UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For The Quarterly Period Ended September 30, 1998
Commission File Number: 000-24366
GORAN CAPITAL INC.
(Exact name of registrant as specified in its charter)
CANADA Not Applicable
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
181 University Avenue
Box 11, Suite 1101
Toronto, Ontario M5H 3M7
4720 Kingsway Drive
Indianapolis, Indiana 46205
(Address of Principal Executive Offices)
Registrant's telephone number, including area code: (416) 594-1155 (Canada)
(317) 259-6400 (U.S.)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
As of September 30, 1998, there were 5,839,466 shares of Registrant's common
stock issued and outstanding exclusive of shares held by Registrant.
<PAGE>
Form 10-Q Index
For The Quarter Ended September 30, 1998
Page
Number
PART I FINANCIAL INFORMATION
Item 1 Financial Statements
Unaudited Consolidated Financial Statements:
Unaudited Consolidated Balance Sheets at
September 30, 1998 and December 31, 1997 ..........................3
Unaudited Consolidated Statements of Earnings For
The Three and Nine Months Ended September 30, 1998
and 1997 ........................................................4-5
Unaudited Consolidated Statements of Shareholders'
Equity ............................................................6
Unaudited Consolidated Statements of Changes in
Cash Resources for the Three and Nine Months Ended
September 30, 1998 and 1997 .......................................7
Condensed Notes to Unaudited Consolidated Financial
Statements ........................................................8
Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations ..............................12
PART II OTHER INFORMATION ................................................21
SIGNATURES ................................................................23
INDEX TO EXHIBITS
Exhibit 11 - Computation of Per Share Earnings ...................24
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1 FINANCIAL STATEMENTS
GORAN CAPITAL INC.
UNAUDITED CONSOLIDATED BALANCE SHEETS
(Canadian GAAP, stated in thousands of U.S. dollars)
<TABLE>
<CAPTION>
September 30, December 31,
ASSETS 1998 1997
<S> <C> <C>
Cash and investments $256,170 $247,124
Accounts receivable:
Premiums receivable 209,773 89,762
Due from insurance companies 16,421 13,782
Due from associated companies 1,959 1,442
Accrued and other receivables 2,481 2,658
------- -------
TOTAL ACCOUNTS RECEIVABLE 230,634 107,644
Reinsurance recoverable on outstanding claims 236,390 94,424
Prepaid reinsurance premiums 42,693 36,607
Capital assets, net of accumulated depreciation 18,722 12,230
Deferred policy acquisition costs 15,232 11,849
Deferred income taxes 5,185 2,098
Intangibles 45,287 42,562
Other assets 14,102 6,310
------- -------
TOTAL ASSETS $864,415 $560,848
======= =======
LIABILITIES
Accounts Payable:
Due to insurance companies $164,773 $37,350
Accrued and other payables 20,817 27,266
------- -------
185,590 64,616
Outstanding claims 301,103 152,871
Unearned premiums 146,009 118,616
Bank loans 13,600 4,182
------- -------
646,302 340,285
------- -------
Minority interest:
Equity in net assets of subsidiaries 23,856 25,231
Preferred securities 135,000 135,000
------- -------
158,856 160,231
------- -------
SHAREHOLDERS' EQUITY
Capital stock 18,376 18,010
Contributed surplus 2,775 2,775
Retained earnings 37,898 39,839
Cumulative translation adjustment 208 (292)
------- -------
TOTAL SHAREHOLDERS' EQUITY 59,257 60,332
------- -------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $864,415 $560,848
======= =======
</TABLE>
See notes to consolidated financial statements
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<PAGE>
GORAN CAPITAL INC.
UNAUDITED CONSOLIDATED STATEMENTS OF EARNINGS
(Canadian GAAP, stated in thousands of U.S. dollars, except per share data)
<TABLE>
<CAPTION>
Three Months Ended
September 30,
1998 1997
<S> <C> <C>
Gross premiums written $95,887 $100,455
Less ceded premiums (23,418) (18,979)
------- -------
Net premiums written 72,469 81,476
Change in net unearned premiums 21,699 (6,750)
------- ------
Net premiums earned 94,168 74,726
Fee income 3,813 4,199
Net investment income 3,281 3,669
Net realized capital gain 1,145 3,683
------- ------
Total Revenues 102,407 86,277
------- ------
Net claims incurred 92,490 55,644
General and administrative expenses 27,468 18,154
Interest expense 129 540
Amortization of intangibles 698 393
------- ------
Total expenses 120,785 74,731
------- ------
Earnings before undernoted items (18,378) 11,546
Provision for income taxes (5,902) 3,864
Distribution of preferred securities, net of tax 2,101 687
Minority interest (4,344) 2,586
------- ------
Earnings from continuing operations (10,233) 4,409
Loss from discontinued operations -- 286
------- ------
Net Earnings (Loss) $(10,233) $ 4,123
======= ======
Earnings (loss) per share from continuing operations - basic $(1.76) $0.79
==== ====
Earnings (loss) per share from continuing operations - fully diluted $(1.76) $0.74
==== ====
Net earnings (loss) per share - basic $(1.76) $0.74
==== ====
Net earnings (loss) per share - fully diluted $(1.76) $0.69
==== ====
See notes to consolidated financial statements
</TABLE>
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<PAGE>
GORAN CAPITAL INC.
UNAUDITED CONSOLIDATED STATEMENTS OF EARNINGS
(Canadian GAAP, stated in thousands of U.S. dollars, except per share data)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
1998 1997
<S> <C> <C>
Gross premiums written $443,588 $375,814
Less ceded premiums (163,029) (147,514)
------- -------
Net premiums written 280,559 228,300
Change in net unearned premiums (14,888) (14,304)
------- --------
Net premiums earned 265,671 213,996
Fee income 15,203 14,990
Net investment income 10,177 10,453
Net realized capital gain 3,959 5,466
------- -------
Total Revenues 295,010 244,905
------- -------
Net claims incurred 218,979 160,159
General and administrative expenses 67,734 50,644
Interest expense 361 2,991
Amortization of intangibles 1,719 687
------- -------
Total expenses 288,793 214,481
------- -------
Earnings before undernoted items 6,217 30,424
Provision for income taxes 2,536 10,105
Distribution of preferred securities, net of tax 6,327 687
Minority interest (890) 7,309
------- -------
Earnings from continuing operations (1,756) 12,323
Loss from discontinued operations (185) (858)
------- -------
Net Earnings (Loss) $ (1,941) $ 11,465
======= =======
Earnings (loss) per share from continuing operations - basic $(.30) $2.21
=== ====
Earnings (loss) per share from continuing operations - fully diluted $(.30) $2.10
=== ====
Net earnings (loss) per share - basic $(.33) $2.06
=== ====
Net earnings (loss) per share - fully diluted $(.33) $1.95
=== ====
</TABLE>
See notes to consolidated financial statements
-5-
<PAGE>
GORAN CAPITAL INC.
UNAUDITED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(Canadian GAAP, stated in thousands of U.S. dollars)
<TABLE>
<CAPTION>
Cumulative Retained Total
Common Contributed Translation Earnings Shareholders'
Stock Surplus Adjustment (Deficit) Equity
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1996 $17,416 $2,775 $(334) $27,401 $47,258
Issuance of common shares 43 --- --- --- 43
Change in cumulative
translation adjustment --- --- 76 --- 76
Net earnings --- --- --- 11,465 11,465
--- --- --- ------ ------
Balance at September 30, 1997 $17,459 $2,775 $(258) $38,866 $58,842
====== ===== === ====== ======
Balance at December 31, 1997 $18,010 $2,775 $(292) $39,839 $60,332
Issuance of common shares 366 --- --- --- 366
Change in cumulative
translation adjustment --- --- 500 --- 500
Net earnings (loss) --- --- --- (1,941) (1,941)
------ ----- --- ------ -------
Balance at September 30, 1998 $18,376 $2,775 $208 $37,898 $59,257
====== ===== === ====== ======
</TABLE>
See notes to consolidated financial statements
-6-
<PAGE>
GORAN CAPITAL INC.
UNAUDITED CONSOLIDATED STATEMENTS OF CHANGES IN CASH RESOURCES
(Canadian GAAP, stated in thousands of U.S. dollars)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
1998 1997
<S> <C> <C>
CASH PROVIDED BY OPERATING ACTIVITIES
Net earnings (loss) for the period $(1,941) $11,465
Items not affecting cash resources:
Amortization and depreciation 3,210 1,192
Loss (gain) on disposal of investments (3,959) (5,465)
Minority interest in net income of consolidated subsidiary (890) 7,138
Decrease (increase) in other assets (156,251) (136,511)
Decrease (increase) in deferred policy acquisition costs (3,383) 762
Increase (decrease) in deferred income taxes (3,087) --
Increase (decrease) in unearned premiums 27,393 29,259
Increase (decrease) in outstanding losses 148,232 93,384
Decrease (increase) in accounts receivable (122,650) (88,021)
Increase (decrease) in accounts payable 120,974 105,153
------- -------
7,648 18,356
------- -------
FINANCING ACTIVITIES:
Increase (reduction) of borrowed funds 9,418 (41,363)
Proceeds from consolidated minority interest owners -- 2,474
Issue of preferred securities -- 130,100
Issue of share capital 366 199
------- -------
9,784 91,410
------- -------
INVESTING ACTIVITIES:
Net purchase of marketable securities (15,543) (49,912)
Acquisition of subsidiary (3,000) --
Net purchase of minority interest shares (1,208) (61,000)
Net purchase of capital assets (7,690) (3,807)
Other -- 30
------- -------
(27,441) (114,689)
Change in cash resources during the period (10,009) (4,923)
Cash resources, beginning of period 36,557 33,731
------- -------
Cash resources, end of period $ 26,548 $ 28,808
======= =======
</TABLE>
See notes to consolidated financial statements
-7-
<PAGE>
GORAN CAPITAL INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
For The Three and Nine Months Ended September 30, 1998
NOTES TO THE CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(1) The accompanying unaudited condensed financial statements have been
prepared in accordance with the instructions to Form 10-Q and do not
include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements. In
the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for fair presentation have
been included. Operating results for the interim periods are not
necessarily indicative of the results that may be expected for the year
ended December 31, 1998. Interim financial statements should be read in
conjunction with the Company's annual audited financial statements.
These unaudited consolidated financial statements have been prepared by
the Company in accordance with accounting principles generally
accepted in Canada ("CDN GAAP"). These principles also conform in
all material respects with accounting principles generally accepted in
the United States ("US GAAP") except as disclosed in Note 4. All
material intercompany amounts have been eliminated.
(2) On March 2, 1998, the Company announced that it had signed an agreement
with CNA to assume its multi-peril and crop hail operations. CNA wrote
approximately $110 million of multi-peril and crop hail insurance
business in 1997. The Company will reinsure 100% of all multi-peril and
crop hail premiums written by CNA during 1998 and cede a small portion
of the Company's total crop book of business (approximately 22% MPCI
and 15% crop hail) back to CNA. Starting in the year 2000, assuming no
event of change of control as defined in the agreement, the Company can
purchase the insurance premiums reinsured to CNA through a call
provision or CNA can require the Company to buy the insurance premiums
reinsured to CNA. Regardless of the method of takeout of CNA, CNA must
not compete in MPCI or crop hail for a period of time. There was no
purchase price. The formula for the buyout in the year 2000 is based on
a multiple of average pre-tax earnings that CNA received from
reinsuring the Company's book of business.
(3) On July 8, 1998, the Company acquired North American Crop Underwriters
(NACU) a Henning, Minnesota based managing general agency which focuses
exclusively on crop insurance. The acquisition price was $4 million
with $3 million paid at closing and $1 million due July 1, 2000 without
interest. This acquisition captures 100% of the MPCI underwriting gain
and fees on approximately $27 million of premiums. Prior to this
transaction, NACU received all fees and 50% of the underwriting gain
with the balance going to the Company through the CNA transaction.
-8-
<PAGE>
(4) UNITED STATES ACCOUNTING PRINCIPLES
These unaudited consolidated financial statements have been prepared
in accordance with CDN GAAP. The differences between CDN GAAP and US
GAAP are as follows:
<TABLE>
<CAPTION>
For the Three Months Ended For the Nine Months Ended
September 30, September 30, September 30, September 30,
1998 1997 1998 1997
<S> <C> <C> <C> <C>
Reported net earnings (loss) $(10,233) $4,123 $(1,941) $11,465
US/Canada GAAP differences:
Discounting on outstanding claims -- -- -- 38
------ ----- ----- -----
Revised net earnings (loss) $(10,233) $4,123 $(1,941) $11,503
====== ===== ===== ======
Earnings (loss) per share - basic $(1.75) $.81 $(.33) $1.87
==== === === ====
Earnings (loss) per share -
fully diluted $(1.75) $.81 $(.33) $1.87
==== === === ====
</TABLE>
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
<S> <C> <C>
Shareholders' equity in accordance with Canadian GAAP $59,257 $60,332
Add (deduct) effect of difference in accounting for:
Deferred income taxes 1,911 1,975
Outstanding claims (1,696) (1,765)
Minority interest portion (71) (70)
Receivables from sale of capital stock (312) (346)
Unrealized gain on investments* 316 1,336
------ ------
Shareholders' equity in accordance with US GAAP $59,405 $61,462
====== ======
</TABLE>
*Note: The increase in shareholders' equity attributable to the unrealized
gain of $316 and $1,336 at September 30, 1998 and December 31, 1997,
respectively, are net of deferred taxes of $375 and $1,005 and related
minority interest of $230 and $658.
(5) As part of the agreement by the Company to assume the multi-peril and
crop operations of CNA, the Company agreed to reimburse CNA for certain
direct overhead costs incurred by CNA during the first quarter of 1998
before the Company assumed the book of business. CNA has requested
reimbursement of $2.8 million in expenses which the Company believes
should only be $1.1 million. Negotiations are in process to settle this
reimbursement. The Company fully expects the ultimate settlement will
approximate $1.1 million and has therefore, accrued this amount in its
consolidated financial statements evenly throughout 1998. In the
unforeseen event the ultimate settlement is greater than $1.1 million,
the Company will accrue the full additional amount at that time.
The Company expects to receive a proposed assessment from the
California Department of Insurance (CDOI) which could approximate
$3 million. This expectation is based on ongoing discussions with the
CDOI, although no formal written notification has been received by the
Company. This fine relates to the charging of brokers fees to
policyholders by independent agents who have placed business for one of
the Company's nonstandard automobile carriers, Superior Insurance
Company. The CDOI has indicated that such broker fees were improper
and has requested reimbursement to
-9-
<PAGE>
the policyholders by Superior Insurance Company. The Company did not
receive any amount of these broker fees. As the ultimate outcome
of this potential assessment is not deemed probable the Company has
not accrued any amount in its consolidated financial statements.
Although the assessment has not been formally made by the CDOI at this
time, the Company believes it can prevail and will vigorously
defend any potential assessment.
(6) Year 2000 Compliance
General
The Year 2000 Project (Project) is proceeding on schedule. The
Project is addressing the inability of computer software and hardware
to distinguish between the year 1900 and the year 2000. In
1996, the Company began a company-wide replacement of hardware and
software systems to address this and other issues. This replacement is
using systems from Dell, Hewlett Packard, Sun Systems, Compaq, Oracle
and ZIM as well as some software conversions using Java. The new
hardware is in place and operational at all subsidiaries. The software
systems are in place in our nonstandard auto operations and are being
implemented on a state-by-state basis. The Company began implementing
the new nonstandard auto operating system in those states in which the
Company writes annual policies (annual states). 60% of those annual
states are currently in production with the remaining 40% scheduled to
be in place by December 31, 1998. The remaining non-annual states are
on schedule to be completed by March 31, 1999. The Company has
developed a contingency plan for use in the event that there is a
delay. A decision to adopt the contingency plan, if necessary, will
be made by December 1, 1998. The Y2K issue does not have an effect on
the crop operations until October 1, 1999. The Company is converting
non-compliant systems, through programmatic means, into a Java based
Y2K compliant environment. The crop operations are at 38% of completion
for this conversion and are scheduled to be completed by the end of
January 1999. Contingency plans for crop operations are being
considered at this time. A number of the Company's other IT projects
are being delayed or completely eliminated due to the implementation
of the Project. The delay and/or elimination of these projects has
caused or could cause a loss of market share in the nonstandard auto
market.
Project
The Company has divided the Project into three sections-Infrastructure,
Applications/Business Systems and Third Party Suppliers. There are
common portions of each of these divisions which are: (1) identifying
Y2K items, (2) assigning a priority for those items identified,
(3) repairing or replacing those items, (4) testing the fixes, and
(5) designing a contingency and business continuation plan for each
subsidiary.
In February 1998, all items had been identified and the plans for
replacement or repair were proposed to management. These plans were
approved and the process began.
The infrastructure section of the Project was quickly implemented and
tested by the Company's IT staff and has been completed since May of
1998. All desktop, mini and midrange systems as well as phone
switches, phones and building security systems have been tested for Y2K
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<PAGE>
compliance. The only outstanding issue is a security system in one of the
Company's buildings, which may need to be disconnected. This issue is addressed
by business continuance. Any new systems required by the Company are being
tested and certified prior to purchase. Two mainframes being used by the Company
are not Y2K certified or compliant. These machines have been replaced by Sun and
HP compliant systems and are being kept in production until new applications are
put in place on the new machines.
The applications systems section of the Project includes: (1) the replacement of
nonstandard auto companies Policy Administration and Claims systems, (2) the
conversion of crop operations systems in total, and (3) replacement of non
compliant business systems company-wide (this includes wordprocessors, network
operating systems, spreadsheet programs, presentation systems, etc.)
The Company had already made the decision to transition off all of it's
nonstandard auto legacy systems and this process had been in work since 1996.
These systems are Y2K compliant and are on schedule for completion by the end of
March 31, 1999. The conversion of crop systems began in August 1998 and is
scheduled for completion by the end of January 1999. Business systems are being
replaced as vendors certify their compliance. The Company is at 80% compliance
in this area.
The Company relies on third party vendors for investments, reinsurance treaties
and banking. The Company began inquiring about Y2K compliance with its third
party vendors beginning in July 1998. To date all vendors have replied regarding
their compliance efforts. Those that are not in compliance have until the end of
1Q, 1999 to do so, or they will be replaced.
Costs
The Company considers the cost associated with the Project to be material. The
Company has estimated the total cost to be $5.7 million. The total amount
expended through September 1998 on all infrastructure and software upgrades is
approximately $4.5 million. The Company expects to spend another $1.2 million in
its efforts to complete the Project. This does not include additional annual
maintenance costs that will be incurred as we move forward. Funding for these
costs will continue to be provided by funds from operations. The Company expects
that the new nonstandard auto system will significantly enhance service
capability and reduce future operating costs.
Risks
Failure to correct the Y2K problem could cause a failure or interruption of
normal business operations. These failures could materially affect the Company's
operational results, financial condition and liquidity. Due to the nature of the
Y2K problem, the Company is uncertain whether it will have a material affect.
The Company believes that the possibility of significant business interruptions
should be reduced by implementation of the Project.
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<PAGE>
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS OF THE COMPANY
The Company underwrites and markets nonstandard private passenger automobile
insurance and crop insurance.
Nonstandard Automobile Insurance Operations
The Company, through its wholly owned subsidiaries, Pafco and Superior, is
engaged in the writing of insurance coverage on automobile physical damage and
liability policies for "nonstandard risks". Nonstandard insureds are those
individuals who are unable to obtain insurance coverage through standard market
carriers due to factors such as poor premium payment history, driving
experience, record of prior accidents or driving violations, particular
occupation or type of vehicle. The Company offers several different policies
which are directed towards different classes of risk within the nonstandard
market. Premium rates for nonstandard risks are higher than for standard risks.
Since it can be viewed as a residual market, the size of the nonstandard private
passenger automobile insurance market changes with the insurance environment and
grows when the standard coverage becomes more restrictive. Nonstandard policies
have relatively short policy periods and low limits of liability. Due to the low
limits of coverage, the period of time that elapses between the occurrence and
settlement of losses under nonstandard policies is shorter than many other types
of insurance. Also, since the nonstandard automobile insurance business
typically experiences lower rates of retention than standard automobile
insurance, the number of new policyholders underwritten by nonstandard
automobile insurance carriers each year is substantially greater than the number
of new policyholders underwritten by standard carriers.
Crop Insurance Operations
The two principal components of the Company's crop insurance business are
Multi-Peril Crop Insurance ("MPCI") and private named peril, primarily crop hail
insurance. Crop insurance is purchased by farmers to reduce the risk of crop
loss from adverse weather and other uncontrollable events. Farms are subject to
drought, floods and other natural disasters that can cause widespread crop
losses and, in severe cases, force farmers out of business. Historically, one
out of every twelve acres planted by farmers has not been harvested because of
adverse weather or other natural disasters. Because many farmers rely on credit
to finance their purchases of such agricultural inputs as seed, fertilizer,
machinery and fuel, the loss of a crop to a natural disaster can reduce their
ability to repay these loans and to find sources of funding for the following
year's operating expenses.
The Company, like other private insurers participating in the MPCI program,
generates revenues from the MPCI program in two ways. First, it markets, issues
and administers policies, for which it receives administrative fees; and second,
it participates in a profit-sharing arrangement in which it receives from the
government a portion of the aggregate profit, or pays a portion of the aggregate
loss, in respect of the business it writes. The Company writes MPCI and crop
hail insurance through approximately 1,118 independent agencies in 42 states.
MPCI is a government-sponsored program with accounting treatment which differs
in certain respects from the more traditional property and casualty insurance
lines. For income statement purposes under generally accepted accounting
principles, gross premiums written consist of the aggregate amount of MPCI
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<PAGE>
premiums paid by farmers for buy-up coverage (MPCI coverage in excess of CAT
Coverage), and any related federal premium subsidies, but do not include MPCI
premium on CAT Coverage (the minimum available level of MPCI Coverage). By
contrast, net premiums written do not include any MPCI premiums or subsidies,
all of which are deemed to be ceded to the FCIC as a reinsurer. The Company's
profit or loss from its MPCI business is determined after the crop season ends
on the basis of a complex profit sharing formula established by law and the
FCIC. For generally accepted accounting principles income statement purposes,
any such profit or loss sharing earned or payable by the Company is treated as
an adjustment to commission expense and is included in policy acquisition and
general and administrative expenses.
The Company also receives from the FCIC (i) an expense reimbursement payment
equal to a percentage of gross premiums written for each Buy-Up Coverage policy
it writes ("Buy-Up Expense Reimbursement Payment") and (ii) an LAE reimbursement
payment equal to 13.0% of MPCI Imputed Premiums for each CAT Coverage policy it
writes (the "CAT LAE Reimbursement Payment"). For 1998 and 1997, the Buy-Up
Expense Reimbursement Payment has been set at 27% and 29%, respectively, of the
MPCI Premium. For generally accepted accounting principles income statement
purposes, the Buy-Up Expense Reimbursement Payment is treated as a contribution
to income and reflected as an offset against policy acquisition and general and
administrative expenses. The CAT LAE Reimbursement Payment and the MPCI Excess
LAE Reimbursement Payment are, for income statement purposes, recorded as an
offset against LAE, up to the actual amount of LAE incurred by the Company in
respect of such policies, and the remainder of the payment, if any, is recorded
as Other Income.
In June 1998, the United States Congress passed legislation which provided
permanent funding for the crop insurance industry. However, beginning with the
1999 crop year, the Buy-Up Expense Reimbursement Payment was reduced to 24.5%,
the CAT LAE Reimbursement Payment was reduced to 11% and the $60 CAT coverage
fee will no longer go to the insurance companies.
The Company expects to more than offset these reductions through growth in fee
income from non-federally subsidized programs such as AgPI(R) and GEO Ag Plus(R)
initiated in 1998. The Company has also been working to reduce its costs. While
the Company fully believes it can more than offset these reductions, there is no
assurance the Company will be successful in its efforts or that further
reductions in federal reimbursements will not continue to occur.
In addition to MPCI, the Company offers stand alone crop hail insurance, which
insures growing crops against damage resulting from hail storms and which
involves no federal participation, as well as its proprietary product which
combines the application and underwriting process for MPCI and hail coverages.
This product tends to produce less volatile loss ratios than the stand alone
product since the combined product generally insures a greater number of acres,
thereby spreading the risk of damage over a larger insured area. Approximately
half of the Company's hail policies are written in combination with MPCI.
Although both crop hail and MPCI provide coverage against hail damage, under
crop hail coverages farmers can receive payments for hail damage which would not
be severe enough to require a payment under an MPCI policy. The Company believes
that offering crop hail insurance enables it to sell more policies than it
otherwise would.
In addition to crop hail insurance, the Company also sells a small volume of
insurance against crop damage from other specific named perils. These products
cover specific crops and are generally written on terms that are specific to the
kind of crop and farming practice involved and the amount of
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<PAGE>
actuarial data available. The Company plans to seek potential growth
opportunities in this niche market by developing basic policies on a diverse
number of named crops grown in a variety of geographic areas and to offer these
policies primarily to large producers through certain select agents.
AgPI(R) protects businesses that depend upon a steady flow of a crop (or crops)
to stay in business. This protection is available to those involved in
agribusiness who are a step beyond the farm gate, such as elevator operators,
custom harvesters, cotton gins and businesses that are dependent upon a single
supplier of products, (i.e., popping corn).
These businesses have been able to buy normal business interruption insurance to
protect against on-site calamities such as a fire, wind storm or tornado. But
until now, they have been totally unprotected by the insurance industry if they
incorporate a production shortfall in their trade area which limited their
ability to bring raw materials to their operation. AgPI(R) allows the
agricultural business to protect against a disruption in the flow of the raw
materials it depends on. AgPI(R) was formally introduced at the beginning of the
1998 crop year.
Geo AgPLUS(TM) provides to the farmer the soil sampling results combined with
fertility maps and the software that is necessary to run their precision farming
program. Grid soil sampling, when combined with precision farming, allows the
farmer to apply just the right amount of fertilization, thus balancing the soil
for a maximum crop yield. Precision farming increases the yield to the farmer,
reduces the cost of unnecessary fertilization and enhances the environment by
reducing overflows of fertilization into the ecosystem. Geo AgPLUS(TM) is an IGF
Insurance Company trademarked precision farming division that is now marketing
its fee based products to the farmer.
In order to reduce the Company's potential loss exposure under the MPCI program,
in addition to reinsurance obtained from the FCIC, the Company purchases
stop-loss reinsurance from other private reinsurers. Such private reinsurance
would not eliminate the Company's potential liability in the event a reinsurer
was unable to pay or losses exceeded the limits of the stop-loss coverage. For
crop hail insurance, the Company has in effect various layers of stop-loss
reinsurance.
Certain other conditions of the Company's crop business may affect comparisons
of the Company's results and operating ratios with those of other insurers,
including: (i) the seasonal nature of the business whereby profits are generally
recognized predominantly in the second half of the year, (ii) the short-term
nature of crop business whereby losses are known within a short time period, and
(iii) the limited amount of investment income associated with crop business. In
addition, cash flows from the crop business differ from cash flows from certain
more traditional lines.
In 1996, the Company instituted a policy of recognizing (i) 35% of its estimated
MPCI gross premiums written for each of the first and second quarters, 20% for
the third quarter and 10% for the fourth quarter, (ii) commission expense at the
applicable rate of MPCI gross premiums written recognized and (iii) Buy-Up
Expense Reimbursement at the applicable rate of MPCI gross premiums written
recognized along with normal operating expenses incurred in connection with
premium writings. In the third quarter, if a sufficient volume of policyholder
acreage reports have been received and processed by the Company, the Company's
policy is to recognize MPCI gross premiums written for the first nine months
based on a re-estimate which takes into account actual gross premiums processed.
If an insufficient volume of
-14-
<PAGE>
policies has been processed, the Company's policy is to recognize in the third
quarter 20% of its full year estimate of MPCI gross premiums written, unless
other circumstances require a different approach. The remaining amount of gross
premiums written is recognized in the fourth quarter, when all amounts are
reconciled. The Company also recognizes the MPCI underwriting gain or loss
during each quarter, reflecting the Company's best estimate of the amount of
such gain or loss to be recognized for the full year, based on, among other
things, historical results, plus a provision for adverse developments. In the
third and fourth quarters, a reconciliation amount is recognized for the
underwriting gain or loss based on final premium and loss information.
Results of Operations
For the three and nine months ended September 30, 1998, the Company recorded net
losses of $(10,233,000) and $(1,941,000) or $(1.76) and $(.33) per share
(basic). This is approximately a decrease of 348% and 117% from 1997 comparable
amounts of $4,123,000 and $11,465,000 or $0.74 and $2.06 per share (basic).
The loss in the third quarter of 1998 was due to losses in both the Company's
crop and nonstandard automobile operations. The Company's loss in its crop
operations was due primarily to crop hail losses from Hurricane Bonnie and other
weather related events and higher than expected commission expenses, primarily
from the integration of the crop business acquired from CNA. As compared to 1997
the Company's crop results were also impacted by a much smaller underwriting
gain on MPCI due primarily to severe drought conditions in certain parts of the
country and overly wet conditions in other parts of the country. However, the
Company accrues a low estimated underwriting gain until results become known in
the third and fourth quarters and the Company did not have to reverse profits
previously booked for MPCI in the third quarter of 1998. The Company's loss in
its nonstandard automobile operations was due primarily to recently noted
reserve development and management taking a more conservative reserve assumption
for its nonstandard operations. Falling nonstandard automobile premium volume
also lead to a higher than normal expense ratio in the quarter.
-15-
<PAGE>
<TABLE>
<CAPTION>
For the three months
ended September 30,
1998 1997
<S> <C> <C>
NONSTANDARD AUTOMOBILE INSURANCE OPERATIONS:
Gross premiums written $61,536 $77,505
====== ======
Net premiums written $55,381 $61,789
====== ======
Net premiums earned $64,742 $61,059
Fee income 3,827 4,380
Net investment income 2,960 2,702
Net realized gain 1,121 3,837
------ ------
TOTAL REVENUES 72,650 71,978
------ ------
Losses and loss adjustment expenses 57,589 44,873
Policy acquisition and general and administrative expenses 19,563 18,170
------ ------
TOTAL EXPENSES 77,152 63,043
------ ------
Earnings (loss) before income taxes $(4,502) $ 8,935
====== ======
GAAP RATIOS (Nonstandard Automobile Only):
Loss and LAE Ratio 88.95% 73.5%
Expense ratio, net of billing fees 24.31 22.6
------ ----
Combined ratio 113.26% 96.1%
====== ====
CROP INSURANCE OPERATIONS:
Gross premiums written(2) $32,423 $23,997
====== ======
Net premiums written $15,313 $4,576
====== =====
Net premiums earned $29,170 $10,985
Fee income (12) (181)
Net investment income 55 52
Net realized capital gain 47 (55)
------ ------
TOTAL REVENUES 29,260 10,801
------ ------
Losses and loss adjustment expenses 34,312 9,030
Policy acquisition and general and administrative expenses(1) 6,572 (2,609)
Interest expense and amortization of intangibles 287 40
------ ------
TOTAL EXPENSES 41,171 6,461
------ ------
Earnings (loss) before income taxes $(11,911) $ 4,340
====== ======
</TABLE>
(1) Negative crop expenses are caused by inclusion of MPCI expense reimbursement
and underwriting gain. (2) Includes premiums assumed from CNA in accordance with
the Strategic Alliance Agreement.
-16-
<PAGE>
<TABLE>
<CAPTION>
For the nine months
ended September 30,
1998 1997
<S> <C> <C>
NONSTANDARD AUTOMOBILE INSURANCE OPERATIONS:
Gross premiums written $231,042 $243,052
======= =======
Net premiums written $206,802 $195,632
======= =======
Net premiums earned $203,563 $189,303
Fee income 12,535 11,584
Net investment income 8,894 7,796
Net realized gain 3,762 5,521
------- -------
TOTAL REVENUES 228,754 214,204
------- -------
Losses and loss adjustment expenses 164,237 143,897
Policy acquisition and general and administrative expenses 56,367 53,662
------- -------
TOTAL EXPENSES 220,604 197,559
------- -------
Earnings before income taxes $ 8,150 $ 16,645
======= =======
GAAP RATIOS (Nonstandard Automobile Only):
Loss and LAE Ratio 80.68% 76.0%
Expense ratio, net of billing fees 21.53 22.2
------ ----
Combined ratio 102.21% 98.2%
====== ====
CROP INSURANCE OPERATIONS:
Gross premiums written(2) $210,618 $132,353
======= =======
Net premiums written $68,167 $21,256
====== ======
Net premiums earned $57,791 $18,753
Fee income 2,670 3,406
Net investment income 220 144
Net realized capital gain 217 (55)
------ ------
TOTAL REVENUES 60,898 22,248
------ ------
Losses and loss adjustment expenses 53,050 13,299
Policy acquisition and general and administrative expenses(1) 6,822 (8,635)
Interest expense and amortization of intangibles 520 65
------ ------
TOTAL EXPENSES 60,392 4,729
------ ------
Earnings before income taxes $ 506 $17,519
====== ======
</TABLE>
(1) Negative crop expenses are caused by inclusion of MPCI expense reimbursement
and underwriting gain. (2) Includes premiums assumed from CNA in accordance with
the Strategic Alliance Agreement.
Consolidated gross premiums written decreased 4.5% and increased 18.0% for the
three and nine months ended September 30, 1998 compared to comparable periods in
1997.
-17-
<PAGE>
Gross premiums written for the nonstandard auto segment decreased 20.6% for the
three months ended September 30, 1998 and decreased 4.9% for the nine months
ended September 30, 1998 compared to comparable periods in 1997. The decrease in
nonstandard automobile premiums reflects the effects of competitive pressures,
the results of certain product changes in certain key states and the operational
aspects of implementation of the Company's new operating system. The Company has
addressed the product changes in its key states that contributed to the falling
premium volume and is working to implement appropriate product and rate changes
in its other states. The Company has also recently entered South Florida and the
State of Arizona and has launched its Spanish Language Policy in Florida. The
Company's new operating system is functioning adequately in the States of
Florida, California and Arizona with additional states coming on line in the
near future. The Company expects that the results of these efforts will improve
future premium volume and reduce the costs to do business.
Gross premiums written for the crop segment increased 35.1% and 59.1% for the
three and nine months ended September 30, 1998 compared to comparable periods in
1997. Such increase was due to the transaction with CNA, internal growth and new
products such as AgPI. Premium increases were noted in all lines of crop
insurance. Crop premiums for the three and nine months ended September 30 are as
follows:
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
1998 1997 1998 1997
<S> <C> <C> <C> <C>
CAT imputed $1,502 $4,965 $34,140 $31,028
MPCI 18,071 15,195 125,368 94,211
Crop hail and named perils 14,356 8,802 77,721 38,142
AgPI (4) -- 7,529 --
------ ------ ------- ------
33,925 28,962 244,758 163,381
Less: CAT imputed (1,502) (4,965) (34,140) (31,028)
------ ------ ------- -------
$32,423 $23,997 $210,618 $132,353
====== ====== ======= =======
</TABLE>
MPCI premiums are considered to be 100% ceded to the federal government for
accounting purposes. Quota share cession rates for other lines of insurance for
the three and nine months ended September 30 are as follows. The Company
canceled its nonstandard auto quota share treaty with the intention to commute
the agreement effective October 1, 1998.
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
Nonstandard automobile 10% 20%
Crop hail 25% 40%
Named peril 50% 50%
</TABLE>
Fee income decreased 9.1% for the three months ended September 30, 1998 and
increased 1.4% for the nine months ended September 30, 1998 as compared to the
corresponding periods of the prior year. The decrease in the third quarter of
1998 results from the Company's practice of offsetting CAT fees with crop LAE
costs. Such offset was greater in 1998. Fee income on nonstandard automobile
operations also decreased in the third quarter as a direct result of lower
premium volume in the quarter. The small increase in fee income year to date in
1998 compared to 1997 is primarily the result of higher nonstandard automobile
fees as a percentage of direct premiums written although premium volume
decreased in that segment. These fees averaged 5.43% and 4.77% of gross premiums
written in 1998 and 1997, respectively. Crop fees, primarily
-18-
<PAGE>
CAT fees increased due to growth in premium volume. However, crop fee income
appears lower due to reclass of CAT LAE fees as an offset to loss costs. This
was due to the higher LAE costs in 1998 due to the higher volume of claims.
Net investment income decreased 10.6% and 2.6% for the three and nine months
ended September 30, 1998 as compared to the corresponding periods of the prior
year. Such decrease was due primarily to greater invested assets offset by a
declining yield due to market conditions.
The loss ratio for the nonstandard automobile segment for the three and nine
months ended September 30, 1998 was 89.0% and 80.7% as compared to 73.5% and
76.0% in 1997. In the third quarter of 1998, the Company recorded additional
gross loss reserves of approximately $8 million. A mid-year review of reserves
as of June 30, 1998 by the Company's independent actuaries resulted in recorded
loss reserve levels at June 30, 1998 approximating recommended levels.
Development since that date and more conservative assumptions has resulted in
the reserve adjustment.
The crop hail loss ratio for the nine months ended September 30, 1998 was 85.5%
compared to 67.1% in 1997. The loss ratio for 1998 is net of reinsurance
recoveries on its stop loss layer. This loss ratio was dramatically affected by
Hurricane Bonnie in the third quarter. Excluding the effects of Hurricane Bonnie
and related reinsurance recoveries the crop hail loss ratio would have been
75.0%.
Policy acquisition and general and administrative expenses have increased as a
result of the increased volume of business produced by the Company. Policy
acquisition and general and administrative expenses rose to $27,468,000 and
$67,734,000 or 29.2% and 25.5% of net premium earned for the three and nine
months ended September 30, 1998 compared to $18,154,000 and $50,644,000 or 24.3%
and 23.7% of net premium earned in the corresponding periods of 1997. The
increase in the overall expense ratio in the third quarter reflects increases in
both the Company's crop and nonstandard automobile operations. Increases related
to crop operations reflect a much lower MPCI underwriting gain in 1998 as
compared to 1997, as previously discussed, and higher operating and commission
costs due primarily to the integration of the Company's crop acquisitions.
Increases related to nonstandard automobile operations reflect the higher than
normal expense ratio in the third quarter due to the declining premium volume.
Nonstandard automobile and crop operations have integrated acquisitions and are
undergoing a restructuring to reduce operating costs.
Crop segment expenses include agent commissions, stop loss reinsurance costs and
operating expenses which are offset by MPCI Expense Reimbursements and MPCI
Underwriting Gain. The increase in expenses results primarily from a 2% lower
MPCI Expense Reimbursement for 1998 versus 1997, higher commissions due to
competition and integration costs of the CNA transaction and a lower MPCI
underwriting gain as previously discussed. Although the third quarter generally
provides more evidence to support this underwriting gain, it remains an estimate
until all harvest results are known in the fourth quarter. The Company had been
accruing an estimated gain of 10% in the first two quarters of 1998 and adjusted
this estimate in the third quarter to 12%. In 1997 the Company realized a MPCI
underwriting gain in excess of 20% due to the record harvest results and more
consistent weather patterns.
Amortization of intangibles includes goodwill from the acquisition of Superior,
additional goodwill from the acquisitions of the minority interest position in
GGSH and NACU, debt or preferred security issuance costs and
-19-
<PAGE>
organizational costs. The increase in 1998 reflects the effects of the
Preferred Securities Offering in late 1997.
Interest expense primarily represents interest incurred since April 30, 1996 on
the GGS Senior Credit Facility. The GGS Senior Credit Facility was repaid with
the proceeds from the Preferred Securities Offering.
Income tax expense (benefit) was (32.1%) and 40.8% of pre-tax income (losses)
for the three and nine months ended September 30, 1998 compared to 33.5% and
33.2% in 1997. The increased rate is due to higher goodwill amortization.
Distributions on Preferred Securities are calculated at a rate of 9.5% net of
federal income taxes.
Operations of Granite Re continue to be profitable with net earnings of $0.9
million in 1998 compared to $1.4 million in 1997. The decrease in earnings in
1998 compared to 1997 resulted primarily from claims on crop reinsurance
provided to IGF.
Financial Condition
The Company's total assets of $864,415,000 at September 30, 1998 increased by
$303,567,000 from $560,848,000 as of December 31, 1997. Such increase was due to
an increase in cash and invested assets primarily from the Company's nonstandard
automobile operations. With the decrease in nonstandard automobile premium
volume in the third quarter such increase has also slowed. Increases in
receivables and reinsurance assets result primarily from the Company's growth in
its crop operations which carry higher balances during the year until harvest
results are complete and such assets are collected. There is a corresponding
increase in related liabilities. The increase in fixed assets is due to the
purchase of the Company's new crop operation headquarters and substantial
investment in new operating systems to improve efficiencies. Increase in notes
payable primarily reflects short term borrowings from a line of credit at the
Company's crop operations until harvest results are settled and FCIC funds are
received. The decrease in stockholders equity results from the Company's net
loss. The Company has not substantially changed its investment portfolio.
Net cash from operating activities declined to $7,648,000 in 1998 from
$18,356,000 in 1997 due to the Company's loss from operations. Investing
activities reflect the Company's normal investment activities. Financing
activities include normal activities on the Company's line of credit for crop
operations.
While the Company's crop operations are experiencing some short term cash needs
due to the high volume of crop hail losses, the Company believes it has
sufficient resources to meet its cash flow needs for this operation. In the
event the Company has maximized its borrowing capacity under its line of credit,
the Company can elect to owe the FCIC funds with interest until receipt of its
expense reimbursement and MPCI underwriting gain payments, the latter of which
is made over a three-year period.
SIG's Preferred Security obligations of approximately $13 million per year is
funded from the Company's nonstandard automobile management company and dividend
capacity from the crop operations. The nonstandard auto funds are the result of
management and billing fees in excess of operating costs. For calendar 1997 the
coverage ratio of nonstandard automobile cash flows to Preferred Security costs
was 2.2x. The Company estimates this ratio decreased
-20-
<PAGE>
to 1.48x in the third quarter of 1998 and expects this ratio to increase to 1.8x
for all of 1998 with increasing premium volume and stable costs. Coverage from
the Company's crop operations entailed a dividend capacity of $13.4 million in
1998 that will reduce to approximately $4.5 million in 1999 as a result of the
Company's operations and statutory limitations. The Company also has
approximately $10 million in excess funds for debt service. Surplus needs at the
insurance companies will be handled primarily by reinsurance for which the
Company believes it has good relationships and numerous alternatives. It should
be noted that the additional nonstandard automobile reserves did not increase
the accident year loss ratios to levels that would require recovery from
reinsurers. SIG believes it can continue to meet its obligations in 1999 and
that coverage will increase through higher nonstandard automobile premium
volumes and more profitable crop operations.
The Trust Indenture for the Preferred Securities contains certain preventative
covenants. These covenants are based upon SIG's Consolidated Coverage Ratio of
earnings before interest, taxes, depreciation and amortization (EBITDA) whereby
if SIG's EBITDA falls below 2.5 times Consolidated Interest Expense (including
Preferred Security distributions) for the most recent four quarters the
following restrictions become effective:
SIG may not incur additional Indebtedness or guarantee additional
Indebtedness.
SIG may not make certain Restricted Payments including
loans or advances to affiliates, stock repurchases and a limitation on
the amount of dividends is inforce.
SIG may not increase its level of Non-Investment Grade Securities
defined as equities, mortgage loans, real estate, real estate loans
and non-investment grade fixed income securities.
These restrictions currently apply, and will continue to apply until SIG's
Consolidated Coverage Ratio is in compliance with the terms of the Trust
Indenture. This does not represent a Default by SIG on the Preferred Securities.
SIG is in compliance with these preventative covenants as of September 30, 1998.
Forward Looking Statements
All statements, trend analyses, and other information herein contained relative
to markets for the Company's products and/or trends in the Company's operations
or financial results, as well as other statements including words such as
"anticipate," "could," "feel(s)," "believe," "believes," "plan," "estimate,"
"expect," "should," "intend" and other similar expressions, constitute
forward-looking statements under the Private Securities Litigation Reform Act of
1995. These forward-looking statements are subject to known and unknown risks,
uncertainties and other factors which may cause actual results to be materially
different from those contemplated by the forward-looking statements. Such
factors include, among other things: (i) general economic conditions, including
prevailing interest rate levels and stock market performance; (ii) factors
affecting the Company's crop operations such as weather-related events, final
harvest results, commodity price levels, governmental program changes, new
product acceptance and commission levels paid to agents; and (iii) factors
affecting the Company's nonstandard automobile operations such as premium
volume, levels of operating expenses as compared to premium volume, ultimate
development of loss reserves and implementation of the Company's operating
system.
-21-
<PAGE>
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company's insurance subsidiaries are parties to litigation
arising in the ordinary course of business. The Company believes that the
ultimate resolution of these lawsuits will not have a material adverse effect on
its financial condition or results of operations. The Company, through its
claims reserves, reserves for both the amount of estimated damages attributable
to these lawsuits and the estimated costs of litigation.
ITEM 2. CHANGES IN SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTER TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6(a). EXHIBITS
(11) Statement Regarding Computation of Per Share Earnings
ITEM 6(b). REPORTS ON FORM 8-K
None
-22-
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Dated: November 12, 1998 By:______________________
Alan G. Symons
President
Dated: November 12, 1998 By:______________________
Gary P. Hutchcraft
Vice President, Treasurer and
Chief Financial Officer
-23-
<PAGE>
GORAN CAPITAL INC. - Consolidated Exhibit 11.01
Analysis of Earnings Per Share
<TABLE>
<CAPTION>
Nine Nine
Months Ended Months Ended
September 30, September 30,
1998 1997
<S> <C> <C> <C>
Average Price (US $) $26.72 (A) $29.34
Proceeds from Exercise of Warrants and Options
(US $) $15,031,886 (B) $3,551,952
========== =========
Shares Repurchased - Treasury Method $562,477 (B)/(A) 121,060
======= =======
Shares Outstanding - Weighted Average 5,825,930 5,552,097
Add: Options and Warrants Outstanding 802,304 733,148
Less: Treasury Method - Shares Repurchased (562,477) (121,060)
------- -------
Shares Outstanding for US GAAP Purposes 6,065,757 (C) 6,164,185
========= =========
Net Earnings in Accordance with US GAAP $(1,941,000) (D) $11,465,000
========== ==========
Earnings Per Share - US GAAP - Basic $(.33) $2.06
=== ====
Earnings Per Share - US GAAP - Fully Diluted $(.33) (D)/(C) $1.86
=== ====
</TABLE>
Note: The calculation of fully diluted earnings per share is non dilutive in
1998 and therefore is shown as the same as the basic earnings per share.
-24-
<PAGE>
