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<PAGE>
FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1998
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: 0-14950
Argonaut Group, Inc.
(Exact name of Registrant as specified in its charter)
Delaware 95-4057601
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1800 Avenue of the Stars, Suite 1175
Los Angeles California 90067-4213
(Address of principal executive offices) (Zip code)
(310) 553-0561
(Registrant's telephone number including area code)
Securities registered pursuant to section 12(g) of
the Act:
Title of Securities Exchanges on which Registered Common Stock, par
value of $.10 per share National Association of Securities Dealers, Inc.
Automated Quotation System.
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No ____
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. ?
As of March 18, 1999, registrant had 24,027,511 shares of Common Stock
outstanding, and the aggregate market value of the voting stock held by
nonaffiliates was approximately $583 million.
DOCUMENTS INCORPORATED BY REFERENCE
Part II: Excerpts from Argonaut Group, Inc.'s Annual Report to Shareholders for
the Year Ended December 31, 1998. Part III: Excerpts from Argonaut Group, Inc.'s
Proxy Statement for the Annual Meeting of Shareholders to be held on April 27,
1999.
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2
Argonaut Group, Inc.
Annual Report on Form 10-K
For the Year Ended December 31, 1998
TABLE OF CONTENTS
<TABLE>
<CAPTION>
<S> <C> <C>
PART I
Item 1. Business 3
Item 2. Properties 11
Item 3. Legal Proceedings 11
Item 4. Submission of Matters to a Vote of Security Holders 12
PART II
Item 5. Market for Registrant's Common Equity and Related 13
Stockholder Matters
Item 6. Selected Financial Data 13
Item 7. Management's Discussion and Analysis of 13
Financial Condition and Results of Operations
Item 7A. Quantitative and Qualitative Disclosures about Market Risk 14
Item 8. Financial Statements and Supplementary Data 15
Item 9. Changes in and Disagreements with Accountants on 15
Accounting and Financial Disclosure
PART III
Item 10. Directors and Executive Officers of the Registrant 16
Item 11. Executive Compensation 16
Item 12. Security Ownership of Certain Beneficial Owners
and Management 16
Item 13. Certain Relationships and Related Transactions 16
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 16
</TABLE>
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PART I
Item 1. Business
Introduction
Argonaut Group, Inc. ("Argonaut Group") is a holding company whose subsidiaries
are primarily engaged in the selling, underwriting, and servicing of workers
compensation and other lines of property-casualty insurance. Workers
compensation accounted for 83% of premiums in 1998. See "Item 6. Selected
Financial Data" for certain financial information regarding industry segments in
which the Company operates. Argonaut Group is incorporated in Delaware. Argonaut
Group's executive offices are located at 1800 Avenue of the Stars, Suite 1175,
Los Angeles, California 90067, telephone 310.553.0561. The term "the Company"
refers to Argonaut Group and all its subsidiaries.
Argonaut Insurance Company ("Argonaut Insurance"), Argonaut Group's larger
insurance subsidiary, was established in California in 1948. Workers
compensation is the primary line of insurance written by Argonaut Insurance and
its subsidiaries: Argonaut-Midwest Insurance Company, Argonaut-Northwest
Insurance Company, Argonaut-Southwest Insurance Company, and Georgia Insurance
Company. Argonaut Insurance and these subsidiaries also write complementary
lines of commercial insurance for a small number of their clients, primarily
consisting of general and automobile liability.
Argonaut Great Central Insurance Company ("Argonaut Great Central") is Argonaut
Group's other principal insurance subsidiary. Established in Illinois in 1948
and purchased by Argonaut Insurance Company in 1971, Argonaut Great Central
specializes in providing package insurance policies including property, general
liability, workers compensation, and umbrella coverage for certain classes of
insureds. Argonaut Insurance is Argonaut Great Central's immediate parent.
AGI Properties, Inc. ("AGI Properties"), a non-insurance company, owns and
leases certain real properties. AGI Properties was incorporated in California
in 1970. Argonaut Insurance is AGI Properties' immediate parent.
Products
The Company has two primary product lines: workers compensation
insurance and other property-casualty insurance. Incorporated herein by
reference is the information appearing as "Note 10 - Business Segments" in the
Notes to the Consolidated Financial Statements of the Annual Report.
See Exhibit Index.
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4
Workers Compensation
Workers compensation insurance is a statutory system which provides for
compensation of a policyholder's employees and their dependents for injuries
(other than self-inflicted wounds) arising out of or suffered in the course of
the employee's employment, even though the injuries may have resulted from the
negligence or wrongful conduct of the employee himself or any other person.
Workers compensation insurance is sold primarily by Argonaut Insurance and its
subsidiaries. Net earned premiums for this line of business were $115.6 million,
$140.6 million, and $129.5 million, in 1998, 1997, and 1996, respectively.
Other Property-Casualty Insurance
This product includes general and automobile liability, commercial
multiple-peril, and various other insurance coverages. Premiums for these
product lines were $22.9 million, $24.3 million, and $32.2 million, in 1998,
1997, and 1996, respectively.
Argonaut Insurance offers general and automobile liability and other insurance
to commercial clients in conjunction with workers compensation insurance.
Liability insurance compensates third parties for damages resulting from the
actions of the insured.
Commercial multiple-peril insurance, one of Argonaut Great Central's primary
products, is a composite product designed for the small-to-medium sized business
which needs basic insurance coverage and simple insurance administration.
Commercial multiple-peril policies generally cover property, plant, inventory,
general liability, and associated coverages.
Ceded Reinsurance
The Company's policy regarding reinsurance is based upon the capitalization of
the subsidiaries. The goal is to limit the exposure to surplus from losses
resulting from catastrophes and large or unusually hazardous risks.
As is the case with direct premiums written, cessions on reinsurance contracts
are recognized ratably over the period to which the premium relates.
To take advantage of attractive pricing in the reinsurance market, Argonaut
Insurance reduced the limit of retention on its primary excess of loss
reinsurance treaty from $2 million to $250,000 effective May 1, 1998. Its limit
of retention is $250,000 on its wrap up treaty. Argonaut Great Central's limit
of retention is $500,000 on the property and liability treaty, $300,000 on the
First Workers' Compensation Excess of Loss Reinsurance Treaty and $250,000 on
the First Underlying Excess of Loss Reinsurance Treaty.
Incorporated herein by reference is the information appearing as
"Note 3- Reinsurance" in the Notes to the Consolidated Financial Statements
of the Annual Report. See Exhibit Index.
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5
Competition
The property-casualty insurance industry is characterized by a large number of
competing companies and modest market shares by industry participants. According
to A.M. Best, a leading insurance industry rating and analysis firm, as of
December 31, 1998, there are about 3,350 property-casualty insurance companies
operating in the United States, with the 100 largest companies (groups and
unaffiliated) writing about 80% of the industry's premiums.
The Company's principal competitors cannot be easily classified. The Company's
principal lines of business are written by numerous insurance companies.
Competition for any one account may come from a very large national firm or a
smaller regional company selling either directly or through agents and brokers.
For the Company's principal line of business, workers compensation, additional
competition comes from state workers compensation funds.
Regulation
Since, 1994, the Company's insurance subsidiaries have been subject to the
Risk-Based Capital (RBC) for Insurers Model Act. The RBC calculation takes into
account: (1) asset risk, (2) credit risk, (3) underwriting risk, and (4) all
other relevant risks. The RBC for Insurers Model Act provides for four levels of
regulatory authority: (1) Company Action Level Event, (2) Regulatory Action
Level Event, (3) Authorized Control Level Event, and (4) Mandatory Control Level
Event. These four levels of authority provide for increasing regulatory remedies
for companies that fail to comply with the RBC for Insurers Model Act.
As of December 31, 1998, calculations show that the Company's insurance
subsidiaries' RBC coverage far exceeds the minimum required.
The Company's insurance subsidiaries are members of the statutorily created
insolvency guarantee associations in all states where they are authorized to
transact business. These associations were formed for the purpose of paying
claims of insolvent companies. The Company is assessed its pro rata share of
such claims based upon its premium writings, subject to a maximum annual
assessment per line of insurance. Such costs can generally be recovered through
surcharges on future premiums. The Company does not believe that assessments on
current insolvencies will have a material effect on its financial condition or
results of operations.
The Company has no policyholder dividend restrictions.
Under the provisions of the California Insurance Code, there is a maximum amount
of shareholder dividends which can be paid without prior approval of the
Insurance Commissioner. Under these provisions, as of December 31, 1998,
Argonaut Insurance could pay to Argonaut Group a maximum dividend of $20.5
million without the Insurance Commissioner's approval.
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6
Marketing
Argonaut Insurance and Argonaut Great Central operate in substantially different
markets.
Incorporated herein by reference is the information appearing as "Note 1 -
Business and Significant Accounting Policies" in the Notes to the Consolidated
Financial Statements of the Annual Report. See Exhibit Index.
Argonaut Insurance Company is authorized to operate in all 50 states. Its
primary line of business, workers compensation insurance, accounts for 99% of
its premiums (83% of total consolidated premiums). These policies are primarily
written on a retrospective rating basis or with large deductible provisions. For
retrospectively rated policies, Argonaut Insurance's risk regarding inadequate
price levels is mitigated to a certain extent as the insured will have to pay
additional premiums (or will be refunded premiums) based upon their actual loss
experience.
Argonaut Great Central is authorized to operate in 33 states and considers
itself to be a specialty company with a defined target market. Argonaut Great
Central's dominant products are commercial multiple-peril and workers
compensation insurance. Argonaut Great Central's policies are marketed through
agents.
Neither Argonaut Insurance nor Argonaut Great Central market any of their
policies through managing general agents.
Run Off Lines
Incorporated herein by reference is the information appearing as "Note 12-
Run Off Lines" in the Notes to the Consolidated Financial Statements of the
Annual Report. See Exhibit Index.
Loss ratios for the run off line of business are not meaningful as there are no
current year premiums associated with the current year losses on this line of
business.
Investments
The Company's investment portfolio continues to emphasize high quality fixed
income and equity investments. As a percentage of the total investment
portfolio, U.S. Treasury securities comprise the largest portion of the
Company's holdings. Obligations of states and political subdivisions have
decreased from 1997 as a result of maturities and sales. The proceeds from these
maturities and sales were reinvested in high quality preferred and common stocks
and Other U.S. Agencies (FNMA and FHLM).
The Company's investment policy is to invest only in securities issued by
investment-grade issuers. It does not invest in high-yield or so called "junk
bonds," derivatives, speculative real estate, or mortgage backed securities.
Incorporated herein by reference is the information appearing as "Note 2 -
Investments" and "Note 7 - Net Investment Income" in the Notes to the
Consolidated Financial Statements of the Annual Report. See Exhibit Index.
Page 6
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7
Reserves for Losses and Loss Adjustment Expenses
Incorporated herein by reference is the information set forth under the caption
"Management's Discussion and Analysis of Results of Operations and Financial
Condition-Results of Operations" in the Annual Report to Shareholders of
Argonaut Group for the fiscal year ended December 31, 1998 and in "Note 4 -
Reserves for Losses and Loss Adjustment Expenses" in the Notes to the
Consolidated Financial Statements of the Annual Report. See Exhibit Index.
Reserves for environmental claims were $96.3 million and $98.2 million at
December 31, 1998 and 1997, respectively. Reserves for asbestos claims were
$76.6 and $101.4 million at December 31, 1998 and 1997.
In the opinion of management, the Company's reserves for each of these liability
issues represent the Company's best estimate of its ultimate liabilities, based
on currently known facts, current law, current technology, and assumptions
considered reasonable where facts are not known. Due to significant
uncertainties and related management judgments, however, there can be no
assurance that future loss development, favorable or unfavorable, can be
accurately predicted.
The following tables on page 8 and 9 indicate the manner in which reserves for
losses and loss adjustment expenses at the end of a particular year change as
time passes. The first table (Table I) presented is net of the effects of
reinsurance. The second table (Table II) presented includes only amounts related
to direct insurance.
The first line shows the reserves as originally reported at the end of the
stated year. The second section shows the cumulative amounts paid as of the end
of successive years related to those reserves. The third section shows the
original recorded reserves as of the end of successive years adjusted to reflect
facts and circumstances later discovered. The last line, cumulative deficiency
or redundancy, compares the adjusted reserves to the reserves as originally
established and shows that the reserves as originally recorded were either
inadequate or excessive to cover the estimated cost of claims as of December 31,
1998.
Conditions and trends that have affected the development of these reserves in
the past will not necessarily recur in the future. It would not be appropriate
to use this cumulative history in the projection of future performance.
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8
Table I
Analysis of Losses and Loss Adjustment Expenses (LAE)
Development (in millions)
(Net of Reinsurance)
<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------
1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
---- ---- ---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Reserves for Losses
and LAE (a) $1,337.0 $1,348.5 $1,287.8 $1,201.9 $1,107.6 $976.6 $858.1 $951.0 $845.7 $723.3
Cumulative Amount
Paid as of: (b)
One year later 260.0 313.1 307.3 276.9 259.9 239.7 214.2 179.0 172.7
Two years later 464.9 537.5 525.8 489.2 444.7 417.9 356.2 309.7
Three years later 603.2 698.5 697.6 638.9 588.8 531.5 468.6
Four years later 704.4 835.7 821.4 759.5 684.1 623.9
Five years later 801.7 940.1 919.5 839.9 758.5
Six years later 884.5 1,021.3 991.0 906.8
Seven years later 952.3 1,082.7 1,051.3
Eight years later 1,004.8 1,134.2
Nine years later 1,049.3
Reserves Re-estimated
as of:
One year later 1,317.2 1,358.3 1,285.2 1,197.1 1,086.8 996.5 1,073.6 934.0 819.2
Two years later 1,284.7 1,356.9 1,311.9 1,202.0 1,083.0 1,180.8 1,038.9 895.5
Three years later 1,261.3 1,381.9 1,315.9 1,203.0 1,283.4 1,159.2 1,014.1
Four years later 1,282.9 1,374.1 1,325.9 1,403.1 1,277.3 1,152.5
Five years later 1,257.5 1,384.9 1,514.9 1,400.6 1,268.2
Six years later 1,265.3 1,572.0 1,524.3 1,396.2
Seven years later 1,442.0 1,575.6 1,518.8
Eight years later 1,447.0 1,572.8
Nine years later 1,448.9
Cumulative (Deficiency)
Redundancy:(c) ($111.9) ($224.3) ($231.0) ($194.3) ($160.6) ($175.9) ($156.0) $55.5 $26.5
</TABLE>
(a) Reserves for losses and LAE, net of reserves for reinsurance.
(b) Cumulative amount paid, net of reinsurance payments.
(c) Represents changes of net reserves between the original estimate (for each
accident year) of the indicated year and
the reserve re-estimated as of the end of the current year.
Re-estimated reserves are calculated by adding cumulative
amount paid to unpaid loss and LAE and incurred but not reported (IBNR) at
year end for each accident year.
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Table II
Analysis of Losses and Loss Adjustment Expenses (LAE)
Development (in millions)
(Direct Insurance Only)
<TABLE>
<CAPTION>
1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
---- ---- ---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Reserves for Losses
and LAE (a) $1,587.4 $1,561.8 $1,494.4 $1,390.9 $1,284.1 $1,161.5 $1,026.1 $1,158.8 $1,024.9 $895.9
Cumulative Amount
Paid as of: (b)
One year later 509.2 384.7 355.7 325.6 288.3 267.5 245.2 234.7 197.0
Two years later 770.5 656.2 621.6 564.4 499.3 474.8 437.8 389.3
Three years later 954.4 862.6 818.2 739.3 668.9 625.4 572.1
Four years later 1,097.1 1,023.5 965.1 884.2 787.9 737.5
Five years later 1,216.7 1,149.2 1,086.1 983.5 881.4
Six years later 1,318.7 1,252.8 1,174.5 1,069.3
Seven years later 1,408.1 1,327.6 1,253.6
Eight years later 1,473.3 1,396.5
Nine years later 1,533.9
Reserves Re-estimated
as of:
One year later 1,770.2 1,619.3 1,512.6 1,414.2 1,291.7 1,179.7 1,300.3 1,159.7 1,006.2
Two years later 1,764.0 1,645.8 1,570.2 1,448.8 1,278.8 1,423.1 1,282.8 1,134.3
Three years later 1,772.2 1,702.3 1,603.7 1,440.6 1,533.8 1,404.1 1,267.2
Four years later 1,829.1 1,719.7 1,604.2 1,694.5 1,526.6 1,412.1
Five years later 1,820.3 1,723.6 1,841.5 1,687.5 1,532.5
Six years later 1,823.6 1,956.8 1,850.4 1,698.0
Seven years later 2,045.6 1,958.8 1,859.5
Eight years later 2,052.8 1,970.0
Nine years later 2,067.1
Cumulative (Deficiency)
Redundancy: (c) ($479.7) ($408.2) ($365.1) ($307.1) ($248.4) ($250.6) ($241.1) $24.5 $18.7
</TABLE>
(a) Reserves for losses and LAE, excluding effects of reinsurance.
(b) Cumulative amount paid, excluding effects of reinsurance.
(c) Represents changes of direct reserves between the original estimate
(for each accident year) of the indicated year and the reserve re-estimated as
of the end of the current year. Re-estimated reserves are calculated
by adding cumulative amounnt paid to unpaid loss and LAE and incurred but not
reported (IBNR) at year end for each accident year.
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Capital Adequacy
Several measures of capital adequacy are common in the property-casualty
industry. The two most often used are (a) premium-to-surplus (which measures
pressures on capital from inadequate pricing) and, (b) reserves-to-surplus
(which measures pressures on capital from inadequate loss and loss adjustment
expense reserves).
The following table shows the consolidated premium-to-surplus and
reserves-to-surplus ratios of the Company's insurance subsidiaries (on a
statutory basis).
<TABLE>
<CAPTION>
Year Ended December 31,
1998 1997 1996
<S> <C> <C> <C>
Ratio of:
Premium-to-surplus 0.2 0.3 0.3
=== === ===
Reserves-to-surplus 1.1 1.5 2.0
=== === ===
</TABLE>
The Company believes that its 1998 capital ratios are satisfactory.
Ratings
The Company's insurance subsidiaries are rated by A.M. Best. A.M. Best is
generally considered to be the leading insurance rating agency, and its ratings
are used by insurance buyers, agents and brokers, and other insurance companies
as an indicator of financial strength and security, and are not intended to
reflect the quality of the rated company for investment purposes. Argonaut
Insurance and its pooled subsidiaries has carried an "A+" (Superior) rating
since 1991. Argonaut Great Central is rated separately and carries an "A-"
(Excellent) rating.
Standard & Poor's currently rates the claims-paying ability of Argonaut
Insurance and its pooled subsidiaries as "AA+" and Argonaut Great Central as
"A".
Employees
At December 31, 1998, the Company employed 499 full-time employees. Of this
total, Argonaut Insurance employed 415 people (362 professional/managerial and
53 clerical/operational). Argonaut Great Central employed 71 people (45
professional/managerial and 26 clerical/operational). Argonaut Group employed 13
people (12 professional/managerial and 1 clerical/operational). The Company is
not a party to any collective bargaining agreements.
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Item 2. Properties
Argonaut Insurance's headquarters are located in a facility that consists of an
office building on approximately two acres of land in Menlo Park, California.
Argonaut Great Central's headquarters are located in a facility in Peoria,
Illinois. Argonaut Insurance and Argonaut Great Central own the buildings in
which their headquarters are located. In addition, the Company has entered into
short term leases in conjunction with its operations at various locations
throughout the country. The Company believes that its properties are adequate
for its present needs.
Item 3. Legal Proceedings
On August 30, 1996, the Los Angeles County Metropolitan Transportation Authority
(MTA) filed a civil action against Argonaut Insurance alleging breach of
contract, breach of the covenant of good faith and fair dealing, and requesting
ancillary relief in the form of an accounting, an injunction and restitution in
connection with allegations regarding failures to perform under certain
contracts of insurance.
Argonaut Insurance has responded to the complaint, and brought certain
counterclaims against the MTA, and possibly others, in connection with the facts
underlying the lawsuit. Argonaut Insurance believes it has meritorious defenses,
and intends to vigorously contest these claims. Argonaut Insurance is unable,
with any degree of certainty, to comment upon the range of any potential loss,
or whether such an outcome is probable or remote, in light of the lack of any
discovery conducted in the case, and the preliminary investigation conducted
thus far.
The Company has been sued in sixteen referenced lawsuits brought on behalf of
alleged classes of purchasers of retrospectively rated worker's compensation
insurance, alleging that the defendants, including other compensation
insurers, charged the purported class unlawful premiums. The lawsuits
are El Chico Restaurants, Inc. and Southwest Cafes of Tennessee, Inc. v.
The Aetna Casualty and Surety Company, et al.; Civil Action No. 97-92-I,
pending in the Chancery Court for Davidson County, Tennessee, filed on
January 8, 1997; El Chico Restaurants, Inc. v. The Aetna Casualty and Surety
Company, et al.; Civil Action File No. 97-RCCV-28, pending in the Superior
Court of Richmond County, Georgia, filed on January 10, 1997; Bristol Hotel
Management Corp., et al. v. Aetna Casualty & Surety Co. A/K/A Aetna Group, et
al.; Civil Action No. CL 9700727A, pending in the Circuit Court of
the Fifteenth Judicial Circuit, in and for Palm Beach County, Florida, filed
on August 15, 1997; Bristol Hotel Management Corp., et al. v. Aetna Casualty
& Surety Co. A/K/A Aetna Group, et al.; Civil Action No. 97-2240, pending
in the United States District Court for the Southern District of Florida,
Miami Division, filed on July 17, 1997; Foodarama Supermarkets, Inc. and WSR
Corporation d/b/a Strauss Discount Auto v. Aetna Casualty & Surety Co., et al.;
Docket No. L-3556-97, pending in the Superior Court of New Jersey Law
Division, Morris County, filed on November 17, 1997; CR/PL Management
Co., et al. v. Allianz Insurance Company, et al.; Civil Action
No. 98-01635; pending in the
Circuit Court of Cook County, Illinois County Department,
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12
Chancery Division, filed February 6, 1998; Hill-Behan Lumber Company, et
al.; v. Aetna Casualty and Surety Company, et al.; Case No. 982-00338;
pending in the Circuit Court of the City of St. Louis, State of Missouri,
filed on February 12, 1998; Foodrama Supermarkets, Inc., et al. v. Allianz
Insurance Company, et al.; Civil Action No. 001138; pending in the Court of
Common Pleas, Philadelphia County, Civil Division, filed on February 6, 1998;
Sandwich Chef of Texas, Inc., et al. v. Reliance National Indemnity Insurance
Company, et al., Case No.98-01631; In the District Court of Harris County,
Texas, 295th Judicial District, was filed on May 6, 1998; AARP, et al. v.
National Surety Corp., et al., No. 98-820589-CZ; Wayne County Circuit
Court,
State of Michigan, was filed on June 30, 1998; Alumax, Inc., et al. v. Allianz
Insurance Company, et al., Case No. CV98032222; In the Circuit Court of
Jefferson County, Alabama, was filed on May 21, 1998; Burnham Service
Corp., et al. v. NCCI, Inc., et al., Case No. 9800321; Supreme Court of the
State of New York, County of New York, was filed on June 30, 1998; FFE
Transportation Services, Inc., et al. v. NCCI, et al., Case No.
98-RCCV-509;
Superior Court of Richmond County, State of Georgia, was filed on June 11,
1998; Payless Cashways, Inc., et al. v. National Surety Corp., et al., Case
No. 9812388; Fayette Circuit Court, Division 1, Commonwealth of Kentucky, was
filed on June 30, 1998; and Albany International Corp., et al. v. American
National Fire Insurance Co., et al., Case No. CV98-11695; Superior Court of
the State of Arizona, County of Maricopa, was filed on June 26, 1998;
DAL-Tile Corporation, et al.; v. National Council on Compensation Insurance,
Inc., et al.; Case No. 311263; Pending in Superior Court of the State of
California, County of Riverside, was filed on April 17, 1998.
The Company intends to vigorously defend these lawsuits. Management is unable to
determine the potential financial impact of these lawsuits at this time.
On February 19, 1999 in an action involving a reinsurance collection case
entitled Stonewall Insurance Co. v. Argonaut Insurance Co., (wherin a
counterclaim was filed by Argonaut against Stonewall), a jury returned a verdict
in Argonaut's favor that included punitive damages of $13.0 million. Judgement
has not yet been entered and the time for post-trial motions and appeal has not
yet begun. The Company has not recorded any amount for punitive damages in
regards to this case at this time.
The insurance subsidiaries of the Company are parties to other various legal
proceedings which are considered routine and incidental to their business and
are not material to the Company's financial condition or results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of Argonaut Group's security holders during
the last quarter of its fiscal year ended December 31, 1998.
Page 12
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13
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Market Information
The Company's common stock trades on the NASDAQ Stock Market under the symbol
AGII. The closing price on March 18, 1999 was $24.25 per share. The information
on high and low common stock prices set forth under the caption "Common Stock
Market Prices" in the Annual Report to Shareholders of Argonaut Group for the
fiscal year ended December 31, 1998, is incorporated herein by reference. See
Exhibit Index.
Holders of Common Stock
The number of holders of record of the Company's Common Stock as of February 26,
1999 was 7,550.
Dividends
The information set forth under the caption "Management's Discussion and
Analysis of Results of Operations and Financial Condition - Liquidity and
Capital Resources" in the Annual Report to Shareholders of Argonaut Group for
the fiscal year ended December 31, 1998 and in "Note 6 - Shareholders' Equity"
in the Notes to the Consolidated Financial Statements of the Annual Report, is
incorporated herein by reference. See Exhibit Index.
Item 6. Selected Financial Data
The information set forth under the caption "Selected Financial Data" in
the Annual Report to Shareholders of Argonaut Group for the fiscal year ended
December 31, 1998, is incorporated herein by reference. See Exhibit Index.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The information set forth under the caption "Management's Discussion and
Analysis of Results of Operations and Financial Condition" in the Annual Report
to Shareholders of Argonaut Group for the fiscal year ended December 31, 1998,
is incorporated herein by reference. See Exhibit Index.
On January 28, 1998, the Company announced that it was reviewing a range of
strategic alternatives to enhance shareholder value. These alternatives include
the potential combination with another company. The Company had engaged Credit
Suisse First Boston Corporation to assist in this process. On November 24, 1998
the Company announced that it had completed the review and determined it would
remain an independent provider of specialty property-casualty insurance products
through its 26 offices throughout the United States. The Company will continue
to pursue its specialty niches, with emphasis on value-added workers
compensation and its strength in "wrap-up" construction projects for industry
and government entities using its safety engineering expertise.
Page 13
<PAGE>
14
On October 19, 1998, the Year 2000 Information and Readiness Disclosure Act
("Y2K Act")(Pub. L. No. 105-271, 12 Stat. 2386 (1998) to be codified at 15
U.S.C. ss. 1) was enacted into law by President Clinton. The following
disclosure is defined by section 3(9) of the Y2K Act.
The Company established a Year 2000 project team in November of 1996 to prepare
its computer hardware, operating system software, computer programs, and voice
and data communications to address Year 2000 compliance and remediation issues.
The Company's external Year 2000 plan covers the information exchange process
with vendors and business partners, and includes validating and testing the
readiness of its outsource data center service providers.
It is the opinion of management that as of April 30, 1998, the Company's client
server policy management, policy rating and claims processing systems are Year
2000 compliant. These computer systems use a four-position field to store and
process all dates. In addition, it is the opinion of management that effective
September 30, 1998, the Company's mission critical mainframe legacy systems have
been remediated to process dates beyond the Year 2000. The Company has completed
testing its mission critical business processing client server and mainframe
legacy systems, computer hardware, computer infrastructure systems software and
office automation software to assure continuity of service beyond the Year 2000.
The Company will continue the testing of non-mission critical user systems and
validating the above mission critical systems for Year 2000
compliance/remediation into 1999. The Company will prepare a contingency plan
that will include a designated team to resolve any unforeseen problems that
arise beyond the Year 2000.
The total project cost is estimated to be approximately $4.4 million. All costs
associated with the project have been expensed as incurred.
Statement of Position ("SOP") 97-3, Accounting by Insurance and Other
Enterprises for Insurance-Related Assessments was also issued in 1997. The
Company's required adoption date is January 1, 1999. The Company does not
anticipate SOP 97-3 to have an impact on its results of operations or financial
position.
SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, was
issued on June 16, 1998. The Company's required adoption date is January 1,
2000. The Company does not anticipate SFAS No. 133 to have an impact on its
results of operations or financial position.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
The primary market risk exposures that result in an impact to the Company's
investment portfolio relates to equity price changes and interest rate changes.
The Company holds a well diversified portfolio of investments in common stock
representing U.S. firms in industries and market segments ranging from small
market capitalization stocks to the Standard & Poor's 500 stocks. These equity
investments are not made for trading purposes. Equity price risk is managed
primarily through the daily monitoring of funds committed to the various types
securities owned by the Company and by limiting the exposure in any one
investment or type of investment.
Page 14
<PAGE>
15
At December 31, 1998 the fair market value of the Company's investment in common
stock was $341.8 million. The potential loss in fair value at December 31, 1998
using a 10% hypothetical decline in prices, is estimated to be approximately
$34.2 million.
The Company's primary exposure to interest rate risk relates to its fixed
maturity investments including redeemable and nonredeemable preferred stock.
These investments are not made for trading purposes. Changes in market interest
rates directly impact the market value of the fixed maturity securities and
preferred stocks. The following interest rate sensitivity analysis measures the
potential change in fair value for the Company's fixed maturity investments and
preferred stock as of December 31, 1998 resulting from changes in the rate of
100 and 200 basis points.
<TABLE>
<CAPTION>
Interest Rate Sensitivity Analysis
Modified
Fair Value Yield to Duration
(millions) Maturity (years)
<S> <C> <C> <C>
- -200bp 1,124.8 3.3% 5.1
- -100bp 1,073.1 4.3% 4.4
Base Case 1,029.4 5.3% 3.9
+100bp 991.0 6.3% 3.6
+200bp 956.4 7.2% 3.4
</TABLE>
The Company manages its exposure to interest rate risks by adhering to
specific
guidelines in connection with its investment portfolio. The maximum maturity
guidelines are presently as follows: (1) U.S. Treasury Securities-5
years. (2) Government Sponsored Agencies-10 years. (3) Municipal
Bonds-10 years. (4) Preferred Stocks-variable depending on structure of the
individual security.
Item 8. Financial Statements and Supplementary Data
The Report of Independent Public Accountants and consolidated financial
statements and related notes of Argonaut Group, Inc. and subsidiaries listed on
the index to financial statements set forth in Item 14(a)1 of this Form 10-K
Report are incorporated herein by reference to the Annual Report to Shareholders
of Argonaut Group for the fiscal year ended December 31, 1998.
The Company does not identify each asset with any one line of business and any
such allocation would be arbitrary.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
Page 15
<PAGE>
16
PART III
Item 10. Directors and Executive Officers of the Registrant
Incorporated herein by reference is the information appearing under the captions
"Election of Directors", "Executive Officers," "Security Ownership of Principal
Shareholders and Management" , and Section 16(a) Beneficial Ownership Reporting
Compliance in the registrant's Proxy Statement to be filed with the Securities
and Exchange Commission relating to the registrant's Annual Meeting of
Shareholders to be held on April 27, 1999.
Item 11. Executive Compensation
Incorporated herein by reference is the information appearing under the captions
"Compensation of Executive Officers", "Indemnity Agreements", "Pension Plan",
and "Compensation of Directors" in the registrant's Proxy Statement to be filed
with the Securities and Exchange Commission relating to the registrant's Annual
Meeting of Shareholders to be held on April 27, 1999.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Incorporated herein by reference is the information appearing under the caption
"Security Ownership of Principal Shareholders and Management" in the
registrant's Proxy Statement to be filed with the Securities and Exchange
Commission relating to the registrant's Annual Meeting of Shareholders to be
held on April 27, 1999.
Item 13. Certain Relationships and Related Transactions
Incorporated herein by reference is the information appearing under the caption
"Compensation and Stock Option Committee Interlocks and Insider Participation"
in the registrant's Proxy Statement to be filed with the Securities and Exchange
Commission relating to the registrant's Annual Meeting of Shareholders to be
held on April 27, 1999.
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a)1. Financial Statements
Selected Financial Data
Report of Independent Public Accountants
Consolidated Balance Sheets - December 31, 1998 and 1997
Consolidated Statements of Operations
For the Years Ended December 31, 1998, 1997, and 1996
Page 16
<PAGE>
17
Consolidated Statements of Comprehensive Income
For the Years Ended December 31, 1998, 1997, and 1996
Consolidated Statements of Shareholders' Equity
For the Years Ended December 31, 1998, 1997, and 1996
Consolidated Statements of Cash Flow
For the Years Ended December 31, 1998, 1997, and 1996
Notes to Consolidated Financial Statements
Quarterly Financial Data (Unaudited)
Common Stock Market Prices (Unaudited)
Management's Discussion and Analysis of Results of Operations and
Financial Condition
(a)2. Financial Statement Schedules
Report of Independent Public Accountants on Schedules
Schedule I - Condensed Financial Information of Registrant
December 31, 1998 and 1997
Schedule V - Supplementary Insurance Information December 31,
1998, 1997, and 1996
All other schedules and notes specified under Regulation S-X are omitted because
they are either not applicable, not required, or the information called for
therein appears in response to the items of Form 10-K or in the financial
statements or notes thereto.
(a)3. Exhibits
The following exhibits are numbered in accordance with Item 601 of Regulation
S-K and, except as noted, are filed herewith.
2. Information Statement of Registrant (incorporated by reference to the
Exhibit 2 to the Registrant's Form 10 Registration Statement dated
September 3, 1986, filed with the Securities and Exchange Commission on
September 4, 1986).
3.1 Certificate of Incorporation of Registrant (incorporated by reference
to the Exhibit 3.1 to the Registrant's Form 10 Registration Statement
dated September 3, 1986, filed with the Securities and Exchange
Commission on September 4, 1986).
3.2 Bylaws of the Registrant (incorporated by reference to the Exhibit 3.2
to the Registrant's Form 10 Registration Statement dated September 3,
1986, filed with the Securities and Exchange Commission on September 4,
1986).
Page 17
<PAGE>
18
10.1 Argonaut Group, Inc. 1986 Stock Option Plan (incorporated by reference
to the Exhibit 10.1 to the Registrant's Form 10 Registration Statement
dated September 3, 1986, filed with the Securities and Exchange
Commission on September 4, 1986).
10.2 Argonaut Group, Inc. Retirement Plan (incorporated by reference to the
Exhibit 10.2 to the Registrant's Form 10 Registration Statement dated
September 3, 1986, filed with the Securities and Exchange Commission on
September 4, 1986).
10.3 Tax Agreement by and among Registrant and its subsidiaries and
Teledyne, Inc. (incorporated by reference to the Exhibit 10.3 to the
Registrant's Form 10 Registration Statement dated September 3, 1986,
filed with the Securities and Exchange Commission on September 4,
1986).
10.4 Argonaut Group, Inc. 1986 Stock Option Plan, as amended (incorporated
by reference to the Exhibit 4.3 to the Registrant's Registration
Statement on Form S-8 filed with the Securities and Exchange Commission
on February 13, 1987).
10.5 401(k) Retirement Savings Plan (incorporated by reference to the
Exhibit 10.4 to the Registrant's Form 10-K filed with the Securities
and Exchange Commission on February 28, 1989).
10.6 Employee Stock Investment Plan (incorporated by reference to the
Exhibit 4.3 to the Registrant's Registration Statement on Form S-8
filed with the Securities and Exchange Commission on October 10, 1989).
10.7 Argonaut Group, Inc. 1986 Stock Option Plan, as amended (incorporated
by reference to the Exhibit 4.3 to the Registrant's Registration
Statement on Form S-8 filed with the Securities and Exchange Commission
on December 9, 1997).
10.8 Argonaut Group, Inc. Form of Employee Retention Agreement for
Messrs. Rinsch and Halliday dated as of February 24, 1998.
10.9 Argonaut Group, Inc. Form of Employee Retention Agreement for
Messrs. Mellin and Polak dated as of February 24, 1998.
10.10 Argonaut Group, Inc. Form of Employee Retention Agreement for
Argonaut Group, Inc. dated as of February 24, 1998.
13. The following materials are excerpted from the Annual Report to
Shareholders of Argonaut Group, Inc. for the fiscal year ended
December 31, 1998:
a) Selected Financial Data
b) Financial Statements
c) Common Stock Market Prices
d) Management's Discussion and Analysis of Results of Operations
and Financial Condition
Page 18
<PAGE>
19
21. Subsidiaries of Registrant (incorporated by reference to the Exhibit 21
to the Registrant's Form 10 Registration Statement dated September 3,
1986, filed with the Securities and Exchange Commission on September 4,
1986).
23. Consent of Independent Public Accountants.
27. Financial Data Schedule for December 31, 1998 Form 10-K.
(b) Reports on Form 8-K.
There were no Reports filed on Form 8-K for the quarter ended
December 31, 1998
Page 19
<PAGE>
20
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.
ARGONAUT GROUP, INC.
By /s/ Charles E. Rinsch
Charles E. Rinsch
President
Date: March 19, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
Signature Title Date
/s/ Charles E. Rinsch President, Chief Executive March 19, 1999
- ---------------------------
Charles E. Rinsch Officer, and Director
/s/ James B Halliday Vice President, Secretary, March 19, 1999
James B Halliday and Treasurer (principal
financial and accounting
officer)
/s/ George A. Roberts Director March 19, 1999
- -------------------------
George A. Roberts
/s/ Jerrold V. Jerome Director March 19, 1999
- -------------------------
Jerrold V. Jerome
/s/ Fayez S. Sarofim Director March 19, 1999
- -------------------------
Fayez S. Sarofim
/s/ Henry E. Singleton Director March 19, 1999
- -------------------------
Henry E. Singleton
Page 20
<PAGE>
21
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULES
To the Shareholders of Argonaut Group, Inc.
We have audited in accordance with generally accepted auditing standards, the
consolidated financial statements included in Argonaut Group, Inc.'s annual
report to shareholders incorporated by reference in this Form 10-K, and have
issued our report thereon dated January 7, 1999. Our audit was made for the
purpose of forming an opinion on the basic consolidated financial statements
taken as a whole. The schedules listed in Part IV, Item 14(a)(2) are presented
for purposes of complying with the Securities and Exchange Commission's rules
and are not part of the basic consolidated financial statements. These schedules
have been subjected to the auditing procedures applied in our audit of the basic
consolidated financial statements and, in our opinion, are fairly stated in all
material respects in relation to the basic consolidated financial statements
taken as a whole.
ARTHUR ANDERSEN LLP
San Francisco, California
March 12, 1999
<PAGE>
22
<TABLE>
<CAPTION>
ARGONAUT GROUP, INC.
SCHEDULE I
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
($ in millions)
BALANCE SHEET
December 31,
-------------------------------
Assets 1998 1997
--------------- ---------------
<S> <C> <C>
Short-term investments $10.1 $5.3
Cash & cash equivalents 0.3 0.5
Investment in subsidiary 661.1 604.0
Cost in excess of net assets purchased 35.5 38.3
Deferred Federal income taxes receivable 68.8 89.7
Other assets 9.3 8.7
=============== ===============
$785.1 $746.5
=============== ===============
Liabilities & Shareholders' Equity
Income taxes payable $7.0 $3.3
Other liabilities 1.0 0.6
Due from/(to) subsidiaries 22.7 24.7
Shareholders' equity 754.4 717.9
=============== ===============
$785.1 $746.5
=============== ===============
</TABLE>
<TABLE>
<CAPTION>
STATEMENT OF OPERATIONS For The Year Ended December 31,
-----------------------------------------------
1998 1997 1996
--------------- --------------- ---------------
<S> <C> <C> <C>
Revenues $4.1 $ 5.3 $4.4
Expenses:
Amortization of cost in excess of net assets 2.8 2.8 2.8
Other expenses 5.2 4.0 4.0
--------------- --------------- ---------------
Loss before tax and undistributed earnings (3.9) (1.5) (2.4)
Provision for income taxes (1.8) 0.5 4.5
--------------- --------------- ---------------
Net loss before equity in earnings of subsidiary (2.1) (2.0) (6.9)
Equity (loss) in undistributed earnings of subsidiary 64.8 50.5 (87.1)
--------------- --------------- ---------------
Net Income (loss) $ 62.7 $ 48.5 $ (94.0)
=============== =============== ===============
</TABLE>
<PAGE>
23
<TABLE>
<CAPTION>
ARGONAUT GROUP, INC.
SCHEDULE I
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
($ in millions)
STATEMENTS OF CASH FLOW For The Year Ended December 31,
-------------------------------------
1998 1997 1996
------------ ----------- ------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $62.7 $48.5 $(94.0)
Adjustments to reconcile net income (loss) to
net cash provided by operations:
Amortization 2.8 2.8 2.8
Undistributed loss (earnings) in subsidiary (88.5) (62.5) 118.6
Dividend from subsidiary 40.5 38.3 45.0
Decrease in deferred Federal income taxes
(payable) receivable 20.8 13.1 (27.5)
Decrease (increase) in due from/to subsidiaries (2.0) (2.5) (1.7)
Increase in income taxes payable 3.7 2.1 0.9
Other, net (0.2) (0.4) (2.1)
------------ ----------- ------------
39.8 39.4 42.0
------------ ----------- ------------
Cash flows from investing activities:
Decrease (increase) in short-term investments
(4.8) (2.2) 2.7
------------ ----------- ------------
(4.8) (2.2) 2.7
------------ ----------- ------------
Cash flows from financing activities:
Repurchase of common stock (0.5) - (10.8)
Payment of cash dividend (39.3) (38.1) (34.6)
Exercise of stock options 4.6 1.2 0.8
------------ ----------- ------------
(35.2) (36.9) (44.6)
------------ ----------- ------------
Increase (decrease) in cash & cash equivalents (0.2) 0.3 0.1
Cash & cash equivalents, beginning of period 0.5 0.2 0.1
============ =========== ============
Cash & cash equivalents, end of period $ 0.3 $0.5 $0.2
============ =========== ============
</TABLE>
<PAGE>
24
<TABLE>
<CAPTION>
ARGONAUT GROUP, INC.
SCHEDULE V
SUPPLEMENTARY INSURANCE INFORMATION
Years Ended December 31, 1998, 1997, and 1996
($ in millions)
Amortization
Future Other Premium Net Ben, (Deferral) Other Premiums
Invest. Loss,
DPAC Benefits UPR Payables Revenue Income & LAE DPAC Insur. Written
Exp
Segment (a) (b) (c) (d) (e) (f) (1) (g) (h) (i) (2) (j)
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Year Ended December 31, 1998
Workers Comp
3.0 499.6 17.1 - 115.6 28.2 75.5 0.3 61.4 119.2
All Other
1.8 396.3 19.7 - 22.9 22.3 19.6 0.4 9.8 24.9
Unallocable
- - - - - 26.9 - - - -
========== ========= ========== ========= ==================== ========= ========== ========= ==========
4.8 895.9 36.8 - 138.5 77.4 95.1 0.7 71.2 144.1
========== ========= ========== ========= ==================== ========= ========== ========= ==========
Year Ended December 31, 1997
Workers Comp
2.7 572.4 20.8 - 140.6 36.5 91.1 (1.3) 69.4 132.3
All Other
1.3 452.5 19.4 - 24.3 28.8 21.7 0.1 10.0 25.9
Unallocable
- - - - - 21.9 - - - -
========== ========= ========== ========= ==================== ========= ========== ========= ==========
4.0 1,024.9 40.2 - 164.9 87.2 112.8 (1.2) 79.4 158.2
========== ========= ========== ========= ==================== ========= ========== ========= ==========
Year Ended December 31, 1996
Workers Comp
4.1 659.5 47.3 - 129.5 42.3 81.2 (0.5) 52.9 147.5
All Other
1.2 534.2 18.0 - 32.2 34.3 265.0 (0.1) 11.8 28.6
Unallocable
- - - - - 12.9 - - - -
========== ========= ========== ========= ==================== ========= ========== ========= ==========
5.2 1,193.7 65.3 - 161.7 89.5 346.2 (0.6) 64.7 176.1
========== ========= ========== ========= ==================== ========= ========== ========= ==========
</TABLE>
(a) Deferred Policy Acquisition Costs
(b) Future Policy Benefits, Claims, and Claim Adjustment Expenses
(c) Unearned Premiums
(d) Other Policy Claims and Benefits Payable
(e) Premium Revenue
(f) Net Investment Income
(g) Benefits, Claims, and Claim Adjustment Expenses
(h) Amortization of Deferred Policy Acquisition Costs
(i) Other Insurance Expenses
(j) Premiums Written
(1) Net investment income allocated based upon
each segment's share of investable funds
(2) Other insurance expenses allocated based on
specific identification, where possible, and related activities.
<PAGE>
25
EXHIBIT INDEX
Document
Exhibit
No.
The following exhibits are numbered in accordance with Item 601 of Regulation
S-K and, except as noted, are filed herewith.
2. Information Statement of Registrant (incorporated by reference to the
Exhibit 2 to the Registrant's Form 10 Registration Statement dated
September 3, 1986, filed with the Securities and Exchange Commission on
September 4, 1986).
3.1 Certificate of Incorporation of Registrant (incorporated by reference
to the Exhibit 3.1 to the Registrant's Form 10 Registration Statement
dated September 3, 1986, filed with the Securities and Exchange
Commission on September 4, 1986).
3.2 Bylaws of the Registrant (incorporated by reference to the Exhibit 3.2
to the Registrant's Form 10 Registration Statement dated September 3,
1986, filed with the Securities and Exchange Commission on September 4,
1986).
10.1 Argonaut Group, Inc. 1986 Stock Option Plan (incorporated by reference
to the Exhibit 10.1 to the Registrant's Form 10 Registration Statement
dated September 3, 1986, filed with the Securities and Exchange
Commission on September 4, 1986).
10.2 Argonaut Group, Inc. Retirement Plan (incorporated by reference to the
Exhibit 10.2 to the Registrant's Form 10 Registration Statement dated
September 3, 1986, filed with the Securities and Exchange Commission on
September 4, 1986).
10.3 Tax Agreement by and among Registrant and its subsidiaries and
Teledyne, Inc. (incorporated by reference to the Exhibit 10.3 to the
Registrant's Form 10 Registration Statement dated September 3, 1986,
filed with the Securities and Exchange Commission on September 4,
1986).
10.4 Argonaut Group, Inc. 1986 Stock Option Plan, as amended (incorporated
by reference to the Exhibit 4.3 to the Registrant's Registration
Statement on Form S-8 filed with the Securities and Exchange Commission
on February 13, 1987).
10.5 401(k) Retirement Savings Plan (incorporated by reference to the
Exhibit 10.4 to the Registrant's Form 10-K filed with the Securities
and Exchange Commission on February 28, 1989).
10.6 Employee Stock Investment Plan (incorporated by reference to the
Exhibit 4.3 to the Registrant's Registration Statement on Form S-8
filed with the Securities and Exchange Commission on October 10, 1989).
10.7 Argonaut Group, Inc. 1986 Stock Option Plan, as amended (incorporated
by reference to the Exhibit 4.3 to the Registrant's Registration
Statement on Form S-8 filed with the Securities and Exchange Commission
on December 9, 1997).
10.8 Argonaut Group, Inc. Form of Employee Retention Agreement for
Messrs. Rinsch and Halliday dated as of February 24, 1998.
10.9 Argonaut Group, Inc. Form of Employee Retention Agreement for
Messrs. Mellin and Polak dated as of February 24, 1998.
10.10 Argonaut Group, Inc. Form of Employee Retention Agreement for
Argonaut Group, Inc. dated as of February 24, 1998.
13. The following materials are excerpted from the Annual Report to
Shareholders of Argonaut Group, Inc. for the fiscal year ended
December 31, 1998:
a) Selected Financial Data
b) Financial Statements
c) Common Stock Market Prices
d) Management's Discussion and Analysis of Results of Operations
and Financial Condition
21. Subsidiaries of Registrant (incorporated by reference to the Exhibit 21
to the Registrant's Form 10 Registration Statement dated September 3,
1986, filed with the Securities and Exchange Commission on September 4,
1986).
23. Consent of Independent Public Accountants.
27. Financial Data Schedule for December 31, 1998 Form 10-K.
(b) Reports on Form 8-K.
There were no Reports filed on Form 8-K for the quarter ended
December 31, 1998
<PAGE>
1
Exhibit 13
Selected Financial Data
<TABLE>
<CAPTION>
In millions For the Years Ended December 31, 1998 1997 1996 1995 1994
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA
Premiums:
Workers compensation $ 115.6 $ 140.6 $ 129.5 $ 176.7 $ 240.2
Other insurance 22.9 24.3 32.2 31.4 39.5
- -------------------------------------------------------------------------------------------------------------------
138.5 164.9 161.7 208.1 279.7
Net investment income 77.4 87.2 89.5 102.0 110.7
Gains on sales of investments 51.2 4.5 21.6 3.1 3.8
- -------------------------------------------------------------------------------------------------------------------
Total revenue $ 267.1 $ 256.6 $ 272.8 $ 313.2 $ 394.2
===================================================================================================================
Underwriting gain (loss) before income taxes:
Workers compensation $ (24.1) $(21.2) $ (5.3) $ 3.3 $ 7.7
Other continuing lines (7.1) (8.4) (124.6) (35.6) (24.3)
Run off lines 0.6 2.4 (127.4) - 12.0
- -------------------------------------------------------------------------------------------------------------------
$ (30.6) $ (27.2) $ (257.3) $ (32.3) $ (4.6)
===================================================================================================================
Income (loss) before income taxes $ 93.5 $61.3 $ (149.0) $ 69.7 $ 106.0
Provision for income taxes 30.8 12.8 (55.0) 12.8 29.3
- -------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 62.7 $ 48.5 $(94.0) $ 56.9 $ 76.7
===================================================================================================================
Net income (loss) per common share:
Basic $ 2.62 $ 2.04 $(3.92) $ 2.34 $ 3.00
===================================================================================================================
Diluted $ 2.61 $ 2.02 $(3.92) $ 2.32 $ 2.97
===================================================================================================================
BALANCE SHEET DATA
Portfolio investments $1,372.8 $1,369.1 $1,395.5 $1,489.2 $1,484.8
===================================================================================================================
Total assets $1,780.6 $1,860.5 $1,944.4 $1,977.5 $2,058.8
===================================================================================================================
Reserves for losses and loss
adjustment expenses $ 895.9 $1,024.9 $1,158.8 $1,026.1 $1,161.5
===================================================================================================================
Shareholders' equity $ 754.4 $ 717.9 $ 665.3 $ 810.8 $ 745.6
===================================================================================================================
Cash dividends declared per
common share $ 1.64 $ 1.60 $1.44 $ 1.28 $ 1.12
===================================================================================================================
</TABLE>
The accompanying notes are an integral part of these financial statements.
13-1
<PAGE>
2
Exhibit 13
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders of Argonaut Group, Inc.
We have audited the accompanying consolidated balance sheets of Argonaut Group,
Inc. (a Delaware corporation) and subsidiaries as of December 31, 1998 and 1997,
and the related consolidated statements of operations, comprehensive income,
shareholders' equity, and cash flows for each of the three years in the period
ended December 31, 1998. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Argonaut Group,
Inc. and subsidiaries as of December 31, 1998 and 1997, and their results of
operations, comprehensive income and cash flows for each of the three years in
the period ended December 31, 1998, in conformity with generally accepted
accounting principles.
ARTHUR ANDERSEN LLP
San Francisco, California
January 7, 1999
13-2
<PAGE>
3
Exhibit 13
<TABLE>
<CAPTION>
Consolidated Balance Sheets
In millions except per share amounts December 31, 1998 1997
<S> <C> <C>
ASSETS
Investments:
Fixed maturities, available for sale, at fair value $ 942.8 $ 857.6
(cost: 1998-$915.5; 1997-$845.8)
Equity securities, available for sale, at fair value 408.5 440.1
(cost: 1998-$197.4; 1997-$227.4)
Short-term investments, available for sale, at fair value 19.9 80.9
Securities in transit 1.6 (9.5)
- -------------------------------------------------------------------------------------------------------------------
1,372.8 1,369.1
Cash and cash equivalents 24.5 59.0
Accrued investment income 18.7 20.3
Receivables:
Reinsurance 196.1 210.2
Agents' balances 63.8 74.2
Accrued retrospective premiums 52.8 61.8
Cost in excess of net assets purchased 35.5 38.3
Unearned premiums on ceded reinsurance 0.9 0.8
Deferred federal income taxes receivable, net - 11.5
Other assets 15.5 15.3
- -------------------------------------------------------------------------------------------------------------------
$1,780.6 $1,860.5
===================================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Reserves for losses and loss adjustment expenses $ 895.9 $1,024.9
Unearned premiums 36.8 40.2
Accrued policyholder dividends (2.5) (2.4)
Deferred federal income taxes payable, net 14.2 -
Other liabilities 81.8 79.9
- -------------------------------------------------------------------------------------------------------------------
1,026.2 1,142.6
===================================================================================================================
Shareholders' equity:
Common stock -- $.10 par, 35,000,000 shares authorized, 24,077,792 and
23,854,720 shares issued and outstanding
at December 31, 1998 and December 31, 1997, respectively 2.4 2.4
Additional paid-in capital 102.9 98.3
Retained earnings 494.1 471.2
Net unrealized appreciation on securities 155.0 146.0
---------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------
754.4 717.9
- -------------------------------------------------------------------------------------------------------------------
$1,780.6 $1,860.5
===================================================================================================================
</TABLE>
The accompanying notes are an integral part of these financial statements.
13-3
<PAGE>
4
Exhibit 13
<TABLE>
<CAPTION>
Consolidated Statements of Operations
In millions except per share amounts For the Years Ended December 31, 1998 1997 1996
<S> <C> <C> <C>
Premiums and other revenue:
Premiums, net $ 138.5 $164.9 $ 161.7
Net investment income 77.4 87.2 89.5
Gains on sales of investments 51.2 4.5 21.6
---------------------------------------------------------------------------------------------------------
Total revenue 267.1 256.6 272.8
- ------------------------------------------------------------------------------------------------------------
Expenses:
Losses and loss adjustment expenses 95.1 112.8 346.2
Underwriting, acquisition, and insurance expenses 74.9 80.6 64.1
Amortization of cost in excess of net assets purchased 2.8 2.8 2.8
Policyholder dividends 0.8 (0.9) 8.7
---------------------------------------------------------------------------------------------------------
Total expenses 173.6 195.3 421.8
- ------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes 93.5 61.3 (149.0)
Provision for income taxes 30.8 12.8 (55.0)
- -------------------------------------------------------------------------------------------------------------
Net income (loss) $ 62.7 $ 48.5 $ (94.0)
===================================================================================================================
Net income (loss) per common share:
Basic $ 2.62 $ 2.04 $ (3.92)
===================================================================================================================
Diluted $ 2.61 $ 2.02 $ (3.92)
===================================================================================================================
</TABLE>
The accompanying notes are an integral part of these
financial statements.
13-4
<PAGE>
5
Exhibit 13
<TABLE>
<CAPTION>
Consolidated Statements of Comprehensive Income
In millions except amounts per share 1998 1997 1996
(Unaudited)
<S> <C> <C> <C>
Net income (loss) $62.7 $48.5 $ (94.0)
Other comprehensive income:
Unrealized gain on securities:
Gain arising during the year 65.0 67.7 11.0
Reclassification adjustment for gains included in net income (51.2) (4.5) (21.6)
--------------------------------------------------------------------------------------------------------
Other comprehensive income (loss) before tax 13.8 63.2 (10.6)
Income tax expense related to other comprehensive income (loss) 4.8 22.1 (3.7)
- -------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss), net of tax 9.0 41.1 (6.9)
- -------------------------------------------------------------------------------------------------------------
Comprehensive income (loss) $71.7 $89.6 $(100.9)
===================================================================================================================
</TABLE>
The accompanying notes are an integral part of these financial statements.
13-5
<PAGE>
6
Exhibit 13
<TABLE>
<CAPTION>
Consolidated Statements of Shareholders' Equity
In millions except per share amounts Common Additional Retained Net Shareholders'
Stock Paid-In Earnings Unrealized Equity
Capital Appreciation on Securities
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1995 $2.4 $ 97.7 $598.9 $111.8 $810.8
Net loss (94.0) (94.0)
Change in net unrealized
appreciation on securities (6.9) (6.9)
Retirement of common stock (1.4) (9.4) (10.8)
Cash dividends ($1.44 per share) (34.6) (34.6)
Stock options exercised 0.8 0.8
- -------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1996 2.4 97.1 460.9 104.9 665.3
Net income 48.5 48.5
Change in net unrealized
appreciation on securities 41.1 41.1
Cash dividends ($1.60 per share) (38.2) (38.2)
Stock options exercised 1.2 1.2
- -------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1997 2.4 98.3 471.2 146.0 717.9
Net income 62.7 62.7
Change in net unrealized
appreciation on securities 9.0 9.0
Retirement of common stock (0.5) (0.5)
Cash dividends ($1.64 per share) (39.3) (39.3)
Stock options exercised 4.6 4.6
- -------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1998 $2.4 $102.9 $494.1 $155.0 $754.4
===================================================================================================================
</TABLE>
The accompanying notes are an integral part of these financial statements.
13-6
Exhibit 13
<PAGE>
7
<TABLE>
<CAPTION>
Consolidated Statements of Cash Flow
In millions For the Years Ended December 31, 1998 1997 1996
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 62.7 $ 48.5 $ (94.0)
Adjustments to reconcile net income (loss) to
net cash used by operations:
Amortization and depreciation 8.6 12.1 12.1
Decrease in accrued investment income 1.6 2.1 1.5
Decrease (increase) in reinsurance receivables 14.1 24.4 (36.0)
Decrease (increase) in agents' balances 10.4 2.3 (2.5)
Decrease in accrued retrospective premiums 9.0 18.8 11.9
Decrease (increase) in unearned premiums on ceded reinsurance (0.1) 0.2 1.6
Decrease (increase) in deferred federal income taxes receivable 20.8 13.4 (27.6)
Increase (decrease) in reserves for losses and loss adjustment expenses(129.0) (134.0) 132.8
Increase (decrease) in unearned premiums (3.4) (25.1) 1.3
Increase (decrease) in accrued policyholder dividends (0.1) (3.7) 6.2
Increase (decrease) in income taxes payable 6.8 38.6 (36.8)
Increase (decrease) in other assets and liabilities (6.9) (15.0) 4.4
--------------------------------------------------------------------------------------------------------
(5.5) (17.4) (25.1)
- ------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Sales of fixed maturity investments 13.0 13.0 35.7
Maturities and mandatory calls of fixed maturity investments 45.1 392.0 165.1
Sales of equity securities 248.3 76.0 28.5
Purchases of fixed maturity investments (335.1) (319.2) (112.6)
Purchases of equity securities (15.0) (15.0) (64.4)
Decrease (increase) in short-term investments 61.0 (74.8) 28.8
Other, net (11.1) 10.7 (4.1)
----------------------------------------------------------------------------------------------------------
6.2 82.7 77.0
- ------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Repurchase of common stock (0.5) - (10.8)
Payment of cash dividend (39.3) (38.1) (34.6)
Exercise of stock options 4.6 1.2 0.8
---------------------------------------------------------------------------------------------------------
(35.2) (36.9) (44.6)
- -------------------------------------------------------------------------------------------------------------
Increase (decrease) in cash and cash equivalents (34.5) 28.4 7.3
Cash and cash equivalents, beginning of period 59.0 30.6 23.3
- ------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 24.5 $ 59.0 $ 30.6
===================================================================================================================
Additional disclosure:
Income taxes paid $ 1.7 $ - $ 9.2
===================================================================================================================
</TABLE>
The accompanying notes are an integral part of these
financial statements.
13-7
<PAGE>
8
Exhibit 13
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
BUSINESS Argonaut Group, Inc. (the Company) is a holding company whose
subsidiaries are primarily engaged in the selling, underwriting, and servicing
of workers compensation and other lines of property-casualty insurance. Workers
compensation is the primary line of insurance written by Argonaut Insurance
Company, the larger insurance subsidiary. The Company also writes a limited
amount of complementary lines of commercial insurance, primarily general and
automobile liability. Argonaut Insurance's target market is companies whose
workers compensation needs will result in significant annual premiums (generally
between $250,000 and $5 million) in classes of insurance which require specific
expertise to underwrite prudently, enhance the safety of the workplace, and
effectively manage losses through partnership with the insured. These classes
include contractors, wholesalers, retailers, light manufacturers and "high tech"
firms, service firms (such as in the hospitality industry), and clients who use
self-insurance to meet some or all of their insurance needs. Argonaut Great
Central specializes in commercial multiple-peril, workers compensation, and
umbrella coverages specifically for food merchants, restaurants, churches, and
laundry/dry cleaners. They also provide workers compensation for mid-sized
accounts, generally with annual premiums of $100,000 to $300,000.
BASIS OF PRESENTATION The consolidated financial statements of Argonaut Group,
Inc. and subsidiaries have been prepared in accordance with generally accepted
accounting principles (GAAP), which differ from statutory insurance accounting
practices. The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. The
financial statements include the accounts and operations of Argonaut Group, Inc.
and its subsidiaries. All material intercompany accounts and transactions have
been eliminated. Certain prior year balances have been restated to reflect
current year classifications. For purposes of reporting cash flows, cash and
cash equivalents include cash on hand and securities with an original maturity
of less than ninety days.
INVESTMENTS Investments in fixed maturities at December 31, 1998 and 1997
include bonds, notes, and redeemable preferred stocks. Equity securities include
common and nonredeemable preferred stocks. Short-term investments consist of
funds which are in excess of the Company's near-term operating and claims-paying
needs and are invested in repurchase agreements, commercial paper, and money
market funds. All investments are considered available for sale and are carried
at fair value. Fair values for fixed maturity investments and equity securities
are based on quoted market prices or dealer quotes. Unrealized appreciation or
depreciation on fixed maturity investments and equity securities is included,
net of applicable deferred income taxes, in shareholders' equity. Gains and
losses on sales of investments are computed on the specific identification
method and are reflected in total revenue.
RECEIVABLES Agents' balances are presented net of a reserve for uncollectible
accounts of $1.7 million and $1.4 million at December 31, 1998 and 1997
respectively. Accrued retrospective premiums are based upon actuarial estimates
of expected ultimate losses. Management believes that the accrued retrospective
premium receivable is reasonable. While the eventual receivable may differ from
the current estimates, management does not believe that the difference will have
a material effect, either adversely or favorably, on the Company's financial
position and results of operations.
COST IN EXCESS OF NET ASSETS PURCHASED Cost in excess of net assets purchased of
$35.5 million at December 31, 1998 and $38.3 million at December 31, 1997,
relate to Teledyne, Inc.'s acquisition of Argonaut Insurance Company in 1969,
and is net of accumulated amortization of $34.1 million and $31.3 million,
respectively. Cost in excess of net assets purchased is being amortized on a
straight-line basis over a 25-year period beginning October 1, 1986. At each
balance sheet date, the Company evaluates the recoverability of its cost in
excess of net assets purchased in relation to anticipated future cash flows on
an undiscounted basis. If the carrying value of the cost in excess of net assets
purchased exceeds anticipated future cash flows on an undiscounted basis, then
the cost in excess of net assets purchased is deemed to be impaired and written
down to the value of the anticipated future cash flows. Based on this annual
assessment, the Company expects its cost in excess of net assets purchased to be
fully recovered.
13-8
<PAGE>
9
Exhibit 13
RECOGNITION OF PREMIUM REVENUE & RELATED EXPENSES Premium revenue is recognized
ratably over the period to which the premium relates. Policy acquisition costs,
included in other assets, consisting primarily of commissions and premium taxes,
are deferred and amortized over the period in which the related premium is
earned. Deferred policy acquisition costs are limited to their estimated
realizable value based on the related unearned premium and take into account
anticipated claims and claims expenses, based on historical and current
experience and investment income.
PER SHARE DATA In February 1997, the Financial Accounting Standards Board
("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 128,
"Earnings Per Share", which requires the presentation of "basic" and "diluted"
earnings per share ("EPS") and is effective for periods ending after December
15, 1997. Basic EPS is calculated based on the weighted-average number of shares
outstanding and diluted EPS includes the effects of dilutive potential common
shares. The effect of this accounting change on reported EPS data is as follows.
<TABLE>
<CAPTION>
For the Year Ended December 31,
Income Shares Per-Share
(Numerator) (Denominator) Amount
(Millions) (Dollars)
<S> <C> <C> <C>
Basic EPS:
Income available to
common stockholders
1998 $ 62.7 23,954,443 $ 2.62
1997 $ 48.5 23,827,934 $ 2.04
1996 $(94.0) 23,984,543 $(3.92)
Effect of Dilutive Securities:
Options issued
1998 77,000
1997 231,850
1996 247,421
Diluted EPS:
Income available to common
stockholders +
assumed conversions
1998 $ 62.7 24,031,443 $ 2.61
1997 $ 48.5 24,059,784 $ 2.02
1996 $(94.0) 24,231,964 $(3.92)
</TABLE>
Diluted earnings per common share for 1996 is the same as basic earnings per
share because the result of the calculation is antidilutive due to the net
operating loss reported for the year.
13-9
<PAGE>
10
Exhibit 13
2. Investments
Gains on sales and calls of investments for the years ended December 31, were as
follows.
<TABLE>
<CAPTION>
In millions 1998 1997 1996
<S> <C> <C> <C>
Fixed maturities $ 0.2 $0.4 $ 0.3
Equity securities 51.0 4.1 21.3
------------------------------------------------
$51.2 $4.5 $21.6
</TABLE>
=============================================================================
The amortized cost and fair value of fixed maturity investments as of December
31, were as follows.
<TABLE>
<CAPTION>
In millions 1998
Amortized Gross Gross Fair
Cost Unrealized Unrealized Value
Gains Losses
<S> <C> <C> <C> <C>
U.S. Treasury securities $237.6 $11.0 $ - $248.6
U.S Government agencies 585.9 14.1 0.1 599.9
Obligations of states and
political subdivisions 78.3 1.7 - 80.0
Redemptive
preferred stock 13.7 0.8 0.2 14.3
-------------------------------------------------------
$915.5 $27.6 $0.3 $942.8
</TABLE>
=============================================================================
<TABLE>
<CAPTION>
In millions 1997
Amortized Gross Gross Fair
CostUnrealizedUnrealized Value
Gains Losses
<S> <C> <C> <C> <C>
U.S. Treasury securities $454.9 $ 5.5 $ - $460.4
U.S Government agencies 281.2 4.1 - 285.3
Obligations of states and
political subdivisions 95.8 1.8 0.2 97.4
Redemptive
preferred stock 13.9 0.8 0.2 14.5
-------------------------------------------------------
$845.8 $12.2 $0.4 $857.6
</TABLE>
=============================================================================
13-10
<PAGE>
11
Exhibit 13
The amortized cost and market values of fixed maturity investments as of
December 31, 1998 by contractual maturity, are shown below.
<TABLE>
<CAPTION>
In millions
Amortized Fair
Cost Value
<S> <C> <C>
Due in one year or less $119.1 $120.1
Due after one year to five years 124.5 128.9
Due after five years to ten years 671.9 693.8
---------------------------------------------------------
$915.5 $942.8
</TABLE>
===============================================================================
The expected maturities may differ from the contractual maturities because
debtors may have the right to call or prepay obligations without penalties.
Proceeds from sales of fixed maturity investments were $13.3 million, $13.0
million, and $35.7 million in 1998, 1997, and 1996, respectively. Gross gains of
$0.2 million, $0.3 million, and $0.4 million and no gross losses were realized
on those sales in 1998, 1997, and 1996, respectively. At December 31, 1998 the
fair value and amortized cost of bonds on deposit with various insurance
regulatory agencies were $422.9 million and $409.6 million, respectively.
Additionally, U.S. Treasury Notes with an amortized cost of $6.8 million and
fair value of $7.0 million were pledged as collateral for surety bonds which
were issued to various states in lieu of depositing bonds. At December 31, 1998
and 1997, there were no investments in any one investee exceeding 10% of
shareholders' equity.
13-11
<PAGE>
12
Exhibit 13
3. Reinsurance
The Company reinsures certain risks with other insurance companies. Such
arrangements serve to limit the Company's maximum loss on catastrophes and large
or unusually hazardous risks. The Company is liable for reinsurance ceded in the
event its reinsurers do not meet their obligations. The Company's reserves for
nonrecoverable reinsurance were $11.2 million and $9.3 million as of December
31, 1998 and 1997, respectively. Under certain of the reinsurance agreements,
funds are held to secure performance of reinsurers in meeting their obligations.
The amount of such funds was $18.1 million and $25.8 million at December 31,
1998 and 1997, respectively. Estimated losses recoverable from reinsurers and
the ceded portion of unearned premiums are reported as assets. Losses and loss
adjustment expenses of $95.1 million, $112.8 million, and $346.2 million for the
years ending December 31, 1998, 1997, and 1996, respectively, are net of
cessions of $19.1 million, $27.1 million, and $72.9 million, respectively. While
the Company is not in the business of assuming reinsurance risks, it is required
to accept certain assigned risks and other legally mandated reinsurance
obligations. In previous years, the Company actively assumed various forms of
casualty reinsurance for which it continues to maintain reserves for loss and
loss adjustment expenses (Note 12). Premiums for the years ended December 31,
were as follows.
<TABLE>
<CAPTION>
In millions 1998 1997 1996
<S> <C> <C> <C>
Direct written premiums $160.4 $165.7 $187.8
Reinsurance ceded to
other companies (18.6) (15.8) (15.6)
Reinsurance assumed from
other companies 2.3 8.3 4.0
------------------------------------------------------------------------------
Net written premiums $144.1 $158.2 $176.2
===================================================================================================================
Direct earned premiums 154.0 176.6 $172.2
Reinsurance ceded to
other companies (18.5) (16.0) (17.4)
Reinsurance assumed from
other companies 3.0 4.3 6.9
-------------------------------------------------------------------------
Net earned premiums $138.5 $164.9 $161.7
===================================================================================================================
Percentage of reinsurance
assumed to net earned premiums 2.2% 2.6% 4.3%
</TABLE>
13-12
<PAGE>
13
Exhibit 13
4. Reserves for Losses and Loss Adjustment Expenses
The following table provides a reconciliation of reserves for losses and loss
adjustment expenses for the years ended December 31, 1998, 1997, and 1996.
<TABLE>
<CAPTION>
In millions 1998 1997 1996
<S> <C> <C> <C>
Reserves for losses and loss
adjustment expenses at
beginning of year $1,024.9 $1,158.8 $1,026.1
Losses and loss adjustment expenses:
Provision for losses and loss
adjustment expenses for claims
occurring in the current year 128.2 132.6 178.8
Increase (decrease) in estimated
losses and loss adjustment expenses
for claims occurring in prior years (14.0) 7.3 240.3
-------------------------------------------------------------------------------------------------
114.2 139.9 419.1
- -----------------------------------------------------------------------------------------------
Losses and loss adjustment
expense payments for claims
occurring during:
Current year 45.4 39.7 42.1
Prior years 197.8 234.1 244.3
-----------------------------------------------------------------------------------------
243.2 273.8 286.4
- ----------------------------------------------------------------------------------------------
Reserves for losses and loss
adjustment xpenses at end of year $ 895.9 $1,024.9 $1,158.8
</TABLE>
==============================================================================
Reserves for losses and loss adjustment expenses represent the estimated
indemnity cost and related adjustment expenses necessary to investigate and
settle claims. Such estimates are based upon individual case estimates for
reported claims, estimates from ceding companies for reinsurance assumed, and
actuarial estimates for losses which have been incurred but not yet reported to
the insurer. Any change in probable ultimate liabilities is reflected in current
operating results. The ultimate cost of claims, particularly liability claims,
is difficult to predict for several reasons including: the uncertain time period
for reporting claims, changes in the legal environment and court decisions, and
federal and state legislation which may dramatically increase the liability
between the time a policy is written and associated claims are ultimately
resolved. As an example, liability for exposure to toxic substances and
environmental impairment, which did not appear likely or even exist when the
policies were written, has been imposed by legislators and judicial
interpretation. Tort liability has been expanded by some jurisdictions to cover
defective workmanship. Liabilities assumed from other insurance companies under
reinsurance contracts are subject to the same factors, and further complicated
by long periods of time between the date of occurrence and the date of the
Company's notification of the claim. 1996 reserves were substantially affected
by a $229 million increase of loss reserves, principally relating to certain
general liability and reinsurance policies written in the 1970s. Management
believes the reserves for loss and loss adjustment expenses established are
adequate and the associated estimate of reinsurance recoverable is reasonable.
While the eventual ultimate liability and reinsurance recoverable may differ
from the current estimates, management does not believe that the difference will
have a material effect, either adversely or favorably, on the Company's
financial position and results of operations. The Company discounted certain
workers compensation pension-type reserves using a maximum interest rate of 3.5%
in 1998 and 1997. The amount of unamortized discount was $35.5 million at
December 31, 1998 and $38.7 million at December 31, 1997.
13-13
<PAGE>
14
Exhibit 13
5. Income Taxes
The Company's income tax provision includes the following components.
<TABLE>
<CAPTION>
In millions 1998 1997 1996
<S> <C> <C> <C>
Current tax provision $ 10.0 $ (0.3) $(27.6)
Deferred tax provision related to:
Future tax deductions 16.4 18.9 (6.7)
Net operating loss carryforward 16.2 (5.1) (18.8)
Deferred alternative minimum
tax provision (11.8) (0.7) (1.9)
- -------------------------------------------------------------------------
Income tax provision $ 30.8 $12.8 $(55.0)
=================================================================================================================
</TABLE>
A reconciliation of the Company's income tax provision to the provision which
would have resulted if the tax had been computed at the statutory rate is as
follows.
<TABLE>
<CAPTION>
In millions 1998 1997 1996
<S> <C> <C> <C>
Income tax provision at statutory
tax rates (35%) $32.3 $21.1 $(52.6)
Tax effect of:
Tax exempt interest (1.4) (1.7) (1.9)
Dividends received deduction (1.7) (6.1) (5.0)
Other permanent adjustments, net 0.6 (1.6) 3.4
State income tax provision 1.0 1.1 1.1
-------------------------------------------------------------------------
Income tax provision $30.8 $12.8 $(55.0)
</TABLE>
==============================================================================
Deferred taxes arise from temporary differences in the recognition of revenue
and expenses for tax and financial reporting purposes. Net deferred tax assets
(liabilities) at December 31, 1998, 1997, and 1996 result from the following
tax-effected temporary differences. Tax benefit of $1.5 million associated with
the exercise of employee stock options was allocated to equity in 1998.
<TABLE>
<CAPTION>
In millions 1998 1997 1996
<S> <C> <C> <C>
Deferred liability on unrealized
gains
Unrealized gains $(83.5) $(78.6) $(56.5)
Other, net (5.8) 5.6 3.3
Deferred tax assets:
Reserve discounting 44.9 53.8 74.9
Alternative minimum tax 15.0 6.8 6.3
Net operating loss carryforward 15.2 23.9 18.8
----------------------------------------------------------------
Deferred tax asset(liability), net $(14.2) $11.5 $46.8
</TABLE>
==============================================================================
Realization of deferred tax assets is dependent upon the Company's generation of
sufficient taxable income in the future to recover tax benefits that cannot be
recovered from taxes paid in the carryback period, generally three years.
Although realization is not assured, management believes it is more likely than
not that all of the deferred tax asset will be realized. The amount of the
deferred tax asset considered realizable, however, could be reduced in the near
term if estimates of future taxable income during the carryforward period are
reduced. The Company has a regular federal tax net operating loss carryforward
of $26.9 million which will expire after 2011 and $16.5 million which will
expire in 2012.
13-14
<PAGE>
15
Exhibit 13
6. Shareholders' Equity
The Company is authorized to issue 5,000,000 shares of $0.10 par value preferred
stock. No preferred shares were issued or outstanding at December 31, 1998.
During 1998, the Company retired 22,577 shares of its common stock acquired
through exercise of employee stock options, or forfeited in the employee stock
purchase plan. No shares were reacquired during 1997 and 360,245 shares were
reacquired during 1996. The Company's insurance subsidiaries are regulated by
the various states in which they do business and prepare their financial
statements in accordance with statutory accounting principles. The amount of
statutory net income and surplus (shareholders' equity) for the insurance
subsidiaries for the years ended December 31, were as follows.
<TABLE>
<CAPTION>
In millions 1998 1997 1996
<S> <C> <C> <C>
Net income (loss) $70.9 $ 61.6 $(122.6)
Surplus $643.1 $564.8 $ 487.1
</TABLE>
Various state insurance laws restrict the amount that may be transferred to
Argonaut Group, Inc. from its subsidiaries in the form of dividends without
prior approval of regulatory authorities. In addition, that portion of the
Company's net equity which results from the difference between statutory
insurance practices and generally accepted accounting principles would not be
available for dividends. At December 31, 1998, $20.5 million was available for
dividends to Argonaut Group without prior regulatory approval. During 1998,
dividends of $40.5 million were paid to Argonaut Group.
13-15
<PAGE>
16
Exhibit 13
7. Net Investment Income
Investment income and expenses for the years ended December 31, were as follows.
<TABLE>
<CAPTION>
In millions 1998 1997 1996
<S> <C> <C> <C>
Investment income:
Interest and dividends on
fixed maturities $60.0 $62.0 $69.2
Dividends on equity securities 13.0 20.7 24.2
Interest on short-term investments 2.0 2.8 1.6
Other 3.5 2.1 1.2
--------------------------------------------------------------------------
78.5 87.6 96.2
Investment expenses (1.1) (0.4) (1.0)
Interest relating to Prop 103 - - (5.7)
--------------------------------------------------------------------------------------
Net investment income $77.4 $87.2 $89.5
===================================================================================================================
</TABLE>
8. Underwriting, Acquisition, and Insurance Expenses
Underwriting, acquisition, and insurance expenses for the years ended December
31, were as follows.
<TABLE>
<CAPTION>
In millions 1998 1997 1996
<S> <C> <C> <C>
Commissions $14.6 $15.8 $13.0
General expenses 50.7 45.1 44.3
State assessments 4.4 12.5 2.2
Taxes, licenses, and bureau fees 5.9 6.0 5.2
----------------------------------------------------------------------------
75.6 79.4 64.7
Amortization (deferral) of policy
acquisition costs (0.7) 1.2 (0.6)
--------------------------------------------------------------------------
$74.9 $80.6 $64.1
</TABLE>
===============================================================================
13-16
<PAGE>
17
Exhibit 13
9. BENEFIT PLANS
PENSION The Company sponsors a qualified defined benefit plan and a
non-qualified unfunded supplemental defined benefit plan. The following table
sets forth change in benefit obligation, change in plan assets, weighted-average
assumptions and components of net periodic benefit cost as of December 31 with
respect to the qualified and non-qualified pension plans.
<TABLE>
<CAPTION>
In millions 1998 1997
<S> <C> <C>
CHANGE IN BENEFIT OBLIGATION
Benefit obligation at beginning of year $25.5 $21.9
Service cost 1.7 1.5
Interest cost 1.8 1.6
Plan participant's contributions
Amendments - 0.1
Actuarial gain 2.6 1.1
Benefits paid (1.0) (0.6)
-------------------------------------------------------
Benefit obligation at end of year 30.6 25.6
===================================================================================================================
CHANGE IN PLAN ASSETS
Fair value of plan assets at beginning
of year 30.6 27.1
Actual return on plan assets 2.3 1.7
Employer contribution 0.1 2.4
Plan participants' contributions
Benefits paid (1.0) (0.6)
Fair value of plan assets at end of year 32.0 30.6
===================================================================================================================
Funded status 1.4 5.0
Unrecognized actuarial loss (0.8)(3.0)
Unrecognized prior service cost 1.3 1.4
Unrecognized net transit obligation (0.3)(0.4)
-------------------------------------------------------
Net amount recognized $1.6 $3.0
===================================================================================================================
Amounts recognized in the statement of
Financial position consist of:
Prepaid benefit cost $2.6 $4.0
Accrued benefit liability (1.4) (1.3)
Intangible asset 0.4 0.3
Accumulated other comprehensive income - -
Net amount recognized $1.6 $3.0
</TABLE>
==============================================================================
<TABLE>
<CAPTION>
In millions 1998 1997
<S> <C> <C>
ASSUMPTIONS AS OF DECEMBER 31
Weighted average discount rate 6.5% 7.0%
Long term rate of return on plan assets 6.0% 6.0%
Expected rate of increase in future
compensation levels 4.5% 4.5%
</TABLE>
<TABLE>
<CAPTION>
In millions 1998 1997
<S> <C> <C>
COMPONENTS OF NET PERIODIC BENEFIT COST
Service cost $ 1.7 $ 1.5
Interest cost 1.8 1.6
Expected return on plan assets (1.8) (1.6)
Amortization of:
Transition asset (0.1) (0.1)
Prior service cost 0.2 0.1
Loss (0.2) (0.3)
-----------------------------------------------------
Total (0.1) (0.3)
-------------------------------------------------------
Net periodic benefit cost $ 1.6 $ 1.2
</TABLE>
==============================================================================
13-17
<PAGE>
18
Exhibit 13
The projected benefit obligation, accumulated benefit obligation, and fair value
of plan assets for the pension plan with accumulated benefit obligations in
excess of plan assets were $1.8 million, $1.5 million, and $0 respectively, as
of December 31, 1998 and $1.6 million, $1.3 million, and $0, respectively, as of
December 31, 1997.
STOCK OPTIONS In August 1986, the Board of Directors of Argonaut Group, Inc.
adopted the 1986 Stock Option Plan covering an aggregate 1,500,000 shares of
Argonaut Group, Inc. Common Stock. An amendment to the Plan increasing the
number of shares of common stock issuable under the Plan from 1,500,000 to
2,000,000 was approved on April 23, 1996 at the Company's Annual Meeting. Under
the 1986 Stock Option Plan, options to purchase shares of Argonaut Group, Inc.
common stock may be granted to certain key employees. The options may be
incentive stock options or nonqualified stock options. If incentive options are
granted, the exercise price of the options will be the fair market value of the
shares on the date that the option is granted. The exercise price of
nonqualified stock options to be granted can be below the fair market value of
the shares on the grant date. To date all options granted have been at the fair
market value of the shares on the date of grant, and as such, no compensation
expense has been recognized as accounted for under APB Opinion No. 25. The
options are nontransferable and are exercisable in installments. In October,
1995 the Financial Accounting Standards Board issued Statement of Financial
Accounting Standard No. 123 "Accounting for Stock-Based Compensation" (FAS 123).
As permitted by FAS 123, the Company will not change its method of accounting
for stock options but has provided the additional required disclosures in the
tables below. The additional compensation costs that would have been recorded if
the Company had adopted FAS 123 are not material. At December 31, 1998, 468,140
shares were available for future grant. The options are fully vested after 6
years and expire after 11 years. A summary of the status of the Company's stock
option plan at December 31, 1998, 1997, and 1996 is presented in the table
below.
<TABLE>
<CAPTION>
1998 1997 1996
NumberWeighted-Average NumberWeighted-Average NumberWeighted-Average
of Shares Exercise Price of SharesExercise Price of SharesExercise Price
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of the year1,080,940 $24.63 1,036,170 $23.79 970,860 $22.32
Granted 160,500 34.35 151,900 29.01 168,250 32.86
Exercised (244,400) 12.97 (64,880) 17.84 (43,440) 17.39
Cancelled (99,700) 30.74 (42,250) 30.05 (59,500) 30.23
-------- -------- --------
Outstanding at end of the year 897,340 $28.87 1,080,940 $24.63 1,036,170 $23.79
Exercisable at end of year 416,230 26.20 560,560 19.91 521,040 18.13
Weighted-average fair value of options
granted during the year $ 4.67 $4.26 $ 4.69
</TABLE>
The following table summarizes information about stock options outstanding at
December 31, 1998.
<TABLE>
<CAPTION>
Range of Number Weighted-Average Weighted-Average Number Weighted-Average
Exercise Price Outstanding at Remaining Exercise Price Exercisable Exercise Price
12/31/98 Contractual Life at 12/31/98
<S> <C> <C> <C> <C> <C>
$12.58 to $23.75 112,440 1.98 yrs. $21.16 112,440 $21.16
$26.25 to $35.50 784,900 7.46 yrs. $29.97 303,790 $28.07
------- -------
897,340 416,230
</TABLE>
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions used for grants in 1998, 1997 and 1996, respectively: risk-free
rates of 5.56% and 5.64% for options issued in 1998, 6.32% and 6.73% for options
issued in 1997, and 6.00%, 6.04% and 6.31% for options issued in 1996; expected
dividend yields of 5.43%, 5.10%, and 4.62%; expected lives of 6.00, 6.15, and
5.51 years; and expected volatility of 19.01%, 16.65%, and 15.39%.
EMPLOYEE SAVINGS PLANS Substantially all employees of the Company are eligible
to participate in employee savings plans. Under these plans, a percentage of an
employee's pay may be contributed to various savings alternatives including,
under one plan, investment in the Company's common stock. The plans call for the
Company to match the employee's contribution under various formulae. Charges to
income related to such Company matching were $0.7 million in 1998 and $0.6
million per year in 1997 and 1996.
13-18
<PAGE>
19
Exhibit 13
10. Business Segments
The Company and its subsidiaries are engaged principally in the business of
selling workers compensation and other insurance. The Company's insurance
subsidiaries are authorized to sell a portfolio of workers compensation,
commercial and homeowners multi-peril, automobile liability and physical damage,
medical malpractice, fire, and other lines in all states and the District of
Columbia. On June 30, 1997 the Financial Accounting Standards Board issued
Statement of Financial Accounting Standard ("SFAS") No. 131 "Disclosures About
Segments of an Enterprise and Related Information" effective for fiscal years
beginning after December 15, 1997. In accordance with the selection criteria
established by SFAS 131, the Company has identified and disclosed as business
segments the lines of business considered significant to the company as a whole.
Net pre-tax underwriting loss represents net earned premium less operating
expenses for each segment, and excludes general corporate expenses and other
income and expenses of a general corporate nature. Depreciation, capital
expenditures, and other assets are not identifiable with any particular segment.
Other general corporate assets consist principally of investments (fixed
maturities and equity securities) and receivables (reinsurance, agents balances
and accrued retrospective premiums). There are no major customers from whom the
Company derives 10% or more of its revenue. Information on the Company's
business segments for the years ended December 31 is as follows.
<TABLE>
<CAPTION>
In millions 1998 1997 1996
<S> <C> <C> <C>
Net earned premiums:
Workers compensation $115.6 $140.6 $ 129.5
Other lines 22.9 24.3 32.2
Run off lines - - -
----------------------------------------------------------------------------------------
Net earned premiums $138.5 $164.9 $ 161.7
===================================================================================================================
Pre-tax underwriting income (loss):
Workers compensation $(24.1) $ (20.9) $ (5.3)
Other lines (7.1) (8.7) (124.6)
Run off lines 0.6 2.4 (127.4)
------------------------------------------------------------------------------------
Total pre-tax underwriting (loss) (30.6) (27.2) (257.3)
General corporate expenses (4.5) (3.2) (2.8)
Net investment income 77.4 87.2 89.5
Gains on sales of investments 51.2 4.5 21.6
Provision for income taxes 30.8 12.8 (55.0)
-------------------------------------------------------------------------------------------------------------
Net Income (loss) $ 62.7 $ 48.5 $ (94.0)
</TABLE>
==============================================================================
13-19
<PAGE>
20
Exhibit 13
11. Commitments and Contingencies
Rental expenses for operating leases, principally for offices, were $4.2
million, $4.0 million, and $3.8 million in 1998, 1997, and 1996, respectively.
As of December 31, 1998, future minimum noncancellable operating lease
commitments are as follows: $3.8 million in 1999, $3.6 million in 2000, $2.8
million in 2001, $2.0 million in 2002, $1.7 million in 2003 and thereafter for a
total of $13.9 million. The Company's insurance subsidiaries are members of the
statutorily created insolvency guarantee associations in all states where they
are authorized to transact business. These associations were formed for the
purpose of paying the claims of insolvent companies. The Company is assessed its
pro rata share of such claims based on its premium writings, subject to a
maximum annual assessment per line of insurance. Such costs can generally be
recovered through surcharges on future premiums. The Company does not believe
that assessments on current insolvencies will have a material effect on its
financial condition or results of operations. On August 30, 1996, the Los
Angeles County Metropolitan Transportation Authority (MTA) filed a civil action
against the Company alleging breach of contract, breach of the covenant of good
faith and fair dealing, and requesting ancillary relief in the form of an
accounting, an injunction and restitution in connection with allegations
regarding failures to perform under certain contracts of insurance. The MTA
contends that it has been damaged by an unspecified amount. The Company has
responded to the Complaint, and brought certain counterclaims against the MTA,
and possibly others, in connection with the facts underlying the lawsuit. The
Company believes it has meritorious defenses, and intends to vigorously contest
these claims. The Company is unable, with any degree of certainty, to comment
upon the range of any potential loss, or whether such an outcome is probable or
remote, in light of the lack of any discovery conducted in the case, and the
preliminary investigation conducted thus far. The Company has been sued in
sixteen lawsuits brought on behalf of alleged classes of purchasers of
retrospectively rated workers compensation insurance, alleging that the
defendants, including other compensation insurers, charged the purported class
unlawful premiums. Plaintiffs have threatened to bring similar claims against
the Companies in several other states. The Companies intend to vigorously defend
these lawsuits. Management is unable to determine the potential financial impact
of these lawsuits at this time. The insurance subsidiaries of the Company are
parties to legal actions incidental to their business. Based on the advice of
counsel, management of the Company believes that the resolution of these matters
will not materially affect the Company's financial condition or results of
operations.
13-20
<PAGE>
21
Exhibit 13
12. Run Off Lines
Although the Company has discontinued active underwriting of hospital liability,
medical malpractice liability, and assumed casualty reinsurance, these lines are
in run off status, meaning that the Company is still obligated to pay losses
incurred on policies written in past years. Each of these lines is characterized
by long elapsed periods between the occurrence of a claim and ultimate payment
of the settled claim. The Company has a specialized and dedicated staff to
administer and settle hospital liability and medical malpractice claims. The
following tables present the Company's reserves for losses and loss adjustment
expenses and their underwriting loss, including detailed information for the
years ended December 31.
<TABLE>
<CAPTION>
RESERVES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
In millions 1998 1997 1996
<S> <C> <C> <C>
Run off lines:
Reinsurance assumed $213.0 $217.8 $229.4
Medical malpractice 29.0 54.4 57.8
-------------------------------------------------------------------------------------
242.0 272.2 287.2
Continuing lines 653.9 752.7 871.6
-----------------------------------------------------------
Total reserves $895.9 $1,024.9 $1,158.8
</TABLE>
=============================================================================
<TABLE>
<CAPTION>
UNDERWRITING INCOME (LOSS)
In millions 1998 1997 1996
<S> <C> <C> <C>
Run off lines:
Reinsurance assumed $ (1.3) $ 0.4 $(127.5)
Medical malpractice 1.9 2.0 0.1
--------------------------------------------------------------------------------------
0.6 2.4 (127.4)
Continuing lines (31.2) (29.6) (129.9)
------------------------------------------------------------
Total underwriting loss $(30.6) $(27.2) $(257.3)
</TABLE>
==============================================================================
13. Permitted Statutory Accounting Practices
The Company's insurance subsidiaries prepare their statutory financial
statements in accordance with accounting practices prescribed or permitted by
the insurance departments of the state in which they are domiciled. Prescribed
statutory accounting practices include a variety of publications of the National
Association of Insurance Commissioners ("NAIC"), as well as state laws,
regulations, and general administrative rules. Permitted statutory accounting
practices encompass all accounting practices not so prescribed but which the
appropriate regulatory agency has allowed in practice. The Company's insurance
subsidiaries do not apply any permitted statutory accounting practices, which
individually or in the aggregate materially affect statutory surplus or
risk-based capital.
13-21
<PAGE>
22
Exhibit 13
Quarterly Financial Data - unaudited
The following table represents unaudited quarterly financial data for the years
ended December 31, 1998 and 1997. In the opinion of management, all adjustments
necessary to present fairly the results of operations for such periods have been
made. Total revenues and net income include gains on the sale of investments.
The Company cannot anticipate when or if similar gains may occur in the future.
Since financial results rely heavily on estimates, caution should be used in
drawing specific conclusions from quarterly consolidated results.
<TABLE>
<CAPTION>
In millions except per share amounts Three Months Ended
March 31 June 30 Sept. 30 Dec. 31
<S> <C> <C> <C> <C>
1998
Total revenues $98.0 $56.3 $ 60.4 $ 52.4
Underwriting loss (7.6) (5.0) (10.5) (7.5)
Net income 36.7 8.8 10.4 6.8
Net income per
common share
Basic* 1.54 0.37 0.43 0.28
Diluted* 1.52 0.36 0.43 0.28
Comprehensive income 23.5 14.5 14.1 19.6
1997
Total revenues $67.9 $60.7 $ 60.3 $ 67.7
Underwriting loss (0.1) (4.7) (10.0) (12.4)
Net income 15.5 12.8 9.3 10.9
Net income per common
share
Basic* 0.65 0.54 0.39 0.46
Diluted* 0.65 0.53 0.39 0.45
Comprehensive income 9.1 43.6 29.1 7.8
</TABLE>
*Basic and diluted earnings per share are computed independently for each
quarter and the full year based on the respective average number of common
shares outstanding; therefore, the sum of the quarterly net income per share
data may not equal the net income per share for the year.
Common Stock Market Prices - unaudited
The following table shows the high, low, and closing prices during each quarter
in the past two years.
<TABLE>
<CAPTION>
Quarter Ended March 31 June 30 Sept. 30 Dec. 31
<S> <C> <C> <C> <C>
1998
High 37 1/2 37 33 1/8 27 7/8
Low 31 30 24 21 1/4
Close 36 1/8 31 5/8 25 1/2 24 1/2
1997
High 31 1/2 31 3/8 36 3/8 38 1/8
Low 27 1/4 26 3/4 29 1/2 29 5/8
Close 28 29 1/2 34 7/8 33 7/8
</TABLE>
13-22
<PAGE>
23
Exhibit 13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF
OPERATIONS AND FINANCIAL CONDITION
RESULTS OF OPERATIONS Earned premium income decreased to $138.5 million for the
year ended December 31, 1998, from $164.9 million in 1997, and from $161.7
million recorded in 1996. This decline resulted in part from significant rate
decreases over the past several years, and from the Company's unwillingness to
compete against unrealistic pricing in the marketplace, which has continued to
affect underwriting results. Premiums were also impacted, by discontinuing
workers compensation coverage for businesses providing temporary or leased
employees; the reduction in mid-market workers compensation accounts at Argonaut
Great Central; and the increase in premiums ceded to reinsurers for providing
increased coverage in 1998. The impact of large deductible programs on inforce
premium remained virtually the same as 1997 at $95.3 million. Net investment
income was $77.4 million, $87.2 million, and $89.5 million for 1998, 1997, and
1996, respectively. Lower interest rates, some restructuring of the investment
portfolio, and negative cash flow related to claims payments on run off lines of
business contributed to the decrease. Pre-tax gains on sales of investments were
$51.2 million, $4.5 million, and $21.6 million for 1998, 1997, and 1996,
respectively. The 1998 gain resulted primarily from the call of Navistar
International Series D preferred stock and from resolution of class action
litigation related to investment trades in prior years. The 1996 gain resulted
primarily from Federal Paper Board's sale to International Paper for a
combination of cash and International Paper stock. We cannot anticipate when or
if similar gains or losses may occur in the future. Losses and loss adjustment
expenses were $95.1 million, $112.8 million and $346.2 million in 1998, 1997,
and 1996, respectively. 1996 results were substantially affected by a $229
million increase of loss reserves, principally relating to certain liability and
reinsurance policies written in the 1970s. The Company's loss ratio, including
our run off lines of business, was 69% in 1998, 68% in 1997, and 214% in 1996.
The loss ratio in our workers compensation line of business was 65% in 1998 and
1997, and 63% in 1996. The loss ratio in other continuing lines of business was
87%, 94%, and 427% in 1998, 1997, and 1996, respectively. In the opinion of
management, the Company's reserves represent the Company's best estimate of its
ultimate liabilities, based on currently known facts, current law, current
technology, and assumptions considered reasonable where facts are not known. Due
to significant uncertainties and related management judgments, however, there
can be no assurance that future loss development, favorable or unfavorable, will
not occur. Underwriting expenses totaled $74.9 million in 1998, $80.6 million in
1997, and $64.1 million in 1996. Underwriting expenses are composed of four
components: general expenses, commissions, premium taxes, and state fees and
assessments. The $5.7 million decrease results from lower commissions and taxes
on the decreased premiums. General expenses increased in 1998, however, from
non-recurring costs for upgrading systems for Year 2000 compliance, and costs
related to the review of strategic alternatives and the related employee
retention plan. Policyholder dividend expense (recapture) was $0.8 million in
1998, $(0.9) million in 1997, and $8.7 million in 1996. These charges reflect
the loss experience of participating policyholders, the basis for dividend
payments. Particularly in California, with the advent of open rating in 1995,
fewer participating policies are being written. After-tax income from operations
was $62.7 million in 1998 compared with income of $48.5 million in 1997, and an
operating loss of $94.0 million in 1996. Operations for the current year were
impacted primarily by the realized gain from investments discussed above. The
after-tax loss in 1996 was a result of the strengthening of loss reserves
discussed above.
13-23
<PAGE>
24
Exhibit 13
LIQUIDITY AND CAPITAL RESOURCES The Company's insurance subsidiaries require a
significant degree of liquidity and adequate capital to meet ongoing obligations
to policyholders and claimants, and to cover ordinary operating expenses. During
the three years ended December 31, 1998, the Company generated sufficient
capital from operating and investment income to meet all of its obligations. The
Company maintains adequate levels of liquidity and surplus capacity to manage
the risks inherent with any differences between the duration of its liabilities
and invested assets. Management believes that the Company continues to maintain
sufficient liquidity to pay claims and expenses, as well as to cover unforeseen
events such as reinsurer insolvencies, inadequate premium rates, or reserve
deficiencies. In addition to its investment portfolio, subsidiaries of Argonaut
Group also own real property for use as Home Office facilities for Argonaut
Insurance Company and Argonaut Great Central, as well as three commercial
properties in California. These real properties are included in "Other Assets"
at $5.2 million, their original cost less accumulated depreciation. The market
value for these properties is estimated at between $75 and $95 million. Under
provisions of the California Insurance Code, there is a maximum amount of
dividends which can be paid without prior approval of the Insurance
Commissioner. Under these provisions, as of December 31, 1998, Argonaut
Insurance could pay to Argonaut Group, Inc. a maximum dividend of $20.5 million
without the Insurance Commissioner's approval. During 1998, Argonaut Insurance
paid the Company dividends of $40.5 million. The quarterly dividend for 1998 was
$0.41 per common share. During 1998, total cash dividends paid by the Company to
its shareholders were $1.64 per share. On July 27, 1989, the Argonaut Group
Board of Directors authorized the repurchase of up to six million shares of its
outstanding common stock, of which 5,390,213 have been reacquired to date. It is
presently expected that dividends received from the Company's subsidiaries will
be the primary source of funds for the stock repurchase program and to meet any
other capital requirements the Company may develop.
NEW ACCOUNTING STANDARDS In February 1998, the Financial Accounting Standards
Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No.
132, "Employers' Disclosures about Pensions and Other Postretirement Benefits,"
which amended FASB Statements No. 87, 88, and 106 and revised the disclosure
requirements for pensions and other postretirement benefits. In 1997, the FASB
issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information", which establishes new requirements on the reporting of information
about operating segments, products and services, geographic area and major
customers, and, SFAS No. 130, "Reporting Comprehensive Income", which
establishes standards for reporting and display of comprehensive income and its
components. Comprehensive income includes all changes in equity during a period
except those resulting from investments by owners and distributions to owners.
The Company has implemented SFAS No. 132, 131, and 130 for the year ended
December 31, 1998. Statement of Position ("SOP") 97-3, Accounting by Insurance
and Other Enterprises for Insurance-Related Assessments was also issued in 1997.
The Company's required adoption date is January 1, 1999. The Company does not
anticipate SOP 97-3 to have an impact on its results of operations or financial
position. SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities, was issued on June 16, 1998. The Company's required adoption date is
January 1, 2000. The Company does not anticipate SFAS No. 133 to have an impact
on its results of operations or financial position.
13-24
<PAGE>
25
Exhibit 13
YEAR 2000 On October 19, 1998, the Year 2000 Information and Readiness
Disclosure Act ("Y2K Act")(Pub. L. No.
105-271, 12 Stat. 2386 (1998) to be codified at 15 U.S.C. ss. 1) was enacted
into law by President Clinton. The following disclosure is defined by section
3(9) of the Y2K Act. The Company established a Year 2000 project team in
November of 1996 to prepare its computer hardware, operating system software,
computer programs, and voice
and data communications to address Year 2000 compliance and remediation issues.
The Company's external Year 2000 plan covers the information exchange process
with vendors and business partners, and includes validating and testing the
readiness of its outsource data center service providers. It is the opinion of
management that as of April 30, 1998, the Company's client server policy
management, policy rating and claims processing systems are Year 2000 compliant.
These computer systems use a four-position field to store and process all dates.
In addition, it is the opinion of management that effective September 30, 1998,
the Company's mission critical mainframe legacy systems have been remediated to
process dates beyond the Year 2000. The Company has completed testing its
mission critical business processing client server and mainframe legacy systems,
computer hardware, computer infrastructure systems software and office
automation software to assure continuity of service beyond the Year 2000. The
Company will continue the testing of non-mission critical user systems and
validating the above mission critical systems for Year 2000
compliance/remediation into 1999. The Company will prepare a contingency plan
that will include a designated team to resolve any unforeseen problems that
arise beyond the Year 2000. The total project cost is estimated to be
approximately $4.4 million. All costs associated with the project have been
expensed as incurred.
13-25
<PAGE>
1
Exhibit 23
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation by
reference in this Form 10-K and into the Company's previously filed Registration
Statement File No. 33-12034 and 33-31547, of our report dated January 7, 1999,
included in Argonaut Group, Inc.'s 1998 Annual Report to Shareholders. It should
be noted that we have not audited any consolidated financial statements of the
Company subsequent to December 31, 1998 or performed any audit procedures
subsequent to the date of our report.
ARTHUR ANDERSEN LLP
San Francisco, California
March 12, 1999
<TABLE> <S> <C>
<ARTICLE> 7
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<DEBT-HELD-FOR-SALE> 943
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 409
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 1,373
<CASH> 25
<RECOVER-REINSURE> 23
<DEFERRED-ACQUISITION> 5
<TOTAL-ASSETS> 1,781
<POLICY-LOSSES> 896
<UNEARNED-PREMIUMS> 37
<POLICY-OTHER> (3)
<POLICY-HOLDER-FUNDS> 40
<NOTES-PAYABLE> 0
0
0
<COMMON> 2
<OTHER-SE> 752
<TOTAL-LIABILITY-AND-EQUITY> 1,781
139
<INVESTMENT-INCOME> 77
<INVESTMENT-GAINS> 51
<OTHER-INCOME> 0
<BENEFITS> 95
<UNDERWRITING-AMORTIZATION> (1)
<UNDERWRITING-OTHER> 76
<INCOME-PRETAX> 94
<INCOME-TAX> 31
<INCOME-CONTINUING> (31)
<DISCONTINUED> 1
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 63
<EPS-PRIMARY> 3
<EPS-DILUTED> 3
<RESERVE-OPEN> 1,025
<PROVISION-CURRENT> 128
<PROVISION-PRIOR> (14)
<PAYMENTS-CURRENT> 46
<PAYMENTS-PRIOR> 197
<RESERVE-CLOSE> 896
<CUMULATIVE-DEFICIENCY> 19
</TABLE>
