<PAGE> 1
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 0-25984
=========
SUPERIOR NATIONAL INSURANCE GROUP, INC.
(Exact name of registrant as specified in its charter)
CALIFORNIA 95-3994873
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
26601 AGOURA ROAD
CALABASAS, CA 91302
(Address of principal executive offices)
(818) 880-1600
(Registrant's telephone number, including area code)
==========
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
--- ---
Number of shares of Common Stock, without par value, outstanding as of
close of business on August 5, 1996: 3,432,723 shares.
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<PAGE> 2
SUPERIOR NATIONAL INSURANCE GROUP, INC.
INDEX TO FORM 10-Q
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed consolidated balance sheets as of
June 30, 1996 (unaudited) and December 31, 1995....................................... 3
Condensed consolidated statements of income for the three and six months ended
June 30, 1996 (unaudited) and June 30, 1995 (unaudited)............................... 4
Condensed consolidated statement of changes in shareholders' equity
for the six months ended June 30, 1996 (unaudited).................................... 5
Condensed consolidated statements of cash flows for the six months ended
June 30, 1996 (unaudited) and June 30, 1995 (unaudited)............................... 6
Notes to condensed consolidated financial statements (unaudited)............................... 7
Item 2. Management's Discussion and Analysis of Consolidated Financial Condition and
Results of Operations.......................................................................... 8
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K................................................................ 16
SIGNATURE........................................................................................................ 17
EXHIBIT INDEX.................................................................................................... 18
</TABLE>
<PAGE> 3
SUPERIOR NATIONAL INSURANCE GROUP, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
<TABLE>
<CAPTION>
June 30, December 31,
ASSETS 1996 1995
----------- ------------
(Unaudited) (*)
<S> <C> <C>
Investments:
Bonds and notes:
Available-for-sale, at market
(cost: 1996, $52,384; 1995, $41,800) $ 51,543 $ 42,053
Equity securities, at market
Common stock (cost: $686; 1996 and 1995) 643 689
Funds withheld from reinsurers, at amortized cost
Bonds and notes, at amortized cost
(market: 1996, $84,954; 1995, $117,073) 87,359 114,921
Invested cash (certificates of deposit and other short-
term instruments) 1,624 --
Invested cash (certificates of deposit and other
short-term instruments) 11,994 6,045
Restricted investment 1,580 1,700
-------- --------
TOTAL INVESTMENTS 154,743 165,408
Cash (Restricted cash: 1996, $1,030; 1995, $2,686) 2,290 2,952
Reinsurance receivable 32,054 38,892
Premiums receivables (less allowance for doubtful
accounts: 1996, $300; 1995, $500) 15,513 14,724
Deferred policy acquisition costs 3,062 2,780
Income taxes 9,847 10,085
Other assets 9,530 9,501
-------- --------
TOTAL ASSETS $227,039 $244,342
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Claims and claim adjustment expenses $122,650 $140,774
Unearned premiums 9,633 10,220
Long-term debt 7,930 8,530
Policyholder dividends 6,187 8,094
Repurchase transaction 3,553 --
Accounts payable and other liabilities 10,883 12,199
-------- --------
TOTAL LIABILITIES 160,836 179,817
PREFERRED SECURITIES ISSUED BY AFFILIATE;
authorized 1,100,000 shares; issued and outstanding
966,860 shares in 1996 and 922,137 shares in 1995 22,272 21,045
Shareholders' Equity:
Common stock, no par value; authorized
25,000,000 shares; issued and outstanding
3,430,373 shares in 1996 and 1995 15,943 15,943
Unrealized gain (loss) on investments, net of taxes (584) 169
Paid in capital - warrants 2,206 2,206
Retained earnings 26,366 25,162
-------- --------
TOTAL SHAREHOLDERS' EQUITY 43,931 43,480
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $227,039 $244,342
======== ========
</TABLE>
* Derived from audited financial statements
See Notes to Condensed Consolidated Financial Statements.
3
<PAGE> 4
SUPERIOR NATIONAL INSURANCE GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ----------------------
1996 1995 1996 1995
------- ------- ------- -------
<S> <C> <C> <C> <C>
REVENUES:
Premiums written, net of reinsurance ceded $24,153 $21,689 $42,796 $46,251
(Increase) decrease in net unearned
premiums (17) 631 237 (697)
------- ------- ------- -------
Net premiums earned 24,136 22,320 43,033 45,554
Net investment income 2,074 2,034 4,265 4,800
------- ------- ------- -------
TOTAL REVENUES 26,210 24,354 47,298 50,354
EXPENSES:
Claims and claim adjustment expenses,
net of reinsurance recoveries 12,325 7,608 22,600 23,842
Commissions, net of reinsurance
commissions 2,783 3,251 5,258 6,208
Policyholder dividends (1,705) (3,801) (1,406) (3,178)
Interest expense 2,268 2,786 4,796 4,876
General and administrative expenses
Underwriting 9,652 4,273 13,377 7,585
Other (519) 150 (389) 256
------- ------- ------- -------
TOTAL EXPENSES 24,804 14,267 44,236 39,589
------- ------- ------- -------
INCOME BEFORE INCOME TAXES AND PREFERRED
SECURITIES DIVIDENDS AND ACCRETION AND
DISCONTINUED OPERATIONS 1,406 10,087 3,062 10,765
Income tax expense (benefit) 475 (530) 1,048 (340)
------- ------- ------- -------
INCOME BEFORE PREFERRED SECURITIES
DIVIDENDS AND ACCRETION AND DISCONTINUED
OPERATIONS 931 10,617 2,014 11,105
Preferred securities dividends and
accretion, net of income taxes (405) (361) (810) (723)
Loss from operation of discontinued
property and casualty operations, net of
income taxes -- (9,842) -- (9,842)
------- ------- ------- -------
NET INCOME $ 526 $ 414 $ 1,204 $ 540
======= ======= ======= =======
EARNINGS PER COMMON AND DILUTIVE
COMMON EQUIVALENT SHARES:
INCOME BEFORE PREFERRED SECURITIES
DIVIDENDS AND ACCRETION, AND
DISCONTINUED OPERATIONS $ 0.20 $ 3.10 $ 0.42 $ 3.24
Preferred securities dividends and accretion (0.08) (0.11) (0.15) (0.21)
Loss from discontinued property and
casualty operations -- (2.87) -- (2.87)
------- ------- ------- -------
NET INCOME $ 0.12 $ 0.12 $ 0.27 $ 0.16
======= ======= ======= =======
</TABLE>
See notes to condensed Consolidated Financial Statements.
4
<PAGE> 5
SUPERIOR NATIONAL INSURANCE GROUP, INC.
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(Amounts in thousands)
(Unaudited)
<TABLE>
<CAPTION>
Total
Net Unrealized Paid in Share-
Common Gain (loss) on Capital- Retained holders'
Stock Investments Warrants Earnings Equity
-----------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1995 $15,943 $ 169 $2,206 $25,162 $43,480
Net income -- -- -- 1,204 1,204
Change in unrealized gain
(loss) on investments, net
of taxes -- (753) -- -- (753)
----------------------------------------------------------------
Balance at June 30, 1996 $15,943 $(584) $2,206 $26,366 $43,931
================================================================
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
5
<PAGE> 6
SUPERIOR NATIONAL INSURANCE GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
(Unaudited)
<TABLE>
<CAPTION>
Six Months Ended June 30,
------------------------
1996 1995
-------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,204 $ 540
-------- --------
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Amortization of bonds and preferred stock (386) (1,898)
(Gain)/loss on sale of investments (21) 469
(Gain) on sale of funds withheld investments (2,424) (203)
Preferred securities dividends and accretion 1,227 1,095
Decrease in reinsurance receivables 6,838 15,540
(Increase) decrease in premiums receivables (789) 5,297
(Increase) in deferred policy acquisition costs (282) (734)
Decrease (increase) in income taxes 626 (4,065)
(Decrease) in claims and claim adjustment
expense reserves (18,124) (14,678)
(Decrease) increase in unearned premium reserves (587) 471
(Decrease) in policyholder dividends payable (1,907) (5,143)
(Decrease) in discontinued operations -- (4,223)
(Decrease) in other liabilities, net of other assets (1,345) (129)
-------- --------
Total adjustments (17,174) (8,201)
-------- --------
Net cash (used in) operating activities (15,970) (7,661)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Retirement of long-term debt (600) (600)
Proceeds from repurchase transaction 3,553 --
-------- --------
Net cash provided by (used in) financing activities 2,953 (600)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of bonds and notes:
Investments available-for-sale (28,960) (3,436)
Investment funds withheld from reinsurers (67,428) (27,631)
Investments allocated to discontinued operations -- (1,581)
Sales of bonds and notes: Investments available-for-sale 17,363 13,985
Maturities of bonds and notes: Investments available-for sale 798 201
Sales and maturities of bonds and notes:
Funds withheld from reinsurers 98,011 33,221
Net (increase) in invested cash (5,805) (5,942)
Net (increase) in invested cash for funds withheld from
reinsurers (1,624) --
-------- --------
Net cash provided by investing activities 12,355 8,817
-------- --------
Net increase (decrease) in cash (662) 556
Cash at beginning of period 2,952 2,533
-------- --------
Cash at end of period $ 2,290 $ 3,089
======== ========
Supplemental disclosure of cash flow information:
Cash paid during the year for income taxes $ 4 $ 4
======== ========
Cash paid during the year for interest $ 331 $ 441
======== ========
</TABLE>
See Notes to Condensed Consolidated Financial Statements
6
<PAGE> 7
SUPERIOR NATIONAL INSURANCE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE SIX MONTHS ENDED JUNE 30, 1996
(UNAUDITED)
NOTE A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A.1 BASIS OF PRESENTATION
Superior National Insurance Group, Inc. ("SNIG") is a holding company
that, through its wholly-owned subsidiary, Superior National Insurance Company
("SNIC"), is engaged in writings workers' compensation insurance principally in
the State of California, and until September 30, 1993, was engaged in writing
commercial property and casualty insurance. The "Company" refers to SNIG and its
subsidiaries.
The accompanying unaudited condensed consolidated financial statements
of the Company have been prepared in accordance with generally accepted
accounting principles for interim financial information and with the
instructions to Form 10-Q and Article 10 of regulation S-X. Accordingly, they do
not include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. In the opinion of
management, all adjustments, including normally occurring accruals, considered
necessary for a fair presentation have been included. Certain reclassifications
of prior year amounts have been made to conform with the 1996 presentation.
Operating results for the six months ended June 30, 1996 are not necessarily
indicative of the results to be expected for the year ended December 31, 1996.
For further information, refer to the consolidated financial statements and
footnotes thereto included in SNIG's annual report on Form 10-K for the year
ended December 31, 1995.
A.2 EARNINGS PER SHARE ("EPS")
Earnings per common and dilutive common equivalent shares for the three
and six months ended June 30, 1996 and 1995 are based on the average number of
common shares outstanding during each period and assuming conversion of all
stock options and warrants which are common stock equivalents. Common share
equivalents included in the computation represent shares issuable upon assumed
exercise of stock options and warrants which would have a dilutive effect. If
the calculation of income per share including all common stock equivalents is
antidilutive, such common stock equivalents are excluded from the EPS amounts.
The number of shares used in the EPS calculations are 5,318,118 shares for the
three and six months ended June 30, 1996; and 3,429,873 shares for the three and
six months ended June 30, 1995.
A.3 CLAIMS AND CLAIM ADJUSTMENT EXPENSES RESERVES
The liability for unpaid claims and claim adjustment expenses is based
on an evaluation of reported losses and on estimates of incurred but unreported
losses. The reserve liabilities are determined using adjusters' individual case
estimates and statistical projections, which can be affected by many external
factors that are difficult to predict, including changes in the economy, trends
in medical treatments and litigation, changes in regulatory environment, medical
services, and employment rights. The liability is reported net of estimated
salvage and subrogation recoverable. Adjustments to the liability resulting from
subsequent developments or revisions to the estimate are reflected in results of
operations in the period which such adjustment become known. While there can be
no assurance that reserves at any given date are adequate to meet SNIG's
obligations, the amounts reported on the balance sheet are management's best
estimate of that amount.
7
<PAGE> 8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS:
The following selected financial data and analysis provide an
assessment of SNIG's financial results for the three months ended June 30, 1996
as compared to the three months ended June 30, 1995. Certain prior period
amounts have been reclassified to conform to the current period presentation.
Selected financial data as reported for the three months ended June 30, 1996 and
1995 are presented below.
<TABLE>
<CAPTION>
Three Months Ended June 30,
---------------------------
(Dollars in thousands) 1996 1995
--------- -------
<S> <C> <C>
Gross premiums written $ 26,344 $23,539
Net premiums written $ 24,153 $21,689
Net premiums earned $ 24,136 $22,320
Less: Net claims and claim adjustment expenses (12,325) (7,608)
Underwriting expenses (12,435) (7,524)
Policyholder dividends 1,705 3,801
-------- -------
Underwriting profit 1,081 10,989
Net investment income 2,053 2,479
Net investment gains (losses) 21 (445)
Interest expense (2,268) (2,786)
Other 519 (150)
-------- -------
Income before income taxes 1,406 10,087
Income tax expense (benefit) 475 (530)
-------- -------
Income before preferred securities dividends and
accretion and discontinued operations 931 10,617
Preferred securities dividends and accretion, net of taxes (405) (361)
Loss from operation of discontinued property and
casualty, net of taxes - (9,842)
-------- -------
Net Income $ 526 $ 414
======== =======
Underwriting ratios (GAAP Basis):
Net claims and claim adjustment expense ratio 51.1 % 34.1 %
Underwriting expense ratio 51.5 % 33.7 %
Policyholder dividends ratio (7.1)% (17.0)%
-------- -------
Combined ratio 95.5 % 50.8 %
======== =======
</TABLE>
8
<PAGE> 9
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Gross premiums written increased $2.8 million or 12% in the second
quarter of 1996 as compared to the same period in 1995. The increase was
encouraging as this may indicate workers' compensation rates are beginning to
stabilize after almost two years of intense price competition. The competitive
market conditions were brought on by California's elimination of its minimum
rate law in favor of an open rating system effective January 1, 1995. While,
estimated annual premium increased 12% in the second quarter of 1996 as compared
to the same period in 1995, production measured in policy counts associated with
those premiums increased 29%. The Company is continuing to make strenuous
efforts to increase production, subject to the constraints of sound underwriting
standards, and to reduce the Company's fixed and semi-fixed expense ratios
commensurate with premium levels.
Net premiums written increased $2.5 million or 11% in the second
quarter of 1996. The increase in net premiums written is reflective of the
increase in gross premiums written as discussed above.
Net premiums earned increased $1.8 million or 8% in the second quarter
of 1996. The increase in net premiums earned reflects the increase in net
premiums written described above.
Net claims and claim adjustment expenses increased $4.7 million or 62%
in the second quarter of 1996 due primarily to a $6 million favorable
development adjustment recorded in the second quarter of 1995. The net claims
and claim adjustment expense ratio increased 17.0 percentage points to 51.1% in
the second quarter of 1996 from 34.1% in the same period in 1995. During the
second quarter of 1995, the Company recognized $6 million of favorable workers'
compensation reserve development on accident years prior to 1995, as a result of
continued decreases in the Company's estimates of frequency and severity of
claims incurred for those years. The net claims and claim adjustment expense
ratio for the second quarter of 1995, excluding the $6 million favorable
development, was 61.0% compared to 51.1% for the same period in 1996. The 9.9
percentage points improvement in the second quarter of 1996 was due primarily to
improved net claims and claim adjustment expense margins on the 1996 accident
year.
Underwriting expenses, excluding policyholder dividends, increased $4.9
million or 65% in the second quarter of 1996 as compared to the same period in
1995. The increase was due primarily to a $5.3 million adjustment recorded in
the second quarter of 1996 for accrued costs related to the settlement of funds
withheld amounts associated with a reinsurance contract. Underwriting expenses
for the second quarter of 1996, excluding the $5.3 million in accrued costs,
were $7.1 million as compared to $7.5 million for the same period in 1995. The
underwriting expense ratio, excluding the $5.3 million in accrued costs,
improved 4.3 points to 29.4% for the second quarter of 1996 from 33.7% for the
corresponding period in 1995 due primarily to increased premium production.
General and administrative expenses for the second quarter of 1996 were
comparable to the corresponding period in 1995.
Policyholder dividends reductions in the second quarter of 1996
increased income by $1.7 million as compared to $3.8 million for the same period
in 1995. Prior to open rating, policyholder dividends served both as an economic
incentive to employers for safe operations and as a means of price
differentiation. As a result of consumers' preference for the lowest net price
at the policy's inception under open rating, dividends are no longer a
significant factor in the marketing of workers' compensation insurance in
California. Consequently, the Company has adjusted its policyholder dividends
reserves downward by $2.0 million in the second quarter of 1996 and $3.1 million
in the corresponding period of 1995.
Underwriting profit from continuing operations decreased $9.9 million
to $1.1 million in the second quarter of 1996 from $11.0 million in the same
period in 1995. The change in underwriting results for the second quarter of
1996 is attributable to a $6 million decrease in workers' compensation reserves
and $3.1 million reduction in policyholder dividends recorded in the second
quarter of 1995. The underwriting results for the second quarter of 1996 also
included $5.3 million in accrued costs related to the settlement of funds
withheld amounts associated with a reinsurance contract, which was partially
offset by a $2.0 million reduction in policyholder dividends reserves.
Underwriting profits for the second quarter of 1996 and 1995, excluding the
9
<PAGE> 10
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
adjustments discussed above, were $4.4 million and $1.9 million, respectively.
The improvement of $2.5 million in the second quarter of 1996 was due primarily
to improved net claims and claim adjustment expense margins on the 1996 accident
year. The improved underwriting results in 1996, also reflect the Company's
focus on maintaining underwriting margins by controlling writings that are not
within the Company's underwriting guidelines, curtailing writings in
unprofitable agencies, and emphasizing loss control management.
Net investment income decreased $0.4 million or 17% in the second
quarter of 1996 compared to the same period in 1995. The decrease in net
investment income is due to a decrease in the average investable assets of $12.7
million, and a decline in the average portfolio investment yield as a result of
generally lower market interest rates in the second quarter of 1996, as compared
to the same period in 1995.
Interest expense for the second quarter of 1996 was $2.3 million as
compared to $2.8 million for the same period in 1995. The decrease of $0.5
million was a result of lower interest expense due to declining funds withheld
balances and declining bank term loan as a result of principal paydown.
10
<PAGE> 11
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Selected financial data as reported for the six months ended June 30, 1996 and
1995 are presented below.
<TABLE>
<CAPTION>
Six Months Ended June 30,
-------------------------
(Dollars in thousands) 1996 1995
-------- --------
<S> <C> <C>
Gross premiums written $ 47,129 $ 49,882
Net premiums written $ 42,796 $ 46,251
Net premiums earned $ 43,033 $ 45,554
Less: Net claims and claim adjustment expenses (22,600) (23,842)
Underwriting expenses (18,635) (13,793)
Policyholder dividends 1,406 3,178
Underwriting profit 3,204 11,097
-------- --------
Net investment income 4,244 5,269
Net investment gains (losses) 21 (469)
Interest expense (4,796) (4,876)
Other 389 (256)
-------- --------
Income before income taxes 3,062 10,765
Income tax expense (benefit) 1,048 (340)
-------- --------
Income before preferred securities dividends and accretion 2,014 11,105
and discontinued operations
Preferred securities dividends and accretion, net of taxes (810) (723)
Loss from operation of discontinued property and
casualty, net of taxes - (9,842)
-------- --------
Net Income $ 1,204 $ 540
======== ========
Underwriting ratios (GAAP Basis):
Net claims and claim adjustment expense ratio 52.5 % 52.3 %
Underwriting expense ratio 43.3 % 30.3 %
Policyholder dividends ratio (3.3)% (7.0)%
-------- --------
Combined ratio 92.5 % 75.6 %
======== ========
</TABLE>
Gross premiums written decreased $2.8 million or 6% in the first six
months of 1996 as compared to the same period in 1995. Although premiums written
for the second quarter of 1996 were higher than the prior year as addressed in
the "Results of Operations - Three months ended June 30, 1996 and 1995" section,
the premium shortfall of $5.6 million during the first quarter of 1996 as
compared to the prior year quarter, caused the year-to-date premiums for 1996 to
fall below last year's level. The decrease was expected as a result of the lack
of mandated rates due to the replacement of California's minimum rate law by an
open rating system effective January 1, 1995. The competitive market conditions
have been further intensified by certain carriers who are willing to underwrite
business at rates that in management's opinion are inadequate. For the six
months ended June 30, 1996, estimated annual premium decreased 5% as compared to
the corresponding period in 1995, but production measured in policy counts
associated to those premiums increased by 23%. The Company's average policy size
decreased 27% to $9,481 as of June 1996 from $13,020 as of June 1995. While, it
appears the decline in premium volume has reversed; because of continued
volatility of premium pricing, regulatory changes, or
11
<PAGE> 12
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
changes in competition; it is uncertain whether this stabilization of premium
rates will be continued. The Company chooses not to sacrifice margin and
shareholder return for the sake of market share, and the Company will remain
cautious in its premium production consistent with its disciplined underwriting
philosophy. The Company will remain focused on small to medium size customers
employing a pricing strategy adequate to produce a reasonable profit. SNIC
believes the rates it has filed with the Department of Insurance (the "DOI") are
adequate, but it is unable to predict the degree to which such rates are
competitive in the marketplace given the intense competition among insurers.
Net premiums written decreased $3.5 million or 7% in the first six
months of 1996. The decrease in net premiums written is reflective of the
decrease in gross premiums written as discussed above.
Net premiums earned decreased $2.5 million or 6% in the first six
months of 1996. The decrease in net premiums earned reflects the decrease in net
premiums written described above.
Net claims and claim adjustment expenses decreased $1.2 million or 5%
to $22.6 million in the first six months of 1996 from $23.8 million in the same
period in 1995. The net claims and claim adjustment expense ratio increased to
52.5% in the first six months of 1996 from 52.3% in the same period of 1995.
However, the 1995 claims and claim adjustment expenses include a $6 million
decrease in the estimated ultimate claims and claim adjustment expenses on
accident years prior to 1995 as a result of continued decreases in Company's
estimates of frequency and severity of claims incurred for those years. The net
claims and claim adjustment expense ratio, excluding the $6 million favorable
development, was 65.5% for the six months ended June 1995, as compared to 52.5%
for the same period in 1996. The 13.0 percentage point improvement in 1996 was
due primarily to improved net claims and claim adjustment expense margins on the
1996 accident year.
Underwriting expenses, excluding policyholder dividends, increased $4.8
million or 35% in the first six months of 1996 as compared to the same period in
1995. The increase was due primarily to a $5.3 million adjustment recorded in
the second quarter of 1996 for accrued costs related to the settlement of funds
withheld amounts associated with a reinsurance contract. Underwriting expenses
for the first six months of 1996, excluding the $5.3 million in accrued costs,
were $13.3 million as compared to $13.8 million for the same period in 1995. The
underwriting expense ratio, excluding the $5.3 million in accrued costs,
increased to 30.9% in the first six months of 1996 from 30.3% for the
corresponding period in 1995, due primarily to a decrease in premium production
without a commensurate decrease in general and administrative expenses.
Policyholder dividends reductions in the first six months of 1996
increased income by $1.4 million as compared to $3.2 million for the same period
in 1995. Prior to open rating, policyholder dividends served both as an economic
incentive to employers for safe operations and as a means of price
differentiation. As a result of consumers' preference for the lowest net price
at the policy's inception under open rating, dividend paying is no longer a
significant factor in the marketing or selling of workers' compensation
insurance in California. Consequently, the Company has adjusted its policyholder
dividends reserves downward by $2.0 million in the first six months of 1996 and
$3.1 million in the corresponding period of 1995. The Company is continuing to
observe, analyze and react to the issue of policyholder dividends in the context
of varying pricing philosophies emerging from open rating.
Underwriting profit from continuing operations decreased $7.9 million
to $3.2 million in the first six months of 1996 from $11.1 million in the same
period in 1995. The change in underwriting results for the first six months of
1996 is attributable to a $6 million decrease in workers' compensation reserves
and $3.1 million reduction in policyholder dividends recorded in the first six
months of 1995. The underwriting results for the first six months of 1996 also
included $5.3 million in accrued costs related to the settlement of funds
withheld amounts associated with a reinsurance contract, which was partially
offset by a $2 million reduction in policyholder dividends reserves.
Underwriting profits for the six months ended June 1996 and 1995, excluding the
above discussed adjustments, were $6.5 million and $2.0 million, respectively.
The improvement of $4.5 million in the first six months of 1996 is due primarily
to improved net claims and claim adjustment expense margins on the 1996 accident
year. The improved underwriting results also reflect the Company's focus on
maintaining underwriting margins by controlling writings that are not within the
Company's underwriting guidelines, curtailing writings in unprofitable agencies,
and emphasizing loss control management.
12
<PAGE> 13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Net investment income decreased $1.0 million or 19% in the first six
months of 1996 as compared to the same period in 1995. The decrease is
attributable to a decrease in the average investable assets of $12.5 million,
and a decline in the average portfolio investment yield as a result of generally
lower market interest rates, in the first six months of 1996 as compared to the
same period in 1995.
A summary of net investment income, excluding capital gains (losses),
for the three and six months ended June 30, 1996 and 1995 are as follows:
<TABLE>
<CAPTION>
Three months ended June 30, Six months ended June 30,
--------------------------- -------------------------
(Dollars in thousands) 1996 1995 1996 1995
------ ------ ------ ------
<S> <C> <C> <C> <C>
Interest on debt $1,919 $2,197 $4,151 $4,695
instrument
Interest on invested cash 251 392 332 746
------ ------ ------ ------
Total investment income 2,170 2,589 4,483 5,441
Investment expense 117 110 239 172
------ ------ ------ ------
Net investment income $2,053 $2,479 $4,244 $5,269
====== ====== ====== ======
</TABLE>
The distribution of SNIG's consolidated investment portfolio is as
follows (in thousands):
<TABLE>
<CAPTION>
June 30, 1996 December 31, 1995
-------------------------- ---------------------------
Amortized Market Amortized Market
Available for Sale: Cost Value Cost Value
---- ----- ---- -----
<S> <C> <C> <C> <C>
U.S. Government
Agencies & Authorities $33,922 $33,427 $22,549 $22,524
Collateralized Mortgage Obligations 10,250 9,858 10,753 10,779
Corporate Instruments 7,112 7,131 7,398 7,612
State & Political Subdivisions 1,100 1,127 1,100 1,138
------- ------- ------- --------
Total Available for Sale $52,384 $51,543 $41,800 $42,053
======= ======= ======= =======
<CAPTION>
June 30, 1996 December 31, 1995
-------------------------- ---------------------------
Amortized Market Amortized Market
Funds Withheld from Reinsurers Cost Value Cost Value
---- ----- ---- -----
<S> <C> <C> <C> <C>
U.S. Government
Agencies & Authorities $80,140 $78,167 $103,496 $105,554
Collateralized Mortgage Obligations 2,001 2,001 2,306 2,316
Special Revenue - - 2,118 2,183
Corporate Instruments 5,218 4,786 7,001 7,020
------- ------- -------- --------
Total Bonds and Notes 87,359 84,954 114,921 117,073
Invested Cash 1,624 1,624 - -
------- ------- -------- --------
Total Funds Withheld From Reinsurers $88,983 $86,578 $114,921 $117,073
======= ======= ======== ========
</TABLE>
13
<PAGE> 14
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
<TABLE>
<CAPTION>
June 30, 1996 December 31, 1995
---------------------- -----------------
Market Market
Equity Securities Cost Value Cost Value
---- ----- ---- -----
<S> <C> <C> <C> <C>
Corporate $686 $643 $686 $689
---- ---- ---- ----
Total $686 $643 $686 $689
==== ==== ==== ====
</TABLE>
The Company's management monitors the matching of assets and
liabilities and attempts to maintain its investment duration at the mid-point of
the length of its net claim and claim adjustment expenses payout pattern.
Investment duration is the weighted average measurement of the current maturity
of a fixed income security, in terms of time, of the present value of the future
payments to be received from that security. However, in selecting assets to
purchase for its investment portfolio, the Company considers each security's
modified duration and the effect of that security's modified duration on the
portfolio's overall modified duration. Modified duration is a measurement that
estimates the percentage change in market value of an investment for a small
change in interest rates. The modified duration of fixed maturities at June 30,
1996 was 2.38 years compared to 4.69 years at December 31, 1995. At June 30,
1996, 98% of the carrying values of investments in the fixed maturities
portfolio were rated as investment grade by the Securities Valuation Office of
the National Association of Insurance Commissioners.
Interest expense for the first six months of 1996 was $4.8 million as
compared to $4.9 million for the same period in 1995. The decrease of $0.1
million was due to lower interest expense on the bank term loan as a result of
principal paydown.
DISCONTINUED OPERATIONS:
Discontinued operations claims stabilized during the second quarter
after seven months of heavy activity beginning September 1995 associated with a
California Supreme Court decision affecting construction defect claim coverage.
The Company has significant exposure to construction defect liabilities on
casualty insurance policies underwritten from 1986 to 1991. Management continues
to closely monitor its potential exposure to construction defect claims.
Management believes its current reserves are adequate to cover this increase in
claims activity depending on the length of time the recent reporting trends
continue. There can be no assurance, therefore, that further upward development
of ultimate loss costs associated with construction defect claims will not
occur. The Company will continue to closely monitor the adequacy of its loss
reserves in the discontinued operations.
LIQUIDITY AND CAPITAL RESOURCES:
Liquidity is a measure of an entity's ability to secure sufficient cash
to meet its contractual obligations and operating needs. The Company's cash
inflows are generated from cash collected for policies sold, investment income
on the existing portfolio and sales and maturities of investments. The Company's
cash outflows consist primarily of payments for policyholders' claims, operating
expenses and dividend obligations.
During the first six months of 1996, the Company used $16 million in
its operations versus $7.7 million during the same period in 1995. SNIG believes
that it has adequate short-term investments and readily marketable investment
grade securities to cover both claim payments and expenses. As of June 30, 1996,
the Company had total cash, cash equivalents and investments of $157.0 million.
This amount includes $89.0 million in funds withheld from Centre Re and $1.6
million in restricted cash. The Company's remaining invested assets were
comprised of $51.5 million in bonds and notes, held at market value; $0.6
million in equity securities; $12.0 million in invested cash, including
certificates of deposit with maturities less than one year and money market
deposits; and $2.3 million in cash.
14
<PAGE> 15
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Cash flow used in operations for the six months ended June 30, 1996 was
$16.0 million compared to $7.7 million for the corresponding period in 1995. The
$8.3 million decline in cash from operating activities was due primarily to a
$3.7 million decrease in premiums received, $1.3 million in increased claims
payments for workers' compensation, and $3.3 million in increased claims
payments for the property and casualty operations.
The Company generated $3.0 million in cash from financing activities
for the six months ended June 30, 1996 and used $0.6 million for the
corresponding period in 1995. The cash generated by financing activities in the
first six months of 1996 was funded by the proceeds received from a repurchase
transaction which was partially offset by the principal paydown of the bank term
note. The use of cash in the first quarter of 1995 was related to the principal
paydown of the bank term loan.
Early in 1995, SNIC entered into an agreement with a national brokerage
house to allow it to enter into $5 million in repurchase agreements that are
secured by either U.S. treasuries or government agency bonds. This type of
financing allows SNIC a great deal of flexibility to manage short-term
investments, avoiding the unnecessary realization of losses to satisfy short
term cash needs. As of June 30, 1996, the book value including accrued interest
for repurchase agreement outstanding was $3.6 million. The market value of the
security underlying the agreement was $3.5 million. The agreement matured on
July 24, 1996 with an interest rate of 5.40%.
Because SNIG depends on dividends from its insurance subsidiary for its
net cash flow requirements, absent other sources of cash flow, SNIG cannot pay
dividends materially in excess of the amount of dividends that could be paid by
SNIC to SNIG. Insurance companies are also subject to restrictions affecting the
amount of stockholder dividends and advances that may be paid within any one
year without the prior approval of the DOI. The California Insurance Code
provides that amounts may be paid as dividends on an annual noncumulative basis
(generally based on the greater of (1) net income for the preceding year or (2)
10% of statutory surplus as regards policyholders as of the preceding December
31) without prior notice to, or approval by, the DOI. No ordinary dividends were
paid during the six months ended June 30, 1996.
SNIC is a party to various leases principally associated with the
Company's home and branch office space. Such leases contain provisions for
scheduled lease charges and escalations in base rent over the lease term. The
Company's minimum commitment with respect to these leases in 1996 is
approximately $1.9 million. These leases expire from 1996 to 2001.
Other than the Company's obligations to pay claims, policyholder
dividends, ceded reinsurance premiums, lease expenses and the Company's
commitments to pay principal and interest on the bank debt, the Company has no
significant cash commitments.
15
<PAGE> 16
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit:
<TABLE>
<CAPTION>
Exhibit Description
------- -----------
<S> <C>
27 Financial Data Schedule
</TABLE>
(b) Reports on Form 8-K:
The Company did not file any reports on Form 8-K during the
three months ended June 30, 1996.
16
<PAGE> 17
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: August 12, 1996 SUPERIOR NATIONAL INSURANCE GROUP, INC.
By /s/ J. Chris Seaman
-------------------------------
Name: J. Chris Seaman
Title: Executive Vice President and
Chief Financial Officer
17
<PAGE> 18
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit Description Page
- ------- ----------- ----
<S> <C> <C>
27 Financial Data Schedule 19
</TABLE>
18
<TABLE> <S> <C>
<ARTICLE> 7
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> JUN-30-1996
<DEBT-HELD-FOR-SALE> 51,543
<DEBT-CARRYING-VALUE> 87,359
<DEBT-MARKET-VALUE> 84,954
<EQUITIES> 643
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 154,743
<CASH> 2,290
<RECOVER-REINSURE> 132
<DEFERRED-ACQUISITION> 3,062
<TOTAL-ASSETS> 227,039
<POLICY-LOSSES> 122,650
<UNEARNED-PREMIUMS> 9,633
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 6,187
<NOTES-PAYABLE> 7,930
22,272
0
<COMMON> 15,943
<OTHER-SE> 27,988
<TOTAL-LIABILITY-AND-EQUITY> 227,039
43,033
<INVESTMENT-INCOME> 4,244
<INVESTMENT-GAINS> 21
<OTHER-INCOME> 0
<BENEFITS> 22,600
<UNDERWRITING-AMORTIZATION> 7,996
<UNDERWRITING-OTHER> 10,639
<INCOME-PRETAX> 3,062
<INCOME-TAX> 1,048
<INCOME-CONTINUING> 2,014
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,204
<EPS-PRIMARY> 0.27
<EPS-DILUTED> 0.27
<RESERVE-OPEN> 140,774
<PROVISION-CURRENT> 25,799
<PROVISION-PRIOR> (996)
<PAYMENTS-CURRENT> 5,801
<PAYMENTS-PRIOR> 37,126
<RESERVE-CLOSE> 122,650
<CUMULATIVE-DEFICIENCY> (996)
</TABLE>
