-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, SjUjBjcI4M8kHfFKzkDrknI+bbce7GCyx3YNby0NQOXpA/nAg9N0QRSXAPhR+HxR 5nKpJhNGV+9dqiRdHejAQA== 0000950148-98-000710.txt : 19980401 0000950148-98-000710.hdr.sgml : 19980401 ACCESSION NUMBER: 0000950148-98-000710 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 15 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980331 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: FREMONT GENERAL CORP CENTRAL INDEX KEY: 0000038984 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 952815260 STATE OF INCORPORATION: NV FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-08007 FILM NUMBER: 98580504 BUSINESS ADDRESS: STREET 1: 2020 SANTA MONICA BLVD STREET 2: STE 600 CITY: SANTA MONICA STATE: CA ZIP: 90404 BUSINESS PHONE: 3103155500 MAIL ADDRESS: STREET 1: 2020 SANTA MONICA BLVD CITY: SANTA MONICA STATE: CA ZIP: 90404 10-K405 1 FORM 10-K405 1 ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997 COMMISSION FILE NUMBER 1-8007 ------------------------ FREMONT GENERAL CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) NEVADA 95-2815260 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER) 2020 SANTA MONICA BOULEVARD, SANTA MONICA, CALIFORNIA 90404 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (310) 315-5500 ------------------------ SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: COMMON STOCK, $1.00 PAR VALUE LIQUID YIELD OPTION(TM) NOTES DUE 2013 (ZERO COUPON-SUBORDINATED) FREMONT GENERAL FINANCING I -- 9% TRUST ORIGINATED PREFERRED SECURITIES(SM) (TITLE OF EACH CLASS) NEW YORK STOCK EXCHANGE (NAME OF EACH EXCHANGE ON WHICH REGISTERED) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of the voting stock held by non-affiliates of the registrant as of February 27, 1998: COMMON STOCK, $1.00 PAR VALUE -- $1,438,798,000 The number of shares outstanding of each of the issuer's classes of common stock as of February 27, 1998: COMMON STOCK, $1.00 PAR VALUE -- 34,578,000 SHARES DOCUMENTS INCORPORATED BY REFERENCE: Portions of the proxy statement for the 1998 annual meeting of stockholders are incorporated by reference into Part III of this report. ================================================================================ 2 PART I ITEM 1. BUSINESS The following business section contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. The Company's actual results could differ materially from those projected in these forward-looking statements as a result of certain risks and uncertainties, including those factors set forth in this "Item 1. Business" section and elsewhere in this Form 10-K including, but not limited to, "Competition," "Loss and Loss Adjustment Expense Reserves," "Analysis of Loss and Loss Adjustment Expense Development," "Investment Portfolio," "Real Estate Lending," "Loan Origination and Acquisition," "Commercial Finance," "Discontinued Operations," "Regulation," and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations." GENERAL Fremont General Corporation is a nationwide insurance and financial services holding company operating select businesses in niche markets. The insurance business of Fremont General (Fremont General Corporation and its subsidiaries or "the Company") includes one of the largest underwriters of workers' compensation insurance in the nation. Fremont General's financial services business includes commercial real estate lending, residential real estate lending, commercial finance and premium financing. The Company's reported assets as of December 31, 1997 were $6.1 billion, with 1997 pre-tax earnings of $159 million. The primary operating strategy of the Company is to build upon its core business units through acquisition opportunities and new business development. The Company's secondary strategy is to achieve income balance and geographic diversity among its business units in order to limit the exposure of the Company to industry, market and regional concentrations. The Company's stock is traded on the New York Stock Exchange under the symbol "FMT." The Company's workers' compensation operation currently has major market positions in California, Illinois, Arizona, Wisconsin, Idaho and Alaska. At December 31, 1997, the Company underwrote policies in thirty-nine states and the District of Columbia. For the years ended December 31, 1997 and 1996, the Company had workers' compensation insurance premiums earned of $571 million and $457 million, respectively. Consistent with its primary strategy, the Company's workers' compensation insurance operations have grown dramatically since 1994 through acquisitions. On August 1, 1997, the Company acquired Industrial Indemnity Holdings, Inc. ("Industrial"). Industrial, which specializes in underwriting workers' compensation insurance, has a strong presence in the western United States dating back over seventy years. On February 22, 1995, the Company acquired Casualty Insurance Company ("Casualty"), the largest underwriter of workers' compensation insurance in Illinois, with additional operations in several other mid-western states. These acquisitions have provided the Company with a broad national platform upon which to build its workers' compensation insurance business, while providing geographic diversity to mitigate potential fluctuations in earnings from cyclical downturns in various regional economies. (See "Property and Casualty Insurance Operations" and Note B of Notes to Consolidated Financial Statements.) A.M. Best rates the Company's workers' compensation insurance subsidiaries on a consolidated basis as "A-" (Excellent) for 1997. An "A-" rating is A.M. Best's fourth highest rating category out of fifteen rating categories ranging from "A++" (Superior) to "F" (In Liquidation). The Company's financial services operations, which are comprised primarily of Fremont General Credit Corporation ("FGCC"), have grown significantly since 1992. These operations are engaged primarily in commercial and residential real estate lending, mainly in California; commercial finance lending, principally to small and middle market companies nationwide; and insurance premium financing, primarily in California. The Company's financial services loan portfolio has grown significantly from $712 million at December 31, 1992 to $2.0 billion at December 31, 1997. (See "Financial Services Operations.") By engaging in several selected geographically diverse businesses, the Company believes it can achieve greater stability in its operating results. Since the year ended December 31, 1993 to the year ended 2 3 December 31, 1997, the Company's income before taxes grew at a compound annual rate of approximately 25% to $159 million for 1997. The Company's book value increased from $272 million at December 31, 1992 to $833 million at December 31, 1997. Management believes that ownership of the Company's Common Stock by employees has been an important element in the Company's success by enabling the Company to attract and retain the best available personnel for positions of substantial responsibility and to provide additional incentive and motivation to such individuals to promote the success of the Company. As of December 31, 1997, officers and directors of the Company, their families and the Company's benefit plans beneficially owned approximately 30% of the Company's outstanding Common Stock. Fremont General, a Nevada corporation, was incorporated in 1972. PROPERTY AND CASUALTY INSURANCE OPERATIONS Fremont Compensation Insurance Group and its subsidiaries ("Fremont Compensation") underwrites primarily workers' compensation insurance in thirty-nine states and the District of Columbia, with major market positions in California, Illinois, Arizona, Wisconsin, Idaho and Alaska. With the acquisition of Industrial in 1997 and Casualty in 1995, Fremont Compensation is one of the largest workers' compensation insurers in the United States. These acquisitions have broadened the geographic diversity of the Company's premium writings. Using the Company's estimated annual premiums on policies in effect at December 31, 1997 (referred to as "inforce premium"), the percentage of the Company's inforce premium in California and Illinois totaled 61%, down from 75% at December 31, 1996. The Company believes this geographic diversity has mitigated potential fluctuations in earnings from cyclical downturns in various regional economies. A.M. Best rates the Company's workers' compensation insurance subsidiaries on a consolidated basis as "A-" (Excellent). Workers' compensation insurance is a government-mandated ("statutory") system which requires every employer to either purchase insurance or self-insure in order to provide its employees with medical care and other specified benefits for work-related injuries or illnesses. Compensation is payable regardless of who was at fault. Most employers provide for this potential liability by purchasing workers' compensation insurance from insurance carriers. There are four types of benefits payable under workers' compensation policies: medical benefits, vocational rehabilitation benefits, disability benefits and death benefits. The amounts of disability and death benefits payable for claims are established by statute, vocational rehabilitation benefits are provided with certain limitations in some jurisdictions, including California, and no dollar limitation is set forth for medical benefits. (See "Regulation -- Insurance Regulation.") Premiums. Workers' compensation insurance premiums are based upon the policyholder's payroll and may be affected significantly by changes in general economic conditions which impact employment and wage levels, as well as by government regulation. Insurance premiums are also subject to supervision and regulation by the state insurance authority in each state. Most of the states in which the Company does business, including California and Illinois, operate under an open rating system. Illinois has been operating under an open rating system since 1982. California adopted an open rating system effective January 1, 1995 through the repeal of the minimum rate law. In an open rating system, workers' compensation insurers are provided with advisory premium rates by job classification and each insurance company determines its own rates based in part upon its particular operating costs and loss experience. Although insurance companies are not required to adopt such advisory premium rates, companies in Illinois generally follow such rates. This characteristic has resulted in increased price competition in Illinois, where overall average decreases in advisory premium rates of 7.9%, 10.0% and 13.6% became effective January 1, 1998, 1997, and 1996, respectively. In contrast, insurance companies in California have, since the adoption of an open rating system, generally set their premium rates below such advisory premium rates. Before January 1, 1995, California operated under a minimum rate law, whereby premium rates established by the California Department of Insurance were the minimum rates which could be charged by an insurance carrier. (See "Regulation -- Insurance Regulation.") The repeal of the minimum rate law resulted in lower premiums and lower profitability on the Company's 3 4 California workers' compensation insurance policies due to increased price competition. (See "Competition.") Underwriting and Loss Control. Prior to insuring a workers' compensation account, the Company's underwriting department reviews the employer's prior loss experience, safety record, credit history, operations, geographic location and employment classifications. The Company generally avoids industries and businesses involving hazardous conditions or high exposure to multiple injuries resulting from a single occurrence. The Company targets accounts that appear to have a strong work ethic among employees, long-term employees and a genuine interest in the adoption of and adherence to loss control standards. The Company's loss control department participates in the initial underwriting process and also provides on-going services to policyholders based on individual needs and potential risk exposure. In the initial underwriting phase, the Company underwriter will review both the loss experience and description of operations and where there is a concern about the potential hazards or claim trends, a loss control consultant will be requested to pre-screen the account prior to policy issuance. This pre-screening process involves meeting with the employer's management to assess the extent to which management is committed to safety in the workplace, surveying the employer's operations, reviewing past loss patterns and evaluating the safety program. After the policy is issued, the loss control department will provide service calls to the insured based on both regulatory requirements and specific needs to assist the employer in developing and maintaining safety programs and procedures, review periodic loss reports, identify weaknesses in the employer's loss prevention procedures and assist in correcting these weaknesses. In some states, loss control must target those employers who have a high claim frequency, and provide specific services to assist in accident prevention. Accident and claim records maintained by the Company are also reviewed by the loss control department and service calls are initiated when adverse claim trends develop. Any insured who requests loss control service is provided this service free of charge. Accident prevention services include physical surveys for hazard recognition, safety program evaluation, loss trend analysis and employee training. Policyholders' Dividends. Since 1995, the Company's workers' compensation insurance policies have been predominately written as non-participating and, therefore, do not include provisions for the insurer to declare and pay dividends to a policyholder after the expiration of the policy. Prior to 1995, the Company's California policies were predominately written as participating, thereby obligating the Company to consider the payment of dividends to a policyholder, based upon the policyholder's loss experience, the Company's overall loss experience and competitive conditions. This shift in policy type is due primarily to the increased competition in the California market which resulted from the repeal of the minimum rate law, effective January 1, 1995. (See "Premiums" and "Regulation -- Insurance Regulation.") This shift to non-participating policies has continued and is a characteristic element of the competitive environment. Claims Administration. The Company's policy is to settle valid claims promptly and to work closely with policyholders to return injured workers to the job quickly, while avoiding litigation if possible. Claims personnel communicate frequently with policyholders, injured employees and medical providers. The Company's policy is to control the number of cases assigned to its claims personnel, to identify and investigate questionable claims and to produce early and cost-effective case settlements of valid claims. As part of its "zero tolerance" program, the Company refuses to settle any claim that it believes to be fraudulent. The Company, where permitted, utilizes its own non-lawyer hearing representatives in most claims adjudicated administratively and has found this practice to be significantly less expensive than using legal counsel. The Company provides rehabilitation programs for injured workers and aggressively pursues the containment of medical costs through its subsidiary, Fremont Health Corporation. This subsidiary provides services to the Company's claims personnel which are designed to reduce medical costs and return injured workers to the job quickly. Such services include integrated medical case management; a proprietary, directly-contracted group of preferred providers who have unique experience in industrial medicine; a review of medical bills using both internal and outsourced resources; medical peer review panels of credentialed regional medical providers; and comprehensive return-to-work programs designed to return injured workers back to work as quickly as medical treatment standards permit. The integrated case management service involves 4 5 nurses employed by Fremont Health who work closely with the claims personnel to provide prompt and aggressive medical treatment to mitigate the effects of the workers' injuries. Competition. The insurance industry is characterized by competition on the basis of price and service. Prior to January 1, 1995, minimum premium rates were prescribed for workers' compensation insurance in California by the Department of Insurance, and competition for underwriting such insurance in California had been based principally upon an insurance carrier's financial strength and history of paying policyholders' dividends. Secondary considerations included loss control and claims administration, the ability to respond promptly to agents and brokers, and commission schedules for agents and brokers. The repeal of the California minimum rate law, effective January 1, 1995, has resulted in increased price competition which has adversely affected the Company's results of operations for its workers' compensation insurance business in California. (See "Regulation -- Insurance Regulation.") In 1997, however, the Company observed a moderation of price competition in California. The Company recently expanded its workers' compensation operation through the acquisition on August 1, 1997 of Industrial, which underwrites workers' compensation insurance in several western states. Excluding California, these western states have collectively exhibited relatively stable competitive environments. In Illinois, price competition has also impacted the Company's results of operations. The advisory premium rates in Illinois, which are established by the National Council on Compensation Insurance and which workers' compensation insurance companies in Illinois tend to follow, decreased 7.9%, 10% and 13.6% effective January 1, 1998, 1997 and 1996, respectively. In the fourth quarter of 1997, however, the Company observed some moderation of price competition in Illinois. It is uncertain whether this moderation will continue. Although the Industrial and Casualty acquisitions have established the Company with major market positions in several states outside of California, based on the competitive nature of the insurance industry and the inherent risks associated with the Company entering into a new geographic market, there can be no assurance that the Company will continue to maintain its market share in the future. Furthermore, state regulatory changes could affect competition in the states where the Company transacts insurance business. Although the Company is one of the largest writers of workers' compensation insurance in several states, including California and Illinois, certain of the Company's competitors are larger and have greater resources than the Company. Marketing. The Company markets its workers' compensation insurance products through more than 1,800 non-exclusive independent insurance agents and brokers, many of whom have been associated with the Company for more than 15 years. At December 31, 1997, the ten largest agents accounted for approximately 22% of the Company's workers compensation insurance premiums. The largest producer accounted for 4.7%. Medical Malpractice Insurance. The Company's medical malpractice insurance operation underwrites primarily standard professional liability insurance on a "claims made" basis, mainly in California. Coverage is provided for claims reported to the Company during the policy period arising from incidents that occurred at any time that the insured was covered by the policy. The Company offers coverage for individual medical doctors, anesthesiologists, podiatrists, chiropractors, as well as medical groups, community clinics, laboratories and miscellaneous medical clinics. The Company markets its policies exclusively through approximately 300 non-exclusive independent insurance agents and brokers. On January 1, 1998, the Company entered into reinsurance and assumption agreements with a reinsurer whereby substantially all of the assets and liabilities related to the medical malpractice policies were ceded to the reinsurer. These reinsurance agreements are part of several other agreements which collectively resulted in the sale of the Company's medical malpractice operations effective January 1, 1998. The effect on operations from these agreements was not material, and revenue and operating income from medical malpractice operations were not significant in 1997, 1996, or 1995. Reinsurance Ceded. Reinsurance is ceded primarily to reduce the liability on individual risks and to protect against catastrophic losses. The Company follows the industry practice of reinsuring a portion of its risks. For this coverage, the Company pays the reinsurer a portion of the premiums received on all policies. The Company maintains excess of loss reinsurance treaties with various reinsurers for each of its insurance lines. Under the current workers' compensation reinsurance treaties, various reinsurers assume liability on that portion of the loss that exceeds $1 million per occurrence, up to a maximum of $399 million 5 6 per occurrence. Effective January 1, 1998, the Company purchased additional excess of loss reinsurance for its workers' compensation insurance business through two treaties. With these two reinsurance treaties added, various reinsurers assume liability on that portion of the loss that exceeds $100,000 per occurrence, up to a maximum of $399 million per occurrence. (See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations -- Premiums.") For medical malpractice insurance, excess of loss reinsurance covers claims and losses above $1 million, up to a maximum of $5 million. On January 1, 1998, the Company entered into reinsurance and assumption agreements with a reinsurer whereby substantially all of the assets and liabilities related to the Company's medical malpractice policies were ceded to the reinsurer. (See "Medical Malpractice Insurance.") Although reinsurance makes the assuming reinsurer liable to the insurer to the extent of the reinsurance ceded, it does not legally discharge an insurer from its primary liability for the full amount of the policy liability. All of the foregoing reinsurance is with non-affiliated reinsurers. The Company believes that the terms of its reinsurance contracts are consistent with industry practice and, based on its understanding of the reinsurers' financial condition and reputations in the reinsurance marketplace, that its reinsurers are financially sound. The Company encounters disputes from time to time with its reinsurers, which, if not settled, are typically resolved in arbitration. Substantially all of the Company's treaties are for annual terms. In general, the reinsurance agreements are of the treaty variety and cover all underwritten risks of types specified in the treaties. As of December 31, 1997, Employers Reassurance Corporation was the only reinsurer that accounted for more than 10% of the Company's total reinsurance recoverable while General Reinsurance Corporation was the only reinsurer that accounted for more than 10% of total amounts recoverable from all reinsurers on property and casualty paid and unpaid losses. With respect to the Company's life insurance operations within the financial services segment, the Company entered into reinsurance and assumption agreements with a reinsurer whereby substantially all of the Company's universal life insurance was ceded to the reinsurer effective December 31, 1995, and all the annuity business was ceded to the reinsurer effective January 1, 1996. As a result of these agreements, the Company has substantially reduced its life insurance operations and no significant gain or loss was recognized from these agreements. (See "Financial Services Operations.") Operating Data. Set forth below is certain information pertaining to the Company's property and casualty insurance business as determined in accordance with generally accepted accounting principles ("GAAP") for the years indicated. (See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" for a discussion of certain of this information.)
YEAR ENDED DECEMBER 31, -------------------------------------------------------- 1997 1996 1995 1994 1993 -------- -------- -------- -------- -------- (THOUSANDS OF DOLLARS, EXCEPT PERCENTS) Net premiums earned................. $601,183 $486,860 $606,917 $433,584 $455,765 Net investment income and other(1).......................... 102,645 92,254 85,912 52,471 57,448 Underwriting profit (loss).......... 42,022 25,339 (2,820) 8,794 (5,356) Income before taxes................. 144,667 117,593 83,092 61,265 52,092 Loss ratio........................ 64.7% 68.9% 76.0% 63.1% 70.0% Expense ratio..................... 27.5% 25.9% 24.5% 23.4% 21.3% Policyholders' dividend ratio..... 0.8% -- -- 11.5% 9.9% -------- -------- -------- -------- -------- Total combined ratio...... 93.0% 94.8% 100.5% 98.0% 101.2% ======== ======== ======== ======== ========
- --------------- (1) Includes net realized investment gains (losses) and interest expense. 6 7 Statutory Combined Ratio. The following table reflects the combined ratios of the Company's workers' compensation insurance business determined in accordance with statutory accounting practices, together with the workers' compensation industry-wide combined ratios after policyholders' dividends, as compiled by A.M. Best, for the years indicated.
YEAR ENDED DECEMBER 31, ---------------------------------------------------- 1997 1996 1995 1994 1993 ------------- ------ ------ ------ ------ Workers' Compensation: Company................................ 96.6% 97.9% 100.1% 98.5% 98.8% Industry(1)............................ not available 99.7% 97.0% 101.4% 109.1%
- --------------- (1) Nationwide statutory combined ratio information for the workers' compensation insurance industry for 1993 through 1996 is from A.M. Best's Aggregates & Averages, Property-Casualty (1994 through 1997 editions). Premium-to-Surplus Ratio. Regulatory authorities regard the premium-to-surplus ratio as an important indicator of operating leverage. A lower ratio indicates a greater ability on the part of the insurer to withstand abnormal loss experience. Guidelines established by the National Association of Insurance Commissioners ("NAIC") provide that a property and casualty insurer's premium-to-surplus ratio is satisfactory if it is below 3 to 1. The following table sets forth the Company's consolidated ratio of net property and casualty premiums written during the period to policyholders' surplus on a statutory basis at the end of the period, for the periods indicated:
YEAR ENDED DECEMBER 31, -------------------------------------------------------- 1997(1) 1996 1995(2) 1994 1993 -------- -------- -------- -------- -------- (THOUSANDS OF DOLLARS, EXCEPT RATIOS) Net premiums written during the year.............................. $820,532 $473,123 $683,711 $425,631 $454,867 Policyholders' surplus at end of year.............................. 548,280 399,893 299,408 235,294 221,857 Ratio............................... 1.5x 1.2x 2.3x 1.8x 2.1x
- --------------- (1) Includes net written premium for Industrial for the period January 1, 1997 through July 31, 1997, which was prior to the Company's acquisition of Industrial on August 1, 1997. (2) Includes net written premium for Casualty for the period January 1, 1995 through February 21, 1995, which was prior to the Company's acquisition of Casualty on February 22, 1995. Loss and Loss Adjustment Expense Reserves. In many cases, significant periods of time, ranging up to several years or more, may elapse between the occurrence of an insured loss, the reporting of the loss to the insurer, and the insurer's payment of that loss. To recognize liabilities for future unpaid losses, insurers establish reserves, which are balance sheet liabilities, representing estimates of future amounts needed to pay claims with respect to insured events that have occurred. Reserves are also established for loss adjustment expense reserves ("LAE") representing the estimated expenses of settling claims, including legal and other fees, and general expenses of administering the claims adjustment process. Reserves for losses and LAE ("loss reserves") are based not only on historical experience but also on management's judgment of the effects of matters such as future economic and social forces likely to impact the insurer's experience with the type of risk involved, circumstances surrounding individual claims, and trends that may affect the probable number and nature of claims arising from losses not yet reported. Consequently, loss reserves are inherently subject to a number of highly variable circumstances. Loss reserves are revalued periodically using a variety of actuarial and statistical techniques for producing current estimates of expected claim costs. Claim frequency and severity and other economic and social factors are considered in the reevaluation process. A provision for inflation in the calculation of estimated future claim costs is implicit since reliance is placed on both actual historical data, which reflect past inflation, and on other 7 8 factors which are judged to be appropriate modifiers of past experience. Adjustments to liabilities are reflected in operating results for the periods to which they are made. Reconciliation of Loss and Loss Adjustment Expense Reserves. The following table shows the GAAP reconciliation of the estimated liability for losses and LAE for the Company's property and casualty insurance subsidiaries (excluding discontinued operations) and the effect on income for each of the three years indicated. RECONCILIATION OF RESERVES FOR LOSSES AND LAE
YEAR ENDED DECEMBER 31, -------------------------------------- 1997 1996 1995 ---------- ---------- ---------- (THOUSANDS OF DOLLARS) Reserves for losses and LAE, net of reinsurance recoverable, at beginning of year.................... $1,010,886 $1,185,706 $ 610,510 Incurred losses and LAE: Provision for insured events of the current year, net of reinsurance.................................... 441,524 334,657 459,951 Increase (decrease) in provision for insured events of prior years, net of reinsurance................ (52,323) 750 1,382 ---------- ---------- ---------- Total incurred losses and LAE................ 389,201 335,407 461,333 Payments: Losses and LAE, net of reinsurance, attributable to insured events of: Current year...................................... (253,323) (108,247) (132,358) Prior years....................................... (386,469) (401,980) (358,423) ---------- ---------- ---------- Total payments............................... (639,792) (510,227) (490,781) ---------- ---------- ---------- Subtotal..................................... 760,295 1,010,886 581,062 Liability for losses and LAE for companies acquired during the year...................................... 1,049,100 -- 604,644 ---------- ---------- ---------- Reserves for losses and LAE, net of reinsurance recoverable, at end of year.......................... 1,809,395 1,010,886 1,185,706 Reinsurance recoverable for losses and LAE, at end of year................................................. 353,928 245,459 269,986 ---------- ---------- ---------- Reserves for losses and LAE, gross of reinsurance recoverable, at end of year.......................... $2,163,323 $1,256,345 $1,455,692 ========== ========== ==========
Analysis of Loss and Loss Adjustment Expense Development. The following table shows the cumulative amount paid against the previously recorded liability at the end of each succeeding year and the cumulative development of the estimated liability for the ten years ending December 31, 1997. Conditions and trends that have affected the development of these reserves and payments in the past will not necessarily recur in the future. Accordingly, management does not believe that it is appropriate to use this cumulative history to project future performance. 8 9 The re-estimated liability portion of the following table shows the year by year development of the previously estimated liability at the end of each succeeding year. The re-estimated liabilities are increased or decreased as more information becomes known about the frequency and severity of claims for individual years. The increases or decreases are reflected in the current year's operating earnings. Each column shows the reserve held at the indicated calendar year-end and cumulative data on re-estimated liabilities for the year and all prior years making up those calendar year end liabilities. The effect on income of the charge (credit) during the current period (i.e., the difference between the estimated liability at December 31 and the liability estimated one year later) is shown in the previous table above for each of the three most recent years as "Increase (decrease) in provision for insured events of prior years." CHANGES IN HISTORICAL RESERVES FOR LOSS AND LAE FOR THE LAST TEN YEARS GAAP BASIS AS OF DECEMBER 31, 1997
YEAR ENDED DECEMBER 31, ------------------------------------------------------------------------------------- 1987 1988 1989 1990 1991 1992 1993 1994 -------- -------- -------- -------- -------- -------- -------- -------- (THOUSANDS OF DOLLARS) Reserves for Loss and LAE, net of reinsurance recoverable.......... $390,799 $406,823 $647,559 $652,284 $627,103 $633,394 $644,190 $610,510 Net reserve re-estimated as of: One year later..... 402,902 396,091 636,039 624,953 668,107 629,268 626,956 611,892 Two years later.... 389,973 377,080 607,253 647,959 660,729 615,747 633,333 632,397 Three years later............ 374,330 356,961 607,492 638,879 651,482 621,348 641,166 644,485 Four years later... 361,209 350,736 599,052 627,194 654,403 626,174 659,968 Five years later... 358,645 375,550 593,527 631,165 659,050 685,517 Six years later.... 369,320 373,514 596,808 634,628 717,517 Seven years later............ 371,863 375,364 600,646 675,661 Eight years later............ 372,920 380,467 630,176 Nine years later... 378,011 399,852 Ten years later.... 385,579 Net cumulative redundancy (deficiency)......... 5,220 6,971 17,383 (23,377) (90,414) (52,123) (15,778) (33,975) Cumulative amount of reserve paid, net of reserve recoveries, through: One year later..... 128,565 125,563 226,101 245,777 257,951 240,552 236,774 241,667 Two years later.... 213,323 211,529 374,876 403,105 419,638 402,048 392,237 397,640 Three years later............ 266,605 263,229 461,366 495,707 521,729 499,924 484,474 495,825 Four years later... 298,956 291,817 514,890 550,404 583,013 558,935 545,574 Five years later... 316,483 320,511 547,535 585,094 623,022 600,071 Six years later.... 333,461 339,998 567,871 608,802 652,990 Seven years later............ 346,547 351,805 583,580 629,321 Eight years later............ 353,517 362,802 597,623 Nine years later... 361,092 373,790 Ten years later.... 369,766 -------- -------- Net reserve -- December 31,............................................................. $644,190 $610,510 Reinsurance recoverable................................................................. 138,737 136,151 -------- -------- Gross reserve -- December 31,........................................................... $782,927 $746,661 ======== ======== Net re-estimated reserve...................................................................................... Re-estimated reinsurance recoverable.......................................................................... Gross re-estimated reserve.................................................................................... Gross cumulative redundancy (deficiency)...................................................................... YEAR ENDED DECEMBER 31, ------------------------------------ 1995 1996 1997 ---------- ---------- ---------- (THOUSANDS OF DOLLARS) Reserves for Loss and LAE, net of reinsurance recoverable.......... $1,185,706 $1,010,886 $1,809,395 Net reserve re-estimated as of: One year later..... 1,186,456 958,563 -- Two years later.... 1,116,673 Three years later............ Four years later... Five years later... Six years later.... Seven years later............ Eight years later............ Nine years later... Ten years later.... Net cumulative redundancy (deficiency)......... 69,033 52,323 -- Cumulative amount of reserve paid, net of reserve recoveries, through: One year later..... 401,980 386,469 -- Two years later.... 662,943 Three years later............ Four years later... Five years later... Six years later.... Seven years later............ Eight years later............ Nine years later... Ten years later.... ---------- ---------- ---------- Net reserve -- December $1,185,706 $1,010,886 $1,809,395 Reinsurance recoverable 269,986 245,459 353,928 ---------- ---------- ---------- Gross reserve -- Decemb $1,455,692 $1,256,345 $2,163,323 ========== ========== ========== Net re-estimated reserv $1,116,673 $ 958,563 Re-estimated reinsuranc 268,483 237,396 ---------- ---------- Gross re-estimated rese $1,385,156 $1,195,959 ========== ========== Gross cumulative redund $ 70,536 $ 60,386 ========== ==========
9 10 The Company is required to maintain reserves to cover its estimated ultimate liability for losses and LAE with respect to reported and unreported claims incurred as of the end of each accounting period. These reserves do not represent an exact calculation of liabilities, but rather are estimates involving actuarial projections at a given time of what the Company expects the ultimate settlement and administration of claims will cost based on facts and circumstances then known, predictions of future events, estimates of future trends in claims' frequency and severity and judicial theories of liability as well as other factors. The Company regularly reviews its reserving techniques, overall reserve position and its reinsurance. In light of present facts and current legal interpretations, management believes that adequate provision has been made for loss reserves. In making this determination, management has considered its claims experience to date, loss development history for prior accident years, estimates of future trends of claims frequency and severity, and various external factors such as judicial theories of liability. However, establishment of appropriate reserves is an inherently uncertain process, and there can be no certainty that currently established reserves will prove adequate in light of subsequent actual experience. Subsequent actual experience has resulted and could result in loss reserves being too high or too low. Future loss development could require reserves for prior periods to be increased, which would adversely impact earnings in future periods. In 1996 and 1995, there was relatively insignificant aggregate development on prior accident years. In 1997, the Company decreased its losses and LAE reserves for 1996 and prior accident years by $52.3 million. This reserve decrease relates primarily to loss and LAE reserves on workers' compensation policies written in the Company's mid-west region and represents the recognition of a decrease in the frequency of reported claims on the 1996 and 1995 accident years. Additionally, the Company's management believes that its implementation of more effective claims handling procedures in the mid-west region has contributed to the reduction in LAE reserves during calendar year 1997 and relating to the 1996 and prior accident years. The Company is not able to determine with certainty the specific cause or causes of increases and decreases in claims experience that led to these changes in reserves but has reached its own conclusion based on a review of its internal data base and a subjective evaluation of external factors. The following discussion is a summary of the principal considerations that the Company evaluated in determining workers' compensation insurance reserves adjustments in 1997. The Company acquired Casualty on February 22, 1995. This acquisition provided the Company a significant presence in several mid-western states, primarily Illinois. By the end of 1995, the Company observed a significant reduction in the frequency of reported claims on the 1995 accident year as compared to Casualty's historical experience prior to 1995. Also during 1995, the Company had been active in assimilating the operations of Casualty into its existing operating environment, which included, among other things, implementing more effective claims handling procedures. Therefore, the Company could not determine with certainty whether or not the observed lower frequency in reported claims was a one-time event occurring as a result of these changes in claims handling procedures. In 1997, the Company observed the continued trend in lower reported claim experience on the 1996 and 1995 accident years, which also had been confirmed in the industry through an evaluation of industry data. Appropriate reserve adjustments were, therefore, made by the Company in recognition of this confirmed trend in lower loss experience on the 1996 and 1995 accident years for the mid-west region. INVESTMENT PORTFOLIO The Company manages its investments internally. The following portfolio information reflects the Company's continuing operations. 10 11 The following table reflects the amortized cost and fair value of fixed maturity investments and non-redeemable preferred equity securities by major category, as well as the amortized cost and fair value of cash and short-term investments on the dates indicated.
DECEMBER 31, 1997 DECEMBER 31, 1996 ----------------------- ----------------------- AMORTIZED FAIR AMORTIZED FAIR COST VALUE COST VALUE ---------- ---------- ---------- ---------- (THOUSANDS OF DOLLARS) Available for sale: United States Treasury securities and obligations of other US government agencies and corporations.............. $ 165,847 $ 168,788 $ 70,039 $ 76,314 Obligations of states and political subdivisions........................... 99,876 101,899 -- -- Redeemable preferred stock................ 27,618 28,350 -- -- Mortgage-backed securities................ 560,015 575,360 324,011 308,228 Corporate securities Banks.................................. 9,374 9,573 35,000 35,155 Financial.............................. 373,630 388,999 115,382 118,443 Transportation......................... 7,139 9,270 27,163 27,559 Industrial............................. 591,587 611,637 432,653 439,448 ---------- ---------- ---------- ---------- Total............................. 1,835,086 1,893,876 1,004,248 1,005,147 Non-redeemable preferred stock............ 356,223 378,832 351,812 354,958 ---------- ---------- ---------- ---------- Total............................. $2,191,309 $2,272,708 $1,356,060 $1,360,105 ========== ========== ========== ========== Short-term investments...................... $ 164,626 $ 164,626 $ 118,582 $ 118,582 Cash........................................ 64,987 64,987 55,378 55,378
As of December 31, 1997, substantially all of the fixed maturity investments in the portfolio were rated investment grade by Standard and Poor's, Moody's and Fitch's rating services. Of these investments, 76% were rated A or higher, 21% were rated BBB and 3% were rated BB. As of December 31, 1997, these investment securities had an approximate fair value of $1.9 billion, which was higher than amortized cost by approximately $59 million. The Company does not currently plan or intend to invest in securities rated below investment grade. The following table reflects the average cash and the average amortized cost of the investment assets of the Company for the periods indicated.
YEAR ENDED DECEMBER 31, --------------------------------------- 1997 1996 1995 ----------- ----------- ----------- (THOUSANDS OF DOLLARS, EXCEPT PERCENTS) Average cash and investment assets: Cash..................................................... $ 53,666 $ 40,467 $ 24,657 Investment assets........................................ 1,970,602 1,752,181 1,591,972 ---------- ---------- ---------- Total............................................ $2,024,268 $1,792,648 $1,616,629 ========== ========== ========== Investment yield earned on (excluding realized gains and losses): Cash and investment assets............................... 7.48% 7.06% 7.38% Investment assets only................................... 7.68% 7.22% 7.49% Investment yield earned on (including realized gains and losses): Cash and investment assets............................... 7.38% 6.97% 7.38% Investment assets only................................... 7.58% 7.13% 7.49%
The Company has designated its entire portfolio as investments that would be available for sale in response to changing market conditions, liquidity requirements, interest rate movements and other investment factors. At December 31, 1997 and 1996, the Company held securities having an amortized cost of 11 12 $2.191 billion and $1.356 billion, respectively, as available for sale. (See Notes A and C of Notes to Consolidated Financial Statements.) The following table sets forth maturities in the fixed maturity and short-term investment portfolios at December 31, 1997:
AMORTIZED COST PERCENTAGE ---------- ---------- (THOUSANDS OF DOLLARS, EXCEPT PERCENTS) One year or less....................................... $ 185,711 9% Over 1 year through 5 years............................ 115,270 6 Over 5 years through 10 years.......................... 132,025 7 Over 10 years.......................................... 1,006,691 50 Mortgage-backed securities............................. 560,015 28 ---------- ---- Totals....................................... $1,999,712 100% ========== ====
FINANCIAL SERVICES OPERATIONS Real Estate Lending The real estate lending operations of FGCC, which began in 1990 through the acquisition of a California thrift and loan ("the thrift"), currently consists of more than 3,300 residential real estate accounts, 500 commercial real estate accounts, 13,300 insurance premium finance accounts and 42,000 deposit accounts. The thrift's deposits are serviced through 13 branch offices in California and its deposits are insured by the Federal Deposit Insurance Corporation ("FDIC"). (See "Regulation -- Thrift and Loan Regulation.") The thrift's operations are primarily engaged in commercial and residential real estate lending. Additionally, insurance premium financing is provided and is collateralized by security interests in return premiums. Income before taxes from the real estate lending operation has increased significantly from $6 million in 1992 to $26 million in 1997. The loan portfolio of the real estate lending operation has grown from $376 million at the end of 1992 to $1.5 billion at the end of 1997, due to increased loan originations and to the purchase of loan portfolios from other financial institutions. The thrift funds its lending activities through its deposits and capital. Deposits consist principally of certificates of deposit and installment investment certificates (which are similar to passbook accounts and money market accounts). Deposits totaled $1.5 billion at December 31, 1997. The ability of the Company's thrift to continue to originate loans, and of borrowers to repay outstanding loans, may be impaired by adverse changes in local or regional economic conditions which affect such areas or by adverse changes in the real estate market in those areas. Such events could also significantly impair the value of the underlying collateral. If the thrift's collateral were to prove inadequate, the Company's results of operations could be adversely affected. In addition, the financial services industry is characterized by competition on the basis of price and service. Loan Origination and Acquisition. The thrift originates loans through independent loan brokers and through its own loan agents and through bulk purchases which have been immaterial over the past three years. The thrift originates commercial real estate loans primarily for its own portfolio rather than for resale to third parties. For residential real estate loans, the thrift began a program in 1997 of selling certain residential real estate loans to other financial institutions. This allowed the thrift an opportunity to become more selective in its residential real estate loan portfolio. Additionally, this program has allowed the thrift to offer a broader range of residential real estate loans to its customers, primarily through independent brokers. In 1997, $159 million of residential real estate loans were sold, all without recourse to the Company or the thrift, to various other entities. The thrift's commercial real estate loan originations are primarily secured by first deeds of trust on income-producing properties in California. The real estate securing these loans include a wide variety of property types including office, retail, industrial and multi-family properties. Loans include short-term bridge 12 13 and construction facilities for the rehabilitation and lease-up of existing properties or new construction, as well as five to ten year permanent loans. The majority of the commercial real estate loans originated are adjustable rate loans and generally range between $1 million to $8 million. As of December 31, 1997, the average loan size was $2.1 million and the approximate average loan-to-value ratio was 72%, using the most current available appraised values and current balances outstanding. The total amount of commercial real estate loans outstanding at December 31, 1997 was $1.05 billion or 71% of the thrift's loan portfolio. Loans secured by commercial real estate are generally considered to entail a higher level of risk than loans secured by residential real estate. Although the properties securing the thrift's commercial real estate loans generally have good operating histories, there can be no assurance that such properties will continue to generate sufficient funds to allow their owners to make full and timely mortgage loan payments. At December 31, 1997, the thrift had 21 non-accrual commercial real estate loans totaling approximately $14 million and commercial real estate owned of approximately $4 million. The thrift also originates loans secured by single-family residences. At December 31, 1997, single family residential real estate loans represented $380 million, or 26%, of the thrift's loan portfolio. Substantially all of these loans are secured by first deeds of trust. These loans have principal amounts primarily below $300,000, have maturities generally of thirty years and are approved in accordance with lending policies approved by the thrift's Board of Directors, which include standards covering, among other things, collateral value, loan to value and customer debt ratio. At December 31, 1997, the average single-family loan amount was $110,000, and the approximate average loan-to-value ratio was 74%, using appraised values at the time of loan origination and current balances outstanding. At December 31, 1997, the thrift had 85 non-accrual residential real estate loans totaling approximately $10 million and residential real estate owned of approximately $4 million. During 1997, the Company began originating commercial real estate loans outside of California. For residential real estate loans, originations outside of California commenced in 1996. The Company intends to seek portfolio growth outside of California in order to achieve greater geographic diversity in the loan portfolio and thereby lessen the Company's exposure to regional concentrations. The total amount of commercial and residential real estate loans outstanding on properties located outside of California at December 31, 1997 was $44 million and $58 million, respectively. (See "Regulation -- Thrift and Loan Regulation -- California Law.") The real estate lending operation also includes an entity that finances property and casualty insurance premiums for small businesses. This premium finance loan portfolio is collateralized by the unearned premiums of the underlying insurance policies. (See "Regulation -- Thrift and Loan Regulation -- California Law.") Revenue and operating income from this operation were not significant in 1997, 1996 or 1995. The portfolio of the thrift's loans receivable as of the dates indicated are summarized in the following table by type of primary collateral.
YEAR ENDED DECEMBER 31, ---------------------------------- 1997 1996 1995 ---------- ---------- -------- (THOUSANDS OF DOLLARS) Commercial real estate loans................................ $1,053,851 $ 855,150 $730,599 Residential real estate loans............................... 379,962 267,428 165,888 Premium finance and other thrift loans...................... 54,421 305 2,330 ---------- ---------- -------- Loans receivable before deferred fees and costs............. 1,488,234 1,122,883 898,817 Purchase discount and deferred fees and costs............... (7,410) (8,933) (9,865) ---------- ---------- -------- Total loans receivable, purchase discount and deferred fees and costs......................... 1,480,824 1,113,950 888,952 Less allowance for possible loan losses..................... (33,341) (24,759) (17,498) ---------- ---------- -------- Loans receivable, net..................................... $1,447,483 $1,089,191 $871,454 ========== ========== ========
Funding Sources. The thrift obtains funds from depositors by offering certificates of deposit and installment investment certificates insured by the FDIC to the legal maximum through its 13 branches in 13 14 California. The thrift has typically offered higher interest rates to its depositors than do most full service financial institutions. At the same time, it has minimized the cost of maintaining these accounts by not offering non-interest bearing or unlimited withdrawal transaction accounts or services such as checking, safe deposit boxes, money orders, ATM access and other traditional retail services. The thrift generally effects deposit withdrawals by issuing checks rather than disbursing cash, which minimizes operating costs associated with handling and storing cash. Additional financing became available from the Federal Home Loan Bank of San Francisco effective January 1995. This financing is available at varying rates and terms. As of December 31, 1997, $325 million was available under the facility and no borrowings were outstanding. The table below summarizes the thrift's certificates of deposit as of December 31, 1997 which are stated in amounts of $100,000 or more, by maturity and by type.
CERTIFICATES OF DEPOSIT $100,000 OR MORE, MATURING ------------------------------------------------------ 3 MONTHS OVER 3 THROUGH OVER 6 THROUGH OVER OR LESS 6 MONTHS 12 MONTHS 12 MONTHS TOTAL -------- -------------- -------------- --------- -------- Retail................................. $13,632 $23,894 $25,864 $ 7,408 $ 70,798 IRA's.................................. 1,147 1,456 3,203 1,531 7,337 Wholesale.............................. -- 1,050 -- -- 1,050 Brokered............................... 6,424 18,756 -- 17,195 42,375 ------- ------- ------- ------- -------- Total........................ $21,203 $45,156 $29,067 $26,134 $121,560 ======= ======= ======= ======= ========
Commercial Finance The Company's commercial finance subsidiary provides working capital loans, primarily secured by accounts receivable, inventory and machinery and equipment to small and middle market companies on a nationwide basis. The total commercial finance loan portfolio has grown from $282 million at December 31, 1992 to $547 million at December 31, 1997. This growth has been achieved through development of the customer base through loan originations and through participation in syndicated loan transactions. In 1997, income before taxes from commercial finance was $16.4 million. The lending market continues to be competitive for small to middle market commercial borrowers. As a result, the Company has experienced decreasing yields on its commercial finance loans. In addition, adverse economic developments can negatively affect the business and results of operations of the commercial finance subsidiary in a number of ways. Such developments can reduce the demand for loans, impair the ability of borrowers to pay loans and impair the value of the underlying collateral. Commercial finance loans made by the Company are primarily on a revolving short-term basis (generally two or three years) and secured by assets which primarily include accounts receivable, inventory, machinery and equipment and, to a lesser extent, real estate and other types of collateral. In addition, the Company also makes term loans secured primarily by equipment and real estate. The term loans originated in conjunction with revolving loans are cross-collateralized (i.e., the same collateral is used to support both the term loans and all the related revolving loans) and coterminous with the related revolving loan made to the same borrower. The term to maturity for the term loans is generally five to seven years; however, certain term loans are "balloon loans" that amortize over a longer period and therefore do not amortize fully before their respective maturities. Commercial finance loans also include secured loans originated and serviced by other asset-based lenders and participated in by the Company. As of December 31, 1997, the average outstanding commercial finance loan balance was $2.5 million. Loans outstanding to a single borrower generally range in size from $250,000 to $20 million. The major avenue of growth for the commercial finance operation remains the establishment of new lending relationships. The Company has a national presence with regional offices in Santa Monica, Chicago, New York and Atlanta, as well as several other marketing offices across the country. To provide a stable source of funds to facilitate the continued expansion of its asset-based lending business, the Company, in 1993, established the Fremont Small Business Loan Master Trust ("Fremont Trust"). The purpose of the Fremont Trust is to securitize commercial finance loans originated by the Company (the "asset securitization program"). The Fremont Trust is a master trust that can issue multiple series of asset-backed certificates that represent undivided interests in the Fremont Trust's assets (primarily commercial finance loans), which the 14 15 Company will continue to service after securitization. As of December 31, 1997, the Fremont Trust had an aggregate of $235 million senior series and an aggregate of $39 million of subordinated series of term asset-backed certificates outstanding. The interest rate on the certificates, set monthly, ranged from LIBOR plus 0.23% to LIBOR plus 0.95% at December 31, 1997. The securities issued in this program have a scheduled maturity of two to four years, but could mature earlier depending on fluctuations in the outstanding balances of loans in the portfolio and other factors. As of December 31, 1997, up to $265 million in additional publicly offered term asset-backed certificates may be issued pursuant to a shelf registration statement to fund future growth in the commercial finance loan portfolio. In December 1995, a commercial paper facility was established as part of the asset securitization program. This facility, which expires in December 1998, provides for the issuance of up to $150 million in commercial paper, dependent upon the level of assets within the asset securitization program. As of December 31, 1997, $13 million in commercial paper was outstanding under this facility. The commercial finance operation also has an unsecured revolving line of credit with a syndicated bank group that presently permits borrowings of up to $450 million, which includes a revolving credit facility of $350 million and a term loan of $100 million. The revolving credit facility converts to a term loan in August 2000, with ultimate maturity of the term loan in June 2002. The $100 million term loan matures July 2001. The balance outstanding at December 31, 1997 of the revolving credit facility and the term loan was $66 million and $100 million, respectively, with a weighted average interest rate of 6.32%. This credit line is primarily used to finance assets that are not included in the Company's asset securitization program. The Company's commercial finance customer base consists primarily of small to middle market manufacturers and distributors that generally require financing for working capital and debt restructuring. At December 31, 1997, the Company had approximately 220 commercial finance loans outstanding in 35 states. At such dates, approximately 32% of total commercial finance loans outstanding were made to companies based in California, and no other state accounted for more than 10% of total commercial finance loans outstanding. Commercial finance loans are asset-based revolving loans which permit a company to borrow from the lender at any time during the term of the loan agreement, up to the lesser of a maximum amount set forth in the loan agreement or a percentage of the value of the collateral which primarily secures such loans. Under an asset-based lending agreement, the borrower retains the credit and collection risk with respect to the collateral in which the lender takes a security interest. Cash collections are received as often as daily by or on behalf of the borrower after the loan is initially made. These collections are paid to the lender to reduce the loan balance. While consideration is given to the net worth and profitability of a client, asset-based loans are generally extended to borrowers who do not have bank sources of credit readily available and are based on the estimated liquidation value of the collateral pledged to secure the loan. The largest percentage of realized losses has resulted from fraud or collateral misrepresentations by the borrower. The Company seeks to protect itself against this risk through a comprehensive system of collateral monitoring and control. The Company's auditors perform auditing procedures of a borrower's books and records and physically inspects the collateral prior to approval and funding, as well as approximately every 90 days during the term of the loan. General economic conditions beyond the Company's control can and do impact the ability of borrowers to repay loans and also the value of the assets collateralizing such loans. Over the past four years, the majority of the Company's loans that have been liquidated have been fully repaid, as the Company attempts to work closely with the borrower through the liquidation to ensure repayment of the loan. The Company seeks to limit its credit exposure by maintaining conservative collateral valuations and perfection of its security interests. The Company primarily competes with commercial finance companies and banks, most of whom are larger and have greater financial resources than the Company's commercial finance operation. The principal competitive factors are the rates and terms upon which financing is provided and customer service. The lending market has been and remains competitive for small to middle market commercial borrowers. As a result, the Company has experienced decreasing yields on its commercial finance loans. 15 16 Life Insurance Prior to January 1, 1996, the Company offered life insurance products, including annuities, credit life and disability insurance and term life insurance for consumers, through a subsidiary. On December 31, 1995 and on January 1, 1996, the Company entered into reinsurance and assumption agreements with a reinsurer whereby assets and liabilities related to certain life insurance and annuity policies were ceded to the reinsurer. These reinsurance agreements are part of several other agreements which have collectively resulted in the substantial reduction of the Company's life insurance operations. The Company continues to remain primarily obligated for approximately $169 million of account value of annuities which, at December 31, 1997, have been fully coinsured with Employers Reassurance Corporation. The effect on operations from these agreements was not material, and revenue and operating income from this subsidiary were not significant in 1997, 1996 or 1995. DISCONTINUED OPERATIONS The Company's discontinued operations consist primarily of assumed treaty and facultative reinsurance business that was discontinued between 1986 and 1991. In 1990, the Company established a management group to actively manage the liquidation of this business. The liabilities associated with this business are long term in duration and, therefore, the Company continues to be subject to claims being reported. Claims under these reinsurance treaties include professional liability, product liability and general liability which include environmental claims. The discontinued operations' assets at December 31, 1997 consisted of $197 million in cash and investment grade fixed income securities, reinsurance recoverables of $52 million and other assets totaling $8 million. The Company estimates that the dedicated assets supporting these operations and all future cash inflows will be adequate to fund future obligations. However, should those assets ultimately prove to be insufficient, the Company believes that its property and casualty subsidiaries would be able to provide whatever additional funds might be needed to complete the liquidation without having a material adverse effect on the Company's consolidated financial position or results of operations. (See Note N of Notes to Consolidated Financial Statements.) The discontinued operations have investment portfolios which resemble the portfolios in the ongoing operations with regard to asset allocation, performance and maturities. REGULATION Insurance Regulation The Company's workers' compensation insurance operations now operate in thirty-nine states and the District of Columbia with major concentrations in California, Illinois, Arizona, Wisconsin, Idaho and Alaska. Insurance companies are subject to supervision and regulation by the state insurance authority in each state in which they transact business. Such supervision and regulation relate to numerous aspects of an insurance company's business and financial condition. The primary purpose of such supervision and regulation is the protection of policyholders rather than investors or shareholders of an insurer. The extent of such regulation varies, but generally derives from state statutes that delegate regulatory, supervisory and administrative authority to state insurance departments. Accordingly, the authority of the state insurance departments includes the establishment of minimum solvency standards which must be met and maintained by insurers, the licensing to do business of insurers and agents, restrictions on investments by insurers, establishing premium rates for certain property and casualty insurance, and life and disability insurance, establishing the provisions which insurers must make for current losses and future liabilities and the approval of policy forms. Additionally, most states require issuers to participate in assigned risk plans which provide insurance coverage to individuals or entities who are unable to obtain coverage from existing insurers in those states. The net profit or loss incurred in the administration of these plans is allocated back to participant insurers based on the insurers' relative market share (i.e., insurance premiums) in each state. State insurance departments also conduct periodic examinations of the affairs of insurance companies and require the filing of annual and other reports relating to the financial condition of insurance companies. The Company's multistate insurance 16 17 operations require, and will continue to require, significant resources of the Company in order to continue to comply with the regulations of each state in which it transacts business. Workers' Compensation Regulation. Illinois began operating under an open rating system in 1982 and California began operating under such a system effective January 1, 1995. In an open rating system, workers' compensation companies are provided with advisory premium rates by job classification and each insurance company determines its own rates based in part upon its particular operating and loss costs. Although insurance companies are not required to adopt such advisory premium rates, companies in Illinois generally follow such rates. In contrast, insurance companies in California have, since the adoption of an open rating system, generally set their premium rates below such advisory premium rates. Before January 1, 1995, California operated under a minimum rate law, whereby premium rates established by the California Department of Insurance were the minimum rates which could be charged by an insurance carrier. The repeal of the minimum rate law on January 1, 1995 resulted in lower premiums and lower profitability in the Company's California workers' compensation insurance business due to increased price competition. The Company's acquisition of Casualty, with policies written primarily outside of California, lessened the impact of the repeal of the minimum rate law in 1995 by providing geographic diversity, which mitigated the impact of these regulatory changes in California. Beginning in 1995, the Company's policies were predominately written as non-participating, which does not include provisions for policyholder dividend consideration. Prior to January 1, 1995, the Company's policies, which were written primarily in California, were primarily written as participating, which obligated the Company to consider policyholder dividend payments. This shift in policy type is due primarily to the increased competition in the California market which resulted from the repeal of the minimum rate law, effective January 1, 1995. The shift to non-participating policies has continued and is a characteristic element of the competitive environment. In addition, the Company's subsidiaries are required, with respect to their workers' compensation line of business, to maintain on deposit investments meeting specified standards that have an aggregate market value equal to the Company's loss reserves. Insurance Guaranty Association Laws. Under insolvency or guaranty fund laws in most states in which the Company's insurance subsidiaries operate, insurers doing business in those states can be assessed, up to the prescribed limits, for losses incurred by policyholders as a result of the insolvency of other insurance companies. The amount and timing of such assessments are beyond the control of the Company and generally have not had an adverse impact on the Company's earnings in years in which such assessments have been made. Premiums written under workers' compensation policies are subject to assessment only with respect to covered losses incurred by the insolvent insurer under workers' compensation policies. The Company believes it does not face any material exposure to guaranty fund assessments. Holding Company Regulation. The Company is subject to the California Insurance Holding Company System Regulatory Act (the "Holding Company Act"). This act, and similar laws in other states, require the Company to periodically file information with the California Department of Insurance and other state regulatory authorities, including information relating to its capital structure, ownership, financial condition and general business operations. Certain transactions between an insurance company and its affiliates, including sales, loans or investments which in any twelve month period aggregate at least 5% of its admitted assets or 25% of its statutory capital and surplus, also are subject to prior approval by the Department of Insurance. The Holding Company Act also provides that the acquisition or change of "control" of a California domiciled insurance company or of any person who controls such an insurance company cannot be consummated without the prior approval of the Insurance Commissioner. In general, a presumption of "control" arises from the ownership of voting securities and securities that are convertible into voting securities, that in the aggregate, constitute 10% or more of the voting securities of a California insurance company or of a person that controls a California insurance company, such as Fremont General. The Liquid Yield Option(TM) Notes ("LYONs") constitute a security convertible into the voting Common Stock of the Company, and the shares of Common Stock into which a holder's LYONs are convertible and any other securities convertible into Common Stock must be aggregated with any other shares of Common Stock of the holder for purposes of determining the percentage ownership. Additionally, the Company's 9% Trust 17 18 Originated Preferred Securities(SM), which were sold on March 1, 1996 by a wholly-owned subsidiary, are a non-voting security and only represent an interest in the assets of this subsidiary. A person seeking to acquire "control," directly or indirectly, of the Company must generally file with the Insurance Commissioner an application for change of control containing certain information required by statute and published regulations and provide a copy of the application to the Company. The Holding Company Act also effectively restricts the Company from consummating certain reorganizations or mergers without prior regulatory approval. The Holding Company Act also limits the ability of the Company's insurance subsidiaries to pay dividends to the Company. The act permits a property and casualty insurance company to pay dividends in any year which, together with other dividends or other distributions made within the preceding twelve months, do not exceed the greater of 10% of its statutory surplus or 100% of its net income as of the end of the preceding year, subject to certain limitations. Larger dividends are payable only upon prior regulatory approval. Applicable regulations further require that an insurer's statutory surplus following a dividend or other distribution be reasonable in relation to its outstanding liabilities and adequate to its financial needs. Based upon restrictions presently in effect, the maximum amount available for payment of dividends by the Company's property and casualty subsidiaries during 1998 without prior regulatory approval is approximately $67.8 million. In addition, insurance regulations require that the Department of Insurance be given fifteen days advance notice of any dividend payment. Other Regulations. The NAIC adopted a formula to calculate risk based capital ("RBC") of property and casualty insurance companies for inclusion in annual statements. The purpose of the RBC model is to help state regulatory authorities monitor the capital adequacy of property and casualty insurance companies by measuring several major areas of risk facing property and casualty insurers including underwriting, credit and investment risks. Companies having less statutory surplus than the RBC model calculates will be required to adequately address these risk factors and will be subject to varying degrees of regulatory intervention, depending on the level of capital inadequacy. As of December 31, 1997 the Company's insurance subsidiaries engaged in continuing operations exceed all RBC levels requiring any regulatory intervention. Thrift and Loan Regulation The Company's thrift is subject to supervision and regulation by the Department of Financial Institutions of the State of California (the "DFI") and, as an insured institution, by the FDIC. None of the Company's subsidiaries which comprise the real estate lending operation are regulated or supervised by the Office of Thrift Supervision, which regulates savings and loan institutions. Fremont General is generally not directly regulated or supervised by the DFI, the FDIC, the Federal Reserve Board or any other bank regulatory authority, except with respect to guidelines concerning its relationship with the real estate lending subsidiaries. Such guidelines include (i) general regulatory and enforcement authority of the DFI and the FDIC over transactions and dealings between Fremont General and the thrift, (ii) specific limitations regarding ownership of the capital stock of the parent company of any thrift and loan company, and (iii) specific limitations regarding the payment of dividends from the thrift as discussed below. The thrift is examined on a regular basis by both agencies. Federal and state regulations prescribe certain minimum capital requirements and, while the thrift is currently in compliance with such requirements, the Company could in the future be required to make additional investments in the thrift in order to maintain compliance with such requirements. Federal and state regulatory authorities have the power to prohibit or limit the payment of dividends by the thrift. The Company does not believe that the restrictions on the thrift's ability to pay dividends imposed by federal or state law will adversely affect the ability of Fremont General to meet its obligations. Future changes in government regulation and policy could adversely affect the thrift and loan industry, including the Company's thrift. California Law. The thrift and loan business conducted by the Company's thrift is governed by the California Industrial Loan Law and the rules and regulations of the Commissioner of the DFI which, among other things, regulate the collateral requirements and maximum maturities of the various types of loans that are permitted to be made by California-chartered industrial loan companies, i.e., thrift and loan, investment and loan, or premium financing companies. 18 19 Subject to restrictions imposed by applicable California law, the thrift is permitted to make secured and unsecured consumer and non-consumer loans. The maximum term for repayment of loans made by thrift and loan companies is approximately forty years depending upon collateral and priority of secured position, except that loans with repayment terms in excess of approximately thirty years may not in the aggregate exceed 5% of total outstanding loans and obligations of the thrift. Consumer loans secured by real property with terms in excess of three years must be repayable in substantially equal periodic payments unless such loans are covered under the Garn-St. Germain Depository Institutions Act of 1982 (primarily single-family residential loans). Non-consumer loans may be repayable in unequal periodic payments during their respective terms. California law limits lending activities outside of California by thrift and loan companies to no more than 40% of total assets. California law contains extensive requirements for the diversification of the loan portfolios of thrift and loan companies. A thrift and loan with outstanding investment certificates may not, among other things, place more than 5% of its loans or other obligations in loans or obligations which are secured only partially, but not primarily, by real property; may not make any one loan secured primarily by improved real property which exceeds 20% of its paid-up and unimpaired capital stock and surplus not available for dividends; may not lend an amount in excess of 5% of its paid-up and unimpaired capital stock and surplus not available for dividends upon the security of the stock of any one corporation; may not make loans to, or hold the obligations of, any one person as primary obligor in an aggregate principal amount exceeding 20% of its paid-up and unimpaired capital stock and surplus not available for dividends; and may have no more than 70% of its total assets in loans which have remaining terms to maturity in excess of seven years and are secured solely or primarily by real property. At December 31, 1997, the thrift was in compliance with all of these requirements. A thrift and loan generally may not make any loans to, or hold an obligation of, any of its directors or officers or any director or officer of its holding company or affiliates, except in specified cases and subject to regulation by the DFI. Further, a thrift and loan may not make any loan to, or hold an obligation of, any of its shareholders or any shareholder of its holding company or affiliates, except that this prohibition does not apply to persons who own less than 10% of the stock of a holding company or affiliate which is listed on a national securities exchange, such as Fremont General. Any person who wishes to acquire (i) 10% or more of the voting securities of a California thrift and loan company, or (ii) 10% or more of the voting securities of a holding company of a California thrift and loan company, such as the Company, must obtain the prior approval of the DFI. The LYONs are not voting securities of the Company, but the shares of Common Stock into which such LYONs are convertible constitute voting securities of the Company. Additionally, the Company's 9% Trust Originated Preferred Securities(SM), which were sold on March 1, 1996 by a wholly-owned subsidiary, are a non-voting security and only represent an interest in the assets of this subsidiary. The Company's thrift must also obtain prior written approval from the DFI before it may open or relocate any branch or loan production office or close a branch office. The Industrial Loan Law prohibits an industrial loan company from having deposits at any time in an aggregate sum in excess of 20 times the aggregate amount of its paid-up unimpaired capital and amounts of its unimpaired surplus declared by its by-laws not to be available for cash dividends. The Company's thrift currently has an authorized ratio of deposits to such capital of 17 to 1. Federal Law. The thrift's deposits are insured by the FDIC to the full extent permitted by law. As an insurer of deposits, the FDIC issues regulations, conducts examinations, requires the filing of reports and generally supervises the operations of institutions to which it provides deposit insurance. The Company's thrift is subject to the rules and regulations of the FDIC to the same extent as other financial institutions which are insured by that entity. The approval of the FDIC is required prior to any merger, consolidation or change in control or the establishment or relocation of any branch office of the thrift. This supervision and regulation is intended primarily for the protection of the insured deposit funds. Prior written notice to the FDIC is required to close a branch office. The thrift is subject to federal risk-based capital adequacy guidelines which provide a measure of capital adequacy and are intended to reflect the degree of risk associated with both on- and off-balance sheet items, including residential real estate loans sold with recourse, legally binding loan commitments and standby letters 19 20 of credit. A financial institution's risk-based capital ratio is calculated by dividing its qualifying capital by its risk-weighted assets. Financial institutions are generally expected to meet a minimum ratio of qualifying total capital to risk-weighted assets of 8%, of which at least 4% of qualifying total capital must be in the form of core capital ("Tier 1") -- common stock, noncumulative perpetual preferred stock, minority interests in equity capital accounts of consolidated subsidiaries and allowed mortgage servicing rights, less all intangible assets other than allowed mortgage servicing rights and eligible purchased credit card relationships. Supplementary capital ("Tier 2") consists of the allowance for loan and lease losses up to 1.25% of risk- weighted assets, cumulative perpetual preferred stock, long-term preferred stock (original maturity of at least 20 years), perpetual preferred stock, hybrid capital instruments, term subordinated debt and intermediate term preferred stock (original average maturity of five years or more). The maximum amount of Tier 2 capital which may be recognized for risk-based capital purposes is limited to 100% of Tier 1 capital (after any deductions for disallowed intangibles). The aggregate amount of term subordinated debt and intermediate term preferred stock that may be treated as Tier 2 capital is limited to 50% of Tier 1 capital. Certain other limitations and restrictions also apply. At December 31, 1996, the Tier 2 capital of the thrift consisted of approximately $13.8 million of allowance for possible loan losses. As of December 31, 1997, the thrift's allowance for possible loan losses for Tier 2 capital increased to $17.0 million. (See "Financial Services -- Real Estate Lending.") The following table presents the thrift's risk-based capital position at the dates indicated:
DECEMBER 31, 1997 DECEMBER 31, 1996 -------------------------- --------------------------- PERCENT OF PERCENT OF RISK-WEIGHTED RISK-WEIGHTED AMOUNT ASSETS AMOUNT ASSETS ---------- ------------- ---------- ------------- (THOUSANDS OF DOLLARS, EXCEPT PERCENTS) Tier I capital........................... $ 131,126 9.69% $ 104,521 9.52% Minimum requirement...................... 54,135 4.00 43,898 4.00 ---------- ----- ---------- ----- Excess......................... $ 76,991 5.69% $ 60,623 5.52% ========== ===== ========== ===== Total capital............................ $ 148,106 10.94% $ 118,320 10.78% Minimum requirement...................... 108,269 8.00 87,796 8.00 ---------- ----- ---------- ----- Excess......................... $ 39,837 2.94% $ 30,524 2.78% ========== ===== ========== ===== Risk-weighted assets..................... $1,353,366 $1,097,445 ========== ==========
The FDIC has adopted a 3% minimum leverage ratio which is intended to supplement risk-based capital requirements and to ensure that all financial institutions continue to maintain a minimum level of core capital. A minimum leverage ratio of 3% is required for institutions which have been determined to be the highest of five categories used by regulators to rate financial institutions. All other institutions (including the Company's thrift) will likely be required to maintain leverage ratios of at least 1% to 2% above the 3% minimum. It is improbable, however, that an institution with a 3% core capital-to-total assets ratio would be rated in the highest category since a strong capital position is so closely tied to the rating system. Therefore, the "minimum" leverage ratio is, for all practical purposes, significantly above 3%. The following table presents the thrift's leverage ratio (the ratio of Tier 1 capital to the quarterly average total assets) at the dates indicated:
DECEMBER 31, 1997 DECEMBER 31, 1996 -------------------------- --------------------------- PERCENT OF PERCENT OF AVERAGE TOTAL AVERAGE TOTAL AMOUNT ASSETS AMOUNT ASSETS ---------- ------------- ---------- ------------- (THOUSANDS OF DOLLARS, EXCEPT PERCENTS) Tier I capital........................... $ 131,126 8.29% $ 104,521 8.55% Minimum requirement...................... 47,439 3.00 36,683 3.00 ---------- ---- ---------- ---- Excess......................... $ 83,687 5.29% $ 67,838 5.55% ========== ==== ========== ==== Average total assets for the quarter ended December 31,..................... $1,581,284 $1,222,751 ========== ==========
20 21 The FDIC has designated the Company's thrift as a "well-capitalized" institution under the regulations promulgated under the Federal Deposit Insurance Corporation Improvement Act of 1991. A "well-capitalized" institution has a total risk-based capital ratio of at least 10%, has a Tier 1 risk-based capital ratio of at least 6.0%, has a leverage ratio of at least 5.0% and is not subject to any written agreement, order, capital directive or prompt corrective action directive issued by the FDIC under Section 8 or Section 38 of the Federal Deposit Insurance Act to meet and maintain a specific capital level for any capital measure. The total risk-based capital ratio is the ratio of qualifying total capital to risk-weighted assets and the Tier 1 risk-based capital ratio is the ratio of Tier 1 capital to risk-weighted assets. As a "well-capitalized" institution, the thrift's annual FDIC insurance premiums were 1.3 cents per $100 of eligible domestic deposits in 1997. The insurance premium payable is subject to semi-annual adjustment. The FDIC, by the first day of the month preceding each semi-annual period, is required to notify each insured institution of its assessment risk-classification upon which the insurance premium assessment for the following period will be based. The FDIC has the authority to assess to all insured institutions collectively, additional premiums to cover losses and expenses associated with insuring deposits maintained at financial institutions and for other purposes it deems necessary. Limitations on Dividends. Under California law, a thrift is not permitted to declare dividends on its capital stock unless it has at least $750,000 of unimpaired capital plus additional capital of $50,000 for each branch office maintained. In addition, no distribution of dividends is permitted unless: (i) such distribution would not exceed a thrift's retained earnings; (ii) any payment would result in violation of the approved maximum capital to thrift investment certificate ratio; or (iii) in the alternative, after giving effect to the distribution, the sum of a thrift and loan's qualified assets would be not less than 125% of certain of its liabilities, or with certain exceptions, current assets would be not less than current liabilities. In addition, a thrift and loan is prohibited from paying dividends from that portion of capital which its board of directors has declared restricted for dividend payment purposes. In policy statements, the FDIC has advised insured institutions that the payment of cash dividends in excess of current earnings from operations is inappropriate and may be cause for supervisory action. Under the Financial Institutions Supervisory Act and the Financial Institutions Reform, Recovery and Enforcement Act of 1989, federal regulators also have authority to prohibit financial institutions from engaging in business practices which are considered to be unsafe or unsound. It is possible that, depending upon the financial condition of the Company's thrift and other factors, such regulators could assert that the payment of dividends in some circumstances might constitute unsafe or unsound practices and could prohibit payment of dividends even though technically permissible. The Company's thrift is also subject to federal consumer protection laws, including the Truth In Savings Act, the Truth in Lending Act, the Community Reinvestment Act and the Real Estate Settlement Procedures Act. Commercial Finance The Company's commercial finance subsidiary is licensed by the California Finance Lenders Law by the California Department of Financial Institutions as a commercial finance lender and a personal property broker and holds certain other licenses. Intercompany Transactions The payment of stockholders' dividends and the advancement of loans to the Company by its subsidiaries are and may continue to be subject to certain statutory and regulatory restrictions. EMPLOYEES At December 31, 1997, the Company had 2,843 employees, none of whom is represented by a collective bargaining agreement. The Company believes its relations with employees are good. 21 22 ITEM 2. PROPERTIES Substantially all facilities used by the Company are leased. ITEM 3. LEGAL PROCEEDINGS The Company and its subsidiaries and affiliates are parties to various legal proceedings, which in some instances include claims for punitive damages, all of which are considered routine and incidental to their business. The Company believes that ultimate resolution or settlement of such matters will not have a material adverse effect on its consolidated financial position. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 22 23 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock is traded on the New York Stock Exchange ("NYSE") under the trading symbol "FMT." The following table sets forth the high and low sales prices of the Company's Common Stock adjusted retroactively for a three for two stock split effective January 8, 1996 as reported as composite transactions on the NYSE and the cash dividends declared on the Company's Common Stock during each quarter presented.
DIVIDENDS HIGH LOW DECLARED ---- ---- --------- 1997 1st Quarter......................................... 32 5/8 28 $0.15 2nd Quarter......................................... 40 1/4 26 3/8 0.15 3rd Quarter......................................... 48 1/4 36 3/4 0.15 4th Quarter......................................... 55 5/16 42 5/16 0.15 ===== Total..................................... $0.60 ===== 1996 1st Quarter......................................... 26 1/4 22 5/64 $0.15 2nd Quarter......................................... 25 1/4 21 5/8 0.15 3rd Quarter......................................... 29 5/8 21 1/2 0.15 4th Quarter......................................... 31 1/2 28 1/4 0.15 ----- Total..................................... $0.60 =====
On December 31, 1997, the closing sale price of the Company's Common Stock on the NYSE was $54.75 per share. There were 1,481 stockholders of record as of December 31, 1997. The Company has paid cash dividends in every quarter since its initial public offering in 1977. While the Company intends to continue to pay dividends, the decision to do so is made quarterly by the Board of Directors and is dependent on the earnings of the Company, management's assessment of future capital needs, and other factors. As a holding company, Fremont General's ability to pay dividends to its stockholders is partially dependent on dividends from its subsidiaries. The ability of several of these subsidiaries to distribute dividends is subject to regulation under California law. (See Note K to Consolidated Financial Statements.) 23 24 ITEM 6. SELECTED FINANCIAL DATA
YEAR ENDED DECEMBER 31, ------------------------------------------------------------- 1997(1) 1996 1995(2) 1994 1993 --------- --------- --------- --------- --------- (THOUSANDS OF DOLLARS, EXCEPT PERCENTS AND PER SHARE DATA) INCOME STATEMENT DATA: Property and casualty premiums earned........... $601,183 $486,860 $606,917 $433,584 $455,765 Loan interest................ 194,412 163,765 162,992 113,382 87,244 Net investment income........ 149,729 123,531 119,523 76,821 77,198 Realized investment gains (losses).................. (1,964) (1,658) 1 (315) 2,165 Other revenue................ 30,935 23,306 34,381 29,676 29,033 -------- -------- -------- -------- -------- Total revenues............... $974,295 $795,804 $923,814 $653,148 $651,405 ======== ======== ======== ======== ======== Property and casualty income.................... $144,667 $117,593 $ 83,092 $ 61,265 $ 52,092 Financial services income.... 42,286 36,589 35,737 28,014 21,456 Other interest and corporate expense................... (28,060) (25,873) (18,502) (7,708) (9,200) -------- -------- -------- -------- -------- Income before taxes.......... 158,893 128,309 100,327 81,571 64,348 Income tax expense........... (50,601) (41,021) (32,305) (25,759) (21,638) -------- -------- -------- -------- -------- Net income................... $108,292 $ 87,288 $ 68,022 $ 55,812 $ 42,710 ======== ======== ======== ======== ======== GAAP RATIOS FOR PROPERTY AND CASUALTY SUBSIDIARIES: Loss ratio................... 64.7% 68.9% 76.0% 63.1% 70.0% Expense ratio................ 27.5% 25.9% 24.5% 23.4% 21.3% Policyholder dividends ratio..................... 0.8% -- -- 11.5% 9.9% -------- -------- -------- -------- -------- Combined ratio............... 93.0% 94.8% 100.5% 98.0% 101.2% ======== ======== ======== ======== ======== PER SHARE DATA: Cash dividends declared...... $ 0.60 $ 0.60 $ 0.51 $ 0.45 $ 0.44 Stockholders' equity: Including FASB 115 for 1994 - 1997(3).......... 24.09 19.90 19.62 13.82 N/A Excluding FASB 115 for 1994 - 1997(3).......... 22.56 19.81 18.76 16.40 14.55 Net income: Basic..................... 3.80 3.54 2.68 2.21 1.92 Diluted................... 3.23 2.73 2.18 1.82 1.66 WEIGHTED AVERAGE SHARES USED TO CALCULATE PER SHARE DATA: Basic........................ 28,529 24,658 25,391 25,304 22,274 Diluted...................... 34,293 33,603 33,313 33,031 28,243
24 25
DECEMBER 31, -------------------------------------------------------------- 1997(1) 1996 1995(2) 1994 1993 ---------- ---------- ---------- ---------- ---------- (THOUSANDS OF DOLLARS) BALANCE SHEET DATA: Total assets....................... $6,090,627 $4,307,512 $4,477,399 $3,134,390 $2,669,290 Fixed income and other investments..................... 2,442,813 1,484,310 1,937,890 888,918 1,055,289 Loans receivable................... 1,983,687 1,688,040 1,499,043 1,440,774 846,443 Claims and policy liabilities...... 2,460,550 1,579,325 1,971,719 1,012,704 1,007,054 Short-term debt.................... 26,290 16,896 72,191 176,325 78,087 Long-term debt..................... 691,068 636,456 693,276 468,390 451,581 Trust Originated Preferred Securities(SM)(4)............... 100,000 100,000 -- -- -- Stockholders' equity: Including FASB 115 for 1994 - 1997(3)....................... 832,815 559,117 498,090 351,013 N/A Excluding FASB 115 for 1994 - 1997(3)....................... 779,906 556,488 476,491 416,378 369,369
- --------------- (1) The Company acquired Industrial Indemnity Holdings, Inc. on August 1, 1997. (2) The Company acquired Casualty Insurance Company on February 22, 1995. (3) Effective January 1994, FASB 115 changed the accounting treatment afforded the Company's investment portfolio wherein unrealized gains and losses on securities designated by the Company as available for sale are included net of deferred taxes, as a component of stockholders' equity. (4) Company-obligated mandatorily redeemable preferred securities of subsidiary Trust holding solely Company junior subordinated debentures. 25 26 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD & A") contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. The Company's actual results could differ materially from those projected in these forward-looking statements as a result of certain risks and uncertainties, including those factors set forth in this MD & A section and elsewhere in this Form 10-K including, but not limited to "Item 1. Business." GENERAL Fremont General is a nationwide insurance and financial services holding company operating select businesses in niche markets. Fremont General's insurance business includes one of the largest underwriters of workers' compensation insurance in the nation. The Company's financial services business includes commercial real estate lending, residential real estate lending, commercial finance and insurance premium financing. The Company's reported assets as of December 31, 1997 were $6.1 billion, with 1997 pre-tax earnings of $159 million. The primary operating strategy of the Company is to build upon its core business units through acquisition opportunities and new business development. The Company's secondary strategy is to achieve income balance and geographic diversity among its business units in order to limit the exposure of the Company to industry, market and regional concentrations. The Company's stock is traded on the New York Stock Exchange under the symbol "FMT." The Company began its workers' compensation insurance operations in 1959 and continues to derive the majority of its revenues from this business. The Company's workers' compensation insurance business has grown through internal expansion, as well as through the acquisition of other workers' compensation insurance companies and currently has major market positions in California, Illinois, Arizona, Wisconsin, Idaho and Alaska. At December 31, 1997 the Company had business in thirty-nine states and the District of Columbia. Consistent with its primary strategy, the Company's workers' compensation insurance operations have grown dramatically since 1994 through acquisitions. On August 1, 1997, the Company acquired Industrial Indemnity Holdings, Inc. ("Industrial") from Talegen Holdings, Inc. ("Talegen"), a subsidiary of Xerox Corporation. Industrial, which specializes in underwriting workers' compensation insurance, has a strong presence in the western United States dating back over seventy years. On February 22, 1995, the Company acquired Casualty Insurance Company ("Casualty"), the largest underwriter of workers' compensation insurance in Illinois, with additional operations in several other mid-western states. These acquisitions have provided the Company with a broad national platform upon which to build its workers' compensation insurance business, while providing geographic diversity to mitigate potential fluctuations in earnings from cyclical downturns in various regional economies. (See "Results of Operations -- Property and Casualty Insurance Operations" and Note B of Notes to Consolidated Financial Statements.) 26 27 The Company's balance sheet at December 31, 1997 was significantly impacted by the acquisition of Industrial. The purchase price consisted of $365 million in cash and $9.5 million in acquisition costs bringing the total cost of the acquisition to $374.5 million. Additionally, pursuant to the terms of the acquisition agreement, the Company paid-off a $79 million outstanding debt obligation that Industrial owed to Talegen. The acquisition was treated as a purchase for accounting purposes and five months of Industrial's operating results are included in the Company's results of operations for the year ended December 31, 1997. At the acquisition date, the assets acquired and liabilities assumed are summarized in the following table:
(THOUSANDS OF DOLLARS) ---------------------- Assets acquired: Fixed maturity investments -- at market................... $ 544,054 Short-term investments.................................... 514,233 Premiums receivable and agents' balances.................. 43,796 Reinsurance recoverable on paid and unpaid losses......... 148,331 Deferred income taxes..................................... 127,421 Costs in excess of net assets acquired.................... 77,608 Other assets, including cash, accrued investment income, deferred policy acquisition costs and trade name....... 287,475 ---------- $1,742,918 ========== Liabilities assumed: Losses and loss adjustment expenses....................... $1,144,701 Other policy liabilities.................................. (10,768) Long-term debt............................................ 78,750 Other liabilities......................................... 165,235 ---------- Total liabilities assumed.............................. 1,377,918 ---------- Net Purchase Price.......................................... $ 365,000 ==========
Allocation of the purchase price is subject to valuations and other studies which are not yet complete. Accordingly, the final allocation of the purchase price may be different from the amounts summarized in the preceding table. The Company's financial services operations, which are comprised primarily of the results of Fremont General Credit Corporation ("FGCC"), have grown significantly and are engaged primarily in commercial and residential real estate lending, mainly in California; commercial finance lending, principally to small and middle market companies nationwide; and insurance premium financing, primarily in California. The Company's financial services loan portfolio has grown significantly from $712 million at December 31, 1992 to $2.03 billion at December 31, 1997. (See "Financial Services Operations.") The Company's real estate lending operations, which began in 1990 through the acquisition of a California thrift, currently consists of more than 3,300 residential real estate accounts, 500 commercial real estate accounts, 13,300 insurance premium finance accounts and 42,000 deposit accounts serviced through 13 branch offices in California. The thrift operations are primarily engaged in commercial and residential real estate lending. For commercial real estate loans, principal amounts primarily range between $1 million to $8 million and for residential real estate loans, principal amounts are generally below $300,000. Additionally, insurance premium financing is provided and is collateralized by security interests in return premiums. The Company's operating strategy is to grow its loan portfolio through origination of new loans and acquisition of loan portfolios that meet its underwriting guidelines applied to origination of new loans. The loan portfolio of the real estate lending operation grew from $376 million at the end of 1992 to $1.5 billion at the end of 1997, due to increased loan originations and to the purchase of loan portfolios from other financial institutions. (See "Item 1. Business -- Financial Services Operations -- Real Estate Lending.") 27 28 The Company's commercial finance operation provides working capital loans, primarily secured by accounts receivable, inventory and machinery and equipment, to small and middle market companies on a nationwide basis. The total commercial finance loan portfolio grew from $282 million at December 31, 1992 to $547 million at December 31, 1997. This growth has been achieved primarily through development of the customer base through loan originations and through participation in syndicated loan transactions. (See "Item 1. Business -- Financial Service Operations -- Commercial Finance.") The lending market continues to be competitive for small to middle market commercial borrowers. As a result, the commercial finance operation has experienced decreasing yields on its commercial finance loans. The ability of the Company to continue to originate loans, and of borrowers to repay outstanding loans, may be impaired by adverse changes in local or regional economic conditions which affect such areas or by adverse changes in the real estate market in those areas. Such events could also significantly impair the value of the underlying collateral. If the Company's collateral were to prove inadequate, the Company's results of operations could be adversely affected. By engaging in several selected businesses which are geographically diverse the Company believes it can achieve greater stability in its operating results. Since the year ended December 31, 1993 to the year ended December 31, 1997, the Company's income before taxes grew at a compound annual rate of approximately 25% to $159 million for 1997. The Company's book value increased from $272 million at December 31, 1992 to $833 million at December 31, 1997. Between 1986 and 1991, the Company discontinued its domestic treaty reinsurance business, its other primary and excess property and casualty insurance operations and the underwriting of all remaining assumed reinsurance. In 1990, a single management group was put in charge of all discontinued operations, and it is the intention of the Company to complete the liquidation of these operations by the commutation of liabilities and as claims are paid. (See "Item 1. Business -- Discontinued Operations" and Note N of Notes to Consolidated Financial Statements.) RESULTS OF OPERATIONS The Company has achieved growth in net income during the three years ended December 31, 1997 by providing diverse insurance and financial services to primarily small and medium-sized businesses. Higher revenues and net income were also achieved through the acquisition of Industrial and Casualty. The following table presents information for each of the three years in the period ended December 31, 1997 with respect to the Company's core business segments.
YEAR ENDED DECEMBER 31, ------------------------------ 1997 1996 1995 -------- -------- -------- (THOUSANDS OF DOLLARS) Revenues: Property and casualty............................. $738,072 $596,841 $708,187 Financial services................................ 235,474 197,601 214,975 Corporate......................................... 749 1,362 652 -------- -------- -------- Total..................................... $974,295 $795,804 $923,814 ======== ======== ======== Income (Loss) Before Taxes: Property and casualty............................. $144,667 $117,593 $ 83,092 Financial services................................ 42,286 36,589 35,737 Corporate......................................... (28,060) (25,873) (18,502) -------- -------- -------- Total..................................... $158,893 $128,309 $100,327 ======== ======== ========
The Company generated revenues of $974 million for 1997, as compared to revenues of $796 million and $924 million for 1996 and 1995, respectively. The acquisition of Industrial resulted in higher revenues in the property and casualty insurance segment in 1997 as compared to 1996. (See "Property and Casualty 28 29 Insurance Operations.") Higher revenues in the financial services segment in 1997 were achieved primarily from increased loan interest revenues which resulted from significant growth in the average loan portfolios of the combined real estate lending and commercial finance operations. (See "Financial Services Operations.") Revenues were lower in 1996 as compared to 1995, due principally to lower workers' compensation insurance premiums in the property and casualty insurance segment and lower life insurance revenues in the financial services segment. The lower workers' compensation insurance premiums were due primarily to lower premiums earned in California and to a lesser extent lower premiums earned in Illinois. The lower life insurance revenues in the financial services segment were due to certain reinsurance and assumption agreements with a reinsurer which became effective December 31, 1995 and January 1, 1996 and resulted in the substantial reduction of the Company's life insurance operations. Realized investment gains (losses) were $(1,964,000), $(1,658,000), and $1,000 for 1997, 1996 and 1995, respectively. Up until January 1, 1998 the Company maintained a small medical malpractice insurance operation within the property and casualty insurance segment. On January 1, 1998, the Company entered into reinsurance and assumption agreements with a reinsurer whereby substantially all of the assets and liabilities related to the medical malpractice policies were ceded to the reinsurer. These reinsurance agreements are part of several other agreements which collectively result in the sale of the Company's medical malpractice operations effective January 1, 1998. The effect on the Company's results of operations from these agreements was not material. Revenues from medical malpractice operations were $32.6 million, $31.6 million and $34.3 million for 1997, 1996 and 1995, respectively. The Company had net income of $108.3 million or $3.23 diluted earnings per share for 1997, as compared to $87.3 million or $2.73 diluted earnings per share and $68.0 million or $2.18 diluted earnings per share for 1996 and 1995, respectively. Income before taxes for 1997 was $158.9 million as compared to $128.3 million and $100.3 million for 1996 and 1995, respectively. The property and casualty insurance operations, consisting primarily of workers' compensation insurance, posted income before taxes of $144.7 million for 1997, as compared to $117.6 million and $83.1 million for 1996 and 1995, respectively. The increase of 23% in income before taxes in 1997 as compared to 1996 is due primarily to the recognition of continued lower claim frequency, mainly in the mid-west region and the acquisition of Industrial. The increase in income before taxes of 41% in 1996 as compared to 1995 was due predominately to lower claim frequency and the acquisition of Casualty, offset partially by lower income on the Company's California business. The combined ratio for 1997 was 93.0% compared to 94.8% and 100.5% for 1996 and 1995, respectively. The financial services business segment posted increases of 16% and 2% in income before taxes for 1997 and 1996, respectively. The increase in 1997 is due mainly to the general growth in the average loan portfolio to $1.9 billion in 1997 from $1.6 billion in 1996, as well as to continued improvements in the Company's loan charge-off experience. (See "Financial Services Operations.") Although income before taxes was relatively flat in 1996 as compared to 1995, the results in 1996 were negatively impacted by the establishment of a specific loan loss associated with one loan in the commercial finance loan portfolio. Also impacting the financial services segment in 1996 was the substantial elimination of the Company's life insurance operations resulting from certain reinsurance and assumption agreements entered into between the Company and a reinsurer which became effective December 31, 1995 and January 1, 1996. This segment, which consists principally of real estate lending, commercial finance and insurance premium finance, recorded income before taxes of $42.3 million, $36.6 million and $35.7 million for 1997, 1996 and 1995, respectively. Corporate revenues consisted primarily of investment income, while corporate expenses consisted primarily of interest expense and general and administrative expense. The corporate loss before income taxes was $28.1 million, $25.9 million and $18.5 million for 1997, 1996 and 1995, respectively. The increase in the corporate loss before taxes in 1997 as compared to 1996 was due mainly to lower investment income and higher administrative expenses. The increase in the corporate loss before taxes in 1996 as compared to 1995 was due principally to increased interest expense and increased administrative expenses. The increase in interest expense is mainly due to additional debt incurred in the acquisition of Casualty, as well as to accrued dividends in connection with a public offering on March 1, 1996 of $100 million of 9% Trust Originated 29 30 Preferred Securities(SM) (the "Preferred Securities") sold by a consolidated wholly-owned subsidiary of the Company. (See "Liquidity and Capital Resources.") The accrued dividends on the Preferred Securities have been classified in the Consolidated Statements of Income as interest expense. (See Note J of Notes to Consolidated Financial Statements.) Income tax expense of $50.6 million, $41.0 million and $32.3 million for 1997, 1996 and 1995, respectively, represents an effective tax rate of 32% each year on pretax income of $158.9 million, $128.3 million and $100.3 million for the corresponding periods. The Company's effective tax rates for all years presented are lower than the enacted federal income tax rate of 35%, due primarily to tax exempt investment income which reduces the Company's taxable income. Property and Casualty Insurance Operations The following table represents information with respect to the Company's property and casualty insurance operations:
YEAR ENDED DECEMBER 31, ------------------------------ 1997 1996 1995 -------- -------- -------- (THOUSANDS OF DOLLARS) Revenues............................................ $738,072 $596,841 $708,187 Expenses............................................ 593,405 479,248 625,095 -------- -------- -------- Income Before Taxes................................. $144,667 $117,593 $ 83,092 ======== ======== ========
Revenues from the property and casualty insurance operations consist primarily of workers' compensation insurance premiums earned and net investment income. Expenses consist primarily of loss and loss adjustment expenses, policy acquisition costs and other operating costs and expenses. Premiums. Premiums earned from the Company's property and casualty insurance operations were $601.2 million for 1997, as compared to $486.9 million and $606.9 million for 1996 and 1995, respectively. The higher premiums in 1997 were due primarily to the acquisition of Industrial. With this acquisition, the Company has broadened the geographic diversity of its premium writings. Using the Company's estimated annual premiums on policies in effect at December 31, 1997 (referred to as "inforce premium"), the percentage of the Company's inforce premium in California and Illinois totaled 61%, down from 75% at December 31, 1996. Premiums were significantly lower in 1996 as compared to 1995, due primarily to lower premiums earned in California and to a lesser extent lower premiums earned in Illinois. The lower premiums in California were due primarily to the increased price competition resulting from California's adoption of an open rating system effective January 1, 1995. The Company has recently observed a moderation of price competition in California. In the fourth quarter of 1997, the Company also observed some moderation of price competition in Illinois where competitive pressures also resulted in lower premiums in 1996. (See "Item 1. Business -- Property and Casualty Insurance Operations -- Workers' Compensation Insurance" and "Variability of Operating Results" and "Workers' Compensation Regulation.") The Industrial acquisition has also afforded the Company a significant presence in the western United States, in addition to California. These western states, excluding California, have collectively exhibited relatively stable competitive environments. On January 1, 1998, the Company purchased additional excess of loss reinsurance for its workers' compensation insurance business in an effort to further reduce the volatility of operating results which occurs through fluctuations in loss costs. The additional reinsurance reduces the point at which reinsurers assume liability from $1 million per occurrence to $100,000 per occurrence. (See "Item 1. Business -- Property and Casualty Insurance Operations -- Reinsurance Ceded.") The impact of this additional reinsurance will be lower premiums earned and lower loss and loss adjustment expenses. Net Investment Income. Net investment income within the property and casualty insurance operations was $138.9 million, $111.6 million and $101.3 million in 1997, 1996 and 1995, respectively. Significantly higher invested assets, due primarily to the acquisition of Industrial, resulted in increased investment income in 1997 as compared to 1996. (See "Item 1. Business -- Investment Portfolio.") 30 31 Loss and Loss Adjustment Expense. The property and casualty loss and loss adjustment expenses ("LAE") were $389.2 million, $335.4 million and $461.3 million in 1997, 1996 and 1995, respectively. In addition, the ratio of these losses and LAE to property and casualty insurance premiums earned ("loss ratio") was 64.7%, 68.9% and 76.0% in 1997, 1996 and 1995, respectively. The decrease in the loss ratio in 1997 is due mainly to the recognition of a decrease in the frequency of reported claims on the 1996 and 1995 accident years in the Company's mid-west region, offset partially by higher loss ratios associated with Industrial on the 1997 accident year. Additionally, the Company's management believes that its implementation of more effective claims handling procedures in the mid-west region has contributed to the reduction in loss and loss adjustment expenses during calendar year 1997 and relating to the 1996 and prior accident years. The decrease in the loss ratio in 1996 as compared to 1995 was due principally to the recognition of lower claim frequency and severity in the Company's mid-west region. The Company is not able to determine with certainty the specific cause or causes of increases and decreases in reported claims experience, but has reached its own conclusions based on a review of its internal data base and a subjective evaluation of external factors. (See "Item 1. Business -- Property and Casualty Insurance Operations -- Loss and Loss Adjustment Expense Reserves.") The Company regularly reviews its reserving techniques, overall reserve position and reinsurance. In light of present facts and current legal interpretations, management believes that adequate provisions have been made for loss reserves. In making this determination, management has considered its claims experience to date, loss development history for prior accident years and estimates of future trends of claims frequency and severity. However, establishment of appropriate reserves is an inherently uncertain process, and there can be no certainty that currently established reserves will prove adequate in light of subsequent actual experience. Subsequent actual experience has resulted, and could result, in loss reserves being too high or too low. Future loss development could require reserves for prior periods to be increased, which would adversely impact earnings in future periods. Policy Acquisition Costs and Other Operating Costs and Expenses. The ratio of policy acquisition costs and other operating costs and expenses to premiums earned is referred to as the expense ratio, which was 27.5%, 25.9% and 24.5% in 1997, 1996 and 1995, respectively. The increase in this ratio in 1997 is due primarily to higher agents' commission costs and higher operating costs and expenses. The increase in this ratio in 1996, as compared to 1995, was due primarily to higher operating costs and expenses, partially offset by lower agents' commission costs. Dividends to Policyholders. The policyholder dividends ratio for the Company's property and casualty insurance operations was 0.8% in 1997 and there were no dividends accrued in 1996 or 1995. The Company believes that these ratios are low by industry standards. The low ratios are due primarily to the type of workers' compensation insurance policies written by the Company. The Company's workers' compensation insurance policies are predominately written as non-participating, which means that they do not include provisions for dividend consideration. The dividends accrued in 1997 were due mainly to the acquisition of Industrial. (See "Item 1. Business -- Property and Casualty Insurance Operations -- Policyholders' Dividends.") Variability of Operating Results. The Company's profitability can be affected significantly by many factors including competition, the severity and frequency of claims, interest rates, regulations, court decisions, the judicial climate, and general economic conditions and trends, all of which are outside of the Company's control. These factors have contributed, and in the future could contribute, to significant variation of results of operations in different aspects of the Company's business from quarter to quarter and year to year. With respect to the workers' compensation insurance business, changes in economic conditions can lead to reduced premium levels due to lower payrolls as well as increased claims due to the tendency of workers who are laid off to submit workers' compensation claims. Legislative and regulatory changes can also contribute to variable operating results for workers' compensation insurance businesses. For example, in 1995, the Company experienced the negative impact of lower premiums and lower profitability on the Company's California workers' compensation business due to increased price competition resulting from legislation enacted in California in July 1993 which, among other things, repealed the minimum rate law effective January 1, 1995. Additionally, price competition in Illinois, where the Company has a significant presence, continues to adversely impact the Company's profitability, where overall average decreases of 7.9%, 10.0% and 13.6% in 31 32 advisory premium rates, which workers' compensation insurance companies in Illinois tend to follow, became effective January 1, 1998, 1997 and 1996, respectively. (See "Workers' Compensation Regulation.") The acquisition of Industrial may mitigate the adverse effects of this price competition in Illinois by providing the Company with a broader geographic diversity of its premium writings. The Company anticipates that its results of operations and financial condition will continue to be adversely affected by the increased price competition in Illinois. Also, the establishment of appropriate reserves necessarily involves estimates, and reserve adjustments have caused significant fluctuations in operating results from year to year. Workers' Compensation Regulation. At December 31, 1997, approximately 61% of the Company's inforce premiums were in California and Illinois. Illinois began operating under an open rating system in 1982 and California began operating under such a system effective January 1, 1995. In an open rating system, workers' compensation companies are provided with advisory premium rates by job classification and each insurance company determines its own rates based in part upon its particular operating and loss costs. Although insurance companies are not required to adopt such advisory premium rates, companies in Illinois generally follow such rates. This characteristic has resulted in increased price competition in Illinois, where overall average decreases in advisory premium rates of 7.9%, 10.0% and 13.6% became effective January 1, 1998, 1997 and 1996, respectively. In contrast, insurance companies in California have, since the adoption of an open rating system, generally set their premium rates below such advisory premium rates. Before January 1, 1995, California operated under a minimum rate law, whereby premium rates established by the California Department of Insurance were the minimum rates which could be charged by an insurance carrier. Most of the states in which the Company writes premiums operate under some form of open rating system. In July 1993, California enacted legislation to reform the workers' compensation insurance system and to, among other things, repeal the minimum rate law effective January 1, 1995. This repeal resulted in lower premiums and lower profitability in the Company's California workers' compensation insurance business due to increased price competition. The Company's acquisition of Casualty, with policies written primarily outside of California, lessened the impact of these legislative changes in California by increasing the geographic diversity of the Company's workers' compensation business, which tends to mitigate the impact of economic and regulatory changes within a regional marketplace. The Company further broadened its geographic diversity in 1997 with the acquisition of Industrial, whose premium writings were spread across several western states, including California. (See "Item 1. Business -- Regulation -- Insurance Regulation.") Financial Services Operations The financial services operations of FGCC are principally engaged in commercial and residential real estate lending, commercial finance and insurance premium financing. The Company also has small life insurance operations included in this segment which were substantially reduced in 1996. Revenues consist principally of interest income and, to a lesser extent, life insurance premiums, fees and other income. The following table presents information with respect to the Company's financial services operations:
YEAR ENDED DECEMBER 31, ------------------------------ 1997 1996 1995 -------- -------- -------- (THOUSANDS OF DOLLARS) Revenues............................................ $235,474 $197,601 $214,975 Expenses............................................ 193,188 161,012 179,238 -------- -------- -------- Income Before Taxes................................. $ 42,286 $ 36,589 $ 35,737 ======== ======== ========
Revenues increased 19% in 1997 due primarily to greater loan interest revenue attributable to the growth in the average loan portfolio of the commercial and residential real estate lending operations. Revenues decreased 8% in 1996 as compared to 1995, due primarily to lower life insurance revenues. Effective January 1, 1996, the Company substantially reduced its life insurance operations through certain reinsurance and assumption agreements entered into between the Company and a reinsurer. The effect on income before taxes and net income from these reinsurance agreements was not material. (See Note F of Notes to 32 33 Consolidated Financial Statements.) The average loan portfolio grew in 1997 to $1.9 billion from $1.6 billion and $1.5 billion in 1996 and 1995, respectively. Income before taxes in the financial services operations was $42.3 million, $36.6 million and $35.7 million for 1997, 1996 and 1995, respectively. The 16% increase in income before taxes in 1997 is mainly due to higher income before taxes in the real estate lending operation. Contributing to this higher income before taxes were higher loan interest revenue due to a greater average real estate loan portfolio and a lower loan loss provision relative to loans receivable, which resulted from improved loan loss experience. These conditions were partially offset by an increase in the cost of funds and increases in operating expenses. Income before taxes was relatively flat in the financial services segment for 1996 as compared to 1995, which was due to higher income before taxes in the real estate lending operation as lower loan loss experience resulted in a lower provision for loan losses. Substantially offsetting this was lower income in the commercial finance operation due primarily to a specific loan loss associated with one loan in the commercial finance loan portfolio. Additionally, lower income was earned in the life insurance operation due to certain reinsurance and assumption agreements which became effective on December 31, 1995 and January 1, 1996 and which resulted in a substantial reduction in the Company's life insurance operations in 1996. The following table identifies the interest income, interest expense, average interest-bearing assets and liabilities, and interest margins for the Company's financial services operations:
YEAR ENDED DECEMBER 31, ------------------------------------------------------------------------------------------------ 1997 1996 1995 ------------------------------ ------------------------------ ------------------------------ AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/ BALANCE INTEREST COST BALANCE INTEREST COST BALANCE INTEREST COST ---------- -------- ------ ---------- -------- ------ ---------- -------- ------ (THOUSANDS OF DOLLARS, EXCEPT PERCENTS) Interest bearing assets(1): Commercial finance and other assets..................... $ 596,230 $ 64,211 10.77% $ 606,836 $ 66,099 10.89% $ 589,285 $ 69,919 11.87% Thrift and loan: Cash equivalents........... 103,228 5,571 5.40 142,533 7,431 5.21 105,470 5,883 5.58 Investments................ 65,893 3,808 5.78 33,559 1,902 5.67 1,053 33 3.13 Commercial real estate loans.................... 954,181 93,973 9.85 749,912 72,732 9.70 683,331 67,952 9.94 Residential real estate loans.................... 321,007 30,707 9.57 209,802 20,151 9.60 133,761 12,843 9.60 Insurance premium financing and other thrift loans... 55,230 6,328 11.46 53,209 5,988 11.25 38,256 4,513 11.80 ---------- -------- ---------- -------- ---------- -------- Total interest bearing assets..................... $2,095,769 $204,598 9.76% $1,795,851 $174,303 9.71% $1,551,156 $161,143 10.39% ========== ======== ========== ======== ========== ======== Interest bearing liabilities: Savings deposits............. $ 268,344 $ 13,610 5.07% $ 247,648 $ 12,268 4.95% $ 136,588 $ 7,279 5.33% Time deposits................ 1,030,787 60,055 5.83 755,160 43,351 5.74 664,397 40,072 6.03 Commercial paper and other... 5,325 312 5.86 3,353 189 5.64 15,873 1,189 7.49 Securitization obligation.... 301,545 18,551 6.15 295,827 18,035 6.10 321,667 21,200 6.59 Debt with banks.............. 216,869 14,406 6.64 243,292 12,864 5.29 174,816 12,308 7.04 Debt from affiliates......... 49,735 2,810 5.65 57,174 5,637 9.86 49,369 2,388 4.84 ---------- -------- ---------- -------- ---------- -------- Total interest bearing liabilities................ $1,872,605 $109,744 5.86% $1,602,454 $ 92,344 5.76% $1,362,710 $ 84,436 6.20% ========== ======== ========== ======== ========== ======== Net interest income............ $ 94,854 $ 81,959 $ 76,707 ======== ======== ======== Net yield...................... 4.53% 4.56% 4.95%
- --------------- (1) Average loan balances include non-accrual loan balances. The margin between the Company's interest income and expense decreased slightly in 1997 due to a decrease in the yields in the commercial finance segment as increases in the credit quality of the commercial finance portfolio and continued competition resulted in lower yields. Partially offsetting this was a slight increase in the net margins in the real estate lending operation, due primarily to an increase in the yields on commercial real estate loans, which was offset partially by lower yields on the residential real estate loans. The 33 34 net margins decreased in 1996 as compared to 1995, due primarily to an increase in lower yielding cash equivalents in the real estate lending operation and a decrease in the yields in the commercial finance operation resulting primarily from increased competition. Loans Receivable and Reserve Activity. The following table shows loans receivable in the various financing categories and the percentages of the total represented by each category:
DECEMBER 31, ------------------------------------------------------------ 1997 1996 1995 ------------------ ------------------ ------------------ % OF % OF % OF AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL ---------- ----- ---------- ----- ---------- ----- (THOUSANDS OF DOLLARS, EXCEPT PERCENTS) Accounts receivable and inventory loans: Commercial finance........................................ $ 389,252 19% $ 385,734 22% $ 415,038 27% Term loans: Thrift and loan........................................... 1,480,824 73 1,167,611 68 931,822 61 Commercial finance and other loans........................ 158,013 8 172,442 10 183,964 12 ---------- --- ---------- --- ---------- --- Total term loans........................................ 1,638,837 81 1,340,053 78 1,115,786 73 ---------- --- ---------- --- ---------- --- 2,028,089 100 1,725,787 100 1,530,824 100 Less allowance for possible loan losses..................... 44,402 2 37,747 2 31,781 2 ---------- --- ---------- --- ---------- --- Loans receivable.......................................... $1,983,687 98% $1,688,040 98% $1,499,043 98% ========== === ========== === ========== ===
The following table illustrates the maturities of the Company's loans receivable:
MATURITIES AT DECEMBER 31, 1997 ------------------------------------------- 1 TO 24 25-60 OVER 60 MONTHS MONTHS MONTHS TOTAL -------- -------- -------- ---------- (THOUSANDS OF DOLLARS) Accounts receivable and inventory loans -- variable rate...................... $389,252 $ -- $ -- $ 389,252 Term loans -- variable rate............. 264,097 619,827 525,568 1,409,492 Term loans -- fixed rate................ 110,471 59,737 59,137 229,345 -------- -------- -------- ---------- Total................................. $763,820 $679,564 $584,705 $2,028,089 ======== ======== ======== ==========
The Company monitors the relationship of fixed and variable rate loans and interest bearing liabilities in order to minimize interest rate risk. During 1997, the Company began originating both commercial and residential real estate loans outside of California. The Company intends to seek portfolio growth outside of California in order to achieve greater geographic diversity in its loan portfolio and thereby lessen the Company's exposure to regional economic conditions. The total amount of commercial and residential real estate loans outstanding on properties located outside of California at December 31, 1997 was $44 million and $58 million, respectively. Adverse economic developments can negatively affect the Company's financial services business and results of operations in a number of ways. Such developments can reduce the demand for loans, impair the ability of borrowers to pay loans and impair the value of the underlying collateral. 34 35 The following table describes the asset classifications, loss experience and reserve reconciliation of the financial services operations as of or for the periods ended as shown below:
DECEMBER 31, ------------------------------------ 1997 1996 1995 ---------- ---------- ---------- (THOUSANDS OF DOLLARS, EXCEPT PERCENTS) Non-accrual loans....................................... $ 31,525 $ 19,785 $ 33,467 Accrual loans 90 days past due.......................... 927 1,355 3,025 REO..................................................... 9,571 10,016 4,941 ---------- ---------- ---------- Total non-performing assets............................. $ 42,023 $ 31,156 $ 41,433 ========== ========== ========== Beginning allowance for possible loan losses............ $ 37,747 $ 31,781 $ 27,406 Provision for loan losses............................... 12,319 13,885 14,575 Reserves established with portfolio acquisitions........ -- 1,830 -- Charge-offs: Commercial finance and other loans.................... 3,384 6,106 2,373 Thrift and loan: Commercial real estate............................. 1,484 4,244 9,248 Residential real estate loans...................... 1,266 624 1,012 Insurance premium financing and other thrift loans............................................ 824 169 528 ---------- ---------- ---------- Total charge-offs..................................... 6,958 11,143 13,161 ---------- ---------- ---------- Recoveries: Commercial finance and other loans.................... 12 20 513 Thrift and loan: Commercial real estate............................. 469 862 37 Residential real estate loans...................... 642 186 1,659 Insurance premium financing and other thrift loans............................................ 171 326 752 ---------- ---------- ---------- Total recoveries...................................... 1,294 1,394 2,961 ---------- ---------- ---------- Net charge-offs......................................... 5,664 9,749 10,200 ---------- ---------- ---------- Ending allowance for possible loans losses.............. $ 44,402 $ 37,747 $ 31,781 ========== ========== ========== Allocation of allowance for possible loans losses: Commercial finance and other loans.................... $ 11,061 $ 11,933 $ 13,259 Thrift and loan....................................... 33,341 25,814 18,522 ---------- ---------- ---------- Total allowance for possible loan losses.............. $ 44,402 $ 37,747 $ 31,781 ========== ========== ========== Total loans receivable.................................. $2,028,089 $1,725,787 $1,530,824 Average total loans receivable.......................... 1,906,448 1,594,918 1,505,779 Net charge-offs to average total loans receivable....... 0.30% 0.61% 0.68% Non-performing assets to total loans receivable......... 2.07% 1.81% 2.71% Allowance for possible loan losses to total loans receivable............................................ 2.19% 2.19% 2.08% Allowance for possible loan losses to non-performing assets................................................ 105.66% 121.15% 76.70% Allowance for possible loan losses to non-accrual loans and accrual loans 90 days past due.................... 136.82% 178.56% 87.09%
Non-performing assets increased to $42.0 million at December 31, 1997 from $31.2 million at December 31, 1996. Overall, these increases are generally consistent with the significant increase in total loans receivable to $2.03 billion at December 31, 1997 from $1.73 billion at December 31, 1996. In 1996, non-performing assets decreased to $31.2 million at December 31, 1996 from $41.4 million at December 31, 1995. This decrease is due primarily to decreases in non-accrual loans in the real estate lending and commercial 35 36 finance operations, offset partially by an increase in real estate owned ("REO") in the real estate lending operation. The decrease in non-accrual loans in the commercial finance lending operation is primarily due to one loan in the commercial finance portfolio classified as non-accrual at December 31, 1995 and subsequently charged-off in 1996. The lower provision for loan losses over the three years ended December 31, 1997 are due primarily to improved loan loss experience in the real estate lending operation. Additionally, a lower loan loss provision occurred in the commercial finance operation in 1997 as the Company was adversely impacted in 1996 by a specific loan loss provision associated with one loan in the commercial finance loan portfolio. Substantially all of the charge-offs in the commercial finance operation in 1996 were related to this loan. The Company's overall improved loan loss experience is evidenced by the decreases in the ratio of net charge-offs to average total loans receivable over the three years ended December 31, 1997, as well as the relative stability of the ratio of non-performing assets to total loans receivable in the preceding table. The reductions in the charge-off ratio occurred during a period in which loans receivable increased. MARKET RISK The Company is subject to market risk resulting primarily from fluctuations in interest rates arising from balance sheet financial instruments such as investments, loans and debt. In the property and casualty insurance operations, the greatest interest rate risk exposure occurs where the interest rate of the financial instrument is fixed in nature and there is a difference between the fixed rate of the financial instrument and the market rate. The greatest interest rate risk exposure in the financial services operations occurs when interest rate gaps arise wherein assets are funded with liabilities having different repricing intervals or different market indices to which the instruments' interest rates are tied. Changes in interest rates will affect the Company's net investment income, loan interest, interest expense and total stockholders' equity. The objective of the Company's asset and liability management activities is to provide the highest level of net interest income and to seek cost effective sources of capital, while maintaining acceptable levels of interest rate and liquidity risk. The Company has designated its entire investment portfolio as investments that would be available for sale in response to changing market conditions, liquidity requirements, interest rate movements and other investment factors. (See "Item 1. Business -- Investment Portfolio.") The Company currently owns no derivative financial instruments and, consequently, is not subject to market risk for such off-balance sheet financial instruments. Furthermore, the Company does not have exposure to foreign currency or commodity price risk. PROPERTY AND CASUALTY INSURANCE OPERATIONS -- INTEREST RATE RISK The property and casualty insurance operations have exposure to changes in long-term interest rates due mainly to the significant investment in the available-for-sale investment portfolio. Fluctuations in these interest rates affect the carrying value of the fixed rate investments resulting in fluctuations in unrealized gains and losses on investments, which also affects the Company's stockholders' equity. For an investment in a fixed rate bond, a rise in market interest rates for bonds with a similar remaining term and face amount will result in a decline in the fair value of the fixed rate bond. The converse situation applies as well. 36 37 The following table presents principal cash flows of the investment portfolio by expected maturity dates. The weighted-average interest rate is based on expected maturities for fixed interest rate investments. For variable interest rate investments, the weighted-average interest rate is based on implied forward rates from appropriate annual spot rate observations as of the reporting date. PROPERTY AND CASUALTY INSURANCE OPERATIONS INTEREST RATE SENSITIVITY
PRINCIPAL AMOUNT MATURING IN: --------------------------------------------------------------------------- FAIR VALUE 1998 1999 2000 2001 2002 THEREAFTER TOTAL AT 12/31/97 -------- -------- ------- ------- ------- ---------- ---------- ----------- (THOUSANDS OF DOLLARS) Rate sensitive assets: Securities available for sale: Fixed interest rate investments................... $310,392 $145,861 $28,890 $14,587 $12,556 $1,438,348 $1,950,634 $1,997,902 Average interest rate......... 7.49% 7.48% 7.51% 11.03% 6.57% 7.54% 7.55% Variable interest rate investments................... $ 10,735 $ 803 $ 871 $20,944 $ 1,024 $ 159,440 $ 193,817 $ 193,337 Average interest rate......... 6.95% 8.00% 8.00% 6.48% 8.00% 6.15% 6.26%
FINANCIAL SERVICES OPERATIONS -- INTEREST RATE RISK The Company's financial services operations are subject to interest rate risk resulting from differences between the rates on, and repricing characteristics of, interest-earning real estate and commercial finance loans and the rates on, and repricing characteristics of, interest-bearing liabilities such as thrift deposits and debt. Interest rate gaps may arise when assets are funded with liabilities having different repricing intervals or different market indices to which the instruments' interest rate is tied and to this degree earnings will be sensitive to interest rate changes. Additionally, interest rate gaps could develop between the market rate and the interest rate on loans in the Company's loan portfolio, which could result in borrowers' prepaying their loan obligations to the Company. While the Company attempts to match the characteristics of interest rate sensitive assets and liabilities to minimize the effect of fluctuations in interest rates, the Company does not currently utilize derivative financial instruments to meet these objectives. For the financial services operations, the expected maturity date does not necessarily reflect the net market risk exposure because certain instruments are subject to interest rate changes before expected maturity. 37 38 The following table provides information about the assets and liabilities of the Company's financial services operations that are sensitive to changes in interest rates. For loans, investments, thrift deposits and other liabilities with contractual maturities, the table presents principal cash flows and related weighted-average interest rates by contractual maturity, adjusted for estimated loan prepayments based upon historical behaviors of its loan portfolio. Thrift deposits that have no contractual maturity are presented as maturing in 1998. FINANCIAL SERVICES OPERATIONS INTEREST RATE SENSITIVITY
PRINCIPAL AMOUNT MATURING IN: ------------------------------------------------------------------------------- FAIR VALUE AT 1998 1999 2000 2001 2002 THEREAFTER TOTAL DECEMBER 31, 1997 ---------- -------- -------- -------- ------- ---------- ---------- ----------------- (THOUSANDS OF DOLLARS) Rate sensitive assets: Commercial finance and other assets: Variable interest rate loans and other assets.............. $ 508,571 -- -- -- -- $38,694 $ 547,265 $ 547,265 Average interest rate.............. 13.62% -- -- -- -- 7.57% 13.19% Fixed interest rate securities.......... $ 27,645 -- -- -- -- -- $ 27,645 $ 27,645 Average interest rate.............. 5.59% -- -- -- -- -- 5.59% Thrift and loan: Fixed interest rate real estate loans... $ 63,312 $ 43,177 $ 21,613 $ 15,287 $ 7,663 $19,801 $ 170,853 $ 173,325 Average interest rate.............. 10.48% 9.82% 9.90% 9.91% 10.01% 10.06% 10.12% Variable interest rate real estate loans... $ 415,622 $377,675 $195,133 $145,095 $88,226 $38,735 $1,260,486 $1,282,713 Average interest rate.............. 9.72% 9.31% 9.82% 9.75% 9.69% 9.84% 9.62% Fixed interest rate securities.......... -- $ 15,000 $ 45,000 -- -- -- $ 60,000 $ 60,000 Average interest rate.............. -- 5.64% 5.64% -- -- -- 5.64% Variable interest rate securities.......... $ 44,903 $ 1,500 $ 1,500 $ 1,500 $ 1,500 $32,473 $ 83,376 $ 83,376 Average interest rate.............. 6.48% 5.48% 5.48% 5.48% 5.48% 5.48% 6.02% Other interest-bearing assets.............. $ 76,031 $ 331 $ 214 $ 194 $ 175 $ 1,269 $ 78,214 $ 78,214 Average interest rate.............. 9.60% 13.24% 13.29% 13.34% 13.42% 13.86% 9.71% Rate sensitive liabilities: Variable interest rate thrift deposits....... $ 306,174 -- -- -- -- -- $ 306,174 $ 306,174 Average interest rate................ 5.20% -- -- -- -- -- 5.20% Fixed interest rate thrift deposits....... $1,050,303 $116,695 $ 12,373 $ 2,139 $ 5,314 $ 11 $1,186,835 $1,187,728 Average interest rate................ 5.80% 6.05% 6.10% 6.07% 6.21% 6.31% 5.83% Variable interest rate commercial paper and other................. $ 12,990 -- -- -- -- -- $ 12,990 $ 12,990 Average interest rate................ 6.57% -- -- -- -- -- 6.57% Variable interest rate securitization obligation............ $ 274,260 -- -- -- -- -- $ 274,260 $ 274,260 Average interest rate................ 6.36% -- -- -- -- -- 6.36% Variable interest rate debt with banks....... $ 166,000 -- -- -- -- -- $ 166,000 $ 166,000 Average interest rate................ 6.32% -- -- -- -- -- 6.32% Variable interest rate debt from affiliates............ $ 32,341 -- -- -- $20,000 -- $ 52,341 $ 52,341 Average interest rate................ 5.66% -- -- -- 6.42% -- 5.95%
38 39 FREMONT GENERAL CORPORATION (PARENT-ONLY) -- INTEREST RATE RISK Fremont General Corporation (parent only) is also subject to interest rate exposure related to LIBOR and U.S. prime interest rates because of its long-term debt and other obligations with both fixed and variable interest rates. For fixed rate obligations, the Company runs the risk that if market rates decline, the related required payments will exceed those based on the current market rates. For obligations with variable interest rates, fluctuations in the market rates will directly affect interest expense. The following table provides information about interest rate sensitive assets and liabilities of Fremont General Corporation (parent only). For short-term investments with variable interest rates, the table presents principal cash flows by expected maturity dates. The weighted-average interest rates are based on implied forward rates as derived from appropriate annual spot rate observations as of the reporting date. FREMONT GENERAL CORPORATION (PARENT ONLY) INTEREST RATE SENSITIVITY
PRINCIPAL AMOUNT MATURING IN: --------------------------------------------------------------------- FAIR VALUE AT 1998 1999 2000 2001 2002 THEREAFTER TOTAL 12/31/97 ------- ------ ------ ------ -------- ---------- -------- ------------- (THOUSANDS OF DOLLARS) Rate sensitive assets: Fixed interest rate short-term investments......................... $15,419 -- -- -- -- -- $ 15,419 $ 15,419 Average interest rate............... 6.27% -- -- -- -- -- 6.27% Rate sensitive liabilities: Fixed interest rate debt borrowings... -- -- -- -- -- $ 34,501 $ 34,501 $ 30,016 Average interest rate............... -- -- -- -- -- 5.00% 5.00% Variable interest rate debt borrowings.......................... $ 800 $1,946 $1,946 $1,946 $241,945 -- $248,583 $248,583 Average interest rate............... 6.91% 6.91% 6.91% 6.91% 6.30% -- 6.32% Fixed interest rate Company-obligated mandatorily redeemable preferred securities of subsidiary Trust holding solely Company junior subordinated debentures............. -- -- -- -- -- $100,000 $100,000 $103,750 Average interest rate............... -- -- -- -- -- 9.00% 9.00%
LIQUIDITY AND CAPITAL RESOURCES The property and casualty insurance operations must have cash and liquid assets available to meet their obligations to policyholders in accordance with contractual obligations, in addition to having the funds available to meet ordinary operating costs. These operations have several sources of funds to meet their obligations, including cash flow from operations, recoveries from reinsurance contracts and investment securities. By statute, the majority of the cash from these operations is required to be invested in investment grade securities to provide protection for policyholders. The Company invests in fixed income and preferred equity securities with an objective of providing a reasonable return while limiting credit and liquidity risk. The Company's investment portfolio had an unrealized gain of $81.4 million and $4.0 million at December 31, 1997 and 1996, respectively. The Company's thrift and loan subsidiary, which is principally engaged in real estate lending, finances its lending activities primarily through customer deposits, which have grown from $1.114 billion at December 31, 1996 to $1.493 billion at December 31, 1997. The thrift is also eligible for financing through the Federal Home Loan Bank of San Francisco, which financing is available at varying rates and terms. As of December 31, 1997, $325 million was available under the facility and no borrowings were outstanding. The Company's commercial finance operation funds its lending activities primarily through its asset securitization program, an unsecured revolving line of credit with a syndicated bank group and its capital. The asset securitization program was established in 1993 to provide a stable and cost effective source of funds to 39 40 facilitate the expansion of this business. As of December 31, 1997, an aggregate of $235 million of senior series and an aggregate of $39 million of subordinated series of term asset-backed certificates were outstanding. The interest rate on the certificates, set monthly, ranged from LIBOR plus 0.23% to LIBOR plus 0.95% at December 31, 1997. The securities issued in this program have a scheduled maturity of two to four years, but could mature earlier depending on fluctuations in the outstanding balances of loans in the portfolio and other factors. As of December 31, 1997, up to $265 million in additional publicly offered term asset-backed certificates may be issued pursuant to a shelf registration statement to fund future growth in the commercial finance loan portfolio. In February 1996, $135 million of the senior series certificates ("Series C") were issued. The proceeds were used, in conjunction with existing cash, to retire $200 million in Series A certificates, which were outstanding as of December 31, 1995. In April 1997, $109 million in certificates ("Series D") were issued, comprised of $100 million in senior certificates and $9 million in subordinated certificates. The Series D certificates were issued to retire $100 million in maturing Series B certificates. In December 1995, a commercial paper facility was established as part of the asset securitization program. This facility, which expires in December 1998, provides for the issuance of up to $150 million in commercial paper, dependent upon the level of assets within the asset securitization program. As of December 31, 1997, $13 million in commercial paper was outstanding under this facility. The commercial finance operation also has an unsecured revolving line of credit with a syndicated bank group that presently permits borrowings of up to $450 million, which includes a revolving credit facility of $350 million and a term loan of $100 million. The revolving credit facility converts to a term loan in August 2000, with ultimate maturity of the term loan in June 2002. The $100 million term loan matures July 2001. The balance outstanding at December 31, 1997 of the revolving credit facility and the term loan was $66 million and $100 million, respectively, with a weighted average interest rate of 6.32%. This credit line is primarily used to finance assets which are not included in the Company's asset securitization program. (See "Item 1. Business -- Financial Services Operations -- Commercial Finance.") As a holding company, Fremont General pays its operating expenses, meets its other obligations and pays stockholders' dividends from its cash on hand, management fees paid by its subsidiaries and dividends paid by its subsidiaries. During 1997, stockholders' dividends totaling $17.8 million were paid. Stockholders' dividends declared aggregated $18.9 million, $15.8 million and $13.1 million during 1997, 1996 and 1995, respectively. Several of the Company's subsidiaries are subject to certain statutory and regulatory restrictions and various agreements, principally loan agreements, that restrict their ability to distribute dividends to the Company. The Company expects that during the next few years dividends from its subsidiaries will consist of dividends from its property and casualty insurance subsidiaries and dividends on preferred stock of its thrift and loan holding company and commercial finance subsidiaries. The maximum amount available for payment of dividends by the property and casualty insurance subsidiaries at December 31, 1997 without prior regulatory approval is approximately $67.8 million. To facilitate general corporate operations, the Company maintains a revolving line of credit with a syndicated bank group that currently permits borrowings of up to $400 million, of which $240 million was outstanding as of December 31, 1997. On August 1, 1997, the Company completed the acquisition of Industrial which resulted in the disbursement of funds totaling $453.5 million, comprised of $365 million in purchase price, $79 million in the pay-off of an outstanding debt obligation that Industrial owed to Talegen, and $9.5 million in costs incurred in connection with the acquisition. The disbursement of cash used to fund the acquisition includes $219 million in borrowings under the Company's existing line of credit and the remainder from internally generated funds. (See "General.") On February 22, 1995, the Company completed the acquisition of Casualty for $256.5 million, which consisted of $231.5 million in cash and $25 million in a note payable to the seller. In September 1995, the note payable to the seller was refinanced using the Company's existing revolving line of credit. The cash used to fund the acquisition includes $55 million in borrowings under the Company's existing line of credit and the remainder from internally generated funds. (See "General.") 40 41 During 1997, an aggregate $266.7 million principal amount at maturity of Liquid Yield Option(TM) Notes due October 12, 2013 (Zero Coupon-Subordinated) ("LYONs") were converted into 5.1 million shares of the Company's Common Stock. The effect of these conversions was an increase in stockholders' equity and a decrease in long-term debt of $117 million. During 1996, an aggregate $72.5 million principal amount at maturity of LYONs were converted into 1.4 million shares of the Company's Common Stock. The effect of the 1996 conversions was an increase in stockholders' equity and a decrease in long-term debt of $31 million. On March 1, 1996, Fremont General Financing I, a statutory business trust (the "Trust") and consolidated wholly-owned subsidiary of the Company, sold $100 million of 9% Trust Originated Preferred Securities(SM) ("the Preferred Securities") in a public offering. The Preferred Securities represent preferred undivided beneficial interests in the assets of the Trust. The proceeds from the sale of the Preferred Securities were invested in 9% Junior Subordinated Debentures of the Company ("the Junior Subordinated Debentures"). The proceeds from the sale of the Junior Subordinated Debentures were used to repay approximately $50 million in revolving bank line of credit indebtedness, with the remainder used for general corporate purposes. The $100 million Junior Subordinated Debentures are the sole asset of the Trust. The Preferred Securities will be redeemed upon maturity of the Junior Subordinated Debentures in 2026, subject to the election available to the Company to extend the maturity up to 2045, and they may be redeemed, in whole or in part, at any time on or after March 31, 2001 and under certain specified circumstances. The Junior Subordinated Debentures rank pari passu with the Company's $34,501,000 aggregate principal amount at maturity of Liquid Yield Option(TM) Notes due 2013, and subordinate and junior to all senior indebtedness of the Company. Payment of distributions out of cash held by the Trust, and payments on liquidation of the Trust or the redemption of the Preferred Securities are guaranteed by the Company. Net cash provided by (used in) operating activities of continuing operations was $(18.0) million, $(96.0) million and $39.5 million for 1997, 1996 and 1995, respectively. Net cash used in continuing operations decreased in 1997 as compared to 1996, due primarily to an increase in net income; a decrease in other assets and an increase in other liabilities; and an increase in depreciation and amortization. Partially offsetting these conditions were higher policy acquisition costs deferred, net of amortization and a lower provision for deferred taxes. The significant decrease in other assets was due mainly to a $45 million collection on a policyholder receivable classified in other assets and the increase in other liabilities is due mainly to increases in accrued federal income taxes payable. Net cash provided by (used in) operating activities decreased in 1996 as compared to 1995 due primarily to a decrease in claims and policy liabilities, a lower amortization of policy acquisition costs, higher discount amortization on fixed maturity investments, and a decrease in other liabilities due primarily to the settlement of accrued operating costs. These conditions were partially offset by higher net income, lower policy acquisition costs deferred, higher depreciation and amortization, and an increase in the change in accrued investment income. The decrease in claims and policy liabilities, the lower amortization of policy acquisition costs, and the lower policy acquisition costs deferred resulted primarily from lower premium volume in the Company's workers' compensation insurance business. The higher discount amortization on fixed maturity investments is due mainly to an acceleration of discount amortization on certain mortgage-backed securities during 1996. The significant increase in the change in accrued investment income in 1996 as compared to 1995 is due primarily to the 1995 acquisition of Casualty which resulted in a significant increase in the accrual of investment income for 1995 and thereby negatively impacted net cash provided by operating activities in 1995. Net cash provided by (used in) investing activities was $(393.2) million, $229.8 million and $(514.0) million for 1997, 1996 and 1995, respectively. The decrease in net cash provided by (used in) investing activities was due mainly to the August 1, 1997 acquisition of Industrial for a cash disbursement of $303.0 million (net of cash acquired); an increase in investment purchases, net of sales, maturities and short-term investment activity; and an increase in loan originations, net of repayments. The increase in loan originations is consistent with the general growth in the Company's financial services' loan portfolio. The decrease in short-term investments is due primarily to the investing of the acquired short-term investment portfolio of Industrial into long-term investments. The increase in net cash provided by (used in) investing activities in 1996 as compared to 1995 is due principally to a decrease in investment purchases, net of sales, maturities, and calls; the February 1995 purchase of Casualty for a net cash disbursement of $255.8 million; 41 42 and an increase in receipts from repayments of loans, net of originations. The significant decrease in short-term and other investments of $376.0 million and the significant level of securities purchased in 1995 was due primarily to the effects of investing the acquired short-term investment portfolio of Casualty into long-term securities. Net cash provided by (used in) financing activities was $420.8 million, $(118.0) million and $483.0 million in 1997, 1996 and 1995, respectively. Net cash provided by (used in) financing activities increased in 1997 as compared to 1996, due primarily to an increase in long-term debt proceeds, net of short-term and long-term repayments; an increase in thrift deposits; a decrease in the funding of certain deferred compensation plans, net of stock options exercised; and the payment in 1996 of $363.4 million in the settlement of certain reinsurance and assumption agreements within the Company's life insurance operations. (See "Results of Operations -- Financial Services Operations.") The increase in long-term debt proceeds, net of repayments, is due mainly to $140 million in net additional borrowings used in conjunction with the acquisition of Industrial. (See "General.") Partially offsetting these increases in financing activities were decreases in annuity receipts, net of contract withdrawals, which is consistent with the Company's substantial reduction in life insurance operations in 1996. Additionally, the Company's financing activities in 1996 were significantly impacted by the proceeds of $100 million from the sale of the Preferred Securities, which were issued on March 1, 1996. Net cash provided by (used in) financing activities decreased in 1996 as compared to 1995, due primarily to lower long-term and short-term debt proceeds, net of repayments; the previously mentioned settlement of certain reinsurance and assumption agreements within the life insurance operation; a decrease in annuity contract receipts, net of contract withdrawals; and an increase in deferred compensation plans. These conditions were partially offset by the proceeds from the sale of the Preferred Securities. The increase in deferred compensation plans is due primarily to the repurchase by the Company of its Common Stock in 1996 pursuant to certain deferred compensation programs. The amortized cost of the Company's invested assets were $2.36 billion and $1.48 billion at December 31, 1997 and 1996, respectively. The approximately $880 million increase in the invested assets resulted primarily from the approximately $1.1 billion in invested assets acquired in the acquisition of Industrial. Partially offsetting the acquired investments was $225 million in internal funds which formed a part of the purchase price in acquiring Industrial. (See "General" and Note B of Notes to Consolidated Financial Statements.) The Company's property and casualty premium to surplus ratio for the year ended December 31, 1997 was 1.5 to 1, which is within industry guidelines. The FDIC has established certain capital and liquidity standards for its member institutions, and the Company's thrift and loan subsidiary was in compliance with these standards as of December 31, 1997. (See "Item 1. Business -- Regulation -- Thrift and Loan Regulation.") In August 1994 an additional $23 million was contributed to the capital of this subsidiary to support the growth in the loan portfolio during 1994. The Company believes that its existing cash, its bank lines of credit, revenues from operations and other available sources of liquidity will be sufficient to satisfy its liquidity needs for the next several years. INFORMATION SYSTEMS -- "YEAR 2000" The Company's operations rely on various computer-based information systems in the conduct of its businesses ("Systems"). Currently, some of these Systems will be unable to function properly after December 31, 1999 due to the inability of the affected Systems to recognize the year 2000. This problem exists for a substantial number of business enterprises, both domestically and internationally, and has been referred to as the "Year 2000" problem. As of December 31, 1997, significant Year 2000 compliance issues remain only within the Company's workers' compensation operation. The Company's financial services Systems, administrative Systems (personnel, payroll and accounting) and treasury Systems (cash management and investment portfolio management) have all been rendered substantially Year 2000 compliant. The Company also has initiated discussions with its significant policyholders, agents, suppliers, borrowers and financial institutions to ensure that those parties have appropriate plans to remediate Year 2000 issues where their computer systems interface with the Company's Systems or otherwise impact its operations. 42 43 With regard to the workers' compensation operation, the Company developed an action plan in 1996 to render its workers' compensation Systems Year 2000 compliant. Based on an evaluation of the progress made as of December 31, 1997, the Company estimates that its workers' compensation Systems, excluding those Systems supporting Industrial which were acquired August 1, 1997, will be Year 2000 compliant by September 30, 1998. The Industrial Systems are expected to be converted to Year 2000 compliant systems by June 30, 1999. The costs to be incurred by the Company in completing these Year 2000 initiatives are not expected to have a material impact on the Company's results of operations. NEW ACCOUNTING STANDARDS In February 1997, the FASB issued Statement No. 128 ("FASB 128"), "Earnings Per Share" which is effective for periods ending after December 15, 1997. Under FASB 128, primary earnings per share, which included the dilutive effect of stock options, has been replaced by basic earnings per share, which excludes the dilutive effect of stock options as well as certain shares of the Company's Common Stock awarded under the Company's Restricted Stock Award Plan. (See Note K of Notes to Consolidated Financial Statements.) Additionally, fully diluted earnings per share has been replaced by diluted earnings per share. All previously recorded earnings per share amounts have been restated to conform to the new standard. See Note P for the computation of earnings per share. In June 1997, the FASB issued Statement No. 130 ("FASB 130"), "Reporting Comprehensive Income" and Statement 131 ("FASB 131"), "Disclosures about Segments of an Enterprise and Related Information." Both standards are effective for periods beginning after December 15, 1997. FASB 130 requires most companies to report "Comprehensive Income" a new, additional measure of income, to include foreign currency translation gains and losses and other unrealized gains and losses that are today excluded from net income and reflected instead in equity. FASB 131 changes the disclosure guidelines for reporting operating segments. These new standards will affect presentation of financial statements, however, will not have an effect on reported net income or stockholders' equity. ITEM 7.(A) QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information set forth under the subheadings "Market Risk," "Property and Casualty Insurance Operations -- Interest Rate Risk, "Financial Services Operations -- Interest Rate Risk," and "Fremont General Corporation (Parent-only) -- Interest Rate Risk" in the Company's Management's Discussion and Analysis is incorporated herein by reference. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The Company's Consolidated Financial Statements, including supplementary data, are set forth in the "Index" on page 49 hereof. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 43 44 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information set forth under the subheadings "Election of Directors," "Executive Officers and Compensation," and "Section 16(a) Beneficial Ownership Reporting Compliance" in the Company's definitive Proxy Statement for the 1998 Annual Meeting of Stockholders is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION The information set forth under the subheadings "Election of Directors," "Compensation of Directors," "Executive Officers and Compensation," "Summary Compensation Table," "Summary Compensation Table -- Explanations," "Option/SAR Grants in Last Fiscal Year," "Option Grants Table -- Explanations," "Option Exercises and Year-End Values Table/Aggregate Option Exercises in Last Fiscal Year and Fiscal Year-End Option Values," "Long-Term Incentive Plans -- Awards in Last Fiscal Year (1)," "Employment Agreements" and "Retirement and Other Benefit Plans, A-I" in the Company's definitive Proxy Statement for the 1998 Annual Meeting of Stockholders is incorporated herein by this reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information set forth under the subheading "Principal and Management Stockholders" in the Company's definitive Proxy Statement for the 1998 Annual Meeting of Stockholders is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information immediately following the captions "Election of Directors" and "Employment Agreements" in the Company's definitive Proxy Statement for the 1998 Annual Meeting of Stockholders is incorporated herein by reference. 44 45 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a)(1) and (a)(2) and (d) FINANCIAL STATEMENTS AND SCHEDULES. Reference is made to the "Index -- Consolidated Financial Statements and Financial Statements Schedules -- Annual Report on Form 10-K filed as part of this Annual Report. (a)(3) and (c) EXHIBITS.
EXHIBIT NO. DESCRIPTION ----------- ----------- 2.1 Stock Purchase Agreement by and among Talegen Holdings, Inc., Fremont Indemnity Company and Fremont General Corporation dated as of May 16, 1997 including exhibits thereto. (Filed as Exhibit No. 2.1 to Current Report on Form 8-K, as of August 1, 1997, Commission File Number 1-8007, and incorporated herein by reference.) 2.2 Tax Allocation and Indemnification Agreement, dated as of May 16, 1997 by and among Xerox Financial Services, Inc., Talegen Holdings, Inc., Industrial Indemnity Holdings, Inc., Fremont General Corporation, and Fremont Indemnity Corporation, a California corporation. (Filed as Exhibit No. 2.2 to Current Report on Form 8-K, as of August 1, 1997, Commission File Number 1-8007, and incorporated herein by reference.) 3.1 Restated Articles of Incorporation of Fremont General Corporation. (Filed as Exhibit No. 3.1 to Registration Statement on Form S-3 File No. 33-64771 which was declared effective on March 1, 1996, and incorporated herein by reference.) 3.2 Certificate of Amendment of Articles of Incorporation of Fremont General Corporation. (Filed as Exhibit 3.2 to Registration Statement on Form S-3 File No. 33-64771 which was declared effective on March 1, 1996 and incorporated herein by reference.) 3.3 Amended and Restated By-Laws of Fremont General Corporation. (Filed as Exhibit No. 3.3 to Annual Report on Form 10-K, for the fiscal year ended December 31, 1995, Commission File Number 1-8007, and incorporated herein by reference.) 4.1 Form of Stock Certificate for Common Stock of the Registrant. (Filed as Exhibit No. (1) Form 8-A filed on March 17, 1993, Commission File Number 1-8007, and incorporated herein by reference.) 4.2 Indenture with respect to Liquid Yield Option Notes Due 2013 between the Registrant and Bankers Trust Company. (Filed as Exhibit No. 4.4 to Registration Statement on Form S-3 filed on October 1, 1993, and incorporated herein by reference.) 4.3 Indenture among the Registrant, the Trust and First Interstate Bank of California, a California banking corporation, as trustee. (Filed as Exhibit No. 4.3 to Annual Report on Form 10-K, for the fiscal year ended December 31, 1995, Commission File Number 1-8007, and incorporated herein by reference.) 4.4 Amended and Restated Declaration of Trust among the Registrant, the Regular Trustees, The Chase Manhattan Bank (USA), a Delaware banking corporation, as Delaware trustee, and The Chase Manhattan Bank, N.A., a national banking association, as Institutional Trustee. (Filed as Exhibit No. 4.5 to Annual Report on Form 10-K, for the fiscal year ended December 31, 1995, Commission File Number 1-8007, and incorporated herein by reference.) 4.5 Preferred Securities Guarantee Agreement between the Registrant and The Chase Manhattan Bank, N.A., a national banking association, as Preferred Guarantee Trustee. (Filed as Exhibit No. 4.6 to Annual Report on Form 10-K, for the fiscal year ended December 31, 1995, Commission File Number 1-8007, and incorporated herein by reference.) 4.6 Common Securities Guarantee Agreement by the Registrant. (Filed as Exhibit No. 4.7 to Annual Report on Form 10-K, for the fiscal year ended December 31, 1995, Commission File Number 1-8007, and incorporated herein by reference.)
45 46
EXHIBIT NO. DESCRIPTION ----------- ----------- 4.7 Form of Preferred Securities. (Included in Exhibit 4.5). (Filed as Exhibit No. 4.8 to Annual Report on Form 10-K, for the fiscal year ended December 31, 1995, Commission File Number 1-8007, and incorporated herein by reference.) 4.8 Form of 9% Junior Subordinated Debenture. (Included in Exhibit 4.3). (Filed as Exhibit No. 4.9 to Annual Report on Form 10-K, for the fiscal year ended December 31, 1995, Commission File Number 1-8007, and incorporated herein by reference.) 10.1 (a) Fremont General Corporation Employee Stock Ownership Plan as amended. (Filed as Exhibit No. 10.1 to Annual Report on Form 10-K, for the fiscal year ended December 31, 1995, Commission File Number 1-8007, and incorporated herein by reference.) 10.1 (b) Amendment Number Two to the Fremont General Corporation Employee Stock Ownership Plan. 10.2 Amended and Restated Trust Agreement for Fremont General Corporation Employee Stock Ownership Plan. (Filed as Exhibit No. 10.2 to Annual Report on Form 10-K, for the fiscal year ended December 31, 1995, Commission File Number 1-8007, and incorporated herein by reference.) 10.3 (a) Fremont General Corporation and Affiliated Companies Investment Incentive Plan. (Filed as Exhibit No. 10.3 to Annual Report on Form 10-K, for the fiscal year ended December 31, 1995, Commission File Number 1-8007, and incorporated herein by reference.) 10.3 (b) Amendments Number One, Two and Three to the Fremont General Corporation and Affiliated Companies Investment Incentive Plan. (Filed as Exhibit No. 10.3(b) to Quarterly Report on Form 10-Q, for the period ended September 30, 1997, Commission File Number 1-8007, and incorporated herein by reference.) 10.3 (c) Amendment Number Four to the Fremont General Corporation and Affiliated Companies Investment Incentive Plan. 10.4 (a) Trust Agreement for Investment Incentive Plan. (Filed as Exhibit No. (10)(xi) to Annual Report on Form 10-K, for the Fiscal Year Ended December 31, 1993, Commission File Number 1-8007, and incorporated herein by reference.) 10.4 (b) Amendment to Trust Agreement for Investment Incentive Plan. (Filed as Exhibit No. 10.4 to Annual Report on Form 10-K, for the fiscal year ended December 31, 1995, Commission File Number 1-8007, and incorporated herein by reference.) 10.5 Supplemental Retirement Plan of the Company, as restated January 1, 1997. (Filed as Exhibit No. 10.5 to Quarterly Report on Form 10-Q, for the period ended September 30, 1997, Commission File Number 1-8007, and incorporated herein by reference.) 10.6 Trust Agreement for Supplemental Retirement Plan of the Company and the Senior Supplemental Retirement Plan of the Company, as amended. (Filed as Exhibit No. 10.6 to Annual Report on Form 10-K, for the fiscal year ended December 31, 1995, Commission File Number 1-8007, and incorporated herein by reference.) 10.7 Senior Supplemental Retirement Plan, as restated January 1, 1997. (Filed as Exhibit No. 10.7 to Quarterly Report on Form 10-Q, for the period ended September 30, 1997, Commission File Number 1-8007, and incorporated herein by reference). 10.8 (a) Excess Benefit Plan of the Company. (Filed as Exhibit No. (10)(vi) to Annual Report on Form 10-K, for the Fiscal Year Ended December 31, 1993, Commission File Number 1-8007, and incorporated herein by reference.) 10.8 (b) Amendment to Excess Benefit Plan of the Company. (Filed as Exhibit No. 10.8 to Annual Report on Form 10-K, for the fiscal year ended December 31, 1995, Commission File Number 1-8007, and incorporated herein by reference.)
46 47
EXHIBIT NO. DESCRIPTION ----------- ----------- 10.8 (c) Trust Agreement for Excess Benefit Plan. (Filed as Exhibit No. 10.8 to Annual Report on Form 10-K, for the fiscal year ended December 31, 1995, Commission File Number 1-8007, and incorporated herein by reference.) 10.9 Amended Non-Qualified Stock Option Plan of 1989 and related agreements of the Company. (Filed as Exhibit No. 10.9 to Annual Report on Form 10-K, for the fiscal year ended December 31, 1996, Commission File Number 1-8007, and incorporated herein by reference.) 10.10 1997 Stock Plan and related agreements. (Filed as Exhibit No. 10.10 to Quarterly Report on Form 10-Q, for the period ended June 30, 1997, Commission File Number 1-8007, and incorporated herein by reference.) 10.11(a) Long-Term Incentive Compensation Plan of the Company -- Senior Executive Plan. (Filed as Exhibit No. 10.10 (a) on Form 10-Q for the period ended September 30, 1996, Commission File Number 1-8007, and incorporated herein by reference.) 10.11(b) Long-Term Incentive Compensation Plan of the Company (Filed as Exhibit No. 10.10 (b) on Form 10-Q for the period ended September 30, 1996, Commission File Number 1-8007, and incorporated herein by reference.) 10.12 1995 Restricted Stock Award Plan As Amended and forms of agreement thereunder. (Filed as Exhibit No. 4.1 to Registration Statement on Form S-8/S-3 File No. 333-17525 which was filed on December 9, 1997, and incorporated herein by reference.) 10.13 Fremont General Corporation Employee Benefits Trust Agreement ("Grantor Trust") dated September 7, 1995 between the Company and Merrill Lynch Trust Company of California. (Filed as Exhibit No. 10.12 to Annual Report on Form 10-K, for the fiscal year ended December 31, 1995, Commission File Number 1-8007, and incorporated herein by reference.) 10.14(a) Employment Agreement between the Company and James A. McIntyre dated January 1, 1994. (Filed as Exhibit No. (10)(i) to Quarterly Report on Form 10-Q for the period ended March 31, 1994, Commission File Number 1-8007, and incorporated herein by reference.) 10.14(b) First Amendment to Employment Agreement between the Company and James A. McIntyre dated August 1, 1996. (Filed as Exhibit No. 10.10 to Quarterly Report on Form 10-Q, for the period ended June 30, 1997, Commission File Number 1-8007, and incorporated herein by reference.) 10.14(c) Second Amendment to Employment Agreement between the Company and James A. McIntyre dated August 8, 1997. (Filed as Exhibit No. 10.14(c) to Quarterly Report on Form 10-Q, for the period ended September 30, 1997, Commission File Number 1-8007, and incorporated herein by reference.) 10.15(a) Employment Agreement between the Company and Louis J. Rampino dated February 8, 1996. (Filed as Exhibit No. 10.14(a) to Annual Report on Form 10-K, for the fiscal year ended December 31, 1995, Commission File Number 1-8007, and incorporated herein by reference.) 10.15(b) Employment Agreement between the Company and Wayne R. Bailey dated February 8, 1996. (Filed as Exhibit No. 10.14 to Annual Report on Form 10-K, for the fiscal year ended December 31, 1995, Commission File Number 1-8007, and incorporated herein by reference.) 10.16 Management Continuity Agreement between the Company and Raymond G. Meyers dated February 8, 1996. (Filed as Exhibit No. 10.15 to Annual Report on Form 10-K, for the fiscal year ended December 31, 1995, Commission File Number 1-8007, and incorporated herein by reference.) 10.17 1998 Management Incentive Compensation Plan of the Company. 10.18 Continuing Compensation Plan for Retired Directors. (Filed as Exhibit No. 10.17 to Annual Report on Form 10-K, for the fiscal year ended December 31, 1995, Commission File Number 1-8007, and incorporated herein by reference.)
47 48
EXHIBIT NO. DESCRIPTION ----------- ----------- 10.19 Non-Employee Directors' Deferred Compensation Plan. (Filed as Exhibit No. 10.18 to Annual Report on Form 10-K, for the fiscal year ended December 31, 1995, Commission File Number 1-8007, and incorporated herein by reference.) 10.20 Credit Agreement among Fremont General Corporation, Various Lending Institutions and the Chase Manhattan Bank, N.A., As Agent dated August 1, 1997. (Filed as Exhibit No. 10.20 to Quarterly Report on Form 10-Q, for the period ended September 30, 1997, Commission File Number 1-8007, and incorporated herein by reference). 10.21 Credit Agreement $15,000,000 by and among Merrill Lynch Trust Company of California as trustee for the Fremont General Corporation Employee Stock Ownership Trust. The Plan Committee (hereinafter described) on behalf of the Fremont General Corporation Employee Stock Ownership Plan, Fremont General Corporation, and First Interstate Bank of California August 10, 1995. (Filed as Exhibit No. (10)(viii) to Quarterly Report on Form 10-Q for the period ended September 30, 1995, and incorporated herein by reference.) 21 Subsidiaries of the Company 23 Consent of Ernst & Young LLP Independent Auditors 27 Financial Data Schedule
(b) Report on Form 8-K during the quarter ended December 31, 1997: A current report on Form 8-K/A dated October 14, 1997 which included the financial statements of the business acquired and the Company's pro forma condensed consolidated financial information. This report amended Current Report on form 8-K dated August 14, 1997 that reported the completion on August 1, 1997 of the acquisition of Industrial Indemnity Company ("Industrial") pursuant to a Stock Purchase Agreement dated as of May 16, 1997 by and among the Company, Fremont Indemnity Company, a California corporation and wholly-owned subsidiary of the Company ("Fremont Indemnity") and Talegen Holdings, Inc., a Delaware corporation and subsidiary of Xerox Corporation ("Talegen"), whereby Fremont Indemnity purchased from Talegen all of the issued and outstanding capital stock of Industrial. 48 49 FREMONT GENERAL CORPORATION CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES ANNUAL REPORT ON FORM 10-K ------------------------ INDEX
PAGES ----- Report of Independent Auditors.............................. 50 Consolidated Financial Statements: Consolidated Balance Sheets as of December 31, 1997 and 1996................................................... 51 Consolidated Statements of Income for the years ended December 31, 1997, 1996 and 1995....................... 52 Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1996 and 1995....................... 53 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1997, 1996 and 1995........... 54 Notes to Consolidated Financial Statements................ 55 Schedules: II -- Condensed Financial Information of Registrant...... 76 III -- Supplementary Insurance Information................ 80 IV -- Reinsurance........................................ 81 V -- Valuation and Qualifying Accounts................... 82 VI -- Supplemental Information Concerning Property/Casualty Insurance Operations................. 83
All other schedules are omitted because of the absence of conditions under which they are required or because the necessary information is provided in the consolidated financial statements or notes thereto. 49 50 REPORT OF INDEPENDENT AUDITORS Stockholders and Board of Directors Fremont General Corporation We have audited the accompanying consolidated balance sheets of Fremont General Corporation and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1997. Our audits also included the financial statement schedules listed in the Index at Item 14(a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated 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 Fremont General Corporation and subsidiaries at December 31, 1997 and 1996, and the consolidated results of their operations and cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein. ERNST & YOUNG LLP Los Angeles, California March 20, 1998 50 51 FREMONT GENERAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
DECEMBER 31, ------------------------ 1997 1996 ---------- ---------- (THOUSANDS OF DOLLARS) ASSETS Securities available for sale at fair value: Fixed maturity investments (cost: 1997 -- $1,835,086; 1996 -- $1,004,248).................................... $1,893,876 $1,005,147 Non-redeemable preferred stock (cost: 1997 -- $356,223; 1996 -- $351,812)...................................... 378,832 354,958 ---------- ---------- Total securities available for sale.................... 2,272,708 1,360,105 Loans receivable............................................ 1,983,687 1,688,040 Short-term investments...................................... 164,626 118,582 Other investments........................................... 5,479 5,623 ---------- ---------- TOTAL INVESTMENTS AND LOANS............................ 4,426,500 3,172,350 Cash........................................................ 64,987 55,378 Accrued investment income................................... 42,038 26,794 Premiums receivable and agents' balances.................... 146,144 99,404 Reinsurance recoverable on paid losses...................... 20,287 13,173 Reinsurance recoverable on unpaid losses.................... 522,928 438,459 Deferred policy acquisition costs........................... 38,014 25,551 Costs in excess of net assets acquired...................... 149,321 67,287 Deferred income taxes....................................... 148,757 64,035 Other assets................................................ 275,144 79,881 Assets held for discontinued operations..................... 256,507 265,200 ---------- ---------- TOTAL ASSETS........................................... $6,090,627 $4,307,512 ========== ========== LIABILITIES Claims and policy liabilities: Losses and loss adjustment expenses....................... $2,163,323 $1,256,345 Life insurance benefits and liabilities................... 180,976 202,465 Unearned premiums......................................... 78,625 87,422 Dividends to policyholders................................ 37,626 33,093 ---------- ---------- TOTAL CLAIMS AND POLICY LIABILITIES.................... 2,460,550 1,579,325 Reinsurance premiums payable and funds withheld............. 13,049 4,106 Other liabilities........................................... 250,877 65,574 Thrift deposits............................................. 1,492,985 1,114,352 Short-term debt............................................. 26,290 16,896 Long-term debt.............................................. 691,068 636,456 Liabilities of discontinued operations...................... 222,993 231,686 ---------- ---------- TOTAL LIABILITIES...................................... 5,157,812 3,648,395 Commitments and contingencies Company-obligated mandatorily redeemable preferred securities of subsidiary Trust holding solely Company junior subordinated debentures............................ 100,000 100,000 STOCKHOLDERS' EQUITY Common Stock, par value $1 per share -- Authorized; 49,500,000 shares; Issued and outstanding: (1997 -- 34,571,000 and 1996 -- 28,093,000)........................ 34,571 28,093 Additional paid-in capital.................................. 323,065 168,452 Retained earnings........................................... 508,533 419,136 Deferred compensation....................................... (86,263) (59,193) Net unrealized gain on investments, net of deferred taxes... 52,909 2,629 ---------- ---------- TOTAL STOCKHOLDERS' EQUITY............................. 832,815 559,117 ---------- ---------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY............. $6,090,627 $4,307,512 ========== ==========
See notes to consolidated financial statements. 51 52 FREMONT GENERAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME
YEAR ENDED DECEMBER 31, ------------------------------ 1997 1996 1995 -------- -------- -------- (THOUSANDS OF DOLLARS, EXCEPT PER SHARE DATA) REVENUES Property and casualty premiums earned....................... $601,183 $486,860 $606,917 Loan interest............................................... 194,412 163,765 162,992 Net investment income....................................... 149,729 123,531 119,523 Realized investment gains (losses).......................... (1,964) (1,658) 1 Other revenue............................................... 30,935 23,306 34,381 -------- -------- -------- TOTAL REVENUES......................................... 974,295 795,804 923,814 EXPENSES Losses and loss adjustment expenses......................... 389,201 335,407 461,333 Policy acquisition costs.................................... 115,899 96,177 126,099 Provision for loan losses................................... 12,319 13,885 14,575 Other operating costs and expenses.......................... 150,847 107,260 120,963 Dividends to policyholders.................................. 4,734 -- -- Interest expense............................................ 142,402 114,766 100,517 -------- -------- -------- TOTAL EXPENSES......................................... 815,402 667,495 823,487 -------- -------- -------- Income before taxes......................................... 158,893 128,309 100,327 Income tax expense.......................................... 50,601 41,021 32,305 -------- -------- -------- NET INCOME........................................ $108,292 $ 87,288 $ 68,022 ======== ======== ======== PER SHARE DATA: Net Income: Basic..................................................... $ 3.80 $ 3.54 $ 2.68 Diluted................................................... 3.23 2.73 2.18
See notes to consolidated financial statements. 52 53 FREMONT GENERAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, --------------------------------------- 1997 1996 1995 ----------- ----------- ----------- (THOUSANDS OF DOLLARS) OPERATING ACTIVITIES Net income........................................... $ 108,292 $ 87,288 $ 68,022 Adjustments to reconcile net income to net cash provided by operating activities: Change in premiums receivable and agents' balances and reinsurance recoverable on paid losses...... 1,194 4,043 7,495 Change in accrued investment income................ 3,879 3,602 (21,186) Change in claims and policy liabilities............ (212,274) (211,482) (72,824) Amortization of policy acquisition costs........... 115,899 96,177 126,099 Policy acquisition costs deferred.................. (121,004) (93,478) (148,365) Provision for deferred income taxes................ 18,360 24,798 22,810 Provision for loan losses.......................... 12,319 13,885 14,575 Depreciation and amortization...................... 33,524 26,592 20,334 Net amortization on fixed maturity investments..... (20,250) (21,976) (1,793) Realized investment (gains) losses................. 1,964 1,658 (1) Change in other assets and liabilities............. 40,146 (27,116) 24,323 ----------- ----------- ----------- NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES.................................... (17,951) (96,009) 39,489 INVESTING ACTIVITIES Securities available for sale: Purchases of securities............................ (4,227,342) (1,527,408) (2,773,842) Sales of securities................................ 3,936,908 1,679,631 2,000,772 Securities matured or called....................... 62,288 52,806 101,957 Securities held to maturity: Purchases of securities............................ -- -- (117,660) Securities matured or called....................... -- -- 5,464 Decrease in short-term and other investments......... 469,559 239,684 615,705 Loan originations and bulk purchases funded.......... (980,837) (644,193) (458,801) Receipts from repayments and bulk sales of loans..... 672,871 441,311 377,768 Acquisition of companies, less cash acquired......... (303,033) -- (255,803) Purchases of property and equipment.................. (23,617) (12,035) (9,527) ----------- ----------- ----------- NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES.................................... (393,203) 229,796 (513,967) FINANCING ACTIVITIES Proceeds from short-term debt........................ -- 14,929 30,134 Repayments of short-term debt........................ (5,052) (72,191) (199,268) Proceeds from long-term debt......................... 274,260 79,058 325,000 Repayments of long-term debt......................... (170,750) (111,004) (42,808) Net increase in thrift deposits...................... 378,633 188,040 179,335 Annuity contract receipts............................ 1,386 132,550 217,648 Annuity contract withdrawals......................... (32,637) (44,184) (18,874) Settlement under life insurance reinsurance agreements......................................... -- (363,415) -- Proceeds from sale of Preferred Securities........... -- 100,000 -- Dividends paid....................................... (17,838) (15,016) (12,618) Stock options exercised.............................. 13,129 1,428 80 Purchase of fractional shares........................ (1) -- (25) Decrease (increase) in deferred compensation plans... (20,367) (28,163) 4,375 ----------- ----------- ----------- NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES.................................... 420,763 (117,968) 482,979 ----------- ----------- ----------- INCREASE IN CASH..................................... 9,609 15,819 8,501 Cash at beginning of year.......................... 55,378 39,559 31,058 ----------- ----------- ----------- CASH AT END OF YEAR.................................. $ 64,987 $ 55,378 $ 39,559 =========== =========== ===========
See notes to consolidated financial statements. 53 54 FREMONT GENERAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
NET ADDITIONAL UNREALIZED COMMON PAID-IN RETAINED DEFERRED GAIN (LOSS) ON STOCK CAPITAL EARNINGS COMPENSATION INVESTMENTS TOTAL ------- ---------- -------- ------------ -------------- -------- (THOUSANDS OF DOLLARS) Balance at January 1, 1995.... $15,388 $ 80,264 $331,713 $(10,987) $(65,365) $351,013 Net income for 1995......... -- -- 68,022 -- -- 68,022 Cash dividends to stockholders............. -- -- (13,080) -- -- (13,080) Ten percent stock dividend................. 1,538 37,498 (39,036) -- -- -- Three-for-two stock split... 8,464 (8,464) -- -- -- -- Stock options exercised..... 3 77 -- -- -- 80 ESOP shares allocated....... -- -- -- 4,375 -- 4,375 Other adjustments........... -- 728 (12) -- -- 716 Net change in unrealized gain (loss) on investments, net of deferred taxes........... -- -- -- -- 86,964 86,964 ------- -------- -------- -------- -------- -------- Balance at December 31, 1995........................ 25,393 110,103 347,607 (6,612) 21,599 498,090 Net income for 1996......... -- -- 87,288 -- -- 87,288 Cash dividends to stockholders............. -- -- (15,759) -- -- (15,759) Conversion of LYONs......... 1,399 29,127 -- -- -- 30,526 Stock options exercised..... 57 (1,654) -- 3,025 -- 1,428 Shares issued or acquired for employee benefit plans.................... 1,244 31,291 -- (64,918) -- (32,383) Amortization of restricted stock.................... -- -- -- 5,277 -- 5,277 ESOP shares allocated less additional shares purchased................ -- 9 -- 4,210 -- 4,219 Other adjustments........... -- (424) -- (175) -- (599) Net change in unrealized gain (loss) on investments, net of deferred taxes........... -- -- -- -- (18,970) (18,970) ------- -------- -------- -------- -------- -------- Balance at December 31, 1996........................ 28,093 168,452 419,136 (59,193) 2,629 559,117 Net income for 1997......... -- -- 108,292 -- -- 108,292 Cash dividends to stockholders............. -- -- (18,895) -- -- (18,895) Conversion of LYONs......... 5,144 112,051 -- -- -- 117,195 Stock options exercised..... 1,334 21,158 -- 37 -- 22,529 Shares acquired or allocated for employee benefit plans.................... -- 8,234 -- (34,207) -- (25,973) Amortization of restricted stock.................... -- -- -- 7,536 -- 7,536 ESOP shares allocated....... -- 617 -- 7,043 -- 7,660 Other adjustments........... -- 12,553 -- (7,479) -- 5,074 Net change in unrealized gain (loss) on investments, net of deferred taxes........... -- -- -- -- 50,280 50,280 ------- -------- -------- -------- -------- -------- Balance at December 31, 1997........................ $34,571 $323,065 $508,533 $(86,263) $ 52,909 $832,815 ======= ======== ======== ======== ======== ========
See notes to consolidated financial statements. 54 55 FREMONT GENERAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE A -- NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES Fremont General Corporation is a nationwide insurance and financial services holding company operating select businesses in niche markets. The insurance business of Fremont General (Fremont General Corporation and its subsidiaries or "the Company") includes one of the largest underwriters of workers' compensation insurance in the nation. The Company's financial services business includes commercial real estate lending, residential real estate lending, commercial finance and a small insurance premium financing operation. Real estate lending represents over 64% of loan interest revenues (1996 -- 56%; 1995 -- 50%) and represents both commercial and residential lending secured by real estate located primarily in California. Commercial finance accounts for substantially all of the remaining loan interest revenues and represents asset-based loans to middle market companies nationwide (32% in California), primarily secured by accounts receivable and inventory. The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles which, as to the subsidiary insurance companies, differ from statutory accounting practices prescribed or permitted by regulatory authorities. The significant accounting policies followed by the Company that materially affect financial reporting are summarized below. Consolidation: The consolidated financial statements include the accounts and operations, after intercompany eliminations, of Fremont General Corporation and all subsidiaries. (See Note N for the accounting treatment of discontinued operations.) Use of Estimates: The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Investments: Fixed maturity investments represent bonds and redeemable preferred stocks that mature more than one year after the purchase date. Non-redeemable preferred stocks are equity securities, the majority of which do not include adjustable dividend yield provisions. Premiums and discounts on investments in securities are primarily amortized using the interest method over the estimated lives of the investments. The estimated lives of such investments are determined based upon the current expectations of future cash flows. Adjustments for other-than-temporary market declines are recorded when determination of loss is probable and is reflected with a write-down of amortized cost to net realizable value. Short-term investments are carried at cost, which approximates their fair value. Realized investment gains and losses are included as a component of revenues based on specific identification of the investment sold. Loans: Loans are stated net of unearned income and allowance for possible loan losses. The allowance is increased by provisions charged against operations and reduced by loan amounts charged off by management. Allowances for credit losses are based on discounted cash flows using the loans' effective interest rate or the fair value of the collateral for collateral dependent loans. The allowance is maintained at a level considered adequate to provide for potential losses on loans based on management's evaluation of the loan portfolio. While management uses all available information to estimate the level of the allowance for credit losses, future additions may be necessary based on changes in the amounts and timing of future cash flows expected due to changes in collateral values supporting loans, general economic conditions and borrowers' financial conditions. Management classifies loans as non-accrual when the collection of future interest is not assured by the borrower's financial condition and the value of underlying collateral and guarantees securing the loan. Subsequent collections on non-accrual loans are applied as a reduction of principal. The Company's charge-off policy is based on a monthly loan-by-loan review. 55 56 FREMONT GENERAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Loans in process of foreclosure, repossessed assets, and in-substance foreclosures are included in the financial statements at the lower of cost or estimated realizable value (net of estimated costs to sell). Estimated realizable values are based on management's evaluation of numerous factors, including appraisals, sales of comparable assets and estimated market conditions. Furniture and Equipment: Furniture and equipment are included in other assets and are stated at cost, less accumulated depreciation. Leasehold improvements are amortized over the terms of the lease. Generally, depreciation is computed by the straight-line method over periods ranging from two to twelve years. Premium Income: Revenues from property and casualty premiums are recognized proportionately over the terms of the related policies. Direct property and casualty premiums earned but not billed at the end of each accounting period are estimated and accrued, and differences between such estimates and final billings are included in current operations. Revenues for universal life and investment-type insurance products consist of policy charges for the cost of insurance, policy initiation, administration and surrender fees and are included in other revenue. Premiums receivable and agents' balances and reinsurance recoverable on paid and unpaid losses include allowances for doubtful accounts of $7,048,000 and $7,401,000 at December 31, 1997 and 1996, respectively. Losses and Loss Adjustment Expenses: The estimated liabilities for losses and loss adjustment expenses include the accumulation of estimates for losses and claims reported prior to the balance sheet dates, estimates (based primarily on projections of historical developments) of claims incurred but not reported and estimates of expenses for investigating and adjusting all incurred and unadjusted claims. Amounts reported are estimates of the ultimate costs of settlement, net of subrogation and salvage recoveries, which are necessarily subject to the impact of future changes in economic and social conditions. Management believes that, given the inherent variability in any such estimates, the aggregate reserves are within a reasonable and acceptable range of adequacy. Reserves are continually monitored and reviewed, and as settlements are made or reserves adjusted, differences are included in current operations. Included in the loss and loss adjustment expense liability recorded on the consolidated balance sheet at December 31, 1997 and 1996 is $87,013,000 and $90,148,000, respectively, of workers' compensation accident and health permanent disability and death reserves which have been discounted at 5%. These reserves arose from the acquisition in 1995 of Casualty Insurance Company ("Casualty"). (See Note B.) The Company has continued the practice previously adopted by Casualty of discounting permanent disability loss reserves for both statutory accounting practices and generally accepted accounting principles. Unearned Premiums: Property and casualty insurance unearned premiums are calculated using the monthly pro rata basis. Life Insurance Benefits and Liabilities: Policyholder contract liabilities for universal life and investment-type products represent the premiums received plus accumulated interest, less mortality and other administrative charges under the contracts and before applicable surrender charges. Policy benefits and claims that are charged to expense include benefit claims incurred in excess of related policy account balances. (See Note F.) Deferred Policy Acquisition Costs: Commissions, premium taxes and certain sales and underwriting expenses are capitalized and amortized as premiums are earned over the terms of the related property and casualty policies. Anticipated investment income is considered in determining if premium deficiencies exist. The costs of acquiring new and renewal life and annuity insurance contracts, prior to the transactions described in Note F, have been deferred. These life and annuity deferred acquisition costs were amortized over anticipated gross margins for such contracts prior to their reinsurance. As a result of the transactions described in Note F, substantially all acquisition costs on life insurance and annuity contracts have been eliminated. 56 57 FREMONT GENERAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Dividends to Policyholders: Dividends, if applicable, to policyholders on workers' compensation insurance contracts are accrued during the period in which the related premiums are earned. Thrift Deposits: Thrift deposits consist of certificates of deposit at the Company's California thrift and loan subsidiary. Such balances are credited with interest at rates ranging from 2.57% to 8.68% at December 31, 1997. The estimated fair value of the thrift deposits was $1,493,877,000 at December 31, 1997. Intangibles: The excess of the costs of acquisitions over net assets acquired (net of accumulated amortization: 1997 -- $21,125,000; 1996 -- $16,322,000) is being amortized over various periods ranging primarily from 7 to 25 years, which represents the estimated life of the intangible assets associated with such acquisitions. Additionally, the trade names acquired in the acquisitions of Industrial Indemnity Holdings, Inc. ("Industrial") and Casualty (net of accumulated amortization: 1997 -- $1,571,000; 1996 -- $697,000) are being amortized over 40 years. (See Note B regarding intangibles related to the acquisitions of Industrial and Casualty.) Credit Risk: Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of temporary cash investments, fixed maturity securities, preferred stocks, real estate and commercial finance loans and reinsurance recoverables. The Company places its temporary cash investments with high credit quality financial institutions and limits the amounts of credit exposure to any one financial institution. Concentrations of credit risk with respect to investments in fixed maturities, preferred stocks and commercial finance loans are limited due to the large number of such investments and their distribution across many different industries and geographic regions. Concentration of credit risk with respect to thrift and loan finance receivables is limited due to the large number of borrowers; however, the majority of the thrift and loan finance receivables are from borrowers within the state of California. To minimize its exposure to significant losses from reinsurance insolvencies, the Company evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurers. As of December 31, 1997, Employers Reassurance Corporation was the only reinsurer that accounted for more than 10% of total reinsurance recoverables while General Reinsurance Corporation was the only reinsurer that accounted for more than 10% of total property and casualty reinsurance recoverables. The remaining reinsurance recoverables were spread over 204 reinsurers. Fair Values of Financial Instruments: The Company uses various methods and assumptions in estimating its fair value disclosures for financial instruments. For fixed maturity investments and preferred stocks, fair values are determined from certain valuation services, as well as from quoted market prices. Loans receivable with variable rates, as well as thrift deposits for passbook and money market type accounts, are deemed to be at fair value. The fair values of thrift certificates of deposits, real estate loans and other fixed rate loans are estimated using discounted cash flow analyses, using interest rates currently being offered for similar accounts or loans to borrowers with similar credit ratings. For short-term debt, the carrying amount of the Company's borrowings approximates fair value. The fair value of the Company's long-term debt and mandatorily redeemable preferred securities of a subsidiary Trust is based on quoted market prices for securities actively traded. For long-term debt not actively traded, and for bank borrowings, the fair value is estimated using discounted cash flow analyses, based on the Company's current incremental borrowing rates for similar types of borrowing arrangements. 57 58 FREMONT GENERAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The carrying amounts and fair values of the Company's financial instruments at December 31, 1997 are summarized in the following table:
CARRYING ESTIMATED AMOUNT FAIR VALUE ---------- ---------- (THOUSANDS OF DOLLARS) ASSETS Fixed maturity investment (Note C)........................ $1,893,876 $1,893,876 Non-redeemable preferred stock (Note C)................... 378,832 378,832 Loans receivable (Note D)................................. 1,983,687 2,008,387 LIABILITIES Thrift deposits (Note A).................................. 1,492,985 1,493,877 Short-term debt (Note H).................................. 26,290 26,290 Long-term debt (Note I)................................... 691,068 705,559 Company-obligated manditorily redeemable preferred securities of subsidiary Trust holding solely Company junior subordinated debentures (Note J)................. 100,000 103,750
Insurance related financial instruments, other than those classified as investment contracts, are exempt from fair value disclosure requirements. The carrying amount of reinsurance paid recoverables approximates their fair value as they are expected to be realized within one year. New Accounting Standards: In February 1997, the Financial Accounting Standards Board ("FASB") issued Statement No. 128 ("FASB 128"), "Earnings Per Share" which is effective for periods ending after December 15, 1997. Under FASB 128, primary earnings per share, which included the dilutive effect of stock options, has been replaced by basic earnings per share, which excludes the dilutive effect of stock options as well as certain shares of the Company's Common Stock awarded under the Company's Restricted Stock Award Plan. Additionally, fully diluted earnings per share has been replaced by diluted earnings per share. All previously recorded earnings per share amounts have been restated to conform to the new standard. See Note P for the computation of earnings per share. In June 1997, the FASB issued Statement No. 130 ("FASB 130"), "Reporting Comprehensive Income" and Statement 131 ("FASB 131"), "Disclosures about Segments of an Enterprise and Related Information." Both standards are effective for periods beginning after December 15, 1997. FASB 130 requires most companies to report "Comprehensive Income" a new, additional measure of income, to include foreign currency translation gains and losses and other unrealized gains and losses that are currently excluded from net income and reflected instead in equity. FASB 131 changes the disclosure guidelines for reporting operating segments. These new standards will affect the presentation of financial statements, however, will not have an effect on reported net income or stockholders' equity. Reclassifications: Certain 1996 and 1995 amounts have been reclassified to conform to the 1997 presentation. NOTE B -- ACQUISITION On August 1, 1997, the Company completed the acquisition of Industrial Indemnity Holdings, Inc. ("Industrial") from Talegen Holdings, Inc., a subsidiary of Xerox Corporation ("Talegen"). Industrial specializes in underwriting workers' compensation insurance with a strong presence in the western United States dating back over 70 years. The purchase price paid by the Company consisted of $365 million in cash and $9.5 million in acquisition costs bringing the total cost of the acquisition to $374.5 million. Additionally, pursuant to the terms of the acquisition agreement, the Company paid off a $79 million outstanding debt obligation that Industrial owed to Talegen. The purchase price included $87 million of costs in excess of net 58 59 FREMONT GENERAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) assets acquired that is being amortized over 25 years and approximately $58 million of an intangible asset for the trade name that is being amortized over 40 years. The acquisition was treated as a purchase for accounting purposes. Allocation of the purchase price is subject to valuations and other studies which are not yet complete. However, management of the Company does not believe such differences will have a material impact on the results of operations or stockholders' equity. The operating results of Industrial are included in the Company's consolidated statement of income from the date of acquisition. The following unaudited pro forma consolidated data present operating results of the Company as if the acquisition of Industrial had occurred January 1, 1997 and 1996, respectively. The pro forma results are not intended to be indicative of the consolidated results of operations that would have been reported if the acquisition had occurred at the dates indicated or of the consolidated results of future operations.
YEAR ENDED DECEMBER 31, -------------------- 1997 1996 -------- -------- (MILLIONS OF DOLLARS EXCEPT PER SHARE DATA) Revenues.................................................... $1,168 $1,100 Net income.................................................. 114 92 Per share data: Net income Basic..................................................... $ 4.01 $ 3.74 Diluted................................................... 3.41 2.88
On February 22, 1995, the Company completed the acquisition of Casualty Insurance Company ("Casualty"). The purchase price paid by the Company was $250 million, plus an additional $6.5 million of acquisition related costs bringing the total cost to $256.5 million. The acquisition, accounted for as a purchase, included approximately $45 million of costs in excess of net assets acquired which is being amortized over 25 years, and approximately $15 million of an intangible asset for the trade name which is being amortized over 40 years. Income from Casualty has been included in the consolidated income statement since February 22, 1995. 59 60 FREMONT GENERAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE C -- INVESTMENTS The amortized cost and fair values of the fixed maturity investments and non-redeemable preferred stock by major category are summarized in the following table:
GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE ---------- ---------- ---------- ---------- (THOUSANDS OF DOLLARS) At December 31, 1997 United States Treasury securities and obligations of other US government agencies and corporations.................................. $ 165,847 $ 2,972 $ 31 $ 168,788 Obligations of states and political subdivisions.................................. 99,876 2,023 -- 101,899 Redeemable preferred stock....................... 27,618 732 -- 28,350 Mortgage-backed securities....................... 560,015 15,356 11 575,360 Corporate securities Banks......................................... 9,374 199 -- 9,573 Financial..................................... 373,630 16,939 1,570 388,999 Transporation................................. 7,139 2,131 -- 9,270 Industrial.................................... 591,587 25,801 5,751 611,637 ---------- ------- ------- ---------- Total.................................... 1,835,086 66,153 7,363 1,893,876 Non-redeemable preferred stock................... 356,223 22,758 149 378,832 ---------- ------- ------- ---------- Total.................................... $2,191,309 $88,911 $ 7,512 $2,272,708 ========== ======= ======= ========== At December 31, 1996 United States Treasury securities and obligations of other US government agencies and corporations.................................. $ 70,039 $ 6,621 $ 346 $ 76,314 Mortgage-backed securities....................... 324,011 2,202 17,985 308,228 Corporate securities Banks......................................... 35,000 193 38 35,155 Financial..................................... 115,382 3,416 355 118,443 Transporation................................. 27,163 396 -- 27,559 Industrial.................................... 432,653 9,192 2,397 439,448 ---------- ------- ------- ---------- Total.................................... 1,004,248 22,020 21,121 1,005,147 Non-redeemable preferred stock................... 351,812 7,477 4,331 354,958 ---------- ------- ------- ---------- Total.................................... $1,356,060 $29,497 $25,452 $1,360,105 ========== ======= ======= ==========
60 61 FREMONT GENERAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The amortized cost and fair value of fixed maturity investments at December 31, 1997 by contractual maturity, are summarized in the following table:
AMORTIZED FAIR COST VALUE ---------- ---------- (THOUSANDS OF DOLLARS) One year or less............................................ $ 21,085 $ 21,161 Over 1 year through 5 years................................. 115,270 115,871 Over 5 years through 10 years............................... 132,025 132,130 Over 10 years............................................... 1,006,691 1,049,354 Mortgage-backed securities.................................. 560,015 575,360 ---------- ---------- Totals............................................ $1,835,086 $1,893,876 ========== ==========
The contractual maturities in the foregoing table may differ from actual maturities because certain borrowers have the right to sell or repay obligations with or without call or prepayment penalties. Proceeds from sales of securities and related realized gains and losses are summarized in the following table:
YEAR ENDED DECEMBER 31, ------------------------------------ 1997 1996 1995 ---------- ---------- ---------- (THOUSANDS OF DOLLARS) Proceeds from sales............................. $3,936,908 $1,679,631 $2,000,772 Gross realized gains............................ 51,413 10,012 20,923 Gross realized losses........................... 53,377 11,670 20,922
Investment income by major category of investments is summarized in the following table:
YEAR ENDED DECEMBER 31, ------------------------------ 1997 1996 1995 -------- -------- -------- (THOUSANDS OF DOLLARS) Fixed maturities.................................... $111,798 $ 85,352 $ 75,581 Non-redeemable preferred stock...................... 29,343 25,545 25,661 Short-term.......................................... 10,804 14,646 19,354 Other............................................... 299 147 109 -------- -------- -------- 152,244 125,690 120,705 Investment expenses................................. 2,515 2,159 1,182 -------- -------- -------- Net investment income..................... $149,729 $123,531 $119,523 ======== ======== ========
The Company relies on external rating agencies to establish quality ratings for its investments. The Company only purchases securities that are rated investment grade by at least one rating agency, but may hold investments that are subsequently downgraded to non-investment grade. As of December 31, 1997, all investments held by the Company are current as to principal and interest, with no investment in default. Included in investments is $28,350,000 of fixed maturity investments and $79,681,000 of non-redeemable preferred stock of Travelers Group, Inc. and its subsidiaries, that in total exceeds 10% of stockholders' equity 61 62 FREMONT GENERAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) at December 31, 1997. Using Standard and Poor's, Moody's and Fitch's rating services, the quality mix of the Company's fixed maturity investment portfolio at December 31, 1997 is summarized in the following table: AAA (including US government obligations)................... 37% AA.......................................................... 7 A........................................................... 32 BBB......................................................... 21 BB.......................................................... 3 ---- 100% ====
The par value of fixed maturity investments and cash totaling $1,334,407,000 at December 31, 1997 were on deposit with regulatory authorities in compliance with legal requirements related to the insurance operations. The Company currently holds no derivative financial instruments. NOTE D -- LOANS RECEIVABLE Loans receivable consist of commercial and residential real estate loans, commercial finance loans and insurance premium notes receivable. Commercial and residential real estate loans are secured by real property. Commercial finance loans are asset-based loans that are secured by the borrowers' eligible trade accounts receivable, inventories, equipment and real estate. Insurance premium notes receivable are collateralized by security interests in return premiums. The Company's thrift and loan subsidiary generates primarily real estate loans. Commercial and residential real estate loans have terms ranging from one to thirty years. Finance charges are recognized as revenue over the life of the loan using the interest method. Loan origination fees and the related costs are deferred and amortized over the life of the loan using the interest method. The loans are net of allowance for possible loan losses of $33,341,000 and $24,759,000 at December 31, 1997, and 1996, respectively. Included in loans receivable are real estate loans which have been placed on non-accrual status totaling $24,139,000 and $17,439,000 at December 31, 1997 and 1996, respectively. Real estate acquired in foreclosure, which is classified under other assets, totaled $8,021,000 and $10,016,000 at December 31, 1997 and 1996, respectively, and is recorded at the lower of the carrying value of the loan or the estimated fair value less disposal costs. Commercial finance loans are stated at the unpaid balance of cash advanced net of allowance for possible loan losses of $11,061,000 and $11,933,000 at December 31, 1997 and 1996, respectively. The amount of cash advanced under these loans is based on stated percentages of the borrowers' eligible collateral. Interest on the commercial loans is computed on the basis of daily outstanding balances times the contractual interest rate and is reported as earned income on the accrual method. Total loan balances on which income recognition has been suspended were $7,386,000 (seven loans) and $2,346,000 (three loans) at December 31, 1997 and 1996, respectively. Insurance premium notes receivable mature within one year. Interest income on these notes is recognized using the rule-of-seventy-eight method which results in approximately level interest rate yield over the life of the notes. 62 63 FREMONT GENERAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Activity in the allowance for possible loan losses is summarized in the following table:
YEAR ENDED DECEMBER 31, --------------------------- 1997 1996 1995 ------- ------- ------- (THOUSANDS OF DOLLARS) Balance, beginning of year............................. $37,747 $31,781 $27,406 Provision for loan losses.............................. 12,319 13,885 14,575 Recoveries............................................. 1,294 1,394 2,961 Charge-offs............................................ (6,958) (11,143) (13,161) Reserves established with portfolio acquisitions....... -- 1,830 -- ------- ------- ------- Balance, end of year................................... $44,402 $37,747 $31,781 ======= ======= =======
At December 31, 1997, the recorded investment in loans that are considered to be impaired was $31,806,000, of which $31,525,000 were on a non-accrual basis. The Company's policy is to consider a loan impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Evaluation of a loan's collectability is based on the present value of expected cash flows or the fair value of the collateral, if the loan is collateral dependent. As a result of charge-offs, these impaired loans do not necessarily have a related specific reserve for credit losses allocated to them. However, $23,239,000 of loans considered impaired do have an allowance that totaled $2,981,000. The average net investment in impaired loans was $27,391,000, $26,833,000 and $31,325,000 for 1997, 1996 and 1995, respectively. Interest income of $892,000 has been recognized on the cash basis of accounting on loans classified as impaired during the year ended December 31, 1997. The carrying amounts at December 31, 1997 and 1996 and estimated fair values at December 31, 1997 of loans receivable are summarized in the following table:
1997 1996 ------------------------ ---------- CARRYING ESTIMATED CARRYING AMOUNT FAIR VALUE AMOUNT ---------- ---------- ---------- (THOUSANDS OF DOLLARS) Real estate loans.............................. $1,433,168 $1,457,868 $1,122,578 Commercial finance, insurance premium finance and other loans.............................. 605,938 605,938 618,503 ---------- ---------- ---------- 2,039,106 2,063,806 1,741,081 Purchase discount and deferred fees............ (11,017) (11,017) (15,294) Allowance for possible loan losses............. (44,402) (44,402) (37,747) ---------- ---------- ---------- Loans receivable............................... $1,983,687 $2,008,387 $1,688,040 ========== ========== ==========
NOTE E -- CLAIM LIABILITIES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES The following table provides a reconciliation of the beginning and ending reserve balances for the Company's claim liabilities for losses and loss adjustment expenses ("LAE") on a net-of-reinsurance basis to the gross amounts reported in the Company's consolidated balance sheets. 63 64 FREMONT GENERAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEAR ENDED DECEMBER 31, -------------------------------------- 1997 1996 1995 ---------- ---------- ---------- (THOUSANDS OF DOLLARS) Reserves for losses and LAE, net of reinsurance recoverable, at beginning of year............ $1,010,886 $1,185,706 $ 610,510 Incurred losses and LAE: Provision for insured events of the current year, net of reinsurance.................. 441,524 334,657 459,951 Increase (decrease) in provision for insured events of prior years, net of reinsurance............................... (52,323) 750 1,382 ---------- ---------- ---------- Total incurred losses and LAE............. 389,201 335,407 461,333 Payments: Losses and LAE, net of reinsurance, attributable to insured events of: Current year.............................. (253,323) (108,247) (132,358) Prior years............................... (386,469) (401,980) (358,423) ---------- ---------- ---------- Total payments.......................... (639,792) (510,227) (490,781) ---------- ---------- ---------- Subtotal............................. 760,295 1,010,886 581,062 Liability for losses and LAE for companies acquired during the year..................... 1,049,100 -- 604,644 ---------- ---------- ---------- Reserves for losses and LAE, net of reinsurance recoverable, at end of year.................. 1,809,395 1,010,886 1,185,706 Reinsurance recoverable for losses and LAE, at end of year.................................. 353,928 245,459 269,986 ---------- ---------- ---------- Reserves for losses and LAE, gross of reinsurance recoverable, at end of year...... $2,163,323 $1,256,345 $1,455,692 ========== ========== ==========
In 1996 and 1995, there was relatively insignificant aggregate development on prior accident years. In 1997, the Company decreased its losses and LAE reserves for 1996 and prior accident years by $52.3 million. This reserve decrease relates primarily to loss and LAE reserves on workers' compensation policies written in the Company's mid-west region and represents the recognition of a decrease in the frequency of reported claims on the 1996 and 1995 accident years. Additionally, the Company's management believes that its implementation of more effective claims handling procedures in the mid-west region has contributed to the reduction in LAE reserves during calendar year 1997 and relating to the 1996 and prior accident years. The Company is not able to determine with certainty the specific cause or causes of increases and decreases in claims experience that led to these changes in reserves but has reached its own conclusion based on a review of its internal data base and a subjective evaluation of external factors. NOTE F -- 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. Reinsurance contracts do not relieve the Company from its obligations to policyholders. The failure of reinsurers to honor their obligations could result in losses to the Company; consequently, allowances are established for amounts deemed uncollectible. The Company evaluates the financial condition and economic characteristics of its reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. 64 65 FREMONT GENERAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The effect of ceded reinsurance on property and casualty premiums are summarized in the following table:
YEAR ENDED DECEMBER 31, --------------------------------------------------------------- 1997 1996 1995 ------------------- ------------------- ------------------- WRITTEN EARNED WRITTEN EARNED WRITTEN EARNED -------- -------- -------- -------- -------- -------- (THOUSANDS OF DOLLARS) Direct............................. $611,211 $591,506 $462,881 $470,111 $564,675 $580,442 Assumed............................ 19,647 23,650 18,839 25,075 41,613 55,572 Ceded.............................. 9,766 13,973 7,536 8,326 22,498 29,097 -------- -------- -------- -------- -------- -------- Net property and casualty premiums...................... $621,092 $601,183 $474,184 $486,860 $583,790 $606,917 ======== ======== ======== ======== ======== ========
The effect of ceded reinsurance on losses and loss adjustment expenses was a decrease in expenses of $14,167,000, $13,617,000 and $19,651,000 for the three years ended December 31, 1997, 1996 and 1995, respectively. The Company entered into reinsurance and assumption agreements with a reinsurer whereby substantially all of the Company's universal life insurance and annuity business was ceded to the reinsurer effective December 31, 1995, and all the annuity business was ceded to the reinsurer effective January 1, 1996. As a result of these agreements, the Company's life insurance operations have been substantially reduced of with no significant gain or loss recorded. Included in life insurance benefits and liabilities and reinsurance recoverable on unpaid losses in the accompanying balance sheet is approximately $169,000,000 related to one of the reinsurance contracts that continues to be on a coinsurance basis. NOTE G -- INCOME TAXES The major components of income tax expense are summarized in the following table:
YEAR ENDED DECEMBER 31, --------------------------- 1997 1996 1995 ------- ------- ------- (THOUSANDS OF DOLLARS) Federal income tax Current.............................................. $29,225 $13,233 $ 6,964 Deferred............................................. 18,360 24,798 22,810 ------- ------- ------- 47,585 38,031 29,774 State income tax....................................... 3,016 2,990 2,531 ------- ------- ------- Total income tax provision........................... $50,601 $41,021 $32,305 ======= ======= =======
65 66 FREMONT GENERAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) A reconciliation of the effective federal tax rates in the consolidated statements of income with the prevailing federal income tax rate of 35% is summarized in the following table:
YEAR ENDED DECEMBER 31, --------------------------- 1997 1996 1995 ------- ------- ------- (THOUSANDS OF DOLLARS) Federal income tax at 35%.............................. $55,613 $44,908 $35,114 Effects of: Dividends received deduction......................... (5,654) (6,238) (5,678) Dividends in stock-based deferred compensation....... (785) (357) (432) Amortization of costs in excess of net assets acquired.......................................... 1,810 1,269 839 Reduction in prior years' tax liabilities............ (2,336) -- -- Other................................................ (1,063) (1,551) (69) ------- ------- ------- Federal income tax provision........................... $47,585 $38,031 $29,774 ======= ======= =======
In 1997, the Company reversed $2,336,000 of a previously accrued amount as a result of the expected favorable resolution of certain tax matters. Net payments made (net cash received) for federal and state income taxes were $(7,876,000), $778,000, and $13,429,000 for 1997, 1996 and 1995, respectively. The deferred income tax balance includes the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and for income tax purposes. The components of the Company's deferred tax assets as of December 31, 1997 and 1996 are summarized in the following table:
DECEMBER 31, -------------------- 1997 1996 -------- -------- (THOUSANDS OF DOLLARS) Discount on liabilities for losses and loss adjustment expenses.................................................. $116,350 $ 56,623 Accrued expenses............................................ 30,152 2,295 Employee benefit expenses................................... 18,352 2,104 Allowance for possible loan losses and other doubtful accounts.................................................. 17,646 14,578 Unearned premiums........................................... 11,365 8,009 Dividends to policyholders.................................. 9,374 11,578 Other, net.................................................. 7,002 -- -------- -------- Deferred income tax asset amounts......................... 210,241 95,187 Net unrealized gain on investments.......................... (28,489) (1,416) Deferred policy acquisition costs........................... (13,301) (8,937) Earned but unbilled premiums................................ (12,294) (9,057) Deferred loan origination costs............................. (6,113) (5,230) Accrual of market discount.................................. (1,287) (3,463) Other, net.................................................. -- (3,049) -------- -------- Deferred income tax liability amounts..................... (61,484) (31,152) -------- -------- Net deferred income tax asset.......................... $148,757 $ 64,035 ======== ========
The Company's principal deferred tax assets arise due to the discounting of liabilities for losses and loss adjustment expenses ("loss reserves") which delays a portion of the loss reserve deduction for income tax 66 67 FREMONT GENERAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) purposes, the provision for doubtful loan accounts, the accrual of dividends to policyholders, a portion of the unearned premiums, certain accrued expenses, and certain employee benefit expenses. In the Company's opinion, the deferred tax assets will be fully realized and no valuation allowance is necessary because the Company has the ability to generate sufficient future taxable income in both the insurance and financial services segments to realize the tax benefits. NOTE H -- SHORT-TERM DEBT Short-term debt is summarized in the following table:
DECEMBER 31, ------------------ 1997 1996 ------- ------- (THOUSANDS OF DOLLARS) Commercial paper facility of a subsidiary, maturity dates through January 6, 1998 (weighted average interest rate, 1997 -- 6.57%; 1996 -- 5.67%)............................. $12,990 $14,929 Current portion of long-term debt........................... 13,300 1,967 ------- ------- $26,290 $16,896 ======= =======
At December 31, 1997, the thrift and loan subsidiary had a borrowing capacity with the Federal Home Loan Board of San Francisco in excess of $325 million of which there were no outstanding advances. This subsidiary has pledged certain loans to secure any future borrowings which are available at varying rates and terms. The commercial finance subsidiary has lines of credit totaling $15,000,000 that expire July 31, 1998. Interest is based on the prime lending rate. At December 31, 1997, there were no outstanding advances under these lines of credit. NOTE I -- LONG-TERM DEBT Long-term debt is summarized in the following table:
DECEMBER 31, -------------------- 1997 1996 -------- -------- (THOUSANDS OF DOLLARS) Fremont General Corporation Liquid Yield Option Notes due 2013, less discount (1997 -- $18,976; 1996 -- $172,517).................... $ 15,525 $128,728 $400 million Revolving Credit Facility.................... 240,000 10,000 Note Payable due 2002..................................... 8,583 11,674 Subsidiaries: Variable Rate Asset Backed Certificates................... 274,260 265,000 $450 million Bank Line of Credit.......................... 166,000 223,000 Other Note Payable, interest rate -- 7.25%................ -- 21 -------- -------- 704,368 638,423 Less current portion........................................ 13,300 1,967 -------- -------- $691,068 $636,456 ======== ========
In August 1997, the Company amended and restated an agreement on a $400,000,000 Revolving Credit Facility with several banks. Borrowings and repayments are a minimum of $5,000,000 at the option of the Company until the maturity date in 2002. Interest is based on, at the Company's option, the higher of the Federal Funds rate plus 1/2% or the banks' prime lending rate, Eurodollar rates plus an applicable margin or by 67 68 FREMONT GENERAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) competitive bids by the banks. All applicable margins are based on the Company's credit rating. The weighted average interest rate at December 31, 1997 on the outstanding balance of $240,000,000 was 6.30%. A facility fee ranging from .125% to .300%, dependent on the Company's credit rating, is charged on the total facility. The facility fee rate during 1997 was .175%. The stock of a subsidiary insurance holding company has been pledged as collateral for this loan. During July 1994, the Fremont General Employee Stock Ownership Plan ("ESOP") borrowed $11,000,000 (see Note L) from a bank due in seven equal annual installments commencing on April 1, 1996. The maximum principal amount of this loan was increased to $15 million in August, 1995 and the term was extended to April 1, 2002. The Note Payable due 2002 is secured by certain shares of the ESOP and the interest and principal payments are guaranteed by the Company. Interest is based on, at the Company's option, the bank's prime lending rate, LIBOR plus 1%, or an applicable certificate of deposit rate. The interest rate at December 31, 1997 was 6.906% . In 1993, the Company sold in a public offering an aggregate $373,750,000 principal amount at maturity of Liquid Yield Option Notes due October 12, 2013 (Zero Coupon-Subordinated) (the "LYONs") at an issue price of $372.42 for a total net proceeds to the Company of approximately $135,000,000. The yield to maturity is 5% with no periodic payments of interest. Each LYON is convertible into 19.287 shares of the Company's Common Stock and is non-callable for five years. Holders converted aggregate principal amounts of $266,744,000 and $72,505,000 of LYONs into 5,145,000 and 1,398,000 shares of the Company's Common Stock during 1997 and 1996, respectively. The Variable Rate Asset Backed Certificates reflect the sale of certificates pursuant to an asset securitization program established by the commercial finance subsidiary of the Company in 1993. As of December 31, 1997, an aggregate $235 million of senior series and a $39 million of subordinated series of term asset-backed certificates were outstanding. The interest rate on the certificates, set monthly, ranged from LIBOR plus 0.23% to LIBOR plus 0.95% at December 31, 1997. The securities issued in this program have a scheduled maturity of two to four years but could mature earlier depending on fluctuations in the outstanding balances of loans in the portfolio and other factors. This subsidiary also has an agreement for a committed bank line of credit totaling $450 million. The total commitment includes a revolving credit facility of $350 million expiring June 2002 and a term loan of $100 million maturing July 2001. The balance outstanding at December 31, 1997 of the revolving credit facility and the term loan was $66 million and $100 million, respectively, with a weighted average interest rate of 6.32%. The carrying amounts and the estimated fair values of long-term borrowings at December 31, 1997 are summarized in the following table:
CARRYING ESTIMATED AMOUNT FAIR VALUE -------- ---------- (THOUSANDS OF DOLLARS) LYONs....................................................... $ 15,525 $ 30,016 Variable Rate Asset Backed Certificates..................... 274,260 274,260 $400 million Revolving Credit Facility...................... 240,000 240,000 $450 million Bank Line of Credit............................ 166,000 166,000 Note Payable due 2002....................................... 8,583 8,583 -------- -------- Total long-term borrowings............................. $704,368 $718,859 ======== ========
68 69 FREMONT GENERAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The aggregate amount of maturities on long-term debt and sinking fund requirements are summarized in the following table (thousands of dollars): 1998............................................ $ 13,300 1999............................................ 26,946 2000............................................ 204,446 2001............................................ 26,946 2002............................................ 417,205 Thereafter...................................... 15,525 -------- $704,368 ========
Total interest payments on short-term and long-term debt were $125,048,000, $101,515,000, and $91,278,000 in 1997, 1996 and 1995, respectively. NOTE J -- COMPANY OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY TRUST HOLDING SOLELY COMPANY JUNIOR SUBORDINATED DEBENTURES On March 1, 1996, Fremont General Financing I, a statutory business trust (the "Trust") and consolidated wholly-owned subsidiary of the Company, sold $100 million of 9% Trust Originated Preferred Securities(SM) ("the Preferred Securities") in a public offering. The Preferred Securities represent preferred undivided beneficial interests in the assets of the Trust. The proceeds from the sale of the Preferred Securities were invested in 9% Junior Subordinated Debentures of the Company ("the Junior Subordinated Debentures"). The $100 million Junior Subordinated Debentures are the sole asset of the Trust. The Preferred Securities will be redeemed upon maturity of the Junior Subordinated Debentures in 2026, subject to the election available to the Company to extend the maturity up to 2045, and they may be redeemed, in whole or in part, at any time on or after March 31, 2001 and under certain specified circumstances. The Junior Subordinated Debentures rank pari passu with the Company's $34,501,000 million aggregate principal amount at maturity of LYONs due 2013, and subordinate and junior to all senior indebtedness of the Company. (See Note I.) Payment of distributions out of cash held by the Trust, and payments on liquidation of the Trust or the redemption of the Preferred Securities are guaranteed by the Company to the extent that the Trust has funds available to make such payments. Trust distributions of $9,000,000 and $7,375,000 in 1997 and 1996, respectively were included in interest expense. The Company has provided for back-up undertakings that, considered together, constitute a full and unconditional guarantee by the Company of the Trust's obligations under the Preferred Securities. NOTE K -- STOCKHOLDERS' EQUITY AND RESTRICTIONS The Company is authorized to issue up to 2,000,000 shares of $.01 par value Preferred Stock; however none has been issued to date. Consolidated stockholders' equity is restricted by the provisions of certain long-term debt agreements. At December 31, 1997, the most restrictive loan covenants require the Company to maintain total stockholders' equity of at least $475,000,000 before FASB 115 adjustments. The Company has a stock option plan for the benefit of certain key members of management. Under the plan, up to 2,681,000 shares are allocable to participants. Options are granted at exercise prices not less than the fair value of the stock on the date of grant. Grantees vest at the rate of 25% per year beginning on the first anniversary of the grant and expire after ten years. 69 70 FREMONT GENERAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The Company has elected to continue following Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" for measuring compensation cost and to adopt the additional disclosure provisions of FASB Statement No. 123 ("FASB 123") "Accounting for Stock-Based Compensation." Pro forma net income, basic and diluted earnings per share data for the year ended December 31, 1997, calculated as if the recognition and measurement provisions of FASB 123 had been adopted, would have been $107,165,000, $3.76 and $3.20, respectively, compared to reported net income, basic and diluted earnings per share of $108,292,000, $3.80 and $3.23, respectively. For the years ended December 31, 1996 and 1995, the pro forma effect would have increased compensation expense by $16,000 and $10,000, respectively, with no effect on earnings per share. The pro forma effects are not likely to be representative of the effects on reported net income for future years because FASB 123 has not been applied to options granted prior to January 1, 1995. The Black-Scholes option pricing method was used to value the options as of the grant date with the following assumptions: risk-free interest rate of 5.68%; expected life of 7 years; expected volatility of 23% and expected dividend yield of 1.13%. The calculated fair value of the options granted during 1997 was $10.06. The stock option activity is summarized in the following table:
NUMBER WEIGHTED AVERAGE OF SHARES EXERCISE PRICE ---------- ---------------- Outstanding at January 1, 1995........................ 1,799,606 $10.34 Granted............................................. 30,940 15.68 Exercised........................................... (19,489) 10.53 Forfeited........................................... (11,015) 13.69 ---------- Outstanding at December 31, 1995...................... 1,800,042 10.41 Exercised........................................... (170,218) 8.02 Forfeited........................................... (39,353) 14.15 ---------- Outstanding at December 31, 1996...................... 1,590,471 10.57 Granted............................................. 846,000 29.79 Exercised........................................... (1,335,097) 9.83 ---------- Outstanding at December 31, 1997...................... 1,101,374 26.23 ==========
The exercise prices of the option shares outstanding at December 31, 1997 range from $8.889 to $29.875. The weighted average remaining contractual life is approximately six and one-half years for the 255,374 option shares that range from $8.889 to $15.682 per share and nine years for the 846,000 option shares that range from $28.00 to $29.875 per share. The number of shares exercisable at the end of the year and related weighted average exercise prices are summarized in the following table:
DECEMBER 31, ------------------------------- 1997 1996 1995 ------- --------- --------- Shares exercisable.................................. 160,089 1,358,159 1,319,748 Related weighted average exercise price............. $14.28 $9.86 $9.05
The portion of the consolidated stockholders' equity represented by the Company's investment in its insurance subsidiaries and its thrift and loan subsidiary is subject to various laws and regulations, whereby amounts available for payment of dividends are restricted. Retained earnings and additional paid-in capital of the property and casualty companies currently available for dividend distribution is $67,753,000. No dividends are currently available from the thrift and loan subsidiary. 70 71 FREMONT GENERAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Net income and stockholders' equity of domestic insurance subsidiaries, as filed with regulatory authorities on the basis of statutory accounting practices, are summarized in the following table:
1997 1996 1995 -------- -------- -------- (THOUSANDS OF DOLLARS) Statutory net income for the year................... $113,058 $122,988 $104,032 Statutory stockholder's equity at year end.......... 567,470 438,203 321,148
During 1996, the Company issued 1,301,000 common shares with a fair value of approximately $33 million to fund stock-based compensation programs. (See Note L.) On December 4, 1995, the Board of Directors declared a three-for-two Common Stock split for stockholders of record on January 8, 1996 that was distributed on February 7, 1996. Also during 1995, a ten percent stock dividend was distributed June 15, 1995 to stockholders of record May 30, 1995. NOTE L -- EMPLOYEE BENEFIT PLANS The Company sponsors a 401(k) Plan and a leveraged Employee Stock Ownership Plan ("ESOP"), both of which cover substantially all employees with at least one year of service. Contribution expense for these plans amounted to $10,681,000, $6,005,000, and $11,015,000 for 1997, 1996 and 1995, respectively, of which $5,844,000, $3,115,000 and $8,656,000 related to the ESOP. Cash contributions to the ESOP, which relate to 1997, 1996 and 1995, were $2,028,000, $3,090,000 and $3,000,000, respectively. The contributions, which are generally discretionary, are based on total compensation of the participants. Shares pledged as collateral under a loan made to the ESOP by a bank (see Note I) are reported as deferred compensation in the consolidated balance sheet. The annual contributions made by the Company to the ESOP are used to repay the loan. As the debt is repaid, shares are released from collateral and are allocated to participants based on total compensation. Dividends received by the ESOP on its pledged shares, amounting to $325,000, $391,000 and $374,000 in 1997, 1996 and 1995, respectively, were additionally used to service these loans. Interest expense was $467,000, $392,000 and $196,000 for 1997, 1996 and 1995, respectively. In May of 1996, an additional 341,000 shares of the Company's Common Stock were acquired by the ESOP. Of the 2,678,000 total shares of Company stock owned by the ESOP at December 31, 1997, 2,136,000 shares are allocated to participants and 542,000 shares are not allocated to participants and are considered unearned. Unearned shares acquired prior to January 1, 1993 (201,000 shares as of December 31, 1997) continue to be accounted for in accordance with the historical cost approach (AICPA Statement of Opinion 76-3). Unearned shares acquired subsequent to December 31, 1992 (341,000 shares as of December 31, 1997) are accounted for in accordance with the current fair value approach (AICPA Statement of Position 93-6) and are not considered outstanding for earnings per share purposes. At December 31, 1997, the fair value of the unearned shares accounted for under the current fair value approach was $18,674,000. During 1996, the Company adopted a Restricted Stock Award Plan ("RSAP") for certain management level employees. In 1997, the Company purchased an aggregate of 478,000 shares at an aggregate cost of approximately $22 million to fund this plan. During 1996, the Company purchased an aggregate of 824,000 shares at an aggregate cost of approximately $20 million and issued 1,244,000 shares with a fair value at the date of award of approximately $33 million to fund this plan. Amounts awarded under the RSAP are amortized over 10 years. Amortization expense for the RSAP amounted to $7,536,000 and $5,277,000, for 1997 and 1996, respectively. Unamortized amounts are reported as deferred compensation in the consolidated balance sheet. 71 72 FREMONT GENERAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE M -- COMMITMENTS AND CONTINGENCIES The Company is a defendant in a number of legal actions arising primarily from claims made under insurance policies or in connection with previous reinsurance agreements. Those actions have been considered in establishing the Company's liabilities. Management and its legal counsel are of the opinion that the settlement of those actions will not have a material effect on the Company's financial position or results of operations. An insurance subsidiary of the Company outsourced its data processing operation to Electronic Data Systems in 1992. Under terms of the contract, this subsidiary will pay a minimum $7,500,000 per year for a period of ten years, until 2002. Total rental expense for 1997, 1996 and 1995, was $13,019,000, $11,120,000, and $14,909,000, respectively. The Company leases office facilities and certain equipment under non-cancelable operating leases, the terms of which range from one to ten years. Certain leases provide for an increase in the basic rental to compensate the lessor for increases in operating and maintenance costs. The leases also provide renewal options. Under present leases, rental commitments are summarized in the following table (thousands of dollars): 1998............................................ $ 30,008 1999............................................ 28,698 2000............................................ 26,926 2001............................................ 23,288 2002............................................ 18,894 Thereafter...................................... 87,135 -------- $214,949 ========
NOTE N -- DISCONTINUED OPERATIONS The Company discontinued all of its assumed reinsurance operations, as well as certain other insurance operations, during the period 1986 to 1991. These operations consisted primarily of facultative and treaty reinsurance covering primary and excess property and casualty insurance coverages. All discontinued insurance operations are accounted for using the liquidation basis of accounting whereby all future cash inflows and outflows are considered in determining whether dedicated assets are sufficient to meet all future obligations. The Company determines the adequacy of the assets dedicated to fund the liabilities of discontinued operations by: (i) estimating the ultimate remaining liabilities; (ii) discounting these liabilities using estimates of payment patterns and investment yields derived from the dedicated investment portfolio; and (iii) comparing this discounted estimate of liabilities to the dedicated assets. The Company estimates that the dedicated assets (primarily cash, investment securities and reinsurance recoverables) supporting these operations and all future cash inflows will be adequate to fund future obligations. However, should those assets ultimately prove to be insufficient, the Company believes that its property and casualty subsidiaries would be able to provide whatever additional funds might be needed to complete the liquidation without having a material adverse effect on the Company's consolidated financial position or results of operations. 72 73 FREMONT GENERAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) A statement of financial condition of the discontinued operations is summarized in the following table:
DECEMBER 31, ---------------------- 1997 1996 --------- --------- (THOUSANDS OF DOLLARS) Assets Cash and invested assets, at amortized cost............... $196,945 $200,070 Reinsurance recoverables.................................. 52,166 57,908 Other assets.............................................. 7,396 7,222 -------- -------- Total.................................................. $256,507 $265,200 ======== ======== Liabilities Reserves for loss and loss adjustment expenses............ $159,595 $170,534 Deferred income taxes..................................... 39,815 48,655 Reinsurance payable and funds withheld.................... 6,455 5,872 Other liabilities......................................... 17,128 6,625 -------- -------- Total.................................................. $222,993 $231,686 ======== ========
The amortized cost and fair value of cash and invested assets of the discontinued operations as of December 31, 1997 are summarized in the following table:
AMORTIZED COST FAIR VALUE -------------- ---------- (THOUSANDS OF DOLLARS) Fixed maturities......................................... $132,235 $134,453 Non-redeemable preferred stock........................... 47,814 51,954 Cash and other invested assets........................... 16,896 16,896 -------- -------- Cash and invested assets............................... $196,945 $203,303 ======== ========
The average maturity of the fixed income portfolio was 5.68 years at December 31, 1997. The quality mix of the fixed maturity portfolio as of December 31, 1997 is summarized in the following table: AAA (including US government obligations)................... 5% AA.......................................................... 12 A........................................................... 12 BBB......................................................... 46 BB.......................................................... 25 --- 100% ===
At December 31, 1997, all investments included in discontinued operations were current with respect to principal and interest. It is the Company's belief that the carrying value of the investments will be fully realized. 73 74 FREMONT GENERAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE O -- OPERATIONS BY INDUSTRY SEGMENT The following data for the years ended December 31, 1997, 1996 and 1995 provide certain information necessary for industry segment disclosure.
YEAR ENDED DECEMBER 31, ------------------------------------ 1997 1996 1995 ---------- ---------- ---------- (THOUSANDS OF DOLLARS) REVENUES Property and casualty........................... $ 738,072 $ 596,841 $ 708,187 Financial services.............................. 235,474 197,601 214,975 Corporate....................................... 749 1,362 652 ---------- ---------- ---------- $ 974,295 $ 795,804 $ 923,814 ========== ========== ========== INCOME (LOSS) BEFORE INCOME TAXES Property and casualty........................... $ 144,667 $ 117,593 $ 83,092 Financial services.............................. 42,286 36,589 35,737 Corporate....................................... (28,060) (25,873) (18,502) ---------- ---------- ---------- $ 158,893 $ 128,309 $ 100,327 ========== ========== ========== AMORTIZATION AND DEPRECIATION EXPENSE Property and casualty........................... $ 16,377 $ 9,680 $ 8,677 Financial services.............................. 6,403 4,772 3,032 Corporate....................................... 10,744 12,140 8,625 ---------- ---------- ---------- $ 33,524 $ 26,592 $ 20,334 ========== ========== ========== CAPITAL EXPENDITURES Property and casualty........................... $ 17,144 $ 7,232 $ 7,404 Financial services.............................. 4,815 2,813 1,931 Corporate....................................... 1,658 1,990 192 ---------- ---------- ---------- $ 23,617 $ 12,035 $ 9,527 ========== ========== ==========
YEAR ENDED DECEMBER 31, ------------------------------------ 1997 1996 1995 ---------- ---------- ---------- (THOUSANDS OF DOLLARS) IDENTIFIABLE ASSETS Property and casualty*.......................... $3,353,114 $1,890,695 $2,055,511 Financial services.............................. 2,436,976 2,122,077 2,131,412 Corporate....................................... 44,030 29,540 27,974 ---------- ---------- ---------- $5,834,120 $4,042,312 $4,214,897 ========== ========== ==========
- --------------- * Assets held for discontinued operations are excluded from the above table. 74 75 FREMONT GENERAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE P -- EARNINGS PER SHARE The following table sets forth the computation of basic and diluted earnings per share:
1997 1996 1995 ----------- ----------- ----------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Net income (numerator for basic earnings per share)......... $108,292 $ 87,288 $ 68,022 Effect of dilutive securities: LYONs..................................................... 2,527 4,547 4,489 -------- -------- -------- Income available to common stockholders after assumed conversions (numerator for diluted earnings per share).... $110,819 $ 91,835 $ 72,511 ======== ======== ======== Weighted-average shares (denominator for basic earnings per share).................................................... 28,529 24,658 25,391 Effect of dilutive securities: Restricted stock.......................................... 1,902 1,136 -- Stock options............................................. 187 968 713 LYONs..................................................... 3,675 6,841 7,209 -------- -------- -------- Dilutive potential common shares............................ 5,764 8,945 7,922 Adjusted weighted-average shares and assumed conversions (denominator for diluted earnings per share).............. 34,293 33,603 33,313 ======== ======== ======== Basic earnings per share.................................... $ 3.80 $ 3.54 $ 2.68 ======== ======== ======== Diluted earnings per share.................................. $ 3.23 $ 2.73 $ 2.18 ======== ======== ========
For additional disclosures regarding the LYONs, stock options and restricted stock see Notes I, K and L, respectively. NOTE Q -- QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
THREE MONTH PERIODS ENDED --------------------------------------------------- MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, --------- -------- ------------- ------------ (THOUSANDS OF DOLLARS, EXCEPT PER SHARE DATA) 1997 Revenues.................................. $194,735 $206,155 $267,272 $306,133 Net income................................ 24,359 24,938 28,819 30,176 Net income per share...................... 0.75 0.75 0.85 0.88 1996 Revenues.................................. $203,633 $199,708 $197,386 $195,077 Net income................................ 18,517 22,426 22,939 23,406 Net income per share...................... 0.60 0.71 0.71 0.72
Net income and net income per share increased after the quarter ended June 30, 1997 due primarily to the acquisition of Industrial which was completed on August 1, 1997. (See Note B.) Net income and net income per share increased after the quarter ended March 31, 1996 due primarily to lower incurred losses in the property and casualty insurance segment resulting from lower claim frequency in the workers' compensation operation. 75 76 FREMONT GENERAL CORPORATION (PARENT COMPANY) SCHEDULE II -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT BALANCE SHEETS ASSETS
DECEMBER 31, ---------------------- 1997 1996 ---------- -------- (THOUSANDS OF DOLLARS) Cash........................................................ $ 889 $ 1,678 Notes receivable from subsidiaries*......................... 301,609 80,218 Investment in subsidiaries*................................. 871,653 724,524 Short-term investments...................................... 15,419 6,084 Excess of cost of acquisition of subsidiaries over net assets acquired........................................... 7,221 7,549 Other receivables from subsidiaries*........................ 7,588 5,459 Amounts due from discontinued subsidiaries*................. 6,969 -- Deferred income taxes....................................... 148,757 64,035 Other assets................................................ 20,623 18,491 ---------- -------- TOTAL ASSETS.............................................. $1,380,728 $908,038 ========== ======== LIABILITIES Accrued expenses and other liabilities...................... $ 48,752 $ 13,026 Amounts due to subsidiaries*................................ 131,960 79,435 Amounts due to discontinued subsidiaries*................... -- 2,965 Notes payable to subsidiary*................................ 103,093 103,093 Current portion of long-term debt........................... 800 1,946 Long-term debt.............................................. 263,308 148,456 ---------- -------- TOTAL LIABILITIES......................................... 547,913 348,921 Commitments and contingencies STOCKHOLDERS' EQUITY Preferred Stock, par value $.01 -- authorized 2,000,000 shares; none issued Common Stock, par value $1 per share -- Authorized: 49,500,000; Issued and outstanding: (1997 - 34,571,000 and 1996 - 28,093,000)............................................ 34,571 28,093 Additional paid-in capital.................................. 323,065 168,452 Retained earnings........................................... 508,533 419,136 Deferred compensation....................................... (86,263) (59,193) Net unrealized gain on investments, net of deferred taxes... 52,909 2,629 ---------- -------- TOTAL STOCKHOLDERS' EQUITY................................ 832,815 559,117 ---------- -------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY................ $1,380,728 $908,038 ========== ========
- --------------- *Eliminated in consolidation See notes to condensed financial statements. 76 77 FREMONT GENERAL CORPORATION (PARENT COMPANY) SCHEDULE II -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF INCOME
YEAR ENDED DECEMBER 31, ------------------------------ 1997 1996 1995 -------- -------- -------- (THOUSANDS OF DOLLARS) INCOME Interest income from subsidiaries*.......................... $ 12,086 $ 5,841 $ 4,170 Dividends from consolidated subsidiaries*................... 4,278 4,228 6,051 Net investment income....................................... 650 1,357 648 Realized investment gains (losses).......................... 34 (2) -- Other income*............................................... 11,180 8,997 8,518 -------- -------- -------- TOTAL INCOME.............................................. 28,228 20,421 19,387 EXPENSES Interest expense............................................ 12,615 12,151 13,282 Interest on notes payable to subsidiary*.................... 9,278 7,603 -- General and administrative.................................. 30,723 22,868 18,883 -------- -------- -------- TOTAL EXPENSES............................................ 52,616 42,622 32,165 -------- -------- -------- (24,388) (22,201) (12,778) Income tax benefit.......................................... (14,578) (12,213) (1,632) -------- -------- -------- Loss before equity in undistributed income of subsidiary companies................................................. (9,810) (9,988) (11,146) Equity in undistributed income of subsidiary companies...... 118,102 97,276 79,168 -------- -------- -------- NET INCOME................................................ $108,292 $ 87,288 $ 68,022 ======== ======== ========
- --------------- *Eliminated in consolidation See notes to condensed financial statements. 77 78 FREMONT GENERAL CORPORATION (PARENT COMPANY) SCHEDULE II -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, --------------------------------- 1997 1996 1995 --------- --------- --------- (THOUSANDS OF DOLLARS) OPERATING ACTIVITIES Net income............................................... $ 108,292 $ 87,288 $ 68,022 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed income from continuing operations of subsidiaries........................ (118,102) (97,276) (79,168) Change in accrued investment income................. (3) 2 (1) Change in amounts due to or from subsidiaries....... (76,761) (42,999) 6,676 Provision for deferred income taxes................. 18,360 24,798 22,810 Provision for depreciation and amortization......... 10,744 12,145 8,612 Realized investment (gains) losses.................. (34) 2 -- Change in other assets and liabilities.............. 73,138 6,999 (9,002) --------- --------- --------- NET CASH PROVIDED BY (USED IN) CONTINUING OPERATIONS..................................... 15,634 (9,041) 17,949 Effect of discontinued operations...................... (9,934) (3,161) 363 --------- --------- --------- NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES........................................ 5,700 (12,202) 18,312 INVESTING ACTIVITIES Purchases of fixed maturity investments................ (11,369) (6,315) (4,988) Sales of fixed maturity investments.................... 11,403 6,310 -- Fixed maturity investments matured or called........... -- -- 5,000 Decrease (increase) in short-term and other investments......................................... (9,334) 2,469 (1,149) Net decrease (increase) in credit lines with subsidiaries........................................ (221,391) 5,092 6,094 Purchase of and additional investments in subsidiaries........................................ (10) (2,000) (81,000) Dividend from subsidiary............................... 18,000 -- -- Purchase of property and equipment..................... (1,658) (1,991) (192) --------- --------- --------- NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES........................................ (214,359) 3,565 (76,235) FINANCING ACTIVITIES Repayment of short-term debt........................... (3,092) -- (1,571) Proceeds from long-term debt........................... 265,000 41,058 110,000 Repayment of long-term debt............................ (35,000) (111,004) (42,808) Proceeds from notes due to subsidiaries................ -- 100,000 -- Dividends paid......................................... (17,838) (15,016) (12,618) Stock options exercised................................ 13,129 1,428 80 Purchase of fractional shares.......................... (1) -- (25) Decrease (increase) in deferred compensation plans..... (14,328) (6,455) 4,375 --------- --------- --------- NET CASH PROVIDED BY FINANCING ACTIVITIES........... 207,870 10,011 57,433 --------- --------- --------- INCREASE (DECREASE) IN CASH......................... (789) 1,374 (490) Cash at beginning of year.............................. 1,678 304 794 --------- --------- --------- CASH AT END OF YEAR................................. $ 889 $ 1,678 $ 304 ========= ========= =========
See notes to condensed financial statements. 78 79 FREMONT GENERAL CORPORATION (PARENT COMPANY) SCHEDULE II -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT NOTES TO CONDENSED FINANCIAL STATEMENTS NOTE 1 -- BASIS OF PRESENTATION In the parent company financial statements, the parent's investment in subsidiaries is stated at cost plus equity in undistributed earnings of subsidiaries since date of acquisition. Parent company financial statements should be read in conjunction with the Company's consolidated financial statements. 79 80 FREMONT GENERAL CORPORATION AND SUBSIDIARIES SCHEDULE III -- SUPPLEMENTARY INSURANCE INFORMATION
DECEMBER 31, YEAR ENDED DECEMBER 31, ------------------------------------------------ ---------------------------------- COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F COLUMN G COLUMN H - ----------------------- ----------- ------------ -------- -------- -------- -------- ------------ RESERVES DEFERRED FOR CLAIMS, DIVIDENDS CLAIMS, POLICY BENEFITS AND TO NET BENEFITS AND ACQUISITION SETTLEMENT UNEARNED POLICY- PREMIUM INVESTMENT SETTLEMENT SEGMENT COSTS EXPENSES PREMIUMS HOLDERS REVENUE INCOME EXPENSES - ----------------------- ------- ---------- -------- ------- -------- -------- -------- (THOUSANDS OF DOLLARS) 1997 Life insurance......... $ 450 $ 180,976 $ -- $ -- $ 696 $ 1,690 $ -- Property and casualty............. 37,564 2,163,323 78,625 37,626 601,183 138,894 389,201 ------- ---------- -------- ------- -------- -------- -------- $38,014 $2,344,299 $78,625 $37,626 $601,879 $140,584 $389,201 ======= ========== ======== ======= ======== ======== ======== 1996 Life insurance......... $ 550 $ 202,465 $ -- $ -- $ 55 $ 2,989 $ -- Property and casualty............. 25,001 1,256,345 87,422 33,093 486,860 111,637 335,407 ------- ---------- -------- ------- -------- -------- -------- $25,551 $1,458,810 $87,422 $33,093 $486,915 $114,626 $335,407 ======= ========== ======== ======= ======== ======== ======== 1995 Life insurance......... $48,938 $ 374,724 $ -- $ -- $14,469 $19,457 $ 19,928 Property and casualty............. 27,700 1,455,692 100,481 40,822 606,917 101,270 461,333 ------- ---------- -------- ------- -------- -------- -------- $76,638 $1,830,416 $100,481 $40,822 $621,386 $120,727 $481,261 ======= ========== ======== ======= ======== ======== ======== YEAR ENDED DECEMBER 31, ---------------------------------- COLUMN A COLUMN I COLUMN J COLUMN K - ----------------------- ------------ -------- -------- AMORTIZATION OF DEFERRED POLICY OTHER NET ACQUISITION OPERATING PREMIUMS SEGMENT COSTS EXPENSES WRITTEN - ----------------------- -------- ------- -------- 1997 Life insurance......... $ -- $ 3,093 $ N/A Property and casualty............. 115,899 43,551 621,092 -------- ------- -------- $115,899 $46,644 $621,092 ======== ======= ======== 1996 Life insurance......... $ -- $ 1,971 $ N/A Property and casualty............. 96,177 26,555 474,184 -------- ------- -------- $ 96,177 $28,526 $474,184 ======== ======= ======== 1995 Life insurance......... $ 7,716 $ 4,412 $ N/A Property and casualty............. 118,383 26,895 583,790 -------- ------- -------- $126,099 $31,307 $583,790 ======== ======= ========
80 81 FREMONT GENERAL CORPORATION AND SUBSIDIARIES SCHEDULE IV -- REINSURANCE
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F -------- ------------ ------------ ------------ ------------ ------------ ASSUMED PERCENTAGE CEDED TO FROM OF AMOUNT GROSS OTHER OTHER NET ASSUMED AMOUNT COMPANIES COMPANIES AMOUNT TO NET ------------ ------------ ------------ ------------ ------------ (THOUSANDS OF DOLLARS, EXCEPT PERCENTS) YEAR ENDED DECEMBER 31, 1997 Life insurance in force*.............. $ 156,866 $100,910 $ -- $ 55,956 0% ========== ======== ======= ======== Premium Revenue Life insurance premiums............. $ 2,479 $ 1,783 $ -- $ 696 0% Property and casualty............... 591,505 13,972 23,650 601,183 4% ---------- -------- ------- -------- $ 593,984 $ 15,755 $23,650 $601,879 ========== ======== ======= ======== YEAR ENDED DECEMBER 31, 1996 Life insurance in force*.............. $ 324,368 $257,552 $ -- $ 66,816 0% ========== ======== ======= ======== Premium Revenue Life insurance premiums............. $ 263 $ 208 $ -- $ 55 0% Property and casualty............... 469,912 8,326 25,274 486,860 5% ---------- -------- ------- -------- $ 470,175 $ 8,534 $25,274 $486,915 ========== ======== ======= ======== YEAR ENDED DECEMBER 31, 1995 Life insurance in force*.............. $1,513,199 $822,309 $ 8,742 $699,632 1% ========== ======== ======= ======== Premium Revenue Life insurance premiums............. $ 15,166 $ 2,333 $ 1,636 $ 14,469 11% Property and casualty............... 579,845 29,097 56,169 606,917 9% ---------- -------- ------- -------- $ 595,011 $ 31,430 $57,805 $621,386 ========== ======== ======= ========
- --------------- * Balance at end of year. Intercompany transactions have been eliminated. 81 82 FREMONT GENERAL CORPORATION AND SUBSIDIARIES SCHEDULE V -- VALUATION AND QUALIFYING ACCOUNTS
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E - --------------------------------------- ---------- --------------------------- ---------- ---------- ADDITIONS --------------------------- BALANCE AT CHARGED TO CHARGED TO BALANCE AT BEGINNING COSTS AND OTHER ACCOUNTS DEDUCTIONS END DESCRIPTION OF PERIOD EXPENSES DESCRIBE DESCRIBE OF PERIOD - --------------------------------------- ---------- ---------- -------------- ---------- ---------- (THOUSANDS OF DOLLARS) YEAR ENDED DECEMBER 31, 1997 Deducted from asset accounts: Allowance for possible loan losses... $37,747 $12,319 $ -- $ 5,664(1) $44,402 Premiums receivable and agents' balances and reinsurance recoverable....................... 7,401 252 -- 605(1) 7,048 ------- ------- ------- ------- ------- Totals............................ $45,148 $12,571 $ -- $ 6,269 $51,450 ======= ======= ======= ======= ======= YEAR ENDED DECEMBER 31, 1996 Deducted from asset accounts: Allowance for possible loan losses... $31,781 $13,885 $ 1,830(2) $ 9,749(1) $37,747 Premiums receivable and agents' balances and reinsurance recoverable....................... 11,147 -- -- 3,746(1) 7,401 ------- ------- ------- ------- ------- Totals............................ $42,928 $13,885 $ 1,830 $13,495 $45,148 ======= ======= ======= ======= ======= YEAR ENDED DECEMBER 31, 1995 Deducted from asset accounts: Allowance for possible loan losses... $27,406 $14,575 $ -- $10,200(1) $31,781 Premiums receivable and agents' balances and reinsurance recoverable....................... 6,959 2,465 1,723(2) -- 11,147 ------- ------- ------- ------- ------- Totals............................ $34,365 $17,040 $ 1,723 $10,200 $42,928 ======= ======= ======= ======= =======
- --------------- (1) Uncollectible accounts written off, net of recoveries and reclassifications. (2) Reserves established with company and portfolio acquisitions. 82 83 FREMONT GENERAL CORPORATION AND SUBSIDIARIES SCHEDULE VI -- SUPPLEMENTAL INFORMATION CONCERNING PROPERTY/ CASUALTY INSURANCE OPERATIONS
DECEMBER 31, YEAR ENDED DECEMBER 31, ---------------------------------------------------- -------------------------------------------- COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F COLUMN G COLUMN H - --------------------------- ----------- ------------ ----------- --------- --------- ---------- ------------------- CLAIMS AND CLAIM ADJUSTMENT RESERVES FOR EXPENSES INCURRED UNPAID RELATED TO DEFERRED CLAIMS AND DISCOUNT IF ------------------- POLICY CLAIM ANY NET (1) (2) ACQUISITION ADJUSTMENT DEDUCTED IN UNEARNED EARNED INVESTMENT CURRENT PRIOR AFFILIATION WITH REGISTRANT COSTS EXPENSES COLUMN C PREMIUMS PREMIUMS INCOME YEAR YEARS - --------------------------- ----------- ------------ ----------- --------- --------- ---------- -------- -------- (THOUSANDS OF DOLLARS) Fremont Compensation Insurance Group and Consolidated Subsidiaries 1997.................. $37,564 $ 2,163,323 $19,782 $ 78,625 $601,183 $138,894 $441,524 $(52,323) 1996.................. $25,001 $ 1,256,345 $22,658 $ 87,422 $486,860 $111,637 $334,657 $ 750 1995.................. $27,700 $ 1,455,692 $23,126 $100,481 $606,917 $101,270 $459,951 $ 1,382 YEAR ENDED DECEMBER 31, -------------------------------------- COLUMN A COLUMN I COLUMN J COLUMN K - --------------------------- ------------ ---------- ---------- AMORTIZATION PAID OF DEFERRED CLAIMS AND POLICY CLAIM NET ACQUISITION ADJUSTMENT PREMIUMS AFFILIATION WITH REGISTRANT COSTS EXPENSES WRITTEN - --------------------------- ------------ ---------- ---------- (THOUSANDS OF DOLLARS) Fremont Compensation Insura Consolidated Subsidiaries 1997.................. $115,899 $639,792 $621,092 1996.................. $ 96,177 $510,227 $474,184 1995.................. $118,383 $490,781 $583,790
83 84 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 the 27th day of March 1998. FREMONT GENERAL CORPORATION /s/ JOHN A. DONALDSON By: -------------------------------------- John A. Donaldson Title: Senior Vice President, Controller and Chief Accounting Officer (Principal Accounting Officer) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons in the capacities and on the dates indicated.
SIGNATURE TITLE DATE --------- ----- ---- /s/ JAMES A. MCINTYRE Chairman of the Board March 27, 1998 - --------------------------------------------- and Chief Executive Officer James A. McIntyre (Principal Executive Officer) /s/ LOUIS J. RAMPINO President, Chief Operating Officer March 27, 1998 - --------------------------------------------- and Director Louis J. Rampino /s/ WAYNE R. BAILEY Executive Vice President, Treasurer, March 27, 1998 - --------------------------------------------- Chief Financial Officer and Director Wayne R. Bailey (Principal Financial Officer) /s/ JOHN A. DONALDSON Senior Vice President, Controller and March 27, 1998 - --------------------------------------------- Chief Accounting Officer John A. Donaldson (Principal Accounting Officer) /s/ HOUSTON I. FLOURNOY Director March 27, 1998 - --------------------------------------------- Houston I. Flournoy /s/ C. DOUGLAS KRANWINKLE Director March 27, 1998 - --------------------------------------------- C. Douglas Kranwinkle /s/ DAVID W. MORRISROE Director March 27, 1998 - --------------------------------------------- David W. Morrisroe /s/ DICKINSON C. ROSS Director March 27, 1998 - --------------------------------------------- Dickinson C. Ross
84 EX-10.1(B) 2 EXHIBIT 10.1(B) 1 EXHIBIT 10-1(b) AMENDMENT NUMBER TWO TO THE FREMONT GENERAL CORPORATION EMPLOYEE STOCK OWNERSHIP PLAN Effective as of August 2, 1997, the Fremont General Corporation Employee Stock Ownership Plan (the "ESOP") is amended to provide that: FIRST: With respect to former employees of Industrial Indemnity Holdings, Inc. or its subsidiaries (collectively "II") who became Employees of Fremont General Corporation or one of its Affiliated Companies (collectively, the "Employer") following acquisition of II by the Employer (the "Acquisition Date"), service with II or any member of the controlled group of corporations which included II prior to the Acquisition Date shall be counted for eligibility and vesting purposes under the ESOP. SECOND: For purposes of allocation under the ESOP in accordance with Section 4.2(c) for the ESOP year ending December 31, 1997: (a) a former II employee who is eligible to participate in the ESOP shall be deemed to have completed "1,000 Hours of Service," and (b) the Compensation of a former II employee who is eligible to participate in the ESOP shall be limited to Compensation paid by the Employer for the period beginning with the Acquisition Date and ending on December 31, 1997. THIRD: Nothing in this amendment shall result in the reduction of the accrued benefit of any Participant. Dated: December 30, 1997 ---------------- FREMONT GENERAL CORPORATION By: /s/ RAYMOND G. MEYERS -------------------------------- RAYMOND G. MEYERS EX-10.3(C) 3 EXHIBIT 10.3(C) 1 EXHIBIT 10-3(C) AMENDMENT NUMBER FOUR TO THE FREMONT GENERAL CORPORATION AND AFFILIATED COMPANIES INVESTMENT INCENTIVE PLAN Effective as of January 1, 1997, Section 2.10 COMPENSATION, of the Fremont General Corporation and Affiliated Companies Investment Incentive Plan is amended by adding the following subparagraph (f) at the end thereof: "(f) Notwithstanding anything in this Section to the contrary, for the Plan Year ending December 31, 1997, Compensation for former employees of Industrial Indemnity Holdings, Inc. or its subsidiaries (collectively "II") who became Employees of Fremont General Corporation or one of its Affiliated Companies (collectively, the "Employer") following acquisition of II by the Employer on August 2, 1997 (the "Acquisition Date") shall be recognized as of the Acquisition Date. Nothing in this amendment shall result in the reduction of the accrued benefit of any Participant." Dated: December 30, 1997 ----------------- FREMONT GENERAL CORPORATION By: /s/ RAYMOND G. MEYERS -------------------------------- RAYMOND G. MEYERS EX-10.17 4 EXHIBIT 10.17 1 EXHIBIT 10-17 FREMONT GENERAL CORPORATION & AFFILIATED COMPANIES MANAGEMENT INCENTIVE COMPENSATION PLAN PURPOSE The Management Incentive Compensation Plan ("the Plan") gives you a personal stake in helping to make our vision for the future a reality. Most importantly, it supports our long-standing belief that our actions speak louder than words, and our results speak for themselves. The Plan is designed to encourage and reinforce performance in achieving or exceeding established pretax earnings goals, and to reward you for these achievements. The details of how you can be substantially rewarded for your contribution to Fremont General Corporation and its affiliated companies ("the Company") are described in this booklet. Please carefully read the following pages as they outline the Plan. ELIGIBILITY - - The Plan year runs from January 1 through December 31. Participants must be actively employed by the Company and in good standing at the end of the Plan year. - - Participants must be actively employed in an eligible position as of June 30 for full participation in that year's Plan. Exceptions must be approved by the Senior Vice President and Chief Administrative Officer of Fremont General Corporation. - - Participants must achieve an individual performance rating of "satisfactory" or better to be eligible. - - Participants must be employed and in good standing by the Company at the time the bonus is paid. DETERMINATION OF FUND The bonus fund for Fremont General Corporation and its affiliated companies is determined by the degree to which each company achieves its pretax earnings goal established in the annual business plan. Funding of the Plan will commence at 80% achievement of pretax earnings targets to a maximum of 120%. The bonus fund is increased as participants become eligible during the Plan year, or reduced as participants become ineligible for the Plan. For some participants, bonuses are weighted between regional or division results and company results. If the region or division achieves at least 80% of its own target, participants are eligible for a bonus based on regional or division results, even if the company does not achieve at least 80% of target. If the region or division and the company each achieve at least 80% of their respective targets, participants are eligible for a bonus based on overall company results. 1 2 BONUS OPPORTUNITIES "Target" bonus is determined by pay grade and is expressed as a percentage of annualized base salary. The personalized statement in this booklet illustrates the range (minimum, target, and maximum) of bonus opportunity for the Plan year. Bonuses are paid in the first quarter following the close of the Plan year. Bonuses are subject to all applicable tax withholding and reporting requirements then in effect. GENERAL PROVISIONS NEW HIRES/PROMOTIONS New hires and promotions occurring during the Plan year must meet the eligibility criteria to be considered an eligible participant. TRANSFERS In the event of a transfer, bonuses will be allocated to the Company where the participant was employed the majority of the Plan year. LEAVES OF ABSENCE Bonuses are calculated based on the number of months the participant worked in an eligible position. Participants on leaves of absence that extend beyond ninety (90) days during the Plan year will not be eligible for full participation. Participants on leaves of absence in excess of six (6) months during the Plan year will be disqualified from any participation in that year's bonus. CORRECTIVE ACTION OR REMEDIAL PROCEDURES If a participant engages in conduct which results in remedial procedures and/or corrective action at or before the time a bonus is paid, or the employee is otherwise not in good standing with the Company at such time, then, notwithstanding any other provisions of this Plan, all or part of any unpaid bonus may be reduced or eliminated at the sole discretion of the Company. RETIREMENT/DISABILITY/DEATH If a participant terminates employment for reasons of retirement, disability, or death, the following schedule applies:
Timing of Event Disposition of Bonus First half of Plan year (1/1 - 6/30) No bonus Last half of Plan year (7/1 - 12/31) Prorated bonus Between year end and payment of bonus Full bonus
2 3 GENERAL PROVISIONS (CONTINUED) TERMINATION Termination of employment, for the purposes of this Plan, shall mean the day the participant leaves the job, which may or may not be the last day on the Company's payroll. PLAN PARTICIPATION Participation in the Plan with respect to a certain plan year is not in and of itself to be construed as evidence of a right to participate in any subsequent plan year. For each successive plan year, participation shall be confirmed only by properly approved designation of the Employee as a participant. PLAN CHANGES AND INTERPRETATION The Company reserves the right at its sole and absolute discretion to revise, supplement, or discontinue all or part of this Plan at any time without notice. All decisions of the Company in regard to interpretation and application of the Plan shall be final and not subject for appeal or review. Furthermore, the Plan does not constitute a contract of employment or other contractual arrangement and nothing contained herein, nor any modifications subsequently adopted, shall be construed to limit the rights the Company has to terminate the Employee's employment, including the Company's right to terminate at will or without cause or notice. 3 EX-21 5 EXHIBIT 21 1 EXHIBIT 21 SUBSIDIARIES OF FREMONT GENERAL CORPORATION Each of the subsidiary companies does business under its incorporated name. 1. Domestic Subsidiaries
NAME STATE OF INCORPORATION - ---- ---------------------- Casualty Insurance Company Illinois Comstock Insurance Company California Employer's First Insurance Company California Fremont American Insurance Company California Fremont Compensation Insurance Company California Fremont Compensation Insurance Group, Inc. Delaware Fremont Financial Corporation California Fremont Funding, Inc. Delaware Fremont Health Corporation California Fremont Indemnity Company California Fremont Investment & Loan California Fremont Life Insurance Company California Fremont Pacific Insurance Company California Fremont Reinsurance Company California Industrial Indemnity Company California Industrial Indemnity Company of Alaska Alaska Industrial Indemnity Company of Idaho Idaho Industrial Indemnity Company of the Northwest Washington Investors Bancor California Menlo Life Insurance Company Arizona
2. Foreign Subsidiaries
NAME JURISDICTION OF INCORPORATION - ---- ----------------------------- Fremont Reinsurance Company, Ltd. Bermuda
EX-23 6 EXHIBIT 23 1 EXHIBIT 23 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in; the Registration Statement on Form S-8 pertaining to the Fremont General Corporation and affiliated companies Investment Incentive Program, the Registration Statement on Form S-8 pertaining to the Fremont General Corporation Supplemental Retirement Plan and Fremont General Corporation Senior Supplemental Retirement Plan, the Registration Statement on Form S-8 pertaining to the Fremont General Corporation non-qualified Stock Option Plan of 1989, the Registration Statement on Form S-8/S-3 as amended pertaining to the Fremont General Corporation 1995 Restricted Stock Award Plan, and the Registration Statement on Form S-8 pertaining to the Fremont General Corporation 1997 Stock Plan of our report dated March 20, 1998 with respect to the consolidated financial statements and schedules of Fremont General Corporation included in the Annual Report (Form 10-K) for the year ended December 31, 1997. /s/ ERNST & YOUNG LLP Los Angeles, California March 30, 1998 EX-27.1997 7 FINANCIAL DATA SCHEDULE
7 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM SEC FORM 10-K AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 0000038984 FREMONT GENERAL CORPORATION 1,000 YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 1,893,876 0 0 378,832 0 0 4,426,500 64,987 20,287 38,014 6,090,627 2,344,299 78,625 0 37,626 717,358 100,000 0 34,571 798,244 6,090,627 601,183 149,729 (1,964) 225,347 389,201 115,899 49,327 158,893 50,601 108,292 0 0 0 108,292 3.80 3.23 1,010,886 441,524 (52,323) (253,323) (386,469) 1,809,395 (52,323) Includes loans receivable, short-term and other investments. Sum of Additional paid-in capital, Retained earnings, Deferred Compensation and Net unrealized gain on investments, net of deferred taxes. Includes Loan interest and Other revenue. Basic earnings per share. Diluted earnings per share. Net of reinsurance recoverable. Net of reinsurance recoverable. On August 1, 1997, the Company acquired Industrial Indemnity Holdings, Inc with reserves of $1,049,100. (Redundancy)
EX-27.1996 8 FINANCIAL DATA SCHEDULE
7 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM SEC FORM 10-K AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 0000038984 FREMONT GENERAL CORPORATION 1,000 YEAR DEC-31-1996 JAN-01-1996 DEC-31-1996 1,005,147 0 0 354,958 0 0 3,172,350 55,378 13,173 25,551 4,307,512 1,458,810 87,422 0 33,093 653,352 100,000 0 28,093 531,024 4,307,512 486,860 123,531 (1,658) 187,071 335,407 96,177 29,937 128,309 41,021 87,288 0 0 0 87,288 3.54 2.73 1,185,706 334,657 750 108,247 401,980 1,010,886 750 Includes loans receivable, short-term and other investments. Sum of Additional paid-in capital, Retained earnings, Deferred Compensation and Net unrealized gain on investments. Includes loan interest and other revenue. Basic earnings per share. Diluted earnings per share. Reserve for Losses and LAE, net of reinsurance recoverable.
EX-27.1995 9 FINANCIAL DATA SCHEDULE
7 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM SEC FORM 10-K AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 YEAR DEC-31-1995 JAN-01-1995 DEC-31-1995 1,296,550 0 0 277,451 0 0 3,436,933 39,559 9,422 76,638 4,477,399 1,830,416 100,481 0 40,822 765,467 0 0 25,393 472,697 4,477,399 621,386 119,523 1 182,904 481,261 126,099 34,433 100,327 32,305 68,022 0 0 0 68,022 2.68 2.18 610,510 459,951 1,382 132,358 358,423 1,185,706 1,382 Includes loans receivable, short-term and other investments. Sum of Additional paid-in capital, Retained earnings, Unearned Employee Stock Ownership Plan shares and Net unrealized gain on investments. Includes loan interest and other revenue. Basic earnings per share. Diluted earnings per share. Reserve for losses and LAE, net of reinsurance recoverable. On February 22, 1995 the Company acquired Casualty Insurance Company with reserves of 604,444. Reserve for Losses and LAE, net of reinsurance recoverable.
EX-27.1997.1Q 10 FINANCIAL DATA SCHEDULE
7 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM SEC FORM 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 0000038984 FREMONT GENERAL CORPORATION 1,000 3-MOS DEC-31-1997 JAN-01-1997 MAR-31-1997 1,021,261 0 0 380,845 0 0 3,370,490 50,843 11,702 26,466 4,501,580 1,402,827 93,973 0 30,456 823,524 100,000 0 29,419 539,952 4,501,580 115,228 29,777 (531) 50,261 73,097 23,511 6,849 35,822 11,463 24,359 0 0 0 24,359 0.93 0.75 0 0 0 0 0 0 0 Includes loans receivable, short-term and other investments. Sum of Additional paid-in-capital, Retained earnings, Deferred Compensation and Net unrealized gain (loss) on investments. Includes Loan interest and other revenue. Basic earnings per share. Diluted earnings per share.
EX-27.1997.2Q 11 FINANCIAL DATA SCHEDULE
7 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM SEC FORM 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 0000038984 FREMONT GENERAL CORPORATION 1,000 6-MOS DEC-31-1997 JAN-01-1997 JUN-30-1997 1,114,922 0 0 406,271 0 0 3,579,455 32,092 13,410 28,078 4,721,266 1,385,638 103,190 0 28,211 805,196 100,000 0 32,649 656,431 4,721,266 236,030 61,045 (1,029) 104,844 149,277 48,782 17,063 71,964 22,667 49,297 0 0 0 49,297 1.82 1.50 0 0 0 0 0 0 0 Includes loans receivable, short-term and other investments. Sum of Additional paid-in-capital, Retained earnings, Deferred Compensation and Net unrealized gain (loss) on investments. Includes Loan interst and Other revenue. Basic earnings per share. Diluted earnings per share.
EX-27.1997.3Q 12 FINANCIAL DATA SCHEDULE
7 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM SEC FORM 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 0000038984 FREMONT GENERAL CORPORATION 1,000 9-MOS DEC-31-1997 JAN-01-1997 SEP-30-1997 2,253,593 0 0 367,330 0 0 4,750,914 65,028 25,675 34,626 6,497,853 2,412,705 153,551 0 59,436 1,162,662 100,000 0 33,013 721,551 6,497,853 404,466 103,739 (1,485) 161,442 254,369 82,889 33,531 114,190 36,074 78,116 0 0 0 78,116 2.79 2.35 0 0 0 0 0 0 0 Includes loans receivable, short-term and other investments. Sum of Additional paid-in-capital, Retained earnings, Deferred Compensation and Net unrealized gain (loss) on investments. Includes Loan interest and Other revenue. Basic earnings per share. Diluted earnings per share.
EX-27.1996.1Q 13 FINANCIAL DATA SCHEDULE
7 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM SEC FORM 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 0000038984 FREMONT GENERAL CORPORATION 1,000 3-MOS DEC-31-1996 JAN-01-1996 MAR-31-1996 1,400,789 0 0 355,210 0 0 3,547,898 42,565 16,126 27,424 4,549,305 1,781,865 103,130 0 39,055 806,887 100,000 0 25,393 429,945 4,549,305 126,677 33,777 (661) 43,840 93,677 25,520 6,899 27,231 8,714 18,517 0 0 0 18,517 0.75 0.60 0 0 0 0 0 0 0 Includes loans receivable and short-term investments. Sum of Additional paid-in-capital, Retained earnings, Deferred Compensation and Net unrealized gain (loss) on investments. Includes Loan interest and Other revenue. Basic earnings per share. Diluted earnings per share.
EX-27.1996.2Q 14 FINANCIAL DATA SCHEDULE
7 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM SEC FORM 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 6-MOS DEC-31-1996 JAN-01-1996 JUN-30-1996 1,053,690 0 0 373,125 0 0 3,142,472 33,909 13,701 25,788 4,472,540 1,738,358 90,580 0 37,003 791,421 100,000 0 26,075 441,587 4,472,540 252,238 65,069 (1,524) 87,558 179,505 49,515 14,931 60,544 19,601 40,943 0 0 0 40,943 1.67 1.31 0 0 0 0 0 0 0 INCLUDES LOANS RECEIVABLE, SHORT-TERM AND OTHER INVESTMENTS. SUM OF ADDITIONAL PAID-IN CAPITAL, RETAINED EARNINGS, DEFERRED COMPENSATION AND NET UNREALIZED GAIN (LOSS) ON INVESTMENTS, NET OF DEFERRED TAXES. INCLUDES LOAN INTERST AND OTHER REVENUE. BASIC EARNINGS PER SHARE. DILUTED EARNINGS PER SHARE.
EX-27.1996.3Q 15 FINANCIAL DATA SCHEDULE
7 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM SEC FORM 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 0000038984 FREMONT GENERAL CORPORATION 1,000 9-MOS DEC-31-1996 JAN-01-1996 SEP-30-1996 1,101,332 0 0 369,170 0 0 3,295,237 30,926 8,852 25,425 4,579,322 1,678,684 88,832 0 35,048 834,663 100,000 0 27,501 489,276 4,579,322 372,334 95,228 (1,694) 134,859 261,540 72,587 22,540 94,221 30,339 63,882 0 0 0 63,882 2.61 2.02 0 0 0 0 0 0 0 Total investments and loans receivable. Additional paid-in capital, Retained earnings, Deferred compensation and Net unrealized gain (loss) on investments, net of deferred taxes. Loan interest and Other revenue. Basic earnings per share. Diluted earnings per share.
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