $172,500,000 offering of 3,450,000
shares of 6 1/4% Convertible Trust Originated Preferred Securities ("TOPrS")
through its wholly-owned consolidated subsidiary, Frontier Financing Trust, a
statutory business trust formed by the Company for the sole purpose of issuing
the TOPrS and investing the proceeds thereof in an equivalent amount of 6 1/4%
Convertible Subordinated Debentures (the "Debentures") of the Company which
mature on October 16, 2026. The initial purchasers' discount of $4,744,000 was
deducted from the proceeds of the offering. The Company also incurred $842,000
of additional offering costs in connection with this transaction, resulting in
net proceeds of $166,914,000 to the Company. The total offering costs have been
capitalized and are being amortized on a straight-line basis over a 30 year
period, in conjunction with the maturity date of the Debentures. The TOPrS are
carried on the balance sheet net of the unamortized offering costs, which at
December 31, 1996 amounted to approximately $5,500,000.
The TOPrS are mandatorily redeemable under certain conditions and amounts due to
holders are fully and unconditionally guaranteed by the Company. The Debentures
(the sole assets of the trust) are
F-28
<PAGE>
<PAGE>
FRONTIER INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--Continued
NOTE M--GUARANTEED PREFERRED BENEFICIAL INTEREST IN COMPANY'S CONVERTIBLE
SUBORDINATED DEBENTURES--Continued
subordinate to all Company debt and to the claims of creditors and policyholders
of the Company's subsidiaries. The TOPrS are convertible into shares of the
Company's Common Stock at an initial conversion rate of 1.0663 shares of Company
Common Stock for each preferred share which is equivalent to a conversion price
of $46.89 per common share (or 3,678,735 shares of Common Stock in total).
Holders of the TOPrS have no voting rights.
The Debentures are redeemable by the Company, at its option, in whole or in part
at a redemption price on or after October 16, 1999, provided the closing price
of the Company's Common Stock is at least 150% of the per share conversion
price, for a minimum of 20 trading days within a period of 30 consecutive
trading days ending on the fifth trading day price to the notice of redemption
or anytime on or after October 16, 2000. The Company has the right to defer
interest payments on the Debentures at any time by extending the interest
payment date for up to 20 consecutive quarters, but not beyond the maturity date
of the Debentures.
Holders of the TOPrS are entitled to receive cumulative cash distributions at an
annual rate of 6 1/4% of the liquidation amount of $50 per share, accruing from
the date of original issuance and payable quarterly in arrears. Such
distributions are made from interest received on the Debentures, which have
terms that parallel the terms of the TOPrS. During 1996, the Company accrued
$2,246,000 payable to holders of the TOPrS and amortized a portion of the
capitalized offering costs. The corresponding expenses are reported as "Minority
interest in income of consolidated subsidiary trust" in the accompanying
consolidated statement of income.
NOTE N--CONCENTRATIONS
The Company, which is licensed to conduct business in 50 states, attempts to
diversify its exposures geographically, as well as across various types of
risks. However, its medical malpractice business in the Florida marketplace
comprises 7.2% of the Company's gross premiums written and its surety and bond
business, which is focused primarily in the California marketplace, accounts for
16.2% of its gross premiums written in 1996. Also, the Company relies primarily
on a small number of reinsurers. At December 31, 1996, the Company has
outstanding gross reinsurance recoverables of $74,002,000 from its largest
reinsurer, Centre Re; however, under the terms of the reinsurance arrangements,
Frontier is withholding $63,766,000 of funds due Centre Re. Accordingly, the net
outstanding recoverable from Centre Re is $10,236,000.
NOTE O--SUBSEQUENT EVENT
On March 31, 1997, the Company announced that it executed a definitive agreement
to acquire 100% of the stock of Lyndon Property Insurance Company and its six
subsidiaries, Lyndon Life Insurance Company, Twin Mercury Life Insurance
Company, Gulfco Life Insurance Company, Lyndon Southern Insurance Company,
Lyndon - DFS Warranty Services, Inc. and Lyndon General Agency of Texas, Inc.,
subject to certain closing conditions and regulatory approval, at a purchase
price of approximately $92,000,000.
F-29
<PAGE>
<PAGE>
FRONTIER INSURANCE GROUP, INC. AND SUBSIDIARIES
SUPPLEMENTAL DATA
QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a summary of unaudited quarterly results of operations for 1996
and 1995 (in thousands, except per share data):
<TABLE>
<CAPTION>
1996 1995
---------------------------------- ----------------------------------
1st 2nd 3rd 4th 1st 2nd 3rd 4th
------- ------- ------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net premiums earned $58,294 $66,148 $70,327 $71,220 $45,754 $46,440 $49,873 $54,153
Total net investment
income 8,477 9,202 9,429 11,825 5,981 7,434 8,168 8,472
Net income 9,264 9,769 9,513 11,521 6,886 7,785 8,245 8,295
Per share data:
Primary earnings per
common share .65 .68 .66 .79 .48 .55 .57 .58
Fully diluted earnings
per common share .65 .68 .66 .74 .48 .55 .57 .58
</TABLE>
Earnings per share information is based on the weighted average number of shares
outstanding for the period and have been adjusted to reflect the effects of
stock dividends and stock splits.
Due to changes in the number of average common stock and equivalent shares
outstanding, quarterly earnings per share may not add to the totals for the
years.
In the second quarter of 1996 and the fourth quarter 1995, the Company increased
reserves related to prior years' by approximately $13,000,000 and $19,000,000,
respectively, which was entirely offset by subrogation recoverable recognized in
connection with the favorable Court of Appeals decision.
F-30
<PAGE>
<PAGE>
SCHEDULE II--CONDENSED FINANCIAL INFORMATION OF REGISTRANT
FRONTIER INSURANCE GROUP, INC. (PARENT COMPANY)
BALANCE SHEETS
(dollar amounts in thousands, except per share data)
<TABLE>
<CAPTION>
December 31
-------------------------------
1996 1995
-------- --------
<S> <C> <C>
ASSETS
Investments in subsidiaries $354,230 $239,557
Investment in limited liability corporation 2,937 2,935
Short-term investments 63,902 1,176
Cash 422 99
Real estate, equipment and software--at cost, less
accumulated depreciation and amortization
(1996--$3,442; 1995--$2,046) 7,227 6,442
Intangible assets, less accumulated amortization
(1996--$3,221; 1995--$2,370) 2,238 3,082
Other assets 9,021 4,889
--------- --------
TOTAL ASSETS $439,977 $258,180
======== ========
LIABILITIES AND SHAREHOLDER'S EQUITY
LIABILITIES
Convertible subordinated debentures
due to subsidiary trust $166,953
Note payable $ 25,000
Accrued expenses and other liabilities 4,450 3,447
--------- --------
TOTAL LIABILITIES 171,403 28,447
SHAREHOLDERS' EQUITY
Preferred stock, par value $.01 per share;
authorized and unissued--1,000,000 shares
Common stock; par value $.01 per share;
(shares authorized: 1996--50,000,000; 1995--20,000,000,
shares issued: 1996--14,689,552; 1995--13,062,501) 147 130
Additional paid-in capital 221,984 167,587
Net unrealized gains on investments held
by subsidiaries (net of tax) 4,807 7,955
Retained earnings 42,424 54,849
--------- --------
SUBTOTAL 269,362 230,521
Less treasury stock--at cost (1996--45,540 shares;
1995--41,400 shares) 788 788
--------- --------
TOTAL SHAREHOLDERS' EQUITY 268,574 229,733
--------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 439,977 $258,180
========= ========
</TABLE>
These condensed financial statements should be read in conjunction with the
accompanying consolidated financial statements and notes thereto.
F-31
<PAGE>
<PAGE>
SCHEDULE II--CONDENSED FINANCIAL INFORMATION OF REGISTRANT--Continued
FRONTIER INSURANCE GROUP, INC. (PARENT COMPANY)
STATEMENTS OF INCOME
(dollar amounts in thousands)
<TABLE>
<CAPTION>
Year Ended December 31
-------------------------------------------
1996 1995 1994
-------- -------- -------
<S> <C> <C> <C>
REVENUES
Dividend income from subsidiary $ 1,500
Investment income 1,256 $ 1,544 $ 2,296
Realized capital losses (377) (1,259)
------- ------- -------
TOTAL REVENUES 2,756 1,167 1,037
EXPENSES
Operating and administrative 582 714 944
Interest expense 4,169 895
------- ------- -------
TOTAL EXPENSES 4,751 1,609 944
------- ------- -------
INCOME (LOSS) BEFORE FEDERAL
INCOME TAXES AND EQUITY
IN UNDISTRIBUTED INCOME OF
SUBSIDIARIES (1,995) (442) 93
Federal income tax expense (benefit)(1) (2,337) (207) 20
------- ------- -------
INCOME (LOSS) BEFORE EQUITY
IN UNDISTRIBUTED INCOME
OF SUBSIDIARIES 342 (235) 73
Equity in undistributed
income of subsidiaries 39,725 31,446 16,907
------- ------- -------
NET INCOME $40,067 $31,211 $16,980
======= ======= =======
</TABLE>
(1) Under the terms of its tax-sharing agreement with its subsidiaries, income
tax provisions for the individual companies are computed on a separate
company basis. Accordingly, the Company's income tax benefit results from
the utilization of the parent company separate return loss to reduce the
consolidated taxable income of the Company and its subsidiaries.
These condensed financial statements should be read in conjunction with the
accompanying consolidated financial statements and notes thereto.
F-32
<PAGE>
<PAGE>
SCHEDULE II--CONDENSED FINANCIAL INFORMATION OF REGISTRANT--Continued
FRONTIER INSURANCE GROUP, INC. (PARENT COMPANY)
STATEMENTS OF CASH FLOWS
(dollar amounts in thousands)
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------
1996 1995 1994
--------- -------- -------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Income (loss) before equity in
undistributed income of subsidiaries $ 342 $ (235) $ 73
Adjustments to reconcile net income
(loss) to net cash provided by
(used in) operating activities:
Change in federal income taxes (1,558) 2,447 (1,502)
Change in due to (from) subsidiaries (215) (4,838) 1,950
Depreciation and amortization 2,287 1,788 977
Realized capital losses 377 1,259
Other (1,692) 721 (144)
--------- -------- -------
NET CASH PROVIDED BY
(USED IN) OPERATING ACTIVITIES (836) 260 2,613
INVESTING ACTIVITIES
Capital contribution to subsidiary (69,800) (19,445)(1)
Purchase of wholly-owned subsidiary (221)
Sales (purchases) of equity securities 4,017 (864)
Net (purchases) sales of
short-term investments (62,726) (1,129) 10,406
Purchase of real estate (395)
Purchases of equipment (2,181) (1,634) (1,209)
Purchase of policy renewal rights (8) (426) (3,427)
Investment in limited liability corporation (2) (2,400)
--------- -------- -------
NET CASH PROVIDED BY
(USED IN) INVESTING ACTIVITIES (134,938) (21,412) 4,906
FINANCING ACTIVITIES
Proceeds from convertible debentures 166,914
Proceeds from borrowings 7,100 25,000
Repayment of borrowings (32,100)
Issuance of common stock 1,103 378 590
Cash dividends paid (6,920) (6,243) (5,717)
Purchase of treasury stock (134) (654)
--------- -------- -------
NET CASH PROVIDED BY (USED IN)
FINANCING ACTIVITIES 136,097 19,001 (5,781)
--------- -------- -------
INCREASE (DECREASE) IN CASH 323 (2,151) 1,738
Cash at beginning of year 99 2,250 512
--------- -------- -------
CASH AT END OF YEAR $ 422 $ 99 $ 2,250
========= ======== =======
</TABLE>
(1) In conjunction with the cash capital contribution, the Company transferred
$28.0 million of equity securities to its subsidiary, for a total
contribution of $47.4 million.
These condensed financial statements should be read in conjunction with the
accompanying consolidated financial statements and notes thereto.
F-33
<PAGE>
<PAGE>
SCHEDULE IV--REINSURANCE
FRONTIER INSURANCE GROUP, INC. AND SUBSIDIARIES
(dollar amounts in thousands)
<TABLE>
<CAPTION>
Col. A Col. B Col. C Col. D Col. E
- ----------------------------- -------- ----------------------- -------- ----------
Percentage
Ceded to Assumed of Amount
Other from Other Net Assumed to
Description Direct Companies Companies Amount Net
- ----------------------------- -------- --------- ---------- -------- ----------
<S> <C> <C> <C> <C>
Year ended December 31, 1996:
Premiums written:
Medical malpractice $139,233 $19,580 $119,653
General liability 108,984 19,443 $4,439 93,980 4.7%
Surety 65,074 8,749 307 56,632 0.5
Workers' compensation 25,125 19,176 304 6,253 4.9
Commercial earthquake 16,396 4,637 145 11,904 1.2
Other 39,246 19,351 3,546 23,441 15.1
-------- ------- ------ -------- ----
TOTAL $394,058 $90,936 $8,741 $311,863 2.8%
======== ======= ====== ======== ====
Year ended December 31, 1995:
Premiums written:
Medical malpractice $117,431 $18,049 $ 99,382
General liability 65,900 12,841 $3,813 56,872 6.7%
Surety 49,137 5,734 142 43,545 0.3
Workers' compensation 11,047 1,683 569 9,933 5.7
Commercial earthquake 4,067 1,159 2,908
Other 11,640 4,091 568 8,117 7.0
-------- ------- ------ -------- ---
TOTAL $259,222 $43,557 $5,092 $220,757 2.3%
======== ======= ====== ======== ===
Year ended December 31, 1994:
Premiums written:
Medical malpractice $ 90,107 $ 2,338 $ 87,769
General liability 45,072 4,419 $ 46 40,699 0.1%
Surety 36,871 388 296 36,779 0.8
Workers' compensation 12,940 1,087 2,704 14,557 18.6
Other 10,624 3,372 232 7,484 3.1
-------- ------- ------ -------- ---
TOTAL $195,614 $11,604 $3,278 $187,288 1.8%
======== ======= ====== ======== ===
</TABLE>
F-34
<PAGE>
<PAGE>
SCHEDULE V--VALUATION AND QUALIFYING ACCOUNTS
FRONTIER INSURANCE GROUP, INC. AND SUBSIDIARIES
(dollar amounts in thousands)
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------
COL. A COL. B COL. C COL. D COL. E
- ----------------------------------------------------------------------------------------------------------------------
ADDITIONS
------------------------------------
Description Balance at (1) (2) Balance at
Beginning of Charged to Costs Charged to Other Deductions end of
Period and Expenses Accounts-Describe Describe Period
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1996:
Reserves and allowances deducted
from asset accounts:
Allowance for doubtful accounts $3,391 $ 365 $1,471(A) $2,285
Allowance for possible reinsurance
uncollectible amounts 115 402 517
Year ended December 31, 1995:
Reserves and allowances deducted
from asset accounts:
Allowance for doubtful accounts $2,237 $1,154 $3,391
Allowance for possible reinsurance
uncollectible amounts 115 115
Year ended December 31, 1994:
Reserves and allowances deducted from
asset accounts:
Allowance for doubtful accounts $1,240 $ 997 $2,237
Allowance for possible reinsurance
uncollectible amounts 101 14 115
</TABLE>
(A) Amounts charged off.
F-35
<PAGE>
<PAGE>
SCHEDULE VI--SUPPLEMENTAL INFORMATION CONCERNING
PROPERTY/CASUALTY INSURANCE OPERATIONS
FRONTIER INSURANCE GROUP, INC. AND SUBSIDIARIES
(Net of Reinsurance)
(amounts in thousands)
<TABLE>
<CAPTION>
Col. A Col. B Col. C Col. D Col. E Col. F
- ----------------- ----------- ------------- ----------- -------- ---------
Net
Deferred Unpaid Claims Discount,
Policy and Claim if any, Net
Affiliation Acquisition Adjustment Deducted in Unearned Earned
with Registrant Costs Expenses Column C Premiums Premiums
- ----------------- ----------- ------------- ----------- -------- --------
<C> <C> <C> <C> <C>
1996 Consolidated $32,871 $373,606 $153,325 $265,989
1995 Consolidated 18,797 294,393 101,741 196,220
1994 Consolidated 13,213 263,202 77,339 156,755
<CAPTION>
Col. A Col. G Col. H Col. I Col. J Col. K
- ----------------- ---------- ------------------- ------------ ----------- ---------
Claims and Claim
Adjustment Expenses Amortization
Total Incurred Related to of Deferred Paid Claims
Net (1) (2) Policy and Claim Net
Affiliation Investment Current Prior Acquisition Adjustment Premiums
with Registrant Income Year Years Costs Expenses Written
- ----------------- ---------- -------- -------- ------------ ----------- ---------
<C> <C> <C> <C> <C> <C> <C>
1996 Consolidated $38,933 $160,470 $(4,479) $57,540 $129,786 $311,863
1995 Consolidated 30,055 126,764 (7,514) 42,258 93,564 220,757
1994 Consolidated 22,975 97,044 13,874 30,463 64,202 187,288
</TABLE>
F-36
<PAGE>
<PAGE>
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.
FRONTIER INSURANCE GROUP, INC.
By: /s/ WALTER A. RHULEN
------------------------------------
Walter A. Rhulen
Chairman of the Board and President
Date: March 27, 1997
Pursuant to the requirements of the Securities Exchange Act of 1934, this annual
report on Form 10-K has been signed below by the following persons on behalf of
the registrant and in the capacities and on the dates indicated.
Signature and Title Date
/s/ WALTER A. RHULEN March 27, 1997
---------------------------------------
Walter A. Rhulen
Chairman of the Board, President
and Director
(Principal Executive Officer)
/s/ PETER L. RHULEN March 27, 1997
---------------------------------------
Peter L. Rhulen
Vice President and Director
/s/ LAWRENCE E. O'BRIEN March 27, 1997
---------------------------------------
Lawrence E. O'Brien
Director
/s/ DOUGLAS C. MOAT March 27, 1997
---------------------------------------
Douglas C. Moat
Director
/s/ ALAN GERRY March 27, 1997
---------------------------------------
Alan Gerry
Director
/s/ MARK H. MISHLER March 27, 1997
---------------------------------------
Mark H. Mishler
Vice President - Finance
and Treasurer
(Principal Financial and Accounting Officer)
<PAGE>
<PAGE>
FRONTIER INSURANCE GROUP, INC.
------------------------------
EXHIBITS TO
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED
DECEMBER 31, 1996
<PAGE>
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<S> <C> <C>
3.1(a) Copy of Registrant's Restated Certificate of Incorporation....................... (1)
3.2 Copy of Registrant's By-Laws..................................................... (2)
4.1 Indenture dated as of October 16, 1996 between the Registrant and The Bank
of New York, as trustee, with form of Debenture attached as Exhibit A thereto...(8)
10.1 Copy of Registrant's Stock Option Plan, including forms of option.................(1)
10.2(a) Copy of Employment Agreement between Registrant
and Walter A. Rhulen............................................................(5)
10.6 Copy of Registrant's Profit Sharing Plan..........................................(2)
10.7 Copy of Asset Purchase Agreement between Registrant
and Rhulen Agency, Inc..........................................................(3)
10.8 Copy of Insurance Placement Agreement between Frontier
Insurance Company and Markel Service, Incorporated..............................(3)
10.9 Copy of Agency Agreement between Frontier Insurance Company
and Markel Service, Incorporated................................................(3)
10.10 Copy of Registrant's 1992 Incentive and Non-Incentive
Stock Option Plan...............................................................(4)
10.11 Copy of Division of Business and Non-Competition Agreement
between Markel Service, Inc. and Frontier Insurance Company.....................(4)
10.12 Description of Registrant's Executive Bonus Plan..................................(5)
10.13 Copy of Credit Agreement between Registrant and The Bank of New York..............(6)
10.14 Stock Purchase Agreement dated February 29, 1996 among Frontier Insurance
Company Acquisition Corp. and, for purposes of Section 2.3(c) and Article 11
only, Capsure Holdings Corp.....................................................(7)
10.15 United Capitol Holding Company and Subsidiaries Financial Statements as of
December 31, 1995 and 1994 (with Independent Auditors' Report thereon)
and Unaudited Interim Condensed Consolidated Financial Statements as of
March 31, 1996.................................................................(7)
10.16 Frontier Insurance Group, Inc. and Subsidiaries' Unaudited Pro Forma
Condensed Consolidated Statements of Income for the Year Ended December
31, 1995 and Three Months Ended March 31, 1996, and Balance Sheet as of
March 31, 1996 together with the related Notes thereto.........................(7)
10.17 Amended and Restated Declaration of Trust dated as of October 16, 1996
among Registrant, as sponsor. Walter A. Rhulen and Peter H. Foley, as regular
trustees. The Bank of New York, as property trustee, and The Bank of New
York (Delaware), as Delaware trustee, with the terms of the Preferred Securities
attached as Annex I thereto, and the form of Preferred Security attached as
Exhibit A-1 thereto.............................................................(8)
</TABLE>
<PAGE>
<PAGE>
<TABLE>
<S> <C> <C>
10.18 Preferred Securities Guarantee Agreement dated as of October 16, 1996 between
the Registrant and The Bank of New York, as trustee for the benefit of the
holders from time to time of the Preferred Securities...........................(8)
10.19 Registration Rights Agreement dated as of October 16, 1996 among Registrant,
Frontier Financing Trust, and Merrill Lynch & Co., Merrill Lynch, Pierce, Fenner
& Smith Incorporated, Donaldson , Lufkin & Jenrette Securities Corporation,
Oppenheimer & Co., Inc. and Stephens Inc., as representatives of the initial
purchasers of the Preferred Securities..........................................(8)
11 Computation of Per Share Earnings.................................................
12 Statement RE: Computation of Ratio of Earnings to Fixed Charges..................
22(a) List of Registrant's Subsidiaries.................................................
23 Consent of Independent Auditors...................................................
29 Schedule P of Annual Statement for year ended December 31, 1996, filed as
a paper format exhibit on Form SE pursuant to Section 232.311 of Regulation
ST, of Frontier Insurance Company and of Frontier Pacific Insurance Company,
as filed with the New York State Department of Insurance and the California
Department of Insurance, respectively..........................................
</TABLE>
(1) Filed as the same numbered Exhibit to the Registrant's Registration
Statement on Form S-1 (File No. 33-7340) and incorporated herein by
reference.
(2) Filed as the same numbered Exhibit to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 1988 and incorporated herein by
reference.
(3) Filed as the same numbered Exhibit to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 1989 and incorporated herein by
reference.
(4) Filed as the same numbered Exhibit to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 1992 and incorporated herein by
reference.
(5) Filed as the same numbered Exhibit to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 1993 and incorporated herein by
reference.
(6) Filed as the same numbered Exhibit to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 1995.
(7) Filed as the same numbered Exhibit to the Registrant's Report on Form 8-K
dated May 22, 1996 and incorporated herein by reference.
(8) Filed as the same numbered Exhibit to the Registrants Report on Form 8-K
dated October 16, 1996 and incorporated herein by reference.
<PAGE>
<PAGE>
FRONTIER INSURANCE GROUP, INC. 1996 FORM 10-K EXHIBIT 11
Computation of Per Share Earnings
(in thousands, except per share dollar amounts)
<TABLE>
<CAPTION>
Year Ended December 31
------------------------------------------
Primary earnings per share: 1996 1995 1994
--------------- ------------- ----------
<S> <C> <C> <C>
Net Income $40,067 $31,211 $16,980
======= ======= =======
Weighted average shares of
common stock outstanding (1) 14,453 14,313 14,291
====== ====== ======
Net income per share of
common stock outstanding (1) $2.77 $2.18 $1.19
===== ===== =====
Fully diluted earnings per share:
Net Income $41,547 $31,211 $16,980
======= ======= =======
Weighted average shares of
common stock and common stock
equivalents outstanding (1) 15,219 14,405 14,401
====== ====== ======
Net income per share of
common stock and common stock
equivalents outstanding (1) $2.73 $2.17 $1.18
===== ===== =====
</TABLE>
- ---------------
(1) Weighted average shares of common stock outstanding have been adjusted to
give effect to the Company's common stock dividends and a 3-for-2 stock
split. Accordingly, net income per share of common stock has been adjusted.
<PAGE>
<PAGE>
FRONTIER INSURANCE GROUP, INC. 1996 FORM 10-K EXHIBIT 12
Computation of Ratio of Earnings to Fixed Charges
(in thousands, except per share dollar amounts)
<TABLE>
<CAPTION>
Year Ended December 31
-------------------------------------------------
1996 1995 1994 1993 1992
------ ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Income before income taxes
and cumulative effect of change
in accounting principle 56,659 43,280 21,330 30,293 25,198
Add:
Minority Interest and interest expense 4,247 895
Net amortization of debt issuance costs 39
Interest portion of rental expense 371 240
Earnings available for payment of combined
fixed charges and preferred stock dividends 61,316 44,415 21,330 30,293 25,198
Combined fixed charges:
Minority Interest and interest expense 4,247 895
Net amortization of debt issuance costs 39
Interest portion of debt issuance costs 371 240
Total Combined fixed charges 4,657 1,135
Ratio of earnings to combined fixed charges (1) 13.2 39.1 N/A N/A N/A
</TABLE>
(1) For purposes of determining this ratio, earnings consist of income before
federal income taxes, cumulative effect of accounting change plus fixed
charges. Fixed Charges consist of 1) minority interest-preferred securities
of subsidiary trust, and interest expense on short-term debt, 2) net
amortization of debt issuance costs and 3) the portion of rental expense
that is representative of the interest factor.
<PAGE>
<PAGE>
FRONTIER INSURANCE GROUP, INC. 1996 FORM 10-K EXHIBIT 22(a)
LIST OF REGISTRANTS SUBSIDIARIES
The following is a list of Registrant's subsidiaries, all of which are
wholly-owned.
State of Jurisdiction
Name and Incorporation
- ------------------------------------------ ----------------------
Frontier Insurance Company New York
Medical Professional Liability Agency, Ltd. New York
Pioneer Claim Management, Inc. New York
Frontier Pacific Insurance Company California
Spencer Douglass Insurance Associates California
United Capitol Holding Company Delaware
United Capitol Insurance Company Wisconsin
Olympic Underwriting Managers, Inc. Georgia
Fischer Underwriting Group, Inc. New Jersey
Regency Financial Corporation Delaware
Regency Insurance Company North Carolina
Emrol Installment Premium Discount, Inc. North Carolina
<PAGE>
<PAGE>
FRONTIER INSURANCE GROUP, INC. 1996 FORM 10-K EXHIBIT 23
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements
(Forms S-8 No. 33-30217, No. 33-39638, and No. 33-77332) pertaining to the
Incentive and Non-Incentive Stock Option Plans of Frontier Insurance Group, Inc.
of our report dated March 26, 1997 (except for Note O, as to which the date is
March 31, 1997), with respect to the consolidated financial statements and
schedules of Frontier Insurance Group, Inc. included in this Annual Report
(Form 10-K) for the year ended December 31, 1996.
/S/ Ernst & Young LLP
-----------------------------
New York, New York
March 31, 1997
<PAGE>
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