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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K/A
Annual Report Pursuant to Section 13 or 15(d) of
The Securities Exchange Act of 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1995 Commission file number 0-20754
MIDLAND FINANCIAL GROUP, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
TENNESSEE 62-1104818
(State of Incorporation) (I.R.S. Employer Identification No.)
825 CROSSOVER LANE, SUITE 112
MEMPHIS, TENNESSEE 38117
(address of principal executive offices) (Zip Code)
Registrants telephone number including area code: (901) 680-9100
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK (NO PAR VALUE)
</TABLE>
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. [ X ] Yes [ ] No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ X ]
As of March 22, 1996 there were 5,546,522 shares of Common Stock outstanding.
The aggregate market value of the Registrant's Common Stock held by
non-affiliates of the registrant (3,956,092 shares) as of March 22, 1996, was
$47,473,104 based on the closing sale price of $12.00 per share on the Nasdaq
National Market System on that date.
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PART I.
ITEM 1. BUSINESS
BACKGROUND
The Company, through Midland Risk Insurance Company and Specialty Risk Insurance
Company, its wholly owned property and casualty insurance subsidiaries,
specializes in the underwriting and marketing of non-standard automobile
insurance to individuals. To a lesser extent, the Company also insures
commercial automobile and related risks and coastal dwellings and provides
automobile insurance for individuals who file for protection under Chapter 13 of
the Bankruptcy Code through its Auto 13 program.
The Company markets its products through six Company-owned and three
non-Company-owned general agencies utilizing over 8,500 independent agencies
located in 20 states, primarily in the southern and western United States.
Management believes that the Company's relationship with the general agencies
and independent agencies has been an important factor in the Company's growth
during the last five years.
Gross premiums written in states where the Company currently writes insurance
policies are as follows:
<TABLE>
<CAPTION>
Gross Premiums Written
Year Ended December 31,
-------------------------------------------------
1995 1994 1993
------- ------- ------
<S> <C> <C> <C>
Alabama $ 4,775 $ 3,368 $ 2,858
Arizona 28,371 26,514 21,061
Arkansas 17,164 2,958 1,564
California 39,365 24,180 21,386
Florida 29,819 28,200 12,929
Georgia 8,895 9,843 4,599
Illinois 3,637 7,603 610
Indiana 2,244 -- --
Louisiana 17,419 15,184 16,025
Mississippi 4,761 889 --
Oklahoma 1,457 249 --
Oregon 6,654 2,467 38
South Carolina 1,598 1,864 2,980
Tennessee 22,630 10,747 6,325
Texas 5,871 3,743 3,843
Other 1,976 311 974
------- ------- ------
Total direct 196,636 138,120 95,192
Reinsurance Assumed 13,570 14,284 6,275
------- ------- ======
Total $210,206 $152,404 $101,467
======= ======= =======
</TABLE>
The following table sets forth the premiums net of reinsurance by line of
business for the periods indicated.
<TABLE>
<CAPTION>
Net Premiums Written
-------------------------------------------------------------------------------------------
1995 1994 1993
----------------------------- ----------------------------- ------------------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Lines of business:
Non-standard automobile
Personal(1) $139,549 81.4% $122,810 81.3% $65,388 85.1%
Commercial 28,239 16.4 24,457 16.2 9,533 12.4
Commercial
multi-peril 2,295 1.3 1,913 1.3 323 .4
Dwelling 1,599 .9 1,759 1.2 1,513 2.0
Other 151 -- 107 -- 62 .1
-------- ----- -------- ----- ------- ------
Total $171,833 100.0% $151,046 100.0% $76,819 100.00%
======== ===== ======== ===== ======= ======
</TABLE>
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(1) Includes net premiums written in the Company's Auto 13 program.
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A typical policyholder of the Company seeks minimum limits of liability ranging
from $25,000 to $50,000 (depending upon state regulations), with a policy term
of either six months or 12 months, and is from 25 to 55 years of age. Premiums
for such insurance are typically higher per dollar of coverage than premiums for
standard or preferred risks. Typically, the Company's insureds have fewer assets
which they desire to protect than persons who buy standard or preferred
policies.
STRATEGY
Non-standard Personal Automobile
During the latter part of 1993 and the early part of 1994, the Company began
expanding its full coverage personal automobile products in the southeastern and
south central part of the United States. During the latter part of 1994 and
early 1995, it expanded those same products to the western part of the United
States, including two of its historically more profitable states -- Arizona and
California. The expansion in the western part of the country was accomplished by
attracting full coverage risks using transfer and multi-car discounts. In
addition, the Company was recognized as the endorsed automobile insurance
carrier for a large association of agents in the state of California. The
expansion of full-coverage risks in the western United States, particularly in
Arizona and California, occurred during an inadequate pricing cycle for physical
damage and related coverage. In addition, the Company experienced adverse
selection from certain association agents in favor of more potentially
profitable contracts with other insurance carriers. As a result of these actions
the Company incurred significant losses during the third and fourth quarters of
1995. These losses were further accentuated by a claims operation that was not
equipped to handle the increase in claims frequency.
The Company has refocused on its core business. It has also instituted
additional underwriting practices and very restrictive guidelines, including
certain prescreening techniques for all new business risks and, particularly,
full coverage risks. It has filed for and received necessary rate increases in
its major markets, except for California where it ceased writing new risks with
physical damage exposure effective October 1, 1995, until such time as its rate
filing is approved. The California rate filing has been submitted and it is
anticipated to be effective May 1996.
Commercial Automobile
The Company has written automobile and other related risks on small commercial
accounts since 1991. This commercial business represented 17.7%, 17.5% and 12.8%
of net premiums written for the years 1995, 1994 and 1993, respectively. Due to
competitive pricing and consequently a deterioration of loss ratios, the Company
made a decision to eliminate certain of its commercial programs in Illinois and
Texas in 1995. These programs generated premiums written of approximately $10
million in 1995. These eliminations are expected to lower the 1996 premium
volume on commercial accounts by approximately 30%.
Operations
The Company operates through six Company-owned and three non-Company-owned
general agency offices. During 1996, the six Company-owned offices will be
consolidated into three regional offices to provide for economies of scale while
continuing the Company's strategy of decentralization. The Company has developed
its operations by acquiring knowledgeable key personnel in local markets where
it operates. These key personnel will be consolidated into the regional offices
to provide management depth.
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NON-STANDARD AUTOMOBILE INSURANCE
General
The personal and commercial non-standard automobile insurance markets consist of
drivers who are unable to obtain coverage from standard carriers due to
undesirable or unverifiable prior driving records, no prior insurance, poor
claims experience, a desire to purchase minimum limits of liability or other
underwriting criteria or market conditions. Generally, these individuals have
fewer assets to protect than insureds who purchase standard or preferred
policies. Premium levels for non-standard risks are substantially higher than
for standard or preferred risks. The Company focuses its sales efforts primarily
on individuals and until mid-1994 priced its products toward liability only
business. The Company has traditionally been competitive for individuals who
have histories of safe driving but require non-standard automobile insurance for
other reasons. In mid-1994, with its move to more full coverage risks, the
Company believes it became more competitive for a broader range of insureds and,
consequently attracted many first-time full coverage buyers as well as many
risks with undesirable insurance and credit histories. This situation, coupled
with what the Company believes to be an inadequately priced market in general,
resulted in a net loss of $10.1 million for the Company during 1995.
The Company believes that opportunities for insurers to write non-standard
automobile insurance are influenced by many factors, including compulsory state
insurance laws, market conditions for standard automobile insurance and state
assigned risk or other residual market plans. The Company believes the
non-standard automobile market has grown during the last five years primarily
due to regulatory changes mandating insurance in certain states and due to
standard carriers exiting certain markets. The Company also believes industry
premium growth in the immediate future will be influenced to a greater extent by
rate increases than in the past five years, due to a recent deterioration of
results for nonstandard automobile carriers which it considers to be its peers.
The Auto 13 Program
The Company offers automobile insurance to individuals who file for protection
(personal reorganization of debt) under Chapter 13 of the United States
Bankruptcy Code. The Auto 13 program provides physical damage coverage only. The
Company underwrites the Auto 13 program as a class of risks on a jurisdiction by
jurisdiction basis, rather than utilizing the underwriting criteria described
elsewhere herein. This coverage protects a creditor's security interest in a
Chapter 13 debtor's automobile and eliminates court hearings to repossess
automobiles for lack of insurance, affording judges and trustees time for other
matters. Unlike its other products, the Company markets its Auto 13 program
directly to bankruptcy judges and trustees for blanket applications to
appropriate Chapter 13 debtors rather than to individuals. During the period
that an individual debtor is in reorganization pursuant to a bankruptcy
court-approved plan of reorganization, the Company's program provides automobile
physical damage insurance for the debtor in accordance with a policy approved by
the bankruptcy trustee and the bankruptcy court. This enables the debtor to
continue employment in order to satisfy the debtor's obligations under the
approved plan. The Company believes that its Auto 13 program is the only one of
its kind in the United States.
MARKETING
The Company began to focus on the non-standard personal automobile market in
1988. Gross premiums written have grown from $27.7 million in 1991 to $210.2
million in 1995 due to the Company's expansion into selected states. The Company
expanded by attracting key personnel in targeted states. Such personnel had
numerous agency and other relationships and years of experience in their
respective markets.
The Company markets its non-standard automobile products through six
Company-owned and three non-Company-owned general agencies utilizing over 8,500
independent agencies in 20 states located primarily
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in the southern and western regions of the United States. The general agencies
owned by the Company are presently being consolidated into three regional
offices of the Company. The three independent general agencies produce
approximately 15% of the Company's premium volume.
Because independent insurance agencies have significant influence over which
insurance company will write insurance policies for their customers, management
views its approximately 8,500 independent insurance agencies as the primary
customers of the Company. Both the general agencies and in turn the independent
agencies are compensated based on a fixed percentage of the premiums written.
During 1995, the Company terminated its relationship with a number of
independent agents, primarily in California, due to the elimination of its full
coverage programs. Several marginal or unprofitable agents were also terminated.
The Company's objective is to be a competitive provider of non-standard
automobile insurance while providing superior service to both agents and
insureds. This objective is largely accomplished through maintenance of good
agent and client relationships and computerization of certain marketing,
underwriting and control and administrative functions. Cost-effective automation
allows the Company to write a greater volume of non-standard automobile business
without significantly increasing administrative expenses and provides a system
for expeditious policy and claims processing.
Set forth below is a comparison of the statutory combined ratios of the Company
with the industry average for the periods indicated.
<TABLE>
<CAPTION>
Statutory Combined Ratios
Year Ended December 31,
------------------------------------------------------------------------
1995 1994 1993
------------------------ ------------------------ -------------
<S> <C> <C> <C>
The Company 111.5 96.3 93.7
Industry average(1) 104.0 108.7 102.7
</TABLE>
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(1) Source: Insurance Services Office, Inc. statistical data for property
and casualty insurance companies. Latest available industry data for
1995 is as of September 30, 1995.
The Company offers both liability and physical damage coverages in the
non-standard automobile insurance market with policies having terms of six or 12
months. The Company offers primarily statutory limits of liability coverage
which vary from state to state, but generally are no more than $25,000 per
person and $50,000 per accident for bodily injury, and in the range of $10,000
to $20,000 for property damage. The commercial and coastal dwelling programs of
the Company provide property and liability limits of up to $1,000,000.
The Company selects the states in which it does business and into which it plans
to expand based on several criteria in a given state, including the size of the
non-standard automobile insurance market, loss results, competition and
regulatory climate. In 1995, the Company expanded its writings in all its major
markets. Premium writings in Arkansas grew significantly in 1995, due to the
appointment of an independent general agent effective January 1, 1995. Premium
volume in Tennessee more than doubled in 1995 due to increased market
penetration by a Company-owned general agency opened in mid-1994. In addition,
the Company expanded into Indiana, Kentucky, and Nevada during 1995. During
1996, the Company intends to reduce its overall premium writings by 20-30% due
to the elimination of certain full coverage personal automobile programs, the
termination of certain agents in late 1995, rate increases it has implemented or
anticipates seeking in 1996, and due to the elimination in 1995 of certain of
its commercial programs, which had become unprofitable. The Company expects
growth in 1996 in certain states as its offices further penetrate the markets,
but this is expected to be more than offset by the effects of the above factors
in other states. Funds
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necessary for the operation of the Company's business will be provided by
operations, which the Company believes will be adequate through the end of 1996.
The Company utilizes and continually enhances industry specific computer
software that provides its general and independent agencies with rating
capability and allows the Company to deliver prompt service while ensuring
consistency in underwriting and controls. The general agencies, and in certain
markets independent agents, have the authority to bind insurance coverages in
accordance with procedures established by the Company. The Company reviews all
coverages bound by the agents promptly and decides whether to accept the
insurance as quoted. Because it has established clear underwriting procedures
and guidelines and promptly reviews the underwriting decisions agents have made,
the Company considers the risk in granting agents binding authority minimal.
REINSURANCE
Effective September 30, 1995, the Company entered into a 30% quota share
reinsurance agreement with Kemper Reinsurance Company covering its personal
automobile programs. Kemper Reinsurance is rated A- by A.M.Best. Through excess
of loss reinsurance, the Company limits its retention on any one risk to $87,500
for personal and $375,000 for commercial risks. The Company's reinsurers under
its excess of loss reinsurance agreements and their respective Best's ratings
are Constitution Reinsurance Corporation (A+), Christiana General Insurance
Corporation (A), Chatham Reinsurance Corporation (B++), Transatlantic
Reinsurance Company (A+), Gerling Global Reinsurance Corporation (A) and The
Mercantile and General Reinsurance Company of America (A-).
Reinsurance makes the assuming reinsurer liable to the extent of the reinsurance
ceded. However, in the event that reinsurance companies are unable to pay their
portion of the loss based on the coverage ceded, a ceding insurer such as the
Company would be responsible for the entire loss. Accordingly, the credit
worthiness of reinsurers is extremely important to the Company. The Company
believes that all amounts due from its reinsurers are collectible.
UNDERWRITING
The Company seeks to classify risks into narrowly defined segments by utilizing
all available underwriting criteria, including driving records of insureds,
class of driver, and type of automobile. The Company maintains an extensive
database which contains statistical records with respect to its insureds and
driving and repair experience by location, class of driver and type of
automobile. The Company utilizes many factors in determining its non-standard
automobile rates, including type, age and location of the vehicle, number of
vehicles per policyholder, number and type of driving violations or accidents,
deductibles, and where allowed by law, age, sex and marital status of the
insured. Management believes this database gives the Company the ability to be
more precise in the underwriting and pricing of its products.
The rate approval process varies from state to state. Most states permit the use
of the rates only after approval by its insurance department, while fewer states
allow the use of rates after only an informational filing.
The Company uses integrated computer software to automate its underwriting and
rating processes. The automated system screens insureds by comparing data on
policy applications with criteria pre-established by the Company at the point of
underwriting decisions, correctly rates and issues policies, and captures
appropriate statistics for necessary management information. The software system
is custom enhanced to address the specific requirements of the Company's target
business.
The Company also extends its automated system to its general and independent
agencies in various forms and levels of integration. Depending upon the degree
of automation used by an agency, the Company provides
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services and support for automated binding, underwriting, and rating of risks
within the guidelines specified as acceptable for the Company's programs. These
services supply the agency with important and pertinent information about the
prospective insured, such as the motor vehicle operation record, credit
background and claims history. This enhances the agency's knowledge of the
Company's operations and aids in the efficient and accurate selection and
pricing of risks suitable for the target business of the Company.
CLAIMS
Insurance claims are typically investigated and settled by claims adjusters on
the Company's staff or affiliated with the Company. The Company currently has
approximately 140 staff and affiliated claims adjusters located in Arizona,
Florida, Louisiana, Tennessee and Texas, with average experience approximating
10 years. These adjusters settle approximately 98% of the Company's claims. The
claims policy of the Company emphasizes timely investigations, settlement of
meritorious claims for equitable amounts, adequate reserving for claims and
control of external claims adjusting expenses. The Company believes its history
of prompt and fair claims policy has demonstrated its commitment to servicing
its agents and insureds and has been a major factor in the growth of its
non-standard automobile and other insurance programs.
During 1995, the Company's California and Arizona claims operations were
consolidated into a regional claims office in Arizona. This move, coupled with
adverse development on full coverage programs in that region, created a
significant backlog of claims, a resulting disruption in responsiveness and
consequently increased loss and loss adjustment expenses on those programs. The
Company significantly increased its claims staff to accommodate the workload and
believes it has taken adequate measures to prevent a similar service problem
from recurring. The Company also believes it suffered no significant permanent
damage to its agency and insured relationships during the disruption of service,
due to its prior track record and due to its concentrated efforts to rectify the
problem.
Claims settlement authority levels are established for each adjuster or manager
based on such person's level of experience. Upon receipt, each claim is reviewed
and assigned to an adjuster based on its type, severity and class of insurance.
The claims department is responsible for reviewing the claim, obtaining
necessary documentation and establishing appropriate loss and expense reserves.
All claims in litigation are monitored by home office supervisors.
LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
Loss reserves are estimates of what an insurer expects to pay claimants. The
Company is required to maintain reserves for payment of estimated losses and
loss adjustment expenses ("LAE") for both reported claims (established for each
case) and losses estimated to have been incurred but which have not yet been
reported ("IBNR"). The Company's ultimate actual liability may be more or less
than current reserve estimates. The Company uses an independent actuary to
assist in determining loss reserves.
As to reported losses, reserves are established on either a case or formula
basis depending on the type and circumstances of the loss. Case reserve amounts
are determined based on the Company's reserving practices which take into
account the type of risk, the circumstances surrounding each claim and policy
provisions relating to types of loss. Formula reserve amounts are based on
historical paid loss data for similar claims with provisions for trend changes
caused by such factors as inflation. Loss reserves are reviewed on a regular
basis and as new data becomes available, estimates are updated and corresponding
adjustments are made to loss reserves. As to incurred claims that have not yet
been reported, loss and loss expense reserves are estimated based on many
variables, including historical and statistical information, inflation, legal
developments, economic conditions, general trends in claim severity and
frequency and any other factors which could affect the adequacy of loss
reserves. The Company uses two different methods for the purpose of establishing
its IBNR reserves, depending on the maturity of the line of business as to which
the reserve is being established. Those methods are the "loss ratio" method and
the "counts and averages" method. In
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addition, the total loss reserves calculations make provisions for estimated
amounts recoverable from salvage and subrogation based on historical results of
the Company. The Company's IBNR reserves are reviewed quarterly by the Company,
and at least semi-annually by an independent actuarial firm. Historically, the
Company's IBNR reserves have been established based on amounts recommended by
the independent actuaries. During 1996, the Company plans to add an in-house
loss reserve actuary whose responsibilities will include determining its IBNR
reserves. Adjustments in aggregate reserves are reflected in the operating
results of the period during which such adjustments are made. Although
management uses many resources to calculate reserves, there is no precise method
for determining the ultimate liability. The Company does not discount loss
reserves for financial statement purposes. In addition, there are no significant
differences between GAAP and statutory reserves.
The following table presents information on changes in the reserve for losses
and loss expenses of the Company for the periods presented:
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------------
1995 1994 1993
---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C>
Reserve for losses and loss adjustment expenses
at beginning of year $ 56,858 $35,287 $ 16,711
Less reinsurance recoverables on unpaid losses
and loss adjustment expenses 6,880 13,634 9,590
-------- ------- --------
Net reserves for losses and loss adjustment expenses
at beginning of year 49,978 21,653 7,121
-------- ------- --------
Add:
Provision for losses and loss adjustment expenses occurring:
Current year 141,130 82,241 38,341
Prior years 10,973 2,070 287
-------- ------- --------
Total 152,103 84,311 38,628
-------- ------- --------
Less:
Loss and loss adjustment expense payments for claims occurring during:
Current year 73,493 39,542 17,334
Prior years 36,383 16,444 6,762
-------- ------- --------
Total 109,876 55,986 24,096
-------- ------- --------
Net reserve for losses and loss adjustment expenses
at end of year 92,205 49,978 21,653
Plus reinsurance recoverables on unpaid losses
and loss adjustment expenses 12,311 6,880 13,634
-------- ------- --------
Reserve for losses and loss adjustment expenses
at end of year $104,516 $56,858 $ 35,287
======== ======= ========
</TABLE>
The reinsurance recoverables on paid losses and loss adjustment expenses are
$4,854,000, $2,744,000 and $2,762,000 for 1995, 1994 and 1993, respectively.
The following table sets forth the development of Company reserves for unpaid
losses and loss adjustment expenses from 1985 through 1995. "Net liability for
losses and loss adjustment expenses" sets forth the estimated liability for
unpaid losses and loss adjustment expenses recorded at the balance sheet date
for each of the indicated years. This liability represents the estimated amount
of losses and loss adjustment expenses for claims arising in the current and all
prior years that are unpaid at the balance sheet date, including losses incurred
but not reported to the Company.
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The portion of the table labeled "Net liability reestimate as of" one year later
through ten years later shows the reestimated amount of the previously recorded
liability based on experience as of the succeeding year. The estimate is
increased or decreased as payments are made and more information becomes known
about the severity of still unpaid claims. For example, the 1985 liability has
developed a deficiency of $7,000 after ten years, in that reestimated losses and
loss adjustment expenses are expected to be more than the initial estimated
liability established in the 1985 financial statements.
The portion of the table labeled "Cumulative redundancy (deficiency)" shows the
cumulative redundancy or deficiency at December 31, 1995 of the reserve estimate
shown on the top line of the corresponding column. A redundancy in reserves
means that reserves established in prior years exceeded actual losses and loss
adjustment expenses or were reevaluated at less than the originally reserved
amount. A deficiency in reserves means that the reserves established in prior
years were less than actual losses and loss adjustment expenses or that the
actual losses and loss adjustment expenses were reevaluated at more than the
originally reserved amount.
The portion of the table labeled "Net Paid (cumulative) as of" one year later
through ten years later shows the cumulative loss and loss adjustment expense
payments made in succeeding years for losses incurred prior to the balance sheet
date. For example, the 1991 column indicates that as of December 31, 1995 the
Company had $2,549,000 paid of the currently reestimated ultimate liability of
$2,616,000 in loss and loss adjustment expenses. This implies that the December
31, 1995 estimate of the remaining liability for 1990 and prior years was
$67,000.
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<TABLE>
<CAPTION>
Year Ended December 31
------------------------------------------------------------------------
1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995
------- -------- ------- -------- ------- --------- -------- ------- ------- -------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net liability for losses and loss
adjustment expenses estimated
at 12/31 $150 $ 894 $627 $474 $ 848 $1,041 $2,259 $ 7,121 $ 21,653 $ 49,978 $ 92,205
Net liability reestimate as of:
One year later 187 1,137 642 502 848 1,104 2,129 7,408 23,722 60,951
Two years later 171 1,023 649 492 898 1,161 2,577 7,159 26,251
Three years later 157 905 645 487 838 1,307 2,628 7,593
Four years later 158 870 647 445 892 1,309 2,616
Five years later 158 870 624 445 864 1,196
Six years later 158 862 624 418 885
Seven years later 157 862 624 441
Eight years later 157 862 624
Nine years later 157 862
Ten years later 157
Cumulative redundancy
(deficiency) as of 12/31/95 $ (7) $ 32 $ 3 $ 33 $ (37) $ (155) $ (357) $ (472) $ (4,598) $ (10,973)
Net paid (cumulative) as of:
One year later 122 907 606 450 790 904 1,060 4,784 16,456 36,383
Two years later 157 862 633 474 841 934 2,168 6,685 22,419
Three years later 151 870 642 481 818 1,173 2,417 7,252
Four years later 158 870 641 445 874 1,175 2,549
Five years later 158 870 624 445 846 1,196
Six years later 158 862 624 418 870
Seven years later 157 862 624 441
Eight years later 157 862 624
Nine years later 157 862
Ten years later 157
Gross liability for losses and
loss adjustment expenses
estimated at 12/31 $16,711 $ 35,287 $ 56,858 $104,516
Reinsurance Recoverable 9,590 13,634 6,880 12,311
Net liability at 12/31 7,121 21,653 49,978 92,205
Liability reestimate as of:
One year later 18,002 38,735 69,737
Two years later 17,014 42,741
Three years later 17,499
Reestimated recoverable 9,906 16,490 8,786
Net reestimated liability 7,593 26,251 60,951
Gross Cumulative Deficiency 788 7,454 12,879
</TABLE>
The Company has experienced a cumulative loss reserve deficiency during the past
five years, primarily due to development on accident years 1994 and 1995 related
to full coverage personal automobile programs and to certain commercial programs
as more fully discussed under Part II, Item 7, "Management's Discussion and
Analysis of Financial Conditions and Results of Operation".
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INVESTMENTS
The Company's investment objectives are to produce an attractive total rate of
return after income taxes, but, at the same time, to protect and enhance
policyholders' capital and surplus on a long-term basis and to maintain adequate
liquidity for insurance operations. The Company's investment policy provides
that at least 50% of the Company's portfolio must be in fixed maturity
securities and no more than 25% of admitted assets can be invested in common
stocks. At December 31, 1995, 89% of the Company's portfolio consisted of
investment grade fixed maturity securities while the remainder consisted of
common stock which totalled 3% of the statutory admitted assets. In addition,
investments in individual securities are limited to a percent of policyholders'
capital and surplus, depending on the security's rating and the type of
security. Fixed maturity portfolio investments of the Company generally have an
effective maturity of three to ten years. At December 31, 1995, approximately 4%
of the fixed maturity investments were callable bonds. The Company retains an
outside investment advisor to manage its entire portfolio.
During September 1995, the Company management changed its intent with respect to
securities classified as held to maturity and reclassified all securities in its
held to maturity portfolio to available for sale.
Further information related to the investment portfolio is included in the Notes
to Consolidated Financial Statements.
A.M. BEST RATING
In February 1996, A.M. Best Company, Inc. lowered its ratings on both MRIC and
SRIC to B (Adequate), and placed the rating under review, pending the outcome of
the Company's proposed merger with Danielson Holding Corporation. See Item 14(b)
below. A.M. Best has indicated they view the proposed acquisition favorably and
they would expect to upgrade the rating to B+ if the transaction is consummated.
Conversely, Best has indicated the rating would be under significant downward
pressure if the transaction is not completed. Best's ratings, which range from
A++ (superior) to F (in Liquidation), are an independent opinion of a company's
financial strength and ability to meet its obligations to policyholders. They
are based on a comparative analysis of the financial condition and operating
performance of insurance companies as determined by their publicly available
reports.
REGULATION
The Company and its property and casualty insurance underwriting subsidiaries
("P&C Subsidiaries") are subject to the insurance laws and regulations of
Tennessee, the domiciliary state of the P&C Subsidiaries, and the laws and
regulations of the other states in which the P&C Subsidiaries are licensed to do
business. At present, the P&C Subsidiaries collectively are licensed to do
business as insurance companies ("admitted") in 20 states and are approved
non-admitted insurers in 12 states. The insurance laws and regulations, as well
as the level of supervisory authority that may be exercised by the various state
insurance departments, vary by jurisdiction, but generally grant broad powers to
supervisory agencies or state regulators to examine and supervise insurance
companies and insurance holding companies with respect to every significant
aspect of the conduct of the insurance business. These laws and regulations
generally require insurance companies to maintain minimum standards of business
conduct and solvency, meet certain financial tests, file certain reports with
regulatory authorities, including information concerning their capital
structure, ownership and financial condition, and require prior approval of
certain changes in control of domestic insurance companies and their direct and
indirect parents and the payment of extraordinary dividends and distributions.
In addition, these laws and regulations require approval for certain
intercompany transfers of assets and certain transactions between insurance
companies and their direct and indirect parents and affiliates, and generally
require that all such transactions have terms no less favorable than terms that
would result from transactions between parties negotiating at arm's length.
Further, many states have enacted laws which restrict an insurer's underwriting
discretion, such as the ability to terminate policies, terminate agents or
reject insurance coverage
-11-
<PAGE> 12
applications. These laws may adversely affect the ability of insurance
companies, including the Company, to earn a profit on its underwriting
operations.
Each P&C Subsidiary is required to file quarterly and annual statutory financial
statements in each jurisdiction in which it is licensed, and is subject to
single and aggregate risk limits and other statutory restrictions concerning the
types and quality of investments and the filing and use of policy forms and
premium rates. Additionally, the P&C Subsidiaries' accounts and operations are
subject to periodic examination by the Tennessee Commissioner of Commerce and
Insurance and by other state insurance regulatory authorities. The Tennessee
Commissioner of Commerce and Insurance is presently performing a regular
examination of the P&C Subsidiaries for the four years ended December 31, 1994,
further described in Note 12 to Notes to Consolidated Financial Statements.
The Tennessee insurance laws and regulations, including insurance holding
company laws, impose restrictions on the amount of dividends that may be paid by
the P&C Subsidiaries. As a result of these laws and regulations, the maximum
amount of dividends that a P&C Subsidiary may pay at any point in time without
prior regulatory approval is the greater of (a) 10% of the statutory
policyholders' surplus of such P&C Subsidiary as of the preceding December 31,
or (b) the net income of such P&C Subsidiary for the preceding calendar year,
less the amount of dividends paid during the preceding 12 months.
Most states have enacted legislation regulating insurance holding companies such
as the Company. The insurance holding company laws and regulations vary by
state, but generally require an insurance holding company and its insurance
company subsidiaries licensed to do business in the state to register and file
certain reports with the regulatory authorities, including information
concerning capital structure, ownership, financial condition, certain
intercompany transactions and general business operations. State holding company
laws also require prior notice or regulatory agency approval of direct or
indirect changes in control of an insurer or its holding company and of certain
material intercompany transfers of assets within the holding company structure.
Tennessee insurance laws and regulations provide that no person may acquire
control of the Company, and thus indirect control of the P&C Subsidiaries,
without obtaining the prior approval of the Tennessee Commissioner of Commerce
and Insurance. Any purchaser of 10% or more of the voting stock of an insurance
holding company is deemed to have acquired control of that company and is
required to obtain the approval of the Tennessee Commissioner of Commerce and
Insurance before consummating such purchase.
Most states in which the P&C Subsidiaries transact business have guaranty fund
laws pursuant to which insurers doing business in such states are assessed by a
state insurance guaranty association in order to fund liabilities to
policyholders and claimants of insolvent insurance companies. Assessments are
based on an insurer's writings in relation to the writings of all guaranty fund
participants. Assessments have not been material to the Company.
An insurer's profitability may also be adversely affected by court decisions.
Premium rates are established using actuarial methods in order to permit an
insurer to earn an underwriting profit. A court decision may undermine or change
the assumptions used in the analysis so as to impact the projected level of
profitability.
In expanding its operations into additional states, the Company is selective. It
carefully considers the legislative and regulatory environment in each state
before commencing operations and will not do business in states where the
climate is not conducive to the operation of its business.
In December, 1993, the NAIC approved a model Risk-Based Capital formula for
determining Risk-Based Capital requirements for property and casualty insurers.
MRIC and SRIC have capital in excess of any regulatory action or reporting
level.
-12-
<PAGE> 13
For the year ended December 31, 1995, MRIC and SRIC failed certain NAIC
Financial Ratios from the Insurance Regulatory Information System ("IRIS") as
follows:
MRIC
- Two Year Overall Operating Ratio of 103% exceeded the usual range of
<100%, due to adverse loss experience described elsewhere herein.
- Investment Yield of 4.2% was less than the lower end of the usual
range (4.5%) due to MRIC's classification of its equity ownership in SRIC as
common stock and due to a significant concentration in tax preferential
securities.
- Liabilities to Liquid Assets of 106% was slightly above the upper
usual range of 105%, due to substantial increases in the year end reserves for
Incurred But Not Reported Losses. This test measures total liabilities against
invested assets, but excludes premiums and agents' receivable balances.
- Agents' Balances to Surplus of 54% exceeds the usual range of <40%
due to a significant balance of receivables on direct bill policies. These are
offset by a liability for unearned premiums which is not considered in the
calculation.
SRIC
- Change in Net Writings of 63% exceeded the usual upper range limit of
33% due to expansion of the Company's programs in Tennessee in 1995, as
described elsewhere herein. Net premiums to surplus ratio, however, of 2.16 to
1, indicating the Company is not excessively leveraged at current premium
levels.
- Investment Yield of 4.5% equalled the minium range of 4.5% due to a
significant increase in invested assets in mid-1995 and due to a concentration
in tax preferential securities.
- Agents' Balances to Surplus of 47% exceeds the usual range of <40%
due to significant direct bill premiums receivable which are offset by
liabilities for unearned premiums.
These results are reviewed by the NAIC and the Company anticipates being placed
on the NAIC watch list.
RESIDUAL MARKETS
Many states require that companies writing private passenger automobile
insurance in that state participate in a residual market mechanism. Although
regulations vary by state, residual market mechanisms are generally designed to
provide insurance coverage for consumers who are unable to obtain insurance in
the voluntary automobile insurance market. In some states, companies participate
in the administration, profit and/or loss associated with those consumers'
policies to the extent provided by state regulations. In other states, assigned
risk pools are utilized. Assigned risk pool insureds are assigned on a rotating
basis to automobile insurers based on the individual insurer's share of the
total automobile insurance market for that state. Insurers then issue and
service those individual insurance risks assigned to them and accept the profit
or loss for those policies. Residual markets have not had a material effect on
the business or results of operations of the Company.
COMPETITION
The Company competes in each state in which it operates for both agents and
insureds with both large national underwriters and smaller regional companies.
Certain of these competitors are larger and have greater financial resources
than the Company. The non-standard automobile insurance business is price
-13-
<PAGE> 14
sensitive and certain competitors of the Company have, from time to time,
decreased their prices in an attempt to gain market share. Management believes
that the Company's prices are generally competitive, but the Company competes
primarily on the basis of underwriting criteria and superior service to its
agents and insureds for drivers with histories of safe driving purchasing
non-standard automobile policies.
EMPLOYEES
At December 31, 1995 the Company employed a total of 424 employees. The Company
is not a party to collective bargaining agreements and management believes
employee relations are excellent.
ITEM 2. PROPERTIES
The corporate headquarters of the Company are located in Memphis, Tennessee,
where the Company leases approximately 32,000 square feet of office space. The
Company-owned general agencies are located in Phoenix, Arizona, Mission Viejo,
California, Shreveport, Louisiana, Dallas, Texas, Portland, Oregon, and
Nashville, Tennessee. These offices occupy an aggregate of approximately 100,000
square feet of leased office space. The Company also leases several small Auto
13 service offices. The Company owns no real properties and believes that its
leased facilities are adequate for its needs.
ITEM 3. LEGAL PROCEEDINGS
In August 1994, the Company and three of its wholly owned subsidiaries were
named in a civil lawsuit on behalf of two Chapter 13 debtors and as putative
representatives of a plaintiff's class challenging the validity of the Chapter
13 automobile insurance program in Alabama. The plaintiffs sought certification
of a class, a declaration that the insurance policies violate Alabama statutes,
a permanent injunction against further implementation of the Chapter 13
automobile insurance program in Alabama, and reimbursement of premiums received
by the Company under the Chapter 13 automobile program in Alabama. The Company
and its subsidiaries denied the material allegations of the complaint and were
awarded Dismissal by Summary Judgement in August 1995. The plaintiffs filed a
motion for reconsideration which was denied in October 1995. The plaintiffs have
appealed this determination and no decision has been rendered to date.
In May 1995, the Company, one of its officers and one of its subsidiaries were
named in a wrongful termination lawsuit by a former employee. The matter is in
the discovery stages. Management believes that it had valid cause for the
dismissal of this employee and will vigorously defend the case. Management
believes that the resolution of this matter will not have a material impact on
the Company's operations.
The Company and its subsidiaries are involved in asserted claims in the normal
course of business. Management believes the outcome of these matters in the
aggregate will not have a material adverse effect on the consolidated financial
statements of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted during the fourth quarter of 1995 to a vote of
security holders.
-14-
<PAGE> 15
PART II.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's common stock trades on the Nasdaq National Market under the symbol
"MDLD." At March 22, 1996, the Company had approximately 2,600 shareholders,
including beneficial owners holding shares in nominee or "street name."
The table below sets forth the high and low stock prices, as well as dividends
declared on common stock, for the two-year period ended December 31, 1995:
<TABLE>
<CAPTION>
QUARTER ENDED: High Low Dividends Declared
----------------- ---------------- -------------------
1994
<S> <C> <C> <C>
March 31............................................. $23 3/4 $18 3/4 $--
June 30.............................................. 22 1/2 18 1/2 --
September 30......................................... 24 1/4 20 3/4 .05
December 31.......................................... 24 14 .05
1995
March 31............................................. 18 3/4 14 3/4 .05
June 30.............................................. 19 17 1/2 .05
September 30......................................... 19 1/2 9 .05
December 31.......................................... 12 1/2 8 1/8 .05
</TABLE>
As of March 22, 1996 market makers in the Company's common stock included:
Bear, Stearns & Co., Inc.; Herzog, Heine, Geduld, Inc.; Loeb Partners
Corporation; Morgan Keegan & Company, Inc.; Raymond James & Associates, Inc.;
Sherwood Securities Corp.; Stephens, Inc.
ITEM 6. SELECTED FINANCIAL DATA (IN THOUSANDS EXCEPT PER SHARE DATA).
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------------------------------------------
1995 1994 1993 1992 1991
----------- ----------- ----------- ----------- -----------
STATEMENT OF INCOME DATA:
<S> <C> <C> <C> <C> <C>
Gross premiums written $210,206 $152,404 $101,467 $60,927 $27,671
Net premiums written 171,833 151,046 76,819 24,748 12,492
Premiums earned 172,394 118,218 55,272 20,571 11,878
Total income 193,046 131,486 64,509 25,137 12,071
Net income (loss) (10,071) 7,925 7,068 2,929 1,116
Net income (loss) available to
stockholders (10,071) 7,925 7,068 1,628 994
Net income (loss) available to
stockholders (1.88) 1.45 1.34 .56 .64
Cash dividend per share .20 .10 -- .09 1.3
Weighted average shares outstanding 5,369 5,477 5,305 2,900 1,613
<CAPTION>
Year Ended December 31,
----------------------------------------------------------------------------
1995 1994 1993 1992 1991
----------- ----------- ----------- ----------- -----------
BALANCE SHEET DATA:
<S> <C> <C> <C> <C> <C>
Total investments, cash and
equivalents $174,803 $165,895 $102,987 $49,483 $13,364
Total assets 283,531 221,820 148,708 76,315 20,630
Notes payable and other debt 27,000 40,000 20,000 286 1,128
Mandatorily redeemable preferred
stock -- -- -- -- 4,805
Stockholders' equity 48,845 57,794 50,620 39,880 6,480
Book value per share 9.06 10.81 9.57 9.18 4.40
SELECTED GAAP RATIOS:
Loss ratio 88.2% 71.3% 69.9% 69.2% 62.3%
Expense ratio 26.8 25.1 23.4 23.0 29.5
-------- ------- ------- ------ -------
Combined ratio 115.0% 96.4% 93.3% 92.2% 91.8%
======== ======= ======= ====== =======
</TABLE>
-15-
<PAGE> 16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND
RESULTS OF OPERATIONS.
The information presented in this discussion and analysis is on the basis of
generally accepted accounting principles ("GAAP")
RESULTS OF OPERATIONS
Year Ended December 31, 1995 compared to the Year Ended December 31,1994
For the year ended December 31, 1995, the Company reported a $10.1 million net
loss. This loss resulted from adverse claims development primarily in Arizona
and California personal automobile programs and to a lesser extent from certain
commercial automobile programs.
During 1994, the Company made a decision to expand its full coverage personal
automobile programs, particularly in two of its larger states, Arizona and
California, where it had previously written substantially liability only
coverage. This decision was based upon several factors, including: the Company
was experiencing a high cancellation rate and low retention rates on liability
only policies; the Company's competitors had reported underwriting profits from
full coverage business; the Company had been successful writing some full
coverage business in certain other states. However, this strategy proved costly.
Upon implementation of the expanded full coverage programs, the Company's
monthly premium volume increased slightly in Arizona, but doubled in California.
In 1995, gross premiums written in Arizona and California were $28.4 and $39.4
million, respectively. Gross premiums written in Arizona and California for 1994
were $26.5 million and $24.2 million, respectively. Both programs generated
sharply increased frequency and consequently, higher loss ratios on the full
coverage business. The increased frequency also presented a claims processing
backlog and consequently increased loss and loss adjustment expenses.
After extensive analysis, the Company concluded that it had attracted a
disproportionate share of insureds with undesirable insurance and credit
histories; market premium levels were inadequate; and in certain situations, the
Company's agents had adversely selected against it in favor of higher incentive
commissions from other carriers. Since identifying these problems, the Company
eliminated its full coverage programs in California and tightened controls over
full coverage in Arizona to more carefully select risks, and in addition,
terminated unprofitable agents. Enhanced underwriting procedures have been
implemented in all states in which the Company operates. In addition, rate
increases have been implemented in Florida, Georgia, Texas and Arizona and will
be implemented in California, Louisiana, Arkansas and Tennessee in early to mid
1996. These actions are expected to reduce the Company's personal automobile
premium writings by approximately 20% in 1996.
To provide additional management controls, the Company established an internal
audit department and a claims audit team in 1995; in early 1996 hired additional
pricing analysts, and a national market analyst; and also in 1996 plans to
continue to upgrade claims staff and hire a Chief Actuary for loss reserving.
The Company also experienced a deterioration in results related to its Illinois
commercial programs and made a decision in early 1995 to close that branch
office and terminate the Illinois program. Expenses associated with the closing
of that branch were approximately $1 million in 1995. Additionally, claims
experience on certain commercial programs in Texas deteriorated while pricing
became very competitive. The Company decided to eliminate those unprofitable
programs as well. Commercial premium writings are also expected to decrease in
1996, by approximately 30% due to these changes.
During 1995, the Company strengthened its prior year loss reserves by
approximately $11 million due to adverse development in both the commercial and
personal programs mentioned above and due to higher than anticipated loss
adjustment expenses. This adverse development was impacted by a processing
backlog in the western region claims office which occurred in the first half of
1995 related to the Arizona and California full-
-16-
<PAGE> 17
coverage programs. The Company believes it has adequately provided for the
development, as well as implemented greater controls and added sufficient claims
staff to prevent any further material adjustments to prior year reserves.
The Company's combined ratio has deteriorated during the last two years to 115%
in 1995; from 96.4% in 1994 and 93.3% in 1993. In 1994, this was due in part to
increased loss ratios but also to increased net acquisition costs caused by the
elimination of quota-share reinsurance January 1, 1994. For 1995, the Company's
loss ratio was significantly higher, at 88.2% versus 71.3% in 1994 due to
adverse experience in the current year as well as to the adverse development of
prior years. The expense ratio for 1995 increased to 26.8% compared to 25.1% in
1994 due to the write off of deferred acquisition costs associated with
discontinued programs and premium reserve deficiencies on certain continuing
lines of business together totaling approximately $5.4 million. These increased
acquisition costs were partially offset by ceding commissions the Company
received from a 30% quota share reinsurance program implemented as of September
30, 1995 for its personal automobile policies. This program was established with
Kemper Reinsurance Company and included a cession of in-force and unearned
premiums as of September 30, 1995.
Overall, the Company's gross premium volume for 1995 grew 38% to $210 million
and its net premium volume grew 14% to $172 million as compared to 1994. This
growth came primarily from California, due to the implementation of new full
coverage programs; from Arkansas, where the Company appointed a new general
agency in 1995; and from growth within Tennessee, where the Company opened a new
general agency office in mid-1994. This growth in volume also caused the
increase in policy fees in 1995 to $10.6 million from $6.5 million in 1994.
Investment income increased by 59% in 1995 as compared to 1994 due to the
investment of the $10 million obtained under the Company's credit facility and
due to the investment of operating cash generated in 1995. The value of the
Company's investment portfolio grew by $25.6 million to $162.3 million at
December 31, 1995, compared to $136.7 million at December 31, 1994.
Increases in loss and loss adjustment expenses were a result of the Company's
growth and the unusual matters discussed above.
While premiums earned increased by 46% in 1995 as compared to 1994, policy
acquisition costs increased by 60%. As noted above, the expense ratio also
increased in 1995. These increases were due to the writeoff of deferred policy
acquisition costs from discontinued programs and from premium reserve
deficiencies.
Operating expenses for 1995 increased significantly to $6.4 million, as compared
to $3.7 million for 1994, due to the Company's continued growth and due to
significant investments in information technology systems and marketing
programs.
Interest expense nearly doubled in 1995 due to the increase in average debt
outstanding related to the Company's bank credit facility.
Year Ended December 31, 1994 compared to the Year Ended December 31,1993
Gross premiums written increased by 50% to $152,404,000 in 1994 compared to
$101,467,000 in 1993. This growth came from several states, including Arizona,
California, Florida and Georgia. Net written premiums increased 97% to
$151,046,000 from $76,819,000 in the prior year, due to the growth in gross
premiums written, but also to the elimination of quota share reinsurance
effective January 1, 1994.
Commissions and policy fees increased 37% in 1994 to $6,491,000 from $4,748,000
in 1993, due to the growth in premium volume.
-17-
<PAGE> 18
Investment income in 1994 increased by 86% compared to 1993 due to the
investment of cash generated from operations, which benefitted by the
elimination of quota share reinsurance, and due to the investment of the
proceeds of the Company's $20 million credit facility. The Company was also able
to take advantage of rising interest rates with this newly invested cash as well
as cash generated from maturities in its investment portfolio.
Other income is derived from premium finance operations, which remained fairly
stable through 1994.
Losses and loss adjustment expenses increased by 118% to $84,311,000 from
$36,628,000 in 1993, due to the growth in premium volume and to the elimination
of quota share reinsurance. Also, as previously announced, the Company
experienced increased frequency which it attributed to heavy rains in most of
its major markets during October and November, 1994, increasing the loss ratio
to 80.7% for the fourth quarter, compared to 67.4% for the first nine months.
The loss ratio for the year was 71.3% compared to 69.9% in 1993.
Policy acquisition costs increased by 152% to $31,431,000 in 1994, compared to
$12,494,000 in 1993. This was directly attributable to the growth in premium
volume. The expense ratio increased to 25.1% in 1994 compared to 23.4% in 1993
due to the elimination of quota share reinsurance, which generated ceding
commission income to offset acquisition costs in prior years.
Interest expense increased to $970,000 in 1994 compared to $52,000 in 1993 due
to outstanding debt under the Company's credit facility through 1994.
The income tax rate for 1994 remained fairly constant at 27.3%, compared to
27.1% in 1993 due to the concentration of the Company's investment portfolio in
tax-preference securities.
LIQUIDITY AND CAPITAL RESOURCES
The operating cash requirements of the Company relate primarily to the payment
of claims, policy acquisition costs and operating expenses. Due to the nature of
risks the Company insures (but for acts of nature, as to which the Company
carries catastrophe reinsurance), the Company's liabilities can be estimated.
These liabilities generally develop and are resolved over a period of less than
three years. Therefore, the Company generally has a predictable schedule of cash
needs. The Company manages its investment activities to maintain adequate
liquidity for operating purposes and to protect its policyholders and
stockholders (i.e., "matching" of liquidity and cash requirements). The
Company's portfolio is heavily weighted toward intermediate fixed maturity
securities. The Company generally invests in investment grade securities and has
a policy of not acquiring real estate investments. Historically, the Company has
not experienced any "mismatches" related to liquidity management and none are
anticipated. At December 31, 1994, the Company's fixed maturity securities were
classified as held to maturity. During 1995, the Company's Investment Committee
made a decision to liquidate and reinvest the proceeds of certain of those
securities to take advantage of higher available yields. As a result, the
Company has reclassified the entire portfolio to available for sale and the
securities are carried at fair value at December 31, 1995. There are no
foreseeable requirements to liquidate any investments prior to their scheduled
maturities.
The Company's objective is to maintain a capital adequacy ratio based on the
industry standard of a maximum of 3:1. For the year ended December 31, 1995, the
capital adequacy ratio was 3:1, compared to 2.41:1 for 1994. During 1996, the
Company anticipates this ratio will decrease due to two factors. The Company
expects to write less premiums in 1996 as a result of its decision to eliminate
certain programs and due to rate increases already taken or anticipated to be
taken during 1996. Second, the Company will utilize its 30% quota share
reinsurance facility on its personal automobile programs throughout 1996. This
reinsurance was obtained effective September 30, 1995.
-18-
<PAGE> 19
The Company secured a $20 million permanent credit facility in December 1993,
which was utilized to expand underwriting capacity in 1994. This facility was
increased to $30 million in December, 1994, with the increase being utilized to
expand underwriting capacity during 1995. At September 30, 1995, the Company
defaulted on certain financial covenants contained in the related loan
agreement. The default was not cured prior to December 31, 1995. The loan
agreement was amended, including revised financial covenants, effective March 1,
1996. Under the terms of the restated loan agreement, the Company is not
required to pay principal until June 30, 1996, and quarterly thereafter through
June 30, 1998. Interest is payable quarterly. See Note 6 "Notes Payable" and
Note 15 "Subsequent Events" of Notes to Consolidated Financial Statements for
further discussion.
IMPACT OF INFLATION
Although the Company's results of operations have not been affected by
inflation, inflation can have a significant impact on property and casualty
insurers because premium rates are established before the amount of losses and
loss adjustment expenses are known. The Company attempts to anticipate increases
from inflation in establishing rates, subject to limitations imposed for
competitive pricing.
The Company considers inflation when estimating liabilities for losses and loss
adjustment expenses, particularly for claims having a long period between
occurrence and settlement. The liabilities for losses and loss adjustment
expenses are management's estimates of the ultimate net cost of underlying
claims and expenses and are not discounted for the time value of money. In times
of high inflation, the normally higher yields on investment income may partially
offset potentially higher claims and expenses.
RECENT ACCOUNTING PRONOUNCEMENTS
See Note 1 of Notes to Consolidated Financial Statements for the impact of
recent accounting pronouncements.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Financial Statements are included herein beginning on page 20.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
There have been no disagreements with the Company's independent accountants on
any matters of accounting principles or practices or financial statement
disclosures.
-19-
<PAGE> 20
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
<TABLE>
<CAPTION>
December 31,
------------------------------
1995 1994
- ----------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Cash and equivalents $ 12,479 $ 29,196
Investment securities (note 3):
Held to maturity:
Fixed maturities, at amortized cost
(fair value $122,953) -- 129,287
Available for sale:
Equity securities, at fair value
(cost $13,039 and $5,877 respectively) 13,408 5,533
Fixed maturities, at fair value
(amortized cost $146,637 and $1,981, respectively) 148,916 1,879
---------- ----------
Total investments 162,324 136,699
Receivables:
Agents and insureds 39,741 17,252
Premium finance contracts 365 1,523
Reinsurance - direct 17,165 9,624
- assumed 654 1,241
Prepaid reinsurance premium 21,207 561
Accrued investment income 2,296 2,244
Deferred policy acquisition costs 9,617 15,148
Equity investments in nonconsolidated companies 293 424
Furniture and equipment, at cost, net of accumulated
depreciation of $1,979 and $1,085, respectively 3,398 2,518
Notes receivable (note 9) 2,158 2,256
Deferred income taxes (note 7) 3,813 1,042
Income taxes recoverable 5,414 --
Other assets 2,607 2,092
---------- ----------
$ 283,531 $ 221,820
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Unpaid losses and loss adjustment expenses
(notes 4 and 5) $ 104,516 $ 56,858
Unearned premiums (note 5) - direct 77,311 55,901
- assumed 5,162 6,479
Due to reinsurers (note 5) 7,946 --
Notes payable (notes 6 and 15) 27,000 40,000
Other liabilities 12,751 4,788
---------- ----------
234,686 164,026
---------- ----------
Stockholders' equity (note 13):
Common stock, no par value. Authorized 50,000,000 shares;
5,389,022 and 5,344,222 shares issued, respectively 39,420 39,258
Additional paid-in capital 1,887 1,887
Retained earnings 5,796 16,943
Unrealized appreciation (depreciation) of
securities available for sale, net 1,742 (294)
---------- ----------
48,845 57,794
---------- ----------
Commitments and contingencies (notes 5, 10 and 11) $ 283,531 $ 221,820
========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
20
<PAGE> 21
CONSOLIDATED STATEMENTS OF INCOME (LOSS)
(Dollars in thousands - except per share data)
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------------
1995 1994 1993
- -------------------------------------------------------------------------------------------------------------
INCOME:
<S> <C> <C> <C>
Premiums earned (note 5) $ 172,394 $ 118,218 $ 55,272
Policy fees 10,649 6,491 4,748
Investment income (note2) 9,258 6,190 3,330
Net realized investment gains (note 3) 578 42 698
Other income 167 545 461
----------- ----------- -----------
193,046 131,486 64,509
----------- ----------- -----------
EXPENSES:
Losses and loss adjustment expenses (notes 4 and 5) 152,103 84,311 38,628
Policy acquisition costs 50,070 31,431 12,494
Operating expenses 6,368 3,745 3,547
Interest 1,880 970 52
Amortization of intangible assets 135 129 106
----------- ----------- -----------
210,556 120,586 54,827
----------- ----------- -----------
Income (loss) before provision for
income taxes and equity interests (17,510) 10,900 9,682
Provision for income taxes (benefit)(note 7) (7,445) 2,980 2,620
----------- ----------- -----------
Income (loss) before equity interests (10,065) 7,920 7,062
Equity interests (6) 5 6
----------- ----------- -----------
Net income (loss) $ (10,071) $ 7,925 $ 7,068
=========== =========== ===========
PER SHARE DATA:
Net income (loss) $ (1.88) $ 1.45 $ 1.34
=========== =========== ===========
Weighted average common shares outstanding 5,369,461 5,477,666 5,305,824
=========== =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
21
<PAGE> 22
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Dollars in thousands)
<TABLE>
<CAPTION>
Common Stock
------------
Shares Additional Unrealized
issued and paid-in Retained appreciation
outstanding Amount capital earnings (depreciation) Total
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balances at
December 31, 1992 4,346,123 $ 35,392 $ 1,887 $ 2,483 $ 118 $ 39,880
Net income -- -- -- 7,068 -- 7,068
Warrants exercised 872,505 3,429 -- -- -- 3,429
Options exercised 70,686 231 -- -- -- 231
Appreciation of
equity securities -- -- -- -- 12 12
--------- ---------- ---------- ---------- ---------- ----------
Balances at
December 31, 1993 5,289,314 39,052 1,887 9,551 130 50,620
Net income -- -- -- 7,925 -- 7,925
Cash dividends paid
($.10 per share) -- -- -- (533) -- (533)
Options exercised 14,000 46 -- -- -- 46
Warrants exercised 40,908 160 -- -- -- 160
Change in fair value
of securities available
for sale net of tax
of $231 -- -- -- -- (424) (424)
--------- ---------- ---------- ---------- ---------- ----------
Balances at
December 31, 1994 5,344,222 39,258 1,887 16,943 (294) 57,794
Net (loss) -- -- -- (10,071) -- (10,071)
Cash dividends paid
($.20 per share) -- -- -- (1,076) -- (1,076)
Options exercised 44,800 162 -- -- -- 162
Change in fair value
of securities available
for sale net of tax
of $1,058 -- -- -- -- 2,036 2,036
--------- ---------- ---------- ---------- ---------- ----------
Balances at
December 31, 1995 5,389,022 $ 39,420 $ 1,887 $ 5,796 $ 1,742 $ 48,845
========= ========== ========== ========== ========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
22
<PAGE> 23
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands - except per share data)
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------------
1995 1994 1993
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (10,071) $ 7,925 $ 7,068
Adjustments to reconcile net income (loss)
to net cash provided by
operating activities:
Net realized (gains) losses on securities 3 (42) (698)
Gain on disposal of fixed assets (33) -- --
Depreciation 894 550 353
Amortization of intangibles 285 351 139
Amortization of discounts and premiums 529 673 264
Deferred taxes (3,828) (526) (249)
Changes in assets and liabilities:
Agent and insured receivables, net (22,489) (10,983) (2,089)
Reinsurance receivables (27,600) 12,826 (7,414)
Premium finance receivables 1,158 (716) (256)
Accrued interest receivable (52) (1,085) (545)
Deferred policy acquisition costs 5,531 (8,062) (5,541)
Other assets (868) (527) (677)
Unpaid losses and loss adjustment expenses 47,658 21,571 18,576
Unearned premiums 20,093 23,505 24,176
Due to reinsurers 7,946 (8) (2,246)
Other liabilities 7,461 430 1,582
Income taxes (5,854) 593 100
----------- ----------- -----------
Net cash provided by operating activities 20,763 46,475 32,543
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Maturities and calls of securities-held to maturity 3,260 4,985 1,145
-available for sale 1,909 251 --
Sales of securities-held to maturity -- 3,160 13,820
-available for sale 15,274 5,720 --
Purchases of securities-held to maturity (29,356) (67,139) (42,824)
-available for sale (13,208) (7,884) --
Investments in nonconsolidated companies 131 (14) 572
Fixed asset additions (2,071) (1,414) (1,104)
Fixed asset disposals 329 -- --
Investment in insurance programs 68 (404) (342)
----------- ----------- -----------
Net cash used in investing activities (23,664) (62,739) (28,733)
----------- ----------- -----------
</TABLE>
23
<PAGE> 24
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------------------------------
1995 1994 1993
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Notes payable to banks 10,000 30,000 20,000
Note receivable from sale of equity investment 91 72 (405)
Notes receivable from others 7 (249) (1,674)
Proceeds from exercise of common stock warrants -- 160 3,429
Proceeds from issuance of common stock options 162 46 231
Repayment of debt (23,000) (10,000) (286)
Dividend to stockholders (1,076) (533) --
Payments received on notes from stockholders -- -- 94
Net cash provided by (used) in financing activities (13,816) 19,496 21,389
----------- ----------- -----------
Net increase (decrease) in cash and equivalents (16,717) 3,232 25,199
Cash and equivalents:
Beginning of year 29,196 25,964 765
----------- ----------- -----------
End of year $ 12,479 $ 29,196 $ 25,964
=========== =========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest $ 1,378 $ 936 $ 4
Income taxes 2,225 2,739 3,020
Noncash investing and financing activities:
Transfers to securities available for sale 149,190 -- --
Unrealized gain (loss) on securities available for sale 3,094 (655) --
</TABLE>
See accompanying notes to consolidated financial statements.
24
<PAGE> 25
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Summary of Significant Accounting Policies
PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Midland
Financial Group, Inc. (the "Company") and its subsidiaries, except Agents'
Financial Services, Inc. a 40% owned affiliate ("AFS"). The Company's
investment in AFS is carried at cost plus its equity in the undistributed
earnings since date of acquisition. All significant intercompany transactions
have been eliminated.
In preparing the consolidated financial statements, management is required to
make estimates and assumptions that affect the reported amounts of assets and
liabilities as of the date of the balance sheet and revenues and expenses for
the period then ended.
Material estimates that are particularly susceptible to significant change in
the near term relate to the determination of the liability for unpaid loss and
loss adjustment expense and the recoverability of deferred policy acquisition
costs. In connection with the determination of these items, management uses
actuarial projections, historical data and current business conditions to
formulate estimates, including assumptions related to the ultimate cost to
settle claims. These estimates by their nature are subject to uncertainties for
various reasons. The Company's results of operations and financial condition
could be adversely affected should the ultimate payments required to settle
claims be materially in excess of the reserves currently provided.
NATURE OF OPERATIONS
The Company writes non-standard personal automobile insurance and commercial
automobile insurance for small businesses through six Company-owned and three
independent general agencies. These general agencies market the Company's
products through approximately 8,500 independent insurance agents in 20 states,
primarily in the southeastern and southwestern regions of the United States.
During 1995, the Company wrote a significant amount of business in Arizona,
California and Florida representing 13%, 19% and 14%, respectively, of gross
written premiums.
The nature of the non-standard automobile insurance business is such that the
Company can from time to time, experience abnormally high levels of claims
payouts in the event of unusual weather and other conditions, such as heavy
rain, hail, wind storms and flooding. The Company utilizes both quota share and
excess of loss reinsurance coverage and catastrophic reinsurance options to
limit its exposure on these risks.
Increasing public interest in the availability and affordability of insurance
has prompted legislative, regulatory and judicial activity in several states.
This includes efforts to contain insurance prices, restrict underwriting
practices and risk classifications, mandate rate reductions and refunds and
generally expand regulation affecting the insurance industry. These regulatory
and judicial activities could impact the Company's premium volume.
The Company manages its credit risk on its investment securities by
maintaining a highly-diversified investment portfolio with limited
concentrations in any given region or industry. Interest rate risk is managed
through a combination of highly liquid debt instruments purchased with an
original maturity of three months or less or fixed maturity securities with an
average contractual maturity of approximately 5 years.
PREMIUMS AND POLICY FEES
Premiums, net of amounts ceded to reinsurers, are recognized as income
ratably over the terms of the policies. Unearned premiums represent premiums
applicable to the unexpired terms of the policies.
The Company operates six general agencies which receive non-refundable fees
for processing policy applications. Such income is recognized when the effort is
completed, generally in the month received.
25
<PAGE> 26
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Reinsurance
In the normal course of business, the Company seeks to reduce the loss that
may arise from catastrophes or other events that cause unfavorable underwriting
results by reinsuring certain levels of risk in various areas of exposure with
other insurance enterprises or reinsurers. Amounts recoverable from reinsurers
are estimated in a manner consistent with the claim liability associated with
the reinsured policy.
Deferred Policy Acquisition Costs
The costs of selling policies (principally commissions and premium taxes) are
deferred and reduced by the amount recovered from reinsurers through ceding
commissions. The net acquisition costs deferred are amortized to expense over
the periods in which the related premiums are earned. In addition, during 1995,
the Company wrote off approximately $5.4 million of these costs related to
premium reserve deficiencies. Anticipated losses and loss adjustment expenses
and investment earnings, based on past experience, are considered in determining
the recoverable acquisition costs to be deferred.
Net deferred policy acquisition costs were (in thousands):
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------------------
1995 1994 1993
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance, beginning of period $ 15,148 $ 7,086 $ 1,545
Acquisition costs deferred 44,539 39,493 18,035
Amortized to expense during the period (50,070) (31,431) (12,494)
----------- ----------- -----------
Balance, end of period $ 9,617 $ 15,148 $ 7,086
=========== =========== ===========
</TABLE>
Unpaid Losses and Loss Adjustment Expenses
The liability for unpaid losses and loss adjustment expenses includes
reported and incurred but not reported losses and loss adjustment expenses.
Losses and loss adjustment expenses include the estimated costs of
investigating and settling unpaid losses. Such amounts are determined on the
basis of claims adjusters' evaluations and other estimates, and accordingly,
there can be no assurance that the ultimate liability will not vary from such
estimates.
Investment Securities
Effective January 1, 1994, the Company adopted Statement of Financial
Accounting Standards No. 115, "Accounting for Certain Investments in Debt and
Equity Securities" (SFAS No. 115). Under SFAS No. 115, fixed maturity securities
for which a company has the ability and management has the positive intent to
hold to maturity are classified as held to maturity securities and are reported
at amortized cost. Fixed maturity and equity securities that are bought and held
principally for the purpose of selling them in the near term are classified as
trading securities and are reported at fair value, with unrealized gains and
losses included in earnings. Fixed maturity and equity securities not classified
as either held to maturity securities or trading securities are classified as
available for sale securities and are reported at fair value, with unrealized
gains and losses (net of deferred taxes) charged or credited as a separate
component of stockholders' equity.
During September 1995, Company management changed its intent with respect to
securities classified as held to maturity and reclassified all securities in its
held to maturity portfolio to available for sale. The transfer had no impact on
earnings. However, a $1.6 million fair value
26
<PAGE> 27
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
adjustment was recorded, resulting in a net $1 million increase in stockholders'
equity, net of tax. Realized gains and losses on the sale of investments are
recognized in the determination of net income or loss on the basis of specific
identification. Amortization of premiums and accretion of discounts are computed
using the interest method. Changes in the valuation of securities which are
considered other than temporary are recorded as losses in the period recognized.
Income Taxes
The Company files a consolidated federal income tax return with its
wholly-owned subsidiaries.
Income taxes are accounted for under the asset and liability method. Deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases and operating
loss and tax credit carryforwards. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment date.
Depreciation
Depreciation on furniture and equipment is provided on a straight-line basis
over the estimated useful lives of the assets (three to seven years).
Cash Equivalents
The Company considers all highly liquid debt instruments purchased with an
original maturity at acquisition of three months or less to be cash equivalents.
Earnings per Share
Earnings per common share are based on the weighted average number of common
shares outstanding, including common stock equivalents, during the periods
presented. Outstanding options and warrants are considered common stock
equivalents at that point where the market price exceeds the option price. The
resultant effect on earnings per share is calculated using the treasury stock
method. At December 31, 1995, these common stock equivalents were anti-dilutive.
Fair Value Disclosures
The following methods were used to estimate the fair value of each class of
financial instruments for which it was practicable to estimate that value. Fixed
maturities and equity securities are valued using quoted market prices, if
available. If a quoted market price is not available, fair value is estimated
using quoted market priced of similar securities. Due to the relatively
short-term nature of cash, short-term investments, accounts receivable, and
accounts payable, their carrying amounts are reasonable estimates of fair value.
Fair value of long-term debt is approximately equal to its recorded value. The
fair value of Catastrophe Insurance Contracts is determined based on the
settlement price on the date of valuation as determined by the exchange on which
the contract was traded.
Recent Accounting Pronouncements
SFAS No. 121 "Accounting for the Impairment of Long-lived Assets and for
Long-lived Assets to be Disposed Of," issued in March, 1995, provides guidance
for recognition of impairment losses related to long-lived assets, and certain
intangibles and related goodwill. The Statement is effective for fiscal years
beginning after December 15, 1995.
27
<PAGE> 28
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SFAS No. 123 "Accounting for Stock-Based Compensation" was issued in October,
1995, and provides for a fair value method of accounting for stock-based
compensation arrangements rather than the intrinsic value method now followed.
Adoption of the fair value method for purposes of
preparing basic financial statements is not required although disclosure of the
effect of such adoption is. The Statement is effective for options awarded after
December 15, 1995.
Management believes the adoption of the above-mentioned statements will not
have a material impact on the Company's consolidated financial statements.
Reclassifications
Certain items in the prior years' financial statements have been reclassified
to conform with the 1995 presentation.
(2) INVESTMENT INCOME
Components of investment income were as follows (in thousands):
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------------
1995 1994 1993
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Fixed maturities $ 7,699 $ 5,318 $ 2,837
Equity securities 607 164 194
Call options on U.S. Treasury Notes (361) 359 --
Cash and cash equivalents 1,894 349 299
----------- ----------- -----------
Investment income $ 9,839 $ 6,190 $ 3,330
=========== =========== ===========
</TABLE>
(3) INVESTMENT SECURITIES
Realized and unrealized investment gains and losses were as follows (in
thousands):
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------------
1995 1994 1993
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Realized gains:
Fixed maturities $ 764 $ 7 $ 104
Equity securities 227 530 965
----------- ----------- -----------
Total gains 991 537 1,069
----------- ----------- -----------
Realized losses:
Fixed maturities 42 45 138
Equity securities 10 450 233
Catastrophe Insurance Contracts 942 -- --
----------- ----------- -----------
Total losses 994 495 371
----------- ----------- -----------
Net realized
securities gains (losses) $ (3) $ 42 $ 698
=========== =========== ===========
Change in unrealized gains (losses):
Fixed maturities $ 8,715 $ (7,812) $ 1,272
=========== =========== ===========
Equity securities $ 713 $ (931) $ 12
=========== =========== ===========
</TABLE>
28
<PAGE> 29
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The amortized cost and estimated fair value of securities follow (in thousands):
<TABLE>
<CAPTION>
December 31, 1995
---------------------------------------------------------
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
- ---------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Available for sale:
Obligations of the U.S.
Government and its agencies $ 1,207 $ 8 $ -- $ 1,215
Obligations of states and
political subdivisions 83,838 1,536 108 85,266
Corporate notes and debentures 19,722 125 37 19,810
Redeemable preferred stock 41,870 1,064 309 42,625
Equity securities 13,039 483 114 13,408
---------- ---------- ---------- ----------
$ 159,676 $ 3,216 $ 568 $ 162,324
========== ========== ========== ==========
</TABLE>
<TABLE>
<CAPTION>
December 31, 1994
--------------------------------------------------------
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
- ---------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Held to maturity:
Obligations of the U.S.
Government and its agencies $ 1,521 $ -- $ 70 $ 1,451
Obligations of states and
political subdivisions 85,749 15 3,200 82,564
Corporate notes and debentures 3,667 9 189 3,487
Redeemable preferred stock 38,350 1 2,900 35,451
---------- ---------- ---------- ----------
129,287 25 6,359 122,953
---------- ---------- ---------- ----------
Available for sale:
Corporate notes and debentures 1,730 21 120 1,631
Redeemable preferred stock 251 -- 3 248
Equity securities 5,877 145 489 5,533
---------- ---------- ---------- ----------
7,858 166 612 7,412
---------- ---------- ---------- ----------
$ 137,145 $ 191 $ 6,971 $ 130,365
========== ========== ========== ==========
</TABLE>
The amortized cost and estimated fair value of fixed maturities by
contractual maturity are shown below. Expected maturities may differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties (in thousands):
<TABLE>
<CAPTION>
Amortized Estimated
cost fair value
- -------------------------------------------------------------------------------------------------
<S> <C> <C>
Available for Sale:
Due in one year or less $ 18,838 $ 18,858
Due after one year through five
years 70,525 71,056
Due after five years through ten
years 37,938 39,242
Due after ten years 19,336 19,760
---------- ----------
$ 146,637 $ 148,916
========== ==========
</TABLE>
29
<PAGE> 30
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Proceeds from sales of securities available for sale during 1995 were
$15,274,000. Gross gains of $991,000 and gross losses of $52,000 were realized
on these sales. In 1994, held to maturity securities with an amortized cost of
$3,163,000 were sold resulting in realized losses of $3,000. All sales from the
held to maturity portfolio in 1994 were made within three months of the
contractual maturity of the security. Proceeds from sales of securities
available for sale during 1994 were $5,720,000. Gross gains of $537,000 and
gross losses of $492,000 were realized on those sales. Proceeds from sales of
securities during 1993 were $13,820,000. Gross gains of $1,069,000 and gross
losses of $371,000 were realized in 1993.
Investments in fixed maturities on deposit with various regulatory bodies as
required by law are as follows (in thousands):
<TABLE>
<CAPTION>
December 31,
---------------------------
1995 1994
- --------------------------------------------------------------------------------------------------
<S> <C> <C>
Arkansas Commissioner of Insurance $ 50 $ 50
California Commissioner of Insurance 200 --
Georgia Commissioner of Insurance 25 25
Louisiana Commissioner of Insurance 140 70
Nevada Commissioner of Insurance 250 250
New Mexico Department of Insurance 375 375
Oklahoma Commissioner of Insurance 100 100
South Carolina Department of Insurance 650 650
Tennessee Department of Insurance 2,025 1,675
---------- ----------
$ 3,815 $ 3,195
========== ==========
</TABLE>
Investments in securities of a single issuer aggregating more than 10% of
stockholders' equity follow (in thousands):
<TABLE>
<CAPTION>
December 31,
---------------------------
1995 1994
- --------------------------------------------------------------------------------------------------
<S> <C> <C>
Shelby County, TN $ 6,670 $ 5,895
Metro Nashville, Davidson County, TN 6,570 5,733
Memphis, TN Electric System 5,206 4,575
</TABLE>
(4) Unpaid Losses and Loss Adjustment Expenses
The Company's consulting actuary has determined that the Company's liability
for unpaid losses and loss adjustment expenses is 2% less than the actuary's
selected ultimate liability and falls within an acceptable range of actuarial
estimates.
30
<PAGE> 31
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table presents information on changes in the reserve for losses
and loss adjustment expenses of the Company for the periods presented (in
thousands):
<TABLE>
<CAPTION>
December 31,
--------------------------------------------
1995 1994 1993
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Reserve for losses and loss adjustment expenses at
beginning of year $ 56,858 $ 35,287 $ 16,711
Less reinsurance recoverables on unpaid losses and
loss adjustment expenses 6,880 13,634 9,590
--------- -------- --------
Net reserves for losses and loss adjustment
expenses at beginning of year 49,978 21,653 7,121
Add:
Provision for losses and loss
adjustment expenses occurring:
Current year 141,130 82,241 38,341
Prior Years 10,973 2,070 287
--------- -------- --------
Total 152,103 84,311 38,628
--------- -------- --------
Less:
Loss and loss adjustment expense
payments for claims occurring:
Current year 73,493 39,542 17,334
Prior years 36,383 16,444 6,762
--------- -------- --------
Total 109,876 55,986 24,096
--------- -------- --------
Net reserve for losses and loss
adjustment expenses at end of year 92,205 49,978 21,653
Plus reinsurance recoverables on
unpaid losses and loss adjustment expenses 12,311 6,880 13,634
--------- -------- --------
Reserve for losses and loss adjustment
expenses at end of year $ 104,516 $ 56,858 $ 35,287
========= ======== ========
</TABLE>
The reinsurance recoverables on paid losses and loss adjustment expenses are
$4,854, $2,744 and $2,762 for 1995, 1994, and 1993, respectively.
During 1995, Midland strengthened its prior year loss reserves by
approximately $11.0 million due to adverse development in both the commercial
and personal programs and due to higher than anticipated LAE. This adverse
development was impacted by a processing backlog in the western region claims
office which occurred in the first half of 1995 related to the Arizona and
California full-coverage programs.
(5) Reinsurance
During 1993 the wholly-owned property and casualty insurance subsidiaries of
the Company maintained "quota share" reinsurance agreements whereby a portion of
premiums written, incurred losses and loss adjustment expenses were ceded to
other insurance companies. These quota-share reinsurance agreements were not
utilized in 1994. At September 30, 1995, these subsidiaries entered into a 30%
quota share agreement with Kemper Reinsurance Company, including a cession of
unearned premiums as of that date. This agreement provides reinsurance on the
Company's personal automobile programs, which generally are for mandatory limits
of liability and other coverages of no more than $25,000 per person and
31
<PAGE> 32
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
$50,000 per accident for bodily injury, and in the range of $10,000 to $20,000
for property
damage.
The commercial and coastal dwelling programs of the Company provide property
and liability limits of up to $1,000,000 Through excess of loss reinsurance, the
Company limits its retention on any one risk to $375,000.
Under reinsurance agreements, in the event that the reinsuring company is
unable to pay its portion of the loss based on the coverage ceded, the Company
would be responsible for the entire loss. The Company evaluates the financial
viability of its reinsurers on a regular basis and has no reason to believe that
these reinsurers will be unable to pay their portion of the loss based on the
coverage ceded.
Amounts ceded under all reinsurance agreements were as follows (in thousands):
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------------------------
1995 1994 1993
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Premiums written $ 38,372 $ 1,359 $ 24,648
Premiums earned 17,719 10,801 25,461
Losses and loss adjustment expenses incurred 14,770 7,279 18,936
Unearned premiums 21,207 554 9,996
Unpaid losses and loss adjustment expenses 12,311 6,880 13,634
</TABLE>
(6) Notes Payable
Components of notes payable were as follows (in thousands):
<TABLE>
<CAPTION>
1995 1994
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Short-term borrowings from bank; 8.5% interest;
Repaid January 1995 -- $ 20,000
Bank credit facility, $30 million, secured by
subsidiary operations:
Fixed portion of borrowings; 7.11% interest; -- 10,000
Floating portion of borrowings; LIBOR+ 2.25%
(8.5% at December 31, 1995) $ 27,000 10,000
-------- --------
$ 27,000 $ 40,000
======== ========
</TABLE>
At September 30, 1995, the Company defaulted on certain financial covenants
related to the bank credit facility, due to generating a net loss from
operations. The Company has since been unable to cure the default. On January
25, 1996, the Company signed an agreement with the lender to change the entire
facility to a floating interest rate equivalent to 8.5% retroactive to October
1, 1995. In addition, the Company paid a $67,500 amendment fee and the lender
fixed the facility at $27 million decreasing with future principal payments.
Effective March 1, 1996, the loan agreement was restructured, with the
payment of an additional $50,000 fee. The floating rate was adjusted to LIBOR+
3.25% through June 30, 1996 and LIBOR+ 3.50% thereafter.
In anticipation of the completion of the Company's proposed merger with
Danielson Holding Corporation, further discussed at Note 15, "Subsequent
Events", the lender has agreed to waive a principal payment scheduled for March
31, 1996. Principal is payable quarterly thereafter through June 1, 1998.
Interest is payable quarterly March 31, 1996 through June 30, 1998.
32
<PAGE> 33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(7) Income Taxes
The components of income tax expense (benefit) are as follows (in thousands):
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------------------------
1995 1994 1993
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Current:
Federal $ (3,845) $ 3,311 $ 2,705
State 228 195 164
-------- ------- -------
(3,617) 3,506 2,869
Deferred:
Federal (3,695) (528) (226)
State (133) 2 (23)
-------- ------- -------
(3,828) (526) (249)
-------- ------- -------
Total $ (7,445) $ 2,980 $ 2,620
======== ======= =======
</TABLE>
Income tax expense differs from the amounts computed by applying the federal
income tax rates to income before income taxes and equity interests due to the
following (in thousands):
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------------------------
1995 1994 1993
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Tax expense at statutory rate $ (5,953) $ 3,715 $ 3,292
State taxes (net of federal deduction) 63 129 93
Dividend received deduction (661) (343) (172)
Tax exempt interest (1,180) (802) (562)
Other, net 286 281 (31)
-------- ------- -------
$ (7,445) $ 2,980 $ 2,620
======== ======= =======
</TABLE>
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at December 31,
1995 and 1994, respectively, are presented below in thousands:
<TABLE>
<CAPTION>
1995 1994
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Deferred tax assets:
Unearned premiums $ 4,244 $ 4,327
Discounted losses 3,407 1,957
Unrealized securities losses -- 151
Deferred compensation 253 --
Net operating loss carryforwards 248 --
Other 192 253
------- -------
Total gross deferred tax asset 8,344 6,688
Less valuation allowance -- --
------- -------
Net deferred tax assets 8,344 6,688
Deferred tax liabilities:
Deferred acquisition costs (3,324) (5,301)
Equipment, principally due
to differences in depreciation (194) (95)
Unrealized securities gains (906) --
Other (107) (250)
------- -------
Total gross deferred tax liability (4,531) (5,646)
======= =======
Net deferred tax asset $ 3,813 $ 1,042
======= =======
</TABLE>
33
<PAGE> 34
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Based upon the level of historical taxable income and projections for future
taxable income over periods which the deferred tax assets are deductible,
management believes it is more likely than not the Company will realize the
benefits of the deductible differences at December 31, 1995.
(8) Related Party Transactions
During 1995, 1994 and 1993, the Company paid fees of $351,000, $324,000,
$201,000, respectively, to an investment company which has certain stockholders
and directors that are also stockholders and directors of the Company.
The Company has a line of credit to an affiliate which bears interest at
prime plus 3%. Balances outstanding related to this line of credit were $1.2
million and $1.3 million at December 31, 1995 and 1994, respectively.
(9) Employee Benefit and Incentive Plans
In April, 1989, the Company adopted a nonqualified incentive stock option
plan for officers and key employees. The plan provided for the granting of
options to purchase up to 154,000 shares of common stock of the Company at
prices not less than fair market value, as determined by the Board of Directors,
on the date options are granted. The options vest ratably over a 5 year period
and are exercisable up to 10 years from the dates of grant. In connection with
the granting of an option, the Company also granted a companion stock
appreciation right ("SAR"). The SAR gives the employee the right to surrender
for cancellation all or part of the shares covered by the option, to the extent
such option is exercisable. In the event of surrender, an employee is entitled
to receive payment of up to 100% of the option exercise price. Options with
related SAR's were granted as follows: 1989, 59,486 shares at $3.26 per share;
1990, 42,000 shares at $3.32; and 1991, 42,000 at $3.71. During 1993, options to
purchase 70,686 shares were exercised for a total of $231,000. During 1994,
options to purchase 14,000 shares were exercised for a total of $46,410. During
1995, options to purchase 44,800 shares were exercised for a total of $162,000.
In November, 1992, the plan was frozen with the simultaneous adoption of a
long-term incentive plan for officers and directors. The remaining options
available for grant under the previous plan were combined with new options
available for grant for a total of 136,514 options available. In 1993 and in
1995, the stockholders approved share increases in the number of shares
available under this plan totalling 500,000. Options under the 1992 plan are
granted at the fair market value at the date of grant, vest over varying periods
at the discretion of the committee, and expire 10 years from the date of grant.
Options to purchase 129,500 shares were granted in 1992 at an option price of
$14 per share. Options to purchase 222,000 shares were granted in 1993 at prices
from $ 20.25 to $ 21.625. Options to purchase 35,000 shares were granted in 1994
at an option price of $14.75. Options to purchase 157,000 shares were granted in
1995 at prices from $9.50 per share to $18.75 per share. No options have been
exercised with respect to the plan.
The Company has a defined contribution plan (Savings Plan) intended to be a
qualified plan under Section 401(a) and 401(k) of the Internal Revenue Code.
Eligible participants include all officers and employees with six months of
service. Employee contributions (up to 15% of defined compensation) are matched
50% by the Company up to a limit of 2.5% of the participant's compensation. The
participants vest in the Company's matched contributions in equal increments
over a four-year period. Matching expense related to the savings plan for the
years ended December 31, 1995, 1994 and 1993 were approximately $99,700,
$120,883, and $84,000, respectively.
34
<PAGE> 35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In 1994, the Company adopted a deferred compensation plan under which certain
employees may defer up to 25% of their compensation and its directors may defer
100% of their compensation. The Company matches 100% of the employee deferrals
up to 10% of their compensation in years in which the Company's net income
reaches certain levels. Amounts deposited into these plans are unsecured
liabilities of the Company. The total liability included in accrued premium
taxes and other expenses for these plans at December 31, 1995 and 1994 was
$979,174 and $373,485, respectively. The contribution matching expense related
to the plan for the year ended December 31, 1994 was $114,698. Due to the net
loss for the year ended December 31, 1995, the Company was not required to match
employee contributions. In connection with the administration of this plan, the
Company has purchased Company-owned life insurance policies insuring the lives
of certain directors, officers and key employees. The purpose of these policies
is to fund the payment of benefits to the participants.
(10) Legal Proceedings
In August 1994, the Company and three of its wholly owned subsidiaries were
named in a civil lawsuit on behalf of two Chapter 13 debtors and as putative
representatives of a plaintiff's class challenging the validity of the Chapter
13 automobile insurance program in Alabama. The plaintiffs sought certification
of a class, a declaration that the insurance policies violate Alabama statutes,
a permanent injunction against further implementation of the Chapter 13
automobile insurance program in Alabama, and reimbursement of premiums received
by the Company under the Chapter 13 automobile program in Alabama. The Company
and its subsidiaries denied the material allegations of the complaint and were
awarded Dismissal by Summary Judgement in August 1995. The plaintiffs filed a
motion for reconsideration which was denied in October 1995. The plaintiffs have
appealed this determination and no decision has been rendered to date.
In May 1995, the Company, one of its officers and one of its subsidiaries
were named in a wrongful termination lawsuit by a former employee. This lawsuit
is pending in the State of Illinois Circuit Court, Seventh Judicial Circuit. The
plaintiff seeks $200,000 in compensatory damages and $1 million in punitive
damages. The matter is in the discovery stages. Management believes that it had
valid cause for the dismissal of this employee and will vigorously defend the
case. Management believes that the resolution of this matter will not have a
material impact on the Company's operations.
The Company and its subsidiaries are involved in asserted claims in the
normal course of business. Management believes the outcome of these matters in
the aggregate will not have a material adverse effect on the consolidated
financial statements of the Company.
(11) Commitments and Contingent Liabilities
Catastrophe Insurance Contracts
The Company utilizes catastrophe insurance futures and options (CAT
contracts) to help manage the Company's risk from catastrophic losses. These CAT
contracts are traded on the Chicago Board of Trade and are designed to track
insured catastrophic losses on a regional and nationwide basis. The CAT
contracts are indexed to loss ratios as determined by Insurance Services Office,
Inc. (ISO) using data obtained from designated reporting companies. ISO
considers losses reported to the designated companies as of the end of the
quarter following the loss quarter. ISO estimates quarterly premiums based on
the most recent statutory annual statements filed by the reporting companies.
Since the premium is known and constant during the life of the CAT contract, any
changes in CAT contract prices are due entirely to changes in the amount of
reported losses.
35
<PAGE> 36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The CAT program is used by management as a supplement to reinsurance
treaties. Depending on CBOT quotes and conditions in the traditional
catastrophic reinsurance market, the standardized nature of the CAT contracts
provides management the opportunity to "shop" for better price and coverage in
specific regions that a reinsurance company may not be able to offer in a timely
fashion.
The program has been used to reduce Midland's exposure to catastrophic risk
with the ISO September Eastern contract at the CBOT. These particular contracts
focus on the Atlantic coast and gulf regions of the country. It is in certain
areas of those regions that management believes it has catastrophic exposure
that is too costly to reinsure "traditionally." The contracts are based on
industry wide loss ratios calculated by the ISO. Management purchases or sells
calls or puts at various loss ratios to be long the loss ratio. This way, if the
industry is suffering from catastrophic losses the loss ratio will increase.
Management believes that gains in the value of the CAT contracts resulting from
catastrophic losses will offset underwriting losses. Should the value of the
contracts decline as a result of lower industry losses, Management believes that
the effect will be offset by lower underwriting losses.
During 1995, the Company wrote 384 contracts with a $9.6 million notional
value, purchased 272 contracts with a $6.8 million notional value, and
terminated 193 contracts with a $4.8 million notional value. The Company
realized gains of $855,000 on terminated contracts during 1995. At December 31,
1995, the Company had unrealized losses of $1.8 million on open contracts. The
contracts are carried at fair value at December 31, 1995. The table below
summarizes the open futures and options positions at December 31, 1995:
<TABLE>
<CAPTION>
Number Premium
of Notional Strike Expiration received Fair
contracts amount price date (paid) Value
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Call options 129 $ 3,225,000 70 4/30/96 $ (261,064) $ --
Put options 12 300,000 70 4/30/96 93,627 184,500
Call options 184 4,600,000 50 4/30/96 581,555 --
Futures 138 3,450,000 70 4/30/96 (2,415,000) 389,970
--- ----------- ----------- --------
463 $11,575,000 $(2,000,882) $574,470
=== =========== =========== ========
</TABLE>
Leases
The Company and its subsidiaries lease office space under noncancelable
operating leases expiring through the year 2006. Rent expense under the leases
was approximately $930,000, $669,000, and $460,000 for the years ended December
31, 1995, 1994 and 1993, respectively. Future rental commitments under
noncancelable operating leases aggregate approximately $5,632,000 at December
31, 1995 and are payable as follows (in thousands):
<TABLE>
<S> <C>
1996 $ 1,294
1997 1,262
1998 769
1999 405
2000 326
2001 and beyond 1,576
--------
$ 5,632
========
</TABLE>
(12) Regulatory Examination
The State of Tennessee Department of Commerce and Insurance (The Examiners)
has completed the fieldwork in connection with its regular examination of
Midland Risk Insurance Company (MRIC) and Specialty Risk Insurance Company
(SRIC) as of December 31, 1994 and issued its report of findings. The Examiners
have questioned the admissibility of certain of the
36
<PAGE> 37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
assets of MRIC and SRIC, including MRIC's $9 million equity investment in SRIC,
for statutory capital purposes. The aggregate amount of assets whose
admissibility the Examiners questioned was approximately $10 million and $9.6
million at December 31, 1995 and 1994, respectively. Midland's management has
responded to the Examiners' report and indicated that it believes the assets
should be admitted for statutory capital purposes. In addition, MRIC and SRIC
continue to prepare financial statements for statutory reporting purposes, which
admit the assets questioned by the Examiners. Midland is unable to determine the
outcome, if any, of the matters raised by the Examiners. However, management
believes that the affect of not admitting such assets would not materially
impact Midland's operations because the resulting impact on Midland's risk-based
capital position and capital adequacy ratio is not expected to affect Midland's
ability to continue its anticipated level of premium writings.
(13) Statutory Capital and Surplus
Statutory accounting practices for insurance companies differ somewhat from
generally accepted accounting principles. Reconciliations of statutory capital
and surplus and income of MRIC and SRIC, as determined using statutory
accounting principles, to the amounts included in the accompanying financial
statements is as follows:
<TABLE>
<CAPTION>
At December 31,
-----------------------------
1995 1994
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Combined statutory capital and surplus $ 56,588 $ 62,558
GAAP adjustments:
Deferred policy acquisition costs 9,617 15,148
Unrealized appreciation on fixed maturities 1,957 --
Deferred income taxes 4,051 (5,549)
Other 760 345
--------- ---------
GAAP stockholders' equity 72,973 72,502
Noninsurance companies adjustments:
Note payable (27,000) (20,000)
Other 2,872 5,292
--------- ---------
Stockholders' equity as presented herein $ 48,845 $ 57,794
========= =========
</TABLE>
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------
1995 1994
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Combined statutory net income (loss) $ (9,617) $ 2,068
GAAP adjustments:
Deferred policy acquisition costs (5,292) 7,159
Deferred income taxes 3,200 (2,727)
--------- ---------
GAAP net income (loss) (11,709) 6,500
Noninsurance companies adjustments 1,638 1,425
--------- ---------
Net income (loss) as presented herein $ (10,071) $ 7,925
========= =========
</TABLE>
MRIC cannot declare dividends in excess of the greater of 10% of statutory
capital and surplus or the net income for the preceding fiscal year unless
approval is obtained from the Tennessee Department of Insurance. In addition,
MRIC is required by the State of Tennessee to maintain statutory capital and
surplus of at least $2,000,000.
37
<PAGE> 38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(14) Quarterly Financial Data (Unaudited)
Presented below is unaudited quarterly financial information for 1995 and
1994. The information has been restated for the effect of reclassifying
securities in the held to maturity portfolio to the available for sale portfolio
during the third quarter of 1995 (see Note 1).
<TABLE>
<CAPTION>
1995
---------------------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Total investments
-held to maturity $ 139,330 $ 144,102 $ -- $ --
-available for sale 8,793 8,828 160,203 162,324
Total assets 219,977 254,276 287,438 283,531
Total stockholders' equity 60,407 63,206 58,111 48,845
Total income 42,870 50,691 55,321 44,164
Total expenses 39,348 47,066 64,554 60,530
Net income (loss) 2,609 2,795 (5,723) (9,752)
Net income (loss) per share .48 .51 (1.05) (1.81)
</TABLE>
<TABLE>
<CAPTION>
1994
---------------------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Total income $ 24,359 $ 32,153 $ 36,199 $ 38,775
Total expenses 21,126 28,600 32,287 38,573
Net income 2,258 2,454 2,637 576
Net income per share .41 .45 .48 .11
</TABLE>
(15) Subsequent Events
On February 9, 1996, the Company's Board of Directors suspended the policy
adopted in August, 1994 of paying a quarterly dividend on its common stock.
On February 26, 1996, the Company entered into an Agreement and Plan of
Merger with Danielson Holding Corporation. The merger agreement was terminated
in July 1996.
Effective March 1, 1996, the Company entered into an Amended and Restated
Loan Agreement with its lender, SunTrust Bank of Nashville. This agreement
provides for principal payments quarterly June 30, 1996 through June 30, 1998
and interest payments quarterly March 31, 1996 through June 30, 1998. The loan
agreement includes new financial covenants, with which management expects to
comply.
38
<PAGE> 39
INDEPENDENT AUDITORS' REPORT
Board of Directors
Midland Financial Group, Inc.:
We have audited the consolidated balance sheets of Midland Financial Group,
Inc. and Subsidiaries as of December 31, 1995 and 1994 and the related
consolidated statements of income (loss), changes in stockholders' equity and
cash flows for each of the years in the three-year period ended December 31,
1995. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Midland Financial
Group, Inc. and Subsidiaries as of December 31, 1995 and 1994, and the results
of their operations and their cash flows for each of the years in the three-year
period ended December 31, 1995 in conformity with generally accepted accounting
principles.
As discussed in note 1, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 115, "Accounting for Certain Investments in
Debt and Equity Securities" in 1994.
KPMG PEAT MARWICK LLP
Memphis, Tennessee
March 22, 1996, except as to note 12,
which is dated May 31, 1996
39
<PAGE> 40
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
<TABLE>
<CAPTION>
NAME: AGE: POSITION:
<S> <C> <C>
Joseph W. McLeary(1)(3)(6)............................. 56 Chairman of the Board, Chief Executive Officer and
Director
Philip R. Zanone(1)(3)................................. 54 Vice Chairman of the Board, Chief Investment Officer and
Director
Charles H. Gray, III(1)(3)............................. 47 President, Chief Operating Officer and Director
Elena Barham .......................................... 37 Senior Vice President, Chief Financial Officer and
Secretary
James E. Farmer........................................ 42 Vice President-Underwriting, Executive Vice President of
the Company's P&C Subsidiaries
Theodore J. Bender(1)(4)(6)............................ 48 Director
Carlos H. Cantu(4)..................................... 62 Director
F. Ross Johnson(1)(2).................................. 64 Director
J. Shea Leatherman(2)(4)(5)............................ 44 Director
John J. Shea, Jr., M.D.(6)............................. 71 Director
Sidney A. Stewart, Jr.(2)(5)........................... 69 Director
</TABLE>
- ---------------------
(1) Member of the Executive Committee.
(2) Member of the Compensation Committee.
(3) Member of the Investment Committee.
(4) Member of the Audit Committee.
(5) Member of the Stock Option Committee.
(6) Member of the Nominating Committee.
Joseph W. McLeary is the Chairman of the Board, Chief Executive Officer and a
Director of the Company and has served in these capacities since 1987. Mr.
McLeary also serves as a director of Equity Inns, Inc. and SCB Computer
Technology, Inc.
Philip R. Zanone has served as the Vice Chairman of the Board and Chief
Investment Officer since 1993. From 1987 until 1993, he was President of the
Company. He has been a Director since 1987.
Charles H. Gray, III served as the Executive Vice President, Chief Operating
Officer and a Director of the Company from 1988 until 1993. Mr. Gray is
currently the President and Chief Operating Officer and remains a Director.
Elena Barham was promoted to Senior Vice President and Chief Financial Officer
in 1993. From 1988 until 1993 she served as Vice President, Controller and
Secretary. She continues to serve as Secretary.
-40-
<PAGE> 41
James E. Farmer joined the Company in 1988 as Vice President-Underwriting of the
Company's P&C Subsidiaries. In 1993, he was promoted to and currently remains
Executive Vice President of the P&C Subsidiaries and Vice President-Underwriting
of the Company.
Theodore J. Bender, III, a Director of the Company since 1993 is a Managing
Director - Corporate Finance Department of The Robinson-Humphrey Company, Inc.,
a securities and investment banking firm. Mr. Bender has served in various
investment banking capacities over the past 18 years with The Robinson-Humphrey
Company, Inc. He serves as a director of The Robinson-Humphrey Company, Inc.
Carlos H. Cantu joined the Company as a Director in 1992. Mr. Cantu is President
and Chief Executive Officer and Director of The ServiceMaster Company, L.P., a
diversified services firm, and has served in the same capacity since 1986.
F. Ross Johnson joined the Company as a Director in 1995. Mr. Johnson has been
the Chairman and Chief Executive Officer of RJM Group, an international
management and advisory firm since 1989. Prior to that Mr. Johnson served as
Chairman and Chief Executive Officer of RJR Nabisco. He serves on the boards of
three other public companies, American Express Company, Archer Daniels Midland
Company and National Service Industries, as well as Canadian-based firms, Noma
Industries, Power Corporation, Black & McDonald and Bionaire.
J. Shea Leatherman has been a Director of the Company since 1987. Mr. Leatherman
has been President of Grant & Leatherman, Inc., a farm management company, and
the General Manager of Riverfield Farms, a farming interest located in
Mississippi, for more than five years.
Dr. John J. Shea has been a Director of the Company since 1987. Dr. Shea has
been the President and a physician at Shea Clinic Corporation for more than five
years.
Sidney A. Stewart, Jr. became a Director of the Company in 1992. Mr. Stewart
retired from Sedgwick James, Inc., an international insurance agency/brokerage
firm, in 1990 after serving as Vice Chairman since 1986. Mr.
Stewart serves as a Director of National Commerce Bancshares Corporation.
Mr. Zanone and Mr. Leatherman are brothers-in-law. Dr. Shea is the uncle of Mr.
Leatherman and of Mr. Leatherman's sister, who is the wife of Mr. Zanone. Mr.
Johnson is the father of the husband of Mr. Zanone's daughter.
-41-
<PAGE> 42
ITEM 11. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The following table sets forth the annual and long-term compensation for
services in all capacities to the Company for 1995, 1994 and 1993 of those
persons who were at December 31, 1995, (i) the Chief Executive Officer and (ii)
the other four most highly compensated executive officers of the Company (the
"Named Officers").
<TABLE>
<CAPTION>
Long Term
Annual Compensation (1) Compensation
------------------- ------------
Options All Other
Name and Salary Bonus Awards Compensation
Principal Position Year $ $ # $ (2)
- ------------------ ---- ------- ------ ------ ------------
<S> <C> <C> <C> <C> <C>
Joseph W. McLeary, 1995 250,000 40,000 15,000 5,500
Chairman of the Board and 1994 150,000 -0- 5,000 15,312
Chief Executive Officer 1993 100,000 62,500 25,000 3,672
Philip R. Zanone, 1995 250,000 40,000 15,000 5,500
Vice Chairman and 1994 150,000 -0- 5,000 17,432
Chief Investment Officer 1993 100,000 62,500 25,000 2,500
Charles H. Gray, III, 1995 450,000 80,000 30,000 5,500
President 1994 200,000 -0- 10,000 23,578
and Chief Operating Officer 1993 170,000 190,000 50,000 4,250
Elena Barham, 1995 200,000 40,000 12,500 5,500
Senior Vice President, 1994 125,000 -0- 5,000 15,310
Chief Financial Officer 1993 76,000 55,000 20,000 3,650
and Secretary
James E. Farmer, 1995 200,000 40,000 12,500 5,500
Vice President-Underwriting 1994 105,000 -0- 5,000 10,431
and Asst. Secretary 1993 75,000 55,000 20,000 2,875
</TABLE>
- -------------------------
(1) Compensation deferred at election of executive includable in category
and year earned.
(2) Includes the matching contributions to the Company's deferred
compensation plan as follows for 1994: Mr. McLeary, $12,812, Mr.
Zanone, $12,812; Mr. Gray, $18,958; Ms. Barham, $10,810; and Mr.
Farmer, $9,250; and of contributions to defined contribution plans.
Each of the Named Officers of the Company set forth in the foregoing cash
compensation table above is a party to an employment agreement with the Company.
The employment agreements between the Company and these Named Officers were
renegotiated effective January 1, 1995, and are for terms expiring in December,
1998 for Messrs. McLeary and Zanone and 1999 for Ms. Barham and Messrs. Gray and
Farmer, unless terminated sooner in accordance with the provisions of such
agreements. In addition, the employment agreements, as amended, provide for
minimum annual base salaries as follows: Mr. McLeary-$250,000; Mr.
Zanone-$250,000; Mr. Gray-$450,000; Ms. Barham-$200,000; and Mr.
Farmer-$200,000. If an employment agreement were terminated other than for
cause, the Company would be required to pay such individual an amount equal to
one year's base salary as a severance payment and continue benefits for two
years after termination, except for Mr. Gray, whose severance compensation is
equal to two times his base salary. The foregoing employment agreements contain
certain noncompetition covenants pursuant to which, for a period
-42-
<PAGE> 43
of one year after termination of employment, Ms. Barham and Mr. Farmer agree not
to solicit customers or employees or to disclose confidential information of the
Company and each of Messrs. McLeary, Zanone and Gray agree, in addition to the
foregoing covenants, not to compete in any manner with the Company.
OPTION GRANTS, EXERCISES AND FISCAL YEAR END VALUES
No options were granted under the Company's 1989 Incentive Stock Option Plan in
1995; option grants shown below for 1995 were under the Company's 1992 Long-Term
Incentive Plan. Shown below is information with respect to the exercised and
unexercised options to purchase Common Shares granted in fiscal 1995 and prior
years under the 1989 Incentive Stock Option Plan and the 1992 Long-Term
Incentive Plan to the Named Officers and held by them at December 31, 1995.
OPTION/SAR GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
INDIVIDUAL GRANTS VALUE AT ASSUMED
% OF TOTAL ANNUAL RATES OF STOCK
OPTIONS/SARS PRICE APPRECIATION FOR
OPTIONS/SARS GRANTED TO EXERCISE OR EXPIRATION OPTION TERM
GRANTED EMPLOYEES IN BASE PRICE DATE -----------------------------
Name (#) FISCAL YEAR ($/SH) DATE 5% 10%
- -------------------------- -------------- ------------------- -------------- --------------- ------------- --------------
<S> <C> <C> <C> <C> <C> <C>
Joseph W. McLeary 15,000(1) 13.0 18.75 8/01/00 $ 77,700 $171,750
Philip R. Zanone 15,000(1) 13.0 18.75 8/01/00 $ 77,700 $171,750
Charles H. Gray, III 30,000(1) 26.0 18.75 8/01/00 $155,400 $343,500
Elena Barham 12,500(1) 10.9 18.75 8/01/00 $ 64,750 $148,125
James E. Farmer 12,500(1) 10.9 18.75 8/01/00 $ 64,750 $148,125
</TABLE>
- ---------
(1) Options vest ratably over five years from date of grant.
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR
AND FY-END OPTION/SAR VALUES
<TABLE>
<CAPTION>
NUMBER OF VALUE OF UNEXERCISED
UNEXERCISED IN-THE-MONEY
OPTIONS/SARS OPTIONS/SARS
SHARES ACQUIRED VALUE AT FY-END (#) AT FY END ($)
NAME ON EXERCISE (#) REALIZED ($) EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE
- ---- --------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Joseph W. McLeary 16,800 240,005 45,700/17,500 35,326/-0-
Philip R. Zanone 16,800 237,905 45,700/17,500 35,326/-0-
Charles H. Gray, III -0- -0- 104,800/27.200 -0-/-0-
Elena Barham 2,800 39,718 32,300/15,000 24,668/-0-
James E. Farmer 2,800 24,668 29,500/15,000 -0-/-0-
</TABLE>
DIRECTORS' COMPENSATION
Independent directors of the Company receive an annual fee of $30,000, plus
travel expenses incurred to attend meetings. Directors who are also officers of
the Company do not receive any annual fee for their services as a director.
Directors may defer the receipt of all or a portion of their fees under the
Company's unfunded deferred compensation program.
-43-
<PAGE> 44
COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION
The Compensation Committee of the Board of Directors (the "Committee") is
composed entirely of independent outside directors. Decisions on compensation of
the Company's executives generally are made by the Committee and are reviewed by
the full Board (except for decisions about awards under the Company's
stock-based compensation plans, which are made solely by an independent
committee in order to satisfy Rule 16b-3 under the Securities Exchange Act of
1934). Set forth below is a report submitted by the Committee addressing the
Company's compensation policies for 1995 as they affected Joseph W. McLeary, the
Company's Chairman of the Board and Chief Executive Officer, Mr. Philip R.
Zanone, the Company's Vice-Chairman and Chief Investment Officer, Mr. Charles H.
Gray, III, the Company's President and Chief Operating Officer, Ms. Elena
Barham, the Company's Senior Vice President, Chief Financial Officer and
Secretary, and Mr. James E. Farmer, the Company's Vice President of Underwriting
and Assistant Secretary (collectively, the "Named Officers").
The Compensation Committee and the management of the Company are committed to
the principle that pay should be commensurate with performance and attainment of
predetermined financial and strategic objectives. The base salaries of the
Company's executives are contained in long-term employment agreements, but are
reviewed each year by the Committee. Through 1994, the Company relied to a large
degree on annual incentive programs to motivate the Named Officers to perform to
the full extent of their abilities for the benefit of the Company's shareholders
and compensated the Named Officers through fixed base salaries somewhat below
competitive amounts paid to senior managers in comparable positions along with
incentive compensation.
During 1995, the Committee reconsidered this philosophy, with these conclusions:
(1) Measuring and rewarding the Named Officers based on the short-term
annual performance of the Company is inconsistent with the major
objective, namely; building long-term shareholder value.
(2) Annual compensation should represent the appropriate level for Named
Officers that competitively compensates them for their performance.
(3) Long-term compensation in the form of stock options should make up a
major share of executive compensation and as a result integrate the
rewards to the executive at the same time as the shareholder receives
appreciation. Importantly, the appreciation is identical between the Named
Officers and the shareholders of the Company. There is no incentive
payment until the shareholders get stock appreciation.
The Committee recommended that future stock options have five-year terms, rather
than the current 10 years to tighten the focus and to produce improved
shareholder value. The compensation program recommended for the Named Officers
was intended to accomplish the following:
(1) Ensure that the Named Officers are properly and competitively
compensated for their performance.
(2) Ensure that their incentives are simple and straightforward and
identical to that of the shareholders they serve.
(3) Ensure that their focus is on the long-term growth in "shareholder
value" and that they are not forced to be distracted by short-term
situations that an annual incentive system generates.
-44-
<PAGE> 45
The Committee negotiated new contracts for the Named Officers including
five-year terms for each of Messrs. Gray and Farmer and Ms. Barham and four-year
terms for Messrs. McLeary and Zanone. In addition, the Named Officers were
awarded five-year stock options during 1995 by the Stock Option Committee.
July 5, 1995 COMPENSATION COMMITTEE
J. Shea Leatherman, Chairman
Sidney A. Stewart, Jr.
F. Ross Johnson
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Messrs. Leatherman, Stewart and Johnson, all of whom are non-employee directors,
served as members of the Compensation Committee during 1995. There were no
compensation committee interlocks in 1995, and no insider participated in
decisions related to his compensation.
-45-
<PAGE> 46
STOCK PRICE PERFORMANCE
The following table shows a comparison of cumulative total return to
shareholders for the Company's common stock, the Nasdaq Composite Index and
Nasdaq insurance company stocks. The table assumes $10,000 invested on December
10, 1992 (the date on which the shares of the Company's common stock were first
publicly traded).
-46-
<PAGE> 47
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT.
To the best knowledge of the Company, based on information filed with the
Securities and Exchange Commission and the Company's stock records, the
following table sets forth, as of March 22, 1996, the number of Common Shares
beneficially owned by (i) each person who beneficially owns more than 5% of the
Common Shares, (ii) directors and persons nominated to become directors of the
Company, and Named Officers (as defined hereinafter), and (iii) directors and
officers as a group.
<TABLE>
<CAPTION>
Name and Address Amount and Nature Percent
of Beneficial Owner of Beneficially Owned (1) of Class
-------------------------- ------------------------- --------
<S> <C> <C> <C>
(i) Fenimore Asset Management, Inc.(2) 426,550 7.7
(ii) John J. Shea, Jr., M.D. (3) 315,997 5.7
Philip R. Zanone (4)(5) 441,339 7.9
Charles H. Gray, III (5)(6) 269,333 4.8
Joseph W. McLeary (5)(7) 177,265 3.2
J. Shea Leatherman (8) 164,039 3.0
Elena Barham (5) 69,477 1.2
James E. Farmer (5) 65,830 1.2
Sidney A. Stewart (5) 25,150 *
F. Ross Johnson (9) 33,000 *
Carlos H. Cantu (5) 15,000 *
Theodore J. Bender, III (10) 14,000 *
(iii) All Directors and Executive
Officers as a Group
(11 persons) 1,590,430 27.0
</TABLE>
- -------------
* Less than one percent
(1) Except as indicated in the footnotes set forth below, the persons named
in the table, to the Company's knowledge, have sole voting and investment
power with respect to all Common Shares shown as beneficially owned by
them. The numbers shown include the shares that are not currently
outstanding but which certain stockholders are entitled to acquire or
will be entitled to acquire within sixty (60) days. Such shares are
deemed to be outstanding for the purpose of computing the percentage of
outstanding Common Shares owned by the particular stockholder and by the
group, but are not deemed to be outstanding for the purpose of computing
the percentage of ownership of any other person.
(2) The address of Fenimore Asset Management, Inc. is 118 N. Grand Street,
Box 310, Cobleskill, New York, 10243.
(3) Dr. Shea's address is Shea Clinic, 6133 Poplar Pike, P.O. Box 17987,
Memphis, Tennessee 38187-0987.
(4) Includes 55,734 shares owned by his wife, Irwin L. Zanone, as to which
Mr. Zanone disclaims beneficial ownership; includes 45,700 shares
issuable upon the exercise of options granted under the Company's stock
option plans; excludes options to purchase 17,500 shares which are not
exercisable within the next 60 days.
(5) The address of each of the Company's officers and of Messrs. Cantu and
Stewart is Midland Financial Group, Inc., 825 Crossover Lane, Suite 112,
Memphis, Tennessee 38117.
(6) Includes 104,800 shares issuable upon the exercise of stock options
granted under the Company's stock option plans; excludes options to
purchase 27,200 shares that are not exercisable within the next 60 days.
-47-
<PAGE> 48
(7) Includes 1,000 shares owned by his wife, Joyce C. McLeary; 44,904 shares
owned by McLeary Financial Group, L.P., of which Mr. McLeary is a limited
partner; 45,700 shares issuable upon the exercise of stock options
granted under the Company's stock option plans; excludes options to
purchase 17,500 shares that are not exercisable within the next 60 days.
(8) Mr. Leatherman's address is Route 1, Box 193, Robinsonville, Mississippi
38664.
(9) Mr. Johnson's address is 2660 Peachtree Street, N.W., Atlanta, Georgia
30305. Mr. Johnson's ownership includes 2,000 shares owned by his wife,
Laurie Johnson, for which he disclaims beneficial ownership.
(10) Mr. Bender's address is 3541 Ridgewood Road, Atlanta, Georgia 30327.
Based solely on review of the copies of reporting forms furnished to the
Company, or written representations that no forms are required, the Company
believes that during 1995 its officers and directors and 10% stockholders
complied with all filing requirements for reporting to the Securities and
Exchange Commission their ownership and changes in ownership of Common Shares
(as required pursuant to Section 16(a) of the Securities and Exchange Act of
1934).
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Messrs. McLeary and Zanone each own 7.8% of the outstanding common stock of
NewSouth Capital Management, Inc. ("NewSouth"), the investment advisor for the
Company's investment portfolio. At December 31, 1995, the Company's portfolio
represented 10% of the assets under management by NewSouth, and in 1995 fees
paid by the Company to NewSouth totaled $351,000 and represented 4.6% of all
fees received by NewSouth during such period. The Company believes that the
amount charged by NewSouth to the Company for investment management services is
competitive with fees that are charged by NewSouth and other managers for
portfolios of similar size and with similar objectives. The Company may elect to
diversify its portfolio management in the future.
In the opinion of management, the foregoing transactions with affiliates were
made under terms that were no less favorable to the Company than those that
could have been obtained from unaffiliated third parties. In the future, the
Company will not enter into any transactions with officers, directors, 5%
stockholders or affiliates unless the terms are no less favorable to the Company
than those that could be obtained from unaffiliated third parties and the
transactions are approved by a majority of the Company's directors, including a
majority of the disinterested directors.
-48-
<PAGE> 49
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) 1. Consolidated Financial Statements
Financial Statements included herein beginning on page 20.:
Consolidated Balance Sheets, as of December 31, 1995 and December
31, 1994.
Consolidated Statements of Income (Loss) for the years ended December 31,
1995, December 31, 1994 and December 31, 1993.
Consolidated Statements of Changes in Stockholders' Equity for the years
ended December 31, 1995, December 31, 1994, and December 31, 1993.
Consolidated Statements of Cash Flows for the years ended December 31,
1995, December 31, 1994 and December 31, 1993.
Notes to Consolidated Financial Statements.
Independent Auditors' Report.
(a) 2. Financial statement schedules.
Independent Auditors' Report
Schedule I-Summary of investments
Schedule II-Condensed financial information of registrant
Schedule IV-Reinsurance
All other schedules are omitted because they are not applicable or the
required information is shown in the Consolidated Financial Statements or
the Notes thereto.
(a) 3. Exhibits. See Index to Exhibits following the financial statement
schedules below.
(b) Reports on Form 8-K.
There were no Current Reports on Form 8-K filed during the quarter ended
December 31, 1995.
A Current Report on Form 8-K was filed on February 28, 1996, relating to the
execution of an Agreement and Plan of Merger dated February 26, 1996 by and
among the Company and Danielson Holding Corporation, a Delaware corporation, and
its wholly-owned subsidiary (the "Agreement"). Upon consummation of the
transaction, the Company will become a wholly-owned subsidiary of Danielson
Holding Corporation. The Agreement provides for holders of the Company's common
stock to receive consideration of 1.6 times audited book value at December 31,
1995 in a combination of cash, preferred stock and common stock of Danielson
Holding Corporation. Subject to the receipt of the requisite shareholder
approvals, other required approvals and the satisfaction or waiver by the
parties of all conditions of the Agreement, the Company anticipates completion
of the merger during the second quarter of 1996.
-49-
<PAGE> 50
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 on January 14, 1997.
MIDLAND FINANCIAL GROUP, INC.
(Registrant)
/s/ Joseph W. McLeary
- -------------------------------------------------
By: Joseph W. McLeary, Chairman of the Board and
Chief Executive Officer
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.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
<S> <C> <C>
/s/ Joseph W. McLeary Chairman of the Board Jamuary 14, 1997
- ------------------------------- and Chief Executive Officer
Joseph W. McLeary (Principal Executive Officer)
/s/ Philip R. Zanone Vice Chairman, Chief Jamuary 14, 1997
- -------------------------------
Philip R. Zanone Investment Officer and Director
/s/ Charles H. Gray, III President, Chief Operating Jamuary 14, 1997
- -------------------------------
Charles H. Gray, III Officer and Director
/s/ Elena Barham Senior Vice President, Jamuary 14, 1997
- ------------------------------- Chief Financial Officer,
Elena Barham and Secretary (Principal Financial Officer)
Director Jamuary 14, 1997
- -------------------------------
F. Ross Johnson
/s/ J. Shea Leatherman Director Jamuary 14, 1997
- -------------------------------
J. Shea Leatherman
/s/ John J. Shea, Jr. Director Jamuary 14, 1997
- -------------------------------
Dr. John J. Shea, Jr.
Director Jamuary 14, 1997
- -------------------------------
Theodore J. Bender
Director Jamuary 14, 1997
- -------------------------------
Carlos H. Cantu
/s/ Sidney A. Stewart, Jr. Director Jamuary 14, 1997
- -------------------------------
Sidney A. Stewart, Jr.
</TABLE>
<PAGE> 51
Independent Auditors' Report
The Board of Directors
Midland Financial Group, Inc.:
Under date of March 22, 1996, except as to note 12, which is dated May 31, 1996,
we reported on the consolidated balance sheets of Midland Financial Group, Inc.
and subsidiaries, as of December 31, 1995 and 1994, and the related
consolidated statements of income (loss), changes in stockholders' equity, and
cash flows for each of the years in the three-year period ended December 31,
1995, as contained herein. Our report refers to changes in accounting
principles related to the adoption in 1994 of the provisions of Statement of
Financial Accounting Standards No. 115, "Accounting for Certain Investments in
Debt and Equity Securities." These consolidated financial statements and our
report thereon are included in the annual report on Form 10-K for the year
1995. In connection with our audits of the aforementioned consolidated
financial statements, we also have audited the financial statement schedules as
listed in the accompanying index. These financial statement schedules are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statement schedules based on our audits.
In our opinion, such financial statement schedules, when considered in relation
to the basic consolidated financial statements taken as a whole, present fairly,
in all material respects, the information set forth therein.
KPMG Peat Marwick LLP
Memphis, Tennessee
March 22, 1996, except as to
note 12, which is dated
May 31, 1996
<PAGE> 52
SCHEDULE I
MIDLAND FINANCIAL GROUP, INC.
SUMMARY OF INVESTMENTS -- OTHER THAN INVESTMENTS IN RELATED PARTIES
DECEMBER 31, 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
Amount at
which shown
in the
Fair balance
Type of Investment Cost value sheet
-------- -------- ----------
<S> <C> <C> <C>
FIXED MATURITIES:
Bonds:
United States Government and government
agencies $ 1,207 $ 1,215 $ 1,215
Municipalities 83,838 85,266 85,266
All other corporate bonds 19,722 19,810 19,810
Redeemable preferred stock 41,870 42,625 42,625
-------- -------- --------
Total fixed maturities 146,637 148,916 148,916
-------- -------- --------
EQUITY SECURITIES:
Common stock 13,039 13,408 13,408
-------- -------- --------
Total equity securities 13,039 13,408 13,408
-------- -------- --------
Total Investments $159,676 $162,324 $162,324
======== ======== ========
</TABLE>
S-1
<PAGE> 53
SCHEDULE II
PAGE 1 OF 5
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
MIDLAND FINANCIAL GROUP, INC.
(PARENT COMPANY ONLY)
CONDENSED BALANCE SHEETS
DECEMBER 31, 1995 AND 1994
(IN THOUSANDS)
<TABLE>
<CAPTION>
1995 1994
---- ----
ASSETS
<S> <C> <C>
Investments in subsidiaries $76,671 $74,425
Cash and equivalents 1,869 29
Securities available for sale -- 6,732
Due from affiliates -- 13,365
Furniture and equipment 2,167 1,335
Notes receivable 1,651 1,756
Other assets 1,049 916
Deferred income taxes 125 --
Income taxes recoverable 1,470 235
------- -------
$85,002 $98,793
======= =======
</TABLE>
<TABLE>
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY
<S> <C> <C>
Notes payable $27,000 $40,000
Due to affiliates 7,212 --
Accrued expenses 1,945 559
Income taxes payable -- 440
------- -------
36,157 40,999
------- -------
STOCKHOLDERS' EQUITY:
Common stock 39,420 39,258
Additional paid-in capital 1,887 1,887
Retained earnings 5,796 16,943
Unrealized appreciation (depreciation) of
securities available for sale 1,742 (294)
------- -------
Total stockholders' equity 48,845 57,794
------- -------
$85,002 $98,793
======= =======
</TABLE>
See accompanying note to condensed financial statements.
S-2
<PAGE> 54
SCHEDULE II
PAGE 2 OF 5
MIDLAND FINANCIAL GROUP, INC.
(PARENT COMPANY ONLY)
CONDENSED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993
(IN THOUSANDS)
<TABLE>
<CAPTION>
1995 1994 1993
-------- --------- -------
<S> <C> <C> <C>
Income:
Investment income $ 1,929 $ 652 $ 186
Net realized securities gain -- -- 186
Management fees 1,284 695 552
Other -- 7 58
-------- -------- --------
3,213 1,354 982
-------- -------- --------
Expenses:
General and administrative 1,908 173 266
Interest expense 1,859 924 --
-------- -------- --------
3,767 1,097 266
-------- -------- --------
Income (loss) before income taxes and equity interests (554) 257 716
Income tax provision (114) (283) (254)
-------- -------- --------
Income (loss) before equity interests (668) (26) 462
Equity interests (6) 5 6
-------- -------- --------
Net income (loss) before equity in undistributed
income of subsidiaries (674) (21) 468
Equity in undistributed income of subsidiaries (9,397) 7,946 6,600
-------- -------- --------
Net income (loss) $(10,071) $ 7,925 $ 7,068
======== ======== ========
</TABLE>
See accompanying note to condensed financial statements.
S-3
<PAGE> 55
SCHEDULE II
PAGE 3 OF 5
MIDLAND FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
Common Stock
-----------------------
Shares Additional Unrealized
issued and paid-in Retained appreciation
outstanding Amount capital earnings (depreciation) Total
----------- ------ ------- -------- -------------- -----
<S> <C> <C> <C> <C> <C> <C>
Balances at
December 31, 1992 4,346,123 $ 35,392 $ 1,887 $ 2,483 $ 118 $ 39,880
Net income -- -- -- 7,068 -- 7,068
Warrants exercised 872,505 3,429 -- -- -- 3,429
Options exercised 70,686 231 -- -- -- 231
Appreciation of
equity securities -- -- -- -- 12 12
Balances at
December 31, 1993 5,289,314 39,052 1,887 9,551 130 50,620
Net income -- -- -- 7,925 -- 7,925
Cash dividends paid
($.10 per share) -- -- -- (533) -- (533)
Options exercised 14,000 46 -- -- -- 46
Warrants exercised 40,908 160 -- -- -- 160
Change in fair value
of securities available
for sale net of tax
of $231 -- -- -- -- (424) (424)
--------- --------- --------- --------- --------- ---------
Balances at
December 31, 1994 5,344,222 39,258 1,887 16,943 (294) 57,794
Net loss -- -- -- (10,071) -- (10,071)
Cash dividends paid
($.20 per share) -- -- -- (1,076) -- (1,076)
Options exercised 44,800 162 -- -- -- 162
Change in fair value
of securities available
for sale net of tax
of $1,058 -- -- -- -- 2,036 2,036
--------- --------- --------- --------- --------- ---------
Balances at
December 31, 1995 5,389,022 $ 39,420 $ 1,887 $ 5,796 $ 1,742 $ 48,845
========= ========= ========= ========= ========= =========
</TABLE>
See accompanying notes to condensed financial statements.
S-4
<PAGE> 56
SCHEDULE II
PAGE 4 OF 5
MIDLAND FINANCIAL GROUP, INC.
(PARENT COMPANY ONLY)
CONDENSED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31 1995, 1994, AND 1993
(IN THOUSANDS)
<TABLE>
<CAPTION>
1995 1994 1993
---- ---- ----
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $(10,071) $ 7,925 $ 7,068
Gain on investments -- -- (186)
Changes in assets and liabilities:
Other assets (133) (779) 390
Accrued expenses and other liabilities 1,386 549(11)
Income taxes payable (1,800) 505 (429)
Other noncash items 137 51 18
-------- -------- --------
Net cash provided by (used in) operating
activities (10,481) $ 8,251 6,850
-------- -------- --------
Cash flows from investing activities:
Investment in subsidiaries (2,246) (17,512) (18,659)
Purchases of investments -- (7,429) (8,985)
Sales of investments 6,732 5,720 3,811
Fixed asset additions 945 (655) (260)
Other 126 (6) (100)
-------- -------- --------
Net cash provided by (used in) investing
activities 5,557 (19,976) (24,099)
-------- -------- --------
Cash flows from financing activities:
Proceeds from credit facility 10,000 30,000 20,000
Notes receivable 102 (177) (1,579)
Proceeds from exercise of common
stock warrants and options 162 206 3,660
Repayment of debt (23,000) (10,000) --
Loans to affiliates 20,576 (10,330) (2,244)
Dividends to stockholders (1,076) (533)
-------- -------- --------
Net cash provided by financing
activities 6,764 9,166 19,837
-------- -------- --------
Increase (decrease) in cash 1,840 (2,559) 2,588
Cash at beginning of year 29 2,588 0
-------- -------- --------
Cash at end of year $ 1,869 $ 29 $ 2,588
======== ======== ========
</TABLE>
See accompanying note to condensed financial statements.
S-5
<PAGE> 57
SCHEDULE II
PAGE 5 OF 5
MIDLAND FINANCIAL GROUP, INC.
(PARENT COMPANY ONLY)
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
NOTE TO CONDENSED FINANCIAL STATEMENTS
(1) The accompanying condensed financial information should be read in
conjunction with the consolidated financial statements of Midland
Financial Group, Inc. and subsidiaries as of December 31, 1995 and 1994
and for the three year period ended December 31, 1995.
S-6
<PAGE> 58
SCHEDULE IV
MIDLAND FINANCIAL GROUP, INC.
REINSURANCE
YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993
(AMOUNTS IN THOUSANDS, EXCEPT PERCENTAGES)
<TABLE>
<CAPTION>
Assumed Percentage
Ceded to from of amount
Direct other other Net assumed
amount companies companies amount to net
------ --------- --------- ------ ------
<S> <C> <C> <C> <C> <C>
Year Ended December 31,
1995:
Premiums
Property casualty $ 175,226 17,719 14,887 172,394 8.64
--------- -------- --------- --------- ---------
Total $ 175,226 17,719 14,887 172,394 8.64
========= ======== ========= ========= =========
Year ended December 31,
1994:
Premiums
Property casualty $ 117,738 10,801 11,281 118,218 9.54
--------- -------- --------- --------- ---------
Total $ 117,738 10,801 11,281 118,218 9.54
========= ======== ========= ========= =========
Year ended December 31,
1993:
Premiums
Property casualty $ 78,329 25,461 2,402 55,272 4.35
--------- -------- --------- --------- ---------
Total $ 78,329 25,429 2,402 55,272 4.35
========= ======== ========= ========= =========
</TABLE>
S-7
<PAGE> 59
EXHIBIT INDEX
NUMBER ASSIGNED
IN REGULATION
S-K, ITEM 601 DESCRIPTION OF EXHIBIT
(3) 3.1 Restated Charter (1) (3.1)
3.2 Bylaws, as amended (3)
(4) 4.1 Specimen Common Stock Certificate (1) (4.1)
(10) 10.1 Tax Allocation Agreement, dated May 1, 1988, by and among
Midland Financial Group, Inc. and Memphis Fire Insurance Company,
Midland Risk Services, Inc. and Delta Claims, Inc. (1) (10.2)
10.2 Expense Allocation Agreement by and among Midland Financial Group,
Inc., Midland Risk Insurance Company, Specialty Risk Insurance
Company, Midland Risk Services, Inc., Agents Financial Services,
Inc., and Delta Claims Service, Inc., dated January 1, 1994. (2)
(10.47)
10.3 Tax Allocation Agreement by and among Midland Financial Group,
Inc. and Midland Risk Insurance Company and Specialty Risk
Insurance Company, dated January 1, 1994.(2) (10.48)
10.4 General Agency Agreement, dated July 15, 1991, by and between
Midland Risk Services--Louisiana, Inc. and Midland Risk Insurance
Company. (1) (10.23)
10.5 General Agency Agreement, dated September 5, 1991, by and between
Midland Risk Services--Arizona, Inc. and Midland Risk Insurance
Company as amended. (1) (10.29)
10.6 General Agency Agreement, dated January 1, 1989, by and between
Midland Risk Services, Inc. and Midland Risk Insurance Company.
(1) (10.30)
10.7 General Agency Agreement, dated July 2, 1992, by and between
Midland Risk Services--Texas, Inc. and Midland Risk Insurance
Company as amended. (1) (10.31)
10.8 General Agency Agreement, dated January 23, 1990, by and between
National Specialty Lines, Inc. and Midland Risk Insurance Company
as amended. (1) (10.32)
10.9 General Agency Agreement, dated October 1, 1991, by and between
Strickland General Agency, Inc. and Midland Risk Insurance Company
as amended. (1) (10.33)
10.10 General Agency Agreement dated March 1, 1994, by and between
Midland Risk Insurance Company, Specialty Risk Insurance Company
and Midland Risk Services-Tennessee, Inc. (3)
10.11 General Agency Agreement dated January 1, 1995, by and between
Midland Risk Insurance Company and Arkansas General Agency, Inc.
(3)
10.12 Quota Share Reinsurance Contract effective September 30, 1995 by
and between Midland Risk Insurance Company, Specialty Risk
Insurance Company and Kemper Reinsurance Company. (3)
10.13 Amended and Restated Loan Agreement between Midland Financial
Group, Inc. and SunTrust Bank (f/k/a Third National Bank) in
Nashville and related Promissory Note, dated April 13, 1995. (3)
<PAGE> 60
10.14 First Amendment to Amended and Restated Loan Agreement between
Midland Financial Group, Inc. and SunTrust Bank, Nashville,
National Association (f/k/a Third National Bank), and related
First Amendment to Amended and Restated Promissory Note, dated
March 1, 1996. (3)
10.15 Stock Pledge Agreement between Midland Financial Group, Inc. and
SunTrust Bank (f/k/a Third National Bank) in Nashville, dated
April 13, 1995. (3)
10.16 Stock Pledge Agreement between Midland Risk Insurance Company and
SunTrust Bank (f/k/a Third National Bank) in Nashville, dated
December 27, 1993. (3)
10.17 Amended and Restated Stock Pledge Agreement between Midland Risk
Services, Inc. and SunTrust Bank (f/k/a Third National Bank) in
Nashville, dated April 13, 1995. (3)
10.18 Amended and Restated Stock Pledge Agreement between Agents
Financial Services- Tennessee, Inc. and SunTrust Bank (f/k/a Third
National Bank) in Nashville, dated April 13, 1995. (3)
10.19 Amended and Restated Stock Pledge Agreement between Midland Risk
Services-Louisiana, Inc. and SunTrust Bank (f/k/a Third National
Bank) in Nashville, dated April 13, 1995. (3)
10.20 Acknowledgement and Consent of Pledgors in favor of SunTrust Bank,
Nashville, National Association (f/k/a Third National Bank)
related to First Amendment to Amended and Restated Loan Agreement
and First Amendment to Amended and Restated Promissory Note dated
March 1, 1996. (3)
10.21 Lease Agreement, as amended, dated September 9, 1991, between
Weston Management Company and Midland Financial Group, Inc. (1)
(10.7)
10.22 Modifications and Ratifications of Lease between Weston Management
Company as manager for Metropolitan Life Insurance Company and
Midland Financial Group, Inc., dated June 1, 1994 and November 4,
1994. (2) (10.44)
10.23 Lease Agreement dated May 17, 1995, by and between Boyle
Investment Company and Midland Financial Group, Inc. (3)
MANAGEMENT CONTRACTS, COMPENSATORY PLANS OR ARRANGEMENTS, ETC.
10.24 Form of Warrant to Purchase Common Shares issued in connection
with an offering of Series A Preferred Stock by the Company. (1)
(10.11)
10.25 Agreement to Issue Stock Warrants, dated November 24, 1992 by and
among Michael A. Robinson, MARCo Holdings, L.P., the Company and
its Directors. (1) (10.61)
10.26 1989 Incentive Stock Option Plan, dated April 21, 1981. (1) (10.9)
10.27 Form of Incentive Stock Option Agreement. (1) (10.10)
10.28 Midland Companies' Employee Savings Plan and Trust Summary Plan
Description effective January 1, 1991. (1) (10.12)
10.29 Form of Employment Agreement between Midland Financial Group,
Inc. and Joseph W. McLeary. (3)
<PAGE> 61
10.30 Form of Employment Agreement between Midland Financial Group,
Inc. and Philip R. Zanone. (3)
10.31 Form of Employment Agreement between Midland Financial Group,
Inc. and Charles Henry Gray, III. (3)
10.32 Form of Employment Agreement between Midland Financial Group,
Inc. and James E. Farmer. (3)
10.33 Form of Employment Agreement between Midland Financial Group,
Inc. and Elena Barham. (3)
10.34 1992 Long-Term Incentive Plan. (1) (10.58)
10.35 Form of Incentive Stock Option Agreement. (1) (10.59)
10.36 Form of Non-Qualified Option Agreement. (1) (10.60)
10.37 Midland Companies Director and Executive Cash or Deferred
Compensation Plan, dated April 1, 1994. (2) (10.74)
(11) 11.1 Statement re Computation of Per Share Earnings.
(21) 21.1 Subsidiaries of Registrant
(23) 23.1 Consent of KPMG Peat Marwick LLP
(28) 28.1 Schedule P-Analysis of Losses and Loss Expenses from the Annual
Statement for the year 1995 of Midland Risk Insurance Company and
Subsidiary. (3)
- ------------
(1) Incorporated by reference from the Exhibits to the Form S-1 Registration
Statement No. 33-53360 of registrant, effective December 10, 1992.
(Exhibit number in Form S-1 is set forth in italics)
(2) Incorporated by reference from the Exhibits to Annual Report on Form 10-K
for the year ended December 31, 1994. (Exhibit number, if different in
1994 10-K, is set forth in italics).
(3) Filed with Annual Report on Form 10-K for the year ended December 31,
1995, originally filed with the commission on March 1, 1996.
<PAGE> 1
EXHIBIT 11.1
MIDLAND FINANCIAL GROUP, INC. AND SUBSIDIARIES
STATEMENT REGARDING COMPUTATION OF EARNINGS PER SHARE
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1995 1994 1993
--------- --------- ---------
<S> <C> <C> <C>
Primary:
Average Shares outstanding 5,369 5,322 5,118
Net effect of dilutive stock options and
warrants - based on the treasury stock
method using average market price -- 156 188
--------- --------- ---------
Common and common equivalent shares 5,369 5,478 5,306
========= ========= =========
Net income (10,071) $ 7,925 $ 7,068
Plus (less):
Preferred stock dividend -- -- --
Accretion of discount on preferred stock -- -- --
Redemption premium on preferred stock -- -- --
Assumed interest based on modified
treasury method -- -- --
--------- --------- ---------
Adjusted net income applicable to $ (10,071) $ 7,925 $ 7,068
common and common equivalent ========= ========= =========
shares
Fully diluted:
Average shares outstanding 5,369 5,322 5,118
Net effect of dilutive stock options and
warrants - based on the treasury stock
method using average market price -- 155 174
--------- --------- ---------
Common and common equivalents shares 5,369 5,477 5,292
========= ========= =========
Net income (loss) $ (10,071) $ 7,925 $ 7,068
========= ========= =========
Per share amount:
Primary:
Net income (1.88) 1.45 1.34
Fully diluted:
Net income (1.88) 1.45 1.34
</TABLE>
<PAGE> 1
EXHIBIT 21.1
MIDLAND FINANCIAL GROUP, INC.
LIST OF SUBSIDIARIES
DECEMBER 31, 1995
Midland Financial Group, Inc. (TN)
Midland Risk Insurance Company (TN)
Specialty Risk Insurance Company (TN)
Agents Financial Services - Tennessee, Inc.
Midland Financial Services, Inc. (LA)
Midland Financial Services - California, Inc.
Midland Financial Services - Texas, Inc.
Agents Financial Services - Arizona, Inc.
Agents Financial Services - Pacific N.W., Inc. (Oregon)
Agents Financial Services - Illinois, Inc.
Delta Claims Services, Inc. (TN)
Midland Risk Services, Inc. (TN)
Midland Risk Services of Louisiana, Inc.
Midland Risk Services - Arizona, Inc.
Midland Risk Services - Texas, Inc.
Midland Risk Insurance Services - California, Inc.
Midland Risk Services - Illinois, Inc.
Midland Risk Services - Pacific N.W., Inc. (Oregon)
Midland Risk Services-Tennessee, Inc.
AutoSurance of America, Inc. (TN)
Midland Risk Services - Nevada, Inc.
Midland Surety Group, L.L.C. (TN)
<PAGE> 1
EXHIBIT 23.1
ACCOUNTANTS' CONSENT
The Board of Directors
Midland Financial Group, Inc.:
We consent to incorporation by reference in the Registration Statement on Form
S-8 for the 1992 Long-Term Incentive Plan and the Registration Statement on Form
S-8 for the 1989 Incentive Stock Option Plan of Midland Financial Group, Inc. of
our report dated March 22, 1996, except as to note 12, which is dated May 31,
1996, relating to the consolidated balance sheets of Midland Financial Group,
Inc. and subsidiaries as of December 31, 1995 and 1994, and the related
consolidated statements of income (loss), changes in stockholder's equity, and
cash flows for each of the years in the three-year period ended December 31,
1995, which report appears in the 1995 annual report on Form 10-K/A of Midland
Financial Group, Inc.
As discussed in note 1 to the consolidated financial statements, the Company
adopted the provisions of Statement of Accounting Standards No. 115, Accounting
for Certain Investments in Debt and Equity Securities, in 1994.
KPMG Peat Marwick LLP
Memphis, Tennessee
January 13, 1997
