FORM 10-Q
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark one)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 0-27462
RISCORP, INC.
(Exact name of registrant as specified in its charter)
FLORIDA 65-0335150
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
One Sarasota Tower Suite 608
2 North Tamiami Trail
Sarasota, Florida 34236
(Address of principal executive offices) (Zip Code)
(941) 366-5015
(Registrant's telephone number,
including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. X Yes No .
Number of shares outstanding of the issuer's Common Stock:
Class Outstanding at October 31, 1998
Class A Common Stock, $.01 par value 14,258,671
Class B Common Stock, $.01 par value 24,334,443
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INDEX
Page No.
Part I Financial Information
Item 1. Financial Statements
<S> <C>
Consolidated Balance Sheets -
September 30, 1998 and December 31, 1997 3-4
Consolidated Statements of Operations -
For the three months ended September 30, 1998 and 1997 5
Consolidated Statements of Operations -
For the nine months ended September 30, 1998 and 1997 6
Consolidated Statements of Cash Flows -
For the nine months ended September 30, 1998 and 1997 7
Notes to Consolidated Financial Statements 8-14
Item 2. Management's Discussion and Analysis of Financial 15-24
Condition and Results of Operations
Part II Other Information
Item 1. Legal Proceedings 24-26
Item 2. Changes to Securities 27
Item 3. Defaults Upon Senior Securities 27
Item 4. Submission of Matters to a Vote of Security Holders 27
Item 5. Other Information 27
Item 6. Exhibits and Reports on Form 8-K 27
Signatures 28
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Part I Financial Information
Item 1. Financial Statements
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RISCORP, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
September 30, 1998 and December 31, 1997
(in thousands)
September 30, December 31, 1997
-----------------
1998
Assets (Unaudited)
Investments:
<S> <C> <C>
Fixed maturities available for sale, at fair value
(amortized cost $11,065 in 1998 and $142,876 in 1997) $ 11,127 $ 145,571
Fixed maturities available for sale, at fair value
(amortized cost $0 in 1998 and $53,437 in 1997)-restricted -- 53,820
Fixed maturities held to maturity, at amortized cost (fair value $9,643 in
1998 and $24,347 in 1997)
9,321 24,090
Fixed maturities held to maturity, at amortized cost (fair value $6,098 in
1998 and $0 in 1997)-restricted
6,150 --
Total investments 26,598 223,481
Cash and cash equivalents 1,541 16,858
Cash and cash equivalents-restricted 15,457 13,295
Premiums receivable, net -- 100,183
Accounts receivable--other 2,634 16,720
Recoverable from Florida Special Disability Trust Fund, net -- 45,211
Reinsurance recoverables -- 184,251
Prepaid expenses 5,365 --
Prepaid reinsurance premiums -- 29,982
Prepaid managed care fees -- 8,420
Accrued reinsurance commissions -- 37,188
Receivable from Zenith 105,083 --
Deferred income taxes 23,394 22,120
Property and equipment, net 345 26,665
Goodwill -- 15,286
Other assets
8,820 9,990
----- -----
Total assets $ 189,237 $ 749,650
============== =============
See accompanying notes to consolidated financial statements.
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RISCORP, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
September 30, 1998 and December 31, 1997
(in thousands)
September 30, December 31, 1997
1998
Liabilities and Shareholders' Equity (Unaudited)
Liabilities:
<S> <C> <C>
Losses and loss adjustment expenses $ -- $ 437,038
Unearned premiums -- 56,324
Notes payable of parent company -- 15,000
Notes payable of subsidiaries 167 609
Deposit balances payable -- 5,512
Investments held for Zenith 6,150 --
Accrued expenses and other liabilities 33,870 65,885
Net assets in excess of cost of business acquired
-- 5,749
Total liabilities 40,187 586,117
--------------- ---------------
Shareholders' equity:
Class A Common Stock, $.01 par value, 100,000,000 shares authorized; shares
issued and outstanding:
14,258,671 in 1998 and 11,855,917 in 1997 146 120
Class B Common Stock, $.01 par value, 100,000,000 shares authorized; shares
issued and outstanding;
24,334,443 in 1998 and 1997 243 243
Preferred stock, $.01 par value, 10,000,000 shares
authorized; 0 shares issued and outstanding -- --
Additional paid-in capital 140,688 135,974
Retained earnings 7,934 25,195
Treasury stock - at cost, 112,582 shares (1)
(1)
Accumulated Other Comprehensive Income:
Net unrealized gains on investments
40 2,002
-- -----
Total shareholders' equity 149,050 163,533
-------------- ---------------
Total liabilities and shareholders' equity $ 189,237 $ 749,650
============= ==============
See accompanying notes to consolidated financial statements.
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RISCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
For the three months ended September 30, 1998 and 1997
(in thousands, except share and per share data)
1998 1997
--------------- ---------------
(Unaudited) (Unaudited)
Revenue:
<S> <C> <C>
Premiums earned $ -- $ 40,417
Fee income -- 7,008
Net realized gains 74 55
Net investment income 2,297 4,049
Other income 141 --
Total revenue
2,512 51,529
----- ------
Expenses:
Losses and loss adjustment expenses -- 31,219
Unallocated loss adjustment expenses -- 3,195
Commissions, underwriting and administrative expenses 3,835 15,291
Interest expense 147 473
Depreciation and amortization 39 2,418
-- -----
Total expenses
4,021 52,596
----- ------
Loss before income taxes 1,509 1,067
Income tax expense (benefit)
189 (433)
--- -----
Net loss $
1,698 $ 634
===
Per share data:
Net loss per common share - basic $ 0.05 $ 0.02
==== ====
Net loss per common share - diluted $ 0.05 0.02
==== ====
Weighted average common shares outstanding 37,062,558 36,868,114
========== ===========
Weighted average common and common share
equivalents outstanding 37,062,558 36,868,114
========== ===========
See accompanying notes to consolidated financial statements.
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RISCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
For the nine months ended September 30, 1998 and 1997
(in thousands, except share and per share data)
1998 1997
---------------- ----------------
(Unaudited) (Unaudited)
Revenue:
<S> <C> <C>
Premiums earned $ 25,819 $ 133,882
Fee income 5,723 17,969
Net realized gains 4,268 380
Net investment income 7,927 12,177
Other income 234 --
Total revenue
43,971 164,408
------ -------
Expenses:
Losses and loss adjustment expenses 24,016 87,140
Unallocated loss adjustment expenses 2,561 11,295
Commissions, underwriting and administrative expenses 30,703 51,862
Interest expense 624 1,442
Depreciation and amortization 3,139 6,257
----- -----
Total expenses
61,043 157,996
------ -------
(Loss) income before income taxes (17,072) 6,412
Income taxes
189 2,602
--- -----
Net (loss) income $(17,261) $3,810
======== =====
Per share data:
Net (loss) income per common share-basic $ (0.47) $ 0.10
====== ====
Net (loss) income per common share-diluted $ (0.47) $ 0.10
====== ====
Weighted average common shares outstanding 36,949,133 36,868,114
========== ==========
Weighted average common shares and common
share equivalents outstanding 36,949,133 37,331,665
========== ==========
See accompanying notes to consolidated financial statements.
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RISCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the nine months ended September 30, 1998 and 1997
(in thousands)
1998 1997
--------------- --------------
(Unaudited) (Unaudited)
<S> <C> <C>
Net cash used in operating activities $ (33,735) $ (24,228)
---------- ----------
Cash flows from investing activities:
Purchase of property and equipment (940) (3,112)
Proceeds from the sale of equipment 255 658
Purchase of fixed maturities available for sale (51,070) (86,170)
Purchase of fixed maturities held to maturity (5,874) --
Proceeds from sale of fixed maturities available for sale 57,824 120,424
Proceeds from maturities of fixed maturities available for sale 6,029 9,868
Proceeds from maturities of fixed maturities held to maturity 6,000 1,000
Purchase of equity securities -- (637)
Proceeds from sale of equity securities 1,324 3,431
Purchase of Maryland Fund, net of cash acquired -- 134
Cash received from Zenith for sale of net assets 35,000 --
Cash assets sold to Zenith (29,308) --
Investments to be transferred to Zenith -- --
------------- --------------
Net cash provided by investing activities 19,240 45,596
----------- ------------
Cash flows from financing activities:
Principal repayments of notes payable (245) (501)
(Decrease) increase in deposit balances payable (1,599) 725
Unearned compensation--stock options -- 547
Purchase of treasury stock -- (2,100)
Other, net -- (222)
Transfer of cash and cash equivalents to restricted 1,022 --
------------ ---------------
Net cash used in financing activities (822) (1,551)
------------- -------------
Net (decrease) increase in cash and cash equivalents (15,317) 19,817
Cash and cash equivalents, beginning of period 16,858 26,307
----------- ------------
Cash and cash equivalents, end of period $ 1,541 $ 46,124
=========== ===========
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 479 $ 1,447
============ ============
Income taxes $ 3,644 $ 3,445
=========== ============
Supplemental schedule of noncash investing and financing activities:
The Company sold substantially all of its insurance assets and liabilities
to Zenith (see Note 5). In conjunction with the sale, a receivable from
Zenith was recorded as follows:
Book value of net assets sold $ 140,083
Cash received from Zenith at closing (35,000)
-------------
Receivable from Zenith $ 105,083
===========
See accompanying notes to consolidated financial statements.
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RISCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements
(Unaudited)
(1) Basis of Presentation
RISCORP, Inc.'s (the "Company" or "RISCORP") consolidated unaudited
interim financial statements have been prepared on the basis of generally
accepted accounting principles ("GAAP") and, in the opinion of
management, reflect all adjustments, consisting only of normal recurring
adjustments, necessary for a fair presentation of the Company's financial
condition, results of operations and cash flows for the periods
presented. The preparation of financial statements in conformity with
GAAP requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosures of
contingent assets and liabilities at the date of the financial statements
and the reported revenues and expenses during the reporting period.
Actual results could differ from those estimates.
On April 1, 1998, the Company and certain of its subsidiaries consummated
the sale of substantially all of their assets to Zenith Insurance Company
("Zenith") and ceased substantially all of their former business
operations. See Note 5 below for further discussion of the Zenith
transaction. Accordingly, the results of operations for the nine months
ended September 30, 1998 will not be indicative of the results that are
expected for the full year ending December 31, 1998. These consolidated
financial statements and notes should be read in conjunction with the
financial statements and notes included in the audited consolidated
financial statements of RISCORP, Inc. and subsidiaries for the year ended
December 31, 1997 contained in the Company's Annual Report on Form 10-K,
which was filed with the Securities and Exchange Commission on March 27,
1998.
The consolidated financial statements include the accounts of the Company
and each of its subsidiaries. All significant intercompany balances have
been eliminated.
(2) Sale of Joint Venture
Joint Venture Arrangement
In January 1996, the Company, through its wholly-owned subsidiary,
RISCORP of Illinois, entered into a joint venture arrangement with Health
Care Service Corporation ("HCSC"), a subsidiary of Blue Cross and Blue
Shield of Illinois, to underwrite and sell managed care workers'
compensation insurance in Illinois. The Company and HCSC each held 50
percent ownership in the joint venture known as Third Coast Holding
Company ("Third Coast"). The Company contributed the use of its
expertise, insurance systems and intellectual property, while HCSC
contributed cash of $10.0 million. The Company's contributed property in
Third Coast was valued at $10.0 million; however, the Company's cost
basis in the contributed property was $0 and as of December 31, 1996, the
Company recorded its initial investment in Third Coast at $0. The
Company's investment in Third Coast at December 31, 1997 was $0.
The Company accounted for its 50 percent investment in Third Coast on the
equity basis of accounting, whereby the Company's recorded investment was
adjusted for its proportionate share of earnings or losses of Third
Coast. The Company discontinued the use of the equity method of
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accounting for Third Coast in the first quarter of 1997 when the
cumulative losses reduced the Company's investment in Third Coast to $0.
In addition, the Company made no financial guarantees relating to Third
Coast and made no financial commitments to provide any future funding to
Third Coast.
The Company and HCSC entered into an agreement dated March 11, 1998 for
the purchase of the Company's 50 percent interest in Third Coast for
$1,324,001. The effective date of the transaction was January 1, 1998.
The gain on the sale of Third Coast of $1,324,001 was included in net
realized gains at March 31, 1998 and in the accompanying Consolidated
Statements of Operations for the nine months ended September 30, 1998.
The Company received all the funds due in connection with this
transaction on April 3, 1998. In connection with the closing of the sale
to Zenith, the Company received notice that Zenith believes that it is
entitled to the proceeds from the sale of Third Coast. The Company
disputes Zenith's entitlement to these proceeds and intends to vigorously
defend any claim asserted by Zenith related to the Third Coast
transaction.
(3) Issuance of Additional Shares of Stock
In September 1996, the Company purchased all of the outstanding stock of
Independent Association Administrators, Inc. ("IAA") and Risk Inspection
Services and Consulting, Inc. ("RISC") in exchange for approximately
$11.5 million, consisting primarily of 790,336 shares of the Company's
Class A Common Stock valued at approximately $10.9 million on the date of
acquisition. IAA and RISC are workers' compensation management services
companies offering services in Alabama.
Under the IAA acquisition agreement, the former IAA shareholders received
790,336 shares of the Company's Class A Common Stock. Pursuant to the
acquisition agreement, if the former IAA shareholders own all of such
Class A Common Stock on September 17, 1998, the Company was obligated to
issue additional shares of the Company's Class A Common Stock in an
amount sufficient to make the value of all shares of the Company's Class
A Common Stock held by the former IAA shareholders equal to an aggregate
fair market value of $10.9 million on September 17, 1998. However, in no
event would the number of additional shares issued to the former IAA
shareholders exceed 790,336 shares. Due to decreases in the market value
of the Company's Class A Common Stock, 790,336 additional shares of the
Company's Class A Common Stock valued at $642,148 were issued on January
9, 1998 to the former shareholders of IAA. The market value of the stock
on January 9, 1998 was $0.8125 per share.
The $642,148 fair market value of the stock issued was recorded by the
Company as goodwill amortization in the March 31, 1998 financial
statements and in the accompanying Consolidated Statements of Operations
for the nine months ended September 30, 1998. This amount was recorded as
an amortization expense because it could not be recovered from the
remaining future profitability of the workers' compensation business that
was still under contract on January 9, 1998.
(4) Commitments and Contingencies
Between November 20, 1996 and January 31, 1997, nine shareholder class
action lawsuits were filed against RISCORP, Inc. and other defendants in
the United States District Court for the Middle District of Florida (the
"Securities Litigation"). In March 1997, the court consolidated these
lawsuits and appointed co-lead plaintiffs and co-lead counsel. The
plaintiffs subsequently filed a consolidated complaint. The consolidated
complaint named as defendants RISCORP, Inc., three of its executive
officers, one non-officer director and three of the underwriters for
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RISCORP, Inc.'s initial public offering. The plaintiffs in the
consolidated complaint purport to represent the class of shareholders who
purchased RISCORP, Inc. Class A Common Stock between February 28, 1996
and November 14, 1996. The consolidated complaint alleges that RISCORP,
Inc.'s Registration Statement and Prospectus of February 28, 1996, as
well as subsequent statements, contained false and misleading statements
of material fact and omissions, in violation of sections 11 and 15 of the
Securities Act and sections 10(b) and 20(a) of the Exchange Act and Rule
10b-5 promulgated thereunder. The consolidated complaint seeks
unspecified compensatory damages. Pursuant to court ordered mediation,
counsel for the parties have engaged in discussions in an effort to
resolve the Securities Litigation. On January 14, 1998, counsel for the
Company, counsel for William D. Griffin and counsel for the plaintiffs
reached an oral agreement on terms to recommend to their clients to
settle this litigation. This agreement was confirmed in a written
Memorandum of Understanding executed by counsel for the respective
parties as of April 29, 1998. The proposed settlement is contingent upon
the following: execution of a definitive settlement agreement and
implementing pleadings and other documentation; consummation of the
transactions contemplated by the Purchase Agreement with Zenith;
disclosure of certain documents to plaintiff's counsel and interviews by
them of various individuals to verify information relating to the
settlement; certification of a settlement class; satisfaction of all
requirements for settlement under Rule 23 of the Federal Rules of Civil
Procedures; payment by RISCORP of $21.0 million into a settlement fund
for the benefit of the settlement class; and release by members of the
settlement class of all claims against the defendants. Counsel to the
parties are in the process of finalizing the initial settlement
documents.
The initial settlement documents have been finalized and the appropriate
pleadings filed with the court. On July 29, 1998, the court issued a
Preliminary Approval Order in which it certified the purported class for
settlement purposes and scheduled a Settlement Fairness Hearing for
October 8, 1998. Through no fault of the Company, approximately 350
members of the class did not receive timely notice and the Settlement
Fairness Hearing has been rescheduled for December 15, 1998.
The Company estimates that $8.0 million of insurance proceeds will be
available for contribution to the settlement amount, as well as related
costs and expenses. The Company recognized the $21.0 million proposed
settlement and the related insurance proceeds in the December 31, 1997
financial statements. Given the preliminary nature of this settlement and
the various contingencies relating to its consummation, there can be no
assurance that this litigation will be ultimately settled on this basis.
On August 20, 1997, Occupational Safety Association of Alabama Workers'
Compensation Fund (the "Fund") filed a breach of contract and fraud
action against the Company and others. The Fund is an association of
self-insured employers who agreed to transfer, in a Loss Portfolio
Transfer Agreement (the "Agreement") dated August 26, 1996, substantially
all of its assets and liabilities to the Company. Co-defendant Peter D.
Norman was a principal and officer of IAA. The complaint alleges that
Norman and IAA breached certain fiduciary duties owed to the Fund in
connection with the subject agreement and transfer. The complaint alleges
that the Company has breached certain provisions of the Agreement and
owes the Fund monies under the terms of the Agreement. The Fund claims,
per a Loss Portfolio Evaluation dated February 26, 1998, that the Fund
overpaid RISCORP by approximately $6.0 million in the subject
transaction.
The court has granted defendant's Motion to Compel Arbitration per the
terms and provisions of the Agreement. The other defendants, including
IAA, have appealed the trial court's denial of their motions to compel
arbitration. These appeals are pending before the Alabama Supreme Court.
Assuming mediation fails, the dispute between the Company and the Fund
will be resolved through arbitration. The Company intends to vigorously
defend this claim, and believes that application of appropriate
accounting and actuarial principles and methodologies to the calculation
at issue may indicate that monies are instead owed to the Company by the
Fund.
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On or about April 13, 1998, the Fund filed a Motion for Preliminary
Injunction which seeks to enjoin the Company from distributing any
dividends or making any type of distributions to shareholders,
withdrawing any proceeds from the escrow account established with certain
proceeds received from Zenith, or dissolving the Company. Although
somewhat confusing, the motion appears to be based on the failure of the
Company to specifically identify this lawsuit in its proxy statement
issued in connection with the sale to Zenith. The motion was denied on
June 12, 1998.
In June 1997, the Company terminated a number of employees in connection
with the workforce reduction. As a result of the workforce reduction and
the sale to Zenith, a number of former employees have initiated
proceedings, including arbitration, against the Company for certain
severance benefits. The Company intends to vigorously defend these suits;
however, there can be no assurance that it will prevail in these
proceedings.
On March 13, 1998, RIC and RISCORP Property & Casualty Insurance Company
("RPC") were added as defendants in a purported class action filed in the
United States District Court for the Southern District of Florida, styled
Bristol Hotel Management Corporation, et. al., v. Aetna Casualty & Surety
Company, a/k/a Aetna Group, et. al. Case No. 97-2240-CIV-MORENO. The
plaintiffs purport to bring this action on behalf of themselves and a
class consisting of all employers in the State of Florida who purchased
or renewed retrospectively rated or adjusted workers' compensation
policies in the voluntary market since 1985. The suit was originally
filed on July 17, 1997, against approximately 174 workers' compensation
insurers as defendants. The complaint was subsequently amended to add the
RISCORP defendants. The amended complaint named a total of approximately
161 insurer defendants. The suit claims that the defendant insurance
companies violated the Sherman Antitrust Act, the Racketeer Influenced
and Corrupt Organizations Act ("RICO"), the Florida Antitrust Act and
committed breach of contract, civil conspiracy and were unjustly enriched
by unlawfully adding improper and illegal charges and fees onto
retrospectively rated premiums and otherwise charging more for those
policies than allowed by law. The suit seeks compensatory and punitive
damages, treble damages under the Antitrust and RICO claims, and
equitable relief. RIC and RPC moved to dismiss the amended complaint and
also adopted certain motions to dismiss the amended complaint filed by
various other defendants. On August 26, 1998, the district court issued
an order dismissing the entire suit against all defendants. The
plaintiffs filed a motion to reconsider the dismissal order, which was
denied by Judge Moreno on September 10, 1998. Most recently, on September
13, 1998, the plaintiffs filed a Notice of Appeal. Management will
continue to monitor the progress of the appeals process as necessary.
The Company, in the normal course of business, is party to various
lawsuits which management believes will not materially affect the
financial position of the Company. Based upon information presently
available, and in light of legal and other defenses available to the
Company, contingent liabilities arising from threatened and pending
litigation are not presently considered by management to be material.
However, no assurance can be given, or may be taken that material adverse
judgments will not be rendered against the Company as a result of the
aforementioned matters.
Other than as noted above, no provision had been made in the Company's
financial statements for the above matters at December 31, 1997 and 1996.
In addition, certain of the lawsuits and related legal expenses may be
covered under directors and officers' insurance coverage maintained by
the Company.
During February 1998, the FDOI completed an examination of the statutory
books and records of RIC and RPC as of December 31, 1996. The FDOI issued
a final report on the December 31, 1996 examination of RIC and RPC on
October 16, 1998. There were no adjustments to the capital and surplus of
RPC and $3.5 million of adjustments which reduced the capital and surplus
of RIC. The most significant examination adjustment to the capital and
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surplus of RIC was the non-admission by the FDOI examiners of $2.2
million of investments that were held by a bank outside of Florida. The
remaining $1.3 million of adjustments related primarily to certain
related party receivables that were either collected or charged to
expense in 1997. These statutory adjustments have no material impact on
the accompanying GAAP financial statements.
The Company has historically met its cash requirements and financed its
growth through cash flow generated from operations and borrowings. The
Company's primary sources of cash flow from operations were premiums and
investment income, and its cash requirements consisted primarily of
payment of losses and loss adjustment expenses, support of its operating
activities including various reinsurance agreements and managed care
programs and services, capital surplus needs for its insurance
subsidiaries, and other general and administrative expenses. As discussed
more fully in Note 5 on April 1, 1998, the Company and certain of its
subsidiaries have sold substantially all of their assets and transferred
certain liabilities to Zenith in exchange for cash. In connection with
this sale to Zenith, the Company and its subsidiaries ceased
substantially all of its former business operations and, accordingly,
since April 1, 1998, the Company's cash requirements have been, and will
continue to be, satisfied through investment income and the liquidation
of investments and other assets.
(5) Sale to Zenith Insurance Company ("Zenith")
Pursuant to an Asset Purchase Agreement dated June 17, 1997, by and among
RISCORP, Inc. ("RISCORP"), certain of its subsidiaries named therein, and
Zenith, RISCORP and its subsidiaries sold substantially all of their
operating assets and transferred certain liabilities to Zenith. The
closing of the transaction occurred on April 1, 1998.
In connection with the closing of this transaction, Zenith paid $35.0
million in cash, of which $10.0 million was placed in escrow pursuant to
the terms of the Asset Purchase Agreement. The final purchase price to be
paid by Zenith will be the excess, if any, of the book value of the
transferred assets over the transferred liabilities assumed by Zenith at
closing. On June 9, 1998, RISCORP delivered to Zenith a closing date
balance sheet (the "Proposed Business Balance Sheet") representing the
audited statement of transferred assets and transferred liabilities as of
Apri1 1, 1998. The Proposed Business Balance Sheet indicated RISCORP's
calculation of the final purchase price to be approximately $141.0
million, less the $35.0 million previously paid by Zenith.
Pursuant to the terms of the Asset Purchase Agreement, on July 9, 1998,
Zenith provided to RISCORP a list of suggested adjustments to the
Proposed Business Balance Sheet. These suggested adjustments totaled
$209.1 million and principally related to differences in the estimation
of losses and loss adjustment expense reserves and the estimate of the
allowance for uncollectible receivables. The adjustments proposed by
Zenith reflect Zenith's position that the aggregate value of the
liabilities assumed by Zenith exceeded the value of the assets
transferred by as much as $68.0 million. Zenith subsequently proposed
approximately $2.5 million in additional adjustments, increasing the
total adjustments proposed by Zenith to approximately $211.6 million.
RISCORP believes that, pursuant to the terms of the Asset Purchase
Agreement, it is impermissible for Zenith to assert these additional
proposed adjustments.
The parties have engaged a nationally recognized independent accounting
firm to serve as neutral auditors and neutral actuaries to resolve the
items in dispute related to the determination of the final purchase
price. Pursuant to the terms of this engagement, each party has delivered
two written submissions to the neutral auditors and neutral actuaries
setting forth each party's analysis of the issues in dispute and have
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responded to various questions raised by the neutral auditors and neutral
actuaries in analyzing these issues. In addition, the neutral auditors
and neutral actuaries have requested written responses from both RISCORP
and Zenith to numerous questions raised in connection with their review
of the disputed issues. Based on RISCORP's review of the submissions
tendered by Zenith, RISCORP has agreed to aggregate adjustments to the
Proposed Business Balance Sheet of $971,323. These adjustments were
recorded in the June 30, 1998 Consolidated Statements of Operations and
in the accompanying Consolidated Statements of Operations for the nine
months ended September 30, 1998. In addition, these adjustments reduced
the receivable from Zenith included in the Proposed Business Balance
Sheet from $141,054,796 to $140,083,473. RISCORP believes that the other
adjustments proposed by Zenith are without merit and RISCORP intends to
vigorously dispute each such proposed adjustment in connection with the
determination of the final purchase price to be paid by Zenith.
Notwithstanding the foregoing, if Zenith should prevail in the dispute
resolution process, it is possible that the final purchase price for this
transaction could be the $35.0 million already received by RISCORP.
In connection with the closing of this transaction, the parties entered
into a letter agreement dated April 1, 1998, pursuant to which RISCORP
retained certain assets necessary for each of its insurance subsidiaries
to maintain the minimum capital and surplus required by law to remain in
good standing in the State where each company is located (the "Definite
Exclusions"). In accordance with the provisions of this letter agreement,
RISCORP's insurance subsidiaries retained marketable securities with
carrying values of $11.4 million as of April 1, 1998. Zenith has disputed
RISCORP's determination of the amount of minimum capital and surplus
required to be retained by it pursuant to the letter agreement.
In addition to the minimum capital and surplus amounts, in the event that
RISCORP is unable to transfer to Zenith (i) certain certificates of
deposit and securities held by regulatory authorities, (ii) the stated
capital of the selling entities other than the insurance subsidiaries, or
(iii) certain certificates of deposit and securities held in trust under
certain reinsurance agreements prior to the date that Zenith is required
to pay the final purchase price, such assets, at Zenith's option and in
its sole discretion, shall be deemed not to be transferred to Zenith (the
"Possible Exclusions"). As of September 30, 1998, the amortized cost of
such certificates of deposit and securities that were still in process of
being transferred to Zenith totaled $6,149,854. If the retention by
RISCORP of the Definite Exclusions or any of the Possible Exclusions
results in the value of the Transferred Liabilities exceeding the value
of the Transferred Assets, the minimum purchase price specified in the
Asset Purchase Agreement will be reduced.
Pursuant to various provisions of the Asset Purchase Agreement, Zenith
has provided notice to RISCORP of certain alleged breaches of the
representations, warranties or covenants made by RISCORP therein. RISCORP
has disputed the allegations asserted by Zenith and has also provided
notice to Zenith of the occurrence of various indemnifiable events for
which RISCORP believes it is entitled to seek indemnification from
Zenith. In addition to disputes with respect to each party's right to be
indemnified, RISCORP anticipates a dispute with Zenith with respect to
its entitlement to the previously described security deposits held by
various state insurance departments and other regulatory agencies that
were not transferred to Zenith at closing. While it is impossible to
predict the ultimate outcome of the issues currently in dispute with
Zenith, RISCORP intends to vigorously defend all allegations asserted by
Zenith with respect to these and other matters and intends to take such
actions as it deems necessary to ensure that Zenith fully complies with
its obligations under the Asset Purchase Agreement.
(6) Comprehensive Income
As of January 1, 1998, the Company adopted Statement of Financial
Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"). This
Standard establishes new rules for the reporting and display of
13
<PAGE>
comprehensive income and its components; however, the adoption of this
standard had no impact on the Company's net income or shareholders'
equity. In addition to certain other adjustments, SFAS 130 requires
unrealized gains or losses on the Company's available for sale
securities, which prior to adoption were reported separately in
shareholders' equity to be included in other comprehensive income. The
components of comprehensive income, net of related income taxes, for the
nine months ended September 30, 1998 and year ended 1997, respectively
are as follows (in thousands):
<TABLE>
<CAPTION>
1998 1997
------------- -------------
<S> <C> <C>
Net (loss) income $ (17,261) $ 1,479
Unrealized gains (losses) on securities available for sale:
Unrealized holding gains (losses) during the period 40 (1,555)
Reclassification adjustment for realized gains included in
net earnings 4,268
-
Comprehensive loss $ (12,953) $ (76)
</TABLE>
(7) Reclassifications
Certain amounts in the financial statements presented have been
reclassified from amounts previously reported in order to be comparable
between periods. These reclassifications have no effect on previously
reported shareholders' equity or net income during the periods involved.
14
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Forward-Looking Statements
This report contains statements that constitute "forward-looking
statements" within the meaning of Section 27A of the Securities Act of
1933, as amended, and Section 21E of the Securities and Exchange Act of
1934, as amended. The words "believe," "estimate," "intend,"
"anticipate," and similar expressions and variations thereof identify
certain of such forward-looking statements, which speak only as of the
dates of which they were made. RISCORP undertakes no obligation to
publicly update or revise any forward-looking statements, whether as a
result of new information, future events, or otherwise. Readers are
cautioned that any such forward-looking statements are not guarantees of
future performance and involve risks and uncertainties, and that actual
results may differ materially from those indicated in the forward-looking
statements as a result of various factors. Readers are cautioned not to
place undue reliance on these forward-looking statements, which are
subject to a number of risks and uncertainties that could cause actual
results to differ materially from those projected. These risks and
uncertainties include but are not limited to the following: (I)
uncertainties with respect to the final purchase price to be paid by
Zenith under the Asset Purchase Agreement; (ii) the value of the
transferred assets and the transferred liabilities; (iii) the ability of
RISCORP to recover any amounts from Zenith as a result of the occurrence
of indemnifiable events; (iv) Zenith's ability to recover from RISCORP
certain assets not transferred to it at closing or Zenith's ability to
prevail with respect to its claims against RISCORP alleging the
occurrence of various indemnifiable events; (v) projections of revenues,
income, losses and cash flows related to operations; (vi) estimates
concerning the effects of litigation or other disputes; and (vii) other
risks detailed herein and from time to time in RISCORP's other reports
and filings with the Securities and Exchange Commission.
Recent Developments
Asset Purchase Agreement with Zenith
See Part 1, Item 1, Notes to Consolidated Financial Statements, Note 5
for further discussion of the Zenith transaction.
Legal Developments
See "Part II, Item 1, Legal Proceedings."
Overview
General
As discussed more fully in Note 5, the Company and certain of its
subsidiaries sold substantially all of their assets and transferred
certain liabilities to Zenith on April 1, 1998. In connection with this
sale to Zenith, the Company and its subsidiaries ceased substantially all
of its former business operations, including its insurance operations,
effective April 1, 1998. Accordingly, after April 1, 1998, the operations
of the Company consisted primarily of the administration of the
day-to-day activities of the surviving corporate entities, compliance
with the provisions of the Asset Purchase Agreement, and the investment,
protection and maximization of the remaining assets of the Company.
Since April 1, 1998, the Company has had no employees or insurance
operations, and has provided no services to self-insurance funds or other
insurance related entities. Because of these significant changes in the
15
<PAGE>
operating activities of the Company after April 1, 1998, a comparison of
the results of operations for the three months and nine months ended
September 30, 1998 to the comparable period in 1997 is meaningless.
Therefore, the results of operations for the three months and six months
ended September 30, 1998 are explained separately with no comparison to
the comparable prior periods. The results of operations of the Company
prior to the April 1, 1998 sale to Zenith, compared to the comparable
period in 1997 are included to comply with the requirements of the
Securities Exchange Act of 1934, as amended, and the rules and
regulations of the Securities and Exchange Commission; however, those
results of operations are not indicative of the operations of the Company
since April 1, 1998 and are not indicative of the anticipated future
operations by the Company.
Results of Operations
April 1, 1998 to September 30, 1998
During the three months ended September 30, 1998, the Company's primary
operating activities were the defense of the Proposed Business Balance
Sheet, the investment of the $25.0 million initial payment received from
Zenith on April 2, 1998, the investment of other invested assets retained
by the Company, compliance with the provisions of the Asset Purchase
Agreement and the administration of the day-to-day activities of the
surviving corporate entities. Compliance with the provisions of the Asset
Purchase Agreement included the transfer of all of the assets and
liabilities, not retained by the Company, to Zenith, and assisting with
the orderly transition of the Company's insurance operations to Zenith.
At September 30, 1998, the Company had investments totaling approximately
$26.6 million, of which approximately $6.2 million consisted of
securities to be transferred to Zenith. Those securities were primarily
regulatory deposits and securities held in trust in connection with
certain reinsurance agreements. The Company is awaiting the release of
the securities by the regulatory agencies and the reinsurers. Upon their
release, the securities will be transferred to Zenith in accordance with
the terms of the Asset Purchase Agreement. A liability was recorded as of
September 30, 1998 for the transfer of these securities to Zenith.
The following is an analysis of other balances contained on the September
30, 1998 balance sheet.
Restricted cash and cash equivalents consisted primarily of the
$10.0 million initial purchase price payment which is being held
in escrow under the terms of the Asset Purchase Agreement.
The Receivable from Zenith in the amount of $105.1 million
represents the remaining purchase price to be received from
Zenith as determined by the Company in connection with the
preparation of the Proposed Business Balance Sheet.
Deferred income taxes of $23.4 million consisted of federal and
state income taxes that are anticipated to be recovered in
future years. At this time, this asset is expected to be fully
recoverable.
Other assets of $8.8 million consisted primarily of $4.8
million of certain insurance recoverables which will be received
when the accrued legal settlements discussed below are actually
paid, and $3.7 million of accrued investment income.
Prepaid expenses of $5.4 million consisted primarily of prepaid
insurance coverages $4.3 million and retainers paid to certain
professionals and consultants of $1.1 million.
16
<PAGE>
Accounts receivable-other of $2.6 million consisted primarily
of a receivable of $2.3 million which will be realized upon the
redemption of the Company's outstanding stock.
Accrued expenses and other liabilities totaled approximately
$33.5 million and consisted primarily of $20.5 million of an
accrued legal settlement, $1.0 million of trade accounts
payable, $0.7 million of unpaid restructuring cost relating to
the June 1997 Corporate restructuring, $1.7 million of accrued
legal, accounting, auditing and actuarial expenses that
primarily relate to the defense of the Proposed Business Balance
Sheet, $2.9 million of consulting expenses relating to a tax
gross up payment for a previous stock award, $1.8 million of
income taxes payable and $4.9 million of other accruals and
payables.
The Company's operating results for the six months ended September 30,
1998 resulted in a net loss of $7.9 million. The following is an analysis
of the Company's revenues and expenses for the six months ended September
30, 1998.
Net realized gains for the six months ended September 30, 1998 were $2.8
million. The net realized gains consisted primarily of gains on the sale
of securities transferred to Zenith in connection with the Asset Purchase
Agreement. For the nine months ended September 30, 1998, net realized
gains were $4.3 million, of which $1.3 million was the gain on the sale
of Third Coast recognized in the first quarter of 1998, more fully
discussed in Note 2 of the consolidated financial statements contained in
this document. Realized gains or losses during the first three quarters
of 1997 were $0.4 million. Investment income for the three months and the
nine months ended September 30, 1998 and 1997 consisted entirely of
earnings from the investment portfolio, excluding unrealized gains &
losses.
Net investment income for the six months ended September 30, 1998 was
$4.8 million. Net investment income consisted of interest income on the
$105.1 million receivable from Zenith of $3.2 million, interest income on
the $10.0 million balance in escrow of $0.3 million and other investment
income of $1.3 million.
Operating expenses for the six months ended September 30, 1998 totaled
approximately $15.4 million. This amount included three significant
non-recurring expenses that arose due to the sale to Zenith. The first
non-recurring expense totaled approximately $3.4 million and consisted of
severance payments to certain of the Company's former executives and
employees. The second expense totaled approximately $4.1 million and
consisted of the issuance of RISCORP stock to Phoenix Management Company,
Ltd. ("Phoenix") in accordance with a Restricted Stock Award Agreement.
The third expense totaled approximately $2.9 million and represented a
payment for a tax gross up related to the issuance of the restricted
stock award to Phoenix.
The remaining $5.0 million of operating expenses consisted of $0.3
million of transition expenses incurred as a result of the sale to
Zenith; $1.0 million of adjustments to the Proposed Business Balance
Sheet (discussed more fully in Note 5); $0.6 million of management
expenses; $0.7 million of accounting and auditing expenses; $1.1 million
of recurring operating expenses such as rent, telephone, insurance and
similar costs and $1.3 million of other expenses.
In September 1998, the Company received a reimbursement of approximately
$1.2 million of legal fees incurred in 1997 and 1998 in connection with
payments made on behalf of certain former officers and directors of the
Company. This reimbursement was included as a reduction in commission,
underwriting and administrative expenses in the accompanying consolidated
statement of operations for the three months ended September 30, 1998.
17
<PAGE>
Depreciation and amortization expense for the six months ended September
30, 1998 was $0.3 million. The Company transferred all assets subject to
amortization to Zenith in connection with the sale and retained
approximately $0.4 million of fixed assets (consisting primarily of
computer equipment) which is being depreciated over three years.
Interest expense for the six months ended September 30, 1998 was $0.2
million. The Company remains liable under one note agreement in the
amount of $0.2 million through November 1998. This note bears interest at
14.85%.
Net investment income for the nine months ended September 30, 1998 was
$7.9 million compared to $12.1 million for the same period in 1997, a net
decrease of $4.2 million. The decline in investment income was due to a
decline in invested assets (including the receivable from Zenith) of
approximately $77.5 million for the nine month period ended September 30,
1998 compared to the same period in 1997. The decrease in invested assets
was primarily due to the sale to Zenith and the decline in written
premiums as discussed below.
The effective tax rate for the nine months ended September 30, 1998 was 0
percent compared to 40.6 percent for the same period in 1997. The decline
in the tax rate was primarily due to the Company's uncertainty of its
ability to recover the tax benefit pertaining to losses incurred after
April 1, 1998.
The weighted average common and common share equivalents outstanding for
the three months ended September 30, 1998 was 36,062,558 versus
36,868,114 for the three months ended September 30, 1997.
Prior to April 1, 1998
The discussion that follows relates to the operations and operating
philosophy of the Company's activities which existed prior to April 1,
1998 and includes the results for the three months ended September 30,
1997 and the nine months ended September 30, 1998 compared to the nine
months ended September 30, 1997.
Prior to 1996, the Company's at-risk operations were focused in Florida.
During 1996, the Company acquired RISCORP National Insurance Company
("RNIC") and its 19 licenses and assumed business from several self
insurance funds outside of Florida which allowed the Company to diversify
its at-risk operations. A comparison of the Company's direct written
premiums for the nine months ended September 30, 1998 and the calendar
year ended December 31, 1997, 1996 and 1995 (prior to reinsurance
cessions or assumptions) by state is presented below:
Direct Premiums Written (a)
(Ddollars in millions) 1998 (b) 1997 1996 1995
Florida $ 29.2 $ 180.8 $ 270.8 $ 284.8
Alabama 4.1 39.1 21.7 --
North Carolina 4.4 32.2 41.4 --
Other 1.0 28.4 22.8 --
--------- --------- --------- --------
Total $ 38.7 $ 280.5 $ 356.7 $ 284.8
======= ======= ======= =======
(a) Includes RIC, RPC and RNIC for 1996, RIC and RPC for
1995. (b) 1st quarter 1998, prior to the sale to Zenith.
Direct written premiums were reduced by specific reinsurance cessions
(1996 and 1995), the 50 percent AmRe quota share reinsurance agreement
for the Company's Florida workers' compensation business (1996 and 1995)
and the 65 percent quota share reinsurance agreement (effective October
1, 1996), with another reinsurer for certain non-Florida business. This
18
<PAGE>
quota share reinsurance agreement was reduced to 60 percent effective
January 1, 1997 and was cancelled on a run-off basis on December 31,
1997.
The majority of the Company's premiums were written in Florida, a
regulated pricing state where premiums for guaranteed cost products were
based on state-approved rates. However, prior to the sale to Zenith, the
Company also offered policies which were subject to premium reductions as
high deductible plans, participating dividend plans, or other loss
sensitive plans. Pricing for these plans tended to be more competitively
based, and the Company experienced increased competition during 1997 and
1998 in pricing these plans. In addition, in October 1996, the Florida
Insurance Commissioner ordered workers' compensation providers to reduce
rates by an average of 11.2 percent for new and renewal policies written
on or after January 1, 1997. Concurrently, with the premium reduction
effective January 1, 1997, the 10 percent managed care credit was phased
out. This credit had been offered since 1994 to employers who met certain
criteria for participating in a qualified workers' compensation managed
care arrangement. In addition, on October 9, 1997, Florida further
reduced premium rates by 1.7 percent for new and renewal policies written
on or after January 1, 1998. The State of North Carolina approved a 13.7
percent decrease in loss costs effective April 1, 1997. The Company
adopted the loss costs in October 1997, which resulted in an overall
effective rate reduction of 8.4 percent.
The Company experienced increased pricing pressures during 1997. During
1997, the Company made the strategic decision to discontinue writing
business owners' protection, commercial multiple peril and auto and focus
on its core workers' compensation business. Net written premiums on these
lines of business were less than $1.0 million during 1997 and were less
than $0.5 million in 1996.
In addition, in June 1997, the Company implemented a strategic plan to
consolidate several of its field offices and announced its intention to
close all field offices, except Charlotte, North Carolina, and
Birmingham, Alabama, by the end of 1997, and to cease writing new
business in certain states including Oklahoma, Virginia, Missouri,
Mississippi, Louisiana and Kansas. The estimated impact of the decision
to discontinue writing business in those states was a reduction of
approximately $16.0 million in direct premiums written.
The Company attempted to lower claims costs by applying managed care
techniques and programs to workers' compensation claims, particularly by
providing prompt medical intervention, integrating claims management and
customer service, directing care of injured employees through a managed
care provider network, and availing itself of potential recoveries under
subrogation and other programs.
Part of the Company's claims management philosophy was to seek recoveries
for claims which were reinsured or which could be subrogated or submitted
for reimbursement under various states' recovery programs. As a result,
the Company's losses and loss adjustment expenses were offset by
estimated recoveries from reinsurers under specific excess of loss and
quota share reinsurance agreements, subrogation from third parties and
state "second disability" funds, including the Florida Special Disability
Trust Fund ("SDTF").
19
<PAGE>
<TABLE>
The following table shows direct, assumed, ceded and net earned
premiums by quarter for 1998 and 1997 (in thousands):
<CAPTION>
Three Months Ended
-----------------------------------------------------------------------------------
9-30-98 6-30-98 3-31-98 3-31-97 6-30-97 9-30-97 12-31-97
----------- ---------- ---------- ----------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C>
Direct premiums earned $ $ $ 48,416 $ 91,516 $ 91,761 $ 77,169 $ 67,800
0 0
Assumed premiums earned 0 0 79 2,827 2,064 1,118 12,500
Premiums ceded to reinsurers 0 0 (22,676) (47,529) (47,173) (37,870) (34,700)
Net premiums earned $ 0 $ 0 $ 25,819 $ 46,814 $ 46,652 $ 40,417 $ 45,600
============ ============ ======== ======== ======== ======== ========
</TABLE>
The number of inforce policies were:
Quarter Ended 1996 1997 1998
March 31 22,777 30,141 18,145
June 30 26,002 29,602 0
September 30 28,772 25,649 0
December 31 30,081 22,357 N/A
The decrease in direct earned premiums for the last six months of 1997
and the first quarter of 1998 was primarily due to the decrease in new
and renewal premiums that the Company experienced in the second, third
and fourth quarters of 1997 from the adverse publicity pertaining to the
A.M. Best ratings of the Company's insurance subsidiaries, the Company's
inability to file its 1996 Form 10-K, 1997 10-Q's and 1996 audited
statutory financial statements in a timely manner, and the delisting of
the Company's stock by NASDAQ. This is illustrated by the decrease in
direct premiums earned of $77.2 million for the three months ended
September 30, 1997 from $84.2 million for the same period in 1996, a net
decrease of $7.0 million.
Direct premiums earned increased to $260.4 million for the nine months
ended September 30, 1997 from $236.4 million for the same period in 1996,
a net increase of $24.0 million. The increase in the direct premiums
earned for the nine months ended September 30, 1997 was primarily the
result of the following factors:
The infusion of approximately $68.9 million of capital into
the Company's insurance subsidiaries from the initial public
offering ("IPO") proceeds allowed the insurance subsidiaries
to increase their premium writing capacity and, as a result,
the Company was able to increase premiums during the last nine
months of 1996 due to its expanded premium writing
capabilities. Written premiums were earned pro rata over the
policy period (usually 12 months) therefore, increased
premiums written during the last nine months of 1996 had a
positive impact on earned premiums in 1996 and 1997.
Written premiums increased in the third and fourth quarters
of 1996 and the first quarter of 1997 from the assumption
reinsurance and loss portfolio agreements entered into by the
Company and from the acquisitions made by the Company during
1996.
Enhanced marketing initiatives implemented by the Company
after the IPO to increase the number of policies and to write
accounts with larger premiums.
In September 1995, the Company entered into a fronting agreement with
another insurer which enabled the Company to begin expansion into states
where its insurance subsidiaries were not licensed. The fronting
agreement was cancelled effective December 31, 1997. The cancellation of
the fronting agreement and the sale to Zenith were the primary reasons
that the assumed premiums decreased to $79 from $6,009 for the nine
months ended September 30, 1998 from the same period in 1997. The
increase in assumed premiums earned during the fourth quarter of 1997
from previous quarters was primarily the result of the Company recording
$11.4 million of earned premiums from the National Council on
Compensation Insurance, Inc. ("NCCI") pool participation. The assumed
20
<PAGE>
premiums from the fronting agreement were approximately $1.1 million and
$2.4 million for the three months ended September 30, 1997 and September
30, 1996, respectively. While the company assumed premiums from several
insurers, the fronting agreement generated the majority of the assumed
premiums.
For the years ended December 31, 1997 and 1996, the Company ceded
approximately 50 percent of its Florida premiums to AmRe under a quota
share reinsurance agreement and 60 percent of the business written by
RNIC under a separate quota share agreement (65 percent during 1996) with
Chartwell. The Company terminated the agreement with Chartwell at
December 31, 1997; however, the reinsurer continues to receive premiums
and to be responsible for their portion of all losses incurred on
policies effective before the termination date. The decrease in ceded
premiums to $22.7 million for the nine months ended September 30, 1998
from $132.6 million for the same period in 1997 was due primarily to the
decrease in direct premiums earned discussed above.
Fee income for the nine months ended September 30, 1998 was $5.7 million
compared to $18.0 million for the same period in 1997, a net decrease of
$12.3 million. The decrease in fee income was primarily due to sale of
the insurance operations to Zenith. Fee income for the first quarter of
1998 was comparable to fee income for the first quarter of 1997. Fee
income for the three months ended September 30, 1997 was $7.0 million
compared to $7.1 million for the same period in 1996, a net decrease of
$0.1 million. The decrease between 1996 and 1997 was primarily due to the
loss of service fees from the conversion of the National Alliance for
Risk Management ("NARM") self insurance funds of North Carolina and
Virginia (which were previously managed by the Company) to at-risk
business via loss portfolio transfers and decreases in RISCORP West
Incorporated ("RWI") service fee income from the termination of RWI's
Mississippi and Louisiana service contracts. The decrease in fee income
was partially offset by new fees generated from the CompSource
acquisition, the fronting agreement, the new service agreement with Third
Coast Insurance Company and growth in other existing fee products.
Realized gains or losses during the third quarter of 1997 were $55,097
and $380,524 for the nine months ended September 30, 1997.
Investment income for the nine months ended September 30, 1997 was $12.6
million compared to $7.6 million for the same period in 1996, a net
increase of $5.0 million. Investment income consists entirely of earnings
from the investment portfolio, excluding realized gains and losses. The
actual yield on invested assets is comparable between quarters.
The loss ratio for the nine months ended September 30, 1998, 1997 and
1996 was 93.0 percent, 65.1 percent and 67.9 percent, respectively. The
increase in the 1998 loss ratio of 27.9 percent was due primarily to
adverse gross loss development during the first quarter of 1998 in the
1997 and prior accident years from certain business written in Florida of
approximately $10.3 million, gross favorable loss development in Alabama
and North Carolina of approximately $2.6 million and gross adverse loss
development of $0.3 million in business written by RNIC and RPC in
several smaller states. The increase in the 1997 loss ratio was due to
adverse loss development in 1996 and prior accident years from certain
business written in Alabama of approximately $4.0 million, adverse loss
development of approximately $1.8 million in certain business written by
RNIC in several smaller states, and favorable loss development of $2.5
million from business written in North Carolina.
Losses and loss adjustment expenses for the nine months ended September
30, 1997, were $87.1 million compared to $89.5 million for the same
period in 1996, a net decrease of $2.4 million, which is considered
comparable.
Unallocated loss adjustment expenses for the nine months ended September
30, 1997, were $11.3 million compared to $9.2 million for the same period
in 1996, a net increase of $2.1 million. This increase was primarily due
to the increased premium volume, increased loss reserves during this
period and unfavorable loss development. The unallocated loss adjustment
expense ratio for the nine months ended September 30, 1998, 1997 and 1996
21
<PAGE>
was 9.9 percent, 7.9 percent and 6.6 percent, respectively. The 9.9
percent ratio at March 31, 1998 is comparable to the December 31, 1997
year to date ratio of 10.7 percent. The 1.2 percent increase in the 1997
ratio was primarily due to increased personnel and personnel related
costs.
Commissions, general and administrative expenses for the three months
ended September 30, 1998 are discussed above. Such expenses for the three
months ended March 31, 1998 were $15.5 million compared to $14.4 million
for the same period in 1997. The net increase of $1.1 million from 1997
to 1998 was primarily attributable to a $4.3 million decrease in
personnel expenses, a $4.4 million increase in legal and consulting
expenses, and a $1.0 million increase in premium taxes, agents
commissions, ceding commission income and underwriting expenses.
Commissions, underwriting and administrative expenses for the three
months ended September 30, 1997 were $15.3 million compared to $13.2
million for the same period in 1996, a net increase of $2.1 million. In
addition, such costs were $14.4 million for the three months ended March
31, 1997. During the second quarter of 1997 the Company recorded a charge
to earnings of $5.9 million in connection with the workforce reduction
and restructuring. This non-recurring charge consisted of $5.1 million of
personnel expenses (primarily severance costs), $0.7 million of occupancy
costs (primarily lease cancellations) and $0.1 million of other
restructuring costs. These restructuring costs were included in the
accompanying financial statements with commissions, underwriting and
administrative expenses. The remaining net increase of $3.0 million ($8.9
million including the restructuring charges) from 1996 to 1997 is
attributable to increases in commissions, premium taxes and personnel
costs caused by higher premiums generated from acquisitions and new and
renewal premium growth, increased operating expenses from the addition of
employees and increases in legal expenses from actions initiated in 1996.
The Company's total employees were 0, 619 and 805 at September 30, 1998,
1997 and 1996, respectively.
Interest expense for the nine months ended September 30, 1997 was $1.4
million compared to $2.1 million for the same period in 1996. The
decrease was due to the repayment of approximately $28.6 million of debt
in March 1996 using the proceeds from the initial public offering.
Depreciation and amortization expense for the nine months ended September
30, 1997 and 1996 were $6.3 million. The amortization expense for the
nine months ended September 30, 1996 contained an impairment loss of $2.7
million related to the goodwill reported in connection with the purchase
of SISB.
The effective tax rate for the nine months ended September 30, 1997 was
40.6 percent compared to 42.1 percent for the same period in 1996.
The weighted average common and common share equivalents outstanding for
the three months ended September 30, 1997 was 36,868,114 versus
37,485,691 for the three months ended September 30, 1996. The weighted
average common shares outstanding for the nine months ended September 30,
1997 and 1996 were 37,331,665 and 35,720,088, respectively. The increase
in the weighted average number of shares for the nine months ended
September 30, 1997, was due primarily to the inclusion of the shares
issued in connection with the February 29, 1996 IPO for the entire first,
22
<PAGE>
second and third quarters of 1997 versus inclusion of such shares for
only seven months for the first, second and third quarters of 1996, and
the inclusion of certain contingent shares reserved for issuance in
connection with the acquisitions of CompSource and IAA, as more fully
discussed in Note 3 of the consolidated financial statements included in
this document. The increase was partially offset by a decrease in common
stock equivalents for option shares assumed to be exercised.
Liquidity and Capital Resources
The Company has historically met its cash requirements and financed its
growth through cash flow generated from operations and borrowings. The
Company's primary sources of cash flow from operations were premiums and
investment income, and its cash requirements consisted primarily of
payment of losses and loss adjustment expenses, support of its operating
activities including various reinsurance agreements and managed care
programs and services, capital surplus needs for its insurance
subsidiaries, and other general and administrative expenses. As discussed
more fully in Note 5, the Company and certain of its subsidiaries sold
substantially all of their assets and transferred certain liabilities to
Zenith in exchange for cash on April 1, 1998. In connection with this
sale to Zenith, the Company and its subsidiaries ceased substantially all
of its former business operations and, accordingly, after April 1, 1998,
the Company's primary source of cash flow will be generated from
investment income. The Company's future cash requirements will be
satisfied through investment income and the liquidation of investments.
Cash flow from operations for the nine months ended September 30, 1998
and 1997 was $(33.7) million and $(24.2) million, respectively. The
decrease from January 1, 1998 to September 30, 1998 was due primarily to
reductions in unearned premiums resulting from a decrease in direct
premiums written and increases in losses and loss adjustment expenses,
unallocated loss adjustment expenses and commissions, underwriting and
administration expenses in relation to premiums earned during the first
quarter of 1998 and due to the expenses related to the sale to Zenith.
These expenses included severance payments to certain employees, the
payment of accrued employee benefits and the payment of other expenses
related to the sale.
The Company has projected cash flows through December 1998 and believes
it has sufficient liquidity and capital resources to support its
operations.
As of September 30, 1998 and 1997, the Company's insurance subsidiaries
had combined statutory capital and surplus of approximately $134.9
million and $92.6 million, respectively. The individual capital and
surplus of each of the Company's insurance subsidiaries exceeded the
minimum statutory capital and surplus required by their state of
domicile.
In addition, the liquidity of the Company could be materially adversely
affected if Zenith should prevail in the dispute resolution process with
respect to the determination of the final purchase price, as well as by
certain legal issues or any material delay in the Company's receipt of
the final payment of the ultimate purchase price determined to be payable
by Zenith. See "Sale to Zenith," "Legal Proceedings" and "Recent
Developments."
The National Association of Insurance Commissioners has adopted
risk-based capital standards to determine the capital requirements of an
insurance carrier based upon the risks inherent in its operations. The
standards, which have not yet been adopted in Florida, require the
computation of a risk-based capital amount which is then compared to a
carrier's actual total adjusted capital. The computation involves
applying factors to various financial data to address four primary risks:
asset risk, insurance underwriting risk, credit risk, and off-balance
23
<PAGE>
sheet risk. These standards provide for regulatory intervention when the
percentage of total adjusted capital to authorized control level
risk-based capital is below certain levels. At September 30, 1998 and
December 31, 1997, the Company's insurance subsidiaries' statutory
surplus was in excess of any risk-based capital action level
requirements.
Year 2000
Effective April 1, 1998, RISCORP ceased substantially all of its former
business operations, including its core insurance and managerial services
operations.
As more fully described above, the Company and certain of its
subsidiaries entered into an Asset Purchase Agreement for the sale of
substantially all of the assets and the assumption of certain liabilities
to Zenith in exchange for cash. RISCORP's computer systems and
proprietary computer software, including the policy issue and management
system and the claims systems, were included in the assets sold to
Zenith. The computer programs retained by RISCORP to support its current
operations are presently Year 2000 compliant.
Part II Other Information
Item 1. Legal Proceedings
Between November 20, 1996 and January 31, 1997, nine shareholder class
action lawsuits were filed against RISCORP, Inc. and other defendants in
the United States District Court for the Middle District of Florida (the
"Securities Litigation"). In March 1997, the court consolidated these
lawsuits and appointed co-lead plaintiffs and co-lead counsel. The
plaintiffs subsequently filed a consolidated complaint. The consolidated
complaint named as defendants RISCORP, Inc., three of its executive
officers, one non-officer director and three of the underwriters for
RISCORP, Inc.'s initial public offering. The plaintiffs in the
consolidated complaint purport to represent the class of shareholders who
purchased RISCORP, Inc. Class A Common Stock between February 28, 1996
and November 14, 1996. The consolidated complaint alleges that RISCORP,
Inc.'s Registration Statement and Prospectus of February 28, 1996, as
well as subsequent statements, contained false and misleading statements
of material fact and omissions, in violation of sections 11 and 15 of the
Securities Act and sections 10(b) and 20(a) of the Exchange Act and Rule
10b-5 promulgated thereunder. The consolidated complaint seeks
unspecified compensatory damages. Pursuant to court ordered mediation,
counsel for the parties have engaged in discussions in an effort to
resolve the Securities Litigation. On January 14, 1998, counsel for the
Company, counsel for William D. Griffin and counsel for the plaintiffs
reached an oral agreement on terms to recommend to their clients to
settle this litigation. This agreement was confirmed in a written
Memorandum of Understanding executed by counsel for the respective
parties as of April 29, 1998. The proposed settlement is contingent upon
the following: execution of a definitive settlement agreement and
implementing pleadings and other documentation; consummation of the
transactions contemplated by the Purchase Agreement with Zenith;
disclosure of certain documents to plaintiff's counsel and interviews by
them of various individuals to verify information relating to the
settlement; certification of a settlement class; satisfaction of all
requirements for settlement under Rule 23 of the Federal Rules of Civil
Procedures; payment by RISCORP of $21.0 million into a settlement fund
for the benefit of the settlement class; and release by members of the
settlement class of all claims against the defendants. Counsel to the
parties are in the process of finalizing the initial settlement
documents.
The initial settlement documents have been finalized and the appropriate
pleadings filed with the court. On July 29, 1998, the court issued a
Preliminary Approval Order in which it certified the purported class for
settlement purposes and scheduled a Settlement Fairness Hearing for
October 8, 1998. Through no fault of the Company, approximately 350
members of the class did not receive timely notice and the Settlement
Fairness Hearing has been rescheduled for December 15, 1998.
24
<PAGE>
The Company estimates that $8.0 million of insurance proceeds will be
available for contribution to the settlement amount, as well as related
costs and expenses. The Company recognized the $21.0 million proposed
settlement and the related insurance proceeds in the December 31, 1997
financial statements. Given the preliminary nature of this settlement and
the various contingencies relating to its consummation, there can be no
assurance that this litigation will be ultimately settled on this basis.
On August 20, 1997, Occupational Safety Association of Alabama Workers'
Compensation Fund (the "Fund") filed a breach of contract and fraud
action against the Company and others. The Fund is an association of
self-insured employers who agreed to transfer, in a Loss Portfolio
Transfer Agreement (the "Agreement") dated August 26, 1996, substantially
all of its assets and liabilities to the Company. Co-defendant, Peter D.
Norman, was a principal and officer of IAA. The complaint alleges that
Norman and IAA breached certain fiduciary duties owed to the Fund in
connection with the subject agreement and transfer. The complaint alleges
that the Company has breached certain provisions of the Agreement and
owes the Fund monies under the terms of the Agreement. The Fund claims,
per a Loss Portfolio Evaluation dated February 26, 1998, that the Fund
overpaid RISCORP by approximately $6.0 million in the subject
transaction.
The court has granted defendant's Motion to Compel Arbitration per the
terms and provisions of the Agreement. The other defendants, including
IAA, have appealed the trial court's denial of their motions to compel
arbitration. These appeals are pending before the Alabama Supreme Court.
Assuming mediation fails, the dispute between the Company and the Fund
will be resolved through arbitration. The Company intends to vigorously
defend this claim, and believes that application of appropriate
accounting and actuarial principles and methodologies to the calculation
at issue may indicate that monies are instead owed to the Company by the
Fund.
On or about April 13, 1998, the Fund filed a Motion for Preliminary
Injunction which seeks to enjoin the Company from distributing any
dividends or making any type of distributions to shareholders,
withdrawing any proceeds from the escrow account established with certain
proceeds received from Zenith, or dissolving the Company. Although
somewhat confusing, the motion appears to be based on the failure of the
Company to specifically identify this lawsuit in its proxy statement
issued in connection with the sale to Zenith. The motion was denied on
June 12, 1998.
In June 1997, the Company terminated a number of employees in connection
with the workforce reduction. As a result of the workforce reduction and
the sale to Zenith, a number of former employees have initiated
proceedings, including arbitration, against the Company for certain
severance benefits. The Company intends to vigorously defend these suits;
however, there can be no assurance that it will prevail in these
proceedings.
On March 13, 1998, RIC and RISCORP Property & Casualty Insurance Company
("RPC") were added as defendants in a purported class action filed in the
United States District Court for the Southern District of Florida, styled
Bristol Hotel Management Corporation, et. al., v. Aetna Casualty & Surety
Company, a/k/a Aetna Group, et. al. Case No. 97-2240-CIV-MORENO. The
plaintiffs purport to bring this action on behalf of themselves and a
class consisting of all employers in the State of Florida who purchased
or renewed retrospectively rated or adjusted workers' compensation
policies in the voluntary market since 1985. The suit was originally
filed on July 17, 1997, against approximately 174 workers' compensation
insurers as defendants. The complaint was subsequently amended to add the
RISCORP defendants. The amended complaint named a total of approximately
161 insurer defendants. The suit claims that the defendant insurance
companies violated the Sherman Antitrust Act, the Racketeer Influenced
and Corrupt Organizations Act ("RICO"), the Florida Antitrust Act and
committed breach of contract, civil conspiracy and were unjustly enriched
by unlawfully adding improper and illegal charges and fees onto
25
<PAGE>
retrospectively rated premiums and otherwise charging more for those
policies than allowed by law. The suit seeks compensatory and punitive
damages, treble damages under the Antitrust and RICO claims, and
equitable relief. RIC and RPC moved to dismiss the amended complaint and
also adopted certain motions to dismiss the amended complaint filed by
various other defendants. On August 26, 1998, the district court issued
an order dismissing the entire suit against all defendants. The
plaintiffs filed a motion to reconsider the dismissal order, which was
denied by Judge Moreno on September 10, 1998. Most recently, on September
13, 1998, the plaintiffs filed a Notice of Appeal. Management will
continue to monitor the progress of the appeals process as necessary.
The Company, in the normal course of business, is party to various
lawsuits which management believes will not materially affect the
financial position of the Company. Based upon information presently
available, and in light of legal and other defenses available to the
Company, contingent liabilities arising from threatened and pending
litigation are not presently considered by management to be material.
However, no assurance can be given, or may be taken that material adverse
judgments will not be rendered against the Company as a result of the
aforementioned matters.
Other than as noted above, no provision had been made in the Company's
financial statements for the above matters at December 31, 1997 and 1996.
In addition, certain of the lawsuits and related legal expenses may be
covered under directors and officers' insurance coverage maintained by
the Company.
During February 1998, the FDOI completed an examination of the statutory
books and records of RIC and RPC as of December 31, 1996. The FDOI issued
a final report on the December 31, 1996 examination of RIC and RPC on
October 16, 1998. There were no adjustments to the capital and surplus of
RPC and $3.5 million of adjustments which reduced the capital and surplus
of RIC. The most significant examination adjustment to the capital and
surplus of RIC was the non-admission by the FDOI examiners of $2.2
million of investments that were held by a bank outside of Florida. The
remaining $1.3 million of adjustments related primarily to certain
related party receivables that were either collected or charged to
expense in 1997. These statutory adjustments have no material impact on
the accompanying GAAP financial statements.
The Company has historically met its cash requirements and financed its
growth through cash flow generated from operations and borrowings. The
Company's primary sources of cash flow from operations were premiums and
investment income, and its cash requirements consisted primarily of
payment of losses and loss adjustment expenses, support of its operating
activities including various reinsurance agreements and managed care
programs and services, capital surplus needs for its insurance
subsidiaries, and other general and administrative expenses. As discussed
more fully in Note 5, the Company and certain of its subsidiaries have
sold substantially all of their assets and transferred certain
liabilities to Zenith in exchange for cash on April 1, 1998. In
connection with this sale to Zenith, the Company and its subsidiaries
ceased substantially all of its former business operations and,
accordingly, after April 1, 1998, the Company's primary source of cash
flow will be generated from investment income. The Company's future cash
requirements will be satisfied through investment income and the
liquidation of investments.
Item 2. Changes to Securities
None.
Item 3.Defaults Upon Senior Securities
None.
26
<PAGE>
Item 4.Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
Shareholder Proposals
The proxy statement to be solicited by management of the Company with
respect to the 1999 Annual Meeting of Shareholders will confer
discretionary authority to vote on proposals of shareholders of the
Company intended to be presented for consideration at such Annual Meeting
that are submitted to the Company after May 14, 1999.
Item 6.Exhibits and Reports on Form 8-K
a) Exhibits
11 Statement Re Computation of Per Share Earnings
27 Financial Data Schedules
b) Reports on Form 8-K
The Company filed a Form 8-K on July 20, 1998 in connection with the
consummation of the transactions contemplated in the Asset
Purchase Agreement and the determination of the final purchase
price, as described more fully in Part 1, Item 1 of this Form
10-Q.
27
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
RISCORP, INC.
(Registrant)
By: /s/Walter E. Riehemann
Walter E. Riehemann
Senior Vice President and Secretary
Date: November 16, 1998
By: /s/Edward W. Buttner, IV
Edward W. Buttner IV, CPA
Principal Accounting Officer
Date: November 16, 1998
28
<PAGE>
<TABLE>
<CAPTION>
Exhibit 11
RISCORP, INC. AND SUBSIDIARIES
Statement Re. Computation of Per Share Earnings
For the three months ended September 30, 1998 and 1997
(in thousands, except share and per share amounts)
1998 1997
--------------- ----------------
(Unaudited) (Unaudited)
<S> <C> <C>
Net loss $ 1,698 $ 634
============== ===============
Weighted average common and common share equivalents outstanding:
Average number of common shares outstanding 36,868,114 36,077,778
Redemption contingency for CompSource acquisition -- --
Redemption contingency for IAA acquisition -- 790,336
Restricted stock vested 194,444 --
Weighted average common shares outstanding - (basic) 37,062,558 36,868,114
Common stock equivalents--assumed exercise of stock options -- --
Weighted average common and common share
equivalents outstanding - (diluted) 37,062,558 36,868,114
=========== ===========
Net loss per common share--basic $ 0.05 $ 0.02
================ ================
Net loss per common share--diluted $ 0.05 $ 0.02
================ ================
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Exhibit 11
RISCORP, INC. AND SUBSIDIARIES
Statement Re. Computation of Per Share Earnings
For the nine months ended September 30, 1998 and 1997
(in thousands, except share and per share amounts)
1998 1997
--------------- ----------------
(Unaudited) (Unaudited)
<S> <C> <C>
Net (loss) income $ (17,261) $ 3,810
=============== ==============
Weighted average common and common share equivalents outstanding:
Average number of common shares outstanding 36,868,114 36,077,778
Redemption contingency for CompSource acquisition -- --
Redemption contingency for IAA acquisition -- 790,336
Restricted stock vested 81,019 --
Weighted average common shares outstanding - (basic) 36,949,133 36,868,114
Common stock equivalents--assumed exercise of stock options -- 263,922
Weighted average common and common share
equivalents outstanding - (diluted) 36,949,133 37,331,665
============ ===========
Net (loss) income per common share--basic $ (0.47) $ 0.10
Net (loss) income per common share--diluted $ (0.47) $ 0.10
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FINANCIAL
STATEMENTS AS OF AND FOR THE PERIOD ENDED SEPTEMBER 30, 1998 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998<F1><F2><F3>
<DEBT-HELD-FOR-SALE> 11,127
<DEBT-CARRYING-VALUE> 15,471
<DEBT-MARKET-VALUE> 15,741
<EQUITIES> 0
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 26,598
<CASH> 16,998
<RECOVER-REINSURE> 0
<DEFERRED-ACQUISITION> 0
<TOTAL-ASSETS> 189,237
<POLICY-LOSSES> 0
<UNEARNED-PREMIUMS> 0
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 167
0
0
<COMMON> 389
<OTHER-SE> 148,661
<TOTAL-LIABILITY-AND-EQUITY> 189,237
25,819
<INVESTMENT-INCOME> 7,927
<INVESTMENT-GAINS> 4,268
<OTHER-INCOME> 234
<BENEFITS> 26,577
<UNDERWRITING-AMORTIZATION> 0
<UNDERWRITING-OTHER> 30,703
<INCOME-PRETAX> (17,072)
<INCOME-TAX> 189
<INCOME-CONTINUING> (17,261)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (17,261)
<EPS-PRIMARY> (.47)
<EPS-DILUTED> (.47)
<RESERVE-OPEN> 437,038
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
<FN>
<F1>Net investment income is reported net of any realized gains and losses in
the Statement of Income.
<F2>Financial Data Schedule information for the year
ending December 31, 1997 is incorporated by reference herein to FORM 10-K annual
report as filed with the Securities and Exchange Commission by the Company on
March 27, 1998.
<F3>Amounts inapplicable or not disclosed as a separate line on
the Statement of Financial Position or Results of Operations are reported as 0
herein.
</FN>
</TABLE>
