<PAGE> 1
Filed Pursuant To Rule 424(b)(4)
Registration No. 333-16499
4,061,013 SHARES
[LOGO] SUMMIT HOLDING SOUTHEAST, INC.
Proposed Holding Company for Bridgefield Employers
Insurance Company
COMMON STOCK
------------------------
All of the 4,061,013 shares of Common Stock offered hereby are being issued
and sold by Summit Holding Southeast, Inc. ("SUMMIT"). See "UNDERWRITING" for
factors considered in determining the public offering price. Summit's Common
Stock has been approved for listing on the Nasdaq National Market under the
symbol "SHSE."
The shares offered hereby constitute such portion of the 5,000,000 shares of
Common Stock that were offered to but not subscribed for by the Eligible
Policyholders (as defined herein) of Employers Self Insurers Fund ("ESIF") and
all directors, officers and certain other management employees (the "MANAGEMENT
GROUP") of Summit and its subsidiaries (including ESIF) in a concurrent
subscription offering that expired on May 9, 1997 (the "SUBSCRIPTION OFFERING,"
and together with this offering (the "PUBLIC OFFERING"), the "OFFERINGS"). See
"THE OFFERINGS -- Subscription Offering." The Offerings are part of an Amended
Plan of Conversion and Recapitalization (the "PLAN OF CONVERSION") pursuant to
which ESIF will convert from a Florida group self-insurance fund to a Florida
stock insurance company (the "CONVERSION") and become a wholly owned subsidiary
of Summit.
------------------------
SEE "RISK FACTORS" BEGINNING ON PAGE 8 FOR A DISCUSSION OF CERTAIN FACTORS
THAT SHOULD BE CONSIDERED BY PROSPECTIVE INVESTORS.
------------------------
THE SECURITIES OFFERED HEREBY HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE
SECURITIES AND EXCHANGE COMMISSION (THE "COMMISSION"), ANY STATE SECURITIES
COMMISSION, OR THE DEPARTMENT OF INSURANCE OF THE STATE OF FLORIDA (THE "FLORIDA
DOI"), NOR HAS THE COMMISSION, ANY STATE SECURITIES COMMISSION OR THE FLORIDA
DOI PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION
TO THE CONTRARY IS A CRIMINAL OFFENSE.
THE FLORIDA DOI HAS APPROVED THE PLAN OF CONVERSION. HOWEVER, THE APPROVAL OF
THE PLAN OF CONVERSION BY THE FLORIDA DOI DOES NOT CONSTITUTE IN ANY WAY A
RECOMMENDATION OR ENDORSEMENT OF THE PLAN OF CONVERSION BY THE FLORIDA DOI.
<TABLE>
<CAPTION>
======================================================================================================================
PRICE TO UNDERWRITING PROCEEDS TO
PUBLIC DISCOUNT(1) SUMMIT(2)
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Per Share.................................. $11.00 $0.77 $10.23
- ----------------------------------------------------------------------------------------------------------------------
Total(3)(4)................................ $55,000,000 $3,465,000 $51,535,000
======================================================================================================================
</TABLE>
(1) No Underwriting Discount or other compensation is payable with regard to
500,000 shares sold to the Management Group. Summit has agreed to indemnify
the Underwriters against certain liabilities, including liabilities under
the Securities Act of 1933, as amended. See "UNDERWRITING."
(2) Before deducting expenses of the Conversion, including the Offerings,
estimated at $1,500,000, which are payable by Summit.
(3) Includes 938,987 shares of Common Stock sold in the Subscription Offering.
(4) Summit has granted the Underwriters a 30-day option to purchase up to
750,000 additional shares of Common Stock from Summit on the same terms and
conditions as the securities offered hereby solely to cover over-allotments,
if any. If the option is exercised in full, the total Price to Public,
Underwriting Discount and Proceeds to Summit will be $63,250,000, $4,042,500
and $59,207,500, respectively. See "UNDERWRITING."
------------------------
The shares of Common Stock are offered by the Underwriters, subject to prior
sale, when, as and if delivered to and accepted by them, and subject to certain
other conditions including the right of the Underwriters to withdraw, cancel,
modify or reject any order in whole or in part. It is expected that delivery of
the shares will be made on or about May 28, 1997, at the offices of Raymond
James & Associates, Inc., St. Petersburg, Florida.
RAYMOND JAMES & ASSOCIATES, INC. ABN AMRO CHICAGO CORPORATION
The date of this Prospectus is May 21, 1997
<PAGE> 2
[PICTURES, CHARTS, ETC.]
CERTAIN PERSONS PARTICIPATING IN THE OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK,
INCLUDING PURCHASES OF THE COMMON STOCK TO STABILIZE ITS MARKET PRICE, PURCHASES
OF THE COMMON STOCK TO COVER SOME OR ALL OF A SHORT POSITION IN THE COMMON STOCK
MAINTAINED BY THE UNDERWRITERS AND THE IMPOSITION OF PENALTY BIDS. FOR A
DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING."
2
<PAGE> 3
PROSPECTUS SUMMARY
Pursuant to the Plan of Conversion, as approved by the members of ESIF at a
Special Meeting of Policyholders on May 9, 1997 (the "SPECIAL MEETING"), ESIF
will convert from a Florida group self-insurance fund to a Florida stock
insurance company, Bridgefield Employers Insurance Company ("BRIDGEFIELD"), and
become a wholly owned subsidiary of a newly formed holding company, Summit.
Unless the context requires otherwise, as used herein, the "Company" refers to
Summit and its subsidiaries as of and following the completion of the Conversion
and a simultaneous reorganization of the Company's operating structure. Unless
otherwise indicated, information in this Prospectus assumes no exercise of the
Underwriters' over-allotment option. All financial information set forth herein
is presented in accordance with generally accepted accounting principles
("GAAP"), unless otherwise noted. The following summary is qualified in its
entirety by the more detailed information and consolidated financial statements
(including the notes thereto) appearing elsewhere in this Prospectus.
THE COMPANY
The Company provides a variety of managed care workers' compensation
products and services to employers and self-insured employer groups primarily in
Florida, as well as in Louisiana and Kentucky. Through the Company's
administrative group (the "ADMINISTRATIVE SUBSIDIARIES"), the Company provides
administrative services for four self-insurance funds (the "FUNDS"), for the
Company's two wholly owned workers' compensation insurance companies (the
"INSURANCE SUBSIDIARIES") and for certain municipalities. These administrative
services include most aspects of the daily operations of the Funds and the
Insurance Subsidiaries, including sales and marketing, underwriting, claims
administration, loss control and policy administration. These services are
provided for a fee, with the Company generally receiving a percentage of
premiums. The Administrative Subsidiaries do not assume any underwriting risk of
the Funds, which are entities formed to provide workers' compensation coverage
for self-insured employer groups on a pooled basis.
The Insurance Subsidiaries, which include Bridgefield and Bridgefield
Casualty Insurance Company ("BRIDGEFIELD CASUALTY"), underwrite and assume the
underwriting risk with respect to workers' compensation insurance policies for
Florida employers of all sizes, primarily in the construction, manufacturing,
wholesale and retail and service industries. As of December 31, 1996, in the
aggregate, the Company's insurance products and administrative services are
provided to approximately 15,800 employers representing approximately $217.4
million in premiums, including approximately $101.0 million in premiums
attributable to the Funds and $116.4 million in premiums attributable to the
Insurance Subsidiaries. See "BUSINESS."
The Company's approach to managed care workers' compensation is to select
responsible employers for coverage, assist such employers in creating a safe
work place and proactively manage claims, thereby returning employees to work
promptly and minimizing losses. Employers' safety programs are monitored by the
Company's staff of approximately 25 loss control field representatives who visit
an employer's work place on at least an annual basis. Reported claims are
proactively managed by the Company so that employees receive prompt care by
healthcare professionals which are part of the Company's provider network. The
Company's claims management professionals direct care through the provider
network, monitor employee treatment and progress toward returning to work and
perform utilization and peer review to control costs. The Company's approach to
managed care workers' compensation has produced an average net ultimate loss
ratio for ESIF during the three fiscal years ended March 31, 1996 of 69.8%,
which is better than the national average of 75.0% during the period 1993
through 1995, based on information published by A.M. Best Company ("A.M. BEST").
See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS." See "BUSINESS -- Strategy" and "-- Managed Care."
The Company believes that the Conversion provides new opportunities for
improving its return on invested capital through growth in its core workers'
compensation business. Following the Conversion, the Company will be able to
offer both self-insurance and traditional indemnity products, which will improve
its ability to service its markets. In addition, as a stock corporation, the
Company may have access to additional capital to finance growth by acquisition
and to expand into other geographic markets (subject to any necessary regulatory
approvals). Key aspects of the Company's business strategy following the
Conversion include:
3
<PAGE> 4
(i) continued use of both self-insurance and indemnity products; (ii) emphasis
on profitable underwriting results; (iii) proactive implementation of managed
care; (iv) leveraging of administrative services capabilities; and (v) emphasis
on excellent customer service. See "BUSINESS -- Strategy."
The Company's business was started in 1977, when Summit Consulting, Inc.
("SCI") was formed to establish and administer workers' compensation
self-insurance programs for group self-insurance funds that are sponsored and
formed by trade associations. The Company's primary Insurance Subsidiary, ESIF
(which pursuant to the Conversion will become Bridgefield), was formed in 1978
as a group self-insurance fund under Florida law and SCI became its
administrator at that time. Between 1979 and 1982, SCI assisted with the
formation of, and became the administrator of, three of the Funds, located in
Florida and Louisiana, and in 1995, SCI became the administrator of the fourth
Fund, located in Kentucky. See "BUSINESS -- Products and Services." None of the
Funds are related to the Company, except that certain of the directors of Summit
are trustees of certain of the Funds, as described in "MANAGEMENT OF THE
COMPANY -- Compensation Committee Interlocks and Insider Participation" and
"CERTAIN TRANSACTIONS." Until January 16, 1996, ESIF was also unrelated to SCI.
Effective on that date, ESIF acquired SCI, its holding company, Summit Holding
Corporation ("SHC"), and all of their affiliates (the "ACQUISITION"). Pursuant
to the Conversion, Summit will become a holding company for ESIF (which will be
Bridgefield after the Conversion) and the other Company subsidiaries. Summit is
a Florida corporation formed in November 1996 solely for this purpose at the
direction of the ESIF Board of Trustees. Prior to the Conversion, Summit has not
commenced operations and has nominal assets and no liabilities. See "THE
COMPANY."
The executive offices of the Company are located at 2310 A-Z Park Road,
Lakeland, Florida 33801. The telephone number at such office is (941) 665-6060.
THE CONVERSION
The Board of Trustees of ESIF has unanimously adopted the Plan of
Conversion, which was approved by its policyholders at the Special Meeting,
whereby ESIF will convert from a Florida group self-insurance fund to a Florida
stock insurance company and become a wholly owned subsidiary of Summit. The
trustees of ESIF stated that they adopted the Plan of Conversion because they
believe that the Conversion will provide several important benefits. The
conversion of ESIF to a stock insurance company that is wholly owned by a
publicly traded holding company is expected to provide improved access to the
capital markets and increased flexibility for raising additional capital in the
form of equity and debt financings. The holding company structure is also
expected to provide increased opportunities for growth, either internally or
through acquisitions, that are generally not available to a group self-insurance
fund and provide greater flexibility for the diversification of business
activities through existing or newly formed subsidiaries or through strategic
partnerships. See "THE CONVERSION -- Reasons for the Conversion."
Currently, each member of ESIF has certain membership interests in ESIF
("MEMBERSHIP INTERESTS") arising under the organizational documents of ESIF, the
insurance laws of the State of Florida (together with all applicable
regulations, the "FLORIDA INSURANCE CODE") and otherwise, including, without
limitation, the right to vote for the election of trustees and the right to
participate in any distribution of the surplus of ESIF in the event of its
liquidation. If the Plan of Conversion becomes effective, all Membership
Interests will be extinguished in the Conversion. In exchange for such
Membership Interests, the Plan of Conversion provides that certain policyholders
(the "ELIGIBLE POLICYHOLDERS") will receive certain consideration including the
elimination of potential assessments, an allocable portion of shares of the
Series A Preferred Stock, $10.00 par value per share (the "SERIES A PREFERRED
STOCK"), of Summit and subscription rights to purchase shares of Common Stock of
Summit in the Subscription Offering at a price (the "SUBSCRIPTION PRICE") equal
to the price per share of the Common Stock being offered for sale to the public
in the Public Offering. Up to 5,000,000 shares of the Common Stock were offered
to Eligible Policyholders less the amount of shares subscribed for by the
Management Group, who were offered up to, and who subscribed and paid for,
500,000 shares of the Common Stock in the Subscription Offering. See "THE
CONVERSION."
The Department of Insurance of the State of Florida (the "Florida DOI") has
approved the Plan of Conversion. However, such approval does not constitute a
recommendation or endorsement of the Plan of
4
<PAGE> 5
Conversion by the Florida DOI. The Conversion will become effective upon the
satisfaction of certain conditions identified in the Plan of Conversion and upon
the Board of Trustees of ESIF declaring the Plan of Conversion effective. The
Board of Trustees may amend the Plan of Conversion, with the concurrence of the
Florida DOI, or withdraw the Plan of Conversion, at any time prior to the
effective date of the Conversion (the "EFFECTIVE DATE").
In accordance with the terms of the Plan of Conversion, no person or
entity, together with associates and persons acting in concert, may purchase in
the Offerings more than 4.99% (the "PURCHASE LIMIT") of the shares of Common
Stock to be outstanding after the Conversion (the "POST OFFERING OUTSTANDING
SHARES"). Notwithstanding the foregoing, Summit will permit any "investment
company" as defined in Section 3 of the Investment Company Act of 1940, as
amended, and may, in its discretion, permit any other purchaser in the
Offerings, to purchase more than 4.99% but less than 10% of the Post Offering
Outstanding Shares, subject to each such purchaser obtaining any required
approval of the Florida DOI. Following the Effective Date, the Florida Insurance
Code, as applicable to Summit as the holding company of a wholly owned Florida
insurance company, will prohibit any person from acquiring 10% or more of the
outstanding voting securities of Summit without the prior approval of the
Florida DOI. Any person who acquires at least 5% but less than 10% of the
outstanding voting securities of Summit will be permitted to do so only by
filing a disclaimer of affiliation and control that is not disallowed by the
Florida DOI.
THE OFFERINGS
Common Stock Offered by Summit...... 5,000,000 shares(1)
Common Stock to be Outstanding After
the Effective Date.................. 5,000,000 shares(2)
Series A Preferred Stock Offered to
Policyholders by Summit and to be
Outstanding After the Effective
Date.............................. 1,639,701 shares(3)
Use of Proceeds..................... To increase Bridgefield's capital to
satisfy applicable requirements of
the Florida Insurance Code, and the
remainder of such proceeds, if any,
will be retained by Summit for
general corporate purposes.
Nasdaq National Market Symbol....... SHSE
- ---------------
(1) The number of shares of Common Stock available for sale in the Public
Offering is the 4,061,013 shares not subscribed for by Eligible
Policyholders and the Management Group in the Subscription Offering.
(2) Assumes that all shares of Common Stock offered pursuant to the Offerings
are sold and does not include 500,000 shares of Common Stock reserved for
issuance under the Incentive Plan and 45,000 shares of Common Stock
reserved for issuance under the 401(k) Plan, as such terms are defined in
"RISK FACTORS -- Shares Eligible for Future Sale; Possible Volatility of
Stock Price." See "MANAGEMENT OF THE COMPANY -- Incentive Plan" and
"-- 401(k) Plan."
(3) The holders of the Series A Preferred Stock will be entitled to receive
annual cash dividends of $0.40 per share, reflecting the rate of 4% per
year, cumulating from the date of issue but payable only as and when
declared by the Board of Directors of Summit; provided, however, that all
cumulated but unpaid dividends shall be paid upon any redemption of the
Series A Preferred Stock or liquidation of Summit. See "DIVIDEND
POLICY -- Series A Preferred Stock."
5
<PAGE> 6
SUMMARY PRO FORMA FINANCIAL AND OTHER DATA
The following unaudited pro forma financial data reflect the acquisition by
ESIF of SHC and its affiliates on January 16, 1996 (the "ACQUISITION") and all
of the transactions constituting the Conversion. The pro forma Statement of
Income data for the fiscal year ended March 31, 1996 reflect the Acquisition and
Conversion as if they had been completed as of April 1, 1995. The pro forma
Statement of Income data for the nine-month period ended December 31, 1995
reflects the Acquisition and the Conversion as if they had been completed as of
April 1, 1995. The pro forma Statement of Income data for the nine-month period
ended December 31, 1996 reflects the Conversion as if it had occurred on April
1, 1996. The pro forma Balance Sheet data at December 31, 1996 reflect the
Conversion as if it had been completed as of December 31, 1996. This information
should be read in conjunction with the pro forma consolidated financial
statements and notes thereto appearing elsewhere in this Prospectus. See
"SELECTED FINANCIAL DATA."
<TABLE>
<CAPTION>
YEAR NINE MONTHS ENDED
ENDED DECEMBER 31,
MARCH 31, ---------------------------
1996 1995(6) 1996(6)
--------- ---------- ---------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE
DATA)
<S> <C> <C> <C>
Statement of Income Data:
Total revenue............................................. $ 169,174 $ 130,757 $ 110,697
Losses and loss adjustment expenses....................... 94,844 67,043 50,236
Other underwriting, general and administrative expenses... 60,952 44,669 45,162
Total losses and operating expenses....................... 155,796 111,712 95,398
Interest expense.......................................... 3,978 3,017 2,719
Amortization and depreciation............................. 5,340 4,074 3,704
Net income before taxes................................... 4,060 11,954 8,876
Net income................................................ 2,978 7,933 5,620
Preferred dividends....................................... 656 492 492
Net income available to common shareholders............... $ 2,322 $ 7,441 $ 5,128
========= ========== =========
Net income per common share............................... $ 0.46 $ 1.49 $ 1.03
========= ========== =========
Weighted average common shares outstanding................ 5,000,000 5,000,000 5,000,000
Other Data(1):
Insurance Subsidiaries:
Net loss ratio(2)....................................... 82.5% 74.7% 67.4%
Expense ratio(3)........................................ 34.1% 31.8% 33.4%
Combined ratio(4)....................................... 116.6% 106.5% 100.8%
Administrative Subsidiaries:
EBITDA(5)............................................... $ 13,860 12,061 6,347
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1996
------------------------------------
(IN THOUSANDS)
<S> <C>
Balance Sheet Data:
Cash and invested assets.................................. $275,319
Total assets.............................................. 526,972
Loss and loss adjustment expenses......................... 376,923
Debt...................................................... 33,000
Total shareholders' equity................................ 77,378
</TABLE>
- ---------------
(1) Excludes inter-company eliminations.
(2) Net loss ratio is the ratio of losses and loss adjustment expenses incurred
to premiums earned.
(3) Expense ratio is the ratio of underwriting, general and administrative
expenses to premiums earned.
(4) Combined ratio is the sum of the net loss ratio and the expense ratio.
(5) EBITDA represents earnings before interest, income taxes, depreciation and
amortization.
(6) The pro forma Statement of Income data does not include investment earnings
on the net Offering proceeds of the issuance of 5,000,000 shares of Common
Stock. Assuming the net proceeds were invested in 180-day U.S. Treasury
Bills, the pro forma amounts would be as follows:
<TABLE>
<CAPTION>
NINE MONTHS ENDED
DECEMBER 31,
YEAR ENDED --------------------
MARCH 31, 1996 1995 1996
-------------- ------- -------
<S> <C> <C> <C>
Net income before taxes..................................... $6,985 $14,123 $10,861
Net income.................................................. 4,803 9,286 6,857
Net income available for common shareholders................ 4,147 8,794 6,365
Net income per common share................................. $ 0.83 $ 1.76 $ 1.27
</TABLE>
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<PAGE> 7
SUMMARY HISTORICAL FINANCIAL AND OTHER DATA
The following summary financial data has been taken from, or derived from,
ESIF's consolidated financial statements, including the related notes thereto.
ESIF's consolidated financial statements as of March 31, 1996 and for the year
ended March 31, 1996 have been audited by Ernst & Young LLP, independent
auditors, whose reports thereon appear elsewhere in this Prospectus. ESIF's
consolidated financial statements as of March 31, 1995 and for the fiscal years
ended March 31, 1994 and 1995 have been audited by Brinton & Mendez, certified
public accountants, whose report thereon appears elsewhere in this Prospectus.
ESIF's consolidated financial statements as of December 31, 1995 and 1996 and
for the nine months ended December 31, 1995 and 1996, as well as the summary
financial data provided as of and for the fiscal years ended March 31, 1992 and
1993 are unaudited, but in the opinion of management contain all adjustments,
consisting of only normal, recurring accruals, for a fair presentation of the
results of such periods. The information set forth below is not necessarily
indicative of the results of such periods. The information set forth below is
not necessarily indicative of the results of future operations and should be
read in conjunction with the consolidated financial statements and notes
thereto. The summary historical financial data includes the operations of SHC
from January 16, 1996, the effective date of the Acquisition.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEARS ENDED MARCH 31, DECEMBER 31,
---------------------------------------------------------- -------------------------
1992 1993 1994 1995 1996 1995 1996
----------- ----------- -------- -------- -------- ----------- -----------
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Statement of Income Data:
Total revenue............. $143,750 $192,067 $158,951 $140,815 $140,328 $103,086 $110,811
Losses and loss adjustment
expenses................ 103,657 149,177 108,411 69,116 94,844 67,043 50,236
Other underwriting,
general and
administrative
expenses................ 32,787 40,145 37,121 41,546 43,657 28,548 45,837
Interest expense.......... -- -- -- -- 847 -- 2,719
Amortization and
depreciation............ -- -- -- -- 1,103 -- 3,729
Income (loss) from
continuing operations
before income taxes..... 7,306 2,745 13,419 30,153 (123) 7,495 8,290
Loss from discontinued
operations.............. -- -- -- -- (197) -- (1,250)
Net income................ $ 6,844 $ 2,953 $ 8,885 $ 19,163 $ 185 $ 5,172 $ 3,198
======== ======== ======== ======== ======== ======== ========
Other Data(1):
Net loss ratio(2)......... 78.5% 82.3% 73.0% 53.8% 82.5% 74.7% 67.4%
Expense ratio(3).......... 24.8% 22.1% 25.0% 32.3% 34.1% 31.8% 33.4%
Combined ratio(4)......... 103.3% 104.4% 98.0% 86.1% 116.6% 106.5% 100.8%
</TABLE>
<TABLE>
<CAPTION>
AS OF
AS OF MARCH 31, DECEMBER 31,
---------------------------------------------------------- -------------------------
1992 1993 1994 1995 1996 1995 1996
----------- ----------- -------- -------- -------- ----------- -----------
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Balance Sheet Data:
Cash and invested
assets.................. $147,056 $176,931 $201,688 $224,956 $220,266 $236,421 $225,319
Recoverable from SDTF..... 5,632 6,745 9,929 15,879 20,060 16,827 21,138
Total assets.............. 307,345 373,069 405,765 425,206 491,844 437,932 476,972
Loss and loss adjustment
expenses................ 304,205 360,425 368,000 367,391 387,632 372,786 376,923
Debt...................... -- -- -- -- 44,000 -- 33,000
Total equity (deficit).... (9,458) (6,485) 2,480 20,065 23,154 31,238 27,378
</TABLE>
- ---------------
(1) Ratios for Insurance Subsidiaries.
(2) Net loss ratio is the ratio of losses and loss adjustment expenses incurred
to premiums earned.
(3) Expense ratio is the ratio of underwriting, general and administrative
expenses to premiums earned.
(4) Combined ratio is the sum of the net loss ratio and the expense ratio.
7
<PAGE> 8
RISK FACTORS
An investment in the Common Stock involves a high degree of risk. In
addition to other information contained in this Prospectus, prospective
investors should consider carefully the following risk factors in evaluating an
investment in the shares of the Common Stock offered hereby. This Prospectus
contains certain forward-looking statements that involve risks and
uncertainties. The Company's actual results could differ materially from the
results reflected in those forward-looking statements. Factors that could cause
or contribute to such differences include, but are not limited to, those
discussed below, as well as those discussed elsewhere in this Prospectus.
HIGHLY COMPETITIVE FLORIDA WORKERS' COMPENSATION MARKET
The workers' compensation insurance industry in Florida is highly
competitive. During the past fifteen years, a significant portion of the Florida
market has been serviced by certain group self-insurance funds, which are
entities that allow employers to obtain workers' compensation coverage on a
pooled basis, typically subjecting each employer to joint and several liability
for the group's losses. Primarily as a result of certain changes in the Florida
Insurance Code, there has been an increasing trend in the workers' compensation
industry in Florida to shift away from coverage offered by such funds and toward
traditional insurance products. Generally, policies issued by insurance
companies are non-assessable; therefore, an insurance company cannot assess its
policyholders for its underwriting or other losses. This structure affords
policyholders greater financial certainty and security, which has led to the
increased demand and availability in Florida of conventional, non-assessable
insurance products. The Administrative Subsidiaries have historically derived a
substantial portion of their revenues from managing the Funds, which in the
fiscal year ended March 31, 1996 accounted for 22% of the Company's total
revenue, on a pro forma basis after giving effect to the Conversion. The Company
believes that the market for workers' compensation products will continue to
shift away from coverage offered by assessable funds to traditional insurance
products. The loss or cancellation of any of the Company's significant client
groups, or the general availability of traditional non-assessable insurance
coverage to members of such groups on more favorable terms than provided under
the Company's programs, could have a material adverse effect on the Company's
business, financial condition and results of operations. See "-- Government
Regulation" and "-- Competition."
GOVERNMENT REGULATION
The workers' compensation insurance business is subject to state-by-state
regulation (which in some instances includes rate regulation and mandatory fee
schedules). These regulations are primarily intended to protect covered
employees and policyholders, not workers' compensation insurance companies,
administrators or their shareholders. Changes in workers' compensation insurance
laws or regulations or their interpretation or administration could have a
material adverse effect on the Company's business, financial condition and
results of operations. In particular, decreases in Florida workers' compensation
rates, such as the 11.2% premium rate reduction effective January 1, 1997, could
have a material adverse effect upon the Company. State regulatory agencies have
discretionary power with respect to most aspects of the Company's business,
including premium rates, capital surplus requirements, reserve requirements and
investment criteria. Many states, including Florida, limit the maximum amount of
dividends and other payments that can be made by insurance companies. This may
limit the amount of dividends that may be paid by the Insurance Subsidiaries to
Summit, which in turn may limit the amount of capital available to Summit for
debt service, expansion, dividend payments to shareholders and other purposes.
See "--Effect of Holding Company Structure; Dividends," "DIVIDEND POLICY,"
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -- Liquidity and Capital Resources" and "BUSINESS -- Regulation."
State laws also require insurance companies to establish reserves for
payment of policyholder liabilities and impose restrictions on the kinds of
assets in which insurance companies may invest. These restrictions may require
the Company to invest its assets more conservatively than it would if it were
not subject to the state law restrictions and may prevent the Company from
obtaining as high a return on its assets as it might otherwise be able to
realize. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS -- Results of Operations" and "BUSINESS-- Investment
Portfolio."
8
<PAGE> 9
Numerous proposals have been debated in Congress and in several state
legislatures regarding healthcare legislation intended to control the cost and
availability of healthcare services. It is not possible to determine what
healthcare reform legislation will be adopted by Congress or any state
legislature, or if and when any such legislation will be adopted and
implemented. In the event that such legislation is adopted and implemented,
there can be no assurance that the Company will be able to adjust effectively to
any regulatory changes made by future healthcare reform legislation and remain
profitable. The Company is unable to predict accurately the nature and effect,
if any, that the adoption of healthcare legislation or regulations or changing
interpretations at the federal or state level would have upon the Company.
Except for certain statutorily prescribed credits, Florida law does not
permit companies to compete on the basis of price in workers' compensation
insurance. This approach is followed in relatively few other states. If Florida
were to adopt an open rating system in which premium rates would be established
with little or no regulatory intervention, the Company's business, financial
condition and results of operations could be materially adversely affected.
POSSIBLE UNDERFUNDING OF FLORIDA SPECIAL DISABILITY TRUST FUND
Florida operates a Special Disability Trust Fund (the "SDTF") that
reimburses insurance carriers, self-insurance funds and self-insured employers
in Florida for certain workers' compensation benefits paid to injured employees.
The SDTF is managed by the State of Florida and is funded through assessments
against Florida insurers and self-insurers. For the three fiscal years ended
March 31, 1994, 1995 and 1996, the Company received SDTF recoveries of $4.5
million, $5.7 million and $5.6 million, respectively, and paid assessments of
$5.5 million, $4.7 million and $5.6 million, respectively. In addition, the
Company's consolidated balance sheet as of December 31, 1996 included an asset
of approximately $21.1 million representing SDTF recoveries that the Company
estimated at that time it would be entitled to receive, based on claims
identified as subject to SDTF recovery and considering the Company's recovery
experience.
The SDTF has not prefunded its claims liability, and no reserves currently
exist to satisfy future claims. Under Florida law, the SDTF is currently
scheduled to expire in the year 2000, unless it is re-created by the Florida
legislature. The SDTF recently underwent legislative review. Under a recent bill
passed by the Florida legislature and submitted to the Governor, the SDTF law
would be amended so that claims arising from accidents occurring on or after
January 1, 1998 would not be accepted for reimbursement by the SDTF. The bill
states the SDTF will be liable for reimbursement for subsequent injuries that
occur prior to January 1, 1998, and that assessments are to continue for funding
purposes.
In addition, the Florida DOI participated with the Florida legislature in
the review of current and proposed statutory accounting treatments of SDTF
projected recoveries, and with respect to how an insurer may include such
estimated recoveries in its admitted asset and loss reserve calculations in
statutory financial statements. Under the bill referred to above, the
anticipated SDTF recoveries that an insurer could take into account when
computing loss reserves in its statutory financial statements would be limited
to recoveries for which a claim has been accepted for payment. Credit for all
other anticipated recoveries would be capped at the total SDTF recovery amount
used by the insurer in 1996, and this capped amount would be phased out over a
five year period, commencing with statutory financial statements filed in the
year 2000 (20% per year reduction of 1996 capped amount).
While it is not possible to predict the outcome of this or any other
legislative or regulatory proposals affecting the SDTF, changes in the SDTF's
operations or funding which decrease the availability of recoveries or increase
assessments payable by the Company, or the discontinuation of the SDTF, could
have a material adverse effect on the Company's business, financial condition or
results of operations.
Subject to the legislation set forth above, the SDTF recoverable recorded
on the Company's balance sheet is an actuarial estimate of the amount the
Company can expect to recover from the SDTF on eligible claims. The Company has
a dedicated claims unit that handles the tracking, submission and collection
process with the SDTF. In the event that there are adverse developments in SDTF
collection experience, the recorded recoverable balance will accordingly be
adjusted.
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With respect to collection patterns, the SDTF reviews reimbursement
requests on a claim by claim basis, with actual collection payments tied to the
paid loss development over a claim's life. The payments are not made ratably or
in any other predictable pattern. A prior actuarial review of the SDTF indicated
the average time frame for collection of a claim made to the SDTF is 6 to 8
years. See "BUSINESS -- Regulation -- Special Disability Trust Fund."
COMPETITION
The market to provide workers' compensation insurance and services is
highly competitive. The Company's competitors include, among others, insurance
companies, specialized provider groups, in-house benefits administrators, state
insurance pools and other significant providers of insurance services. A number
of the Company's current and potential competitors are significantly larger,
with greater financial and operating resources than the Company, and can offer
their services nationwide. The Company's Insurance Subsidiaries do not offer
multi-line insurance products that are offered by some of such competitors. In
addition, after a period of absence from the market, traditional national
insurance companies have re-entered the Florida workers' compensation insurance
market, thereby increasing competition in the Company's principal market. The
general lack of assessibility features in the policies of traditional indemnity
insurance companies gives them a competitive advantage over self-insurance
funds, including the Funds managed by the Company.
Additionally, because of Bridgefield's short operating history as a stock
insurance company, the Company does not currently have a letter rating from A.M.
Best, the leading national insurance rating organization, and it is not yet
entitled to receive such a rating. The Company intends to apply for a letter
rating from A.M. Best in the future, when it is deemed eligible to do so. There
can be no assurance that the Company will receive a rating or that if a rating
is received it will be favorable. The absence of a rating, or an unfavorable
rating in the future, may be a competitive disadvantage in some markets,
especially regarding larger customers with in-house risk managers.
CONCENTRATION IN A SINGLE STATE
All of the Company's insurance policies are written to entities whose
principal places of business are in Florida, and over 90% of the Company's total
revenue for the fiscal year ended March 31, 1996, on a pro forma basis after
giving effect to the Conversion, was derived from insurance products and
administrative services in Florida. Accordingly, the Company could be adversely
affected by economic downturns, significant unemployment, regulatory
developments and other conditions that may occur from time to time in Florida,
which may not significantly affect its more geographically diversified
competitors.
POSSIBLE INADEQUACY OF LOSS RESERVES
The Insurance Subsidiaries are required to maintain reserves to cover their
estimated ultimate liability for losses and loss adjustment expenses with
respect to reported and unreported claims. Reserves are estimates involving
actuarial and statistical projections at a given time of what the insurer
expects to be the cost of the ultimate settlement and administration of claims
based on facts and circumstances then known, predictions of future events,
estimates of future trends in claims severity and judicial theories of
liability, legislative activity and other variable factors, such as inflation.
The establishment of appropriate reserves is an inherently uncertain process,
particularly in the workers' compensation industry in which claims payments can
extend for lengthy periods of time. There can be no assurance that ultimate
losses will not materially exceed the Insurance Subsidiaries' loss reserves. As
discussed in "MANAGEMENT'S DISCUSSION AND ANALYSIS -- Losses and Loss Adjustment
Expense," the Company has experienced considerable reserve deficiencies in years
prior to 1993 and has adjusted its reserves in response to development trends.
There can be no assurance that there will not be deficiencies or adjustments in
the future, resulting from numerous factors including, for example, any
instability in the regulatory environment and loss data inadequacies.
Among other risks relating to loss reserves is the possibility that the
Company may under-accrue for refund liabilities relating to retrospective
policies in the event that a substantial number of the Company's insureds have
less than expected losses during a claims period. Throughout the fiscal years
ended March 31, 1994, 1995 and 1996, and the nine months ended December 31,
1996, the Company established and
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maintained gross aggregate accruals for retrospective refunds in amounts of $6.4
million, $9.2 million, $10.6 million and $10.4 million, respectively. Between
March 31, 1994 and December 31, 1996, the Company paid an aggregate of $0.9
million in excess of these refund accruals.
In addition, there is a risk that premiums receivable related to
retrospectively rated policies may be over-accrued if the loss experience for
the covered policies varies significantly from expected loss ratios. During the
fiscal year ended March 31, 1996, the Company reduced the estimate of accrued
retrospective premiums receivable for all open years by approximately $9.3
million. As further discussed in "MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Losses and Loss Adjustment
Expenses," this reduction was due to the Company's actuaries revising their
assumptions regarding the variance of insureds' loss ratios from the overall
mean. The actuaries' model had previously used, to a large extent, industry
data, and the revisions were done as the actuaries began to use more
individualized data for the Insurance Companies' insureds.
To the extent that reserves prove to be inadequate in the future, the
Insurance Subsidiaries would have to increase such reserves and incur a charge
to earnings in the period such reserves are increased, which could cause
fluctuations in quarterly operating results and which could have a material
adverse effect on the Company's business, financial condition and results of
operations.
RENEWAL RISKS; QUARTERLY FLUCTUATIONS IN OPERATING RESULTS
The members of each of the Funds, and most of the policyholders of
Bridgefield, are eligible to renew their memberships or policies each year on a
common anniversary date. With respect to Bridgefield, this anniversary date each
year is April 1. If a large number of members of any Fund, or a large number of
Bridgefield's policyholders, were to decline renewal in any given year, the
Company's results of operations could be materially adversely affected in the
renewal quarter and subsequent quarters. Results of operations may also
fluctuate as a result of a variety of other factors, including, without
limitation, changes in pricing policies by the Company or its competitors, the
results of actuarial analysis of loss development, demand for the services of
the Administrative Subsidiaries, the introduction of new services and service
enhancements by the Company or its competitors, the market acceptance of new
services, competitive conditions in the industry, changes in operating expenses,
changes in Company strategy, changes in applicable legislation and regulation
and general economic conditions. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS."
POSSIBLE INABILITY TO SERVICE DEBT
In connection with the Acquisition, SHC borrowed $44.0 million from First
Union National Bank of North Carolina and certain other participating banks
(collectively, the "BANKS"), with $36.0 million pursuant to a term loan and $8.0
million pursuant to a revolving line of credit. The outstanding principal
balance of such debt at December 31, 1996 was approximately $33.0 million. The
interest rate for such debt is prime plus 1% for "Base Rate" portions. Scheduled
quarterly payments of the term loan began on September 30, 1996 and extend
through June 30, 2002, with principal payments totaling approximately $1.6
million, $3.8 million, $4.6 million, $9.0 million, $10.0 million and $4.0
million due in calendar years 1997, 1998, 1999, 2000, 2001 and 2002,
respectively. Accrued interest is due with each principal payment. The
commitment under the revolving line of credit was reduced to $5.0 million in
November 1996, and it will reduce by $1.5 million on each of June 30, 2000 and
June 30, 2001, with the remaining $2.0 million becoming due on June 30, 2002. As
collateral for the debt, SHC pledged to the Bank the issued and outstanding
stock of SCI, Bridgefield Casualty, Summit Healthcare Holdings, Inc. and Meritec
Solutions, Inc. ("MERITEC"). Prior to the Effective Date, the Company intends to
execute a credit agreement with the Bank pursuant to which, upon consummation of
the Conversion, the existing debt will be restructured. Under such new credit
facility, as of the Effective Date, the term loan will be $33.0 million and the
revolving line of credit will be $5.0 million, and the interest rate initially
will be prime plus 1%. The annual principal payments (which are payable in
quarterly installments) will be approximately $2.3 million, $5.0 million, $5.6
million, $7.6 million, $9.1 million and $3.4 million in each of calendar years
1997, 1998, 1999, 2000, 2001 and 2002, respectively.
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Pursuant to the Plan of Conversion, all of this debt will be assumed by
Summit following the Effective Date. Summit, which is a holding company, will
have only income from distributions from its wholly owned subsidiaries with
which to service this debt, and there are certain restrictions on the ability of
the Insurance Subsidiaries to make distributions to Summit. See "-- Government
Regulation" and "BUSINESS -- Regulation -- Financial and Investment
Restrictions." There can be no assurance that Summit will have adequate funds
available to pay the required payments on its debt, and the inability of Summit
to service the debt would have a material adverse effect on the Company's
business, financial condition and results of operations.
NEED FOR CAPITAL
As a self-insurance fund, the Company recorded for statutory reporting an
asset for future investment income determined by discounting loss and loss
adjustment expense reserves at a statutory prescribed rate. Upon conversion to a
stock insurance company, the Company will be permitted to record discounts only
on permanent disability cases. As a result of this change, the Company intends
to use substantially all of the net proceeds from the Offerings for the purpose
of satisfying the Florida Insurance Code's minimum capital requirements
applicable to Bridgefield as a stock insurance company, and the Company will not
be able to complete the Conversion without the receipt of net proceeds from the
Offerings of a minimum of approximately $50.0 million, the current estimate of
the amount necessary to capitalize Bridgefield. From time to time, the Company
may be required to increase the capital surplus of the Insurance Subsidiaries to
remain in compliance with state regulatory requirements. If the Company is
unable to generate sufficient capital, either internally or from outside
sources, it could be required to reduce its growth. There can be no assurance
that capital will continue to be available when needed or, if available, will be
on terms acceptable to the Company. See "USE OF PROCEEDS" and "MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS."
RELIANCE ON INDEPENDENT INSURANCE AGENCIES
The Company markets its managed care workers' compensation insurance
products and services through independent insurance agencies. See
"BUSINESS -- Products and Services." As of December 31, 1996, ESIF's top ten
independent agencies accounted for approximately 21% of ESIF's direct in-force
premiums, with the top independent insurance agency accounting for approximately
4%. These agencies offer and sell competitors' products, as well as the
Company's products. As a result, the Company's business depends in part on the
marketing efforts of these agencies and on the Company's ability to offer
workers' compensation insurance products and services that meet the requirements
of these agencies and their customers. In addition, if the Company expands into
additional states, it must establish a network of independent agencies in such
states if it is to successfully market its products. Failure of independent
insurance agencies to market the Company's products and services successfully
could have a material adverse effect on the Company's business, financial
condition and results of operations.
RELIANCE UPON KEY PERSONNEL
Summit's success will, to a large extent, depend upon the continued
services of certain executive officers, particularly, William B. Bull, President
and Chief Executive Officer of the Company, and upon the efforts and abilities
of certain other key management personnel. The loss of the services of Mr. Bull
could materially adversely affect the Company. Mr. Bull is a party to an
employment agreement with Summit, which contains certain confidentiality and
noncompetition provisions. In addition, the Company maintains and is the sole
beneficiary of key-man life insurance policies on the life of Mr. Bull in the
aggregate amount of $9.1 million. See "MANAGEMENT OF THE COMPANY -- Employment
Agreements."
The Company intends to continue hiring additional personnel as necessary to
meet its management, marketing and sales service needs from time to time.
Although the Company believes that, to date, the organization has been
successful in attracting and retaining highly qualified professionals and other
administrative personnel as required by its business, there can be no assurance
that the Company will continue to be successful in this regard. The Company
believes that the future success and development of its business is dependent to
a significant degree on its ability to continue to attract such individuals.
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DEPENDENCE UPON REINSURANCE
The Insurance Subsidiaries currently have in effect excess of loss policies
("EXCESS REINSURANCE") with several reinsurers, including John Hancock Mutual
Life Insurance Company, Lincoln National Life Insurance Company, Republic
Western Insurance Company, Lloyds of London, National Union Fire Insurance
Company and Continental Casualty Company, and policies providing coverage for
prior years with several other reinsurers, under which the reinsurers have
agreed to pay claims and claims expenses over a specific dollar amount per
occurrence. In addition, ESIF has entered into Quota-Share Reinsurance
agreements with American Re-Insurance Company ("AM RE"), St. Paul Fire and
Marine Insurance, Constitution Reinsurance Corp. and Transatlantic Reinsurance
Co. pursuant to which ESIF has ceded to such reinsurers an aggregate of 75% of
net premiums written during such period and such reinsurers have assumed an
aggregate of 75% of the claims and expenses of the Company with respect to
policies written during this period ("ESIF QUOTA SHARE REINSURANCE").
Additionally, Bridgefield Casualty has a quota-share reinsurance agreement in
effect with Am Re under which Bridgefield Casualty cedes to Am Re a percentage
(currently 80%) of all written workers' compensation premiums and Am Re assumes
that same percentage of risks (together with the ESIF Quota Share Reinsurance,
the "QUOTA SHARE REINSURANCE"). These Quota Share Reinsurance policies allow the
Insurance Subsidiaries to write, within regulatory guidelines, a larger number
of policies than they could otherwise. The Company regularly performs internal
reviews of the financial strength of its reinsurers. However, if a reinsurer is
unable to meet any of its obligations under the reinsurance agreements, the
Insurance Subsidiaries would be responsible for the payment of all claims and
claims expenses which the Company has ceded to such reinsurer. Pursuant to the
Order, Bridgefield is permitted to cede reinsurance only to authorized
reinsurers, unless it obtains the prior written approval of the Florida DOI. All
of the reinsurers that are party to the Excess Reinsurance agreements or the
Quota-Share Reinsurance agreements are rated A or better by AM Best. Any failure
on the part of the Company's reinsurers, any inability to obtain reinsurance in
the future or any significant increase in the cost of such reinsurance, could
have a material adverse effect on the Company's business, financial condition
and results of operations. In addition, in the event that the Quota Share
Reinsurance agreement with Am Re is terminated for any reason, Bridgefield
Casualty could be required to substantially increase its capital or to reduce
its level of workers' compensation premiums, unless it is able to establish
another Quota Share Reinsurance arrangement. This could result in material
adverse consequences to the Company's business and growth prospects. See
"BUSINESS -- Reinsurance."
ABSENCE OF PRIOR MARKET
Prior to the Offerings, there has been no public market for the Company's
securities and there can be no assurance that an established and liquid trading
market for such securities will develop or, if developed, will be sustained or
that the market price of the Common Stock will not decline below the Public
Offering Price. Although the Company's application to list the Common Stock on
the Nasdaq National Market has been approved, there can be no assurance that the
Company will be able to maintain such a listing. See "MARKET FOR STOCK."
If the Common Stock is listed on the Nasdaq National Market but the Company
is unable to satisfy the maintenance requirements for the Nasdaq National
Market, the Common Stock may be deleted from such system. In such event, trading
in the Common Stock, if any, would be thereafter conducted in the over-the-
counter market on the "pink sheets" or through the National Association of
Securities Dealer's "Electronic Bulletin Board." Consequently, the liquidity of
the Common Stock could be impaired, not only in the number of securities which
could be bought and sold, but also through delays in the timing of transactions,
the reduction or elimination of security analysts' and the news media's coverage
of the Company, and lower prices for the Company's securities than might
otherwise be attained. See "MARKET FOR STOCK."
SHARES ELIGIBLE FOR FUTURE SALE; POSSIBLE VOLATILITY OF STOCK PRICE
All shares of Common Stock distributed in the Offerings will have been
registered under the Securities Act of 1933, as amended (the "SECURITIES ACT"),
and will be freely tradeable without restriction or further registration under
the Securities Act except for shares held by "affiliates" of the Company, as
that term is defined in Rule 144 ("RULE 144") under the Securities Act. Based on
information provided to the Company
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by its affiliates, the Company believes that approximately 500,000 shares of
Common Stock (approximately 10% of the Post Offering Outstanding Shares) will be
beneficially owned by affiliates on the Effective Date. See "THE
OFFERINGS -- Subscription Offering -- Interests of Certain Persons." Shares
beneficially owned by affiliates of Summit may not be sold except in compliance
with the registration requirements of the Securities Act or pursuant to an
exemption from registration, such as the exemption provided by Rule 144.
Additionally, all shares held by affiliates of the Company are subject to a
lock-up agreement with the Representatives that prohibits their resale prior to
180 days after the Effective Date without the prior consent of Raymond James &
Associates, Inc.
In addition, 500,000 shares of Common Stock are reserved for issuance under
the Summit Holding Southeast, Inc. 1996 Long-Term Incentive Plan (the "INCENTIVE
PLAN") and 45,000 shares are reserved for issuance under the Summit Consulting,
Inc. Retirement Plan (the "401(K) PLAN"). See "MANAGEMENT OF THE
COMPANY -- Incentive Plan" and "-- 401(k) Plan." To date, the Company has not
issued any options to purchase Common Stock under the Incentive Plan, but it
plans to issue options on the Effective Date. See "MANAGEMENT OF THE
COMPANY -- Incentive Plan." The Company intends to file a registration statement
on Form S-8 with the Commission following the completion of the Conversion to
register the shares of Common Stock that may be issued under the Incentive Plan
and in connection with the 401(k) Plan. Sales of substantial amounts of Common
Stock, or the perception that such sales could occur, could adversely affect
prevailing market prices for the Common Stock and could impair the Company's
future ability to obtain capital through an offering of equity securities. See
"SHARES ELIGIBLE FOR FUTURE SALE."
The market price of the Common Stock could be subject to significant
fluctuations in response to variations in financial results or announcements of
material events by the Company or its competitors. It is possible that in some
future periods the Company's operating results could be below market
expectations and, in such an event, the price of the Common Stock would likely
be materially adversely affected. Regulatory changes in the insurance industry
or changes in the general condition of the economy or the financial markets or
other events that are beyond the Company's control could also adversely affect
the market price of the Common Stock. In addition to the foregoing, the stock
market has from time to time experienced price and volume fluctuations which
have significantly affected the market prices of the stocks of many public
companies but which are unrelated to the operating performance of such
companies. See "-- Renewal Risks; Quarterly Fluctuations in Operating Results."
DILUTION
As of December 31, 1996 on a historical basis, ESIF had a net tangible
deficit of approximately $23.6 million. As of December 31, 1996 on a pro forma
basis, after giving effect to the Conversion and the Offerings, the Company's
net tangible book value would be approximately $26.4 million, which includes
approximately $16.4 million from the Series A Preferred Stock, resulting in net
tangible book value of $2.00 per share of Common Stock. Both the historical and
pro forma net tangible book value amounts include a deferred tax asset of
approximately $14.2 million as discussed in note 7 to the financial statements
included elsewhere in this Prospectus. Based upon such pro forma net tangible
book value amount, purchasers of Common Stock in the Offerings will experience
immediate and substantial dilution, equal to the difference between the
effective purchase price paid for such stock and $2.00. Thus, because the
purchase price of a share of Common Stock in the Offerings is the Subscription
Price of $11.00, the immediate dilution in net tangible asset value will be
$9.00 per share. See "SELECTED FINANCIAL DATA" and the financial statements and
notes thereto presented elsewhere in this Prospectus.
OBSTACLES TO CHANGES IN CONTROL; CERTAIN ANTI-TAKEOVER EFFECTS
After the consummation of the Conversion, Summit will be the holding
company of Bridgefield, a Florida stock insurance company. The Florida Insurance
Code will prohibit any person, individually or in conjunction with any
affiliated person, from acquiring, directly or indirectly, 5% or more of the
outstanding voting securities of Summit without prior approval of the Florida
DOI. However, a person who acquires at least 5% but less than 10% of such
outstanding voting securities may file with the Florida DOI a disclaimer of
affiliation and control and, unless such disclaimer is disallowed by the Florida
DOI, such person will not be required to
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seek prior approval of the Florida DOI for the acquisition. In addition to such
insurance regulation, the Florida Business Corporation Act (the "FLORIDA ACT")
contains provisions that may deter or frustrate takeovers of Florida
corporations such as Summit. See "DESCRIPTION OF CAPITAL STOCK -- Anti-Takeover
Provisions -- Florida Corporate Law."
In addition, Summit's Articles of Incorporation authorize the issuance of
5,000,000 shares of "blank check" preferred stock with such designations, rights
and preferences as may be determined from time to time by the Board of
Directors. Accordingly, the Board of Directors is empowered, without the need
for shareholder approval, to issue preferred stock with dividend, liquidation,
conversion or other rights that could adversely affect the voting power or the
rights of the holders of the Common Stock. In the event of issuance, such
preferred stock could be utilized, under certain circumstances, as a method of
discouraging, delaying or preventing a change of control of Summit. In
connection with the Plan of Conversion, Summit will issue 1,639,701 of such
preferred stock shares as the Series A Preferred Stock, the terms of which are
described herein. See "DESCRIPTION OF CAPITAL STOCK -- Preferred Stock."
BENEFITS OF CONVERSION TO AN OFFICER AND DIRECTOR
In connection with the Acquisition on January 16, 1996, the Florida DOI
issued a consent order (the "JANUARY CONSENT ORDER") requiring that William B.
Bull, who currently is the President, Chief Executive Officer and a director of
the Company and at that time was a principal shareholder as well as President
and Chief Executive Officer of SHC, personally indemnify ESIF up to a maximum of
$5.0 million for certain loss, injury or damage to ESIF that may result from the
Acquisition. Pursuant to the Order issued by the Florida DOI, Mr. Bull may be
relieved of such personal indemnification obligations if the Conversion becomes
effective; conversely, if the Conversion is not consummated for any reason, all
provisions of the January Consent Order shall be enforceable by the parties
thereto. See "THE OFFERINGS -- Subscription Offering -- Interests of Certain
Persons." Mr. Bull is not a trustee of ESIF and, therefore, did not vote with
respect to approval of the Plan of Conversion by ESIF's Board of Trustees.
However, as President and Chief Executive Officer of SHC, Mr. Bull may influence
the trustees, and such relief from such personal indemnification obligations
could be a factor that influences Mr. Bull's position on the Conversion.
POTENTIAL CONTROL BY LIMITED NUMBER OF SHAREHOLDERS; POSSIBLE DEPRESSIVE EFFECT
ON THE PRICE OF SUMMIT'S SECURITIES
The sale of blocks of shares of Common Stock in excess of the Purchase
Limit to one or a small number of purchasers in the Public Offering could vest
effective control of the Company in such single purchaser or small number of
purchasers through the ownership of a controlling block of the Post Offering
Outstanding Shares. In such event, such controlling shareholders collectively
would have the ability to elect all of the members of the Board of Directors,
the power to determine the management of the business and the power to determine
the outcome of corporate actions requiring shareholder approval. As a result,
potential acquirers may be discouraged from seeking to acquire control of the
Company through the purchase of Common Stock, which could have a depressive
effect on the price of Summit's securities. In addition, the Company has agreed
that certain institutional investors may purchase up to 10% of the Post Offering
Outstanding Shares, subject to any required approval of the Florida DOI. The
Company has complete discretion with respect to all other purchasers; therefore,
all subscribers who request to exceed the Purchase Limit may not have that
opportunity and may be treated disparately.
DIRECTOR AND OFFICER INDEMNIFICATION AND EXCULPATION
The Florida Act authorizes a Florida corporation to indemnify such
company's directors, officers, employees and agents. Summit has adopted a Bylaw
provision mandating such indemnification for directors, and permitting the Board
of Directors to indemnify officers, employees and agents in certain
circumstances, to the fullest extent permitted by law. In addition, Summit has
entered into agreements with its directors and certain of its executive officers
that contractually obligate Summit to provide indemnification. Pursuant to
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exculpation provisions in Summit's Articles of Incorporation, the personal
liability of a director shall be eliminated or limited to the fullest extent of
the Florida Act.
EFFECT OF HOLDING COMPANY STRUCTURE; DIVIDENDS
The Company does not anticipate paying dividends on the Common Stock in the
foreseeable future. In addition, the source of funds for payment of dividends by
the Company would be dividends paid to it by its subsidiaries. The Florida
Insurance Code limits the amount of dividends which the Insurance Subsidiaries
may pay to Summit and, in any event, for the foreseeable future Summit expects
to cause its subsidiaries to retain all earnings to provide capital for their
operations and business. In addition, if any shares of Series A Preferred Stock
are outstanding, no dividends may be paid to the holders of Common Stock so long
as there are cumulated but unpaid dividends on the Series A Preferred Stock. See
"DIVIDEND POLICY" and "BUSINESS -- Regulation -- Financial and Investment
Restrictions."
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THE COMPANY
The Company's business was started in 1977, when SCI was formed to
establish and administer workers' compensation self-insurance programs for group
self-insurance funds that are sponsored and formed by trade associations. Since
1977, SCI has formed three subsidiaries to assist it in providing certain
specialized administrative services, including loss control consulting, claims
management and reinsurance brokerage. These subsidiaries, together with SCI,
comprise the Company's Administrative Subsidiaries. Pursuant to written
contracts, the Administrative Subsidiaries currently provide administrative
services for the four Funds, which are unrelated to the Company, and for the
Company's Insurance Subsidiaries and certain municipalities. See "BUSINESS."
The Company's Insurance Subsidiaries include Bridgefield (ESIF prior to the
Conversion) and Bridgefield Casualty, which write workers' compensation
insurance coverages. The Company also includes a reinsurance subsidiary, U.S.
Employers Insurance, Inc., a group of healthcare-related companies that were
formed to provide such services as managed care in North Carolina and healthcare
provider network access in Florida, and Employers Safety Group Association,
Inc., the sponsoring trade association for ESIF.
The Company's primary Insurance Subsidiary, ESIF (which will be Bridgefield
after the Conversion), was formed in 1978 as a group self-insurance fund in
Florida. Until January 1996, ESIF was unrelated to the Company and was managed
by the Administrative Subsidiaries pursuant to a written contract. Effective
January 16, 1996, ESIF acquired all of the stock of SHC, a holding company that
had been formed to own, directly or indirectly, all of the other corporations
comprising the Company at that time. The following chart sets forth the
organizational structure of the Company immediately prior to the Conversion:
PRIOR TO THE CONVERSION
ESIF ORGANIZATIONAL CHART
* Discontinued operations.
In November 1996, in connection with the pending Conversion, Summit was
incorporated for the purpose of becoming a holding company for ESIF and its
subsidiaries. Prior to the Conversion, Summit will not engage in any operations
and has nominal assets and no liabilities. Summit currently has seven shares of
Common Stock issued and outstanding, which are owned one share each by the
directors of Summit. Each director paid $11.00 to purchase his share and has
executed a written agreement agreeing to sell such share back to Summit on the
Effective Date for the same price of $11.00. Pursuant to the Conversion, Summit
will issue all of its Common Stock in the Offerings, and ESIF will issue all of
its common stock to Summit, thereby becoming a direct wholly owned subsidiary of
Summit. Also pursuant to the Conversion, the Company's corporate
17
<PAGE> 18
structure will be simplified to reflect two groups, one comprised primarily of
the Administrative Subsidiaries, and one comprised primarily of the Insurance
Subsidiaries. The following chart sets forth the organizational structure of the
Company following the Conversion:
FOLLOWING THE CONVERSION
ESIF ORGANIZATIONAL CHART
* Discontinued operations.
MARKET FOR STOCK
There is no established public trading market for the Common Stock of
Summit. Summit's application for its Common Stock to be quoted on the Nasdaq
National Market under the symbol "SHSE" has been approved. Quotation through the
Nasdaq National Market requires, among other things, that there be at least two
market makers for the Common Stock. Raymond James & Associates, Inc. and ABN
AMRO Chicago Corporation, as representatives of the underwriters of the Public
Offering (the "REPRESENTATIVES"), have advised Summit that they each intend to
make a market in the Common Stock by maintaining bid and asked quotations for
the Common Stock so long as the volume of trading justifies such an undertaking.
However, there can be no assurance that an established and liquid market for the
Common Stock will develop or that quotations will remain available on Nasdaq or
otherwise.
There is no established public trading market for the Series A Preferred
Stock, and Summit does not currently intend to seek a listing of the Series A
Preferred Stock on any securities exchange or any Nasdaq trading system. Holders
of Series A Preferred Stock seeking to sell, transfer or otherwise trade in such
securities must do so in private transactions.
DIVIDEND POLICY
Summit has no intention at present to pay dividends on the Common Stock.
Any payment of dividends on the Common Stock in the future would be subject to
determination and declaration by the Board of Directors of Summit and the
availability of funds therefor. Any future dividend payments by Summit would
depend upon the Company's debt and equity structure, earnings, need for capital
in connection with future acquisitions, and other factors, including economic
conditions, regulatory restrictions and tax considerations.
Should Summit consider paying dividends on the Common Stock in the future,
the source of funds for payment of such dividends would be dividends from the
Insurance Subsidiaries and the Administrative Subsidiaries to Summit, dependent
on such subsidiaries' earnings. Summit currently expects to cause the
18
<PAGE> 19
Insurance Subsidiaries to retain all of their earnings to provide capital for
their operations and business. In addition, under the Florida Insurance Code and
the Order, the Insurance Subsidiaries may not be permitted to pay cash dividends
to Summit generally in excess of 10% of the greater of surplus or net income,
without prior approval of the Florida DOI. See "MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Liquidity and
Capital Resources" and "BUSINESS -- Regulation -- Financial and Investment
Restrictions."
The holders of the Series A Preferred Stock will be entitled to receive,
out of funds legally available for the payment of dividends, cash dividends at
the rate of 4% per annum. Such dividends will cumulate from the date of issue,
whether or not declared by the Board of Directors and whether or not there are
funds of Summit legally available for the payment of such dividends. Such
dividends will be payable only as and when declared by the Board of Directors;
provided, however, that all cumulated but unpaid dividends will be paid upon any
redemption of the Series A Preferred Stock or a liquidation of Summit. Further,
under the terms of the Series A Preferred Stock, so long as any shares of Series
A Preferred Stock are outstanding, no dividends may be paid to the holders of
Common Stock unless any cumulated but unpaid dividends on the Series A Preferred
Stock have been paid or funds have been set apart for the payment thereof. See
"DESCRIPTION OF CAPITAL STOCK -- Preferred Stock -- Series A Preferred Stock."
19
<PAGE> 20
USE OF PROCEEDS
The net proceeds to the Company from the sale of the 5,000,000 shares of
Common Stock offered by the Company will be approximately $50.0 million after
deducting the estimated expenses of the Conversion, which includes estimated
underwriting discounts and sales fees of approximately $3.5 million. Summit
expects to contribute substantially all of such proceeds to Bridgefield to
increase its capital to satisfy applicable requirements of the Florida Insurance
Code, and the remainder of such proceeds, if any, will be retained by Summit for
general corporate purposes. Upon contribution of proceeds to Bridgefield, such
funds will be invested in fixed income securities as permitted by the Florida
Insurance Code. The Conversion is contingent upon the receipt by Summit of net
proceeds sufficient to capitalize Bridgefield in accordance with the
requirements of the Florida Insurance Code. The current estimate of the amount
required is $50.0 million.
CAPITALIZATION
The following table presents the consolidated capitalization at December
31, 1996 of: (i) ESIF and its subsidiaries on a historical basis, and (ii) the
Company as adjusted to reflect the Conversion and the sale of 5,000,000 shares
of Common Stock in the Offerings and the initial application of the proceeds
therefrom, after deducting the estimated expenses of the Offerings. See "USE OF
PROCEEDS," "THE CONVERSION" and "DESCRIPTION OF CAPITAL STOCK."
<TABLE>
<CAPTION>
DECEMBER 31, 1996
----------------------------------------------------
PRO FORMA ADJUSTMENTS
-----------------------
ESIF CONVERSION OFFERINGS
HISTORICAL (A) (B) AS ADJUSTED
---------- ---------- --------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Long term debt................................... $33,000 $ 33,000
Equity:
Preferred stock, $10.00 par value, 5,000,000
shares authorized; no shares issued and
outstanding, 1,639,701 shares as adjusted... -- 16,397 16,397
Common stock, $.01 par value, 20,000,000 shares
authorized; 7 shares issued and outstanding,
5,000,000 shares as adjusted(C)............. -- 50 50
Additional paid-in capital(C).................. -- 49,950 49,950
Retained earnings.............................. 24,857 (16,398) 8,459
Unrealized appreciation on available for sale
securities.................................. 2,521 2,521
------- ------- ------ --------
Total equity................................ 27,378 -- 50,000 77,377
------- ------- ------ --------
Total capitalization........................ $60,378 -- 50,000 $110,377
======= ======= ====== ========
</TABLE>
- ---------------
(A) Assumes the issuance of 1,639,701 shares (par value $10.00 per share) of
Series A Preferred Stock to Eligible Policyholders in connection with the
Conversion.
(B) Assumes the receipt of the net proceeds from the Offerings.
(C) Does not reflect 500,000 shares reserved for issuance under the Incentive
Plan, or 45,000 shares reserved for issuance under the 401(k) Plan. See
"EXECUTIVE COMPENSATION -- Incentive Plan" and "-- 401(k) Plan."
20
<PAGE> 21
SELECTED FINANCIAL DATA
EMPLOYERS SELF INSURERS FUND
The following selected financial data has been taken from, or derived from,
ESIF's consolidated financial statements, including the related notes thereto.
ESIF's consolidated financial statements as of March 31, 1996 and September 30,
1996, and for the year ended March 31, 1996 and for the six months ended
September 30, 1996, have been audited by Ernst & Young LLP, independent
auditors, whose reports thereon appear elsewhere in this Prospectus. ESIF's
consolidated financial statements as of March 31, 1995 and for the fiscal years
ended March 31, 1994 and 1995 have been audited by Brinton & Mendez, certified
public accountants, whose report thereon appears elsewhere in this Prospectus.
ESIF's consolidated financial statements as of December 31, 1996 and for the
nine months ended December 31, 1996, as well as the selected financial data
provided as of and for the fiscal years ended March 31, 1992 and 1993, as of and
for the six months ended September 30, 1996 and as of and for the nine months
ended December 31, 1995 and 1996, are unaudited, but in the opinion of
management contain all adjustments, consisting of only normal, recurring
accruals, for a fair presentation of the results of such periods. The
information set forth below is not necessarily indicative of the results of
future operations and should be read in conjunction with the consolidated
financial statements and notes thereto.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED MARCH 31, SEPTEMBER 30,
---------------------------------------------------------- -------------------------
1992 1993 1994 1995 1996(1) 1995 1996
----------- ----------- -------- -------- -------- ----------- -----------
(UNAUDITED) (UNAUDITED) (UNAUDITED)
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Income Statement Data:
Premiums earned.............. $132,067 $181,339 $148,441 $128,489 $114,893 $ 63,145 $ 49,029
Net investment income........ 11,683 10,728 10,510 12,205 13,210 7,598 6,363
Administrative fees.......... -- -- -- 7,665 -- 17,432
Realized investment gains.... -- -- -- -- 4,354 919 8
Other income................. 121 206 90 216
-------- -------- -------- -------- -------- -------- --------
Total revenue................ 143,750 192,067 158,951 140,815 140,328 71,752 73,048
Losses and loss adjustment
expenses................... 103,657 149,177 108,411 69,116 94,844 42,365 32,135
Other underwriting, general
and administrative
expenses................... 32,787 40,145 37,121 41,546 43,657 21,623 30,532
Interest expense............. -- -- -- -- 847 -- 1,831
Amortization and
depreciation............... 1,103 2,499
-------- -------- -------- -------- -------- -------- --------
Income (loss) from continuing
operations before income
taxes...................... 7,306 2,745 13,419 30,153 (123) 7,764 6,051
Loss from discontinued
operations................. -- -- -- -- (197) -- (890)
Net income................... $ 6,844 $ 2,953 $ 8,885 $ 19,163 $ 185 $ 5,374 $ 2,386
======== ======== ======== ======== ======== ======== ========
Other Data:(2)
Net loss ratio(3)............ 78.5% 82.3% 73.0% 53.8% 82.5% 67.1% 65.5%
Expense ratio(4)............. 24.8% 22.1% 25.0% 32.3% 34.1% 34.2% 33.0%
Combined ratio(5)............ 103.3% 104.4% 98.0% 86.1% 116.6% 101.3% 98.5%
<CAPTION>
NINE MONTHS ENDED
DECEMBER 31,
-------------------------
1995 1996
----------- -----------
(UNAUDITED) (UNAUDITED)
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Income Statement Data:
Premiums earned.............. $ 89,713 $ 74,509
Net investment income........ 10,522 9,606
Administrative fees.......... -- 25,762
Realized investment gains.... 2,726 366
Other income................. 125 568
-------- --------
Total revenue................ 103,086 110,811
Losses and loss adjustment
expenses................... 67,043 50,236
Other underwriting, general
and administrative
expenses................... 28,548 45,837
Interest expense............. -- 2,719
Amortization and
depreciation............... -- 3,729
-------- --------
Income (loss) from continuing
operations before income
taxes...................... 7,495 8,290
Loss from discontinued
operations................. -- (1,250)
Net income................... $ 5,172 $ 3,198
======== ========
Other Data:(2)
Net loss ratio(3)............ 74.7% 67.4%
Expense ratio(4)............. 31.8% 33.4%
Combined ratio(5)............ 106.5% 100.8%
</TABLE>
<TABLE>
<CAPTION>
AS OF
AS OF MARCH 31, SEPTEMBER 30,
---------------------------------------------------------- -------------------------
1992 1993 1994 1995 1996 1995 1996
----------- ----------- -------- -------- -------- ----------- -----------
(UNAUDITED) (UNAUDITED) (UNAUDITED)
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Balance Sheet Data:
Cash and invested assets..... $147,056 $176,931 $201,688 $224,956 $220,266 $231,288 $213,723
Premiums receivable.......... 42,648 69,197 71,520 50,391 38,093 78,229 67,179
Reinsurance recoverable...... 104,229 105,541 95,851 110,141 111,519 107,451 103,861
Recoverable from SDTF........ 5,632 6,745 9,929 15,879 20,060 17,775 21,138
Total assets................. 307,345 373,069 405,765 425,206 491,844 456,012 502,167
Loss and loss adjustment
expenses................... 304,205 360,425 368,000 367,391 387,632 364,210 378,196
Debt......................... -- -- -- -- 44,000 -- 36,500
Total equity (deficit)....... (9,458) (6,485) 2,480 20,065 23,154 31,087 24,993
<CAPTION>
AS OF
SEPTEMBER 30,
-------------------------
1995 1996
----------- -----------
(UNAUDITED) (UNAUDITED)
(IN THOUSANDS)
<S> <C> <C>
Balance Sheet Data:
Cash and invested assets..... $236,421 $225,319
Premiums receivable.......... 48,922 39,828
Reinsurance recoverable...... 112,734 107,058
Recoverable from SDTF........ 16,827 21,138
Total assets................. 437,932 476,972
Loss and loss adjustment
expenses................... 372,786 376,923
Debt......................... -- 33,000
Total equity (deficit)....... 31,238 27,378
</TABLE>
- ---------------
(1) Includes the Acquisition as of January 16, 1996.
(2) Ratio for Insurance Subsidiaries.
(3) Net loss ratio is the ratio of losses and loss adjustment expenses incurred
to premiums earned.
(4) Expense ratio is the ratio of underwriting, general and administrative
expenses to premiums earned.
(5) Combined ratio is the sum of the net loss ratio and the expense ratio.
21
<PAGE> 22
SUMMIT HOLDING CORPORATION
The following selected financial data for the fiscal years ended December
31, 1992, 1993, 1994 and 1995 have been derived from the historical consolidated
financial statements of SHC and subsidiaries, including the related notes
thereto, which have been audited by Ernst & Young, LLP, independent auditors,
whose report thereon appears elsewhere in this Prospectus. The information set
forth below is not necessarily indicative of the results of future operations
and should be read in conjunction with the consolidated financial statements and
notes thereto.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,(1)
-------------------------------------
1992 1993 1994 1995
------- ------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Income Statement Data:
Gross service fees................................... $61,675 $70,814 $73,833 $64,090
Interest income...................................... 149 377 738 1,071
Direct expenses...................................... 29,693 32,957 29,656 25,414
Compensation and other employee benefits............. 13,371 14,503 15,425 16,616
Other operating expenses............................. 7,517 7,707 8,218 8,204
Interest expense..................................... 843 1,610 58 42
Amortization and depreciation........................ 4,729 4,891 4,872 5,112
Income before income taxes........................... 6,139 9,778 16,538 10,877
Net income........................................... $ 3,377 $ 5,939 $10,232 $ 6,857
======= ======= ======= =======
Other Data:
EBITDA(2)............................................ $11,562 $15,902 $20,730 $14,960
Cash flow from:
Operations........................................... $ 9,411 $11,991 $12,591 $ 7,713
Investing activities................................. 3,359 (966) (6,636) (281)
Financing activities................................. (14,047) (4,510) (1,200) (600)
------- ------- ------- -------
Net increase (decrease) in cash and cash
equivalents................................ $(1,277) $ 6,515 $ 4,755 $ 6,832
======= ======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31,(1)
-------------------------------------
1992 1993 1994 1995
------- ------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Balance Sheet Data:
Cash and invested assets............................. $ 238 $ 6,754 $17,072 $22,198
Total assets......................................... 32,104 35,704 40,735 44,832
Current liabilities.................................. 20,218 23,588 18,987 16,727
Debt................................................. 4,510 -- -- --
Shareholders' equity................................. 7,377 12,116 21,748 28,105
</TABLE>
- ---------------
(1) SHC commenced operations on January 1, 1992; therefore, historical data for
1991 is not applicable.
(2) EBITDA represents earnings before interest, income taxes, depreciation and
amortization.
22
<PAGE> 23
PRO FORMA FINANCIAL DATA
The following pro forma financial data present the historical financial
data of ESIF and its subsidiaries on a consolidated basis adjusted to reflect
the pro forma effects of the following transactions:
(1) January 1996 Acquisition of SHC by ESIF;
(2) Conversion of ESIF from a group self-insurance fund to a stock
insurance company; and
(3) Issuance of Common Stock and Series A Preferred Stock in the
Offerings.
The pro forma financial statements presented are:
Balance Sheet as of December 31, 1996
The unaudited pro forma consolidated balance sheet as of December 31, 1996
presents the historical balance sheet of ESIF. Pro forma adjustments, as
described in the related notes, give effect to the Conversion and the Offerings
as if they had been effective at December 31, 1996.
The pro forma balance sheet assumes the issuance of 1,639,701 shares (par
value $10.00 per share) of Series A Preferred Stock to Eligible Policyholders in
connection with the Conversion and the issuance of 5,000,000 shares of Common
Stock (par value $0.01 per share) at the Public Offering Price.
Statement of Income for the Year Ended March 31, 1996
The unaudited pro forma consolidated statement of income for the year ended
March 31, 1996 presents the historical operating results of ESIF (including
operating results of SHC from its Acquisition date of January 16, 1996) and the
historic operating results of SHC for the period April 1, 1995 to January 15,
1996. Pro forma adjustments give effect to the Acquisition of SHC, the
Conversion and the Offerings as if they had occurred on April 1, 1995.
Statement of Income for the Nine Months Ended December 31, 1995
The unaudited pro forma consolidated statement of income for the six months
ended September 30, 1995 presents the historical operating results of ESIF and
SHC. Pro forma adjustments give effect to the Acquisition of SHC, the Conversion
and the Offerings as if they had occurred on April 1, 1995.
Statement of Income for the Nine Months Ended December 31, 1996
The unaudited pro forma consolidated statement of income for the six months
ended September 30, 1996 presents the historical operating results of ESIF. Pro
forma adjustments give effect to the Conversion and the Offerings as if they had
occurred on April 1, 1995.
23
<PAGE> 24
PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET
DECEMBER 31, 1996
<TABLE>
<CAPTION>
PRO FORMA ADJUSTMENTS
EMPLOYERS -----------------------
SELF INSURERS CONVERSION OFFERING
FUND (A) (B) PRO FORMA
------------- ---------- -------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
ASSETS
Investments..................................... $217,886 $ -- $50,000(D) $267,886
Cash and cash equivalents....................... 7,433 -- -- 7,433
Premiums receivable............................. 39,828 -- -- 39,828
Accounts receivable............................. 3,184 -- -- 3,184
Reinsurance recoverable......................... 107,058 -- -- 107,058
Recoverable from Florida Special Disability
Trust Fund.................................... 21,138 -- -- 21,138
Excess of cost over net assets of business
acquired...................................... 45,029 -- -- 45,029
Deferred income taxes........................... 14,162 -- -- 14,162
Other assets.................................... 21,254 -- -- 21,254
-------- -------- ------- --------
Total assets.......................... $476,972 $ -- $50,000 $526,972
======== ======== ======= ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Loss and loss adjustment expenses............. $376,923 -- -- $376,923
Debt.......................................... 33,000 -- -- 33,000
Unallocated policyholder remittances.......... 23,506 -- -- 23,506
Accounts payable.............................. 11,229 -- -- 11,229
Other liabilities............................. 4,936 -- -- 4,936
-------- -------- ------- --------
Total liabilities..................... 449,594 -- -- 449,594
Equity:
Preferred stock............................... -- 16,397(C) -- 16,397
Common stock.................................. -- -- 50(D) 50
Additional paid-in capital.................... -- -- 49,950(D) 49,950
Retained earnings............................. 24,857 (16,397)(C) -- 8,460
Unrealized appreciation on available for sale
securities................................. 2,521 -- -- 2,521
-------- -------- ------- --------
Total equity.......................... 27,378 -- 50,000 77,378
-------- -------- ------- --------
Total liabilities and shareholders
equity.............................. $476,972 $ -- $50,000 $526,972
======== ======== ======= ========
</TABLE>
See notes to pro forma condensed consolidated balance sheet.
24
<PAGE> 25
NOTES TO PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET
DECEMBER 31, 1996
(A) Assumes that the Conversion of ESIF from a group self-insurance fund to a
stock insurance company occurred as of December 31, 1996.
(B) Assumes that the net proceeds from the Offerings were received as of
December 31, 1996.
(C) Adjustment relates to the issuance of 1,639,701 shares (par value $10.00
per share) of Series A Preferred Stock to Eligible Policyholders in
connection with the Conversion.
25
<PAGE> 26
PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF INCOME
FOR THE YEAR ENDED MARCH 31, 1996(A)
<TABLE>
<CAPTION>
(B) (C) (D)(E)
EMPLOYERS SELF SUMMIT HOLDING PRO FORMA
INSURERS FUND CORPORATION ADJUSTMENTS PRO FORMA
-------------- -------------- ----------- ---------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Revenues:
Premiums earned............................. $114,893 $ -- $ -- $ 114,893
Net investment income....................... 13,210 1,026 -- 12,374
(1,855)(F)
(7)(G)
Realized investment gains................... 4,354 -- -- 4,354
Administrative fees......................... 7,665 49,040 (19,358)(H) 37,347
Other income................................ 206 921 (921)(G) 206
-------- ------- -------- ---------
Total revenue....................... 140,328 50,987 (22,141) 169,174
-------- ------- -------- ---------
Expenses:
Losses and loss adjustment expenses......... 94,844 -- -- 94,844
Other underwriting, general, and
administrative expenses.................. 43,657 38,433 (19,358)(H) 60,952
(1,780)(G)
Interest expense............................ 847 30 3,101(I) 3,978
Amortization and depreciation............... 1,103 4,033 341(J) 5,340
(137)(G)
-------- ------- -------- ---------
Total expenses...................... 140,451 42,496 (17,833) 165,114
-------- ------- -------- ---------
Income from continuing operations before
income taxes................................ (123) 8,491 (4,308) 4,060
Income taxes (benefit)........................ (505) 3,130 (1,543)(K) 1,082
-------- ------- -------- ---------
Income from continuing operations............. $ 382 $ 5,361 $ (2,765) $ 2,978
======== ======= ======== =========
Income from continuing operations per common
share....................................... $ .46
=========
Weighted average common shares outstanding.... 5,000,000
</TABLE>
See notes to pro forma condensed consolidated statement of income.
26
<PAGE> 27
NOTES TO PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF INCOME
FOR THE YEAR ENDED MARCH 31, 1996
(A) Assumes the Acquisition and the Conversion occurred on April 1, 1995.
(B) Includes historical data for ESIF and subsidiaries for the year ended March
31, 1996 on a consolidated basis and includes SHC for the period January
16, 1996 through March 31, 1996.
(C) Includes SHC for the period April 1, 1995 through January 15, 1996.
(D) Upon Conversion to a stock property and casualty insurer, Bridgefield will
be subject to guaranty fund assessments by the Florida Insurance Guaranty
Association; however, there were no such assessments during the year ended
March 31, 1996. Accordingly, the pro forma data does not include any
adjustments for the effect of guaranty fund assessments.
(E) The pro forma condensed consolidated statement of income for the year ended
March 31, 1996 does not include investment earnings on the net proceeds of
the Offerings. Assuming that the net proceeds from the Offerings were
invested in 180 day U.S. Treasury Bills yielding 6.1% for the six months
ended September 30, and 5.6% for the six months ended March 31, 1996, pro
forma net income would be increased by $1.8 million to $4.8 million and pro
forma earnings per share would be increased by $0.37 to $0.83.
(F) Adjustment relates to the effect on investment income of foregone
investment earnings on $26.0 million paid by ESIF and on $11.5 million of
SHC capital distributed to SHC shareholders in connection with the
Acquisition at an assumed interest rate of 6.25% (which approximates ESIF's
actual investment earnings rate during the period).
(G) Adjustment relates to a decrease in revenue and operating expenses
attributable to the disposition of Carolina Summit Healthcare, Inc.
("CAROLINA SUMMIT") and discontinued operations of Meritec.
(H) Adjustment relates to elimination of administrative fees paid by ESIF to
SHC.
(I) Adjustment relates to interest expense from the financed portion of the
Acquisition assuming scheduled interest rates ranging from 7% to 9.5%.
(J) Adjustment represents the net of the reversal of the amortization of SHC's
historical intangible assets and the amortization of the goodwill, customer
contracts, and developed software capitalized in the Acquisition.
Amortization periods assumed are as follows: goodwill -- 25 years; customer
contracts -- 10 years; and developed software -- 5 years. Such intangible
asset amortization is not tax deductible. The components of the
amortization adjustment are as follows:
<TABLE>
<CAPTION>
AMORTIZATION EXPENSE
-----------------------------------
HISTORICAL PRO FORMA ADJUSTMENT
---------- --------- ----------
(IN THOUSANDS)
<S> <C> <C> <C>
Goodwill............................................ $ 297 $1,572 $ 1,275
Customer contracts.................................. 1,821 523 (1,298)
Developed software.................................. 633 997 364
------ ------ -------
$2,751 $3,092 $ 341
====== ====== =======
</TABLE>
(K) Adjustment relates to the total income tax effect of adjustments (F)
through (J).
27
<PAGE> 28
PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF INCOME
FOR THE NINE MONTHS ENDED DECEMBER 31, 1995(A)
<TABLE>
<CAPTION>
ASSUMING CONVERSION AND
ISSUANCE OF 5,000,000 SHARES
OF COMMON STOCK AT
(D) THE PUBLIC OFFERING PRICE
(C) SUMMIT ---------------------------------
EMPLOYERS SELF HOLDING PRO FORMA
INSURERS FUND CORPORATION ADJUSTMENTS(E)(F) PRO FORMA
-------------- ----------- ----------------- ------------
(DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Revenues:
Premiums earned....................... $89,713 $ -- $ -- $ 89,713
Net investment income................. 10,522 745 (1,178)(H) 9,509
Realized investment gains............. 2,726 -- -- 2,726
Administrative fees................... -- 47,162 (18,713)(G) 28,449
Other income.......................... 125 1,138 (903)(K) 360
------- ------- -------- ---------
Total revenue................. 103,086 49,045 (21,374) 130,757
Expenses:
Losses and loss adjustment expenses... 67,043 -- -- 67,043
Other underwriting, general and
administrative expenses............ 28,548 36,316 (18,713)(G) 44,669
(1,482)(K)
Interest expense...................... -- 30 2,987(J) 3,017
Amortization and depreciation......... -- 3,873 323(I) 4,074
(122)(K)
------- ------- -------- ---------
Total expenses................ 95,591 40,219 (17,007) 118,803
------- ------- -------- ---------
Income from continuing operations
before income taxes................ 7,495 8,826 (4,367) 11,954
Income taxes.......................... 2,323 3,258 (1,560)(L) 4,021
------- ------- -------- ---------
Income from continuing operations....... $ 5,172 $ 5,568 $ (2,807) $ 7,933
======= ======= ======== =========
Income from continuing operations per
common share.......................... $ 1.49
=========
Weighted average common shares
outstanding........................... 5,000,000
</TABLE>
See notes to pro forma condensed consolidated statement of income.
28
<PAGE> 29
PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF INCOME
FOR THE NINE MONTHS ENDED DECEMBER 31, 1996(B)
<TABLE>
<CAPTION>
ASSUMING CONVERSION AND
ISSUANCE OF 5,000,000 SHARES
OF COMMON STOCK
AT THE PUBLIC OFFERING PRICE
(C) ---------------------------------
EMPLOYERS SELF PRO FORMA
INSURERS FUND ADJUSTMENTS(E)(F) PRO FORMA
-------------- ----------------- ------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C>
Revenues:
Premiums earned.................................. $74,509 $ -- $ 74,509
Net investment income............................ 9,606 (109)(K) 9,497
Realized investment gains........................ 366 -- 366
Administrative fees.............................. 25,762 -- 25,762
Other income..................................... 568 (5)(K) 563
------- ------- ---------
Total revenue............................ 110,811 (114) 110,697
------- ------- ---------
Expenses:
Losses and loss adjustment expenses.............. 50,236 -- 50,236
Other underwriting, general, and administrative
expenses...................................... 45,837 (675)(K) 45,162
Interest expense................................. 2,719 2,719
Amortization and depreciation.................... 3,729 (25)(K) 3,704
------- ------- ---------
Total expenses........................... 102,521 (700) 101,821
------- ------- ---------
Income from continuing operations before income
taxes......................................... 8,290 586 8,876
Income taxes..................................... 3,057 199(L) 3,256
------- ------- ---------
Income from continuing operations.................. $ 5,233 $ 387 $ 5,620
======= ======= =========
Income from continuing operations per common
share............................................ $ 1.03
=========
Weighted average common shares outstanding......... 5,000,000
</TABLE>
See notes to pro forma condensed consolidated statement of income.
29
<PAGE> 30
NOTES TO PRO FORMA CONDENSED CONSOLIDATED STATEMENTS OF INCOME
FOR THE NINE MONTH PERIODS ENDED DECEMBER 31, 1995 AND 1996
(A) Assumes the Acquisition and the Conversion occurred on April 1, 1995.
(B) Assumes the Conversion occurred on April 1, 1995.
(C) Includes historical information for ESIF and subsidiaries for the nine
months ended December 31, 1995 and 1996, respectively, on a consolidated
basis.
(D) Includes SHC for the period April 1, 1995 through December 31, 1995.
(E) Upon the Conversion to a stock property and casualty insurer, Bridgefield
will be subject to guaranty fund assessments by the Florida Insurance
Guaranty Association; however, there were no such assessments during the
nine months ended December 31, 1995 and 1996. Accordingly, the pro forma
data does not include any adjustments for the effect of guaranty fund
assessments.
(F) The pro forma condensed consolidated statements of income for the nine
months ended December 31, 1995 and 1996 do not include investment earnings
on the net proceeds of the Offerings. Assuming that the net proceeds from
the Offerings are invested in 180-day U.S. Treasury Bills yielding 6.10%
and 5.15% for the six months and three months ended September 30, 1995 and
December 31, 1995, respectively, and 5.18% and 5.51% for the six months and
three months ended September 30, 1996 and December 31, 1996, respectively,
pro forma net income for the nine months ended December 31, 1995 and 1996
would be $9.3 million and $6.9 million, respectively, and the pro forma
earnings per share would be $1.76 and $1.27 for the nine months ended
December 31, 1995 and 1996, respectively.
(G) Adjustment relates to elimination of fees paid by ESIF to SHC.
(H) Adjustment relates to the effect on investment income of foregone
investment earnings on $26.0 million paid by ESIF and on $11.5 million of
SHC capital distributed to SHC shareholders in connection with the
Acquisition, at an assumed interest rate of 6.25% (which approximates
ESIF's actual investment earnings rate during the period).
(I) Adjustment represents the net of the reversal of the amortization of SHC's
historical intangible assets and the amortization of the goodwill, customer
contracts, and developed software capitalized in the Acquisition.
Amortization periods assumed are as follows: goodwill -- 25 years; customer
contracts -- 10 years; and developed software -- 5 years. Such intangible
asset amortization is not tax deductible. The components of the
amortization adjustment are as follows:
<TABLE>
<CAPTION>
AMORTIZATION EXPENSE
-----------------------------------
HISTORICAL PRO FORMA ADJUSTMENT
---------- --------- ----------
(IN THOUSANDS)
<S> <C> <C> <C>
Goodwill............................................ $ 187 $ 993 $ 806
Customer contracts.................................. 1,150 330 (820)
Developed software.................................. 400 630 230
------ ------ -----
$1,737 $1,953 $ 216
====== ====== =====
</TABLE>
(J) Adjustment relates to interest expense from the financed portion of the
Acquisition assuming scheduled interest rates ranging from 7% to 9.5%.
(K) Adjustment relates to decrease in revenue and operating expenses
attributable to the disposition of Carolina Summit and Meritec.
(L) Adjustment relates to the total income tax effect of adjustments (G)
through (K).
30
<PAGE> 31
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following analysis of the consolidated results of operations and
financial condition of the Company should be read in conjunction with "SELECTED
CONSOLIDATED FINANCIAL DATA," the Consolidated Financial Statements and the
accompanying Notes to the Consolidated Financial Statements included elsewhere
herein.
OVERVIEW
The Company's managed care workers' compensation insurance operations are
comprised of primarily the Administrative Subsidiaries and the Insurance
Subsidiaries. The Company's income is generated principally from three sources:
fees earned from the management of the Funds, underwriting profits derived from
premiums earned on insurance policies written by the Insurance Subsidiaries, and
investment income generated by invested assets related to insurance
underwriting.
Prior to the Acquisition, ESIF and SHC were non-affiliated and historical
results are therefore not necessarily indicative of future financial results.
Although SHC (through its wholly owned subsidiary, SCI) had provided all
administrative and management services required to operate ESIF since ESIF's
inception in 1978, the two organizations had different financial objectives and
reported historical financial results independently. ESIF used a fiscal year
ending on March 31, and SHC used a fiscal year ending on December 31. As a
result of the Acquisition, SHC became a wholly owned subsidiary of ESIF, and
management began to implement an integrated strategic plan.
All of the Company's insurance policies are written for entities located in
Florida, and a significant portion of the Company's administrative services are
provided to entities operating in Florida. See "RISK FACTORS -- Concentration in
a Single State." Effective January 1, 1994 (with subsequent certain amendments),
Florida enacted new legislation (the "NEW FLORIDA LAW") that changed the
underwriting environment for workers' compensation by, among other things: (i)
limiting certain benefits that must be provided; (ii) eliminating wage loss
benefits in favor of a system of benefits based upon a schedule of impairment
ratings plus supplemental benefits; (iii) obligating employers to rehire injured
workers; (iv) adopting new procedures for dispute resolution designed to reduce
litigation costs; and (v) redefining permanent impairment.
In addition, the New Florida Law authorized insurers and self-insured
groups to apply to the Florida DOI for permission to offer premium credits of up
to 10% from January 1, 1994 through December 31, 1996 to insured employers who
participated in approved managed care arrangements and, effective January 1,
1997, required insured employers to participate in managed care arrangements.
The New Florida Law also authorized premium credits for insured employers who
participate in safety and drug-free workplace programs. In response to the New
Florida Law, which was expected to result in savings to self-insured groups and
insurers, the Florida DOI ordered a 10.6% overall rate decrease, effective
January 1, 1994. In addition, the New Florida Law eliminated the residual market
assessment that was levied against insurance companies to support the
involuntary workers' compensation market and replaced it with a self-funded
joint underwriting association. As a result, the financial obligation of funding
deficits in the residual market mechanism was shifted from traditional insurance
entities to employers who are insured by the joint underwriting association.
While the long term impact of the New Florida Law cannot be determined, the
Company believes that it has resulted in: (i) a more competitive workers'
compensation market in Florida; (ii) conversions by some of the larger
self-insured groups to traditional insurance entities; and (iii) loss portfolio
transfers by self-insured groups to insurance companies.
Effective for insurance policies written or renewing on and after January
1, 1997, self-insured groups and insurers will no longer be authorized to offer
insured employers the 10% managed care premium credit allowed under the New
Florida Law. Based in part upon the elimination of the managed care premium
credit and upon other rate-making factors, the Florida DOI has ordered an 11.2%
overall workers' compensation insurance rate reduction, which will apply to
policies written or renewing on and after January 1, 1997.
The Company believes that it can improve its return on invested capital
following the Conversion through growth in its core workers' compensation
business. Key aspects of the Company's business strategy following
31
<PAGE> 32
the Conversion include: (i) continued use of both self-insurance and indemnity
products; (ii) emphasis on profitable underwriting results; (iii) proactive
implementation of managed care; (iv) leveraging of administrative services
capabilities; and (v) emphasis on excellent customer service.
The Insurance Subsidiaries have entered into certain Quota Share
Reinsurance agreements, pursuant to which 75% and 80% of their net premiums have
been ceded to the respective reinsurers. While such reinsurance agreements will
enable the Insurance Subsidiaries to underwrite a larger number of policies than
they could otherwise write, the ceding of a percentage of the premiums of such
policies to the reinsurer will result in lower premium income to the Company
than in prior years. However, the Company will receive a ceding commission
related to the Quota Share Reinsurance agreements which will be reflected as a
reduction of operating expense. Management does not currently anticipate that
the net income of the Company will be adversely effected by such agreements. See
"BUSINESS -- Reinsurance."
The Company is in the process of disposing of two subsidiaries whose
businesses are unrelated to workers' compensation and no longer fit within the
Company's overall business strategy. The Company has reached an agreement to
sell for cash its health maintenance organization, Carolina Summit. The purchase
price will be net book value, approximately $745,000, and the sale is expected
to be consummated during the second quarter of 1997. The Company has
discontinued all operations of its computer software subsidiary, Meritec, and is
in the process of liquidating that entity. See "BUSINESS -- Disposal of
Business" and notes 17 and 18 of the notes to the consolidated financial
statements. Neither the sale of Carolina Summit nor the liquidation of Meritec
is expected to have a material effect on the Company's results of operations.
Historically, ESIF was not operated for the purpose of generating profits,
but it retained a portion of its earnings and profits to avoid making
assessments against its members. ESIF occasionally during its operating history
paid distributions of profits to its members, but it never made an assessment
against its members. ESIF's indemnity agreements indemnified the member
employers against loss or liability relating to workers' compensation insurance
risk.
The discussion below in "Results of Operations" is divided into four
segments: (i) a comparison of fiscal years ended March 31, 1994, 1995 and 1996
for ESIF, including SHC after the date of the Acquisition; (ii) a comparison of
the six-month periods ended September 30, 1995 and 1996 for ESIF on a
consolidated basis; (iii) comparison of the nine-month periods ended December
31, 1995 and 1996 for ESIF on a consolidated basis; and (iv) a comparison of
fiscal years ended December 31, 1993, 1994 and 1995 for SHC. ESIF's audited
consolidated financial statements for the six-month period ended September 30,
1996, and accompanying comparative discussion and analysis, have been included
herein to provide additional financial data about the Company.
RESULTS OF OPERATIONS
COMPARISON OF FISCAL YEARS ENDED MARCH 31, 1994, 1995 AND 1996 FOR ESIF
REVENUE. Revenue was $159.0 million, $140.8 million and $140.3 million for
the fiscal years ended March 31, 1994, 1995 and 1996, respectively. Revenue
declined for the fiscal year ended March 31, 1995, primarily due to a $20.0
million decrease in premiums earned. Revenue declined by $0.5 million for the
fiscal year ended March 31, 1996, primarily due to a decrease in premiums earned
of $13.6 million, which was offset by the addition of $7.6 million in
administrative fees as a result of the Acquisition and an increase in realized
investment gains of $4.4 million. Set forth below is a discussion of the
composition of revenues for the periods indicated.
32
<PAGE> 33
<TABLE>
<CAPTION>
YEAR ENDED MARCH 31,
------------------------------
1994 1995 1996
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Premiums earned............................................. $148,441 $128,489 $114,893
Net investment income....................................... 10,510 12,205 13,210
Realized investment gains................................... -- -- 4,354
Administrative fees......................................... -- -- 7,665
Other income................................................ -- 121 206
-------- -------- --------
Total revenue..................................... $158,951 $140,815 $140,328
======== ======== ========
</TABLE>
Premiums Earned. Premiums earned decreased by $20.0 million, or 13.4%, for
the year ended March 31, 1995, and decreased by $13.6 million, or 10.6%, for the
year ended March 31, 1996. These declines in premiums resulted in large part
from: (i) lost accounts due to the market's increasing preference for non-
assessable products; (ii) increased competition; (iii) the effects of increasing
participation in the premium credit programs; and (iv) an adjustment in
estimation of accrued retrospective premiums which reduced reported premiums for
the fiscal year ended March 31, 1996 by approximately $9.3 million, a discussed
more fully in "-- Losses and Loss Adjustment Expenses" below.
As discussed in the table below, in the fiscal years ended March 31, 1994,
1995 and 1996, the premium credit programs in the aggregate accounted for
approximately $3.9 million, $11.4 million and $14.1 million, respectively, in
credits.
<TABLE>
<CAPTION>
YEAR ENDED MARCH 31,
------------------------------
1994 1995 1996
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Managed care credits........................................ $ -- $ 6,144 $ 8,811
All other credits........................................... 3,908 5,279 5,250
-------- -------- --------
Total premium credits............................. $ 3,908 $ 11,423 $ 14,061
======== ======== ========
</TABLE>
The premium credits that ESIF has paid for managed care utilization have
been larger during the past two years than all other credits combined. The
percentage of ESIF's covered employers participating in the managed care credit
program was greater than 80% as of December 31, 1996. In January 1997, the 10%
managed care premium credit was eliminated and a 11.2% premium rate reduction
for new and renewal policies became effective.
Net Investment Income. Net investment income increased from $10.5 million
for the fiscal year ended March 31, 1994, to $12.2 million for the fiscal year
ended March 31, 1995, and to $13.2 million for the fiscal year ended March 31,
1996. These increases were due in part to increases in total cash and invested
assets from $201.7 million for the fiscal year ended March 31, 1994 to $220.3
million in the fiscal year ended March 31, 1996 and in part to improved yields
on ESIF's investment portfolio. The investment income generated from the
municipal bond portion of the portfolio was $3.2 million for the fiscal year
ended March 31, 1996.
Realized Investment Gains. Realized investment gains increased from zero
for the fiscal year ended March 31, 1994, to a de minimis amount for the fiscal
year ended March 31, 1995, to $4.4 million for the fiscal year ended March 31,
1996. These gains resulted from the sale of certain invested assets to finance
the Acquisition.
Administrative Fees. The Administrative Subsidiaries generate
administrative fees primarily through contracts with the Funds, pursuant to
which the Administrative Subsidiaries provide marketing, underwriting, claims
administration, loss control and policy administration services. Fees are
generally based on a percentage of each Fund's premiums. For the period
beginning on the date of the Acquisition, January 16, 1996, and ending on March
31, 1996, the administrative fees were $7.7 million.
33
<PAGE> 34
LOSSES AND EXPENSES. ESIF's losses and expenses decreased from $145.5
million for the fiscal year ended March 31, 1994 to $110.7 million for the
fiscal year ended March 31, 1995 and increased to $140.5 million for the fiscal
year ended March 31, 1996. Set forth below is a breakdown of the total annual
expenses.
<TABLE>
<CAPTION>
YEAR ENDED MARCH 31,
------------------------------
1994 1995 1996
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Losses and loss adjustment expenses......................... $108,411 $ 69,116 $ 94,844
Underwriting, general and administrative expenses........... 37,121 41,546 43,657
Interest expense............................................ -- -- 847
Amortization and depreciation............................... -- -- 1,103
-------- -------- --------
Total losses and expenses......................... $145,532 $110,662 $140,451
======== ======== ========
</TABLE>
Losses and Loss Adjustment Expenses. ESIF establishes reserves to cover
its estimated liabilities for losses from claims and for loss adjustment (claim
settlement) expenses ("LAE"). Such loss reserves are established by management
based upon, among other factors: (i) results of actuarial reviews which
incorporate ESIF's experience with similar cases, estimates of future claim
trends, and historical trends such as recurring loss payment and reporting
patterns, claim closures, and product mixes; (ii) facts known to ESIF; and (iii)
regulatory requirements. Losses and LAE incurred for the fiscal year ended March
31, 1994 were $108.4 million compared to $69.1 million for the fiscal year ended
March 31, 1995 and $94.8 million for the fiscal year ended March 31, 1996.
Prior to the fiscal year ended March 31, 1995, management had recorded
reserves in excess of reserve levels required by actuarial reports because the
actuarial estimates for fund years 1991 and earlier had a history of increasing
(or "adversely developing") as the fund years matured and more actual loss data
became known. During the fiscal year ended March 31, 1995, ESIF began to record
reserves at levels primarily supported by actuarial reviews. Since the actuarial
estimates had by that time evidenced a trend of loss adverse development with
the maturity of the fund years. This adverse development trend and management's
response are discussed more fully in "-- Losses and Loss Adjustment Expenses"
below. Management's determination that it was no longer necessary to increase
reserves over the actuarial estimates, together with a reduction in premiums
earned and a lower actuarial loss ratio, resulted in a $39.3 million decrease in
losses and LAE expenses for the fiscal year ended March 31, 1995 as compared to
fiscal year ended March 31, 1994. The subsequent increase of $25.7 million in
losses and LAE for the fiscal year ended March 31, 1996 was primarily the result
of revised actuarial estimates for prior years. The loss ratio for the fiscal
years ended March 31, 1994, 1995 and 1996 was 73.0%, 53.8% and 82.5%,
respectively, or an average of 69.8%. A table showing the development of certain
actuarial net loss ratio trends is included in "-- Losses and Loss Adjustment
Expenses" below.
Underwriting, General and Administrative Expenses. The increase in ESIF's
expenses from $37.1 million to $41.5 million in the fiscal year ended March 31,
1995 was primarily due to four factors: (i) higher administrative taxes; (ii)
higher SDTF assessments; (iii) the introduction and operation of state-wide
managed care programs; and (iv) the increase in commission expenses.
Underwriting, general and administrative expenses increased to $43.7 million
during the fiscal year ended March 31, 1996 primarily due to the Acquisition.
Interest Expense. For the fiscal years ended March 31, 1994 and 1995, ESIF
had no interest expense. In connection with the Acquisition, SHC borrowed $44.0
million from the Bank, and, as a result, interest expense on a consolidated
basis for the fiscal year ended March 31, 1996 was $0.8 million.
Amortization and Depreciation. For the fiscal years ended March 31, 1994
and 1995, ESIF had no amortization or depreciation expense. In connection with
the Acquisition, SHC recorded certain intangibles including software, noncompete
agreements, customer contracts and goodwill. For the fiscal year ended March 31,
1996, amortization of these intangible assets was $1.1 million. The expense
associated with amortization of these intangible assets is not deductible for
federal income tax purposes.
34
<PAGE> 35
NET INCOME. Net income was $8.9 million, $19.2 million and $0.2 million
for the fiscal years ended March 31, 1994, 1995 and 1996, respectively. The
increase in net income of $10.3 million for the fiscal year ended March 31, 1995
resulted primarily from a reduction in ESIF's reserves partially offset by a
decrease in premiums earned. The $19.0 million decrease in net income for the
fiscal year ended March 31, 1996 resulted from decreased premiums as well as
increased losses and LAE.
COMPARISON OF HISTORICAL RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED
SEPTEMBER 30, 1995 AND 1996 FOR ESIF
REVENUE. Revenue for the six months ended September 30, 1995 was $71.8
million as compared with $73.0 million for the six months ended September 30,
1996. SHC generated $17.4 million in administrative fees in the six months ended
September 30, 1996. The following table analyzes the composition and change in
revenues.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
SEPTEMBER 30,
------------------
1995 1996
------- -------
(IN THOUSANDS)
<S> <C> <C>
Premiums earned............................................. $63,145 $49,029
Net investment income....................................... 7,598 6,363
Realized investment gains................................... 919 8
Administrative fees......................................... -- 17,432
Other income................................................ 90 216
------- -------
Total revenue..................................... $71,752 $73,048
======= =======
</TABLE>
Premiums Earned. Premiums earned for the six months ended September 30,
1996 decreased by $14.1 million to $49.0 million. This loss in premium was due
to the market's increased preference for non-assessable products and the
increase in participation in mandated premium credit programs, which premium
credits totaled $8.2 million for the six months ended September 30, 1996 as
compared to $7.0 million for the six months ended September 30, 1995. As noted,
the percentage of ESIF's covered employers participating in the managed care
credit program was greater than 80% as of December 31, 1996. In January 1997,
the 10% managed care premium credit was eliminated and a 11.2% premium rate
reduction for new and renewal policies became effective.
Net Investment Income. Net investment income decreased by $1.2 million
primarily due to the reduction in invested assets related to the Acquisition.
Administrative Fees. SHC generated $17.4 million in administrative fees
through its contracts with administrative clients for the six months ended
September 30, 1996. Administrative fees represent 23.9% of total revenue for the
six-month period and are expected to provide additional future revenues through
SHC's contracts with clients in Florida, Louisiana and Kentucky.
LOSSES AND EXPENSES. ESIF's losses and expenses increased from $64.0
million for the six months ended September 30, 1995 to $67.0 million for the six
months ended September 30, 1996. Set forth below is a discussion of the expenses
for the period.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
SEPTEMBER 30,
------------------
1995 1996
------- -------
(IN THOUSANDS)
<S> <C> <C>
Losses and loss adjustment expenses......................... $42,365 $32,135
Underwriting, general and administrative expenses........... 21,623 30,532
Interest expense............................................ -- 1,831
Amortization and depreciation............................... -- 2,499
------- -------
Total losses and expenses......................... $63,988 $66,997
======= =======
</TABLE>
Losses and Loss Adjustment Expenses. Losses and LAE incurred for the six
months ended September 30, 1995 were $42.4 million compared to $32.1 million for
the six months ended September 30, 1996. The
35
<PAGE> 36
loss ratio decreased from 67.1% for the six months ended September 30, 1995 to
65.5% for the six months ended September 30, 1996. This decrease was the result
of favorable loss development.
Underwriting, General and Administrative Expenses. Underwriting, general
and administrative expenses increased by $8.9 million primarily due to the
Acquisition. The SHC portion of underwriting, general and administrative
expenses was $15.1 million, which indicates a reduction of $6.2 million in
underwriting, general and administrative expenses for ESIF.
The insurance operations ratio decreased slightly from 34.2% on September
30, 1995 to 33.0% on September 30, 1996. It should be noted that the Florida
Department of Labor administrative tax has decreased retrospectively from 3.15%
to 2.50%, effective July 1996. Furthermore, the ongoing expenses related to
managed care approvals should decrease as ESIF's managed care network continues
to service more of the existing policyholder base, thereby reducing delivery
costs.
Interest Expense. Interest expense increased $1.8 million for the six
months ended September 30, 1996 from zero for the six months ended September 30,
1995. Interest expense resulted from the $44.0 million of debt incurred by SHC
to fund the Acquisition.
Amortization and Depreciation. For the six months ended September 30,
1996, amortization and depreciation expense of $2.5 million was recorded
primarily in connection with intangible assets acquired in the Acquisition. The
expense associated with amortization of the intangible assets, which is expected
to be approximately $3.9 million per year, is not deductible for federal income
tax purposes.
NET INCOME. Income from continuing operations for the six months ended
September 30, 1996 was $3.7 million compared to $5.4 million for the six months
ended September 30, 1995. ESIF had $1.3 million of non-recurring charges in
September 1996 which included the disposition of discontinued operations and
conversion costs.
COMPARISON OF HISTORICAL RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED
DECEMBER 31, 1995 AND 1996 FOR ESIF
REVENUE. Revenue for the nine months ended December 31, 1995 was $103.1
million as compared with $110.8 million for the nine months ended December 31,
1996. SHC generated $25.8 million in administrative fees in the nine months
ended December 31, 1996. The following table analyzes the composition and change
in revenues.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
DECEMBER 31,
----------------------
1995 1996
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Premiums earned............................................. $ 89,713 $ 74,509
Net investment income....................................... 10,522 9,606
Realized investment gains................................... 2,726 366
Administrative fees......................................... -- 25,762
Other income................................................ 125 568
-------- --------
Total revenue..................................... $103,086 $110,811
======== ========
</TABLE>
Premiums Earned. Premiums earned for the nine months ended December 31,
1996 decreased by $15.2 million to $74.5 million. This loss in premium was due
to the market's increased preference for non-assessable products and the
increase in participation in mandated premium credit programs, which premium
credits totaled $12.3 million for the nine months ended December 31, 1996 as
compared to $10.5 million for the nine months ended December 31, 1995. As noted,
the percentage of ESIF's covered employers participating in the managed care
credit program was greater than 80% as of December 31, 1996. In January 1997,
the 10% managed care program credit was eliminated and an 11.2% premium rate
reduction for new and renewal policies became effective.
Net Investment Income. Net investment income decreased by $0.9 million
primarily due to the reduction in invested assets related to the Acquisition.
36
<PAGE> 37
Administrative Fees. SHC generated $25.8 million in administrative fees
through its contracts with administrative clients for the nine months ended
December 31, 1996. Administrative fees represent 23.2% of total revenue for the
nine-month period and are expected to provide additional future revenues through
SHC's contracts with clients in Florida, Louisiana and Kentucky.
LOSSES AND EXPENSES. ESIF's losses and expenses increased from $95.6
million for the nine months ended December 31, 1995 to $102.5 million for the
nine months ended December 31, 1996. Set forth below is a discussion of the
expenses for the period.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
DECEMBER 31,
---------------------
1995 1996
------- --------
(IN THOUSANDS)
<S> <C> <C>
Losses and loss adjustment expenses......................... $67,043 $ 50,236
Underwriting, general and administrative expenses........... 28,548 45,837
Interest expense............................................ -- 2,719
Amortization and depreciation............................... -- 3,729
------- --------
Total losses and expenses......................... $95,591 $102,521
======= ========
</TABLE>
Losses and Loss Adjustment Expenses. Losses and LAE incurred for the nine
months ended December 31, 1995 were $67.0 million compared to $50.2 million for
the nine months ended December 31, 1996. The loss ratio decreased from 74.7% for
the nine months ended December 31, 1995 to 67.4% for the nine months ended
December 31, 1996. This decrease was the result of favorable loss development.
Underwriting, General and Administrative Expenses. Underwriting, general
and administrative expenses increased by $17.3 million primarily due to the
Acquisition. The SHC portion of underwriting, general and administrative
expenses was $21.2 million, which indicates a reduction of $3.9 million in
underwriting, general and administrative expenses for ESIF.
The expense ratio increased slightly from 31.8% on December 31, 1995 to
33.4% on December 31, 1996. It should be noted that the Florida Department of
Labor administrative tax has decreased retrospectively from 3.15% to 2.50%,
effective July 1996, while production expenses increased 2.1%.
Interest Expense. Interest expense increased $2.7 million for the nine
months ended December 31, 1996 from zero for the nine months ended December 31,
1995. Interest expense resulted from the $44.0 million of debt incurred by SHC
to fund the Acquisition.
Amortization and Depreciation. For the nine months ended December 31,
1996, amortization and depreciation expense was recorded of $3.7 million
primarily in connection with intangible assets acquired in the Acquisition. The
expense associated with amortization of the intangible assets, which is expected
to be approximately $3.9 million per year, is not deductible for federal income
tax purposes.
NET INCOME. Income from continuing operations for the nine months ended
December 31, 1995 and 1996 was $5.2 million and $5.2 million, respectively. ESIF
had $2.0 million of non-recurring charges during the nine-month period ending
December 31, 1996, which included the disposition of discontinued operations and
conversion costs.
COMPARISON OF FISCAL YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995 FOR SHC
REVENUE. Revenue for the fiscal years ended December 31, 1993, 1994 and
1995 was $70.8 million, $73.8 million and $64.1 million, respectively. Gross
service fee (administrative fee) revenue received from ESIF and the Funds is
computed as a percentage of ESIF's and the Funds' premiums. Such revenue is
recognized by SHC in proportion to ESIF's and the Funds' recognition of premiums
earned. SHC is required to pay certain direct expenses that are a percentage of
the premiums earned by ESIF and the Funds. Such direct expenses principally
include agents' commissions, reinsurance premium costs, association fees and
administrative taxes. Subsequent to the Acquisition, direct expenses are
included in underwriting, general and
37
<PAGE> 38
administrative expenses in ESIF's consolidated financial statements. The changes
in revenue for each of the three years are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1993 1994 1995
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Gross service fees................................. $ 70,814 $ 73,833 $ 64,090
Direct expenses.................................... (32,957) (29,656) (25,414)
-------- -------- --------
Net service fees................................... 37,857 44,177 38,676
Investment and other income........................ 632 934 2,175
-------- -------- --------
Total revenue............................ $ 38,489 $ 45,111 $ 40,851
======== ======== ========
</TABLE>
Net Service Fees. Net service fees increased from $37.9 million in 1993 to
$44.2 million in 1994 and decreased by $5.5 million to $38.7 million for the
fiscal year ended December 31, 1995. The decline in net service fees for this
period is due to a proportional decrease in gross service fees and direct
expenses during 1995, principally attributable to a decrease in premiums earned
by ESIF and the Funds. In 1994, SHC's net service fee revenue included a $3.3
million one-time reimbursement.
Investment and Other Income. Investment income for the fiscal years ended
1993, 1994 and 1995 was $0.4 million, $0.7 million and $1.0 million,
respectively. Included in other income are software consulting and maintenance
fees totaling approximately $0.9 million for the fiscal year ended December 31,
1995. These fees are associated with the Company's subsidiary, Meritec, which
was purchased in July 1995. The disposition of Meritec was completed by December
31, 1996.
EXPENSES. Expenses for the fiscal years ended December 31, 1993, 1994 and
1995 are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1993 1994 1995
------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Compensation and employee benefits.................... $14,503 $15,425 $16,616
Other operating expenses.............................. 7,707 8,218 8,204
Interest expense...................................... 1,610 58 42
Depreciation and amortization......................... 4,891 4,872 5,112
------- ------- -------
Total expenses.............................. $28,711 $28,573 $29,974
======= ======= =======
</TABLE>
Compensation and Employee Benefits. Compensation and employee benefits
increased by $0.9 million to $15.4 million for the fiscal year ended December
31, 1994 compared to $14.5 million for 1993. The increase was principally
attributable to increased payroll costs, combined with increased group life and
health insurance costs. Compensation and employee benefits increased by $1.2
million to $16.6 million for the fiscal year ended December 31, 1995 compared to
$15.4 million for 1994, primarily as a result of increased payroll costs coupled
with the addition of employees resulting from the purchase of Meritec, effective
July 1995.
Interest Expense. Interest expense decreased by $1.6 million or 96.4% to
approximately $58,000 for the fiscal year ended December 31, 1994 compared to
$1.6 million for 1993. In 1993, interest expense included $1.5 million for the
buyout of the Capital Appreciation Rights agreement related to a revolving loan
agreement.
Amortization and Depreciation. Amortization of intangibles for the fiscal
years ended 1993, 1994 and 1995 was $4.1 million, $4.1 million and $4.3 million,
respectively. Intangible assets were originally established in connection with
the acquisition of SCI from Alexander and Alexander Services, Inc. on January 1,
1992.
NET INCOME. Net income for the fiscal years ended 1993, 1994 and 1995 was
$5.9 million, $10.2 million and $6.9 million, respectively. The increase in net
income for 1994 as compared to 1993 of $4.3 million is due to a one-time
reimbursement from one of the Funds, Louisiana Employers Safety Association Self
Insurers Fund, for $3.3 million and a reinsurance premium expense decrease of
$2.0 million. The decrease in net income for 1995 of $3.3 million is due
primarily to lower administrative fee income which is attributable to a decrease
in Fund premiums.
38
<PAGE> 39
LIQUIDITY AND CAPITAL RESOURCES
The Company has historically met its cash requirements and financed its
growth principally through cash flows generated from operations. The Insurance
Subsidiaries' primary sources of cash flows are premiums earned, investment
income and the proceeds from the sale or maturity of invested assets. The
Administrative Subsidiaries' primary source of cash flow is service fees
generated from ESIF and the Funds. The cash requirements of the Insurance
Subsidiaries are primarily for the payment of claims, commissions, reinsurance
premiums and management fees to SCI and the purchase of investment securities.
The cash requirements of the Administrative Subsidiaries are primarily for the
payment of salaries, employees benefits, debt obligations and other operating
expenses. Due to the uncertainty regarding settlement of unpaid claims, the
liquidity requirements of the Company vary, and the Company has attempted to
structure its investment portfolio to take into account the historical payout
patterns. See "BUSINESS -- Investment Portfolio." The Company purchases
reinsurance to mitigate the effect of large claims and help stabilize demands on
its liquidity. See "BUSINESS -- Reinsurance."
As part of the Acquisition, SHC incurred debt of which, at December 31,
1996, consisted of a term loan in the amount of $33.0 million, and no balance
was outstanding under the revolving line of credit. Scheduled quarterly payments
for the term loan began on September 30, 1996 and extend through June 30, 2002,
with principal payments totaling approximately $1.6 million, $3.8 million, $4.6
million, $9.0 million, $10.0 million and $4.0 million due in calendar years
1997, 1998, 1999, 2000, 2001 and 2002, respectively.
Prior to the Effective Date, the Company intends to execute a credit
agreement with the Bank pursuant to which, upon consummation of the Conversion,
the existing debt will be restructured. Under such new credit facility, as of
the Effective Date, the term loan will be $33.0 million and the revolving line
of credit will be $5.0 million, and the interest rate initially will be the
prime rate plus 1%. The annual principal payments (which are payable in
quarterly installments) will be approximately $2.3 million, $5.0 million, $5.6
million, $7.6 million, $9.1 million and $3.4 million in each of calendar years
1997, 1998, 1999, 2000, 2001 and 2002, respectively. The Company anticipates
that its debt obligations will be satisfied from the cash flow generated by the
Administrative Subsidiaries.
For the years ended March 31, 1995 and 1996, net cash provided by operating
activities was $13.3 million and $10.8 million, respectively, while net cash
used in investing activities was $12.3 million and $47.1 million, respectively.
The increase in cash used in investing activities is related to the Acquisition
and the assumption of debt in connection therewith. The Company expects to
redeem the Series A Preferred Stock from future surpluses in excess of
statutorily required capital.
The Company's balance sheets as of March 31, 1996 and December 31, 1996
reflect $20.1 million and $21.1 million, respectively, of recoverables from the
SDTF. The Company received $5.6 million and $6.5 million in actual recoveries
from the SDTF for the fiscal year ended March 31, 1996 and the nine months ended
December 31, 1996, respectively. The SDTF has not failed to make payments on
accepted claims and the Company has no reason to believe that the SDTF will fail
to meet its obligations to pay accepted claims in the future, although there can
be no assurance. If the SDTF is discontinued, the Company believes that the
existing reimbursement obligations of the SDTF would become general obligations
of the State of Florida, although there is no assurance that a reviewing court
would adopt that view. The SDTF has made no acknowledgment with regard to the
enforceability of its reimbursement obligations to insurers such as the Company.
See "BUSINESS -- Regulation -- Special Disability Trust Fund."
As a self-insurance fund, ESIF recorded for statutory reporting an asset of
$42.9 million, $47.3 million and $44.9 million at March 31, 1995, March 31, 1996
and December 31, 1996, respectively, for future investment income determined by
discounting loss and loss adjustment expense reserves at a statutory prescribed
rate. Upon conversion to a stock insurance company Bridgefield will be permitted
to record discounts only on permanent disability cases. The amount of such
discount is estimated at approximately $4.9 million, $4.7 million and $4.2
million at March 31, 1995, March 31, 1996 and December 31, 1996, respectively.
ESIF's statutory basis surplus as a self-insurance fund was approximately $20.4
million at December 31, 1996. Upon conversion to a stock insurance company, and
assuming receipt of the net proceeds from the Offerings, plus $5.5 million of
additional statutory capital which will result from
39
<PAGE> 40
reorganization, Bridgefield's statutory basis surplus as a stock insurance
company would be approximately $35.2 million at December 31, 1996. Such capital
and surplus is considered adequate to satisfy the requirements of the Florida
Insurance Code.
The NAIC has recently adopted risk-based capital standards to establish the
capital requirements of an insurance carrier based upon the risks inherent in
its operations. The standards, which would become effective in Florida under a
bill recently passed by the Florida legislature and submitted to the Governor,
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
various financial factors to address four primary risks: asset risk, insurance
underwriting risk, credit risk and off-balance 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.
Upon the conversion to a stock insurance company and the recapitalization, the
Company expects to exceed such risk-based capitalization levels, as recommended
by the NAIC.
The Company's Insurance Subsidiaries are subject to state insurance laws
and regulations that limit the amount of dividends or distributions that may be
paid by an insurance company to its shareholders. Pursuant to the Florida
Insurance Code, the Insurance Subsidiaries may not, without the prior approval
of the Florida DOI, pay to their shareholders dividends or other distributions
of cash or property, the total fair market value of which exceeds generally the
lesser of 10% of surplus or net income, not including realized capital gains. In
addition, the Order issued by the Florida DOI in connection with the Conversion
requires that all dividends or distributions by the Insurance Subsidiaries be
approved by the Florida DOI in advance, but the Order states that approval will
be given for any dividend or distribution otherwise complying with the Florida
Insurance Code. As a consequence of these legal restrictions and other business
considerations, the amount of dividends that may be paid by the Insurance
Subsidiaries to Summit may be limited, which may in turn limit the amount of
cash available to Summit for servicing its debt and other purposes.
LOSSES AND LOSS ADJUSTMENT EXPENSES
The Company's consolidated balance sheet includes an estimated reserve for
unpaid losses and LAE. This reserve represents management's best estimate of the
ultimate cost of the losses and LAE that are unpaid at the balance sheet date,
including incurred but not reported ("IBNR") claims. Such reserve is established
by management based upon (i) results of actuarial reviews which incorporate the
Company's experience with similar cases, estimates of future claim trends, and
historical trends such as recurring loss payment and reporting patterns, claim
closures and product mixes; (ii) facts known to the Company; and (iii)
regulatory requirements. Such reserve is continually reviewed and, as
adjustments become necessary, such adjustments are included in the results of
current operations.
The following table shows changes in the historical loss and LAE reserve
for ESIF for the ten fiscal years beginning with the year ended March 31, 1987.
The top line shows the reserve recorded at each fiscal year end. Such amount
represents an estimate of unpaid losses and LAE occurring in that year as well
as future payments on claims occurring in prior years. The upper portion of the
table (cumulative paid) presents the cumulative amounts paid during subsequent
years on those losses for which reserves were carried as of each specific year.
The lower portion (reserves re-estimated) shows the re-estimated amounts of the
previously recorded reserve based on experience as of the end of each succeeding
year. The re-estimate changes as more information becomes known about the actual
losses for which the initial reserve was carried. An adjustment to the carrying
value of unpaid losses for a prior year will also be reflected in the
adjustments for each subsequent year. For example, an adjustment made in the
fiscal year ended March 31, 1995 for loss reserves in the fiscal year ended
March 31, 1992 will be reflected in the re-estimated ultimate net loss for each
of the fiscal years ended March 31, 1992 through March 31, 1995. The cumulative
redundancy (deficiency) line represents the cumulative change in estimates since
the initial reserve was established. It is equal to the difference between the
initial reserve and the latest re-estimated reserve amount.
40
<PAGE> 41
ANALYSIS OF LOSS AND LOSS ADJUSTMENT EXPENSE DEVELOPMENT
<TABLE>
<CAPTION>
FISCAL YEAR ENDED MARCH 31,
-----------------------------------------------------------------------------------------------------------
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Reserves for losses
and LAE at end of
period............. $ 37,002 $ 57,488 $125,065 $169,004 $209,605 $169,474 $257,307 $274,102 $259,085 $277,995
Cumulative paid as of
One year later..... $ 23,190 $ 40,028 $ 57,482 $ 74,481 $ 88,815 $ 71,364 $ 73,839 $ 71,915 $ 64,882
Two years later.... 42,031 70,077 100,883 133,064 138,546 118,326 122,411 114,097
Three years
later............ 54,469 92,466 135,490 160,896 170,259 149,424 149,175
Four years later... 63,986 110,856 146,825 176,483 190,179 165,628
Five years later... 70,433 119,024 151,683 185,759 199,556
Six years later.... 72,985 123,810 154,668 189,948
Seven years
later............ 75,390 126,776 158,802
Eight years
later............ 76,457 130,904
Nine years later... 78,730
Reserves re-estimated as of end of year
One year later..... $ 47,332 $101,593 $141,132 $184,334 $202,489 $233,631 $237,318 $247,737 $267,885
Two years later.... 68,254 112,663 156,080 178,786 237,767 214,381 238,014 257,002
Three years
later............ 70,441 126,297 161,652 214,630 231,823 225,238 247,328
Four years later... 75,980 132,163 182,010 209,894 239,113 235,163
Five years later... 78,117 148,221 178,810 209,196 248,352
Six years later.... 86,683 145,937 178,042 215,984
Seven years
later............ 85,476 143,905 184,986
Eight years
later............ 83,430 148,783
Nine years later... 87,400
Cumulative redundancy (deficiency)
Dollars............ $(50,398) $(91,295) $(59,921) $(46,980) $(38,747) $(65,689) $ 9,979 $ 17,100 $ (8,800)
Percentage......... -136.20% -158.81% -48.91% -27.80% -18.49% -38.76% 3.88% 6.24% -3.40%
Net reserves.......................................................................... 257,307 274,102 259,085 277,995
Ceded Reserves........................................................................ 103,118 93,898 108,306 109,637
-------- -------- -------- --------
Gross reserves........................................................................ 360,425 368,000 367,391 387,632
Net reserves re-estimated............................................................. 247,328 257,002 267,885 --
Ceded reserves re-estimated........................................................... 94,271 102,247 101,161 --
-------- -------- -------- --------
Gross reserves re-estimated........................................................... 341,599 359,249 369,046 --
Gross cumulative redundancy (deficiency)
Dollars............................................................................. 18,826 8,751 (1,655)
Percentage.......................................................................... 5.22% 2.38% -0.45%
</TABLE>
As seen in the above table, ESIF's reserve estimates for fiscal years ended
March 31, 1992 and earlier had a history of increasing (or "adversely
developing") as those years matured and more data became available. In addition,
as discussed in "-- Results of Operations" above comparing the years ended March
31, 1994, 1995 and 1996, for the fiscal year ended March 31, 1995 ESIF reduced
its net reserve by approximately 5.5%, and subsequently increased the net
reserve in fiscal year 1996 by approximately 8.3%. The adverse development trend
and the recent reserve adjustments are due to several internal and external
factors, as discussed below.
Although ESIF began operations in 1979, prior to 1985 management believed
that it was not necessary for ESIF to maintain detailed claims data for the
purpose of projecting ultimate loss reserves because its losses over a specified
amount were fully reinsured. Also, at that time self-insurance funds in Florida,
including ESIF, were regulated by the Florida Department of Labor (the "DOL"),
which did not require actuarial verification or the recording of IBNR claims
reserves. Beginning in 1985, due primarily to changes in the reinsurance market,
ESIF no longer had access to full reinsurance, and ESIF for the first time
engaged an independent actuary to assist it in computing ultimate reserve
estimates.
Prior to 1989, ESIF's claims were adjusted and managed by Adjustco, Inc.
("ADJUSTCO"), an independent claims adjusting company, under contract to SCI.
Adjustco was responsible for establishing, monitoring and updating case-based
loss reserves used to set the reserves for ESIF's financial statements. In
January 1989, SCI discontinued the contract with Adjustco and began performing
such claims management functions through its wholly owned subsidiary, Summit
Claims Management, Inc. ("SCM"). This change has
41
<PAGE> 42
increased ESIF's control over the handling of each claim and has permitted ESIF
to collect detailed claims data. Also, due to improved data collection and
computer databases, ESIF is now able to sort the data into smaller subsets that
support more individualized actuarial assumptions, and ESIF is able to perform
more sophisticated analysis of the data.
In 1985, when ESIF first began establishing meaningful loss and LAE
reserves, there was not a substantial volume of company-specific claims data
available. The actuaries relied more heavily on industry data and assumptions.
Management elected to record ESIF's reserves each year at an amount in excess of
the actuarial estimates, a practice which proved to result in a more accurate
reserve amount. As reflected in the table above, even with management increasing
reserves over the actuarial estimates, ESIF's total reserves still experienced
adverse development until 1993.
By 1993, ESIF's business had grown significantly, and it was beginning to
accumulate a much larger volume of company-specific data. Also, the data
regarding claims incurred in prior years and paid in later years was becoming
more reliable as this data aged and matured. The use of this data enabled ESIF's
actuaries to begin estimating more accurate reserve amounts.
In addition, in or around 1994, several external changes occurred which
have improved ESIF's ability to establish more accurate reserve estimates. In
January 1994, the New Florida Law went into effect. For ESIF, one of the most
important reforms implemented by this law was that it permitted workers'
compensation insurers in Florida to settle and close all portions of outstanding
claims, whereas previously they had been permitted to settle and close only the
wage loss portions. This has significantly improved ESIF's ability to predict
the ultimate loss on a claim. Also, because ESIF has been able to settle and
close claims that were still outstanding from prior years, it has been able to
reduce the adverse development of prior years as those years continue to mature.
ESIF's loss ratios have declined over the years and have become more stable.
Another factor that has contributed to ESIF's improved actuarial estimates
is the lessening of medical cost inflation. Prior to 1994, ESIF's experience
showed significant annual inflation in medical expenses, which made estimating
loss reserves with respect to medical costs uncertain. However, with managed
care and other actual or proposed healthcare reforms limiting this rate of
inflation in medical expenses, ESIF has been better able to estimate loss
reserves with respect to such costs.
Also in 1994, the Florida legislature transferred regulatory oversight of
self-insurance funds from the DOL to the Florida DOI. The Florida DOI placed
substantially more emphasis on the actuarial reports and requested that
self-insurance funds record reserves only at amounts that had been agreed upon
by the funds' actuaries.
As a consequence of these factors that had been taking place in the early
1990s, in 1995 ESIF determined that it no longer needed to increase reserves
above the actuarial estimates. ESIF's management believed that the actuarial
estimates were beginning to show a trend of redundancy or only small
deficiencies, as reflected in the table above. As a result, for the fiscal year
ended March 31, 1995, ESIF reduced the aggregate loss and LAE reserve by
approximately $25.4 million, or 9.8% of net reserves. The following table, which
presents the development of actuarial net loss ratios for the same ten-year
period that is set forth above, illustrates how the actuarial estimates have
improved over time. This table shows net loss ratios that have been computed
using only the actuarially estimated reserve amounts, and excludes any
management reserves. The top line of the table shows the net loss ratio for each
year, and each succeeding line shows how that ratio has developed with
42
<PAGE> 43
each succeeding year. The ratios for each succeeding year are for only that
original accident year and are not cumulative.
DEVELOPMENT OF ACTUARIAL NET LOSS RATIOS(1)
<TABLE>
<CAPTION>
YEAR ENDED MARCH 31,
----------------------------------------------------------------------
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996
----- ----- ----- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Actuarial loss & loss adjustment expense
ratios................................... 86.0% 89.8% 77.0% 66.8% 67.0% 59.8% 55.8% 59.8% 60.4%
One year later............................. 86.0% 89.4 85.8 77.0 67.1 64.8 56.2 53.8 58.7
Two years later............................ 92.0 98.9 91.5 77.2 66.9 61.6 61.0 54.3
Three years later.......................... 98.7 97.8 93.4 84.5 70.3 64.2 60.7
Four years later........................... 98.2 100.9 103.1 87.2 75.3 64.7
Five years later........................... 101.3 110.7 103.1 89.9 76.8
Six years later............................ 108.7 110.7 104.3 92.5
Seven years later.......................... 108.1 110.8 106.2
Eight years later.......................... 107.7 111.7
Nine years later........................... 111.6
</TABLE>
- ---------------
(1) Actuarial net loss ratios are estimated billable premium regardless of the
payment plan net of specific reinsurance. This table does not reflect the
impact of aggregate reinsurance.
As shown in this table, the net loss ratios for fiscal years prior to 1992
have steadily increased as those accident years have developed. The net loss
ratios for years 1992 and later have remained relatively stable. These trends
correlate to the trend of the actuarially estimated reserves for years prior to
1992 to develop adversely as those years mature, and for years 1992 and later to
be more accurate and experience less adverse development. By 1995, when
management of ESIF determined that it would not need to record reserves in
excess of the actuarial estimates, these net loss ratios had begun to evidence
the trend toward less adverse development. For example, the net loss ratio for
1987 was 86.0% in that year, and by the end of 1994 the 1987 net loss ratio had
developed to 108.1%. In contrast, the net loss ratio for fiscal year 1992 was
67.0% in that year, but it had positively developed to 61.6% by the end of 1994.
Years subsequent to fiscal year 1992 continued to evidence this trend.
The improved quality and quantity of ESIF's claims data also resulted in
two adjustments in fiscal year 1996, an increase of the loss and LAE reserve and
a decrease of accrued billable premiums relating to ESIF's retrospective rated
insurance policies (the "RETRO PLANS"). For the fiscal year ended March 31,
1996, the loss and LAE reserve was increased consistent with revised actuarial
indications. ESIF's independent actuaries determined that the reserve provision
for claims occurring in prior years should be increased by approximately $10.8
million, which was 4.4% of reserves at the beginning of the year and 3.9% of net
reserves.
During the fiscal year ended March 31, 1996, the amounts incurred and paid
for fund years 1981-1986 were greater than the amounts expected based on the
development pattern underlying the March 31, 1995 reserve estimates, as
demonstrated in the following table:
FUND YEARS 1981-1986
ACTIVITY DURING FISCAL YEAR 1996
<TABLE>
<CAPTION>
EXPECTED ACTUAL EXPECTED ACTUAL
ADDITIONAL ADDITIONAL CHANGE IN CHANGE IN
PAYMENTS PAYMENTS INCURREDS INCURREDS
- ------------ ------------ ------------ ------------
<C> <C> <C> <C>
$4.1 million $7.1 million $2.7 million $7.2 million
</TABLE>
The amounts shown in the foregoing table reflect changes in the cumulative
amount of payments and incurreds on both an estimated and actual basis.
Part of this variance from expectations was due to the significant emphasis
on closing claims during the fiscal year ended March 31, 1996. Management
believed that it was in the long-term best interests of the
43
<PAGE> 44
Company to pursue aggressively settlement of medical claims, even if such
settlement resulted in payments in excess of existing case reserves, in order to
avoid potential increases in claims amounts due to inflation of medical costs,
possible increases in statutory benefit levels and other factors that could not
be fully anticipated. Nevertheless, case reserves, which were expected to
decrease by $1.4 million for these early fund years, actually remained
unchanged.
An in-depth review of these variances was undertaken by the Company's
consulting actuaries. Specifically, data for the indemnity, medical and expense
components of the Company's experience were separately reviewed to better
understand the underlying patterns. This review confirmed the need to
re-evaluate the loss development tail factors supporting the reserve estimates.
As noted above, the Company wrote only a limited amount of business in its
early years of operations. The development patterns that emerged from the actual
loss experience in these early years define the development factors that are
applied to all subsequent years. Consequently, as the experience matures,
changes to the pattern will have a leveraged effect on the actuarial reserve
estimates. At the same time the estimates, over time, rely more heavily on the
Company's actual experience.
In light of this new experience, the actuaries adjusted the development
patterns to reflect these higher levels of expected development. Given the
limited number of claims remaining open for these early years, it is expected
that no additional adjustment in the development pattern will be necessary as
these claims are settled, and reviews made subsequent to March 31, 1996 support
this expectation.
As a result of the revision in development patterns, the actuarial reserve
estimate at March 31, 1996 was increased by approximately $10.8 million as an
additional provision for prior years. The aggregate loss and LAE reserves of the
Company at March 31, 1995 and March 31, 1996 were based upon the best estimates
of such reserves by the Company's consulting actuaries.
With respect to retrospective premiums, the actuaries reduced their
estimate of accrued retrospective premiums by approximately $9.3 million. The
establishment of an estimate of accrued retrospective premiums requires an
analysis of both the overall losses for all Retro Plan participants (the mean
loss ratio) as well as an estimate of the dispersion of individual participant
loss ratios around the overall mean (the variance of the loss ratios). Prior to
March 31, 1996, the actuaries had developed an estimate of the variance using
only a limited amount of information about the individual participants' actual
loss experience. To a large extent, the model was based on industry information
regarding the dispersion of workers' compensation loss ratios around the mean.
The annual review of the amount of accrued retrospective premiums reflected
revised estimates of the participants' mean loss ratio, but did not re-estimate
the variance assumption.
During 1995, ESIF's actuaries reviewed the aggregate information for
participants in the Retro Plans. For years 1986 through 1988, a majority of the
losses had already been paid so that the actuaries were able to evaluate the
actual dispersion of individual participants' losses around the mean. The
actuaries concluded from this review that the earlier assumption of the variance
tended to underestimate the proportion of the insureds that would experience
losses in excess of the Retro Plans cap. The estimate of the variance was
revised to better match the actual experience of the Retro Plans participants
for these earlier years and applied the same assumptions to more recent years.
Thus, although the reserving model remain unchanged, revised assumptions
regarding variance using more individualized data caused the estimates of
retrospective premiums receivable to be reduced.
44
<PAGE> 45
The following table contains summary reconciliations of the beginning and
ending insurance reserves, displayed individually for each of the three most
recent fiscal years and for the six months and nine months ended September 30,
1996 and December 31, 1996, respectively.
<TABLE>
<CAPTION>
YEAR ENDED MARCH 31, SIX MONTHS NINE MONTHS
------------------------------ ENDED ENDED
1994 1995 1996 SEPTEMBER 30, 1996 DECEMBER 31, 1996
-------- -------- -------- ------------------ -----------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Net reserves for losses and LAE at
beginning of year............... $257,307 $274,102 $259,085 $277,995 $277,995
-------- -------- -------- -------- --------
Less: Recoverable from Florida
SDTF(1)......................... (6,745) (9,929) (15,879) (20,060) (20,060)
-------- -------- -------- -------- --------
Net reserves for losses and LAE
less SDTF recoverable assets at
beginning of year............... 250,562 264,173 243,206 257,935 257,935
Add provision for claims occurring
in:
The current year................ 118,889 94,520 84,058 35,663 53,698
Prior years..................... (10,478) (25,404) 10,786 (3,528) (3,462)
-------- -------- -------- -------- --------
Incurred losses during the current
year............................ 108,411 69,116 94,844 32,135 50,236
Deduct payments for claims
occurring in:
The current year................ 17,704 16,857 15,432 3,565 8,378
Prior years..................... 77,096 73,226 64,683 31,898 48,137
-------- -------- -------- -------- --------
Claim payments during the current
year............................ 94,800 90,083 80,115 35,463 56,515
Net reserves for losses and LAE
less SDTF recoverable assets at
end of period................... 264,173 243,206 257,935 254,607 251,656
Add: Recoverable from Florida
SDTF(1)...................... 9,929 15,879 20,060 21,138 21,138
-------- -------- -------- -------- --------
Net reserves for losses and LAE at
end of period................... 274,102 259,085 277,995 275,745 272,794
Add: Reinsurance recoverables
(exclusive of recoverables on
paid losses)................. 93,898 108,306 109,637 102,451 104,129
Gross reserves for losses and LAE
at end of period (GAAP basis)... $368,000 $367,391 $387,632 $378,196 $376,923
======== ======== ======== ======== ========
</TABLE>
- ---------------
(1) The change in the SDTF recoverable asset is included in incurred losses in
the Statement of Income.
A reconciliation of the loss and LAE reserves determined on a GAAP basis
with the reserves recorded on the statutory basis financial statements provided
to state regulatory authorities is as follows:
<TABLE>
<CAPTION>
MARCH 31, 1996
------------------------------- SEPTEMBER 30, DECEMBER 31,
1994 1995 1996 1996 1996
-------- -------- --------- ------------- ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
GAAP basis loss and LAE
reserves..................... $368,000 $367,391 $ 387,632 $ 378,196 $ 376,923
Reinsurance recoverables
included in GAAP loss and LAE
reserves..................... (96,680) (108,440) (106,812) (102,396) (103,508)
Adjustment for the effect of
computing GAAP basis loss
reserves using paid losses
gross of SDTF recoveries..... (15,530) (24,836) (31,376) (28,832) (28,832)
Discounting of indemnity
portion of permanent
disability claims............ 4,730 4,875 4,667 4,235 4,235
-------- -------- --------- --------- ---------
Statutory basis loss and LAE
Reserves..................... $260,520 $238,990 $ 254,111 $ 251,201 $ 248,818
======== ======== ========= ========= =========
</TABLE>
45
<PAGE> 46
The Company's GAAP basis balance sheet also includes the following amounts
related to the Florida SDTF:
<TABLE>
<CAPTION>
MARCH 31,
------------------------------ SEPTEMBER 30, DECEMBER 31,
1994 1995 1996 1996 1996
------ ------- ------- ------------- ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Recoverable from SDTF... $9,929 $15,878 $20,060 $21,138 $21,138
Reinsurance recoverable
related to SDTF....... 7,235 10,317 11,781 8,445 8,445
</TABLE>
The recoverable from SDTF asset has been recorded based on ESIF's
historical collection experience and the amount of claims identified as subject
to SDTF recovery. The SDTF reinsurance recoverable results from calculating such
recoverables using loss and LAE reserves computed using paid losses gross of
SDTF recoveries and in consideration of expected recoveries from SDTF. Certain
of the claims used in the determination of the SDTF recoverable are of an amount
which will pierce reinsurance layers. The Company will pursue recovery of such
claims under the provisions of its reinsurance agreements. Subsequently, as the
Company remits the claims to the SDTF, and ultimately collects these claims from
SDTF, the Company will remit to the reinsurers their portion of the SDTF
recoveries. The aggregate recoverable from SDTF asset and the SDTF related
reinsurance recoverable, which approximates the amount of the increase in loss
reserves resulting from determining the GAAP basis loss reserves using paid loss
data gross of SDTF recoveries, represents managements best estimate of the
aggregate amounts that will be recovered.
The Company received $3.2 million from SDTF for the nine months ended
December 31, 1995 and $6.5 million for the nine months ended December 31, 1996.
In order to quantify the amounts recoverable from the SDTF, which are
management's best estimates of the amounts that will be recovered, ESIF reviewed
its claims that have been identified as subject to SDTF recovery considering
ESIF's historical recovery experience on claims submitted to the SDTF. In
addition, ESIF estimated the amount of claims it expects to recover over the
next four years based on actual collection experience for the most recent two
years, and discounted the expected recoveries using an appropriate interest
rate. The amounts reflected as recoverables from the SDTF were based on the
discounted expected collection amounts rather than on the total claims
identified as subject to SDTF recovery. ESIF believes it will be reimbursed over
a number of years. See "RISK FACTORS -- Possible Underfunding of Florida Special
Disability Trust Fund."
The SDTF has not prefunded its claims liability, and no reserves currently
exist to satisfy future claims. Under Florida law, the SDTF is currently
scheduled to expire in the year 2000, unless it is re-created by the Florida
legislature. The SDTF recently underwent legislative review. Under a recent bill
passed by the Florida legislature and submitted to the Governor, the SDTF law
would be amended so that claims arising from accidents occurring on or after
January 1, 1998 would not be accepted for reimbursement by the SDTF. The bill
states the SDTF will be liable for reimbursement for subsequent injuries that
occur prior to January 1, 1998, and that assessments are to continue for funding
purposes.
In addition, the Florida DOI participated with the Florida legislature in
the review of current and proposed statutory accounting treatments of SDTF
projected recoveries, and with respect to how an insurer may include such
estimated recoveries in its admitted asset and loss reserve calculations in
statutory financial statements. Under the bill referred to above, the
anticipated SDTF recoveries that an insurer could take into account when
computing loss reserves in its statutory financial statements would be limited
to recoveries for which a claim has been accepted for payment. Credit for all
other anticipated recoveries would be capped at the total SDTF recovery amount
used by the insurer in 1996, and this capped amount would be phased out over a
five year period, commencing with statutory financial statements filed in the
year 2000 (20% per year reduction of 1996 capped amount).
While it is not possible to predict the outcome of this or any other
legislative or regulatory proposals affecting the SDTF, changes in the SDTF's
operations or funding which decrease the availability of recoveries or increase
assessments payable by the Company, or the discontinuation of the SDTF, could
have a material adverse effect on the Company's business, financial condition,
or results of operations.
46
<PAGE> 47
Subject to the legislation set forth above, the SDTF recoverable recorded
on the Company's balance sheet is an actuarial estimate of the amount the
Company can expect to recover from the SDTF on eligible claims. The Company has
a dedicated claims unit that handles the tracking, submission and collection
process with the SDTF. In the event that there are adverse developments in SDTF
collection experience, the recorded recoverable balance will accordingly be
adjusted.
With respect to collection patterns, the SDTF reviews reimbursement
requests on a claim by claim basis, with actual collection payments tied to the
paid loss development over a claim's life. The payments are not made ratably or
in any other predictable pattern. A prior actuarial review of the SDTF indicated
the average time frame for collection of a claim made to the SDTF is 6 to 8
years.
47
<PAGE> 48
BUSINESS
OVERVIEW
The Company provides a variety of managed care workers' compensation
products and services to employers and self-insured employer groups primarily in
Florida, as well as in Louisiana and Kentucky. Through the Company's
Administrative Subsidiaries, the Company provides administrative services for
the Funds, for the Insurance Subsidiaries and for certain municipalities. These
administrative services include most aspects of daily operations of the Funds
and the Insurance Subsidiaries, including sales and marketing, underwriting,
claims administration, loss control and policy administration. These services
are provided for a fee, with the Company generally receiving a percentage of
premiums. The Administrative Subsidiaries do not assume any underwriting risk of
the Funds, entities formed to provide workers' compensation coverage for self-
insured employer groups on a pooled basis.
The Insurance Subsidiaries, which include Bridgefield and Bridgefield
Casualty, underwrite and assume the underwriting risk with respect to workers'
compensation insurance policies for Florida employers of all sizes, primarily in
the construction, manufacturing, wholesale and retail, and service industries.
As of December 31, 1996, the Company's insurance products and administrative
services are provided to approximately 15,800 employers representing
approximately $217.4 million in premiums, including approximately $101.0 million
in premiums attributable to the Funds and $116.4 million in premiums
attributable to the Insurance Subsidiaries ($108.3 million in the case of
Bridgefield and $8.1 million in the case of Bridgefield Casualty).
The Company's approach to managed care workers' compensation is to select
responsible employers for coverage, assist such employers in creating a safe
work place, and proactively manage claims, thereby returning employees to work
promptly and minimizing losses. Employers' safety programs are monitored by the
Company's staff of approximately 25 loss control field representatives who visit
an employer's work place on at least an annual basis. Reported claims are
proactively managed by the Company so that employees receive prompt care by
healthcare professionals which are part of the Company's provider network. The
Company's claims management professionals direct care through the provider
network, monitor employee treatment and progress toward returning to work and
perform utilization and peer review to control costs. The Company's approach to
managed care workers' compensation has produced an average net ultimate loss
ratio for ESIF during the three fiscal years ended March 31, 1996 of 69.8%,
which is better than the national average of 75.0% during the period 1993
through 1995, based on information published by A.M. Best. See "MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS,"
"-- Strategy" and "-- Managed Care."
INDUSTRY
Workers' compensation benefits are state-mandated and regulated programs
that generally require employers to provide medical benefits and wage
replacement to employees injured at work, regardless of fault. In the event an
employee suffers a work-related injury, workers' compensation coverage will pay
the medical benefits associated with such injury, regardless of whether the
injured employee participates in any other health or medical benefits program.
Each individual state has a regulatory and adjudicatory system that quantifies
the level of wage replacement to be paid, determines the level of medical care
required to be provided and the cost of permanent impairment, and provides
whether the injured employee or the employer has certain options in selecting
healthcare providers. State laws generally require two types of benefits for
injured employees: (i) medical benefits that include expenses related to
diagnosis and treatment of the injury, as well as rehabilitation, if necessary,
and (ii) indemnity payments that consist of temporary wage replacement,
permanent disability payments or death benefits to surviving family members. To
fulfill this mandated financial obligation, virtually all employers are required
to either purchase workers' compensation insurance from a private insurance
carrier, a state-sanctioned assigned risk pool or a self-insurance fund (an
entity that allows employers to obtain workers' compensation coverage on a
pooled basis, typically subjecting each employer to joint and several liability
for the entire fund) or, if permitted by their state, to self-insure.
48
<PAGE> 49
The Florida workers' compensation market accounted for more than 90% of the
Company's total revenue for the fiscal year ended March 31, 1996 (on a pro forma
basis after giving effect to the Conversion). Florida is the fourth largest
state in terms of population behind California, New York and Texas and,
according to the Florida DOI, the Florida workers' compensation market
approximated $3.2 billion in premiums in 1995. Approximately 62% of Florida's
population is between the ages of 15 and 64, generally considered the employment
pool subject to workers' compensation requirements. Over half of Florida's
employment is in the service and wholesale/retail trade sectors, with
manufacturing, construction and agriculture following (in order of size) to make
up the bulk of the remainder of the state's employment base. Based upon data
reported by the NAIC, had ESIF been a stock insurance company on December 31,
1995, it would have been one of the five largest workers' compensation insurers
in Florida, based on the amount of direct premiums earned. See "RISK
FACTORS -- Concentration in a Single State."
STRATEGY
The Company believes that the Conversion provides new opportunities for
improving its return on invested capital through growth in its core workers'
compensation business. Following the Conversion, the Company will be able to
offer both self-insurance and traditional indemnity products, which will improve
its ability to service its markets. In addition, as a stock corporation, the
Company may have access to additional capital to finance growth by acquisition
and to expand into other geographic markets (subject to any necessary regulatory
approvals). Key aspects of the Company's business strategy following the
Conversion include:
Continued Use of Both Self-Insurance and Indemnity Products. The Company
will continue to offer workers' compensation products and services to its
employer customers through both management of self-insured employer groups and
issuance of traditional indemnity insurance policies. The Company believes that
its ability to offer both self-insurance and indemnity services and products
will enable it to compete more effectively in its current markets, and will
provide it with flexibility for responding to changes in its current markets and
expanding into additional markets.
Emphasis on Profitable Underwriting Results. The Company has historically
focused on underwriting results, achieving what it believes are excellent loss
results due to its integrated system of coordinating major aspects of workers'
compensation product management. The Company intends to continue to emphasize
maintaining strong underwriting results in an effort to provide a competitive
workers' compensation coverage package, to control costs and to maximize return
on invested capital.
Proactive Implementation of Managed Care. Managed care will continue to be
a key part of the Company's overall approach to effective management of workers'
compensation claims. The Company believes that its use of managed care
techniques in combination with selective underwriting enables the Company to
provide high quality and cost-effective care to injured employees, while at the
same time lowering overall insurance costs.
Leveraging of Administrative Services Capabilities. The Company's systems,
procedures and organizational structure are designed to provide effective, high
quality administrative services to multiple workers' compensation entities. The
Company intends to continue pursuing opportunities to further leverage its
administrative services through management of additional self-insurance funds,
indemnity insurance carriers and self-insured governmental entities located
throughout the South.
Emphasis on Excellent Customer Service. The Company believes that the
offering of workers' compensation insurance products and services is best
implemented and managed through emphasis on customer service and frequent
contact with both employer customers and independent sales agents. The Company
intends to continue emphasizing excellent customer and sales support services.
MANAGED CARE
Over the past eight years, the Company has implemented a managed care
approach to workers' compensation. The Company's managed care strategy reduces
costs through loss prevention, early intervention and proactive management of
claims. The Company's focus on loss prevention includes helping employers
49
<PAGE> 50
establish workplace safety programs, making on-site visits to the workplace and
coordinating among the Company's underwriting, loss control, claims management
and sales and marketing groups. Once a claim occurs, the Company's early
intervention procedures enable the Company to identify injuries that have the
potential of resulting in significant expenses and controlling these expenses
from the outset. The Company generally uses a three-point contact system with
the goal of contacting each of the injured employee, the employer and the health
care provider within 24 hours after notification of an initial claim. The
Company's SMART(TM) (Summit Medical Alert Reaction Team) coordinates a medical
claim from inception to completion in order to provide quality health care to
the injured employee so that he or she may return to work as quickly as
possible. The Company believes returning an employee to the job quickly is an
effective means of controlling indemnity payments for lost wages, typically the
largest component of workers' compensation costs as well as medical expenses.
The Company directs claimants to healthcare providers that are part of the
Company's managed care networks. These networks currently include healthcare
providers who have contracted with Heritage/Summit Healthcare of Florida, Inc.,
the Company's wholly owned provider network subsidiary, or with Vincam
Occupational Health Systems, Inc., an unaffiliated provider network. These
arrangements currently give the Company access to healthcare providers in every
county in Florida, including approximately 2,000 total practitioners and
hospitals. The Company is currently one of four workers' compensation companies
with approved managed care provider networks in every Florida county. With such
networks, the Company emphasizes the use of cost control measures such as
utilization review. The Company's total managed care approach, including early
intervention, proactive claims management and use of provider networks, in
combination with state-mandated fee schedules, has resulted in the Company
reducing the amount it pays for medical bills submitted by an average of 44%.
PRODUCTS AND SERVICES
The Company's operations are comprised of two general types: (i)
administrative services provided by the Administrative Subsidiaries, and (ii)
insurance coverage underwritten by the Insurance Subsidiaries.
Administrative Services. The Company provides a full range of management
and administrative services for the Funds and for certain municipalities. The
Company's Administrative Subsidiaries also provide these services for the
Insurance Subsidiaries. The services include those needed to manage an
integrated workers' compensation program, including sales and marketing,
underwriting, claims management, loss control and policy administration.
Claims Management. The Company's claims management group consists of
approximately 170 claims adjusters based at the Company's headquarters and 12
field claims adjusters. The Company believes that it has developed a
sophisticated, efficient claims management system which facilitates the prompt
resolution of claims. On average, each claims adjuster has a case load of 125
outstanding claims, which the Company believes is a contributing factor in
reducing and controlling claims costs. Claims adjusters electronically track the
progress of claims filed and issue regular reviews on the status of cases. On a
bi-monthly basis, claims personnel review selected cases for changes in status
and adjustments to case-specific reserves. In order to provide consistent
service and build customer relationships, the Company assigns claims adjusters
by geographic territory. However, given the special considerations related to
medical claims, the Company has established a designated medical claims
management group which is utilized for medical related claims in all
territories.
Underwriting and Loss Control. The Company's services include
assisting the Funds, the Insurance Subsidiaries and other clients with
formulating their underwriting guidelines and then implementing those guidelines
on behalf of the client. Management believes that one of the Company's most
valuable services for its clients, and one of the ways that the Company is able
to minimize its own insurance risks, is the Company's general practice of
recommending for membership in a Fund, or for issuance of a policy, those
employers who fit the Company's underwriting criteria. Prior to recommending
that the client or the Insurance Subsidiaries accept a risk, the Company's
underwriters review the employer's prior loss experience and safety
50
<PAGE> 51
record, premium payment and credit history, employment classifications and
physical operation. As part of the Company's ongoing loss control efforts, each
employer undergoes a semi-annual review of its coverage.
After accepting an employer for workers' compensation coverage, the second
phase is to help the employer manage its safety risks. The Company employs a
staff of approximately 25 loss control field representatives whose goals include
visiting new employees within 90 days of coverage. Loss control professionals
complete training programs upon joining the Company, and many come with
certifications and professional designations for loss control and safety. Loss
control representatives assist employers in developing and monitoring safety
programs to reduce work related injuries and health hazards. After evaluating an
employer's loss profile, a loss control field representative will help develop a
loss control program and establish accident reporting and claims investigation
protocol. A primary objective for field representatives is to educate employers
on necessary safety systems and health issues which will enable the employers to
manage their own risk.
In an effort to evaluate the underwriting process and provide an early
warning system, the underwriting department, in cooperation with the loss
control department, produces a monthly computer-generated report identifying
specific employers where excessive losses have occurred. Triggered by these
reports, loss control representatives inspect the employer's operations and
issue recommendations based on their findings. Further, loss control
representatives conduct periodic spot checks to determine the effectiveness of
specific recommendations.
Sales and Marketing. All of the Company's products and the Fund
memberships are sold through independent insurance agents. The Company's sales
and agency relations department and telemarketing department work with more than
1,000 independent insurance agencies. The Company's agency executives are sales
professionals who work closely with the larger agencies, maintaining regular
communications with the agencies and keeping them up to date on the Company's
products and services, as well as developments and trends in workers'
compensation insurance. The Company's telemarketing representatives maintain
contact with the smaller agencies by telephone, keeping those agencies informed
about products, services and trends. Often, the Company's agency executives work
with the independent agents in making presentations to potential clients. The
sales department is responsible for maintaining the record of accounts for each
agent and ensuring that proper commissions are paid in a timely manner. Sales
conferences and seminars are held regularly for agents and their staffs.
The Company's creative services department supports the sales and agency
relations functions. This seven-person department functions as an in-house
advertising agency to produce brochures, newsletters, posters, videos and other
visual presentations to assist the independent agents, and in turn their
clients, in understanding how the Company's products and services can satisfy an
employer's workers' compensation insurance needs. The creative services
department also provides a service to members of the Funds by informing them
about developments in safety, claims and other areas of workers' compensation
through internally generated newsletters and articles in trade publications.
Policy Administration. It is an objective of the Company to provide
every insured and Fund member and their employees with timely and quality
service. The Company maintains a group of approximately 30 client service
personnel who answer all incoming client telephone calls and handle other
requests for customer support. These personnel coordinate with the sales force
and field personnel, and they are responsible for maintaining a client database.
In addition, the Company has a group of approximately 20 persons who perform
premium audits, working both internally at the Company's headquarters and in the
field at client sites. These auditors are responsible for making certain that
the payrolls and job classifications for each insured and Fund member are
accurately reflected in the premium amounts charged for coverage. The field
auditors generally conduct a premium audit for every insured and Fund member on
an annual basis. Separately, the Company has a team of approximately 15
individuals who handle collections and disputes related to premiums.
Primary Customers. The Company's primary customers for its
administrative services are its own Insurance Subsidiaries and the four Funds,
including the Florida Retail Federation Self Insurers Fund ("FRF"), the
Louisiana Employers Safety Association Self Insurers Fund ("LESA"), the
Louisiana
51
<PAGE> 52
Retailers Association Self Insurers Fund ("LRA"), and the Kentucky Retail
Federation Self Insurers Fund ("KRF"). SCI assisted with the formation of and
became the administrator for FRF, LRA and LESA in 1979, 1980 and 1982,
respectively. SCI became the administrator of KRF in 1995. None of the Funds are
related to the Company, except that certain of the directors of Summit are
trustees of certain of the Funds, as described in "MANAGEMENT OF THE
COMPANY -- Compensation Committee Interlocks and Insider Participation" and
"CERTAIN TRANSACTIONS." Each of the Funds was formed at the direction of a
particular trade association, and each is a trust organized and operated under
provisions of applicable state law. Each Fund has a board of trustees, but no
officers or employees, and the board of trustees of each Fund has contracted
with SCI to perform most aspects of the daily operations of such Fund.
Each Fund has executed a written administrator's contract with SCI which
defines the services to be performed by SCI and the fee to be paid by the Fund.
These contracts are intended to be (i) long-term in nature, with initial terms
of between two and five years and provisions for automatic renewal, and (ii)
terminable by the Funds for "good cause," which is generally defined to mean a
failure by SCI to perform its obligations under the contract or SCI's fraud or
bankruptcy, with such default by SCI not being cured within a 90-180 day period
after notice from the Fund. For these reasons and because the Funds have no
employees and the Company manages all aspects of their relationships with agents
and members, the Company believes that it would be difficult for the Funds to
cancel their contracts with the Company or move the business to a new
administrator. The Company intends to continue providing the administrative
services that it currently provides, and it has no reason to believe that its
relationships with any of the Funds will be adversely affected by the
Conversion. The Funds have no equity or other type of ownership interest in the
Company and, therefore, are not entitled to participate in the Conversion.
The following table presents the Company's annual administrative fee
revenues received from each Fund:
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31,
---------------------------
1993 1994 1995
------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
FRF....................................................... $32,196 $31,104 $28,990
LESA...................................................... 8,708 8,000 6,035
LRA....................................................... 4,573 4,595 3,904
KRF....................................................... -- -- 294
------- ------- -------
Total........................................... $45,477 $43,699 $39,223
======= ======= =======
</TABLE>
Such annual administrative fee revenues are generally a contractually
agreed upon percentage of each Fund's premiums. Out of such annual
administrative fees, the Company is required to pay certain direct expenses,
including agents commissions, premium taxes and reinsurance premiums.
The following describes certain information about each of the four Funds:
Florida Retail Federation Self Insurers Fund. FRF was established in
1979 as a workers' compensation self-insurance fund targeted specifically
to retailers, service providers, wholesalers and retail-related businesses
in Florida. As of December 31, 1996, FRF had approximately 7,250 member
employers and annual premiums in excess of $77.2 million. FRF memberships
renew each year on January 1.
Louisiana Employers Safety Association Self Insurers Fund. LESA was
established in 1982 and currently provides coverage to over 800 member
employers in Louisiana. As of December 31, 1996, LESA had annual premiums
of approximately $12.0 million. LESA memberships renew each year on April
1. LESA's members have voted in favor of converting the Fund to a
nonassessable mutual insurance company. If such conversion is approved by
the applicable insurance regulators and effected, upon the approval of SCI,
LESA would replace its current administrator's agreement with a managing
general agent agreement, pursuant to which SCI would continue without
interruption to manage the day-to-day operations of LESA, as converted to
an insurance company.
52
<PAGE> 53
Louisiana Retailers Association Self Insurers Fund. LRA was
established in 1980 as a workers' compensation self-insurance fund
targeting specifically wholesalers and retail-related businesses in
Louisiana. As of December 31, 1996, LRA had over 1,250 retail member
employers and annual premiums of approximately $8.9 million. LRA
memberships renew each year on July 1.
Kentucky Retail Federation Self Insurers Fund. KRF is a workers'
compensation self-insurance fund for selected Kentucky retail businesses,
and SCI assumed administration of KRF in August 1995. As of December 31,
1996, KRF had over 1,200 members and annual premiums of approximately $2.9
million. KRF memberships renew each year on January 1.
Insurance Operations. Prior to the Conversion, ESIF was one of the largest
workers' compensation self-insurance funds in Florida, with approximately 4,760
member employers and approximately $108.4 million in annual premiums as of
December 31, 1996. ESIF's policies renew each year on April 1.
ESIF has maintained a relatively steady risk distribution of business
groups. A breakdown of all business segments is shown below:
ESIF'S RISK DISTRIBUTION
AS OF MARCH 31, 1996
<TABLE>
<CAPTION>
APPROXIMATE % OF TOTAL
INDUSTRY PREMIUMS WRITTEN
-------- ---------------------------
<S> <C>
Construction.......................................... 41%
Manufacturing......................................... 18%
Wholesale and retail.................................. 15%
Service............................................... 14%
Transportation........................................ 7%
Agriculture........................................... 5%
---
Total....................................... 100%
===
</TABLE>
During 1995, in an effort to compete with those workers' compensation
insurers who issue non-assessable policies, the Company formed Bridgefield
Casualty, which is licensed to underwrite property/casualty insurance in Florida
and is capitalized with $5.7 million of cash and invested assets. Bridgefield
Casualty began offering a non-assessable workers' compensation policy in Florida
effective January 1, 1996, and as of December 31, 1996 had written approximately
520 such policies representing approximately $8.1 million of annual premiums.
Subject to receipt of licensing approvals, Bridgefield Casualty intends to begin
selling non-assessable workers' compensation policies in Louisiana. Future plans
also include possible workers' compensation offerings in other states as well as
other property/casualty products offered to members of the Funds.
The Company's products and rating plans encompass a continuum of options
designed to fit the needs of its insured employers and employer groups. The
basic product, accounting for approximately 70% of the Insurance Subsidiaries'
premiums in force at March 31, 1996, is a guaranteed cost contract, in which the
premium for each employer is set in advance and varies only based upon changes
in the client's operations or payroll. In return, the Company agrees to assume
statutorily imposed obligations of the employer to provide workers' compensation
benefits to its employees. The premium for such a policy depends upon the type
of work performed by the employees and the general business of the insured. An
employer large enough to qualify, typically those paying more than $25,000 in
annual premiums, may choose a different product, having its premium based on its
loss experience relative to its peers as determined over a one-year period. A
client who desires to assume a certain amount of financial risk may elect a
deductible which makes the client responsible for the first portion of any
claim. In exchange for the deductible election, the employer receives a premium
reduction. The Company also offers a loss sensitive plan (retrospective rated
plan) to employers paying more than $25,000 in annual premiums. Under this plan,
final premium for a period is determined on the basis of the insured's actual
losses during that period. If a client's losses during a claims period are
better than expected, the Company may be required to refund a portion of the
premium previously paid. Throughout the fiscal years ended March 31, 1994, 1995
and 1996, and the nine months ended December 31, 1996, the
53
<PAGE> 54
Company established and maintained gross aggregate accruals for retrospective
refunds in amounts of $6.4 million, $9.2 million, $10.6 million and $10.4
million, respectively. Between March 31, 1994 and December 31, 1996, the Company
paid an aggregate of $0.9 million in excess of these refund accruals.
Retrospective rated policies accounted for 33%, 32%, 30% and 31%, respectively
of total premiums during the fiscal years ended March 31, 1994, 1995 and 1996
and the nine months ended December 31, 1996. The Company secures substantially
all of its retrospective liability through a combination of letters of credit,
cash deposits and other instruments.
REINSURANCE
The Company obtains reinsurance principally to reduce its net liability on
individual risks, to provide protection for catastrophic losses, to stabilize
its underwriting results and to increase its underwriting capacity. In exchange
for reinsurance, the Company pays to its reinsurers a portion of the premiums
that the Company receives.
ESIF currently maintains specific Excess Reinsurance with several
reinsurers, under which the reinsurers have agreed to pay claims and claims
expenses over a specific dollar amount per occurrence. ESIF currently maintains
Excess Reinsurance agreements with John Hancock Life Insurance Company, Lincoln
National Life Insurance Company, Republic Western Mutual Insurance Company and
National Union Fire Insurance Company pursuant to which each of such reinsurers
agrees to pay claims and expenses above a certain amount and up to a specified
limit per claim. The aggregate effect of such agreements is that claims and
claims expenses in excess of $50,000 per claim and up to the statutory amount
per claim will be paid by one or more of such reinsurers in accordance with the
terms of such agreements. Further, ESIF has entered into Quota Share Reinsurance
agreements with Am Re, St. Paul Fire and Marine Insurance, Constitution
Reinsurance Corp. and Transatlantic Reinsurance Co. under which ESIF has ceded
to such reinsurers, in the various proportions taken by each of them, an
aggregate of 75% of the premiums on workers' compensation policies written
during such period, and such insurers, in the respective proportions taken by
each of them, have assumed that same percentage of risks under such policies.
The portions taken by each of such reinsurers is as follows: Am Re -- 35%; St.
Paul Fire and Marine Insurance -- 15%; Constitution Reinsurance
Corporation -- 20%; and Transatlantic Reinsurance Company -- 5%.
Bridgefield Casualty has an Excess Reinsurance agreement with Continental
Casualty Company under which that reinsurer has agreed to pay claims and claims
expenses up to statutory limits per claim, to the extent each claim exceeds $0.5
million. In addition, Bridgefield Casualty has a Quota-Share Reinsurance
agreement in effect with Am Re under which Bridgefield Casualty cedes to Am Re a
percentage (currently 80%) of all written workers' compensation premiums and Am
Re assumes that same percentage of risks.
Quota Share Reinsurance allows the Insurance Subsidiaries to write, within
regulatory guidelines, a larger number of policies than they could otherwise. In
the event that a Quota Share Reinsurance agreement is terminated for any reason,
the Insurance Subsidiaries could be required to increase their capital
substantially or reduce their level of workers' compensation premiums, unless
they are able to establish another Quota Share Reinsurance arrangement.
Reinsurance does not legally relieve an insurer from its liability under
the workers' compensation policies it issues, but it does make the assuming
reinsurer liable to the insurer for the reinsurance ceded. Therefore, the
Company is subject to credit risk with respect to the obligations of its
reinsurers. The Company regularly performs internal reviews of the financial
strength of its reinsurers. However, if a reinsurer is unable to meet any of its
obligations to the Insurance Subsidiaries under the reinsurance agreements, the
Insurance Subsidiaries would be responsible for the payment of all claims and
claims expenses which the Company has ceded to such reinsurer. Pursuant to the
Order, Bridgefield is permitted to cede reinsurance only to authorized
reinsurers, unless it obtains the prior approval of the Florida DOI. See "RISK
FACTORS" -- Dependence on Reinsurance."
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<PAGE> 55
Certain detailed information regarding the Company's total reinsurance
recoverable is provided in the following table (dollars in thousands):
<TABLE>
<CAPTION>
AS OF MARCH 31, 1996 AS OF DECEMBER 31, 1996
----------------------------- -----------------------------
REINSURANCE PAID UNPAID PAID UNPAID
CARRIER RATING(1) CLAIMS CLAIMS TOTAL CLAIMS CLAIMS TOTAL
----------- --------- ------ -------- -------- ------ -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
American Re.......... A+/XII $ -- $ 286 $ 286 $ -- $ 734 $ 734
Cigna................ A-/XIII 297 -- 297 -- -- --
Continental
Casualty........... A/XV -- 10,531 10,531 -- 9,245 9,245
Crossroads(2)........ N/R 917 9,375 10,292 1,847 9,276 11,123
Employers Re......... A++/XV 595 6,805 7,400 808 5,150 5,958
Federal Ins. Co...... A++/XV -- 9,626 9,626 -- 8,417 8,417
INA.................. A-/XIII -- 5,678 5,678 223 5,792 6,015
Lloyds of London..... N/R -- 12,274 12,274 -- 16,856 16,856
National Union....... A++/XV -- -- -- -- 2,385 2,385
Old Republic......... A+/IX 53 17,242 17,295 41 15,132 15,173
Transamerica......... A/XI 20 37,820 37,840 10 31,142 31,152
------ -------- -------- ------ -------- --------
Total...... $1,882(3) $109,637 $111,519 $2,929(4) $104,129 $107,058
====== ======== ======== ====== ======== ========
</TABLE>
- ---------------
(1) 1996 Best's Key Rating Guide -- Property-Casualty Edition.
(2) Based on filings with the Florida DOI, Crossroads maintains trust fund
assets sufficient to fund its reinsurance obligations, although no specific
recoverable from Crossroads is directly secured by such trust fund assets.
(3) All recoverables are less than 90 days old, except $3,000 owed by Employers
Re which is more than 120 days old.
(4) All recoverables are less than 90 days old.
Under the terms of its administrative services contracts, the Company
advises the Funds regarding their reinsurance needs and places such reinsurance.
The Company currently has placed Excess Reinsurance on behalf of each Fund. The
Company pays the Funds' reinsurance premiums out of the Company's service fee
revenues, and the cost per Fund is generally in the range of approximately 5.5%
to 7.0% of premiums earned.
The Company brokers all of its reinsurance and the reinsurance purchased
for the Funds through a wholly owned reinsurance agency, which employs one
agent. The Company receives a brokerage fee from the Funds.
The Company has not experienced any material difficulties in collecting
reinsurance recoverables from any of its reinsurers, including, without
limitation, Crossroads and Lloyds of London. However, no assurance can be given
as to the future ability of any of the Company's reinsurers to meet their
obligations. In recent years, Lloyds of London has reported substantial
aggregate losses which have had adverse effects on it in general and on the
underwriting capacity of its syndicates in particular. These losses and other
adverse developments could affect the ability of certain Lloyds of London
syndicates to continue to trade and the ability of insureds to continue to place
business with particular syndicates. To the Company's knowledge, the Lloyds of
London syndicates with which the Company has contractual relationships have not
experienced any inability to pay their reinsurance obligations as and when due.
However, it is not possible for the Company to predict what effects the
circumstances described above may have on Lloyds of London and the Company's
contractual relationship with Lloyds of London syndicates in future years.
INVESTMENT PORTFOLIO
In general, the Company's investment policy focuses on: (i) safety of
principal; (ii) timing of maturities to match assets and liabilities; and (iii)
diversification. The Company's investment portfolio is managed by First Union
Capital Management, Smith Barney Capital Management and Invesco Capital
Management. These managers have certain discretion to make investments on behalf
of the Company, subject to regulatory restrictions and the Company's investment
policy and guidelines.
The Company's primary investment objective is to minimize risk while
matching portfolio and liabilities duration. The average fixed-income duration
of the portfolio is approximately four years. This duration, when coupled with
the Company's cash and cash equivalents, matches the historical claims liability
duration of
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<PAGE> 56
three years. A secondary objective is to maximize total return, within the
regulatory constraints of the Florida Insurance Code and quality constraints of
NAIC Class I requirements.
In the fiscal year ended March 31, 1996, the Company's investment
activities reflected an unusually high portfolio turnover due to portfolio
restructuring which consisted of: (i) a $50.0 million portfolio allocation to a
new investment manager; (ii) the $26.0 million Acquisition of SHC; and (iii)
approximately $85.0 million of general securities trades designed to take
advantage of market interest rate movements. This $85.0 million of trades
included $15.0 million in yield swaps, $20.0 million to reduce intangible tax
exposure, and a $50.0 million shift to corporate banks to increase yields. The
Company expects future portfolio activity to return to pre-1996 levels. The
Company does not use any derivatives for interest rate hedging or other
purposes.
As of December 31, 1996, approximately 73% of the bonds in the Company's
investment portfolio were rated AA or above by Standard & Poor's ("S&P") and
approximately 96% were either rated A- or better by S&P or are considered Class
I under the NAIC's classification system. The composition of the portfolio as of
December 31, 1995 and 1996 is depicted in the following table.
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
-----------------------------------
1995 1996
---------------- ----------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Government bonds........................................... $ 88,715 37.5% $ 61,267 27.2%
Municipal bonds............................................ 60,365 25.5% 83,803 37.2%
Corporate bonds............................................ 32,106 13.6% 39,612 17.6%
Preferred stock............................................ 3,215 1.4% 4,568 2.0%
Common stock............................................... 11,228 4.7% 14,100 6.3%
Short-term investments..................................... 36,344 15.4% 14,536 6.4%
Cash and cash equivalents.................................. 4,448 1.9% 7,433 3.3%
-------- ----- -------- -----
Total cash and invested assets................... $236,421 100.0% $225,319 100.0%
======== ===== ======== =====
</TABLE>
COMPETITION
The markets for workers' compensation insurance products and services are
highly competitive. The Company's competitors include, among others, insurance
companies, specialized provider groups, in-house benefits administrators, state
insurance pools and other significant providers of workers' compensation,
administration and insurance services. A number of the Company's current and
potential competitors are significantly larger, with greater financial and
operating resources than those of the Company, and can offer their services
nationwide. After a period of absence from the market in Florida, traditional
national insurance companies have re-entered that market, thereby increasing
competition. Their presence in the Company's current market, and in markets into
which the Company might consider for expansion, will likely create greater
competition for acquisitions of workers' compensation businesses, making it more
difficult for the Company to grow by acquisition.
Competitive factors in the workers' compensation insurance field include
premium rates (in some states), levels of service, A.M. Best ratings, levels of
capitalization, quality of managed care services, the ability to reduce loss
ratios and the ability to reduce claims expenses. The Company believes that its
products and services are competitively priced. In addition, the Company
believes its premium rates are typically lower than those for clients assigned
to the state-sponsored risk pools, allowing the Company to provide a viable
alternative for employers in such pools. The Company also believes that its
level of service and its ability to reduce claims are strong competitive factors
that have enabled it to retain existing clients and attract new clients.
Competitive factors relating to the Company's administrative service products
are primarily based upon pricing, service and reputation. See "RISK
FACTORS -- Competition."
A.M. BEST RATING
A.M. Best is a rating agency that reports on the financial condition of
insurance companies. Neither of the Insurance Subsidiaries has been assigned a
rating by A.M. Best because neither company has
56
<PAGE> 57
accumulated the required five consecutive years of operating experience.
Management has met with representatives of A.M. Best to discuss whether ESIF's
prior operations might be considered in assigning a rating to Bridgefield, but
there can be no assurance that any rating will be assigned to either Insurance
Subsidiary in the near future. See "RISK FACTORS -- Competition."
REGULATION
General. Workers' compensation and managed healthcare programs are subject
to various laws and regulations. Both the nature and degree of applicable
government regulation vary greatly depending upon the specific activities
involved. Generally, parties that actually provide or arrange for the provision
of managed care workers' compensation programs, assume financial risk related to
the provision of those programs, or undertake direct responsibility for making
payment or payment decisions for those services, are subject to a number of
complex regulatory schemes that govern many aspects of their conduct and
operations. The managed healthcare field is a rapidly expanding and changing
industry; it is possible that the applicable regulatory frameworks will expand
to have an even greater impact upon the conduct and operation of the Company's
business.
The Company's business is subject to state-by-state regulation of workers'
compensation insurance and workers' compensation insurance management services.
Under the workers' compensation system, employer insurance or self-funded
coverage is governed by individual laws in each of the fifty states and by
certain federal laws. Such regulation is primarily for the benefit and
protection of covered employees and policyholders and not for the benefit of
investors. Changes in individual state regulation of workers' compensation or
managed healthcare may create a greater or lesser demand for some or all of the
Company's products and services, or require the Company to develop new or
modified services in order to meet the needs of the marketplace and compete
effectively in that marketplace. In addition, many states limit the maximum
amount of dividends and other distributions that may be paid in any year by
insurance companies. This may limit the amount of distributions that may be made
by the Company's Insurance Subsidiaries. See "RISK FACTORS -- Government
Regulation."
Premium Rate Restrictions. In general, state regulations governing the
workers' compensation systems and insurance business impose restrictions and
limitations on the Company's business operations that are not imposed on
unregulated businesses. Among other matters, state laws regulate not only the
amounts and types of workers' compensation benefits that must be paid to injured
workers, but also the premium rates that may be charged by the Company to insure
employers for those liabilities. As a consequence, the Company's ability to pay
insured workers' compensation claims out of the premium revenue generated from
the Company's sale of such insurance is dependent upon the level of premium
rates permitted by state laws. In this regard, it is significant that the state
regulatory agency that regulates workers' compensation may not be the same
agency that regulates workers' compensation insurance premium rates.
In Florida, the Florida DOI approves "manual" rates for each of the
approximately 650 employment classification codes prepared and filed by the
National Council on Compensation Insurance ("NCCI"). The carriers operating in
Florida are not permitted to deviate from these approved rates, and competition
is, therefore, primarily related to service and the ability to improve insureds'
experience ratings through loss prevention and effective claims management.
Levels of benefit payments, however, are regulated by the Florida Department of
Labor and Employment Security. Sometimes, mandated benefit changes will be
coupled with permission for appropriate rate changes, but not always.
Taking a different approach, Louisiana is not an NCCI-rated state, but
instead is "open rated," meaning that carriers can apply for, and may receive,
approval to sell workers' compensation coverages at varying rates. However,
since Louisiana established a competitive state-run fund, rates have generally
followed those of the state-run fund.
In both Florida and Louisiana, the legislatures have recently abolished
systems that required carriers doing business in those states to pay residual
market assessments to the states to support the involuntary workers'
compensation markets. The Company believes that such action will have the effect
of increasing competition in both states.
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<PAGE> 58
Statutory Accounting and Solvency Regulations. State regulation of
insurance company financial transactions and financial condition are based on
statutory accounting principles ("SAP"). Such statutory accounting principles
differ in a number of ways from GAAP, which govern the financial reporting of
most other businesses. In general, SAP financial reports are more conservative
than GAAP financial reports, reflecting lower asset values, higher liability
values and lower equity.
State insurance regulators closely monitor the financial condition of
insurance companies reflected in SAP financial statements and can impose
significant financial and operating restrictions on an insurance company that
becomes financially impaired. Regulators generally have the power to impose
restrictions or conditions on the following kinds of activities of a financially
impaired insurance company: transfer or disposition of assets; withdrawal of
funds from bank accounts; extension of credit or making loans; and investment of
funds.
Financial and Investment Restrictions. Insurance company operations are
subject to financial restrictions that are not imposed on other businesses.
State laws require insurance companies to maintain minimum surplus balances and
place limits on the amount of insurance a company may write based on the amount
of the company's surplus. These limitations may restrict the rate at which the
Company's insurance operations can grow. Immediately following the Conversion,
the Company will meet relevant state minimum capital and surplus requirements.
State laws also require insurance companies to establish reserves for
payment of policyholder liabilities and impose restrictions on the kinds of
assets in which insurance companies may invest. These restrictions may require
the Company to invest its assets more conservatively than it would if it were
not subject to the state law restrictions and may prevent the Company from
obtaining as high a return on its assets as it might otherwise be able to
realize. See "-- Investment Portfolio" and "RISK FACTORS -- Government
Regulation." In addition, pursuant to the Order, Bridgefield is required to
maintain a deposit with the Florida DOI of $5.0 million. All net investment
income on such deposit is for the account of Bridgefield.
In addition, under Florida law, an insurance company may not, without
regulatory approval, pay to its shareholders within a 12-month period dividends
or other distributions of cash or property, the total fair market value of which
exceeds generally the lesser of 10% of surplus or net income, not including
realized capital gains. The Order requires that all dividends proposed to be
paid by the Insurance Subsidiaries be approved in advance by the Florida DOI.
However, pursuant to the Order, the Florida DOI has agreed to approve a request
for any dividend that complies with the Florida Insurance Code. This may limit
the amount of dividends that may be paid by the Insurance Subsidiaries to
Summit, which in turn may limit the amount of capital available to Summit for
debt service, expansion, dividend payments to shareholders and other purposes.
The NAIC has recently adopted risk-based capital standards to determine the
capital requirements of an insurance carrier based upon the risks inherent in
its operations. These standards 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 factors to address
four primary risks: asset risk, insurance underwriting risk, credit risk and
off-balance 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. These standards have not yet been adopted in
Florida; however, upon the conversion to a stock insurance company and the
recapitalization, the Company expects to exceed such risk-based capitalization
levels, as recommended by the NAIC.
Special Disability Trust Fund. Florida operates a special disability trust
fund that reimburses Florida insurance carriers, self-insurance funds and
self-insured employers for certain workers' compensation benefits paid to an
employee when he or she is injured on the job and the injury merges with,
aggravates, or accelerates a preexisting injury or physical condition of that
employee. The SDTF is managed by the State of Florida and is funded through
assessments against insurance carriers, self-insurance funds and self-insured
employers providing workers' compensation coverage in Florida. The Company's
SDTF recoveries, recorded as a reduction to losses and LAE incurred, were
approximately $4.5 million, $5.7 million and $5.6 million for the fiscal years
ended March 31, 1994, 1995 and 1996, respectively. The Company's SDTF
assessments were approximately $5.5 million, $4.7 million and $5.6 million for
the fiscal years ended March 31, 1994, 1995 and
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<PAGE> 59
1996, respectively. In addition, the Company's consolidated balance sheet as of
December 31, 1996 included an asset of approximately $21.1 million, representing
SDTF recoveries that the Company estimated at that time it would be entitled to
receive, based on claims identified as subject to SDTF recovery and considering
the Company's recovery experience.
The SDTF has not prefunded its claims liability, and no reserves currently
exist to satisfy future claims. Under Florida law, the SDTF is currently
scheduled to expire in the year 2000, unless it is re-created by the Florida
legislature. The SDTF recently underwent legislative review. Under a recent bill
passed by the Florida legislature and submitted to the Governor, the SDTF law
would be amended so that claims arising from accidents occurring on or after
January 1, 1998 would not be accepted for reimbursement by the SDTF. The bill
states the SDTF will be liable for reimbursement for subsequent injuries that
occur prior to January 1, 1998, and that assessments are to continue for funding
purposes.
In addition, the Florida DOI participated with the Florida legislature in
the review of current and proposed statutory accounting treatments of SDTF
projected recoveries, and with respect to how an insurer may include such
estimated recoveries in its admitted asset and loss reserve calculations in
statutory financial statements. Under the bill referred to above, the
anticipated SDTF recoveries that an insurer could take into account when
computing loss reserves in its statutory financial statements would be limited
to recoveries for which a claim has been accepted for payment. Credit for all
other anticipated recoveries would be capped at the total SDTF recovery amount
used by the insurer in 1996, and this capped amount would be phased out over a
five year period, commencing with statutory financial statements filed in the
year 2000 (20% per year reduction of 1996 capped amount).
While it is not possible to predict the outcome of this or any other
legislative or regulatory proposals affecting the SDTF, changes in the SDTF's
operations or funding which decrease the availability of recoveries or increase
assessments payable by the Company, or the discontinuation of the SDTF, could
have a material adverse effect on the Company's business, financial condition or
results of operations.
Subject to the legislation set forth above, the SDTF recoverable recorded
on the Company's balance sheet is an actuarial estimate of the amount the
Company can expect to recover from the SDTF on eligible claims. The Company has
a dedicated claims unit that handles the tracking, submission and collection
process with the SDTF. In the event that there are adverse developments in SDTF
collection experience, the recorded recoverable balance will accordingly be
adjusted.
With respect to collection patterns, the SDTF reviews reimbursement
requests on a claim by claim basis, with actual collection payments tied to the
paid loss development over a claim's life. The payments are not made ratably or
in any other predictable pattern. A prior actuarial review of the SDTF indicated
the average time frame for collection of a claim made to the SDTF is 6 to 8
years. See "RISK FACTORS -- Possible Underfunding of Florida Special Disability
Trust Fund."
Participation in State Guaranty Funds. Every state has established one or
more insurance guaranty funds or associations that are charged by state law to
pay claims of policyholders insured by a company that becomes insolvent. All
insurance companies must participate in the guaranty associations in the states
where they do business and are assessable for the associations' operating costs,
including the cost of paying policyholder claims against an insolvent insurer.
The Company's financial performance could be adversely affected by guaranty
association assessments as a consequence of the insolvency of other insurers
over which the Company has no control.
Holding Company Act. In addition to the regulatory oversight of the
Insurance Subsidiaries, Summit will also be subject to regulation under the
provisions of the Florida Insurance Code relating to insurance holding company
systems, defined as two or more companies, one or more of which is an insurance
company. Such provisions contain certain reporting requirements, including those
requiring the ultimate parent of a Florida insurance company to file information
relating to its capital structure, ownership and financial condition and the
general business operations of its insurance subsidiary. Such holding company
laws contain special reporting and prior approval requirements with respect to
transactions among affiliates.
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Possible Future Regulation. State legislatures and the federal government
have considered and are considering a number of cost containment and healthcare
reform proposals. The Company believes it may benefit from some proposals that
favor the growth of managed care. However, no assurance can be given that the
state or federal government will not adopt future healthcare reforms that would
adversely affect the Company.
In recent years, the state insurance regulatory framework has come under
increased federal scrutiny, and certain state legislatures have considered or
have enacted laws that altered and, in many cases, increased state authority to
regulate insurance companies and insurance holding companies. Further, the NAIC
and state insurance regulators are re-examining laws and regulations,
specifically focusing on investment laws for insurers, modifications to holding
company regulations, codification of statutory accounting practices, risk-based
capital guidelines, interpretations of existing laws and the development of new
laws. In addition, Congress and certain federal agencies are investigating the
current condition of the insurance industry in the United States to determine
whether to impose federal regulation. The Company cannot predict with certainty
the effect any proposed or future legislation or NAIC initiatives may have on
the conduct of the Company's business or the financial condition or results of
operations of the Company. See "RISK FACTORS -- Government Regulation."
DISPOSAL OF BUSINESS
The Company is in the process of disposing of two subsidiaries whose
businesses are unrelated to workers' compensation and no longer fit within the
Company's overall business strategy. These two businesses are briefly described
below:
Meritec Solutions, Inc. In August 1995, the Company purchased Meritec, a
software company which was previously owned by New York Life Insurance Company.
The Company paid $1.0 million for the business, which had approximately $0.3
million in cash at the time of the purchase. The Company was unable to find a
purchaser for this business and, effective October 31, 1996, the Company
terminated all employees and began winding down the operations. Prior to
December 31, 1996, the Company sold all of Meritec's fixed assets for a nominal
value,and Meritec's only remaining liability is under a lease for office space
in Atlanta. The Company is currently seeking to sublease this space or terminate
the lease. The Company does not expect this liquidation of Meritec to have a
material effect on its financial condition or results of operations.
Carolina Summit Healthcare, Inc. Beginning in 1995, the Company formed a
health maintenance organization in North Carolina designed to provide managed
care for Medicaid recipients and, eventually, employer groups. The Company
capitalized Carolina Summit with $3.0 million, and the North Carolina Department
of Insurance granted Carolina Summit an HMO license, but Carolina Summit has
never conducted any business. Prior to December 31, 1996, the Company liquidated
Carolina Summit's approximately $2.0 million of invested assets. The Company has
also reached an agreement to sell for cash all of the stock of Carolina Summit
to an unrelated third party for a price equal to the aggregate net book value of
Carolina Summit, approximately $745,000. The sale is expected to close in the
second quarter of 1997. The Company continues to own another North Carolina
subsidiary, Carolina Med Summit, Inc. ("CAROLINA MED"), which was formed in
conjunction with Carolina Summit and to facilitate its North Carolina licensing
application. Carolina Med has no assets or liabilities.
See notes 17 and 18 of the notes to ESIF's consolidated financial
statements contained elsewhere in this Prospectus.
INFORMATION TECHNOLOGY SYSTEMS
The Company's centralized information technology systems department
provides, maintains and manages the information resources for all of the
Company. The department currently has four IBM AS/400 mainframe computers
supporting approximately 430 terminals in the Company's Lakeland, Florida
headquarters and remote locations. Some 100 personal computers are used in
networks, as stand-alone units or as host-connected PCs. The Company also
maintains a number of laptop computers for field personnel. More than 80% of the
department's approximately 26 employees have been with the Company five or more
years. The
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department's programming staff averages 10 years of experience. The department's
personnel include full-time programmers, quality-control engineers and
operational support specialists.
EMPLOYEES
The Company employs approximately 430 full-time employees. Approximately
395 employees are based in Florida, while 35 are based in Louisiana and
Kentucky.
PROPERTIES
The Company is headquartered in Lakeland, Florida, where it leases
approximately 80,000 square feet of space in a campus of nine buildings. The
Company also leases office space including approximately 7,000 square feet in
Atlanta, Georgia (Meritec); approximately 6,000 square feet in Raleigh, North
Carolina (Carolina Summit); approximately 5,000 square feet in Baton Rouge,
Louisiana; approximately 2,000 square feet in Lexington, Kentucky; and
approximately 1,000 square feet in Ft. Lauderdale, Florida.
LEGAL PROCEEDINGS
The Company is periodically involved as plaintiff or defendant in various
legal actions incident to its business. Based upon information presently
available to it, management is not aware of any threatened or pending litigation
that is expected to have a material adverse effect on the Company or its
business.
The Internal Revenue Service is currently conducting an audit of SHC. The
Company cannot predict the results of the audit, and no assurance can be given
that the results of the audit will not have a material adverse effect on the
Company's business, financial condition or results of operations.
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MANAGEMENT OF THE COMPANY
GENERAL
The Board of Directors of Summit and the Board of Trustees of ESIF are
composed of seven and six members, respectively. Listed below is certain
information about the directors, executive officers and certain key managers of
Summit and the Trustees of ESIF.
<TABLE>
<CAPTION>
YEAR OF
YEAR FIRST EXPIRATION OF
ELECTED AS TERM AS
TRUSTEE OF DIRECTOR
NAME AGE POSITION WITH SUMMIT AND ESIF ESIF OF SUMMIT
---- --- ------------------------------- ---------- -------------
<S> <C> <C> <C> <C>
Directors and Executive Officers:
William B. Bull........................... 48 President, Chief Executive -- 1997
Officer and Director of Summit
Russell L. Wall........................... 53 Vice President of Finance and -- --
Chief Financial Officer of
Summit
Greg C. Branch............................ 49 Chairman of the Board of 1980 1998
Directors of Summit and of the
Board of Trustees of ESIF
C. C. Dockery............................. 64 Director of Summit and Trustee 1987 1999
of ESIF
John A. Gray.............................. 51 Director of Summit and Trustee 1979 1997
of ESIF
Robert L. Noojin, Sr...................... 62 Director of Summit and Trustee 1979 1998
of ESIF
Thomas S. Petcoff......................... 48 Director of Summit and Trustee 1987 1997
of ESIF
Robert Siegel............................. 66 Director of Summit and Trustee 1978 1999
of ESIF
Other Key Managers:
Allen C. Bennett.......................... 47 Vice President of Summit Loss -- --
Control Services, Inc.
David T. Cederholm........................ 52 Vice President, Operations of -- --
Bridgefield Casualty
Timothy J. Ermatinger..................... 48 Vice President of Operations of -- --
SCI
Ricky T. Hodges........................... 43 Vice President of Claims of -- --
Summit Claims Management, Inc.
</TABLE>
William B. Bull has served as President and Chief Executive Officer of SHC
and its predecessors since 1987 and as President, Chief Executive Officer and a
director of Summit since November 1996. Mr. Bull joined SCI in 1984 as special
assistant to the President and subsequently became Executive Vice President in
1986 with operating responsibilities for such company. Mr. Bull is a member of
various insurance associations and serves on numerous boards including: the
Florida Association of Self-Insurance, Florida Retail Federation, Florida Group
Risk Administrators Association and First Union National Bank of Polk County.
Russell L. Wall has served as Vice President of Finance of SHC since 1988
and has served Summit in the same capacity since November 1996. Mr. Wall is
responsible for the Company's accounting, data processing and client service
operations. Before joining SHC, Mr. Wall worked for three years as a Portfolio
Manager for Eickhoff & Pieper, Inc. Mr. Wall is a Chartered Financial Analyst
and holds an M.B.A. in Finance from the University of Santa Clara.
Greg C. Branch has served as Chairman of the Board and as a Trustee of ESIF
and its predecessors since 1980 and has served as Chairman of the Board and a
director of Summit since November 1996. Mr. Branch
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has served as President of Branch Properties, Inc., a manufacturer, wholesaler
and retailer of animal feeds and fertilizer located in Ocala, Florida since
1973. Mr. Branch is Vice Chairman and a founding director of American Feed
Industry Insurance Company, a property and casualty insurer domiciled in Iowa.
C.C. Dockery founded and remained involved with SCI from 1977 until A&A
purchased SCI in 1984. Mr. Dockery was first elected as a Trustee of ESIF and
its predecessors in 1987 and was elected as a director of Summit in November
1996. Since 1982, Mr. Dockery has been the President, Chief Executive Officer
and majority shareholder of Crossroads Insurance Company, Ltd., a reinsurance
company located in Bermuda. For 21 years, Mr. Dockery served as a director for
Cotton States Mutual Insurance Company, and its affiliate Cotton States Life
Insurance Company, a publicly traded life insurance provider located in Atlanta,
Georgia.
John A. Gray has served as a Trustee of ESIF and its predecessors since
1979 and as a director of Summit since November 1996. Since 1992, Mr. Gray has
served as President of B.F. Deal, Inc., a yacht brokerage and charter company,
and since 1993 has served as Vice President of Marine Resources Management,
Inc., a supplier of marine equipment. From 1975 until his retirement in 1992,
Mr. Gray was President of Dura-Stress, Inc., a manufacturer of pre-stressed and
precast concrete products, located in Leesburg, Florida.
Robert L. Noojin, Sr. has served as a Trustee of ESIF and its predecessors
since 1979 and as a director of Summit since November 1996. Prior to his
retirement in 1994, Mr. Noojin was President of Eagle Supply, Inc., a roofing
supply company headquartered in Tampa, Florida, and a subsidiary of TDA
Industries, Inc. Mr. Noojin currently serves as Chairman Emeritus of Eagle
Supply, Inc.
Thomas S. Petcoff was employed by and involved with SCI from 1977 until A&A
purchased SCI in 1984. Mr. Petcoff was first elected as a Trustee of ESIF and
its predecessors in 1987 and was elected as a director of Summit in November
1996. Mr. Petcoff also serves on the Board of Trustees of FRF and the Board of
Directors of the Florida Retail Federation Association. Since 1984, Mr. Petcoff
has served as President of Centurion Insurance Services, Inc., an insurance
consulting firm and sales agency.
Robert Siegel has served as a Trustee of ESIF and its predecessors since
1978 and as a director of Summit since November 1996. Mr. Siegel is President of
Siegel Gas & Oil Products, which he founded in 1957 and which is located in
Miami, Florida.
Following is certain information about other key employees of the Company:
Allen C. Bennett has served as Vice President of Summit Loss Control
Services, Inc., ("SLCS") a wholly owned subsidiary of SCI, since 1987. Mr.
Bennett is responsible for overseeing the daily operations and staff of such
entity. For two years prior thereto, Mr. Bennett worked at SLCS as a director
and a field loss control consultant.
David T. Cederholm has served as Vice President of Operations of
Bridgefield Casualty since January 1996. Since September 1996, Mr. Cederholm has
also served as a director and Vice Chairman of Bridgefield Casualty. From May
1995 until January 1996, Mr. Cederholm worked as the Assistant to the President
of SCI. From December 1993 until April 1995, Mr. Cederholm served as Vice
President of Atlantic Region of TIG Insurance Company in New York, New York with
responsibility for overseeing and managing the underwriting facilities in the
eastern United States. From December 1992 through December 1993, Mr. Cederholm
served as President of Production Group of Continental Risk Management Services,
a property and casualty insurance company located in New York, New York, where
he was responsible for underwriting and production. For approximately six years
prior thereto, Mr. Cederholm served as President of Continental Special Risk
Underwriters, in New York, New York, overseeing the large account casualty
underwriting unit of Continental Insurance.
Timothy J. Ermatinger has served as Vice President of Operations of SCI
since January 1996. From August 1995 through December 1995, Mr. Ermatinger
worked as the Assistant to the President of SHC. Between February 1993 and
January 1995, Mr. Ermatinger served as Vice President and Chief Financial
Officer of Independence One Mortgage Corp., a wholly owned subsidiary of
Michigan National Bank. From
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May 1986 to February 1993, Mr. Ermatinger was the Executive Vice President of
Alexsis, Inc., a third-party insurance administrator concentrating in property
and casualty claims.
Ricky T. Hodges has served as Vice President of Claims of Summit Claims
Management, Inc.("SCMI") since September 1991. Mr. Hodges has worked at SCMI in
various capacities since January 1984. Mr. Hodges is the current Chairman of the
Florida Workers' Compensation Advisory Council, President of the Workers'
Compensation Claims Professionals and Chairman for the Adjustor Board
Certification Program in Florida.
The Articles of Incorporation of Summit provide for staggered terms of the
members of the Board of Directors. Summit's Board of Directors is divided into
three classes designated as Class I, Class II and Class III. The current terms
of office of the Class I directors will expire at the first annual meeting of
shareholders in 1997; the current terms of office for the Class II directors
will expire at the annual meeting of shareholders in 1998; and the current terms
of office for the Class III directors will expire at the annual meeting of
shareholders in 1999, and in each case upon the election and qualification of a
successor. At each annual meeting of shareholders commencing with the meeting
held in 1997, the successors to the directors whose terms are expiring will be
elected to terms expiring at the third succeeding annual meeting of
shareholders. The division of directors into three classes is to be nearly as
equal as possible, with the Class I, Class II and Class III directors currently
consisting of three, two and two directors, respectively.
The Bylaws of Summit require the Board of Directors to designate from among
its members an Audit Committee and a Compensation Committee. The Audit Committee
has the responsibility to oversee the auditing procedures of the Company,
receive and accept the reports of the Company's internal systems of accounting
and management controls and make recommendations to the full Board of Directors
as to the selection and appointment of auditors for the Company. The
Compensation Committee has the responsibility to make relevant compensation
decisions of the Company.
Director Compensation. Each non-employee member of the Board of Directors
of Summit receives a fee of $10,000 per year and an additional $2,500 for
attendance at each meeting of the Board of Directors of Summit. In addition,
members of committees of the Board of Directors receive a fee of $2,500 for
attendance at each committee meeting. All meetings of the Board of Directors of
the Insurance Subsidiaries and the Administrative Subsidiaries are to be held in
conjunction with meetings of the Board of Directors of Summit, and no additional
compensation is received for being a member of the Board of Directors of any
such subsidiaries.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The members of the Compensation Committee are Greg C. Branch, C.C. Dockery
and Thomas S. Petcoff, each of whom was elected to such position upon the
formation of the Compensation Committee on November 20, 1996. Mr. Branch has
served as a Trustee of ESIF and its predecessors since 1980 and Chairman of the
Board of ESIF since 1994, and has served as Chairman of the Board and a director
of Summit since November 15, 1996. Mr. Dockery founded SCI in 1977, was first
elected as a Trustee of ESIF and its predecessors in 1987 and was first elected
as a director of Summit on November 15, 1996. Mr. Petcoff was an employee of,
and involved with, SCI from 1977 to 1989; he had been a Trustee of ESIF and its
predecessors since 1987, and he had been a director of Summit since November 15,
1996.
C.C. Dockery and Thomas S. Petcoff, directors of Summit, own 80,000 square
feet of office space in Lakeland, Florida and lease such space to SCI. The
property is currently rented by SCI for approximately $90,000 per month under a
lease which runs through March 2000. During the fiscal years ended March 31,
1994, 1995 and 1996, SCI made rental payments of approximately $1.1 million,
$1.2 million and $1.1 million, respectively, for such property.
Mr. Dockery is also the President, Chief Executive Officer and majority
shareholder of Crossroads Insurance Company, Ltd. ("CROSSROADS"), which provides
Excess Reinsurance to ESIF and the Funds. During the fiscal years ended March
31, 1994, 1995 and 1996, the Company paid Crossroads approximately $16.4
million, $7.1 million and $9.6 million, respectively, in premiums for
reinsurance relating to ESIF and
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the Funds. In addition, in each of the years 1988 through 1995, Crossroads ceded
50% of its underwriting risk to U.S. Employers Insurance Company, a wholly owned
subsidiary of ESIF.
Mr. Dockery is the Chairman of the Board of Dockery Management Corporation,
which subleases approximately 2,600 square feet of office space from the
Company, pursuant to a sublease agreement which expires in March 2000 and
provides for rent of approximately $2,800 per month. During the fiscal years
ended March 31, 1994, 1995 and 1996, the Company received approximately $34,000,
$36,000 and $36,000, respectively, in rental payments from such entity.
Mr. Dockery is the President and owner of Dockery Leasing Corporation
("DOCKERY LEASING") which provides aviation services for the Company. During the
fiscal years ended March 31, 1994, 1995 and 1996, the Company paid Dockery
Leasing approximately $32,000, $43,000 and $32,000, respectively, for such
services.
Mr. Dockery was an underwriting member (name) of Lloyds of London from 1984
to 1996. Grey C. Branch has been an underwriting member (name) of Lloyds of
London since 1986. ESIF and the Funds have Excess Reinsurance agreements with
Lloyds of London from time to time.
Mr. Petcoff is President of Centurion Insurance Services, Inc.
("CENTURION"). Pursuant to an agreement between SCI and Centurion dated November
1995, and in connection with Centurion's involvement in the formation of KRF,
SCI pays Centurion an annual fee equal to 1% of KRF's premiums earned in each
year. During the fiscal year ended March 31, 1996, SCI paid fees of
approximately $13,000 to Centurion.
In addition, for reinsurance policies placed by SCI on behalf of KRF, which
are brokered by Centurion, Centurion is entitled to brokerage commissions.
Through the end of the fiscal year ended March 31, 1996, the first year
Centurion brokered a policy for KRF, the Company paid approximately $13,000 to
Centurion for brokerage commissions and SCI also pays Centurion agency
commissions for policies placed with the Funds, and through the end of the
fiscal years ended March 31, 1994, 1995 and 1996, the Company paid approximately
$2,000, $6,000 and $2,000, respectively to Centurion for such agency
commissions.
Mr. Petcoff is on the Board of one of the Funds, FRF, and, is on the Board
of Directors of the Florida Retail Federation (the "ASSOCIATION"). Pursuant to a
written arrangement between SCI and the Association, the Association, as the
sponsoring party of FRF, is entitled to 1% of such Fund's premiums earned in
each year. During the fiscal years ended March 31, 1994, 1995 and 1996, the
Company paid approximately $1.0 million, $1.0 million and $0.9 million to the
Association for such fees. In addition, during the years ended March 31, 1994,
1995 and 1996, FRF paid SCI fees for administrative services of approximately
$32.7 million, $30.5 million and $27.7 million, respectively.
EXECUTIVE COMPENSATION
Summit was incorporated on November 13, 1996 and, therefore, no executive
officer of Summit received compensation in excess of $100,000 during the fiscal
period from such date of incorporation to the date of this Prospectus (the
"FISCAL PERIOD"). Pursuant to the terms of their respective employment
agreements with Summit, William B. Bull, the President and Chief Executive
Officer, and Russell L. Wall, the Vice President of Finance, are to receive an
annual salary of $250,000 and $230,000, respectively. See "-- Employment
Agreements."
EMPLOYMENT AGREEMENTS
On the Effective Date, Summit will enter into an employment agreement with
Mr. Bull pursuant to which he is employed full-time as Summit's President and
Chief Executive Officer. The agreement, which expires on the fifth anniversary
of the date thereof, provides for an annual base salary of $250,000 and the
right for Mr. Bull to receive a bonus in each year of the agreement equal to 5%
of the amount, if any, by which the Company's consolidated net income after
taxes exceeds $6.0 million. In addition to his cash compensation, Mr. Bull
receives additional benefits, including those generally provided to other
employees of the Company. The agreement also provides, in the event of its
expiration or termination, that: (i) Mr. Bull is to be subject to a two-year
confidentiality period and limitation on the use of trade secrets, and (ii) Mr.
Bull is subject to up to
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a one-year non-competition and non-solicitation arrangement with the Company for
which he would receive $8,333.33 per month as consideration for such
non-competition and non-solicitation arrangement.
Summit also will enter into an employment agreement with Russell L. Wall on
the Effective Date, pursuant to which he is employed full-time as Summit's Vice
President and Chief Financial Officer. The agreement, which expires on the third
anniversary of the date thereof, provides for an annual base salary of $230,000
and the right for Mr. Wall to receive a bonus in each year of the agreement
equal to 1.67% of the amount, if any, by which the Company's consolidated net
income after taxes exceeds $8.25 million in calendar year 1997 and $12.16
million in each of calendar years 1998 and 1999. In addition to his cash
compensation, Mr. Wall receives additional benefits, including those generally
provided to other employees of the Company. The agreement also provides, in the
event of its expiration or termination, that: (i) Mr. Wall is to be subject to a
two-year confidentiality period and limitation on the use of trade secrets, as
such term is defined therein, and (ii) Mr. Wall is subject to up to a one year
non-competition and non-solicitation arrangement with the Company. The agreement
further provides for a payment of $8,333.33 per month as consideration for such
non-competition and non-solicitation arrangement.
401(K) PLAN
The Company has adopted the 401(k) Plan, which is intended to qualify under
Section 401(a) of the Tax Code, so that contributions thereto by employees or
the Company and income earned on such contributions would not be taxable to
employees until withdrawn from the 401(k) Plan. All employees of the Company who
have attained the age of 21 and who have completed at least 90 days of service
with the Company are eligible to participate in the 401(k) Plan. The 401(k) Plan
provides that each participant may make elective contributions of up to 16% of
his or her compensation, subject to statutory limits. The Company currently
intends to make matching contributions to the 401(k) Plan on behalf of each
eligible employee in an amount equal to approximately 75% of the employee's
contributions, up to 6% of such employees compensation. In addition, in
connection with the Conversion, the Company intends to make a contribution on
behalf of all persons who are otherwise eligible for the 401(k) Plan on the
Effective Date, of 100 shares of Common Stock (the "CONVERSION CONTRIBUTION"),
subject to IRS limitations. All contributions by employees are fully vested and
are not subject to forfeiture. A participant would vest in contributions made by
the Company to the 401(k) Plan, including the Conversion Contribution, at the
following rates: (i) for less than three "years of service" (as defined in the
401(k) Plan) with the Company, 0%; (ii) for three years of service with the
Company, 33 1/3%; (iii) for four years of service with the Company, 66 2/3%; and
(iv) for five or more years of service with the Company, 100%. Contributions to
the 401(k) Plan may be invested in various available investment alternatives at
the discretion of the participant. Distributions may be made from a
participant's account in the form of a lump sum upon termination of employment,
retirement, disability, death or in the event of financial hardship, subject to
certain limitations as set forth in the 401(k) Plan.
INCENTIVE PLAN
The Board of Directors and shareholders of Summit have adopted the
Incentive Plan. Under such Incentive Plan, certain directors, officers and other
employees of Summit and its subsidiaries can be granted a variety of long-term
incentives, including non-qualified stock options, incentive stock options,
grants of restricted and unrestricted stock, performance share awards, stock
appreciation rights, dividend equivalents and other stock-based awards. The
purpose of the Incentive Plan is to promote the success, and enhance the value,
of Summit and its subsidiaries by linking the personal interests of their
directors, officers and key employees to those of Summit shareholders and by
providing their directors, officers and key employees with an incentive for
outstanding performance.
The Incentive Plan will be administered by the Compensation Committee of
Summit, consisting of three non-employee directors. Such Committee will
determine, in its discretion, among other things, which directors, officers and
employees will receive awards under the Incentive Plan, when the awards will be
granted, the type of awards to be granted, the number of shares or cash involved
in each award, the time or times when any options granted will become
exercisable and, subject to certain conditions, the price and
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duration of such options. A total of 500,000 shares of Common Stock have been
reserved for issuance under the Incentive Plan.
The Board of Directors or the Compensation Committee has the right at any
time to amend or discontinue the Incentive Plan without the consent of Summit's
shareholders or optionees, provided that no such action may adversely affect
awards previously granted without the recipient's consent.
The Incentive Plan provides that in the event of a "change of control" (as
defined in the Incentive Plan) of Summit, all awards granted under the Incentive
Plan that are in the nature of rights that may be exercised shall automatically
become fully exercisable. In addition, at any time prior to or after a change of
control, the Compensation Committee may accelerate awards and waive conditions
and restrictions on any other awards under the Incentive Plan to the extent it
may determine appropriate.
Stock Options. Options granted under the Incentive Plan may be either: (i)
options intended to qualify as incentive stock options under Section 422 of the
Tax Code, or (ii) non-qualified stock options. Incentive stock options may be
granted under the Incentive Plan to employees of Summit and its subsidiaries.
Non-qualified stock options may be granted to directors, officers or employees
of Summit and its subsidiaries. Options may be made exercisable in specified
installments.
The exercise price of incentive stock options, as determined by the
Compensation Committee, may not be less than the fair market value of the Common
Stock on the date of grant and the term of any such option may not exceed ten
years from the date of grant. With respect to any participant in the Incentive
Plan who owns shares representing more than 10% of the voting power of the
outstanding capital shares of Summit, the exercise price of any incentive stock
option may not be less than 110% of the fair market value of such shares on the
date of grant and the term of such option may not exceed five years from the
date of grant. The exercise price of non-qualified stock options is determined
by the Compensation Committee on the date of grant, and the term of such option
may not exceed ten years from the date of grant.
To date, Summit has not granted any awards under the Incentive Plan. In
connection with the Conversion, Summit plans to grant stock options on the
Effective Date to the following directors and executive officers of Summit to
purchase the following number of shares of Common Stock at the same price as the
shares offered hereby: William B. Bull -- 109,627; Russell L. Wall -- 58,438;
Greg C. Branch -- 109,627; C.C. Dockery -- 85,170; John A. Gray -- 34,860;
Robert L. Noojin, Sr. -- 32,586; Thomas S. Petcoff -- 36,564; and Robert
Siegel -- 33,128. The options to be granted to Mr. Bull and Mr. Wall will be
incentive stock options, and 50% of such options will vest 180 days after the
Effective Date and the remaining 50% of such options will vest on the first
anniversary of the Effective Date, provided that such officer remains employed
by Summit. The options to be granted to the other named persons will be
non-qualified stock options and will vest on the Effective Date.
Performance Awards. The Compensation Committee may grant performance
awards entitling the participant to receive Common Stock based upon the
achievement of individual or Company performance goals and upon such other
conditions as the Compensation Committee may determine.
Restricted Stock. A specified number of shares of Common Stock may be
awarded contingently subject to a substantial risk of forfeiture to Summit under
such conditions, and during such periods of time, as the Compensation Committee
may determine ("RESTRICTED STOCK"). A participant who has been awarded
Restricted Stock may, if the award so provides, vote and receive dividends on
such shares, but, generally, may not sell, assign, transfer, pledge or otherwise
encumber the shares during the restricted period. An award of Restricted Stock
may provide that if a participant's employment ceases prior to the end of the
restricted period, all of the participant's Restricted Stock will be forfeited.
Grants may be made without consideration or in consideration of a payment by the
participant that is less than the fair market value of the shares on the grant
date.
Unrestricted Stock. The Compensation Committee may also grant shares (at
no cost or for a purchase price determined by the Compensation Committee) which
are free from any restrictions ("UNRESTRICTED STOCK"). Unrestricted Stock may be
issued in recognition of past services or other valid consideration, and may be
issued in lieu of cash compensation due to the recipient.
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Stock Appreciation Rights. Stock appreciation rights ("SARS") may be
granted to employees which, upon the exercise thereof, entitle the employee to
receive an amount equal to the excess of the market price of the Common Stock
over the grant price of the SAR, as determined by the Compensation Committee.
Such grant price may not be less than the fair market value of a share of Common
Stock on the date of grant in the case of any SAR related to an incentive stock
option.
Dividend Equivalents. The Compensation Committee may grant to a
participant who has received incentive stock options or SARs the right to
receive payments equal to dividends with respect to all or a portion of the
number of shares subject to such incentive stock options or SARs.
As soon as practicable after the Effective Date, Summit intends to file
with the Commission a registration statement on Form S-8 covering the Common
Stock that may be issued upon exercise of options granted under the Incentive
Plan as well as shares that may be granted under such plan and shares that may
be granted pursuant to the Conversion Contribution, thus permitting the resale
of such Common Stock by non-affiliates in the public market without restriction
under the Securities Act.
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CERTAIN TRANSACTIONS
Aeromech, Inc. ("AEROMECH"), an entity in which Mr. Bull currently owns
approximately 10% of the outstanding shares, has provided services to SCI in the
form of airplane maintenance, hangar leasing and office space for the crew since
October 1994. During the fiscal years ended March 31, 1995 and 1996, SCI paid
Aeromech $62,000 and $420,000, respectively, for such services.
SCI had an arrangement with BJ Limo Services, Inc. ("BJ"), a Company in
which Mr. Bull owns 50% of the outstanding stock, pursuant to which BJ provided
the employees of the Company limousine services and, on occasion, the use of a
private airplane and charter boat. This agreement was terminated by the Company
in February 1996. During the fiscal years ended March 31, 1994, 1995 and 1996,
the Company paid approximately $38,000, $17,000 and $9,000, respectively, for
such services.
Mr. Bull is on the Board of Directors of the Florida Retail Federation (the
"ASSOCIATION"), which is the sponsoring trade association for FRF, one of the
Funds administered by SCI. Pursuant to a written arrangement between SCI and the
Association, the Association, as the Fund sponsor, is entitled to a fee equal to
1% of such Fund's premiums earned in each year, and SCI is obligated to pay such
fee out of the administrative fee it receives from FRF. During the fiscal years
ended March 31, 1994, 1995 and 1996, the Company paid approximately $1.0
million, $1.0 million and $0.9 million to the Association for such fees. During
the years ended March 31, 1994, 1995 and 1996, FRF paid SCI fees for
administrative services of approximately $32.7 million, $30.5 million and $27.7
million, respectively.
Mr. Bull is also the sole shareholder of Louisiana Employers Safety
Association, Inc., the sponsoring association for LESA, one of the Funds managed
by SCI, and Mr. Bull has been nominated to be on the Board of Directors of LESA
if it completes a currently proposed conversion to a nonassessable mutual
insurance company.
Any future transactions between the Company and any director, officer or
principal shareholder of the Company, or any affiliate of such a person, will be
on terms no less favorable to the Company than can be obtained from unaffiliated
third parties.
The 1994 and 1995 financial statements of SHC were restated in 1997 to
reflect an estimated return premium of approximately $3.7 million. This
restatement could have given rise to potential claims by the former shareholders
of SHC against ESIF for payment of additional purchase price in connection with
the Acquisition, and to claims by ESIF against such former shareholders for
taxes associated with such return premium. ESIF and the former shareholders of
SHC have agreed to the waiver and release of such potential claims. When such
return premium is paid, the Company will receive approximately $2.5 million net
of taxes. Mr. William Bull and Mr. Russell Wall were each former shareholders of
SHC.
William B. Bull, President, Chief Executive Officer and a director of the
Company, may be relieved of certain personal indemnification obligations if the
Conversion becomes effective. In connection with the Acquisition, the Florida
DOI issued the January Consent Order requiring that Mr. Bull, who was at that
time President and Chief Executive Officer and a principal shareholder of SHC,
personally indemnify ESIF up to a maximum of $5 million for loss, injury or
damage to ESIF that may result from the parties' execution of the merger
agreement pursuant to which ESIF acquired SHC, or that may result from SHC's
execution of a certain credit agreement with the Bank. According to the January
Consent Order, Mr. Bull's indemnification obligations will decrease by $1.0
million for every $4.0 million increase in the statutory net worth of SHC, once
SHC's statutory net worth reaches zero or greater, and such obligations will
expire fully on the earlier of January 11, 2001 or the date upon which the loans
from the Bank are paid in full. Pursuant to the Order issued by the Florida DOI,
if the Conversion is not consummated for any reason, all provisions of the
January Consent Order shall be enforceable by the parties thereto. See "RISK
FACTORS -- Benefits of Conversion to an Officer and Director" and "THE
OFFERINGS -- Subscription Offering -- Interests of Certain Persons."
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PRINCIPAL SHAREHOLDERS
The following table sets forth certain information regarding the
anticipated beneficial ownership of Common Stock and the Series A Preferred
Stock as of the Effective Date by: (i) each of Summit's directors; (ii) each
executive officer of Summit; and (iii) all of Summit's executive officers and
directors as a group. The Company does not believe that any such person will
beneficially own more than 4.99% of the shares of Common Stock or Series A
Preferred Stock as of the Effective Date. The number of shares of Series A
Preferred Stock anticipated to be beneficially owned by each person listed below
includes the number of shares offered in the Subscription Offering to any
Eligible Policyholder with which such person is affiliated. Except as noted
below, each person listed in the table will have sole investment and voting
power with respect to the shares held by such person.
<TABLE>
<CAPTION>
SERIES A
COMMON STOCK PREFERRED STOCK
------------------------ ------------------------
SHARES SHARES
BENEFICIALLY PERCENT BENEFICIALLY PERCENT
NAME OWNED(1) OWNED OWNED OWNED
---- ------------ ------- ------------ -------
<S> <C> <C> <C> <C>
William B. Bull................................... 140,000 2.8% 0
Russell L. Wall................................... 50,000 1.0% 0
Greg C. Branch.................................... 249,627(2) 4.9% 287 *
C. C. Dockery..................................... 182,170 3.6% 39 *
John A. Gray...................................... 43,405 * 0
Robert L. Noojin, Sr.............................. 37,131 * 0
Thomas S. Petcoff................................. 48,104 1.0% 11 *
Robert Siegel..................................... 38,628 * 174 *
All directors and executive officers as a group (8
persons)........................................ 789,065(2) 14.8% 511 *
</TABLE>
- ---------------
* Less than one percent.
(1) Includes 331,935 shares issuable upon exercise of options that will be
granted and will be exercisable on the Effective Date, as follows: Greg C.
Branch -- 109,627; C.C. Dockery -- 85,170; John A. Gray -- 34,860; Robert L.
Noojin, Sr. -- 32,586; Thomas S. Petcoff -- 36,564; and Robert
Siegel -- 33,128.
(2) Includes 4,545 shares to be held by trusts for which Mr. Branch is the
trustee.
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THE CONVERSION
The following summary description of the Conversion, including the Plan of
Conversion, is qualified in its entirety by reference to the Plan of Conversion,
a copy of which is filed as an exhibit to the Registration Statement of which
this Prospectus forms a part.
GENERAL
Pursuant to the Plan of Conversion, ESIF will convert from a Florida group
self-insurance fund to a Florida stock insurance company and become a wholly
owned subsidiary of Summit. Such Conversion will involve principally the
following actions, all of which will occur contemporaneously on the Effective
Date: (i) ESIF will convert from a group self-insurance fund to an assessable
mutual insurance company, an interim step required to satisfy the Florida
Insurance Code; (ii) the assessable mutual insurance company will convert to a
stock insurance company with the name Bridgefield Employers Insurance Company;
(iii) ESIF's current Constitution and Bylaws will be replaced with the Amended
Articles of Incorporation of Bridgefield and the Amended Bylaws of Bridgefield,
containing provisions appropriate for a stock insurance company; (iv) in order
to avoid the expense and inconvenience of issuing shares of the new stock
insurance company to Policyholders, which shares would then be exchanged for
Summit's Series A Preferred Stock in the transaction described below, an
exchange mechanism will be employed to evidence that the Policyholders are
entitled to receive shares of the new stock insurance company but will receive
in lieu thereof share of Summit's Series A Preferred Stock; (v) Eligible
Policyholders will exchange their rights to receive common stock of Bridgefield
for Summit's Series A Preferred Stock, causing Bridgefield to become a wholly
owned subsidiary of Summit; and (vi) Summit will issue its Series A Preferred
Stock to Eligible Policyholders and its Common Stock to purchasers in the
Offerings. The Conversion will not affect the insurance coverage under ESIF's
policies. On November 15, 1996, the Florida DOI approved the Plan of Conversion,
finding that the Conversion is in compliance with the Florida Insurance Code and
that the Plan of Conversion is equitable to ESIF's members.
REASONS FOR THE CONVERSION
ESIF was formed in 1978 to provide a means for Florida employers, primarily
in the construction, manufacturing, wholesale and retail, and service
industries, to self-insure for workers' compensation risks. The business
objective and mission of ESIF was, and continues to be, to provide its
Policyholders a workers' compensation solution that minimizes workplace losses,
helps return injured employees to work quickly and helps protect against large
financial loss at a low total cost to the employer.
During the past several years, the Board of Trustees of ESIF has observed
significant changes in the Florida workers' compensation market, due in part to
the New Florida Law which changed the underwriting environment for workers'
compensation by, among other things: (i) limiting certain benefits that must be
provided; (ii) eliminating wage loss benefits in favor of a system of benefits
based upon a schedule of impairment ratings plus supplemental benefits; (iii)
obligating employers to rehire injured workers; (iv) adopting new procedures for
dispute resolution designed to reduce litigation costs; and (v) redefining
permanent impairment. In addition, the New Florida Law eliminated the residual
market assessment that was levied against insurance companies to support the
involuntary workers' compensation market and replaced it with a self-funded
joint underwriting association. As a result, the financial obligation of funding
deficits in the residual market mechanism was shifted from traditional insurance
entities to employers that are insured by the joint underwriting association.
While the long term impact of the New Florida Law cannot be determined, the
Company believes that it has resulted in: (i) a more competitive workers'
compensation market in Florida; (ii) conversions by some of the larger
self-insured groups to traditional insurance entities; and (iii) loss portfolio
transfers by self-insured groups to insurance companies. See "MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -- Overview."
These changes have made membership in ESIF less attractive to Policyholders
(which are members of ESIF automatically by virtue of their ownership of
Policies) relative to other workers' compensation products available in the
market, particularly with respect to the ongoing contingent liability for all
fund losses
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associated with membership in ESIF. With the increased availability in the
Florida market of traditional workers' compensation insurance products offered
on more favorable terms, employers have become less willing to assume the risks
of self-insurance.
In response to these market changes, the Board reviewed ESIF's strategic
and financial alternatives. Consistent with ESIF's business objective and
mission, the Board's primary objective was to develop a strategy that would
provide ESIF's members with an attractive workers' compensation solution in view
of the changing market conditions. Also, central to the Board's analysis was its
determination that large numbers of Policyholders viewed as unacceptable the
potential liability for fund losses, due to the increasing availability of
traditional workers' compensation products in the Florida market.
The Board considered three available alternatives. First, ESIF could
discontinue operations and distribute net assets, if any, to the members. Under
this alternative, ESIF would remain liable under its in-force policies for
paying workers' compensation claims incurred through the end of the then-current
coverage period under those policies (for most ESIF policies, this would be the
March 31 following the date upon which ESIF discontinued operations). Therefore,
the members of ESIF would continue to be subject to assessments as funds were
needed by ESIF to pay those "run-off" labilities, some of which claims might not
be reported to ESIF for some time after discontinuance. In addition, this
alternative would result in members receiving only the liquidation value of
ESIF, with no consideration for ESIF's potential value as a going concern.
The second alternative considered by the Board was for ESIF to transfer its
business to a third party insurance company. In such a transaction, the
acquiring insurance company will rarely accept responsibility for paying the
incurred but not reported claims of the selling insurer, and the members of ESIF
would continue to be subject to assessments to pay such liabilities of ESIF.
The third alternative that the Board considered was for ESIF to convert
from a self-insurance fund to a stock insurance company and raise capital
through sales of securities. This approach would eliminate the potential for
Policyholder assessments. The Board did not associate valuations with each of
the alternatives, but based on ESIF's past results, the Board concluded that a
continuation of ESIF's current business practices and management would be in the
best interests of ESIF's members. As a result, the Board concluded that the
conversion of ESIF to a stock insurance company was the best alternative for
continuing to provide ESIF's members with an attractive workers' compensation
solution while eliminating the Policyholders' ongoing liability for fund losses.
Pursuant to the Conversion, the Policies held by members of ESIF will be
converted from assessable Policies to non-assessable Policies. As a consequence,
Policyholders will no longer be subject to any assessment for the liabilities of
ESIF arising either before or after the Effective Date. Further, Eligible
Policyholders are expected to realize an economic benefit for their Membership
Interests in the form of Series A Preferred Stock and the right to subscribe for
Common Stock of Summit in the Subscription Offering.
The Conversion offers a number of advantages that could be important to the
future growth and performance of the Company. The conversion of ESIF to a stock
insurance company that is wholly owned by a publicly traded holding company is
expected to provide improved access to the capital markets and increased
flexibility for raising additional capital and expanding through acquisitions.
After completion of the Conversion, Summit will have authority to issue capital
stock that may permit it, subject to market conditions and Florida DOI approval,
to raise additional equity capital through future sales of equity securities.
Summit may also be able to issue capital stock as payment in connection with
acquisitions, subject to Florida DOI approval. In addition, the holding company
structure is expected to provide greater flexibility for the diversification of
business activities through existing or newly formed subsidiaries of Summit or
through strategic partnerships, subject to Florida DOI approval. At the present
time, the Company has no plans with respect to additional offerings of
securities or specific acquisitions and has no specific plans for
diversification. Following the Conversion, Summit also will be able to use
stock-related incentive programs to reward and attempt to attract executives and
other personnel for itself and its subsidiaries.
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Additionally, pursuant to the Conversion, the policies held by members of
ESIF will be converted from assessable policies to non-assessable policies. As a
consequence, members will no longer be subject to any assessment for the
liabilities of ESIF arising either before or after the Effective Date.
CONSIDERATION TO BE PAID TO POLICYHOLDERS
Each person who held an In-Force Policy prior to the Conversion is also a
member of ESIF and has certain Membership Interests that provide, among other
things, rights to vote for the election of trustees and rights to participate in
any distribution of the surplus of ESIF in the event of its liquidation.
Pursuant to the Conversion, each member of ESIF will automatically relinquish
such Membership Interests but will retain all ownership rights and coverage with
respect to its In-Force Policy.
The Plan of Conversion provides that, upon the Conversion of ESIF to a
stock insurance company, each member of ESIF will no longer be subject to any
assessment for the liabilities of ESIF arising either before or after the
Effective Date. No such assessment has been or will be made. The Plan of
Conversion also provides that ESIF will pay each Eligible Policyholder the
following consideration (the "POLICYHOLDER CONSIDERATION"): (i) that number of
shares of Series A Preferred Stock of Summit determined in accordance with a
formula set forth in the Plan of Conversion; and (ii) subscription rights to
purchase up to 249,999 shares of Common Stock (4.99% of the Post Offering
Outstanding Shares). Eligible Policyholders will not be required to pay cash for
Series A Preferred Stock distributed to them in the Conversion, but only for
shares of Common Stock that they may purchase in the Subscription Offering.
On the Effective Date, Summit will issue the Series A Preferred Stock to
the Eligible Policyholders in exchange for their Membership Interests which,
pursuant to the Conversion, become rights to receive the common stock of
Bridgefield. Summit will then receive all of Bridgefield's common stock, and
Bridgefield will become a wholly owned subsidiary of Summit. No shares of Series
A Preferred Stock will be issued to any person other than an Eligible
Policyholder. An aggregate of 1,639,701 shares of Series A Preferred Stock has
been allocated to the Eligible Policyholders. In approving the Plan of
Conversion, the Florida DOI determined that all of the terms thereof, including
the value of the Series A Preferred Stock proposed to be issued to the Eligible
Policyholders, are equitable to the members of ESIF.
SUBSCRIPTION OFFERING
In addition to shares of Series A Preferred Stock that will be issued to
Eligible Policyholders in the Conversion, up to 5,000,000 shares of Common Stock
were offered pursuant to the Subscription Offering. Each Eligible Policyholder
had the right to subscribe for up to 249,999 shares of Common Stock, which is
4.99% of the Post Offering Outstanding Shares. No fewer than 100 shares of
Common Stock have been purchased by any person in the Subscription Offering.
Eligible Policyholders as a group were allowed to purchase in the aggregate up
to 90% of the Post Offering Outstanding Shares.
In addition to the shares of Common Stock which have been subscribed for by
Eligible Policyholders, the Management Group was allowed to subscribe to
purchase up to an aggregate of 10% of the Post Offering Outstanding Shares.
However, no person, either individually or in conjunction with any affiliated
person and whether subscribing as an Eligible Policyholder or a member of the
Management Group or purchasing shares in the Public Offering or otherwise, shall
be permitted to acquire directly or indirectly more than 249,999 shares (4.99%
of the Post Offering Outstanding Shares).
Notwithstanding the foregoing, Summit has agreed that any "investment
company," as defined in Section 3 of the Investment Company Act of 1940, as
amended, may purchase more than 4.99% but less than 10% of the Post Offering
Outstanding Shares, subject to such investor obtaining any required approval of
the Florida DOI. With respect to all other purchasers, Summit will have complete
discretion to approve or reject any request to exceed the Purchase Limit. Any
such approval by Summit will be made prior to the Effective Date and will be
subject to any approval required by the Florida DOI. Except to the extent
required by the Florida DOI, Summit will not be obligated to notify any
subscriber of the waiver of the Purchase Limit for any purchaser.
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The Subscription Offering expired at 5:00 p.m. Eastern Time on May 9, 1997.
A total of 938,987 shares of Common Stock were subscribed for by Eligible
Purchasers and the Management Group in the Subscription Offering. The Board of
Directors of Summit may, at any time, elect to rescind the Subscription Offering
and consequently, not consummate the Public Offering. The Subscription Offering
will not be consummated in the event that the Plan of Conversion is withdrawn by
the Board of Trustees of ESIF.
The Subscription Price was set at $11.00 per share, subject to certain
adjustments to ensure that the subscribers pay the same per share price as the
purchasers in the Public Offering. Summit, after consultation and negotiation
with Raymond James & Associates, Inc. and ABN AMRO Chicago Corporation, and not
based on an appraisal or any other objective factors, set the Public Offering
Price at $11.00 per share.
PUBLIC OFFERING
Because less than all of the shares of Common Stock offered were sold in
the Subscription Offering, the Company is offering such remaining shares in the
Public Offering, which will close on the Effective Date. The Representatives are
acting as representatives of the underwriters of the Public Offering. Purchasers
in the Public Offering are subject to the Purchase Limit, but purchasers in the
Public Offering will not be required to purchase any minimum number of shares.
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DESCRIPTION OF CAPITAL STOCK
The following is a summary description of Summit's capital stock. This
summary does not purport to be complete and is subject to and qualified in its
entirety by the provisions of Summit's Articles of Incorporation (the "SUMMIT
ARTICLES") and Bylaws (the "SUMMIT BYLAWS"), copies of which are included as
exhibits to the Registration Statement of which this Prospectus is a part, and
by the provisions of applicable law.
PREFERRED STOCK
Summit is authorized to issue an aggregate of 5,000,000 shares of preferred
stock, par value $10 per share. The preferred stock may be issued in one or more
series, from time to time, with such designations, rights, preferences and
limitations, including but not limited to dividend rates and conversion
features, as the Board of Directors may determine. Accordingly, preferred stock
may be issued having dividend and liquidation preferences over the Common Stock
without the consent of the holders of Common Stock. In addition, the ability of
the Board to issue preferred stock could also be used by Summit as a means of
resisting a change of control of Summit and, therefore, could be considered an
"anti-takeover" device.
Series A Preferred Stock. In connection with the Conversion, Summit will
issue 1,639,701 shares of Series A Preferred Stock. Holders of the Series A
Preferred Stock have no voting rights, except as are required by the Florida
Act, or on a matter which would adversely affect the preferences, rights or
powers of the holders of Series A Preferred Stock.
Holders of Series A Preferred Stock have no preemptive or preferential
right to purchase or subscribe for any unissued or additional authorized stock
or any securities of Summit and have no rights to convert their Series A
Preferred Stock into Common Stock or any other securities.
The rights, preferences, limitations and restrictions of the Series A
Preferred Stock are set forth in the Certificate of Designation, Preferences and
Rights of Series A Preferred Stock of Summit, a copy of which is filed as an
exhibit to the Registration Statement of which this Prospectus forms a part (the
"SERIES A DESIGNATION") and which should be read in its entirety. In summary:
(i) The Series A Preferred Stock shall, with respect to dividend
rights and rights on liquidation, dissolution and winding up of Summit,
rank prior to all classes or series of equity securities of Summit,
including the Common Stock.
(ii) The holders of Series A Preferred Stock shall be entitled to
receive, out of funds legally available for the payment of dividends, cash
dividends at the rate of 4% per annum. Such dividends shall cumulate
whether or not declared by the Board of Directors, but shall be payable
only as and when declared by the Board; provided, however, that all
cumulated but unpaid dividends shall be paid upon any redemption of the
Series A Preferred Stock or any Liquidation (as defined in the Series A
Designation).
(iii) In the event of any Liquidation of Summit, after payment or
provision for payment of the debts and other liabilities of Summit, and
before any payment or distribution of Summit's assets shall be made or set
apart for the holders of any securities ranking junior to the Series A
Preferred Stock, the holders of the Series A Preferred Stock shall be
entitled to receive $10 per share of Series A Preferred Stock plus an
amount equal to all cumulated but unpaid dividends thereon.
(iv) The Series A Preferred Stock shall be redeemable by Summit at any
time and from time to time, in whole or in part.
(v) The redemption price shall be $10 per share, together with an
amount equal to all cumulated but unpaid dividends thereon to the date of
redemption.
(vi) In the event that Summit enters into any Business Combination (as
defined in the Series A Designation), Summit or some other person shall
make an offer to purchase the then outstanding Series A Preferred Stock for
$10 per share plus an amount equal to all cumulated but unpaid dividends.
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COMMON STOCK
Summit is authorized to issue up to 20,000,000 shares of Common Stock, par
value $.01 per share. As of the date of this Prospectus, Summit had seven
shareholders of record and seven shares of Common Stock outstanding.
Holders of Common Stock are entitled to one vote for each share held of
record at all shareholder meetings for any purpose, including the election of
directors. There is no cumulative voting for election of directors. The Summit
Bylaws require that a majority of the issued and outstanding shares of Summit be
represented to constitute a quorum and transact business at a shareholders'
meeting.
Holders of Common Stock have no preemptive or preferential right to
purchase or subscribe for any unissued or additional authorized stock or any
securities of Summit and have no rights to convert their Common Stock into any
other securities.
Subject to the prior rights of any series of preferred stock which may from
time to time be outstanding, if any, holders of Common Stock are entitled to
ratably receive dividends when, as, and if declared by the Board of Directors
out of funds legally available therefor and, upon the liquidation, dissolution
or winding up of Summit, are entitled to share ratably in all assets remaining
after payment of liabilities and payment of cumulated dividends and liquidation
preferences on the preferred stock, if any.
OTHER CHARACTERISTICS OF CAPITAL STOCK
See "DIVIDEND POLICY" with respect to restrictions on the payment of cash
dividends and "THE OFFERINGS -- Subscription Offering -- Limitations on Common
Stock Purchases" with respect to restrictions on the purchase of securities by
any person.
ANTI-TAKEOVER PROVISIONS
Regulatory Restrictions. Section 628.461 of the Florida Insurance Code
prohibits any person, individually or in conjunction with any affiliated person
of such person, from acquiring, directly or indirectly, 5% or more of the
outstanding voting securities of a Florida-domiciled insurance company or any
controlling company thereof without prior approval of the Florida DOI. However,
a person acquiring less than 10% of such outstanding voting securities may file
with the Florida DOI a disclaimer of affiliation and control and, unless such
disclaimer is disallowed by the Florida DOI, such person will not be required to
seek prior approval of the Florida DOI for the acquisition.
Restrictions in Summit's Articles of Incorporation and Bylaws. A number of
provisions of the Summit Articles and Summit Bylaws concern matters of corporate
governance and certain rights of shareholders. The following discussion is a
general summary of certain provisions of the Summit Articles and Summit Bylaws
relating to stock ownership and transfers, the Board of Directors and business
combinations, which might be deemed to have a potential "anti-takeover" effect.
These provisions may have the effect of discouraging a future takeover attempt
which is not approved by the Board of Directors but which individual
shareholders of Summit may deem to be in their best interests or in which
shareholders may receive a substantial premium for their shares over then
current market prices. As a result, shareholders who might desire to participate
in such a transaction may not have an opportunity to do so. Such provisions will
also render the removal of the current Board of Directors and management more
difficult. The following description is necessarily general and reference should
be made in each case to such Summit Articles and Summit Bylaws, which are filed
as exhibits to the Registration Statement of which this Prospectus forms a part.
Board of Directors. The Board of Directors of Summit is divided into
three classes, each of which contains approximately one-third of the whole
number of the members of the Board. Each class serves a staggered term, with
approximately one-third of the total number of directors being elected each
year. The Summit Articles and Summit Bylaws prohibit cumulative voting for the
election of directors.
A classified board of directors could make it more difficult for
shareholders, including those holding a majority of the outstanding shares, to
force an immediate change in the composition of a majority of the board
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of directors. Because the terms of only one-third of the incumbent directors
expire each year, it requires at least two annual elections for the shareholders
to change a majority of the board of directors, whereas a majority of a
non-classified board may be changed in one year. In the absence of the
provisions of the Summit Articles and Summit Bylaws classifying the Board, all
of the directors would be elected each year.
Authorized Shares. The Summit Articles authorize the issuance of
20,000,000 shares of Common Stock and 5,000,000 shares of preferred stock. The
shares of Common Stock and preferred stock were authorized to provide Summit's
Board of Directors with as much flexibility as possible in using such shares for
financings, acquisitions, stock dividends, stock splits, employee stock options
and other similar purposes. However, these additional authorized shares may also
be used by the Board of Directors to deter future attempts to gain control of
Summit. The Board of Directors has sole authority to determine the terms of any
one or more series of the preferred stock, including voting rights, conversion
rates and liquidation preferences. As a result of the ability to fix voting
rights for a series of preferred stock, the Board has the power to issue a
series of preferred stock to persons friendly to management in order to attempt
to block a post-tender offer merger or other transaction by which a third party
seeks control, and thereby assist management to retain its position. There are
currently no plans for the issuance of preferred stock other than the Series A
Preferred Stock being offered hereby. See "DESCRIPTION OF CAPITAL
STOCK -- Preferred Stock."
Anti-Takeover Effects of Incentive Plan. The Incentive Plan provides that
in the event of a "change of control" (as defined in the Incentive Plan) of
Summit, all awards granted under the Incentive Plan that are in the nature of
rights that may be exercised shall automatically become fully exercisable. In
addition, at any time prior to or after a change of control, the Compensation
Committee may accelerate awards and waive conditions and restrictions on any
other awards under the Incentive Plan to the extent it may determine
appropriate.
Florida Corporate Law. Summit will be subject to several anti-takeover
provisions under the Florida Act that apply to a public corporation under
Florida law unless the corporation has elected to opt out of such provisions in
its articles of incorporation or bylaws. Such provisions also serve to limit
certain related party transactions otherwise permissible under the Florida Act.
Summit has not elected to opt out of such provisions.
The Florida Act contains a provision that generally provides that shares
acquired in a "control share acquisition" will not possess any voting rights
unless voting rights are approved by a majority vote of a corporation's
disinterested shareholders. A "control share acquisition" is an acquisition that
immediately thereafter entitles the acquiring party to vote in the election of
directors within any of the following ranges of voting power: (i) one-fifth or
more but less than one-third of all voting power; (ii) one-third or more but
less than a majority of all voting power; and (iii) a majority or more of all
voting power. Approval of voting rights for control shares requires: (i)
approval by each class or series entitled to vote separately, by majority of all
votes entitled to be cast by the class or series being entitled to vote as a
separate class and (ii) approval by each class or series entitled to vote
separately, by a majority of all votes entitled to be cast by that group
excluding all "control shares."
The Florida Act also contains an "affiliated transactions" provision that
generally requires two-thirds approval of holders of disinterested shares of a
Florida corporation in order to engage in a broad range of transactions with an
"interested shareholder." An "interested shareholder" is defined as a person who
together with affiliates and associates beneficially owns more than 10% of the
outstanding voting shares of the corporation. Transactions that require the
approval of two-thirds of the voting shares beneficially owned by disinterested
shareholders include: (i) mergers or consolidations with the interested
shareholder; (ii) the sale, lease, exchange, mortgage, pledge, transfer or other
disposition to or with the interested shareholders of 5% or more of either the
corporation's total assets or total outstanding shares, or representing 5% or
more of the earning power or net income of the corporation; (iii) issuance or
transfers of shares to the interested shareholder having a market value of 5% or
more of the total market value of the corporation's outstanding shares (except
pursuant to the exercise of stock warrants or rights, or a dividend or
distribution made pro-rata to all shareholders); (iv) a liquidation or
dissolution of the corporation proposed by or pursuant to a written or unwritten
agreement or understanding with the interested shareholder; (v) a
reclassification of securities or
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the corporate reorganization with the interested shareholder that has the effect
of increasing the percentage voting ownership of the interested shareholder by
more than 5%; and (vi) any receipt by the interested shareholder of a benefit,
directly or indirectly, of any loans, advances, guarantees, pledges, other
financial assistance, or tax credits or advantages provided by or through the
corporation.
TRANSFER AGENT
The Transfer Agent and registrar for Summit's Series A Preferred Stock and
Common Stock is ChaseMellon Shareholder Services, L.L.C., New York, New York.
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of the Conversion, Summit will have outstanding 5,000,000
shares of Common Stock, all of which will have been registered under the
Securities Act and will be freely tradable without restriction or further
registration under the Securities Act, except that those shares held by
"affiliates" (as defined in Rule 144 promulgated under the Securities Act) of
Summit will not be freely tradable even though they will have been registered
under the Securities Act. Based on information provided to Summit by its
affiliates, Summit believes that approximately 500,000 shares of Common Stock,
equal to approximately 10% of the Post-Offering Outstanding Shares, will be
beneficially owned by affiliates of Summit. Shares of Common Stock beneficially
owned by affiliates of Summit may not be sold except in compliance with the
registration requirements of the Securities Act or pursuant to an exemption from
registration, such as the exemption provided by Rule 144 under the Securities
Act. Additionally, all shares of Common Stock held by affiliates of Summit are
subject to a lock-up agreement with the Representatives that prohibits their
resale prior to 180 days after the Effective Date without the prior consent of
Raymond James & Associates, Inc.
In general, under Rule 144, as currently in effect, any person (or persons
whose shares are aggregated) who owns shares of Common Stock which have not been
registered under the Securities Act and as to which a minimum of one year has
elapsed since the later of the date of acquisition from and full payment to
Summit or an affiliate of Summit, and any affiliate of Summit who owns Common
Stock, will be entitled to sell, within any three-month period beginning 90 days
after the date of this Prospectus (but subject to the 180 day lock-up described
above), a number of shares of Common Stock that does not exceed the greater of:
(i) 1% of the then outstanding shares of Common Stock (50,000 shares of Common
Stock upon the completion of the Conversion), or (ii) the average weekly trading
volume in the Common Stock in the public market during the four calendar weeks
preceding the date on which notice of the sale is filed with the Commission.
Sales of Common Stock pursuant to Rule 144 are also subject to certain manner of
sale provisions, notice requirements and the availability of current public
information about Summit. Additionally, under Rule 144, any person who holds
shares of Common Stock which have not been registered under the Securities Act
as to which a minimum of two years has elapsed since the later of the date of
acquisition from and full payment to Summit or an affiliate of Summit and who is
not, and for a period of three months prior to the sale of such shares has not
been, an affiliate of Summit is free to sell such shares without regard to the
volume, manner of sale, notice and other provisions of Rule 144.
In addition, 500,000 shares of Common Stock are reserved for issuance under
Summit's Incentive Plan and 45,000 shares of Common Stock are reserved for
issuance in connection with the 401(k) Plan. Summit intends to file a
registration statement on Form S-8 under the Securities Act to register the
shares of Common Stock reserved for issuance under the Incentive Plan and the
401(k) plan within 30 days after the Effective Date. Shares of Common Stock
issued under the Incentive Plan and the 401(k) Plan to non-affiliates of Summit
after the effective date of such registration statement will be freely tradable
in the public market. Shares issued under the Incentive Plan and the 401(k) Plan
to affiliates of Summit after the effective date of such registration statement
will be eligible for sale pursuant to Rule 144.
Prior to the Conversion, there has been no public trading market for
Summit's securities. Summit cannot predict the effect, if any, that sales of
Common Stock following the Conversion, pursuant to a registration statement,
Rule 144, or otherwise, or the availability of such shares for sale, will have
on the market price prevailing from time to time. Sales, or the availability for
sale, of a substantial amount of Common Stock could adversely affect prevailing
market prices for such stock.
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UNDERWRITING
Subject to the terms and conditions of the Underwriting Agreement, the
Company has agreed to sell to each of the Underwriters listed below, and the
Underwriters, for whom Raymond James & Associates, Inc. and ABN AMRO Chicago
Corporation are acting as the Representatives, have severally agreed to
purchase, the respective number of shares of Common stock set forth opposite
their names below.
<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITER SHARES
----------- ---------
<S> <C>
Raymond James & Associates, Inc. ........................... 1,490,507
ABN AMRO Chicago Corporation................................ 1,490,506
Alex. Brown & Sons Incorporated............................. 110,000
Donaldson, Lufkin & Jenrette Securities Corporation......... 110,000
A.G. Edwards & Sons, Inc. .................................. 110,000
Salomon Brothers Inc........................................ 110,000
Robert W. Baird & Co. Incorporated.......................... 70,000
Dain Bosworth Incorporated.................................. 70,000
Friedman, Billings, Ramsey & Co., Inc. ..................... 70,000
Interstate/Johnson Lane Corporation......................... 70,000
Janney Montgomery Scott Inc. ............................... 70,000
Legg Mason Wood Walker, Incorporated........................ 70,000
The Robinson-Humphrey Company, Inc. ........................ 70,000
Allen & Company of Florida Inc. ............................ 50,000
Brean Murray & Co., Inc. ................................... 50,000
Sandler, O'Neill & Partners, L.P. .......................... 50,000
---------
Total............................................. 4,061,013
=========
</TABLE>
The Underwriting Agreement provides that the obligations of the several
Underwriters thereunder are subject to approval of certain legal matters by
their counsel and to various other conditions. The Underwriters are obligated to
purchase all shares of the Common Stock offered hereby, excluding shares covered
by the over-allotment option granted to the Underwriters, if any of such shares
are purchased.
The Company has been advised by the Representatives that the Underwriters
propose to offer the Common Stock to the public at the initial public offering
price per share set forth on the cover page of this Prospectus and to certain
dealers at such price, less a concession not in excess of $.45 per share and
that the Underwriters and such dealers may reallow a concession not in excess of
$.10 per share to other dealers. The public offering price and concessions and
reallowances to dealers may be changed by the Representatives after the initial
Public Offering.
Summit has granted to the Underwriters an option, exercisable within 30
days after the date of the Public Offering, to purchase up to 750,000 shares of
Common Stock from Summit, in addition to the 5,000,000 shares of Common Stock
offered hereby, to cover over-allotments at the same price per share to be paid
by the Underwriters for the other shares offered hereby. If the Underwriters
purchase any additional shares pursuant to this option, each of the Underwriters
will be committed to purchase such additional shares in approximately the same
proportion as set forth in the above table. The Underwriters may purchase such
option only to cover over-allotments ,if any, in connection with the Public
Offering.
Summit has agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act.
Summit and its executive officers have agreed not to sell, contract to sell
or otherwise dispose of any shares of Common Stock for a period of 180 days
after the Effective Date of the Conversion without the prior written consent of
the Representatives. See "SHARES ELIGIBLE FOR FUTURE SALE."
The Underwriters have advised Summit that they do not intend to confirm
sales to any account over which they exercise discretionary authority.
79
<PAGE> 80
Prior to the Offerings, there has been no public market for the Common
Stock of Summit. Consequently, the Public Offering Price for the Common Stock
has been determined by negotiation between Summit and the Representatives. Among
the factors considered in such negotiations were the prevailing market
conditions, the results of operations of the Company in recent periods, the
market capitalizations and stages of development of other companies which the
Company and the Representatives believed to be comparable to the Company,
estimates of the business potential of the Company, the present state of the
Company's development and other factors deemed relevant.
The Company has granted the Underwriters, until April 30, 1998, a right of
first refusal to act as managing underwriters or placement agents, as
appropriate, for any public or private offering of the securities of the Company
or its subsidiaries. The Company has agreed to consult the Underwriters with
regard to any such covered offering prior to consulting any other prospective
underwriter or placement agent and the Company will offer the Underwriters the
opportunity to purchase or sell any such securities on terms not less favorable
to the Company than it can secure elsewhere. The Company has further agreed that
until October 31, 1998, the Company shall give a right to first refusal to act
as the Company's financial adviser in connection with certain mergers,
acquisitions and related transactions.
LEGAL MATTERS
Certain legal matters with respect to the shares of the Common Stock
offered hereby will be passed upon for the Company by Alston & Bird LLP,
Atlanta, Georgia, and Maida, Galloway & Neal, P.A., Tallahassee, Florida, and
for the Underwriters by Holland & Knight LLP, Tampa, Florida.
EXPERTS
The consolidated financial statements of ESIF and subsidiaries as of March
31, 1996 and for the year then ended and the consolidated financial statements
of SHC and subsidiaries for the year ended December 31, 1993, 1994, and 1995
appearing in this Prospectus and Registration Statement have been audited by
Ernst & Young, LLP, independent auditors, as set forth in their reports therein
appearing elsewhere herein and in the Registration Statement and are included in
reliance upon such reports given upon the authority of such firm as experts in
accounting and auditing.
The consolidated financial statements of ESIF and subsidiaries as of March
31, 1994 and 1995 and for the years then ended and as of September 30, 1996 and
for the six months then ended appearing in this Prospectus and Registration
Statement have been audited by Brinton & Mendez, certified public accountants,
as set forth in their reports therein appearing elsewhere herein and in the
Registration Statement and are included in reliance upon such reports given upon
the authority of such firm as experts in accounting and auditing.
CHANGE IN ACCOUNTANTS
In June 1996, ESIF changed principal accountants from Brinton & Mendez to
Ernst & Young, LLP to audit its financial statements. Prior thereto, Brinton &
Mendez had served as ESIF's principal accountants. Prior to the Acquisition,
Ernst & Young, LLP had served as SHC's principal accountants. The decision by
ESIF to change principal accountants was made with the approval of the Board of
Trustees as a result of the decision to pursue the Conversion.
The Company believes, and has been advised by Brinton & Mendez that it
concurs in such belief, that, during the fiscal years ended March 31, 1994 and
1995 and subsequent thereto, the Company and Brinton & Mendez did not have any
disagreement on any matter of accounting principles or practices, financial
statement disclosure or auditing scope or procedure, which disagreement, if not
resolved to the satisfaction of Brinton & Mendez, would have caused it to make
reference in connection with its report on the Company's financial statements to
the subject matter of the disagreement.
No report of Brinton & Mendez on the Company's financial statements for
either of the fiscal years ended March 31, 1994 and 1995 contained an adverse
opinion, a disclaimer of opinion, or qualification or
80
<PAGE> 81
modification as to uncertainty, audit scope or accounting principles. During
such fiscal periods, there were no "reportable events" within the meaning of
Item 304(a)(1) of Regulation S-K promulgated under the Securities Act.
ADDITIONAL INFORMATION
Summit has filed with the Commission, 450 Fifth Street, N.W. , Washington,
D.C. 20549, a Registration Statement on Form S-1 (the "REGISTRATION STATEMENT")
under the Securities Act. This Prospectus does not contain all the information
set forth in the Registration Statement and the exhibits thereto, as permitted
by the rules and regulations of the Commission. For further information,
reference is made to the Registration Statement and to the exhibits filed
therewith. Statements contained in this Prospectus as to the contents of any
contract of other document which has been filed as an exhibit to the
Registration Statement are qualified in their entirety by reference to such
exhibits for a complete statement of their terms and conditions. The
Registration Statement and the exhibits thereto may be inspected without charge
at the offices of the Commission, and copies or all or any part thereof may be
obtained from the Commission's principal office at 450 Fifth Street, N.W.,
Washington, D.C. 20549 or at certain of the regional offices of the Commission
located at 7 World Trade Center, New York, New York 10048, and Citicorp Center,
500 West Madison Street, Suite 1400, Chicago, Illinois 60661, upon payment of
the fees prescribed by the Commission. The Commission also maintains a Web site
that contains reports, proxy and information statements and other information
regarding registrants that file electronically with the Commission. Such
reports, proxy and information statements and other information may be found on
the Commission's site address, http://www.sec.gov.
Summit is not currently subject to the information reporting requirements
of the Securities Exchange Act of 1934, as amended (the "EXCHANGE ACT"). As a
result of the Conversion, Summit will become subject to the information
reporting requirements of the Exchange Act. Summit intends to furnish its
shareholders with annual reports, which will include consolidated financial
statements audited by its independent certified public accountants, and
quarterly reports containing unaudited financial information for the first three
quarters of each fiscal year.
81
<PAGE> 82
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
EMPLOYERS SELF INSURERS FUND AND SUBSIDIARIES
Reports of Independent Auditors........................... F-2
Consolidated Balance Sheets as of March 31, 1995 and
1996................................................... F-4
Consolidated Statements of Income for the years ended
March 31, 1994, 1995 and 1996.......................... F-5
Consolidated Statements of Changes in Equity for the years
ended March 31, 1994, 1995 and 1996.................... F-6
Consolidated Statements of Cash Flows for the years ended
March 31, 1994, 1995 and 1996.......................... F-7
Notes to Consolidated Financial Statements................ F-8
Report of Independent Auditors............................ F-29
Consolidated Balance Sheets as of September 30, 1995
(unaudited) and 1996................................... F-30
Consolidated Statements of Income for the six months ended
September 30, 1995 (unaudited) and 1996................ F-31
Consolidated Statements of Changes in Equity for the six
months ended September 30, 1995 and 1996............... F-32
Consolidated Statements of Cash Flows for the six months
ended September 30, 1995 (unaudited) and 1996.......... F-33
Notes to Consolidated Financial Statements................ F-34
Consolidated Balance Sheets as of December 31, 1995
(unaudited) and 1996 (unaudited)....................... F-55
Consolidated Statements of Income for the nine months
ended December 31, 1995 (unaudited) and 1996
(unaudited)............................................ F-56
Consolidated Statements of Changes in Equity for the nine
months ended December 31, 1995 (unaudited) and 1996
(unaudited)............................................ F-57
Consolidated Statements of Cash Flows for the nine months
ended December 31, 1995 (unaudited) and 1996
(unaudited)............................................ F-58
Notes to Consolidated Financial Statements................ F-59
SUMMIT HOLDING CORPORATION AND SUBSIDIARIES
Report of Independent Auditors............................ F-79
Consolidated Statements of Income for the years ended
December 31, 1993, 1994 and 1995....................... F-80
Consolidated Statements of Stockholders' Equity for the
years ended December 31, 1992, 1993, 1994 and 1995..... F-81
Consolidated Statements of Cash Flows for the years ended
December 31, 1993, 1994 and 1995....................... F-82
Notes to Consolidated Financial Statements................ F-83
FINANCIAL STATEMENT SCHEDULES
EMPLOYERS SELF INSURERS FUND AND SUBSIDIARIES
Reports of Independent Auditors on Financial Statement
Schedules.............................................. F-88
Schedule I -- Summary of Investments as of March 31, 1996,
September 30, 1996 and December 31, 1996............... F-90
Schedule IV -- Reinsurance for the years ended March 31,
1994, 1995 and 1996, for the six months ended September
30, 1995 and 1996 and for the nine months ended
December 31, 1995 and 1996............................. F-92
Schedule VI -- Supplemental Information Concerning
Insurance Operations for the years ended March 31,
1994, 1995 and 1996, for the six months ended September
30, 1995 and 1996 and for the nine months ended
December 31, 1995 and 1996............................. F-93
</TABLE>
Schedule II -- Condensed Financial Statements of the Registrant is omitted
due to minimal capitalization and a lack of operations to date of Summit Holding
Southeast, Inc.
All other schedules are omitted because of the absence of conditions under
which they are required or because the required information is included
elsewhere herein.
F-1
<PAGE> 83
REPORT OF INDEPENDENT AUDITORS
Board of Trustees
Employers Self Insurers Fund
We have audited the accompanying consolidated balance sheet of Employers
Self Insurers Fund (the "Company") and its subsidiaries as of March 31, 1996,
and the related consolidated statements of income, changes in equity, and cash
flows for the year then ended. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these consolidated financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides 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 the Company
and its subsidiaries at March 31, 1996, and the results of their operations and
their cash flows for the year then ended, in conformity with generally accepted
accounting principles.
ERNST & YOUNG LLP
Jacksonville, Florida
July 31, 1996
F-2
<PAGE> 84
INDEPENDENT AUDITORS' REPORT
Board of Trustees
Employers Self Insurers Fund
Lakeland, Florida
We have audited the accompanying consolidated balance sheets of Employers
Self Insurers Fund and its subsidiaries as of March 31, 1995, and the related
consolidated statements of income, equity, and cash flows for each of the two
years in the period ended March 31, 1995. These financial statements are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Employers Self
Insurers Fund and its subsidiaries as of March 31, 1995 and the consolidated
results of their operations and their cash flows for each of the two years in
the period ended March 31, 1995, in conformity with generally accepted
accounting principles.
As discussed in Note 1 to the consolidated financial statements, the Fund's
financial statements have been prepared in conformity with generally accepted
accounting principles applicable to stock property and casualty insurance
companies.
BRINTON & MENDEZ
Certified Public Accountants
Lakeland, Florida
July 26, 1996
F-3
<PAGE> 85
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
MARCH 31,
----------------------
1995 1996
-------- --------
(IN THOUSANDS)
<S> <C> <C>
ASSETS
Invested assets:
Fixed maturities, available-for-sale...................... $204,097 $178,818
Preferred stock........................................... 1,914 3,156
Common stock.............................................. 8,978 11,095
Short-term investments.................................... 6,983 19,770
-------- --------
Total invested assets............................. 221,972 212,839
Cash and cash equivalents................................... 2,984 7,427
Premiums receivable (net of $2,100 and $1,500 allowance for
doubtful accounts, respectively).......................... 50,391 38,093
Accounts receivable......................................... -- 3,157
Reinsurance recoverable, including $10,800 and $9,400 at
March 31, 1995 and 1996, respectively, from related party
reinsurers................................................ 110,141 111,519
Recoverable from Florida Special Disability Trust Fund...... 15,879 20,060
Accrued investment income................................... 3,409 2,936
Income taxes recoverable.................................... -- 9,690
Equipment and software...................................... -- 2,448
Capitalized computer software costs......................... -- 6,038
Value assigned to future administration of insurance
contracts................................................. -- 6,470
Unamortized debt acquisition cost........................... -- 709
Excess of cost over net assets of business acquired......... -- 46,738
Deferred income taxes....................................... 19,100 14,861
Other assets................................................ 1,330 5,791
Net assets of healthcare subsidiary, held for disposition... -- 2,456
Net assets of discontinued operations....................... -- 612
-------- --------
Total assets...................................... $425,206 $491,844
======== ========
LIABILITIES AND EQUITY
Liabilities:
Loss and loss adjustment expenses......................... $367,391 $387,632
Debt...................................................... -- 44,000
Unearned premium and unallocated policyholder
remittances............................................ 18,234 14,635
Accounts payable and accrued expenses..................... 12,690 13,546
Taxes, licenses and fees.................................. 1,861 1,493
Deferred revenue.......................................... 87 7,384
Federal income taxes payable.............................. 4,878 --
-------- --------
Total liabilities................................. 405,141 468,690
Equity:
Retained earnings......................................... 21,474 21,659
Net unrealized appreciation (depreciation) on
available-for-sale securities.......................... (1,409) 1,495
-------- --------
Total equity...................................... 20,065 23,154
-------- --------
Total liabilities and equity...................... $425,206 $491,844
======== ========
</TABLE>
See accompanying notes.
F-4
<PAGE> 86
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEAR ENDED MARCH 31,
------------------------------
1994 1995 1996
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Revenue:
Premiums earned........................................... $148,441 $128,489 $114,893
Net investment income..................................... 10,510 12,205 13,210
Net realized investment gains............................. -- -- 4,354
Administrative fees....................................... -- -- 7,665
Other income.............................................. -- 121 206
-------- -------- --------
Total revenue..................................... 158,951 140,815 140,328
Losses and expenses:
Losses and loss adjustment expenses....................... 108,411 69,116 94,844
Other underwriting, general and administrative expenses
(including administrative service fees paid to Summit
Holding Corporation of $26,001, $26,512 and $19,358 for
the years ended March 31, 1994 and 1995 and for the
period April 1, 1995 to January 16, 1996,
respectively).......................................... 37,121 41,546 43,657
Amortization and depreciation............................. -- -- 1,103
Interest expense.......................................... -- -- 847
-------- -------- --------
Total losses and expenses......................... 145,532 110,662 140,451
-------- -------- --------
Income (loss) from continuing operations before income
taxes..................................................... 13,419 30,153 (123)
Income tax expense (benefit)................................ 4,534 10,990 (505)
-------- -------- --------
Income from continuing operations........................... 8,885 19,163 382
-------- -------- --------
Discontinued operations:
Loss from discontinued operations (net of income tax
benefit of $121)....................................... -- -- (197)
-------- -------- --------
Loss from discontinued operations........................... -- -- (197)
-------- -------- --------
Net income........................................ $ 8,885 $ 19,163 $ 185
======== ======== ========
</TABLE>
See accompanying notes.
F-5
<PAGE> 87
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
YEARS ENDED MARCH 31, 1994, 1995 AND 1996
<TABLE>
<CAPTION>
UNREALIZED
APPRECIATION
(DEPRECIATION) OF
RETAINED AVAILABLE-FOR-SALE
EARNINGS SECURITY INVESTMENTS TOTAL
-------- -------------------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Balance at March 31, 1993.................................. $(6,574) $ 88 $(6,486)
Net income................................................. 8,885 -- 8,885
Change in net unrealized investment gains.................. -- (126) (126)
------- ------- -------
Balance at March 31, 1994.................................. 2,311 (38) 2,273
Net income................................................. 19,163 -- 19,163
Change in net unrealized investment gains.................. -- (1,371) (1,371)
------- ------- -------
Balance at March 31, 1995.................................. 21,474 (1,409) 20,065
Net income................................................. 185 -- 185
Change in net unrealized investment gains.................. -- 2,904 2,904
------- ------- -------
Balance at March 31, 1996.................................. $21,659 $ 1,495 $23,154
======= ======= =======
</TABLE>
See accompanying notes.
F-6
<PAGE> 88
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED MARCH 31,
------------------------------
1994 1995 1996
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income................................................ $ 8,885 $ 19,163 185
Adjustments to reconcile net income to net cash provided by
operating activities:
Amortization and depreciation............................. 485 372 1,103
Net realized gains........................................ (14) -- (4,354)
Bad debt allowance........................................ (146) (216) (600)
(Increase) decrease in premiums receivable................ (6,964) 8,880 12,898
(Increase) decrease in accounts receivable................ (4) 14 (3,157)
Increase in reinsurance recoverable....................... (26,563) (20,424) (1,377)
Increase in Special Disability Trust Fund recoverable..... (3,184) (5,950) (4,181)
(Increase) decrease in accrued investment income.......... (398) (1,184) 473
Increase in federal income tax recoverable................ -- -- (9,690)
(Increase) decrease in deferred income taxes.............. (7,535) 513 4,239
Increase in other assets.................................. -- -- (4,619)
Decrease in discontinued operations....................... -- -- (588)
Increase in loss and loss adjustment expense.............. 39,754 9,677 20,240
Increase (decrease) in unearned premium and unallocated
policyholder remittances............................... 16,115 (2,155) (3,600)
Increase in accounts payable and accrued expenses......... 39 2,291 1,802
Increase (decrease) in taxes, licenses and fees........... -- 1,201 (368)
Increase in deferred revenue.............................. -- 86 7,298
Increase (decrease) in federal income tax payable......... -- 1,043 (4,878)
-------- -------- --------
Net cash provided (used) in operating activities............ 20,470 13,311 10,826
INVESTING ACTIVITIES:
Purchase of investment securities........................... (760,811) (859,038) (982,289)
Disposal and maturity of investment securities.............. 685,168 846,575 972,918
Purchase of equipment and software.......................... -- -- (2,697)
Purchase of Summit Holding Corporation...................... -- -- (39,960)
Other investing activities.................................. 68 152 --
-------- -------- --------
Net cash provided by investing activities................... (75,575) (12,311) (47,108)
FINANCING ACTIVITIES:
Increase in notes payable................................... -- -- 44,000
-------- -------- --------
Net cash provided by financing activities................... -- -- 44,000
-------- -------- --------
Net increase in cash and cash equivalents................... (55,105) 1,000 7,718
Beginning cash and cash equivalents......................... 57,089 1,984 2,984
-------- -------- --------
Ending cash and cash equivalents
Continuing operations..................................... 1,984 2,984 7,427
Operations held for disposition........................... -- -- 3,251
Discontinued operations................................... -- -- 24
-------- -------- --------
Total ending cash and cash equivalents............ $ 1,984 $ 2,984 $ 10,702
======== ======== ========
</TABLE>
See accompanying notes.
F-7
<PAGE> 89
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1994, 1995 AND 1996
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
Organization
Employers Self Insurers Fund ("ESIF") is domiciled in Florida as a group
self-insurance workers' compensation fund defined by section 624.4621, Florida
Statutes. ESIF is regulated by the Bureau of Self Insurance under the Department
of Insurance of the State of Florida (the "Florida DOI").
ESIF was formed in 1978 for the stated purpose of providing statutory
workers' compensation coverage for certain Florida employers. ESIF's wholly
owned subsidiary, Employers Safety Group Association, Inc. ("ESGA"), is a trade
association primarily for employers in the construction, manufacturing,
wholesale and retail, and service industries, and any employer that is a member
of ESGA may obtain coverage from ESIF. An indemnity agreement issued by ESIF
indemnifies the member employer against loss or liability relating to workers'
compensation insurance risk. Any employer that obtains workers' compensation
coverage from ESIF automatically becomes a member of ESIF with certain rights,
including the right to vote for the election of ESIF's Trustees, the right to
receive any distribution of profits that may be authorized by the Trustees and
the right to participate in the distribution of the surplus of ESIF in the event
of its liquidation. However, all members of ESIF are subject to joint and
several liability for the obligations of ESIF. ESIF has historically not been
operated for the purpose of generating profits, but it has retained a portion of
its earnings and profits to avoid making assessments against its members. ESIF
has occasionally during its operating history paid a distribution of profits to
its members, but it has never made an assessment against its members.
ESIF is a trust with a Board comprised of six Trustees, but no employees or
officers. ESIF's bylaws specifically direct the Board to engage an
administrator, and ESIF's administrator since its inception has been Summit
Consulting, Inc. ("SCI"). SCI performs all daily operational activities for
ESIF, including premium and claims processing, pursuant to a written agreement.
SCI also performs similar functions for four other group self-insurance funds
located in Florida, Louisiana and Kentucky.
SCI owns several subsidiaries formed to assist it in providing specialized
administrative services, and SCI is wholly owned by a holding company, Summit
Holding Corporation ("SHC"). Effective January 16, 1996, ESIF purchased all of
the outstanding stock of SHC (see Note 14 for a further discussion of this
acquisition). In addition to SHC and its subsidiaries, ESIF also owns a
reinsurance subsidiary, U.S. Employers Insurance, Inc. ("USEI").
Pursuant to an Amended Plan of Conversion and Recapitalization, and subject
to certain conditions stated therein, ESIF intends to convert to a stock
property and casualty insurance company. In such transaction, ESIF will become
wholly owned by a newly formed holding company, and ESIF's members will receive
preferred stock of the holding company in exchange for the membership interests.
Consolidation and Presentation
The accompanying consolidated financial statements include the accounts,
after intercompany eliminations, of ESIF and its wholly owned subsidiaries and
have been prepared in conformity with generally accepted accounting principles
("GAAP") applicable to stock property and casualty insurance companies, which
differ from statutory accounting practices prescribed or permitted by the
Florida DOI.
Use of Estimates and Assumptions
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect amounts reported in the
financial statements and accompanying notes.
F-8
<PAGE> 90
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Such estimates and assumptions could change in the future as more information
becomes known which could impact the amounts reported and disclosed herein.
Recognition of Revenues
Workers' compensation insurance premiums are based on rates established by
the National Council on Compensation Insurance ("NCCI"). Premium revenues
generally are recognized over the life of the related policies on the daily pro
rata method with a reserve for unearned premiums established for the unexpired
portion of the premiums applicable to those policies. For retrospectively rated
policies, the ultimate premium for a period is determined on the basis of the
insured's actual losses for that period. If the actual losses are less than
expected, ESIF may be required to refund a portion of the premiums previously
paid. ESIF considers loss development experience through the date of the
financial statements in estimating the ultimate premium and, as adjustments to
premiums become necessary as a result of loss development, such adjustments are
included in current operations. All indemnity contracts issued by ESIF prior to
March 31, 1996 have a common anniversary date of April 1, thus there was no
liability for unearned premium or deferred policy acquisition costs at March 31,
1995 or March 31, 1996.
Administrative fee revenue is recognized in proportion to the premiums
earned by the self-insurance funds at the contractual administrative fee
percentage of premiums. Adjustments to revenue for premium audits are recorded
in the period they occur. Fees for administrative services provided to ESIF
subsequent to the date of ESIF's acquisition of SHC have been eliminated in the
consolidated statement of operations.
Reinsurance premiums ceded are recorded and recognized on a pro rata basis
of earned premiums of the contract.
Income Taxes
Income taxes have been provided using the liability method in accordance
with Financial Accounting Standards Board ("FASB") Statement 109, Accounting for
Income Taxes. Under that method, deferred tax assets and liabilities are
determined based on the differences between financial reporting and tax bases of
assets and liabilities and are measured using enacted tax rates.
Investments
In 1993, the FASB issued Statement 115, Accounting for Certain Investments
in Debt and Equity Securities. Statement 115 requires that debt securities are
to be classified as either held-to-maturity (carried at amortized cost),
available-for-sale (carried at market with unrealized gains or losses reported
in equity), or trading (carried at market with unrealized gains or losses
reported in net income).
ESIF believes that it has the ability and intent to hold to maturity its
debt security investments. However, ESIF also recognizes there may be
circumstances where it may be appropriate to sell a security prior to maturity
in response to unforeseen changes in circumstances. Recognizing the need for the
ability to respond to changes in tax position and in market conditions, ESIF has
designated its entire investment portfolio as available-for-sale.
Investments are reported in the accompanying balance sheets on the
following basis:
- Available-for-sale securities are reported at current market value.
Changes in market value of available-for-sale securities, after applicable
deferred income taxes, are reported as unrealized appreciation or
depreciation directly in equity and, accordingly, have no effect on net
income.
F-9
<PAGE> 91
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
- Equity security investments, consisting of common and nonredeemable
preferred stocks, are carried at current market value with changes in such
value reported as unrealized appreciation or depreciation directly in
equity, after applicable income taxes, having no effect on net income.
- Short-term investments are reported at cost.
The cost of securities sold is based on specific identification and the
resulting realized gains and losses are included in the determination of net
income.
In the normal course of business, ESIF is party to financial instruments,
none of which have significant off-balance-sheet risk.
Loss and Loss Adjustment Expenses
The reserve for unpaid loss and loss adjustment expenses ("LAE") represents
management's best estimate of the ultimate cost of the loss and LAE that are
unpaid at the balance sheet date including incurred but not reported claims.
Such reserve is established by management based upon (i) results of actuarial
reviews which incorporate ESIF's experience with similar cases, estimates of
future claim trends, and historical trends such as recurring loss payment and
reporting patterns, claim closures and product mixes; (ii) facts known to the
company, and (iii) regulatory requirements. Such reserve is continually reviewed
and as adjustments become necessary, such adjustments are included in current
operations.
The reserve for permanent indemnity disability claims has been discounted
at 4% as permitted under Florida law. For GAAP purposes, discounting is computed
based on the ESIF's anticipated payout patterns and a discount rate consistent
with that permitted by section 625.091, Florida Statutes. The amount of such
discount was $4.8 million, $4.9 million and $4.7 million at March 31, 1994, 1995
and 1996, respectively.
Prior to the January 16, 1996 acquisition of SHC, certain unallocated LAE
of ESIF were provided by SHC under the administrative agreement between ESIF and
SHC. Subsequent to the acquisition, ESIF has included the liability for such
unallocated LAE in the loss and LAE liability.
Reinsurance
Under FASB Statement No. 113, Accounting and Reporting for Reinsurance of
Short-Duration and Long-Duration Contracts, all assets and liabilities related
to reinsurance ceded contracts are reported on a gross basis rather than the
previous practice of reporting such assets and liabilities net of reinsurance.
The amounts recoverable from reinsurers are classified separately on the balance
sheet.
The accompanying statements of operations reflect premiums and losses
incurred, net of reinsurance ceded (see Note 6). Reinsurance arrangements allow
management to control exposure to potential losses arising from large risks. A
significant portion of the reinsurance is effected under excess of loss
reinsurance contracts. Amounts recoverable from reinsurers are estimated in a
manner consistent with the loss and loss expense reserves associated with the
reinsured policies. Similarly, reinsurance premiums, losses and loss adjustment
expenses are accounted for on bases consistent with those used in accounting for
the related original policies issued and the terms of the reinsurance contracts.
Guaranty Fund Assessments
As a self-insurance fund, ESIF has periodically been assessed by a state
guaranty fund as part of that fund's activities to collect money from solvent
self-insurance funds to cover certain losses to policyholders of insolvent
self-insurance funds, after assessment of the policyholders of the insolvent
funds. This type of guaranty fund is separate from the Florida Special
Disability Trust Fund (the "SDTF"), which is designed to pay insurers for
certain benefits paid to previously injured workers, as discussed in Note 13.
F-10
<PAGE> 92
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Florida statutes limit the assessment to a maximum of 2% of direct written
premiums annually, but because there are many uncertainties regarding the
ultimate amount of assessments, ESIF's policy has been to recognize its
obligation for guaranty fund assessments when it receives notice that an amount
is payable to the guaranty fund. At March 31, 1996, ESIF was not able to
estimate reasonably the potential effects of any future assessments and,
accordingly, the accompanying financial statements do not include any provision
for such future assessments. Assessments charged to expense during the fiscal
years ended March 31, 1994, 1995 and 1996 were $-0- million, $1.5 million and
$1.6 million, respectively. Such assessments are credited against the Company's
administrative tax.
Upon conversion to a stock property and casualty insurer, ESIF will be
subject to assessment by a separate guaranty fund. Such assessments will not be
credited against ESIF's administrative tax.
Concentrations of Credit or Financial Risk
Florida law allows ESIF to write policies only in the State of Florida.
Therefore, all ESIF's premium revenues for the fiscal years ended March 31,
1994, 1995 and 1996 were derived from policies offered to customers located in
Florida. Accordingly, ESIF could be adversely affected by economic downturns,
significant unemployment, and other conditions that may occur from time-to-time
in Florida, which may not as significantly affect its more geographically
diversified competition.
SHC has significant amounts of revenue associated with its third-party
processing as a result of its contracts with several self-insurance funds.
Changes with respect to these contracts could adversely affect ESIF.
As further described in Note 6, ESIF has significant amounts of reinsurance
recoverables as a result of ceding reinsurance under specific and aggregate
reinsurance treaties.
Intangible Assets
Cost in excess of net assets of businesses acquired totaling $49 million
was recorded in conjunction with the January 1996 acquisition of SHC. This
intangible asset is being amortized on a straight-line basis over 25 years.
ESIF's cost associated with the purchase of customer listings recorded in
conjunction with the January 1996 acquisition of SHC totals approximately $6.5
million. This intangible asset is being amortized on a straight-line basis over
10 years.
At the balance sheet date, ESIF evaluates the recoverability of the cost in
excess of net assets acquired and the cost associated with customer listings
through a comparison of forecasted undiscounted cash flows of SHC and the
remaining asset balances.
Equipment and Software
Equipment and software are recorded at cost. Depreciation is computed using
the straight-line method over the useful lives of the related assets.
Cash and Cash Equivalents
ESIF considers all highly liquid investments with original maturities of
three months or less to be cash equivalents.
F-11
<PAGE> 93
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Bad Debt Allowance
The bad debt allowance is based on ESIF's experience with uncollectible
premiums receivable and represents ESIF's best estimate of the ultimate
uncollectible amounts incurred through the balance sheet date.
2. INVESTMENTS
The amortized cost and the fair value of debt security investments are
summarized as follows:
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
AT MARCH 31, 1995
U.S. Treasury and government agencies....... $132,116 $ 671 $2,545 $130,242
States and political subdivisions........... 60,404 324 1,023 59,705
Other debt securities....................... 14,087 72 9 14,150
-------- ------ ------ --------
Total debt securities available-for-sale...... $206,607 $1,067 $3,577 $204,097
======== ====== ====== ========
AT MARCH 31, 1996
U.S. Treasury and government agencies....... 57,655 487 909 57,233
States and political subdivisions........... 68,697 934 270 69,361
Industrial and miscellaneous................ 37,258 850 284 37,824
Mortgage-backed securities:
U.S. government agencies................. 14,320 240 160 14,400
-------- ------ ------ --------
Total debt securities available for sale...... $177,930 $2,511 $1,623 $178,818
======== ====== ====== ========
</TABLE>
The amortized cost and estimated fair value of debt securities at March 31,
1996, by contractual maturity, are shown below. Actual maturities may differ
from contractual maturities because certain borrowers may have the right to call
or prepay obligations with or without call or prepayment penalties.
<TABLE>
<CAPTION>
AMORTIZED FAIR
COST VALUE
--------- --------
(IN THOUSANDS)
<S> <C> <C>
Years to maturity:
One or less............................................... $ 2,366 $ 2,394
After one through five.................................... 58,621 58,743
After five through ten.................................... 89,727 90,094
After ten................................................. 12,896 13,187
-------- --------
$163,610 $164,418
Mortgage-backed securities................................ 14,320 14,400
-------- --------
Total....................................................... $177,930 $178,818
======== ========
</TABLE>
Proceeds from the sales of investments in debt securities during fiscal
year ending March 31, 1994 were $26.3 million. No gains or losses were realized
on those sales. Proceeds from the sales of investments in debt securities during
fiscal year ending March 31, 1995 were $21.8 million. No gains or losses were
realized on those sales. Proceeds from the sales of investments in debt
securities during fiscal year ending March 31, 1996 were $195.5 million. Gross
gains of $3.1 million and gross losses of $1.0 million were realized on those
sales.
F-12
<PAGE> 94
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Unrealized gains and losses on investments in preferred and common stocks
are reported directly in equity and do not affect operations. The gross
unrealized gains and losses on, and the cost and fair value of, those
investments are summarized as follows:
<TABLE>
<CAPTION>
GROSS GROSS
UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
------- ---------- ---------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
AT MARCH 31, 1995
Preferred stocks.............................. $ 1,924 $ 6 $ 16 $ 1,914
Common stocks................................. 8,717 353 92 8,978
------- ------ ---- -------
Total........................................... $10,641 $ 359 $108 $10,892
======= ====== ==== =======
AT MARCH 31, 1996
Preferred stocks.............................. $ 3,167 $ 18 $ 29 $ 3,156
Common stocks................................. 9,576 1,640 121 11,095
------- ------ ---- -------
Total........................................... $12,743 $1,658 $150 $14,251
======= ====== ==== =======
</TABLE>
Major categories of ESIF's investment income are summarized as follows:
<TABLE>
<CAPTION>
YEAR ENDED MARCH 31,
-----------------------------
1994 1995 1996
------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Income from:
Bonds............................................... $ 6,829 $ 9,788 $10,923
Preferred stocks.................................... -- -- 215
Common stocks....................................... 6 16 319
Short-term investments and cash..................... 3,675 2,401 1,753
------- ------- -------
Net investment income................................. $10,510 $12,205 $13,210
======= ======= =======
</TABLE>
The Florida DOI requires cash and investments to be held in trust for the
Florida DOI for 10% of statutory basis loss reserves and the 1986-1995 fund
years aggregate reserve plans. The aggregate plans approved by the Florida DOI
require the interest earned on the related reserves to accumulate with the
restricted principal. The reserves are reviewed annually and a revised funding
plan is submitted to the Florida DOI. At March 31, 1995 and 1996, the amount in
trust is approximately $59.1 million and $62.9 million, respectively. Subsequent
to March 31, 1996, the amount in trust was reduced to $50.9 million, consisting
of $23.8 million related to 10% of statutory basis loss reserves and $26.8
million for the 1986-1995 fund year aggregate reserves.
F-13
<PAGE> 95
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. PROPERTY AND EQUIPMENT
The major components of equipment and software at March 31, 1996 are as
follows (in thousands):
<TABLE>
<S> <C>
Furniture, fixtures and equipment........................... $ 786
Data processing equipment................................... 665
Airplane.................................................... 968
Leasehold improvements...................................... 103
Software.................................................... 176
Automobiles................................................. 17
------
2,715
Less accumulated depreciation............................... 186
------
$2,529
======
</TABLE>
Depreciation expense for the fiscal year ended March 31, 1996 was $0.2
million. Substantially all equipment and software was acquired in the January
1996 acquisition of SHC.
4. INTANGIBLES
The majority of ESIF's intangible assets were recorded in connection with
the acquisition of SHC and are stated at cost, which represents fair value as of
the acquisition date, less accumulated amortization, and include purchased
software, customer accounts and contracts, and the excess of the purchase price
over the fair value of identifiable net assets acquired. Purchased software,
customer accounts and contracts are being amortized on a straight-line basis
over the estimated useful lives and contract period which range from three to
ten years. The excess of cost over the fair value of identifiable net assets
acquired is being amortized on a straight-line basis over 25 years.
Intangible assets consist of the following as of March 31, 1996 (in
thousands):
<TABLE>
<S> <C>
Unamortized debt acquisition costs.......................... $ 757
Purchased software.......................................... 6,300
Goodwill.................................................... 47,185
Customer accounts and contracts............................. 6,608
-------
60,850
Less accumulated amortization............................... 896
-------
$59,954
=======
</TABLE>
5. LEASES
SHC leases office premises and automobiles under noncancellable operating
leases which expire at various dates through the year 2001. These leases
generally contain renewal options and escalation clauses based on increases in
lessors' operating expenses and other charges. ESIF anticipates that most leases
will be renewed or replaced upon expiration.
F-14
<PAGE> 96
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Future minimum annual payments at March 31, 1996 for all noncancellable
leases are (in thousands):
<TABLE>
<S> <C>
Years Ending March 31:
1997...................................................... $1,221
1998...................................................... 1,322
1999...................................................... 1,243
2000...................................................... 1,176
2001...................................................... 101
------
Total minimum future lease payments......................... 5,063
Income from subleases....................................... (124)
------
Net minimum future lease payments........................... $4,939
======
</TABLE>
In excess of 80% of the future lease commitments relates to rented office
premises from certain trustees of ESIF.
Rental expense for the fiscal year ended March 31, 1996 for operating
leases totaled $0.4 million.
6. REINSURANCE
In accordance with general practice in the insurance industry, ESIF's
insurance subsidiaries are engaged in reinsurance transactions to cede risk to
other companies. Reinsurance ceded contracts do not relieve ESIF and its
insurance subsidiaries from their obligation to policyholders, as they remain
liable to their policyholders to the extent that any reinsurer does not meet its
obligations for reinsurance ceded to it under reinsurance contracts. The largest
net amount retained by ESIF or its subsidiaries on any one occurrence is
$500,000 with a $750,000 deductible for each of the fiscal years ended March 31,
1995 and 1996. ESIF currently has the following coverages under specific and
aggregate reinsurance agreements:
F-15
<PAGE> 97
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
SPECIFIC REINSURANCE
(IN THOUSANDS)
<TABLE>
<CAPTION>
FISCAL
YEAR SPECIFIC
ENDED SPECIFIC OCCURRENCE
MARCH 31, CARRIER ATTACHMENT LIMIT
- --------- ------- ---------- ----------
<C> <S> <C> <C>
1982 INA $ 100 $ 2,000
Employers Re 2,100 3,000
1983 INA 125 2,000
Employers Re 2,125 3,000
1984 Employers Re 125 2,000
INA 2,125 Statutory
1985 Employers Re 125 2,000
INA 2,125 Statutory
1986 Employers Re 225 20,000
1987 Safety Mutual(1) 1,000 5,000
Old Republic(2) 1,000 1,000
National Union(2) 2,000 8,000
1988 Old Republic 1,000 5,000
1989 Old Republic 1,000 5,000
1990 Transamerica 1,000 15,000
1991 Transamerica 1,000 15,000
1992 Transamerica 1,000 25,000
1993 Transamerica 1,000 25,000
1994 Lloyd's 500 500
Transamerica 1,000 Statutory
1995 Lloyd's 500 500
Continental Casualty 1,000 Statutory
1996 Federal Insurance Co. 500 500
Federal Insurance Co. 1,000 1,000
Continental Casualty 2,000 Statutory
</TABLE>
- ---------------
(1) 4/1/86 - 5/31/86
(2) 6/1/86 - 3/31/87
F-16
<PAGE> 98
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
AGGREGATE REINSURANCE
(IN THOUSANDS)
<TABLE>
<CAPTION>
FISCAL
YEAR
ENDED AGGREGATE AGGREGATE
MARCH 31 CARRIER ATTACHMENT LIMIT
- --------- ------- ---------- ---------
<C> <S> <C> <C>
1982 INA $ 11,542 $ 2,000
Employers Re 13,542 3,000
INA 16,542 Statutory
1983 INA 11,365 2,000
Employers Re 13,365 3,000
INA 16,365 Statutory
1984 Employers Re 14,341 2,000
INA 16,341 Statutory
1985 Employers Re 17,814 3,000
INA 20,814 Statutory
1986 Employers Re 40,091 301
1987 N/A N/A N/A
1988 N/A N/A N/A
1989 Crossroads 90,648 19,000
1990 Crossroads 110,973 25,000
1991 Crossroads 130,726 31,000
1992 Crossroads 113,015 31,000
1993 Crossroads 141,956 33,401
1994 Crossroads 146,016 34,357
1995 Crossroads 133,800 31,482
1996 Crossroads 115,970 27,287
</TABLE>
Insurance premiums for the fiscal years ended March 31, 1994, 1995 and 1996
are summarized as follows:
<TABLE>
<CAPTION>
1994 1995 1996
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Direct premiums earned................................. $155,559 $135,033 $119,028
Reinsurance ceded...................................... 7,118 6,544 4,135
-------- -------- --------
Net premiums earned.................................... $148,441 $128,489 $114,893
======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
1994 1995 1996
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Gross premiums written................................. $166,370 $153,844 $130,528
Ceded premiums written................................. 10,284 9,417 9,232
-------- -------- --------
Net premiums written................................... $156,086 $144,427 $121,296
======== ======== ========
</TABLE>
F-17
<PAGE> 99
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Losses and LAE incurred for the fiscal years ended March 31, 1994, 1995 and
1996 are summarized as follows:
<TABLE>
<CAPTION>
1994 1995 1996
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Direct losses and LAE.................................. $113,321 $ 74,368 $102,832
Reinsurance ceded...................................... 4,910 5,252 7,988
-------- -------- --------
Net losses and loss adjustment expenses incurred....... $108,411 $ 69,116 $ 94,844
======== ======== ========
</TABLE>
Reinsurance ceded premiums and losses included in the preceding table
reflect the elimination of amounts assumed by USEI through retrocession by
Crossroads Insurance Company, Limited ("Crossroads") of amounts ceded by ESIF to
Crossroads as described in the following paragraph.
Of the reinsurance ceded amounts above for fiscal year ended March 31,
1996, premiums of $5.2 million, and losses and loss adjustment expenses of $0.9
million, are attributable to reinsurance agreements with Crossroads, a Bermuda
domiciled insurance company, in which a Trustee of ESIF has an ownership
interest. Crossroads is licensed to do business in Florida and is a member of
the Florida Insurance Guaranty Association. Fifty percent of business ceded to
Crossroads has been retroceded by Crossroads to USEI. All of ESIF's aggregate
excess reinsurance coverage for fiscal years ended March 31, 1989, 1993, 1994
and 1995 is also ceded to Crossroads. At March 31, 1995 and 1996, loss and LAE
reserves recoverable of approximately $10.8 million and $9.4 million,
respectively (net of amounts retroceded to USEI), are attributable to excess
reinsurance agreements with Crossroads. For the fiscal years 1986, 1987, 1990,
1991 and 1992, effective aggregate excess reinsurance is not currently in place
because these years have been self-funded or because the coverages have expired.
Exposure to significant adverse development for these years is considered
minimal due to the maturity of the loss development for these years.
In fiscal years ended March 31, 1995 and 1996, ESIF did not commute any
ceded reinsurance nor did it enter into or engage in any loss portfolio
transfers. ESIF remains obligated for amounts ceded in the event that the
reinsurers do not meet their obligations.
ESIF's reinsurance recoverable asset at March 31, 1996 is comprised of
amounts related to reinsurance agreements with the following companies (in
thousands):
<TABLE>
<CAPTION>
PAID UNPAID
REINSURANCE CARRIER CLAIMS CLAIMS TOTAL
------------------- ------ -------- --------
<S> <C> <C> <C>
American Re.............................................. $ -- $ 286 $ 286
Cigna.................................................... 297 -- 297
Continental Casualty..................................... -- 10,531 10,531
Crossroads............................................... 917 9,375 10,292
Employers Re............................................. 595 6,805 7,400
Federal Ins. Co.......................................... -- 9,626 9,626
INA...................................................... -- 5,678 5,678
Lloyds of London......................................... -- 12,274 12,274
Old Republic............................................. 53 17,242 17,295
Transamerica............................................. 20 37,820 37,840
------ -------- --------
Total.......................................... $1,882 $109,637 $111,519
====== ======== ========
</TABLE>
Substantially all of the recoverable amounts related to paid claims have
been outstanding less than ninety days at the balance sheet date. The
reinsurance recoverable amounts related to unpaid claims are calculated
considering the provisions of the specific and aggregate reinsurance agreements
and using ultimate losses by accident year consistent with the reported loss and
LAE liabilities.
F-18
<PAGE> 100
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
7. FEDERAL INCOME TAXES
ESIF and its subsidiaries file a consolidated federal income tax return.
ESIF does not have a tax sharing agreement with two of its subsidiaries, ESGA
and USEI. ESIF does not collect from or refund to these subsidiaries the amount
of income taxes or benefits which would result if the entities filed separate
returns. An informal tax sharing agreement exists between ESIF and SHC such that
the amount of taxes or tax benefits are shared as if separate returns were
filed.
Income before federal income taxes differs from taxable income principally
due to tax-exempt investment income, dividends-received tax deductions, and
differences in loss and LAE discounting and unearned premium reserves for tax
and financial reporting purposes.
After carryback of the fiscal year ended March 31, 1996 operations loss to
prior years, federal income taxes of $6.9 million and $12.2 million for fiscal
years ended March 31, 1994 and 1995, respectively, would be subject to recovery
in the event that ESIF incurs net operating losses within three years of the
years for which such taxes were paid. State taxes paid were $0.8 million for
both fiscal years ended March 31, 1995 and 1996.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes.
Significant components of ESIF's deferred tax liabilities and assets as of
March 31, as calculated in accordance with FASB 109, are as follows (in
thousands):
<TABLE>
<CAPTION>
1995 1996
------- -------
<S> <C> <C>
Deferred tax liabilities:
Unrealized investment gains............................... $ -- $ 902
Special Disability Trust Fund recoverables................ 511 175
Reinsurance premium adjustment............................ -- 1,494
Intangible assets......................................... -- 3,684
------- -------
Total deferred tax liabilities.............................. 511 6,255
Deferred tax assets:
Discount on loss and LAE reserves......................... 16,601 18,936
Unallocated remittances................................... 1,372 1,161
Uncollectible premiums.................................... 788 564
Other..................................................... -- 455
Unrealized investment losses.............................. 850 --
------- -------
19,611 21,116
Valuation allowance for deferred tax assets............... -- --
------- -------
Total deferred tax assets................................... 19,611 21,116
------- -------
Net deferred tax assets..................................... $19,100 $14,861
======= =======
</TABLE>
ESIF has made an election under the Internal Revenue Code of 1986 to treat
income tax payments attributable to loss reserve discounting as special
estimated tax payments which are specifically recoverable upon reversal of the
discounting effects. Accordingly, the deferred tax assets attributable to loss
reserve discounting are considered to be fully recoverable. ESIF also has
significant tax loss carryback potential for the fiscal years ended March 31,
1994 and 1995. For those reasons, a deferred tax valuation allowance is not
considered necessary.
F-19
<PAGE> 101
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
ESIF's consolidated federal income tax liability (asset) at March 31 is
summarized as follows (in thousands):
<TABLE>
<CAPTION>
1995 1996
-------- --------
<S> <C> <C>
Current..................................................... $ 4,878 $ (9,690)
Deferred.................................................... (19,100) (14,861)
-------- --------
Total net asset............................................. $(14,222) $(24,551)
======== ========
</TABLE>
Significant components of the provision for income taxes for the fiscal
years ended March 31, attributable to continuing operations are as follows (in
thousands):
<TABLE>
<CAPTION>
1995 1996
------- -------
<S> <C> <C>
Current tax expense (benefit)............................... $11,388 $ 1,424
Deferred taxes.............................................. (397) (1,930)
------- -------
Total income tax expense (benefit) on income................ $10,991 $ (506)
======= =======
</TABLE>
Income taxes paid by ESIF totaled $10.5 million, $12.2 million and $11.2
million in 1994, 1995 and 1996, respectively.
The reconciliation of income tax expense (benefit) for the fiscal years
ended March 31, attributable to continuing operations computed at the U.S.
federal statutory tax rate of 35%, to income tax expense (benefit) is as follows
(in thousands):
<TABLE>
<CAPTION>
1994 1995 1996
------ ------- -------
<S> <C> <C> <C>
Income tax (at 35% of pretax income or loss)............... $4,697 $10,554 $ (43)
Tax-exempt investment income............................... -- (673) (1,067)
Non taxable/deductible (income) expenses................... 51 579 32
Goodwill amortization...................................... -- -- 177
State income taxes......................................... (65) (600) 495
Other items, net........................................... (149) 1,130 (99)
------ ------- -------
Provision (credit) for federal income tax expense
(benefit)................................................ $4,534 $10,990 $ (505)
====== ======= =======
</TABLE>
8. LOSSES AND LAE
The reserves for unpaid losses and LAE are estimated using individual
case-basis valuations and statistical analyses. These estimates are subject to
the effects of trends in loss severity and frequency. Although some variability
is inherent in such estimates, management believes that the reserves for losses
and LAE are adequate. The estimates are reviewed annually by independent
consulting actuaries and adjusted as necessary as experience develops or new
information becomes known; such adjustments are included in current operations.
F-20
<PAGE> 102
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table provides a reconciliation of the beginning and ending
reserve balances for losses and LAE for fiscal years ended March 31, 1994, 1995
and 1996:
<TABLE>
<CAPTION>
YEAR ENDED MARCH 31,
---------------------------------
1994 1995 1996
--------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Net reserves for losses and LAE at beginning of
period............................................ 257,307 274,102 259,085
Less: Recoverable from Florida SDTF(1).............. (6,745) (9,929) (15,879)
--------- --------- ---------
Net reserves for losses and LAE less SDTF
recoverable asset at beginning of year............ 250,562 264,173 243,206
Add provision for claims occurring in:
The current year.................................. 118,889 94,520 84,058
Prior years....................................... (10,478) (25,404) 10,786
--------- --------- ---------
Incurred losses during the current year............. 108,411 69,116 94,844
Deduct payments for claims occurring in:
The current year.................................. 17,704 16,857 15,432
Prior years....................................... 77,096 73,226 64,683
--------- --------- ---------
Claim payments during the current year.............. 94,800 90,083 80,115
Net reserves for losses and LAE less SDTF
recoverable asset at end of period................ 264,173 243,206 257,935
Add: Recoverable from Florida SDTF(1)............... 9,929 15,879 20,060
--------- --------- ---------
Net reserves for losses and LAE at end of period.... 274,102 259,085 277,995
Add: Reinsurance recoverables (exclusive of
recoverables on paid losses)................... 93,898 108,306 109,637
--------- --------- ---------
Gross reserves for losses and LAE at end of period
(GAAP basis)...................................... $ 368,000 $ 367,391 $ 387,632
========= ========= =========
</TABLE>
- ---------------
(1) The change in the SDTF Recoverable asset is included in incurred losses in
the Statement of Income.
The foregoing reconciliation also shows that a $25.4 million reserve
redundancy emerged during the fiscal year ended March 31, 1995. This amount
represents the release of certain loss reserves previously carried which were
determined, based on comparisons to actuarially projected amounts, to be
redundant. The foregoing reconciliation shows that a $10.8 million reserve
strengthening in the March 31, 1995 reserve emerged during the fiscal year ended
March 31, 1996. The increased losses and LAE expense resulted principally from
settling case reserves established in prior years for more than previously
anticipated.
Statutory basis loss reserves were determined using paid loss data net of
historic SDTF recoveries; GAAP basis loss reserves were determined using paid
loss data gross of SDTF recoveries. This adjustment increased loss reserves by
$15.5 million, $24.8 million and $31.4 million at March 31, 1994, 1995 and 1996,
respectively, and increased reinsurance recoverables by $7.2 million, $10.3
million and $11.8 million at March 31, 1994, 1995 and 1996, respectively. In
addition ESIF has recorded, as an asset, amounts recoverable from the SDTF based
upon ESIF's historical collection experience and the amount of claims identified
as subject to SDTF recovery. The recoverable amount recorded at March 31, 1994,
1995 and 1996 was $9.9 million, $15.9 million and $20.1 million, respectively.
In order to quantify the amounts recoverable from the SDTF, ESIF reviews its
claims that have been identified as subject to SDTF recovery considering ESIF's
historical recovery experience on claims submitted to the SDTF. In addition,
ESIF estimates the amount of claims it expects to recover over the next four
years based on actual collection experience for the most recent two years, and
discounts the expected recoveries using an appropriate interest rate. The
amounts reflected as recoverables from the SDTF were based on the discounted
expected collection amounts rather than on the total claims identified as
subject to SDTF recovery.
F-21
<PAGE> 103
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The SDTF reinsurance recoverable results from calculating such recoverables
using loss and LAE reserves computed using paid losses gross of SDTF recoveries
and in consideration of expected recoveries from SDTF. Certain of the claims
used in the determination of the SDTF recoverable are of an amount which will
pierce reinsurance layers. The Company will pursue recovery of such claims under
the provisions of its reinsurance agreements. Subsequently, as the Company
remits the claims to the SDTF, and ultimately collects these claims from SDTF,
the Company will remit to the reinsurers their portion of the SDTF recoveries.
The aggregate recoverable from SDTF asset and the SDTF related reinsurance
recoverable, which approximates the amount of the increase in loss reserves
resulting from determining the GAAP basis loss reserves using paid loss data
gross of SDTF recoveries, represents managements best estimate of the aggregate
amounts that will be recovered.
LAE assumed in the acquisition of SHC represents unallocated LAE reserves
established by ESIF that were, prior to the acquisition, accrued by SHC under
the administrator's contract between ESIF and SHC.
9. ACCRUED RETROSPECTIVE PREMIUMS
Certain workers' compensation insurance policies issued by ESIF are
retrospectively rated, and premiums are based on loss experience incurred under
these contracts to date. Accrued retrospectively rated premiums, including those
relating to bulk incurred but not reported, have been determined by or allocated
to individual policyholder accounts. These amounts are summarized as follows:
<TABLE>
<CAPTION>
MARCH 31,
-----------------
1995 1996
------- -------
(IN THOUSANDS)
<S> <C> <C>
Accrued retrospective premium............................... $44,837 $33,278
</TABLE>
10. EQUITY
ESIF and its insurance subsidiaries, subsequent to the conversion to a
stock property and casualty company, will have legal restrictions as to the
transfer of funds in the form of dividends, loans, and advances. These
restrictions, determined in accordance with statutory reporting practices,
generally limit the payment of dividends to amounts based upon statutory equity
or profits and limit the amount of certain investments to specified percentages
of statutory admitted assets. At March 31, 1996, under regulations applicable to
stock property and casualty insurance companies, $1.6 million of ESIF's
statutory net assets of $16.3 million could be transferred from the insurance
entities subject to regulatory approval.
Equity and net income as determined in accordance with statutory accounting
practices for self-insurance funds as of and for the three fiscal years ended
March 31, 1994, 1995 and 1996 are as follows:
<TABLE>
<CAPTION>
NET INCOME
MARCH 31, EQUITY (LOSS)
--------- ------- ----------
(IN THOUSANDS)
<S> <C> <C>
1994........................................................ $22,311 $ 2,511
1995........................................................ 43,046 22,286
1996........................................................ 16,373 (4,660)
</TABLE>
As a self-insurance fund, ESIF recorded for statutory reporting an asset of
$42.9 million and $47.3 million at March 31, 1995 and 1996, respectively, for
future investment income determined by discounting loss and LAE reserves at a
statutory prescribed rate. Upon conversion to a stock property and casualty
insurer, ESIF will be permitted to record discounts only on the indemnity
portion of permanent disability cases. The amount of such discount is estimated
at $4.9 million and $4.7 million at March 31, 1995 and March 31, 1996,
respectively. It is ESIF's intention to utilize proceeds of a public offering to
meet statutory basis capital and equity requirements for a stock property and
casualty company.
F-22
<PAGE> 104
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In order to improve the regulation of insurer solvency, the National
Association of Insurance Commissioners ("NAIC") issued a model law to implement
risk-based capital ("RBC") requirements for property and casualty insurance
companies, which are designed to assess capital adequacy and to raise the level
of protection that statutory equity provides for policyholder obligations. The
RBC formula for property and casualty insurance companies measures these major
areas of risk facing property and casualty insurers: (i) underwriting, which
encompasses the risk of adverse loss development and inadequate pricing; (ii)
declines in asset values arising from credit risk; and (iii) declines in asset
values arising from investment risks. Pursuant to the model law, insurers having
less statutory equity than required by the RBC calculation will be subject to
varying degrees of regulatory action, depending on the level of capital
inadequacy. Florida, ESIF's state of domicile, has yet to adopt the provisions
of the RBC model law. Upon completion of the conversion and recapitalization,
ESIF's insurance subsidiaries intend to maintain statutory basis equity in
excess of the amount required by Florida law.
11. COMMITMENTS AND CONTINGENCIES
ESIF, in the normal course of business, is named as a defendant in various
legal actions arising principally from claims made under insurance policies and
contracts. Those actions are considered by ESIF in estimating the loss and LAE
reserves. ESIF's management believes that the resolution of those actions will
not have a material effect on ESIF's financial position or results of
operations.
12. CHANGE IN ACCOUNTING ESTIMATES
During the fiscal year ended March 31, 1996, ESIF refined its method of
estimating accrued retrospective premiums. Prior to the 1996 fiscal year, ESIF
estimated the accrued retrospective premiums using aggregate premium and loss
data. The estimation methodology was revised in 1996 such that individual member
premium and loss data was utilized in the calculation. The refinement to using
more detailed data to perform the estimation was implemented by management in
order to more accurately estimate the accrued retrospective premium amounts.
This change decreased the accrued retrospective premium asset and equity at
March 31, 1996 by approximately $9.3 million and $6.0 million, respectively, and
decreased operations results for the fiscal year ended March 31, 1996 by
approximately $6.0 million.
13. SDTF
The State of Florida maintains the SDTF for the purpose of providing
benefits to workers who have a pre-existing condition and incur a second or
subsequent injury. The SDTF is funded through annual assessments against
workers' compensation insurers which are based on a percentage of gross workers'
compensation premiums written.
The SDTF has not charged adequate assessments to actuarially fund its
claims liability. In 1996, the Florida legislature reauthorized the SDTF for
four years; however, in the future, the Florida legislature may impose greater
assessments on insurance carriers, such as ESIF, to satisfy pending claims.
Moreover, it is not possible to predict how the SDTF will operate, if at all, in
the future after the reauthorized period. Changes in the SDTF's operations which
decrease the availability of recoveries from the SDTF, or increase the SDTF
assessments payable by ESIF, or changes in regulations which further limit
ESIF's ability to reduce statutory basis loss reserves for a portion of SDTF
future recoverable amounts, may have a material adverse effect on ESIF's
business, financial condition or results of operations. Discontinuance of the
SDTF could have either a favorable or unfavorable effect on ESIF depending on
the relation of the amount of assessments by SDTF to the amount of recoveries
from SDTF. If the SDTF is discontinued, ESIF believes that the existing
reimbursement obligations of the SDTF would become general obligations of the
State of Florida, although there is no assurance that a reviewing court would
adopt that view. The SDTF has made no acknowledgment with regard to the
enforceability of its reimbursement obligations to insurers such as ESIF.
F-23
<PAGE> 105
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Loss and LAE reserves included in the accompanying financial statements are
presented gross of future SDTF recoveries and have been determined using
historical loss data which excludes SDTF recoveries.
ESIF has recorded an SDTF recoverable of $15.8 million and $20.1 million at
March 31, 1995 and 1996, respectively, for the estimated amounts expected to be
received from the SDTF. The estimated amount of recoveries, which is
management's best estimate of the amount that will be recovered, was based on
claims identified as subject to SDTF recovery as well as ESIF's recovery
experience.
Amounts recovered from SDTF for the fiscal years ended March 31, 1994, 1995
and 1996 were $4.5 million, $5.7 million and $5.6 million, respectively.
Assessments paid by ESIF to the SDTF were $5.5 million, $4.7 million and $5.6
million for the fiscal years ended March 31, 1994, 1995 and 1996, respectively.
ESIF records assessments from SDTF as premiums are written.
14. ACQUISITION OF SHC
On January 16, 1996, ESIF purchased all of the outstanding capital stock of
SHC. The purchase price consisted of $26.0 million paid in cash by ESIF, $11.5
million in cash distributed by SHC, and $44.0 million of debt incurred by SHC
(see Note 15). SHC is a third party administrator which provides insurance
related services (including marketing, policy issuance and servicing, claims
processing and administration, loss control, brokerage, audits, financial and
data processing services and risk management services) to ESIF, four other
self-insurance funds and a property and casualty insurance company. The
acquisition was accounted for using the purchase method, and the results of
operations of SHC are included in the consolidated statement of operations from
the date of acquisition.
The following unaudited pro forma information presents the consolidated
results of operations of ESIF and SHC as if the acquisition had been effective
at April 1, 1994 and April 1, 1995, respectively, after giving effect to
adjustments to reflect the acquisition. This information is intended for
informational purposes only and may not be indicative of ESIF's future results
of operations:
<TABLE>
<CAPTION>
YEAR ENDED MARCH 31,
--------------------
1995 1996
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Total revenues.............................................. $185,693 $169,178
Income (loss) before income tax expense..................... 39,109 3,330
Net income (loss)........................................... 24,576 2,496
</TABLE>
To comply with requirements of the Florida DOI, SHC's chairman has
personally indemnified ESIF up to a maximum of $5.0 million for certain loss,
injury or damage to ESIF which may result from the acquisition of SHC. Such
indemnification will expire on the earlier of January 11, 2001 or on the date
upon which the bank debt, incurred in the acquisition, is retired.
15. NOTES PAYABLE
In connection with the purchase of SHC by ESIF, SHC utilized a bank term
loan with rates based on LIBOR plus 3%. The balance as of March 31, 1996 for SHC
was $36.0 million. Also, a revolving bank credit facility with rates
approximating the prime rate was entered into as part of the agreement. The
balance as of March 31, 1996 for SHC for this agreement was $8.0 million.
Interest expense incurred as of March 31, 1996 was $0.8 million.
F-24
<PAGE> 106
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Maturities for the term loan and reductions in the availability of the
revolving credit facility are as follows:
<TABLE>
<CAPTION>
REDUCTION IN THE
AVAILABILITY OF
TERM THE REVOLVING
LOAN CREDIT FACILITY
------- ----------------
(IN THOUSANDS)
<S> <C> <C>
Years Ending March 31:
1997................................................ $ 4,650 970
1998................................................ 6,600 1,480
1999................................................ 6,600 1,480
2000................................................ 6,600 1,480
2001................................................ 6,600 1,480
Thereafter.......................................... 4,950 1,110
------- -------
$36,000 8,000
======= =======
</TABLE>
As collateral for the debt, SHC pledged the issued and outstanding stock of
SCI and three other wholly owned subsidiaries, Bridgefield Casualty Insurance
Company, Meritec Solutions, Inc. and Carolina Summit Healthcare, Inc. The credit
agreement contains certain covenants which require that certain financial ratios
and/or levels be maintained by SHC and its insurance subsidiary, Bridgefield
Casualty. Among these covenants are the following: operating leverage, fixed
charge coverage ratio, minimum stockholder equity and risk based capital for the
insurance subsidiary.
In addition, the credit agreement places certain operational restrictions
on SHC.
16. EMPLOYEE BENEFIT PLANS
ESIF's subsidiary, SCI, has a deferred savings and profit-sharing plan (the
"401(k)") covering substantially all employees of SHC. Under the 401(k), SCI
makes contributions equal to 75% of the participant's contributions, not to
exceed 6% of the participant's annual compensation. SCI's contributions to the
401(k) totaled $0.1 million for the period January 16, 1996 to March 31, 1996.
17. FAIR VALUES OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used by ESIF in estimating its
fair value disclosures for financial instruments:
- Cash and cash equivalents, short-term investments: The carrying amounts
reported in the balance sheet for these instruments approximate fair
values.
- Investment securities: Fair values for debt security investments are
based on quoted market prices.
- Premiums and accounts receivable: The carrying amounts of ESIF's
receivables approximate fair values.
- Notes payable: ESIF's subsidiary has $44.0 million of notes payable at
March 31, 1996 that approximates its fair value.
F-25
<PAGE> 107
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
ESIF's fair value of reinsurance recoverable approximates its carrying
value for March 31, 1995 and 1996, respectively, as summarized below:
<TABLE>
<CAPTION>
MARCH 31, 1995 MARCH 31, 1996
------------------- -------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
-------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Reinsurance recoverable....................... $110,141 $110,141 $111,519 $111,519
</TABLE>
18. DISCONTINUED OPERATIONS
Effective July 31, 1996, ESIF decided to discontinue its computer software
development operation. This business was acquired in the January 1996
acquisition of SHC. The disposition is expected to occur during the three months
ending December 31, 1996 by abandonment of the operation. ESIF expects to
recognize an after tax loss of approximately $0.9 million on the disposition of
this operation (including operating results for periods subsequent to March 31,
1996).
The financial statements reflect the operating results and the assets and
liabilities of the discontinued operations separately from continuing
operations. The net assets of the computer software development operation at
March 31, 1996 were as follows (in thousands):
<TABLE>
<S> <C>
Assets:
Cash and equivalents...................................... $ 24
Equipment................................................. 431
Other assets.............................................. 468
Software.................................................. 477
------
Total assets................................................ 1,400
Liabilities:
Accounts payable and operating liabilities................ 788
------
Net assets.................................................. $ 612
======
</TABLE>
The operating results of the computer software development subsidiary for
the period January 16, 1996 to March 31, 1996 were as follows (in thousands):
<TABLE>
<S> <C>
Revenue..................................................... $ 305
Expenses.................................................... 622
-----
Loss before income taxes.................................... $(317)
Income tax (benefit)........................................ (120)
-----
Net loss.................................................... $(197)
=====
</TABLE>
F-26
<PAGE> 108
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
19. DISPOSITION
Effective July 31, 1996, ESIF decided to terminate its efforts to develop a
healthcare subsidiary in North Carolina. This start up effort was initiated by
SHC prior to the acquisition of SHC by ESIF. The disposition of this subsidiary
by a sale of its stock is expected to be completed during the first quarter of
1997. ESIF expects to recognize an after tax loss of approximately $0.4 million
on the disposition of this subsidiary (including losses from operations
subsequent to March 31, 1996). The consolidated financial statements include the
operating results and assets and liabilities of this subsidiary. The net assets
of the healthcare subsidiary were as follows at March 31, 1996 (in thousands):
<TABLE>
<S> <C>
Assets:
Cash and equivalents...................................... $3,251
Equipment................................................. 81
Other assets.............................................. 70
------
Total assets................................................ $3,402
Liabilities:
Accounts payable and operating liabilities................ 946
------
Net assets.................................................. $2,456
======
</TABLE>
The operating results for the healthcare subsidiary for the period January
16, 1996 to March 31, 1996 were as follows (in thousands):
<TABLE>
<S> <C>
Revenue..................................................... $ 3
Expenses.................................................... 192
-----
Income (loss) before income taxes........................... (189)
Income tax (benefit)........................................ (71)
-----
Net income (loss)........................................... $(118)
=====
</TABLE>
20. SEGMENT INFORMATION
The operations of ESIF, prior to the January 1996 acquisition of SHC, were
solely in the workers' compensation insurance industry segment. Subsequent to
the acquisition of SHC, ESIF also operates in the insurance administration
segment. Financial information by industry segment for revenues, income before
income taxes, and identifiable assets are summarized as follows:
<TABLE>
<CAPTION>
WORKERS'
COMPENSATION INSURANCE INTERCOMPANY
TOTAL INSURANCE ADMINISTRATION ELIMINATION
-------- ------------ -------------- ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Year Ended March 31, 1994
Revenues............................. $158,591 $158,591 -- --
Income before income taxes........... $ 13,419 $ 13,419 -- --
Identifiable assets.................. $405,765 $405,765 -- --
Year Ended March 31, 1995
Revenues............................. $140,815 $140,815 -- --
Income before income taxes........... $ 30,154 $ 30,154 -- --
Identifiable assets.................. $425,206 $425,206 -- --
Year Ended March 31, 1996
Revenues............................. $140,328 $132,393 $15,051 $(7,116)
Income before from continuing
operations before income taxes.... $ (123) $ (1,559) $ 1,436 --
Identifiable assets.................. $492,178 $401,679 $90,499 --
</TABLE>
Depreciation expense and capital expenditures are not considered material.
F-27
<PAGE> 109
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The preceding financial information does not include the computer software
operations which are presented as discontinued operations in the accompanying
financial statements.
21. RELATED PARTY TRANSACTIONS
As more fully described in Note 5, ESIF has entered into office premises
lease agreements with certain Trustees of ESIF.
As more fully described in Note 6, ESIF has entered into reinsurance
agreements with an insurance company in which a Trustee of ESIF has an ownership
interest.
As more fully described in Note 14, to comply with requirements of the
Florida DOI, SHC's president and chief executive officer has personally
indemnified ESIF up to a maximum of $5.0 million for certain loss, injury, or
damage to ESIF, if any, which may result from the acquisition of SHC.
Entities in which SHC's president and chief executive officer held
ownership interests have provided certain transportation related services to
SHC. Fees paid by SHC to these entities aggregate approximately $0.08 million
and $0.4 million for the years ended March 31, 1995 and 1996, respectively.
SHC's president and chief executive officer is also a member of the Board
of Directors of Florida Retail Federation (the "Association"), which is the
sponsoring trade association for Florida Retail Federation Self Insurers Fund
("FRF"), one of the group self-insurance funds administered by SHC. The
Association, as the fund sponsor, is entitled to a fee equal to 1% of FRF's
premiums earned in each year, and SHC is obligated to pay such fee out of the
administrative fee it receives from FRF. During the fiscal years ended March 31,
1994, 1995 and 1996, SHC paid approximately $1.0 million, $1.0 million and $0.9
million to the Association for such fees. During the years ended March 31, 1994,
1995 and 1996, FRF paid to SHC fees for administrative services of approximately
$32.7 million, $30.5 million and $27.7 million, respectively.
F-28
<PAGE> 110
REPORT OF INDEPENDENT AUDITORS
Board of Trustees
Employers Self Insurers Fund
We have audited the accompanying consolidated balance sheet of Employers
Self Insurers Fund (the Company) and its subsidiaries as of September 30, 1996,
and the related consolidated statements of income, changes in equity, and cash
flows for the six months then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, consolidated financial statements referred to above present
fairly, in all material respects, the financial position of the Company and its
subsidiaries at September 30, 1996, and the results of their operations and
their cash flows for the six months then ended, in conformity with generally
accepted accounting principles.
The accompanying financial statements for 1995 were not audited by us and,
accordingly, we do not express an opinion on them.
ERNST & YOUNG LLP
Jacksonville, Florida
November 21, 1996
F-29
<PAGE> 111
EMPLOYERS SELF INSURERS FUND AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
SEPTEMBER 30,
----------------------
1995 1996
-------- --------
(UNAUDITED)
(IN THOUSANDS)
<S> <C> <C>
ASSETS
Invested assets:
Fixed maturities, available-for-sale...................... $191,263 $173,420
Preferred stock........................................... 2,956 3,787
Common stock.............................................. 15,228 12,298
Short-term investments.................................... 17,176 16,713
-------- --------
Total invested assets............................. 226,623 206,218
Cash and cash equivalents................................... 4,665 7,055
Premiums receivable (net of $2,000 and $2,000 allowance for
doubtful accounts, respectively).......................... 78,229 67,179
Accounts receivable......................................... -- 3,102
Reinsurance recoverable, including $8,000 and $10,000 at
September 30, 1995 and September 30, 1996, respectively,
from related party reinsurers............................. 107,451 103,861
Recoverable from Florida Special Disability Trust Fund...... 17,775 21,138
Accrued investment income................................... 3,646 2,810
Income taxes recoverable.................................... -- 6,234
Equipment and software...................................... -- 2,215
Non-compete agreement....................................... -- 100
Capitalized computer software costs......................... -- 5,408
Value assigned to future administration of insurance
contracts................................................. -- 6,140
Unamortized debt acquisition cost........................... -- 596
Excess of cost over net assets of business acquired......... -- 45,465
Deferred income taxes....................................... 17,514 15,952
Other assets................................................ 109 5,154
Net assets of healthcare subsidiary, held for disposition... -- 2,862
Net assets of discontinued operations....................... -- 678
-------- --------
Total assets...................................... $456,012 $502,167
======== ========
LIABILITIES AND EQUITY
Liabilities:
Loss and loss adjustment expenses......................... $364,210 $378,196
Debt...................................................... -- 36,500
Unearned premium and unallocated policyholder
remittances............................................ 51,208 46,000
Accounts payable and accrued expenses..................... 7,100 10,389
Taxes, licenses and fees.................................. 2,076 1,471
Deferred revenue.......................................... 34 4,618
Federal income taxes payable.............................. 297 --
-------- --------
Total liabilities................................. 424,925 477,174
Equity:
Retained earnings......................................... 26,848 24,045
Net unrealized appreciation (depreciation) on
available-for-sale securities.......................... 4,239 948
-------- --------
Total equity...................................... 31,087 24,993
-------- --------
Total liabilities and equity...................... $456,012 $502,167
======== ========
</TABLE>
See accompanying notes.
F-30
<PAGE> 112
EMPLOYERS SELF INSURERS FUND AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
SIX MONTHS ENDED
SEPTEMBER 30,
----------------------
1995 1996
----------- -------
(IN THOUSANDS)
(UNAUDITED)
<S> <C> <C>
Revenue:
Premiums earned........................................... $63,145 $49,029
Net investment income..................................... 7,598 6,363
Realized investment gains................................. 919 8
Administrative fees....................................... -- 17,432
Other income.............................................. 90 216
------- -------
Total revenue..................................... 71,752 73,048
Losses and expenses:
Losses and loss adjustment expenses....................... 42,365 32,135
Other underwriting, general and administrative expenses
(including administrative service fees paid to Summit
Holding Corporation of $12,573 for the six months ended
September 30, 1995).................................... 21,623 30,532
Amortization and depreciation............................. -- 2,499
Interest expense.......................................... -- 1,831
------- -------
Total losses and expenses......................... 63,988 66,997
------- -------
Income from continuing operations before income taxes....... 7,764 6,051
Income tax expense.......................................... 2,390 2,400
------- -------
Income from continuing operations........................... 5,374 3,651
------- -------
Discontinued operations:
Loss from operation (net of income tax benefit of $212 in
1996).................................................. -- (412)
Loss from disposition (net of income tax benefit of $289
in 1996)............................................... -- (478)
------- -------
Loss from discontinued operations......................... -- (890)
------- -------
Income before extraordinary charge.......................... 5,374 2,761
Extraordinary charge for conversion costs (net of income tax
benefit of $226 in 1996).................................. -- (375)
------- -------
Net income.................................................. $ 5,374 $ 2,386
======= =======
</TABLE>
See accompanying notes.
F-31
<PAGE> 113
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
SIX MONTHS ENDED SEPTEMBER 30, 1995 AND 1996
<TABLE>
<CAPTION>
UNREALIZED
APPRECIATION
(DEPRECIATION) OF
AVAILABLE-FOR-SALE
RETAINED SECURITY
EARNINGS INVESTMENTS TOTAL
-------- ------------------ -------
<S> <C> <C> <C>
(IN THOUSANDS)
Balance at March 31, 1995 (unaudited)....................... $21,474 $(1,409) $20,065
Net income (unaudited)...................................... 5,374 -- 5,374
Change in net unrealized investment gains (unaudited)....... -- 5,648 5,648
------- ------- -------
Balance at September 30, 1995 (unaudited)................... $26,848 $ 4,239 $31,087
======= ======= =======
Balance at March 31, 1996................................... $21,659 $ 1,495 $23,154
Net income.................................................. 2,386 -- 2,386
Change in net unrealized investment gains................... -- (547) (547)
------- ------- -------
Balance at September 30, 1996............................... $24,045 $ 948 $24,993
======= ======= =======
</TABLE>
See accompanying notes.
F-32
<PAGE> 114
EMPLOYERS SELF INSURERS FUND AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
SEPTEMBER 30,
----------------------
1995 1996
--------- ---------
(IN THOUSANDS) (UNAUDITED)
<S> <C> <C>
OPERATING ACTIVITIES:
Net income.................................................. $ 5,374 $ 2,386
Adjustments to reconcile net income to net cash provided by
operating activities:
Amortization and depreciation............................. -- 2,499
Net realized gains........................................ (429) (8)
Bad debt allowance........................................ -- 500
Increase in premiums receivable........................... (27,838) (29,586)
Decrease in accounts receivable........................... -- 56
Decrease in reinsurance recoverable....................... 2,690 11,883
Increase in special disability trust fund recoverable..... (1,896) (1,078)
(Increase) decrease in accrued investment income.......... (236) 127
Decrease in federal income tax recoverable................ -- 3,456
(Increase) decrease in deferred income taxes.............. 1,586 (1,090)
(Increase) decrease in other assets....................... 1,220 (1,905)
Decrease in discontinued operations....................... -- 24
Decrease in loss and loss adjustment expense.............. (3,182) (13,661)
Increase in unearned premium and unallocated policyholder
remittances............................................ 32,973 31,365
Decrease in accounts payable and accrued expenses......... (5,589) (3,960)
(Increase) decrease in taxes, license, and fees........... 214 (22)
Decrease in deferred revenue.............................. -- (2,767)
Decrease in federal income tax payable.................... (4,580) --
--------- ---------
Net cash provided (used) in operating activities............ 307 (1,781)
INVESTING ACTIVITIES:
Purchase of investments securities.......................... (410,101) (816,626)
Disposal and maturity of investment securities.............. 411,475 823,189
Purchase of equipment and software.......................... -- (258)
--------- ---------
Net cash provided by investing activities................... 1,374 6,305
FINANCING ACTIVITIES:
Decrease in notes payable................................... -- (7,500)
--------- ---------
Net cash provided by financing activities................... -- (7,500)
--------- ---------
Net increase (decrease) in cash and cash equivalents........ 1,681 (2,976)
Beginning cash and cash equivalents......................... 2,984 10,702
--------- ---------
Ending cash and cash equivalents
Continuing operations..................................... 4,665 7,055
Operations held for disposition........................... -- 556
Discontinued operations................................... -- 115
--------- ---------
Total ending cash and cash equivalents............ $ 4,665 $ 7,726
========= =========
</TABLE>
See accompanying notes.
F-33
<PAGE> 115
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1995 (UNAUDITED) AND SEPTEMBER 30, 1996
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
Organization
Employers Self Insurers Fund ("ESIF") is domiciled in Florida as a
self-insurance workers' compensation fund defined by section 624.4621, Florida
Statutes. ESIF is regulated by the Bureau of Self Insurance under the Department
of Insurance of the State of Florida ("Florida DOI").
ESIF was formed in 1978 for the stated purpose of providing statutory
workers' compensation coverage for certain Florida employers. ESIF's wholly
owned subsidiary, Employers Safety Group Association, Inc. ("ESGA"), is a trade
association primarily for employers in the construction, manufacturing,
wholesale and retail, and service industries and any employer that is a member
of ESGA may obtain coverage from ESIF. An indemnity agreement issued by ESIF
indemnifies the member employee against loss or liability relating to workers'
compensation insurance risk. Any employer that obtains workers' compensation
coverage from ESIF automatically becomes a member of ESIF with certain rights,
including the right to vote for the election of ESIF's Trustees, the right to
receive any distribution of profits that may be authorized by the Trustees and
the right to participate in the distribution of the surplus of ESIF in the event
of its liquidation. However, all members of ESIF are subject to joint and
several liability for the obligations of ESIF. ESIF has historically not been
operated for the purpose of generating profits, but it has retained a portion of
its earnings and profits to pay its obligations and avoid making assessments
against its members. ESIF has occasionally during its operating history paid a
distribution of profits to its members, but it has never made an assessment
against its members.
ESIF is a trust with a Board comprised of six Trustees, but no employees or
officers. ESIF's bylaws specifically direct the Board to engage an
administrator, and ESIF's administrator since its inception has been Summit
Consulting, Inc. ("SCI"). SCI performs all daily operational activities for
ESIF, including premium and claims processing, pursuant to a written agreement.
SCI also performs similar functions for four other group self-insurance funds
located in Florida, Louisiana and Kentucky.
SCI owns several subsidiaries formed to assist it in providing specialized
administrative services, and SCI is wholly owned by a holding company, Summit
Holding Corporation ("SHC"). Effective January 16, 1996, ESIF purchased all of
the outstanding stock of SHC (see Note 14 for a further discussion of this
acquisition). In addition to SHC and its subsidiaries, ESIF also owns a
reinsurance subsidiary, U.S. Employers Insurance, Inc. ("USEI").
Pursuant to an Amended Plan of Conversion and Recapitalization, and subject
to certain conditions stated therein, ESIF intends to convert to a stock
property and casualty insurance company. In such transaction, ESIF will become
wholly owned by a newly formed holding company and ESIF's members will receive
preferred stock of the holding company in exchange for their membership
interests.
Consolidation and Presentation
The accompanying consolidated financial statements include the accounts,
after intercompany eliminations, of ESIF and its wholly owned subsidiaries and
have been prepared in conformity with generally accepted accounting principles
("GAAP") applicable to stock property and casualty insurance companies, which
differ from statutory accounting practices prescribed or permitted by the
Florida DOI.
The financial statements as of September 30, 1995 and for the six months
then ended are unaudited. In the opinion of management, these unaudited
financial statements have been prepared in accordance with generally accepted
accounting principles and all adjustments, consisting of normal recurring
adjustments, considered necessary for a fair presentation have been included.
F-34
<PAGE> 116
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Use of Estimates and Assumptions
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect amounts reported in the
financial statements and accompanying notes. Such estimates and assumptions
could change in the future as more information becomes known which could impact
the amounts reported and disclosed herein.
Recognition of Revenues
Workers' compensation insurance premiums are based on rates established by
the National Council on Compensation Insurance ("NCCI"). Premium revenues
generally are recognized over the life of the related policies on the daily pro
rata method with a reserve for unearned premiums established for the unexpired
portion of the premiums applicable to those policies. For retrospectively rated
policies, the ultimate premium for a period is determined on the basis of the
insured's actual losses for that period. If the actual losses are less than
expected, ESIF may be required to refund a portion of the premiums previously
paid. ESIF considers loss development experience through the date of the
financial statements in estimating the ultimate premium and, as adjustments to
premiums become necessary as a result of loss development, such adjustments are
included in current operations.
Administrative fee revenue is recognized in proportion to the recognition
of earned premiums by the self-insurance funds at the contractual administrative
fee percentage of premiums. Adjustments to revenue for premium audits are
recorded in the period they occur. Fees for administrative services provided to
ESIF subsequent to the date of ESIF's acquisition of SHC have been eliminated in
the consolidated statement of operations.
Reinsurance premiums ceded are recorded and recognized on a pro rata basis
of earned premiums of the contract.
Income Taxes
Income taxes have been provided using the liability method in accordance
with Financial Accounting Standards Board ("FASB") Statement No. 109, Accounting
for Income Taxes. Under that method, deferred tax assets and liabilities are
determined based on the differences between financial reporting and tax bases of
assets and liabilities and are measured using enacted tax rates.
Investments
In 1993, the FASB issued Statement No. 115, Accounting for Certain
Investments in Debt and Equity Securities. Statement No. 115 requires that debt
securities are to be classified as either held-to-maturity (carried at amortized
cost), available-for-sale (carried at market with unrealized gains or losses
reported in equity), or trading (carried at market with unrealized gains or
losses reported in net income).
ESIF believes that it has the ability and intent to hold to maturity its
debt security investments. However, ESIF also recognizes there may be
circumstances where it may be appropriate to sell a security prior to maturity
in response to unforeseen changes in circumstances. Recognizing the need for the
ability to respond to changes in tax position and in market conditions, the ESIF
has designated its entire investment portfolio as available-for-sale.
Investments are reported in the accompanying balance sheets on the
following basis:
- Available-for-sale securities are reported at current market value.
Changes in market value of available-for-sale securities, after applicable
deferred income taxes, are reported as unrealized appreciation or
depreciation directly in equity and, accordingly, have no effect on net
income.
F-35
<PAGE> 117
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
- Equity security investments, consisting of common and nonredeemable
preferred stocks, are carried at current market value with changes in such
value reported as unrealized appreciation or depreciation directly in
equity, after applicable income taxes, having no effect on net income.
- Short-term investments are reported at cost.
The cost of securities sold is based on specific identification and the
resulting realized gains and losses are included in the determination of net
income.
In the normal course of business, ESIF is party to financial instruments,
none of which have significant off-balance-sheet risk.
Loss and Loss Adjustment Expenses
The reserve for unpaid loss and loss adjustment expenses ("LAE") represents
management's best estimate of the ultimate cost of the loss and LAE that are
unpaid at the balance sheet date including incurred but not reported claims.
Such reserve is established by management based upon: (i) results of actuarial
reviews which incorporate ESIF's experience with similar cases, estimates of
future claim trends, and historical trends such as recurring loss payment and
reporting patterns, claim closures and product mixes; (ii) facts known to the
company; and (iii) regulatory requirements. Such reserve is continually reviewed
and as adjustments become necessary, such adjustments are included in current
operations.
The reserve for permanent indemnity disability claims has been discounted
at 4% as permitted under Florida law. For GAAP purposes, discounting is computed
based on the ESIF's anticipated payout patterns and a discount rate consistent
with that permitted by section 625.091, Florida Statutes. The amount of such
discount was $4.8 million and $4.2 million at September 30, 1995 and 1996,
respectively.
Prior to the January 16, 1996 acquisition of SHC, certain unallocated LAE
of ESIF were provided by SHC under the administrative agreement between ESIF and
SHC. Subsequent to the acquisition, ESIF has included the liability for such
unallocated LAE in the loss and LAE liability.
Reinsurance
Under FASB Statement No. 113, Accounting and Reporting for Reinsurance of
Short-Duration and Long-Duration Contracts, all assets and liabilities related
to reinsurance ceded contracts are reported on a gross basis rather than the
previous practice of reporting such assets and liabilities net of reinsurance.
The amounts recoverable from reinsurers are classified separately on the balance
sheet.
The accompanying statements of operations reflect premiums and losses
incurred, net of reinsurance ceded (see Note 6). Reinsurance arrangements allow
management to control exposure to potential losses arising from large risks. A
significant portion of the reinsurance is effected under excess of loss
reinsurance contracts. Amounts recoverable from reinsurers are estimated in a
manner consistent with the loss and loss expense reserves associated with the
reinsured policies. Similarly, reinsurance premiums, losses and loss adjustment
expenses are accounted for on bases consistent with those used in accounting for
the related original policies issued and the terms of the reinsurance contracts.
Guaranty Fund Assessments
As a self-insurance fund, ESIF has periodically been assessed by a state
guaranty fund as part of that fund's activities to collect funds from solvent
self-insurance funds to cover certain losses to policyholders of insolvent
self-insurance funds, after assessment of such policyholders of the insolvent
funds. This type of guaranty fund is separate from the Florida Special
Disability Trust Fund (the "SDTF"), which is designed to pay insurers for
certain benefits paid to previously injured workers, as discussed in Note 13.
F-36
<PAGE> 118
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Florida law limits the assessment to a maximum of 2% of direct written
premiums annually, but because there are many uncertainties regarding the
ultimate amount of assessments, ESIF's policy has been to recognize its
obligation for guaranty fund assessments when it receives notice that an amount
is payable to the guaranty fund. At September 30, 1996, ESIF was not able to
reasonably estimate the potential effects of any future assessments and,
accordingly, the accompanying financial statements do not include any provision
for such future assessments. Assessments charged to expense during the six
months ended September 30, 1995 and 1996 were $0.8 million and $0.7 million,
respectively. Such assessments are credited against ESIF's administrative tax.
Upon conversion to a stock property and casualty insurer, ESIF will be
subject to assessment by a separate guaranty fund. Such assessments will not be
credited against ESIF's administrative tax.
Concentrations of Credit or Financial Risk
Florida law allows the Company to write policies only in the State of
Florida. Therefore, all of ESIF's premium revenues for the six months ended
September 30, 1995 and 1996 were derived from policies offered to customers
located in Florida. Accordingly, ESIF could be adversely affected by economic
downturns, significant unemployment, and other conditions that may occur from
time-to-time in Florida, which may not as significantly affect its more
geographically diversified competition.
SHC has significant amount of revenue associated with its third-party
processing as a result of its contracts with several self-insurance funds.
Changes with respect to these contracts could adversely affect ESIF.
As further described in Note 6, ESIF has significant amounts of reinsurance
recoverables as a result of ceding reinsurance under specific and aggregate
reinsurance treaties.
Intangible Assets
Cost in excess of net assets of businesses acquired totaling $49.0 million
was recorded in conjunction with the January 1996 acquisition of SHC. This
intangible asset is being amortized on a straight-line basis over 25 years.
ESIF's cost associated with the purchase of customer listings recorded in
conjunction with the January 1996 acquisition of SHC totals approximately $6.5
million. This intangible asset is being amortized on a straight-line basis over
10 years.
At the balance sheet date, ESIF evaluates the recoverability of the cost in
excess of net assets acquired and the cost associated with customer listings
through a comparison of forecasted undiscounted cash flows of SHC and the
remaining asset balances.
Equipment and Software
Equipment and software are recorded at cost. Depreciation is computed using
the straight-line method over the useful lives of the related assets.
Cash and Cash Equivalents
ESIF considers all highly liquid investments with original maturities of
three months or less to be cash equivalents.
F-37
<PAGE> 119
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Bad Debt Allowance
The bad debt allowance is based on ESIF's experience with uncollectible
premiums receivable and represents ESIF's best estimate of the ultimate
uncollectible amounts incurred through the balance sheet date.
2. INVESTMENTS
The amortized cost and the fair value of debt security investments are
summarized as follows:
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
AT SEPTEMBER 30, 1995 (UNAUDITED)
U.S. Treasury and government agencies....... $ 61,796 $1,047 $ 125 $ 62,718
States and political subdivisions........... 66,216 1,346 345 67,217
Industrial and miscellaneous................ 29,277 405 520 29,162
Mortgage-backed securities:
U.S. government agencies................. 31,057 1,120 11 32,166
-------- ------ ------ --------
Total debt securities available-for-sale...... $188,346 $3,918 $1,001 $191,263
======== ====== ====== ========
AT SEPTEMBER 30, 1996
U.S. Treasury............................... $ 49,286 $ 214 $ 875 $ 48,625
States and political subdivisions........... 67,799 950 401 68,348
Industrial and miscellaneous................ 42,875 566 535 42,906
Mortgage-backed securities:
U.S. government agencies................. 13,603 134 196 13,541
-------- ------ ------ --------
Total debt securities available-for-sale...... $173,563 $1,864 $2,007 $173,420
======== ====== ====== ========
</TABLE>
The amortized cost and estimated fair value of debt securities at September
30, 1996, by contractual maturity, are shown below. Actual maturities may differ
from contractual maturities because certain borrowers may have the right to call
or prepay obligations with or without call or prepayment penalties.
<TABLE>
<CAPTION>
AMORTIZED FAIR
COST VALUE
--------- --------
(IN THOUSANDS)
<S> <C> <C>
Years to maturity:
One or less............................................... $ 3,005 $ 3,008
After one through five.................................... 62,368 62,316
After five through ten.................................... 78,234 77,983
After ten................................................. 16,353 16,572
-------- --------
159,960 159,879
Mortgage-backed securities................................ 13,603 13,541
-------- --------
Total....................................................... $173,563 $173,420
======== ========
</TABLE>
Proceeds from the sales of investments in debt securities during the six
months ending September 30, 1996 were $45.8 million. Gross gains of $0.3 million
and gross losses of $0.7 million were realized on those sales. Proceeds from the
sales of investments in debt securities during the six months ending September
30, 1995 were $83.5 million. No gains or losses were realized on those sales.
F-38
<PAGE> 120
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Unrealized gains and losses on investments in preferred and common stocks
are reported directly in equity and do not affect operations. The gross
unrealized gains and losses on, and the cost and fair value of, those
investments are summarized as follows:
<TABLE>
<CAPTION>
GROSS GROSS
UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
------- ---------- ---------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
AT SEPTEMBER 30, 1995 (UNAUDITED)
Preferred stocks.............................. $ 2,890 $ 71 $ 5 $ 2,956
Common stocks................................. 13,387 1,958 117 15,228
------- ------ ---- -------
Total........................................... $16,277 $2,029 $122 $18,184
======= ====== ==== =======
AT SEPTEMBER 30, 1996
Preferred stocks.............................. $ 3,759 $ 53 $ 25 $ 3,787
Common stocks................................. 10,663 1,844 209 12,298
------- ------ ---- -------
Total........................................... $14,422 $1,897 $234 $16,085
======= ====== ==== =======
</TABLE>
Major categories of ESIF's investment income are summarized as follows:
<TABLE>
<CAPTION>
SIX MONTHS ENDED
SEPTEMBER 30,
--------------------
1995 1996
----------- ------
(UNAUDITED)
(IN THOUSANDS)
<S> <C> <C>
Income:
Bonds..................................................... $6,585 $5,159
Preferred stocks.......................................... 79 133
Common stocks............................................. 181 145
Short-term investments and cash........................... 753 926
------ ------
Net investment income....................................... $7,598 $6,363
====== ======
</TABLE>
The Florida DOI requires cash and investments to be held in trust for the
Florida DOI for 10% of statutory basis loss reserves and the 1986-1995 fund
years aggregate reserve plans. The aggregate plans approved by the Florida DOI
require the interest earned on the related reserves to accumulate with the
restricted principal. The reserves are reviewed annually and a revised funding
plan is submitted to the Florida DOI. At September 30, 1995 and 1996, the amount
in trust is approximately $61.0 million and $52.0 million, respectively.
F-39
<PAGE> 121
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. PROPERTY AND EQUIPMENT
The major components of equipment and software at September 30, 1996 are as
follows (in thousands):
<TABLE>
<S> <C>
Furniture, fixtures and equipment........................... $ 914
Data processing equipment................................... 757
Airplane.................................................... 968
Leasehold improvements...................................... 122
Software.................................................... 189
Automobiles................................................. 24
------
2,974
Less accumulated depreciation............................... 616
------
$2,358
======
</TABLE>
Depreciation expense for the period ended September 30, 1996 was $0.4
million. Substantially all equipment and software was acquired in the January
1996 acquisition of SHC.
4. INTANGIBLES
The majority of the ESIF's intangible assets were recorded in connection
with the acquisition of SHC and are stated at cost, which represents fair value
as of the acquisition date, less accumulated amortization, and include purchased
software, customer accounts and contracts, and the excess of the purchase price
over the fair value of identifiable net assets acquired. Purchased software,
customer accounts and contracts are being amortized on a straight-line basis
over the estimated useful lives and contract period which range from three to
ten years. The excess of cost over the fair value of identifiable net assets
acquired is being amortized on a straight-line basis over 25 years.
Intangible assets consist of the following as of September 30, 1996 (in
thousands):
<TABLE>
<S> <C>
Unamortized debt acquisition costs.......................... $ 757
Purchased software.......................................... 6,300
Goodwill.................................................... 47,185
Customer accounts and contracts............................. 6,608
-------
60,850
Less accumulated amortization............................... 3,241
-------
$57,609
=======
</TABLE>
5. LEASES
SHC leases office premises and automobiles under noncancelable operating
leases which expire at various dates through the year 2001. These leases
generally contain renewal options and escalation clauses based on increases in
lessors' operating expenses and other charges. ESIF anticipates that most leases
will be renewed or replaced upon expiration.
F-40
<PAGE> 122
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Future minimum annual payments at September 30, 1996 for all noncancelable
leases are (in thousands):
<TABLE>
<S> <C>
Six Months Ended March 31:
1997...................................................... $ 903
Years Ended March 31:
1998...................................................... 1,578
1999...................................................... 1,547
2000...................................................... 1,180
2001...................................................... 103
------
Total minimum future lease payments......................... 5,311
Income from subleases....................................... (118)
------
Net minimum future lease payments........................... $5,193
======
</TABLE>
In excess of 80% of the future lease commitments relates to rented office
premises from certain trustees of ESIF.
Rental expense for the six months ended September 30, 1996 for operating
leases totaled $0.9 million.
F-41
<PAGE> 123
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
6. REINSURANCE
In accordance with general practice in the insurance industry, the ESIF's
insurance subsidiaries are engaged in reinsurance transactions to cede risk to
other companies. Reinsurance ceded contracts do not relieve ESIF and its
insurance subsidiaries from their obligation to policyholders, as they remain
liable to their policyholders to the extent that any reinsurer does not meet its
obligations for reinsurance ceded to it under reinsurance contracts. The largest
net amount retained by ESIF or its Subsidiaries on any one occurrence is
$500,000 with a $750,000 deductible in the six months ended September 30, 1995
and $500,000 with a $500,000 deductible in the six months ended September 30,
1996. Reinsurance agreements are in force with certain maximum limits, as well
as excess of loss reinsurance agreements.
SPECIFIC REINSURANCE
(IN THOUSANDS)
<TABLE>
<CAPTION>
FISCAL
YEAR SPECIFIC
ENDED SPECIFIC OCCURRENCE
MARCH 31, CARRIER ATTACHMENT LIMIT
- --------- ------- ---------- ----------
<S> <C> <C> <C>
1982 INA $ 100 $ 2,000
Employers Re 2,100 3,000
1983 INA 125 2,000
Employers Re 2,125 3,000
1984 Employers Re 125 2,000
INA 2,125 Statutory
1985 Employers Re 125 2,000
INA 2,125 Statutory
1986 Employers Re 225 20,000
1987 Safety Mutual(1) 1,000 5,000
Old Republic(2) 1,000 1,000
National Union(2) 2,000 8,000
1988 Old Republic 1,000 5,000
1989 Old Republic 1,000 5,000
1990 Transamerica 1,000 15,000
1991 Transamerica 1,000 15,000
1992 Transamerica 1,000 25,000
1993 Transamerica 1,000 25,000
1994 Lloyd's 500 500
Transamerica 1,000 Statutory
1995 Lloyd's 500 500
Continental Casualty 1,000 Statutory
1996 Federal Insurance Co. 500 500
Federal Insurance Co. 1,000 1,000
Continental Casualty 2,000 Statutory
1997 Lloyd's 500 1,500
National Union 2,000 Statutory
</TABLE>
- ---------------
(1) 4/1/86-5/31/86
(2) 6/1/86-3/31/87
F-42
<PAGE> 124
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
AGGREGATE REINSURANCE
(IN THOUSANDS)
<TABLE>
<CAPTION>
FISCAL
YEAR
ENDED AGGREGATE AGGREGATE
MARCH 31 CARRIER ATTACHMENT LIMIT
- -------- ------- ---------- ---------
<S> <C> <C> <C>
1982 INA $ 11,542 $ 2,000
Employers Re 13,542 3,000
INA 16,542 Statutory
1983 INA 11,365 2,000
Employers Re 13,365 3,000
INA 16,365 Statutory
1984 Employers Re 14,341 2,000
INA 16,341 Statutory
1985 Employers Re 17,814 3,000
INA 20,814 Statutory
1986 Employers Re 40,091 301
1987 N/A N/A N/A
1988 N/A N/A N/A
1989 Crossroads 90,648 19,000
1990 Crossroads 110,973 25,000
1991 Crossroads 130,726 31,000
1992 Crossroads 113,015 31,000
1993 Crossroads 141,956 33,401
1994 Crossroads 146,016 34,357
1995 Crossroads 133,800 31,482
1996 Crossroads 115,970 27,287
1997 N/A N/A N/A
</TABLE>
Insurance premiums for the six months ended September 30, 1995 and 1996 are
summarized as follows:
<TABLE>
<CAPTION>
1995 1996
----------- -------
(UNAUDITED)
(IN THOUSANDS)
<S> <C> <C>
Direct premiums earned...................................... $66,351 $52,402
Reinsurance ceded........................................... 3,206 3,373
------- -------
Net premiums earned......................................... $63,145 $49,029
======= =======
</TABLE>
<TABLE>
<CAPTION>
1995 1996
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Gross premiums written...................................... $124,643 $107,274
Ceded premiums written...................................... 6,820 4,096
-------- --------
Net premiums written........................................ $117,823 $103,178
======== ========
</TABLE>
F-43
<PAGE> 125
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Losses and LAE incurred for the six months ended September 30, 1995 and
1996 are summarized as follows:
<TABLE>
<CAPTION>
1995 1996
----------- -------
(UNAUDITED)
(IN THOUSANDS)
<S> <C> <C>
Direct losses and LAE....................................... $42,435 $36,122
Reinsurance ceded........................................... 70 3,987
------- -------
Net losses and LAE incurred................................. $42,365 $32,135
======= =======
</TABLE>
Reinsurance ceded premiums and losses included in the preceding table
reflect the elimination of amounts assumed by USEI through retrocession by
Crossroads Insurance Company, Limited ("Crossroads") of amounts ceded by ESIF to
Crossroads as described in the following paragraph.
Of the reinsurance ceded amounts above for six months ended September 30,
1996, premiums of $-0-, losses and LAE of $1.9 million, are attributable to
reinsurance agreements with Crossroads a Bermuda domiciled insurance company,
which a Trustee of ESIF has an ownership interest. Crossroads is licensed to do
business in Florida and is a member of the Florida Insurance Guaranty
Association. Fifty percent of business ceded to Crossroads has been retroceded
by Crossroads to USEI. All of ESIF's aggregate excess reinsurance coverage for
fiscal years ended March 31, 1989, 1993, 1994 and 1995 is also ceded to
Crossroads. At September 30, 1995 and 1996 loss and LAE reserves recoverable of
approximately $8.0 million and $10.0 million, respectively (net of amounts
retroceded to USEI), are attributable to excess reinsurance agreements with
Crossroads. For the fiscal years 1986, 1987, 1990, 1991 and 1992, effective
aggregate excess reinsurance is not currently in place because these years have
been self-funded or because the coverages have expired. Exposure to significant
adverse development for these years is considered minimal due to the maturity of
the loss development for these years.
In the six months ended September 30, 1995 and 1996, ESIF did not commute
any ceded reinsurance nor did it enter into or engage in any loss portfolio
transfers.
ESIF remains obligated for amounts ceded in the event that the reinsurers
do not meet their obligations.
ESIF's reinsurance recoverable asset at September 30, 1996 is comprised of
amounts related to reinsurance agreements with the following companies (in
thousands):
<TABLE>
<CAPTION>
PAID UNPAID
REINSURANCE CARRIER CLAIMS CLAIMS TOTAL
------------------- ------ -------- --------
<S> <C> <C> <C>
American Re.............................................. $ -- $ 380 $ 380
Cayzer Steel............................................. 2 -- 2
Cigna.................................................... 189 -- 189
Continental Casualty..................................... -- 9,245 9,245
Crossroads............................................... 653 10,305 10,958
Employers Re............................................. 505 6,406 6,911
Federal Ins. Co.......................................... -- 8,417 8,417
INA...................................................... -- 5,156 5,156
Lloyds of London......................................... -- 14,595 14,595
National Union........................................... -- 1,590 1,590
Old Republic............................................. 37 15,172 15,209
Transamerica............................................. 25 31,185 31,210
------ -------- --------
Total.......................................... $1,411 $102,451 $103,862
====== ======== ========
</TABLE>
F-44
<PAGE> 126
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
All of the recoverable amounts related to paid claims have been outstanding
less than ninety days at the balance sheet date. The reinsurance recoverable
amounts related to unpaid claims are calculated considering the provisions of
the specific and aggregate reinsurance agreements and using ultimate losses by
accident year consistent with the reported loss and LAE liabilities.
7. FEDERAL INCOME TAXES
ESIF and its subsidiaries file a consolidated federal income tax return.
ESIF does not have a tax sharing agreement with two of its subsidiaries, ESGA
and USEI. ESIF does not collect from or refund to these subsidiaries the amount
of income taxes or benefits which would result if the entities filed separate
returns. An informal tax sharing agreement exists between ESIF and SHC such that
the amount of taxes or tax benefits are shared as if separate returns were
filed.
Income before federal income taxes differs from taxable income principally
due to tax-exempt investment income, dividends-received tax deductions, and
differences in loss and LAE discounting and unearned premium reserves for tax
and financial reporting purposes.
Federal income taxes of $6.9 million and $12.2 million for the years ended
March 31, 1995 and 1996, respectively, would be subject to recovery in the event
that the Company incurs net operating losses within three years of the years for
which such taxes were paid. State taxes paid was $0.8 million and $0.7 million
for the six months ended September 30, 1995 and 1996, respectively.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes.
Significant components of the ESIF's deferred tax liabilities and assets as
of September 30, as calculated in accordance with FASB Statement No. 109 are as
follows:
<TABLE>
<CAPTION>
1995 1996
------- -------
(UNAUDITED)
(IN THOUSANDS)
<S> <C> <C>
Deferred tax liabilities:
Unrealized investment gains............................... $ 641 $ 572
Special Disability Trust Fund recoverables................ 177 283
Reinsurance Premium Adjustment............................ 1,494
Intangible assets......................................... -- 3,124
Other..................................................... -- 209
------- -------
Total deferred tax liabilities.............................. 818 5,682
Deferred tax assets:
Discount on loss and LAE reserves......................... 16,207 19,780
Unallocated remittances................................... 1,372 1,101
Uncollectible premiums.................................... 753 753
------- -------
18,332 21,634
Valuation allowance for deferred tax assets............... -- --
------- -------
Total deferred tax assets................................... 18,332 21,634
------- -------
Net deferred tax assets..................................... $17,514 $15,952
======= =======
</TABLE>
ESIF has made an election under the Internal Revenue Code of 1986 to treat
income tax payments attributable to loss reserve discounting as special
estimated tax payments which are specifically recoverable upon reversal of the
discounting effects. Accordingly, the deferred tax assets attributable to loss
reserve discounting are considered to be fully recoverable. ESIF also has
significant tax loss carryback potential for
F-45
<PAGE> 127
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the fiscal years ended March 31, 1994 and 1995. For those reasons, a deferred
tax valuation allowance is not considered necessary.
ESIF's consolidated federal income tax liability (asset) at September 30,
is summarized as follows:
<TABLE>
<CAPTION>
1995 1996
-------- --------
(UNAUDITED)
(IN THOUSANDS)
<S> <C> <C>
Current..................................................... $ 297 $ (6,234)
Deferred.................................................... (17,514) (15,952)
-------- --------
Total net asset............................................. $(17,217) $(22,186)
======== ========
</TABLE>
Significant components of the provision for income taxes for the six months
ended September 30, attributable to continuing operations are as follows:
<TABLE>
<CAPTION>
1995 1996
------ -------
(UNAUDITED)
(IN THOUSANDS)
<S> <C> <C>
Current tax expense......................................... $2,292 $ 3,213
Deferred taxes (benefit).................................... 98 (813)
------ -------
Total income tax expense on income.......................... $2,390 $ 2,400
====== =======
</TABLE>
Income taxes paid by ESIF totaled $6.4 million and $3.3 million for the six
months ended September 30, 1995 and 1996, respectively.
The reconciliation of income tax expense for the six months ended September
30, attributable to continuing operations computed at the U.S. federal statutory
tax rate of 35%, to income tax expense is as follows:
<TABLE>
<CAPTION>
1995 1996
------ -------
(UNAUDITED)
(IN THOUSANDS)
<S> <C> <C>
Income tax (at 35% of pretax income or loss)................ $2,717 $ 2,118
Tax-exempt investment income................................ (588) (575)
Non taxable/deductible expenses............................. 22 40
Goodwill amortization....................................... -- 291
State income taxes.......................................... 484 448
Other items, net............................................ (245) 78
------ -------
Provision for federal income tax expense.................... $2,390 $ 2,400
====== =======
</TABLE>
8. LOSSES AND LAE
The reserves for unpaid losses and LAE are estimated using individual
case-basis valuations and statistical analyses. These estimates are subject to
the effects of trends in loss severity and frequency. Although some variability
is inherent in such estimates, management believes that the reserves for losses
and LAE are adequate. The estimates are reviewed annually by independent
consulting actuaries and adjusted as necessary as experience develops or new
information becomes known; such adjustments are included in current operations.
F-46
<PAGE> 128
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table provides a reconciliation of the beginning and ending
reserve balances for losses and LAE for the six months ended September 30, 1995
and 1996:
<TABLE>
<CAPTION>
SIX MONTHS SIX MONTHS
ENDED ENDED
SEPTEMBER 30, 1995 SEPTEMBER 30, 1996
------------------ ------------------
(IN THOUSANDS)
<S> <C> <C>
Net reserves for losses and LAE at beginning of
period.......................................... 259,085 277,995
Less: Recoverable from Florida SDTF(1)............ (15,879) (20,060)
--------- ---------
Net reserves for losses and LAE less SDTF
recoverable asset at beginning of period........ 243,206 257,935
Add provision for claims occurring in:
The current year................................ 42,198 35,663
Prior years..................................... 167 (3,528)
--------- ---------
Incurred losses during the current year........... 42,365 32,135
Deduct payments for claims occurring in:
The current year................................ 3,753 3,565
Prior years..................................... 39,734 31,898
--------- ---------
Claim payments during the current year............ 43,487 35,463
--------- ---------
Net reserves for losses and LAE less SDTF
recoverable asset at end of period.............. 242,084 254,607
Add: Recoverable from Florida SDTF(1)............. 17,775 21,138
--------- ---------
Net reserves for losses and LAE at end of
period.......................................... 259,859 275,745
Add: Reinsurance recoverables (exclusive of
recoverables on paid losses)................. 104,351 102,451
--------- ---------
Gross reserves for losses and LAE at end of period
(GAAP basis).................................... $ 364,210 $ 378,196
========= =========
</TABLE>
- ---------------
(1) The change in the SDTF recoverable asset is included in incurred losses in
the Statement of Income.
The foregoing reconciliation also shows that a $3.5 million reserve
redundancy emerged during the six month period ended September 30, 1996. This
amount represents the release of certain loss reserves previously carried which
were determined, based on comparisons to actuarially projected amounts, to be
redundant.
Statutory basis loss reserves were determined using paid loss data net of
historic SDTF recoveries; GAAP basis loss reserves were determined using paid
loss data gross of SDTF recoveries. This adjustment increased loss reserves by
$27.9 million and $28.8 million at September 30, 1995 and 1996, respectively,
and increased reinsurance recoverables by $10.6 million and $8.4 million at
September 30, 1995 and 1996, respectively. In addition, ESIF has recorded, as an
asset, amounts recoverable from the SDTF based upon ESIF's historical collection
experience and the amount of claims identified as subject to SDTF recovery. The
recoverable amount recorded at September 30, 1995 and 1996 was $17.8 million and
$21.1 million, respectively.
In order to quantify the amounts recoverable from the SDTF, ESIF reviews
its claims that have been identified as subject to SDTF recovery considering
ESIF's historical recovery experience on claims submitted to the SDTF. In
addition, ESIF estimates the amount of claims it expects to recover over the
next four years based on actual collection experience for the most recent two
years, and discounts the expected recoveries using an appropriate interest rate.
The amounts reflected as recoverables from the SDTF were based on the discounted
expected collection amounts rather than on the total claims identified as
subject to SDTF recovery.
F-47
<PAGE> 129
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The SDTF reinsurance recoverable results from calculating such recoverables
using loss and LAE reserves computed using paid losses gross of SDTF recoveries
and in consideration of expected recoveries from SDTF. Certain of the claims
used in the determination of the SDTF recoverable are of an amount which will
pierce reinsurance layers. The Company will pursue recovery of such claims under
the provisions of its reinsurance agreements. Subsequently, as the Company
remits the claims to the SDTF, and ultimately collects these claims from SDTF,
the Company will remit to the reinsurers their portion of the SDTF recoveries.
The aggregate recoverable from SDTF asset and the SDTF related reinsurance
recoverable, which approximates the amount of the increase in loss reserves
resulting from determining the GAAP basis loss reserves using paid loss data
gross of SDTF recoveries, represents managements best estimate of the aggregate
amounts that will be recovered.
LAE assumed in the acquisition of SHC represents unallocated LAE reserves
established by ESIF that were, prior to the acquisition, provided by SHC under
the administrator's contract between ESIF and SHC.
9. ACCRUED RETROSPECTIVE PREMIUMS
Certain workers' compensation insurance policies issued by ESIF are
retrospectively rated, and premiums are based on loss experience incurred under
these contracts to date. Accrued retrospectively rated premiums, including those
relating to bulk incurred but not reported, have been determined by or allocated
to individual policyholder accounts. These amounts are summarized as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30,
-----------------
1995 1996
------- -------
(UNAUDITED)
(IN THOUSANDS)
<S> <C> <C>
Accrued retrospective premium............................... $43,440 $23,990
</TABLE>
10. EQUITY
ESIF and its insurance subsidiaries, subsequent to the conversion to a
stock property and casualty company, will have legal restrictions as to the
transfer of funds in the form of dividends, loans, and advances. These
restrictions, determined in accordance with statutory reporting practices,
generally limit the payment of dividends to amounts based upon statutory surplus
or profits and limit the amount of certain investments to specified percentages
of statutory admitted assets. At September 30, 1996, under regulations
applicable to stock property and casualty insurance companies, $2.0 million of
ESIF's statutory net assets of $20.4 million can be transferred from the
insurance entities without regulatory approval.
Equity and net income as determined in accordance with statutory accounting
practices for self-insurance funds as of and for the six months ended September
30, 1995 and 1996 are as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30, EQUITY NET INCOME
------------- ------- ----------
(IN THOUSANDS)
<S> <C> <C>
1995 (unaudited)............................................ $49,738 $3,076
1996........................................................ 20,465 4,824
</TABLE>
As a self-insurance fund, ESIF recorded for statutory reporting an asset of
$46.9 million at September 30, 1996 for future investment income determined by
discounting loss and LAE reserves at a statutory prescribed rate. Upon
conversion to a stock property and casualty insurer, ESIF will be permitted to
record discounts only on the indemnity portion of permanent disability cases.
The amount of such discount is estimated at $4.2 million at September 30, 1996.
It is ESIF's intention to utilize proceeds of a public offering to meet
statutory basis capital and equity requirements for a stock property and
casualty company.
F-48
<PAGE> 130
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In order to improve the regulation of insurer solvency, the National
Association of Insurance Commissioners issued a model law to implement
risk-based capital ("RBC") requirements for property and casualty insurance
companies, which are designed to assess capital adequacy and to raise the level
of protection that statutory equity provides for policyholder obligations. The
RBC formula for property and casualty insurance companies measures these major
areas of risk facing property and casualty insurers: (i) underwriting, which
encompasses the risk of adverse loss development and inadequate pricing; (ii)
declines in asset values arising from credit risk; and (iii) declines in asset
values arising from investment risks. Pursuant to the model law, insurers having
less statutory equity than required by the RBC calculation will be subject to
varying degrees of regulatory action, depending on the level of capital
inadequacy. Florida, ESIF's state of domicile, has yet to adopt the provisions
of the RBC model law. Upon completion of the conversion and recapitalization,
ESIF's insurance subsidiaries will maintain statutory basis equity in excess of
the amount required by Florida law.
11. COMMITMENTS AND CONTINGENCIES
ESIF, in the normal course of business, is named as a defendant in various
legal actions arising principally from claims made under insurance policies and
contracts. Those actions are considered by ESIF in estimating the loss and LAE
reserves. ESIF's management believes that the resolution of those actions will
not have a material effect on ESIF's financial position or results of
operations.
12. SDTF
The State of Florida maintains the SDTF for the purpose of providing
benefits to workers who have a pre-existing condition and incur a second or
subsequent injury. The SDTF is funded through annual assessments against
workers' compensation insurers which are based on a percentage of gross workers'
compensation premiums written.
The SDTF has not charged adequate assessments to actuarially fund its
claims liability. In 1996, the Florida legislature reauthorized the SDTF for
four years; however, in the future, the Florida legislature may impose greater
assessments on insurance carriers, such as ESIF, to satisfy pending claims.
Moreover, it is not possible to predict how the SDTF will operate, if at all, in
the future after the reauthorized period. Changes in the SDTF's operations which
decrease the availability of recoveries from the SDTF, or increase SDTF's
assessments payable by ESIF or changes in regulations which further limit ESIF's
ability to reduce statutory basis loss reserves for a portion of SDTF future
recoverable amounts may have a material adverse effect on ESIF's business,
financial condition or results of operations. Discontinuance of the SDTF could
have either a favorable or unfavorable effect on ESIF depending on the relation
of the amount of assessments by SDTF to the amount of recoveries from SDTF. If
the SDTF is discontinued, ESIF believes that the existing reimbursement
obligations of the SDTF would become general obligations of the State of
Florida, although there is no assurance that a reviewing court would adopt that
view. The SDTF has made no acknowledgement with regard to the enforceability of
its reimbursement obligations to insurers such as ESIF.
Loss and LAE reserves included in the accompanying financial statements are
presented gross of future SDTF recoveries and have been determined using
historical loss data which excludes SDTF recoveries.
ESIF has recorded an SDTF recoverable of $17.8 million and $21.1 million at
September 30, 1995 and 1996, respectively, for the estimated amounts expected to
be received from the SDTF. The estimated amount of recoveries, which is
management's best estimate of the amount that will be recovered, was based on
claims identified as subject to SDTF recovery as well as ESIF's recovery
experience.
Amounts recovered from SDTF for the six months ended September 30, 1995 and
1996 were $2.2 million and $4.3 million, respectively. Assessments paid by ESIF
to the SDTF were $5.0 million and $2.5 million for the six months ended
September 30, 1995 and 1996, respectively.
F-49
<PAGE> 131
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
ESIF has not recorded a liability for future assessments from SDTF. Such
future assessments will be based on future premium amounts.
13. ACQUISITION OF SHC
On January 16, 1996, ESIF and its subsidiaries purchased all of the
outstanding capital stock of SHC. The purchase price consisted of $26.0 million
paid in cash from the Company, $11.5 million in cash distributed by Summit and
$44.0 million in assumption of debt by SHC (see Note 14). SHC is a third party
administrator which provides insurance related services (including marketing,
policy issuance and servicing, claims processing and administration, loss
control, brokerage, audits, financial and data processing services and risk
management services) to ESIF, four other self-insurance funds and a property and
casualty insurance company. The acquisition was accounted for using the purchase
method, and the results of operations of SHC are included in the consolidated
statement of operations from the date of acquisition.
The following unaudited pro forma information as of the six months ended
September 30, 1995 presents the consolidated results of operations of ESIF and
SHC as if the acquisition had been effective at April 1, 1995 after giving
effect to adjustments to reflect the acquisition. This information is intended
for informational purposes only and may not be indicative of ESIF's future
results of operations (in thousands):
<TABLE>
<S> <C>
Total revenues.............................................. $91,226
Income before income tax expense............................ 11,788
Net income.................................................. 7,855
</TABLE>
To comply with requirements of the Florida DOI, SHC's chairman has
personally indemnified ESIF up to a maximum of $5.0 million for certain loss,
injury or damage to ESIF which may result from the acquisition of SHC. Such
indemnification will expire on the earlier of January 11, 2001 or on the date
upon which the bank debt, incurred in the acquisition, is retired.
14. NOTES PAYABLE
In connection with the purchase of SHC by ESIF, SHC utilized a bank term
loan with rates based on LIBOR plus 3%. The balance as of September 30, 1996 for
SHC was $34.5 million. Also, a revolving bank credit facility with rates
approximating the prime rate was entered into as part of the agreement. The
balance as of September 30, 1996 for SHC for this agreement was $2.0 million.
Interest expense incurred as of September 30, 1996 was $1.7 million.
Subsequent to September 30, 1996, the term loan and revolving credit
facility agreements were amended.
F-50
<PAGE> 132
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Maturities for the combined term loan and revolving credit facility (as
amended) are as follows:
<TABLE>
<CAPTION>
REDUCTION IN THE
TERM AVAILABILITY OF THE
LOAN REVOLVING CREDIT FACILITY
------- -------------------------
(IN THOUSANDS)
<S> <C> <C>
For the Six Months Ending March 31:
1997.......................................... $ 1,825 $ --
For the Years Ending March 31:
1998.......................................... 2,300 --
1999.......................................... 3,925 --
2000.......................................... 5,500 --
2001.......................................... 9,500 1,500
Thereafter.................................... 11,450 3,500
------- -------
$34,500 $5,000
======= =======
</TABLE>
As collateral for the debt, SHC pledged the issued and outstanding stock of
SCI and three other wholly owned subsidiaries, Bridgefield Casualty Insurance
Company, Meritec Solutions, Inc. and Carolina Summit Healthcare, Inc. The credit
agreement contains certain covenants which require that certain financial ratios
and/or levels be maintained by SHC and its insurance subsidiary, Bridgefield
Casualty. Among these covenants are the following: operating leverage, fixed
charge coverage ratio, minimum stockholder equity and risk based capital for the
insurance subsidiary.
15. EMPLOYEE BENEFIT PLANS
ESIF's subsidiary, SHC, has a deferred savings and profit-sharing plan (the
"401(k)") covering substantially all employees. Under the 401(k), SHC makes
contributions equal to 75% of the participant's contributions, not to exceed 6%
of the participant's annual compensation. SHC's contributions to the 401(k)
totaled $0.2 million for the period April 1, 1996 to September 30, 1996.
16. FAIR VALUES OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used by ESIF in estimating its
fair value disclosures for financial instruments:
- Cash and cash equivalents, short-term investments: The carrying amounts
reported in the balance sheet for these instruments approximate fair
values.
- Investment securities: Fair values for debt security investments are
based on quoted market prices.
- Premiums and accounts receivable: The carrying amounts of ESIF's
receivables approximate fair values.
- Notes payable: ESIF's subsidiary has $36.5 million of notes payable at
September 30, 1996 that approximates its fair value.
ESIF's fair value of reinsurance recoverable approximates its carrying
value for September 30, 1995 and 1996, respectively, as summarized below:
<TABLE>
<CAPTION>
SEPTEMBER 30, 1995 SEPTEMBER 30, 1996
------------------- -------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
-------- -------- -------- --------
(UNAUDITED)
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Reinsurance recoverable....................... $107,451 $107,451 $103,861 $103,861
</TABLE>
F-51
<PAGE> 133
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
17. DISCONTINUED OPERATIONS
Effective July 31, 1996, ESIF decided to discontinue its computer software
development. This business was acquired in the January 1996 acquisition of SHC.
The disposition is expected to occur during the three months ending December 31,
1996 by abandonment of the operation. ESIF has recognized an after tax loss of
approximately $0.5 million on the disposition of this operation (including
estimated operating losses to the disposition date).
The financial statements reflect the operating results and the assets and
liabilities of the discontinued operations separately from continuing
operations. The net assets of the computer software development operation at
September 30, 1996 were as follows (in thousands):
<TABLE>
<S> <C>
Assets:
Cash and equivalents...................................... $115
Equipment................................................. 396
Other assets.............................................. 164
Software.................................................. 67
----
Total assets................................................ 742
Liabilities:
Accounts payable and operating liabilities................ 64
----
Net assets.................................................. $678
====
</TABLE>
The operating results of the computer software development operations for
the six month period ended September 30, 1996 were as follows (in thousands):
<TABLE>
<S> <C>
Revenue..................................................... $ 839
Expenses.................................................... 1,463
------
Loss before income taxes.................................... (624)
Income tax (benefit)........................................ (212)
------
Net loss.................................................... $ (412)
======
</TABLE>
18. DISPOSITION
Effective July 31, 1996, ESIF decided to terminate its efforts to develop a
healthcare subsidiary in North Carolina. This start up effort was initiated by
SHC prior to the acquisition of SHC by ESIF. The disposition of this subsidiary
by a sale of its stock is expected to be completed during the first quarter of
1997. The consolidated financial statements include the operating results and
assets and liabilities of this subsidiary. The net assets of the healthcare
subsidiary were as follows at September 30, 1996 (in thousands):
<TABLE>
<S> <C>
Assets:
Cash and equivalents...................................... $ 556
Equipment................................................. 143
Other Assets.............................................. 2,306
------
Total Assets................................................ 3,005
Liabilities:
Accounts payable and operating liabilities................ 143
------
Net Assets.................................................. $2,862
======
</TABLE>
F-52
<PAGE> 134
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The operating results for the healthcare subsidiary (including a $0.2
million pre-tax provision for loss on disposition) for the six month period
ending September 30, 1996 were as follows (in thousands):
<TABLE>
<S> <C>
Revenue..................................................... $ 80
Expenses.................................................... 703
-----
Loss before income taxes.................................... (623)
Income benefit.............................................. (212)
-----
Net loss.................................................... $(411)
=====
</TABLE>
19. SEGMENT INFORMATION
The operations of ESIF, prior to the January 1996 acquisition of SHC, were
solely in the workers' compensation insurance industry segment. Subsequent to
the acquisition of SHC, ESIF also operates in the insurance administration
segment. Financial information by industry segment for revenues, income before
income taxes, and identifiable assets are summarized as follows:
<TABLE>
<CAPTION>
WORKERS'
COMPENSATION INSURANCE INTERCOMPANY
TOTAL INSURANCE ADMINISTRATION ELIMINATION
-------- ------------ -------------- ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Six Months Ended September 30, 1995
(unaudited):
Revenues............................. $ 71,752 $ 71,752 -- --
Income before income taxes........... 7,764 7,764 -- --
Identifiable assets.................. 456,012 456,012 -- --
Six Months Ended September 30, 1996:
Revenues............................. 73,048 54,667 $28,891 $(10,510)
Income before from continuing
operations before income taxes.... 6,051 7,528 $(1,477) --
Identifiable assets.................. $498,085 $498,085 -- --
</TABLE>
Depreciation expense and capital expenditures are not considered material.
The preceding financial information does not include the computer software
operations which are presented as discontinued operations in the accompanying
financial statements.
20. EXTRAORDINARY CHARGE
During the six months ended September 30, 1996 ESIF incurred $0.6 million
of expenses directly related to its conversion from a group self-insurance fund
to a stock insurance company. These expenses are principally professional
service fees paid to attorneys, investment advisors, and accountants related to
obtaining regulatory approval for the conversion, advising the Board of Trustees
as to the fairness of the transaction and auditing ESIF's GAAP basis financial
statements. These costs, net of income tax benefits of $0.2 million, are
presented as an extraordinary charge on ESIF's Statement of Operations for the
six months ended September 30, 1996.
21. RELATED PARTY TRANSACTIONS
As more fully described in Note 5, ESIF has entered into office premises
lease agreements with certain Trustees of ESIF.
As more fully described in Note 6, ESIF has entered into reinsurance
agreements with an insurance company in which a Trustee of ESIF has an ownership
interest.
F-53
<PAGE> 135
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
As more fully described in Note 14, to comply with requirements of the
Florida DOI, SHC's president and chief executive officer has personally
indemnified ESIF up to a maximum of $5.0 million for certain loss, injury, or
damage to ESIF, if any, which may result from the acquisition of SHC.
Entities in which SHC's president and chief executive officer held
ownership interests have provided certain transportation related services to
SHC. Fees paid by SHC to these entities aggregated approximately $0.4 million
and $0.02 million for the six months ended September 30, 1995 and 1996,
respectively.
SHC's president and chief executive officer is also a member of the Board
of Directors of Florida Retail Federation (the "Association") which is the
sponsoring trade association for Florida Retail Federation Self Insurers Fund
("FRF"), one of the group self-insurance funds administered by SHC. The
Association, as the fund sponsor, is entitled to a fee equal to 1% of FRF's
premiums earned in each year, and SHC is obligated to pay such fee out of the
administrative fee it receives from FRF. During the six months ended September
30, 1995 and 1996, SHC paid approximately $0.5 million and $0.4 million to the
Association for such fees. During the six months ended September 30, 1995 and
1996, FRF paid SHC fees for administrative services of approximately $14.2
million and $12.8 million, respectively.
F-54
<PAGE> 136
EMPLOYERS SELF INSURERS FUND AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1995 1996
----------- -----------
(UNAUDITED) (UNAUDITED)
(IN THOUSANDS)
<S> <C> <C>
ASSETS
Invested assets:
Fixed maturities, available-for-sale...................... $181,186 $184,682
Preferred stock........................................... 3,215 4,568
Common stock.............................................. 11,228 14,100
Short-term investments.................................... 36,344 14,536
-------- --------
Total invested assets............................. 231,973 217,886
Cash and cash equivalents................................... 4,448 7,433
Premiums receivable (net of $2,000 and $2,514 allowance for
doubtful accounts, respectively).......................... 48,922 39,828
Accounts receivable......................................... 668 3,184
Reinsurance recoverable, including $9,606 and $11,123 from
related party reinsurers, respectively.................... 112,734 107,058
Recoverable from Florida Special Disability Trust Fund...... 16,827 21,138
Accrued investment income................................... 3,050 3,036
Income taxes recoverable.................................... 2,123 --
Equipment and software...................................... -- 1,448
Capitalized computer software costs......................... -- 5,092
Value assigned to future administration of insurance
contracts................................................. -- 5,975
Unamortized debt acquisition costs.......................... -- 542
Excess of cost over net assets of business acquired......... -- 45,029
Deferred income taxes....................................... 17,150 14,162
Other assets................................................ 37 5,161
-------- --------
Total assets...................................... $437,932 $476,972
======== ========
LIABILITIES AND EQUITY
Liabilities:
Loss and loss adjustment expenses......................... $372,786 $376,923
Debt...................................................... -- 33,000
Unearned premium and unallocated policyholder
remittances............................................ 25,437 23,506
Accounts payable and accrued expenses..................... 7,018 11,229
Taxes, licenses and fees.................................. 1,453 620
Deferred revenue.......................................... -- 4,013
Federal income taxes payable.............................. -- 303
-------- --------
Total liabilities................................. 406,694 449,594
Equity:
Retained earnings......................................... 26,646 24,857
Net unrealized appreciation on available-for-sale
securities............................................. 4,592 2,521
-------- --------
Total equity...................................... 31,238 27,378
-------- --------
Total liabilities and equity...................... $437,932 $476,972
======== ========
</TABLE>
See accompanying notes.
F-55
<PAGE> 137
EMPLOYERS SELF INSURERS FUND AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
NINE MONTHS ENDED
DECEMBER 31,
-------------------------
1995 1996
----------- -----------
(UNAUDITED) (UNAUDITED)
(IN THOUSANDS)
<S> <C> <C>
Revenue:
Premiums earned........................................... $ 89,713 $ 74,509
Net investment income..................................... 10,522 9,606
Realized investment gains................................. 2,726 366
Administrative fees....................................... -- 25,762
Other income.............................................. 125 568
-------- --------
Total revenue..................................... 103,086 110,811
Losses and expenses:
Losses and loss adjustment expenses....................... 67,043 50,236
Other underwriting, general and administrative expenses
(including administrative service fees paid to Summit
Holding Corporation of $18,802 for the nine months
ended December 31, 1995)............................... 28,548 45,837
Amortization and depreciation............................. -- 3,729
Interest expense.......................................... -- 2,719
-------- --------
Total losses and expenses......................... 95,591 102,521
-------- --------
Income from continuing operations before income taxes....... 7,495 8,290
Income tax expense.......................................... 2,323 3,057
-------- --------
Income from continuing operations........................... 5,172 5,233
-------- --------
Discontinued operations:
Loss from operation (net of income tax benefit of $460 in
1996).................................................. -- (893)
Loss from disposition (net of income tax benefit of $184
in 1996)............................................... -- (357)
-------- --------
Loss from discontinued operations.................... -- (1,250)
-------- --------
Income before extraordinary charge.......................... 5,172 3,983
Extraordinary charge for conversion costs (net of income tax
benefit of $474 in 1996).................................. -- (785)
-------- --------
Net income.................................................. $ 5,172 $ 3,198
======== ========
</TABLE>
See accompanying notes.
F-56
<PAGE> 138
EMPLOYERS SELF INSURERS FUND AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
NINE MONTHS ENDED DECEMBER 31, 1995 AND 1996
(UNAUDITED)
<TABLE>
<CAPTION>
UNREALIZED
APPRECIATION
(DEPRECIATION) OF
AVAILABLE-FOR-
RETAINED SALE SECURITY
EARNINGS INVESTMENTS TOTAL
-------- ----------------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Balance at March 31, 1995................................... $21,474 $(1,409) $20,065
Net income.................................................. 5,172 -- 5,172
Change in net unrealized investment gains................... -- 6,001 6,001
------- ------- -------
Balance at December 31, 1995................................ $26,646 $ 4,592 $31,238
======= ======= =======
Balance at March 31, 1996................................... $21,659 $ 1,495 $23,154
Net income.................................................. 3,198 -- 3,198
Change in net unrealized investment gains................... -- 1,026 1,026
------- ------- -------
Balance at December 31, 1996................................ $24,857 $ 2,521 $27,378
======= ======= =======
</TABLE>
See accompanying notes.
F-57
<PAGE> 139
EMPLOYERS SELF INSURERS FUND AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
DECEMBER 31,
--------------------------
1995 1996
----------- -----------
(IN THOUSANDS)
<S> <C> <C>
Operating activities:
Net income.................................................. $ 5,172 $ 3,198
Adjustments to reconcile net income to net cash provided by
operating activities:
Amortization and depreciation............................. (427) 3,729
Amortization of bond premium/discount..................... 110
Net realized investment gains............................. (1,733) (366)
Gain on sale of equipment................................. (278)
Bad debt allowance........................................ -- 1,014
Decrease (increase) in premiums receivable................ 1,573 (2,749)
Increase in accounts receivable........................... (100) (26)
(Increase) decrease in reinsurance recoverable............ (2,428) 4,460
Increase in Special Disability Trust Fund recoverable..... (948) (1,078)
(Increase) decrease in accrued investment income.......... 360 (100)
(Increase) decrease in federal income tax recoverable..... (2,123) 9,690
Decrease in deferred income taxes......................... 1,950 699
Decrease in other assets.................................. 459 701
Decrease in discontinued operations....................... -- 588
Increase (decrease) in loss and loss adjustment
expenses............................................... 5,395 (10,709)
Increase in unearned premium and unallocated policyholder
remittances............................................ 7,202 8,872
Decrease in accounts payable and accrued expenses......... (5,671) (3,263)
Decrease in taxes, licenses, and fees..................... (407) (874)
Decrease in deferred revenue.............................. (2,531) (3,371)
Increase (decrease) in federal income taxes payable....... (4,878) 303
--------- --------
Net cash provided by operating activities................... 865 10,550
Investing activities:
Purchase of investments securities.......................... (253,732) (201,739)
Disposal and maturity of investment securities.............. 255,336 198,093
Purchase of equipment and software.......................... -- (518)
Proceeds from sale of equipment and software................ -- 1,345
--------- --------
Net cash provided by (used in) investing activities......... 1,604 (2,819)
Financing activities:
Decrease in notes payable................................... -- (11,000)
--------- --------
Net cash used in financing activities....................... -- (11,000)
--------- --------
Net increase (decrease) in cash and cash equivalents........ 2,469 (3,269)
Beginning cash and cash equivalents......................... 1,979 10,702
--------- --------
Ending cash and cash equivalents............................ $ 4,448 $ 7,433
========= ========
</TABLE>
See accompanying notes.
F-58
<PAGE> 140
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995 AND 1996
(UNAUDITED)
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
Organization
Employers Self Insurers Fund ("ESIF") is domiciled in Florida as a
self-insurance workers' compensation fund defined by section 624.4621, Florida
Statutes. ESIF is regulated by the Bureau of Self Insurance under the Department
of Insurance of the State of Florida ("Florida DOI").
ESIF was formed in 1978 for the stated purpose of providing statutory
workers' compensation coverage for certain Florida employers. ESIF's wholly
owned subsidiary, Employers Safety Group Association, Inc. ("ESGA"), is a trade
association primarily for employers in the construction, manufacturing,
wholesale and retail, and service industries, and any employer that is a member
of ESGA may obtain coverage from ESIF. An indemnity agreement issued by ESIF
indemnifies the member employee against loss or liability relating to workers'
compensation insurance risk. Any employer that obtains workers' compensation
coverage from ESIF automatically becomes a member of ESIF with certain rights,
including the right to vote for the election of ESIF's Trustees, the right to
receive any distribution of profits that may be authorized by the Trustees and
the right to participate in the distribution of the surplus of ESIF in the event
of its liquidation. However, all members of ESIF are subject to joint and
several liability for the obligations for ESIF. ESIF has historically not been
operated for the purpose of generating profits, but it has retained a portion of
its earnings and profits to pay its obligations and avoid making assessments
against its members. ESIF has occasionally during its operating history paid a
distribution of profits to its members, but it has never made an assessment
against its members.
ESIF is a trust with a Board comprised of six Trustees, but no employees or
officers. ESIF's bylaws specifically direct the Board to engage an
administrator, and ESIF's administrator since its inception has been Summit
Consulting, Inc. ("SCI"). SCI performs all daily operational activities for
ESIF, including premium and claims processing, pursuant to a written agreement.
SCI also performs similar functions for four other group self-insurance funds
located in Florida, Louisiana and Kentucky.
SCI owns several subsidiaries formed to assist it in providing specialized
administrative services, and SCI is wholly owned by a holding company, Summit
Holding Corporation ("SHC"). Effective January 16, 1996, ESIF purchased all of
the outstanding stock of SHC (see Note 13 for a further discussion of this
acquisition). In addition to SHC and its subsidiaries, ESIF also owns a
reinsurance subsidiary, U.S. Employers Insurance, Inc. ("USEI").
Pursuant to an Amended Plan of Conversion and Recapitalization, and subject
to certain conditions stated therein, ESIF intends to convert to a stock
property and casualty insurance company. In such transaction, ESIF will become
wholly owned by a newly formed holding company and ESIF's members will receive
preferred stock of the holding company in exchange for their membership
interests.
Consolidation and Presentation
The accompanying consolidated financial statements include the accounts,
after intercompany eliminations, of ESIF and its wholly owned subsidiaries and
have been prepared in conformity with generally accepted accounting principles
("GAAP") applicable to stock property and casualty insurance companies, which
differ from statutory accounting practices prescribed or permitted by the
Florida DOI.
These financial statements as of December 31, 1995 and 1996 and for the
nine months then ended are unaudited. In the opinion of management, these
unaudited financial statements have been prepared in
F-59
<PAGE> 141
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
accordance with generally accepted accounting principles and all adjustments,
consisting of normal recurring adjustments, considered necessary for a fair
presentation have been included.
Use of Estimates and Assumptions
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect amounts reported in the
financial statements and accompanying notes. Such estimates and assumptions
could change in the future as more information becomes known which could impact
the amounts reported and disclosed herein.
Recognition of Revenues
Workers' compensation insurance premiums are based on rates established by
the National Council on Compensation Insurance ("NCCI"). Premium revenues
generally are recognized over the life of the related policies on the daily pro
rata method with a reserve for unearned premiums established for the unexpired
portion of the premiums applicable to those policies. For retrospectively rated
policies, the ultimate premium for a period is determined on the basis of the
insured's actual losses for that period. If the actual losses are less than
expected, ESIF may be required to refund a portion of the premiums previously
paid. ESIF considers loss development experience through the date of the
financial statements in estimating the ultimate premium and, as adjustments to
premiums become necessary as a result of loss development, such adjustments are
included in current operations.
Administrative fee revenue is recognized in proportion to the recognition
of earned premiums by the self-insurance funds at the contractual administrative
fee percentage of premiums. Adjustments to revenue for premium audits are
recorded in the period they occur. Fees for administrative services provided to
ESIF subsequent to the date of ESIF's acquisition of SHC have been eliminated in
the consolidated statement of operations.
Reinsurance premiums ceded are recorded and recognized on a pro rata basis
of earned premiums of the contract.
Income Taxes
Income taxes have been provided using the liability method in accordance
with Financial Accounting Standards Board ("FASB") Statement No. 109, Accounting
for Income Taxes. Under that method, deferred tax assets and liabilities are
determined based on the differences between financial reporting and tax bases of
assets and liabilities and are measured using enacted tax rates.
Investments
In 1993, the FASB issued Statement No. 115, Accounting for Certain
Investments in Debt and Equity Securities. Statement No. 115 requires that debt
securities are to be classified as either held-to-maturity (carried at amortized
cost), available-for-sale (carried at market with unrealized gains or losses
reported in equity), or trading (carried at market with unrealized gains or
losses reported in net income).
ESIF believes that it has the ability and intent to hold to maturity its
debt security investments. However, ESIF also recognizes there may be
circumstances where it may be appropriate to sell a security prior to maturity
in response to unforeseen changes in circumstances. Recognizing the need for the
ability to respond to changes in tax position and in market conditions, ESIF has
designated its entire investment portfolio as available-for-sale.
F-60
<PAGE> 142
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
Investments are reported in the accompanying balance sheets on the
following basis:
- Available-for-sale securities are reported at current market value.
Changes in market value of available-for-sale securities, after applicable
deferred income taxes, are reported as unrealized appreciation or
depreciation directly in equity and, accordingly, have no effect on net
income.
- Equity security investments, consisting of common and nonredeemable
preferred stocks, are carried at current market value with changes in such
value reflected as unrealized appreciation or depreciation directly in
equity, after applicable deferred income taxes, having no effect on net
income.
- Short-term investments are reported at cost.
The cost of securities sold is based on specific identification and the
resulting realized gains and losses are included in the determination of net
income.
In the normal course of business, ESIF is party to financial instruments,
none of which have significant off-balance-sheet risk.
Loss and Loss Adjustment Expenses
The reserve for unpaid loss and loss adjustment expenses ("LAE") represents
management's best estimate of the ultimate cost of the loss and LAE that are
unpaid at the balance sheet date including incurred but not reported claims.
Such reserve is established by management based upon: (i) results of actuarial
reviews which incorporate ESIF's experience with similar cases, estimates of
future claim trends, and historical trends such as recurring loss payment and
reporting patterns, claim closures and product mixes; (ii) facts known to the
company; and (iii) regulatory requirements. Such reserve is continually reviewed
and as adjustments become necessary, such adjustments are included in current
operations.
The reserve for permanent indemnity disability claims has been discounted
at 4% as permitted under Florida law. For GAAP purposes, discounting is computed
based on ESIF's anticipated payout patterns and a discount rate consistent with
that permitted by section 625.091, Florida Statutes. The amount of such discount
was $4.6 million and $4.2 million at December 31, 1995 and 1996, respectively.
Prior to the January 16, 1996 acquisition of SHC, certain unallocated LAE
of ESIF were provided by SHC under the administrative agreement between ESIF and
SHC. Subsequent to the acquisition, ESIF has included the liability for such
unallocated LAE in the loss and LAE liability.
Reinsurance
Under FASB Statement No. 113, Accounting and Reporting for Reinsurance of
Short-Duration and Long-Duration Contracts, all assets and liabilities related
to reinsurance ceded contracts are reported on a gross basis rather than the
previous practice of reporting such assets and liabilities net of reinsurance.
The amounts recoverable from reinsurers are classified separately on the balance
sheet.
The accompanying statements of operations reflect premiums and losses
incurred, net of reinsurance ceded (see Note 6). Reinsurance arrangements allow
management to control exposure to potential losses arising from large risks. A
significant portion of the reinsurance is effected under excess of loss
reinsurance contracts. Amounts recoverable from reinsurers are estimated in a
manner consistent with the loss and loss expense reserves associated with the
reinsured policies. Similarly, reinsurance premiums, losses and loss adjustment
expenses are accounted for on bases consistent with those used in accounting for
the related original policies issued and the terms of the reinsurance contracts.
F-61
<PAGE> 143
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
Guaranty Fund Assessments
As a self-insurance fund, ESIF has periodically been assessed by a state
guaranty fund as part of that fund's activities to collect funds from solvent
self-insurance funds to cover certain losses to policyholders of insolvent
self-insurance funds, after assessment of such policyholders of the insolvent
funds. This type of guaranty fund is separate from the Florida Special
Disability Trust Fund (the "SDTF"), which is designed to pay insurers for
certain benefits paid to previously injured workers, as discussed in Note 12.
Florida law limits the assessment to a maximum of 2% of direct written
premiums annually, but because there are many uncertainties regarding the
ultimate amount of assessments, ESIF's policy has been to recognize its
obligation for guaranty fund assessments when it receives notice that an amount
is payable to the guaranty fund. At December 31, 1996, ESIF was not able to
reasonably estimate the potential effects of any future assessments and,
accordingly, the accompanying financial statements do not include any provision
for such future assessments. Assessments charged to expense during the nine
months ended December 31, 1995 and 1996 were $1.1 million and $1.0 million,
respectively. Such assessments are credited against ESIF's administrative tax.
Upon conversion to a stock property and casualty insurer, ESIF will be
subject to assessment by a separate guaranty fund. Such assessments will not be
credited against ESIF's administrative tax.
Concentrations of Credit or Financial Risk
Florida law allows ESIF to write policies only in the State of Florida.
Therefore, all of ESIF's premium revenues for the nine months ended December 31,
1995 and 1996 were derived from policies offered to customers located in
Florida. Accordingly, ESIF could be adversely affected by economic downturns,
significant unemployment, and other conditions that may occur from time-to-time
in Florida, which may not as significantly affect its more geographically
diversified competition.
SHC has significant amount of revenues associated with its third-party
processing as a result of its contracts with several self-insurance funds.
Changes with respect to these contracts could adversely affect ESIF.
As further described in Note 6, ESIF has significant amounts of reinsurance
recoverables as a result of ceding reinsurance under specific and aggregate
reinsurance treaties.
Intangible Assets
Cost in excess of net assets of businesses acquired totaling $49.0 million
was recorded in conjunction with the January 1996 acquisition of SHC. This
intangible asset is being amortized on a straight-line basis over 25 years.
ESIF's cost associated with the purchase of customer listings recorded in
conjunction with the January 1996 acquisition of SHC totals approximately $6.5
million. This intangible asset is being amortized on a straight-line basis over
10 years.
At the balance sheet date, ESIF evaluates the recoverability of the cost in
excess of net assets acquired and the cost associated with customer listings
through a comparison of the forecasted undiscounted cash flows of SHC and the
remaining asset balances.
F-62
<PAGE> 144
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
Equipment and software
Equipment and software are recorded at cost. Depreciation is computed using
the straight-line method over the useful lives of the related assets.
Cash and Cash Equivalents
ESIF considers all highly liquid investments with original maturities of
three months or less to be cash equivalents.
Bad Debt Allowance
The bad debt allowance is based on ESIF's experience with uncollectible
premiums receivable and represents ESIF's best estimate of the ultimate
uncollectible amounts incurred through the balance sheet date.
2. INVESTMENTS
The amortized cost and the fair value of debt security investments are
summarized as follows:
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
At December 31, 1995:
U.S. Treasury and government agencies....... $ 58,131 $1,805 $ 6 $ 59,930
States and political subdivisions........... 58,816 1,606 57 60,365
Industrial and miscellaneous................ 30,092 2,014 -- 32,106
Mortgage-backed securities:
U.S. government agencies................. 28,415 501 131 28,785
-------- ------ ------ --------
Total debt securities
available-for-sale................ $175,454 $5,926 $ 194 $181,186
======== ====== ====== ========
At December 31, 1996:
U.S. Treasury and government agencies....... $ 50,423 $ 335 $ 495 $ 50,263
States and political subdivisions........... 82,937 1,272 406 83,803
Industrial and miscellaneous................ 38,354 795 169 38,980
Mortgage-backed securities:
U.S. government agencies................. 10,902 193 91 11,004
Industrial and miscellaneous............. 619 13 -- 632
-------- ------ ------ --------
Total debt securities
available-for-sale................ $183,235 $2,608 $1,161 $184,682
======== ====== ====== ========
</TABLE>
The amortized cost and estimated fair value of debt securities at December
31, 1996, by contractual maturity, are shown below. Actual maturities may differ
from contractual maturities because certain borrowers may have the right to call
or prepay obligations with or without call or prepayment penalties.
F-63
<PAGE> 145
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
<TABLE>
<CAPTION>
AMORTIZED FAIR
COST VALUE
--------- --------
(IN THOUSANDS)
<S> <C> <C>
Years to maturity:
One or less............................................... $ 1,518 $ 1,513
After one through five.................................... 64,128 64,620
After five through ten.................................... 90,476 91,046
After ten................................................. 15,592 15,867
-------- --------
171,714 173,046
Mortgage-backed securities................................ 11,521 11,636
-------- --------
Total............................................. $183,235 $184,682
======== ========
</TABLE>
Proceeds from the sales of investments in debt securities during the nine
months ending December 31, 1995 were $135.4 million. Gross gains of $2.1 million
and gross losses of $0.4 million were realized on those sales. Proceeds from the
sales of investments in debt securities during the nine months ended December
31, 1996 were $66.8 million. Gross gains of $0.7 million and gross losses of
$1.0 million were realized on those sales.
Unrealized gains and losses on investments in preferred and common stocks
are reported directly in equity and do not affect operations. The gross
unrealized gains and losses on, and the cost and fair value of, those
investments are summarized as follows:
<TABLE>
<CAPTION>
GROSS GROSS
UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
------- ---------- ---------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
At December 31, 1995:
Preferred stocks.............................. $ 3,106 $ 109 $ -- $ 3,215
Common stocks................................. 9,583 1,745 100 11,228
------- ------ ---- -------
Total................................. $12,689 $1,854 $100 $14,443
======= ====== ==== =======
At December 31, 1996:
Preferred stocks.............................. $ 4,452 $ 133 $ 17 $ 4,568
Common stocks................................. 11,620 2,718 238 14,100
------- ------ ---- -------
Total................................. $16,072 $2,851 $255 $18,668
======= ====== ==== =======
</TABLE>
Major categories of ESIF's investment income are summarized as follows:
<TABLE>
<CAPTION>
NINE MONTHS ENDED
DECEMBER 31,
---------------------
1995 1996
----------- ------
(IN THOUSANDS)
<S> <C> <C>
Income:
Bonds..................................................... $ 8,945 $7,805
Preferred stocks.......................................... 133 205
Common stocks............................................. 246 229
Short-term investments and cash........................... 1,198 1,367
------- ------
Net investment income....................................... $10,522 $9,606
======= ======
</TABLE>
The Florida DOI requires cash and investments to be held in trust for the
Florida DOI for 10% of statutory basis loss reserves and the 1986-1995 fund
years aggregate reserve plans. The aggregate plans
F-64
<PAGE> 146
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
approved by the Florida DOI require the interest earned on the related reserves
to accumulate with the restricted principal. The reserves are reviewed annually
and a revised funding plan is submitted to the Florida DOI. At December 31, 1995
and 1996, the amount in trust is approximately $61.7 million and $52.7 million,
respectively.
3. PROPERTY AND EQUIPMENT
The major components of equipment and software at December 31, 1996 are as
follows (in thousands):
<TABLE>
<S> <C>
Furniture, fixtures and equipment........................... $ 987
Data processing equipment................................... 835
Leasehold improvements...................................... 103
Software.................................................... 163
Automobiles................................................. 13
------
2,101
Less accumulated depreciation............................... 653
------
$1,448
======
</TABLE>
Depreciation expense for the nine months ended December 31, 1996 was $0.6
million. Substantially all equipment and software was acquired in the January
1996 acquisition of SHC.
4. INTANGIBLES
The majority of ESIF's intangible assets were recorded in connection with
the acquisition of SHC and are stated at cost, which represents fair value as of
the acquisition date, less accumulated amortization, and include purchased
software, customer accounts and contracts, and the excess of the purchase price
over the fair value of identifiable net assets acquired. Purchased software,
customer accounts and contracts are being amortized on a straight-line basis
over the estimated useful lives and contract period which range from three to
ten years. The excess of cost over the fair value of identifiable net assets
acquired is being amortized on a straight-line basis over 25 years.
Intangible assets consist of the following as of December 31, 1996 (in
thousands):
<TABLE>
<S> <C>
Unamortized debt acquisition costs.......................... $ 757
Purchased software.......................................... 6,300
Goodwill.................................................... 47,242
Customer accounts and contracts............................. 6,608
-------
60,907
Less accumulated amortization............................... 4,269
-------
$56,638
=======
</TABLE>
5. LEASES
SHC leases office premises and automobiles under noncancelable operating
leases which expire at various dates through the year 2001. These leases
generally contain renewal options and escalation clauses based on increases in
lessors' operating expenses and other charges. ESIF anticipates that most leases
will be renewed or replaced upon expiration.
F-65
<PAGE> 147
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
Future minimum annual payments at December 31, 1996 for all noncancelable
leases are (in thousands):
<TABLE>
<S> <C>
Three Months Ended March 31:
1997...................................................... $ 449
Years ended March 31:
1998...................................................... 1,581
1999...................................................... 1,547
2000...................................................... 1,180
2001...................................................... 103
------
Total minimum future lease payments......................... 4,860
Income from subleases....................................... (121)
------
Net minimum future lease payments........................... $4,739
======
</TABLE>
In excess of 80% of the future lease commitments relates to rented office
premises from certain trustees of ESIF.
Rental expense for the nine months ended December 31, 1996 for operating
leases totaled $1.3 million.
F-66
<PAGE> 148
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
6. REINSURANCE
In accordance with general practice in the insurance industry, ESIF and its
insurance subsidiaries are engaged in reinsurance transactions to cede risk to
other companies. Reinsurance ceded contracts do not relieve ESIF and its
insurance subsidiaries from their obligation to policyholders, as they remain
liable to their policyholders to the extent that any reinsurer does not meet its
obligations for reinsurance ceded to it under reinsurance contracts. The largest
net amount retained by ESIF or its subsidiaries on any one occurrence is
$500,000 with a $750,000 deductible in the nine months ended December 31, 1995
and $500,000 with a $500,000 deductible in the nine months ended December 31,
1996. Reinsurance agreements are in force with certain maximum limits, as well
as excess of loss reinsurance agreements.
SPECIFIC REINSURANCE
(IN THOUSANDS)
<TABLE>
<CAPTION>
FISCAL YEAR SPECIFIC
ENDED SPECIFIC OCCURRENCE
MARCH 31, CARRIER ATTACHMENT LIMIT
- ----------- ------- ---------- ----------
<C> <S> <C> <C>
1982 INA $ 100 $ 2,000
Employers Re 2,100 3,000
1983 INA 125 2,000
Employers Re 2,125 3,000
1984 Employers Re 125 2,000
INA 2,125 Statutory
1985 Employers Re 125 2,000
INA 2,125 Statutory
1986 Employers Re 225 20,000
1987 Safety Mutual(1) 1,000 5,000
Old Republic(2) 1,000 1,000
National Union(2) 2,000 8,000
1988 Old Republic 1,000 5,000
1989 Old Republic 1,000 5,000
1990 Transamerica 1,000 15,000
1991 Transamerica 1,000 15,000
1992 Transamerica 1,000 25,000
1993 Transamerica 1,000 25,000
1994 Lloyd's 500 500
Transamerica 1,000 Statutory
1995 Lloyd's 500 500
Continental Casualty 1,000 Statutory
1996 Federal Insurance Co. 500 500
Federal Insurance Co. 1,000 1,000
Continental Casualty 2,000 Statutory
1997 Lloyd's 500 1,500
National Union 2,000 Statutory
</TABLE>
- ---------------
(1) 4/1/86 -- 5/31/86
(2) 6/1/86 -- 3/31/87
F-67
<PAGE> 149
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
AGGREGATE REINSURANCE
(IN THOUSANDS)
<TABLE>
<CAPTION>
FISCAL
YEAR
ENDED AGGREGATE AGGREGATE
MARCH 31, CARRIER ATTACHMENT LIMIT
- --------- ------- ---------- ----------
<C> <S> <C> <C>
1982 INA $ 1,542 $ 2,000
Employers Re 13,542 3,000
INA 16,542 Statutory
1983 INA 11,365 2,000
Employers Re 13,365 3,000
INA 16,365 Statutory
1984 Employers Re 14,341 2,000
INA 16,341 Statutory
1985 Employers Re 17,814 3,000
INA 20,814 Statutory
1986 Employers Re 40,091 301
1987 N/A N/A N/A
1988 N/A N/A N/A
1989 Crossroads 90,648 19,000
1990 Crossroads 110,975 25,000
1991 Crossroads 130,413 31,000
1992 Crossroads 111,548 31,000
1993 Crossroads 141,956 33,401
1994 Crossroads 146,016 34,357
1995 Crossroads 133,800 31,482
1996 Crossroads 115,178 27,287
1997 N/A N/A N/A
</TABLE>
Insurance premiums for the nine months ended December 31, 1995 and 1996 are
summarized as follows:
<TABLE>
<CAPTION>
1995 1996
----------- -------
(IN THOUSANDS)
<S> <C> <C>
Direct premiums earned...................................... $94,493 $79,201
Reinsurance ceded........................................... 4,780 4,692
------- -------
Net premiums earned......................................... $89,713 $74,509
======= =======
</TABLE>
<TABLE>
<CAPTION>
1995 1996
----------- --------
(IN THOUSANDS)
<S> <C> <C>
Gross premiums written...................................... $120,442 $113,369
Ceded premiums written...................................... 6,317 5,060
-------- --------
Net premiums written........................................ $114,125 $108,309
======== ========
</TABLE>
F-68
<PAGE> 150
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
Losses and LAE incurred for the nine months ended December 31, 1995 and
1996 are summarized as follows:
<TABLE>
<CAPTION>
1995 1996
----------- -------
<S> <C> <C>
(IN THOUSANDS)
Direct losses and LAE....................................... $71,019 $59,298
Reinsurance ceded........................................... 3,976 9,062
------- -------
Net losses and LAE incurred................................. $67,043 $50,236
======= =======
</TABLE>
Reinsurance ceded premiums and losses included in the preceding table
reflect the elimination of amounts assumed by USEI through retrocession by
Crossroads Insurance Company, Limited ("Crossroads") of amounts ceded by ESIF to
Crossroads as described in the following paragraph.
Of the reinsurance ceded amounts above for the nine months ended December
31, 1996, premiums of $-0-, and losses and LAE of $2.1 million, are attributable
to reinsurance agreements with Crossroads, a Bermuda domiciled insurance
company, which a Trustee of ESIF has an ownership interest. Crossroads is
licensed to do business in Florida and is a member of the Florida Insurance
Guaranty Association. Fifty percent of business ceded to Crossroads has been
retroceded by Crossroads to USEI. All of ESIF's aggregate excess reinsurance
coverage for fiscal years ended March 31, 1989, 1993, 1994 and 1995 is also
ceded to Crossroads. At December 31, 1995 and 1996 loss and LAE reserves
recoverable of approximately $9.6 million and $11.1 million, respectively (net
of amounts retroceded to USEI), are attributable to excess reinsurance
agreements with Crossroads. For the fiscal years 1986, 1987, 1988, 1990, 1991
and 1992, effective aggregate excess reinsurance is not currently in place
because these years have been self-funded or because the coverages have expired.
Exposure to significant adverse development for these years is considered
minimal due to the maturity of the loss development for these years.
In the nine months ended December 31, 1995 and 1996, ESIF did not commute
any ceded reinsurance nor did it enter into or engage in any loss portfolio
transfers.
ESIF remains obligated for amounts ceded in the event that the reinsurers
do not meet their obligations.
ESIF's reinsurance recoverable asset at December 31, 1996 is comprised of
amounts related to reinsurance agreements with the following companies (in
thousands):
<TABLE>
<CAPTION>
PAID UNPAID
CLAIMS CLAIMS TOTAL
------ -------- --------
<S> <C> <C> <C>
Reinsurance Carrier
American Re............................................ $ -- $ 734 $ 734
Continental Casualty................................... -- 9,245 9,245
Crossroads............................................. 1,847 9,276 11,123
Employers Re........................................... 808 5,150 5,958
Federal Ins. Co........................................ -- 8,417 8,417
INA.................................................... 223 5,792 6,015
Lloyd's of London...................................... -- 16,856 16,856
National Union......................................... -- 2,385 2,385
Old Republic........................................... 41 15,132 15,173
Transamerica........................................... 10 31,142 31,152
------ -------- --------
Total.......................................... $2,929 $104,129 $107,058
====== ======== ========
</TABLE>
F-69
<PAGE> 151
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
All of the recoverable amounts related to paid claims have been outstanding
less than ninety days at the balance sheet date. The reinsurance recoverable
amounts related to unpaid claims are calculated considering the provisions of
the specific and aggregate reinsurance agreements and using ultimate losses by
accident year consistent with the reported loss and LAE liabilities.
7. FEDERAL INCOME TAXES
ESIF and its subsidiaries file a consolidated federal income tax return.
ESIF does not have a tax sharing agreement with two of its subsidiaries, ESGA
and USEI. ESIF does not collect from or refund to these subsidiaries the amount
of income taxes or benefits which would result if the entities filed separate
returns. An informal tax sharing agreement exists between ESIF and SHC such that
the amount of taxes or tax benefits are shared as if separate returns were
filed.
Income before federal income taxes differs from taxable income principally
due to tax-exempt investment income, dividends-received tax deductions, and
differences in loss and LAE expense discounting and unearned premium reserves
for tax and financial reporting purposes.
Federal income taxes of $6.9 million and $12.2 million for the years ended
March 31, 1995 and 1996, respectively, would be subject to recovery in the event
that ESIF incurs net operating losses within three years of the years for which
such taxes were paid. State taxes paid was $0.9 million and $0.7 million for the
nine months ended December 31, 1995 and 1996, respectively.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes.
Significant components of ESIF's deferred tax liabilities and assets as of
December 31, as calculated in accordance with FASB Statement No. 109, are as
follows:
<TABLE>
<CAPTION>
1995 1996
----------- -------
(IN THOUSANDS)
<S> <C> <C>
Deferred tax liabilities:
Unrealized investment gains............................... $ 2,771 $ 1,521
Special Disability Trust Fund recoverables................ 302 283
Reinsurance premium adjustment............................ -- 1,494
Intangible assets......................................... -- 4,050
Other..................................................... -- 740
------- -------
Total deferred tax liabilities.................... 3,073 8,088
Deferred tax assets:
Discount on loss and LAE reserves......................... 18,098 19,237
Unearned premium.......................................... 1,372 1,141
Uncollectible premiums.................................... 753 941
Other..................................................... -- 931
------- -------
20,223 22,250
Valuation allowance for deferred tax assets............... -- --
------- -------
Total deferred tax assets......................... 20,223 22,250
------- -------
Net deferred tax assets..................................... $17,150 $14,162
======= =======
</TABLE>
ESIF has made an election under the Internal Revenue Code of 1986 to treat
income tax payments attributable to loss reserve discounting as special
estimated tax payments which are specifically recoverable
F-70
<PAGE> 152
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
upon reversal of the discounting effects. Accordingly, the deferred tax assets
attributable to loss reserve discounting are considered to be fully recoverable.
ESIF also has significant tax loss carryback potential for the fiscal years
ended March 31, 1994 and 1995. For those reasons, a deferred tax valuation
allowance is not considered necessary.
ESIF's consolidated federal income tax liability (asset) at December 31, is
summarized as follows:
<TABLE>
<CAPTION>
1995 1996
----------- --------
(IN THOUSANDS)
<S> <C> <C>
Current..................................................... $ (2,123) $ 303
Deferred.................................................... (17,150) (14,162)
-------- --------
Total net asset................................... $(19,273) $(13,859)
======== ========
</TABLE>
Significant components of the provision for income taxes for the nine
months ended December 31, attributable to continuing operations, are as follows:
<TABLE>
<CAPTION>
1995 1996
----------- ------
(IN THOUSANDS)
<S> <C> <C>
Current tax expense......................................... $ 3,994 $3,006
Deferred taxes (benefit).................................... (1,671) 51
------- ------
Total income tax expense on income................ $ 2,323 $3,057
======= ======
</TABLE>
Income taxes paid by ESIF totaled $10.4 million and $3.3 million for the
nine months ended December 31, 1995 and 1996, respectively.
The reconciliation of income tax expense for the nine months ended December
31, attributable to continuing operations computed at the U.S. federal statutory
tax rate of 35%, to income tax expense is as follows:
<TABLE>
<CAPTION>
1995 1996
----------- ------
(IN THOUSANDS)
<S> <C> <C>
Income tax (at 35% of pretax income or loss)................ $2,623 $2,819
Tax-exempt investment income................................ (802) (905)
Non deductible expenses..................................... 17 60
Goodwill amortization....................................... -- 438
State income taxes.......................................... 463 336
Other items, net............................................ 22 309
------ ------
Provision for federal income tax expense.................... $2,323 $3,057
====== ======
</TABLE>
8. LOSSES AND LAE
The reserves for unpaid losses and LAE are estimated using individual
case-basis valuations and statistical analyses. These estimates are subject to
the effects of trends in loss severity and frequency. Although some variability
is inherent in such estimates, management believes that the reserves for losses
and LAE are adequate. The estimates are reviewed annually by independent
consulting actuaries and adjusted as necessary as experience develops or new
information becomes known; such adjustments are included in current operations.
F-71
<PAGE> 153
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
The following table provides a reconciliation of the beginning and ending
reserve balances for losses and LAE for the nine months ended December 31, 1995
and 1996:
<TABLE>
<CAPTION>
NINE MONTHS ENDED
DECEMBER 31,
----------------------
1995 1996
----------- --------
<S> <C> <C>
(IN THOUSANDS)
Net reserves for losses and LAE at beginning of period...... 259,085 277,995
Less: Recoverable from Florida SDTF(1)...................... (15,879) (20,060)
-------- --------
Net reserves for losses and LAE less SDTF recoverable asset
at beginning of period.................................... 243,206 257,935
Add provision for claims occurring in:
The current year.......................................... 61,955 53,698
Prior years............................................... 5,088 (3,462)
-------- --------
Incurred losses during the current year..................... 67,043 50,236
Deduct payments for claims occurring in:
The current year.......................................... 8,274 8,378
Prior years............................................... 56,072 48,137
-------- --------
Claim payments during the current year...................... 64,346 56,515
-------- --------
Net reserves for losses and LAE less SDTF recoverable asset
at end of period.......................................... 245,903 251,656
Add: Recoverable from Florida SDTF(1)....................... 16,827 21,138
-------- --------
Net reserves for losses and LAE at end of period............ 262,730 272,794
Add: Reinsurance recoverables (exclusive of recoverables on
paid losses).............................................. 110,056 104,129
-------- --------
Gross reserves for losses and LAE at end of period (GAAP
basis).................................................... 372,786 376,923
======== ========
</TABLE>
- ---------------
(1) The change in the SDTF recoverable asset is included in incurred losses in
the Statement of Income.
The foregoing reconciliation also shows that a $3.5 million reserve
redundancy emerged during the nine month period ended December 31, 1996. This
amount represents the release of certain loss reserves previously carried which
were determined, based on comparisons to actuarially projected amounts, to be
redundant.
Statutory basis loss reserves were determined using paid loss data net of
historic SDTF recoveries; GAAP basis loss reserves were determined using paid
loss data gross of SDTF recoveries. This adjustment increased loss reserves by
$26.4 million and $28.8 million at December 31, 1995 and 1996, respectively, and
increased reinsurance recoverables by $10.5 million and $8.4 million at December
31, 1995 and 1996, respectively. In addition, ESIF has recorded, as an asset,
amounts recoverable from the SDTF based upon ESIF's historical collection
experience and the amount of claims identified as subject to SDTF recovery. The
recoverable amount recorded at December 31, 1995 and 1996 was $16.8 million and
$21.1 million, respectively.
In order to quantify the amounts recoverable from the SDTF, ESIF reviews
its claims that have been identified as subject to SDTF recovery considering
ESIF's historical recovery experience on claims submitted to the SDTF. In
addition, ESIF estimates the amount of claims it expects to recover over the
next four years based on actual collection experience for the most recent two
years, and discounts the expected recoveries using an appropriate interest rate.
The amounts reflected as recoverables from the SDTF were based on the discounted
expected collection amounts rather than on the total claims identified as
subject to SDTF recovery.
The SDTF reinsurance recoverable results from calculating such recoverables
using loss and LAE reserves computed using paid losses gross of SDTF recoveries
and in consideration of expected recoveries from SDTF. Certain of the claims
used in the determination of the SDTF recoverable are of an amount which will
pierce reinsurance layers. The Company will pursue recovery of such claims under
the provisions of its
F-72
<PAGE> 154
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
reinsurance agreements. Subsequently, as the Company remits the claims to the
SDTF, and ultimately collects these claims from SDTF, the Company will remit to
the reinsurers their portion of the SDTF recoveries. The aggregate recoverable
from SDTF asset and the SDTF related reinsurance recoverable, which approximates
the amount of the increase in loss reserves resulting from determining the GAAP
basis loss reserves using paid loss data gross of SDTF recoveries, represents
management's best estimate of the aggregate amounts that will be recovered.
LAE assumed in the acquisition of SHC represents unallocated LAE reserves
established by ESIF that were, prior to the acquisition, provided by SHC under
the administrator's contract between ESIF and SHC.
9. ACCRUED RETROSPECTIVE PREMIUMS
Certain workers' compensation insurance policies issued by ESIF are
retrospectively rated, and premiums are based on loss experience incurred under
these contracts to date. Accrued retrospectively rated premiums, including those
relating to bulk incurred but not reported, have been determined by or allocated
to individual policyholder accounts. These amounts are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1995 1996
----------- -------
(IN THOUSANDS)
<S> <C> <C>
Accrued retrospective premium............................... $43,440 $23,990
</TABLE>
10. EQUITY
ESIF and its insurance subsidiaries, subsequent to the conversion to a
stock property and casualty company, will have legal restrictions as to the
transfer of funds in the form of dividends, loans, and advances. These
restrictions, determined in accordance with statutory reporting practices,
generally limit the payment of dividends to amounts based upon statutory surplus
or profits and limit the amount of certain investments to specified percentages
of statutory admitted assets. At December 31, 1996, under regulations applicable
to stock property and casualty insurance companies, $2.0 million of ESIF's
statutory net assets of $20.4 million can be transferred from the insurance
entities without regulatory approval.
Equity and net income as determined in accordance with statutory accounting
practices for self-insurance funds as of and for the nine months ended December
31, 1995 and 1996 are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, EQUITY NET INCOME
- ------------ ------- ----------
(IN THOUSANDS)
<S> <C> <C>
1995........................................................ $49,275 $2,674
1996........................................................ $20,434 $5,108
</TABLE>
As a self-insurance fund, ESIF recorded for statutory reporting an asset of
$44.9 million at December 31, 1996, for future investment income determined by
discounting loss and LAE reserves at a statutory prescribed rate. Upon
conversion to a stock property and casualty insurer, ESIF will be permitted to
record discounts only on the indemnity portion of permanent disability cases.
The amount of such discount is estimated at $4.2 million at December 30, 1996.
It is ESIF's intention to utilize proceeds of a public offering to meet
statutory basis capital and equity requirements for a stock property and
casualty company.
In order to improve the regulation of insurer solvency, the National
Association of Insurance Commissioners issued a model law to implement
risk-based capital ("RBC") requirements for property and casualty insurance
companies, which are designed to assess capital adequacy and to raise the level
of protection that statutory equity provides for policyholder obligations. The
RBC formula for property and casualty insurance
F-73
<PAGE> 155
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
companies measures these major areas of risk facing property and casualty
insurers: (i) underwriting, which encompasses the risk of adverse loss
development and inadequate pricing; (ii) declines in asset values arising from
credit risk; and (iii) declines in asset values arising from investment risks.
Pursuant to the model law, insurers having less statutory equity than required
by the RBC calculation will be subject to varying degrees of regulatory action,
depending on the level of capital inadequacy. Florida, ESIF's state of domicile,
has yet to adopt the provisions of the RBC model law. Upon completion of the
conversion and recapitalization, ESIF's insurance subsidiaries will maintain
statutory basis equity in excess of the amount required by Florida law.
11. COMMITMENTS AND CONTINGENCIES
ESIF, in the normal course of business, is named as a defendant in various
legal actions arising principally from claims made under insurance policies and
contracts. Those actions are considered by ESIF in estimating the loss and LAE
reserves. ESIF's management believes that the resolution of those actions will
not have a material effect on ESIF's financial position or results of
operations.
12. SDTF
The State of Florida maintains the SDTF for the purpose of providing
benefits to workers who have a pre-existing condition and incur a second or
subsequent injury. The SDTF is funded through annual assessments against
workers' compensation insurers which are based on a percentage of net workers'
compensation premiums written.
The SDTF has not charged adequate assessments to actuarially fund its
claims liability. In 1996, the Florida legislature reauthorized the SDTF for
four years; however, in the future, the Florida legislature may impose greater
assessments on insurance carriers, such as ESIF, to satisfy pending claims.
Moreover, it is not possible to predict how the SDTF will operate, if at all, in
the future after the reauthorized period. Changes in the SDTF's operations which
decrease the availability of recoveries from the SDTF, or increase SDTF's
assessments payable by ESIF or changes in regulations which further limit ESIF's
ability to reduce statutory basis loss reserves for a portion of SDTF future
recoverable amounts may have a material adverse effect on ESIF's business,
financial condition or results of operations. Discontinuance of the SDTF could
have either a favorable or unfavorable effect on ESIF depending on the relation
of the amount of assessments by SDTF to the amount of recoveries from SDTF. If
the SDTF is discontinued, ESIF believes that the existing reimbursement
obligations of the SDTF would become general obligations of the State of
Florida, although there is no assurance that a reviewing court would adopt that
view. The SDTF has made no acknowledgement with regard to the enforceability of
its reimbursement obligations to insurers such as ESIF.
Loss and LAE reserves included in the accompanying financial statements are
presented gross of future SDTF recoveries and have been determined using
historical loss data which excludes SDTF recoveries.
ESIF has recorded an SDTF recoverable of $16.8 million and $21.1 million at
December 31, 1995 and 1996, respectively, for the estimated amounts expected to
be received from the SDTF. The estimated amount of recoveries, which is
management's best estimate of the amount that will be recovered, was based on
claims identified as subject to SDTF recovery as well as ESIF's recovery
experience.
Amounts recovered from SDTF for the nine months ended December 31, 1995 and
1996 were $3.2 million and $6.5 million, respectively. The assessment expensed
by ESIF to the SDTF were $5.6 million and $3.9 million for the nine months ended
December 31, 1995 and 1996, respectively.
ESIF has not recorded a liability for future assessments from SDTF. Such
future assessments will be based on future premium amounts.
F-74
<PAGE> 156
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
13. ACQUISITION OF SHC
On January 16, 1996, ESIF and its subsidiaries purchased all of the
outstanding capital stock of SHC. The purchase price consisted of $26.0 million
paid in cash from the Company, $11.5 million in cash distributed by Summit and
$44.0 million in assumption of debt by SHC (see Note 14). SHC is a third party
administrator which provides insurance related services (including marketing,
policy issuance and servicing, claims processing and administration, loss
control, brokerage, audits, financial and data processing services and risk
management services) to ESIF, four other self-insurance funds and a property and
casualty insurance company. The acquisition was accounted for using the purchase
method, and the results of operations of SHC are included in the consolidated
statement of operations from the date of acquisition.
The following unaudited proforma information for the nine months ended
December 31, 1995 presents the consolidated results of operations of ESIF and
SHC as if the acquisition had been effective at April 1, 1995 after giving
effect to adjustments to reflect the acquisition. This information is intended
for informational purposes only and may not be indicative of ESIF's future
results of operations (in thousands):
<TABLE>
<S> <C>
Total revenues.............................................. $130,758
Income before income tax expense............................ 11,442
Net income.................................................. 7,595
</TABLE>
To comply with requirements of the Florida DOI, SHC's chairman has
personally indemnified ESIF up to a maximum of $5.0 million for certain loss,
injury or damage to ESIF which may result from the acquisition of SHC. Such
indemnification will expire on the earlier of January 11, 2001 or on the date
upon which the bank debt, incurred in the acquisition, is retired.
14. NOTES PAYABLE
In connection with the purchase of SHC by ESIF, SHC utilized a bank term
loan with rates based on LIBOR plus 3%. The balance as of December 31, 1996 for
SHC was $33.0 million. Also, a revolving bank credit facility with rates
approximating the prime rate was entered into as part of the agreement. As of
December 31, 1996, there was no balance outstanding for SHC for this agreement.
Interest expense incurred as of December 31, 1996 was $2.6 million.
Prior to December 31, 1996, the term loan and revolving credit facility
agreements were amended.
Maturities for the combined term loan and revolving credit facility (as
amended) are as follows:
<TABLE>
<CAPTION>
REDUCTION IN THE
TERM AVAILABILITY OF THE
LOAN REVOLVING CREDIT FACILITY
------- -------------------------
(IN THOUSANDS)
<S> <C> <C>
For the Three Months Ending March 31:
1997................................................ $ 325 $ --
For the Years Ending March 31:
1998................................................ 2,300 --
1999................................................ 3,925 --
2000................................................ 5,500 --
2001................................................ 9,500 1,500
Thereafter.......................................... 11,450 3,500
------- -------
$33,000 $5,000
======= =======
</TABLE>
F-75
<PAGE> 157
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
As collateral for the debt, SHC pledged the issued and outstanding stock of
SCI and three other wholly owned subsidiaries, Bridgefield Casualty Insurance
Company, Meritec Solutions, Inc. and Carolina Summit Healthcare, Inc. The credit
agreement contains certain covenants which require that certain financial ratios
and/or levels be maintained by SHC and its insurance subsidiary, Bridgefield
Casualty. Among these covenants are the following: operating leverage, fixed
charge coverage ratio, minimum stockholder equity and risk based capital for the
insurance subsidiary.
15. EMPLOYEE BENEFIT PLANS
ESIF's subsidiary, SHC, has a deferred savings and profit-sharing plan (the
"401(k)") covering substantially all employees. Under the 401(k), SHC makes
contributions equal to 75% of the participant's contributions, not to exceed 6%
of the participant's annual compensation. SHC's contributions to the 401(k)
totaled approximately $0.3 million for the period April 1, 1996 to December 31,
1996.
16. FAIR VALUES OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used by ESIF in estimating its
fair value disclosures for financial instruments:
- Cash and cash equivalents, short-term investments: The carrying amounts
reported in the balance sheet for these instruments approximate fair
values.
- Investment securities: Fair values for debt security investments are
based on quoted market prices.
- Premiums and accounts receivable: The carrying amounts of ESIF's
receivables approximate fair values.
- Notes payable: ESIF's subsidiary has $33.0 million of notes payable at
December 31, 1996 that approximates its fair value.
ESIF's fair value of reinsurance recoverable approximates its carrying
value for December 31, 1995 and 1996, respectively, as summarized below:
<TABLE>
<CAPTION>
DECEMBER 31, 1995 DECEMBER 31, 1996
---------------------- -------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
-------- ----------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Reinsurance recoverable..................... $112,734 $112,734 $107,058 $107,058
</TABLE>
17. DISCONTINUED OPERATIONS
Effective July 31, 1996, ESIF decided to discontinue its computer software
development. This business was acquired in the January 1996 acquisition of SHC.
As of December 31, 1996 all assets have been disposed and ESIF has recognized an
after tax loss of approximately $1.2 million on the disposition of this
operation (including estimated operating losses to the disposition date).
F-76
<PAGE> 158
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
The operating results of the computer software development operations for
the nine month period ended December 31, 1996 were as follows (in thousands):
<TABLE>
<S> <C>
Revenue..................................................... $ 660
Expenses.................................................... 2,013
-------
Loss before income taxes.................................... (1,353)
Income tax (benefit)........................................ (460)
-------
Net loss.................................................... $ (893)
=======
</TABLE>
18. DISPOSITION
Effective July 31, 1996, ESIF decided to terminate its efforts to develop a
healthcare subsidiary in North Carolina. This start up effort was initiated by
SHC prior to the acquisition of SHC by ESIF. The disposition of this subsidiary
by a sale of its stock is expected to be completed during the first quarter of
1997. The consolidated financial statements include the operating results and
assets and liabilities of this subsidiary.
The operating results for the healthcare subsidiary for the nine month
period ending December 31, 1996 were as follows (in thousands):
<TABLE>
<S> <C>
Revenue..................................................... $ 114
Expenses.................................................... 701
-----
Loss before income taxes.................................... (587)
Income tax (benefit)........................................ (200)
-----
Net loss.................................................... $(387)
=====
</TABLE>
19. SEGMENT INFORMATION
The operations of ESIF, prior to the January 1996 acquisition of SHC, were
solely in the workers' compensation insurance industry segment. Subsequent to
the acquisition of SHC, ESIF also operates in the insurance administration
segment. Financial information by industry segment for revenues, income before
income taxes, and identifiable assets are summarized as follows:
<TABLE>
<CAPTION>
WORKERS'
COMPENSATION INSURANCE INTERCOMPANY
TOTAL INSURANCE ADMINISTRATION ELIMINATION
-------- ------------ -------------- ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Nine Months Ended December 31, 1995:
Revenues............................. $103,086 $103,086 -- --
Income before income taxes........... $ 7,495 $ 7,495 -- --
Identifiable assets.................. $437,932 $437,932 -- --
Nine Months Ended December 31, 1996:
Revenues............................. $110,811 $ 83,245 $43,517 $(15,951)
Income from continuing operations
before income taxes............... $ 8,290 $ 9,023 $ (733) --
Identifiable assets.................. $472,388 $472,388 -- --
</TABLE>
Depreciation expense and capital expenditures are not considered material.
The preceding financial information does not include the computer software
operations which are presented as discontinued operations in the accompanying
financial statements.
F-77
<PAGE> 159
EMPLOYERS SELF INSURERS FUND
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
20. EXTRAORDINARY CHARGE
During the nine months ended December 31, 1996 ESIF incurred $1.3 million
of expenses directly related to its conversion from a group self-insurance fund
to a stock insurance company. These expenses are principally professional
service fees paid to attorneys, investment advisors, and accountants related to
obtaining regulatory approval for the conversion, advising the Board of Trustees
as to the fairness of the transaction and auditing ESIF's GAAP basis financial
statements. These costs, net of income tax benefits of $0.5 million, are
presented as an extraordinary charge on ESIF's Statement of Operations for the
nine months ended December 31, 1996.
21. RELATED PARTY TRANSACTIONS
As more fully described in Note 5, ESIF has entered into office premises
lease agreements with certain Trustees of ESIF.
As more fully described in Note 6, ESIF has entered into reinsurance
agreements with an insurance company in which a Trustee of ESIF has an ownership
interest.
As more fully described in Note 13, to comply with requirements of the
Florida DOI, SHC's president and chief executive officer has personally
indemnified ESIF up to a maximum of $5.0 million for certain loss, injury, or
damage to ESIF, if any, which may result from the acquisition of SHC.
Entities in which SHC's president and chief executive officer held
ownership interests have provided certain transportation related services to
SHC. Fees paid by SHC to these entities aggregated approximately $0.4 million
and $0.02 million for the nine months ended December 31, 1995 and 1996,
respectively.
SHC's president and chief executive officer is also a member of the Board
of Directors of Florida Retail Federation (the "Association") which is the
sponsoring trade association for Florida Retail Federation Self Insurers Fund
("FRF"), one of the group self-insurance funds administered by SHC. The
Association, as the fund sponsor, is entitled to a fee equal to 1% of FRF's
premiums earned in each year, and SHC is obligated to pay such fee out of the
administrative fee it receives from FRF. During the nine months ended December
31, 1995 and 1996, SHC paid approximately $0.7 million and $0.6 million,
respectively, to the Association for such fees. During the nine months ended
December 31, 1995 and 1996, FRF paid SHC fees for administrative services of
approximately $21.1 million and $19.0 million, respectively.
F-78
<PAGE> 160
REPORT OF INDEPENDENT AUDITORS
Board of Directors
Summit Holding Corporation
We have audited the accompanying consolidated statements of income,
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 1995 of Summit Holding Corporation and its subsidiaries.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated results of operations and cash flows
of Summit Holding Corporation for each of the three years in the period ended
December 31, 1995 in conformity with generally accepted accounting principles.
ERNST & YOUNG LLP
Tampa, Florida
February 9, 1996
except for Note 9,
as to which the date is
March 31, 1997
F-79
<PAGE> 161
SUMMIT HOLDING CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------
1993 1994 1995
----------- ----------- -----------
(RESTATED) (RESTATED)
<S> <C> <C> <C>
Revenues:
Gross service fees (including $25,336,689,
$26,829,023 and $24,867,269 for the years ended
December 31, 1993, 1994 and 1995, respectively,
from Employers Self Insurers Fund)............. $70,813,669 $73,832,809 $64,089,709
Direct expenses................................... 32,956,912 29,655,931 25,413,989
----------- ----------- -----------
Net service fees............................... 37,856,757 44,176,878 38,675,720
Software consulting and maintenance fees.......... -- -- 899,629
Investment and other income....................... 631,924 934,178 1,275,712
----------- ----------- -----------
38,488,681 45,111,056 40,851,061
Expenses:
Compensation and other employee benefits.......... 14,503,311 15,425,560 16,616,339
Other operating expenses.......................... 7,707,071 8,217,870 8,203,572
Depreciation and amortization..................... 4,890,675 4,872,134 5,112,228
Interest expense.................................. 1,609,720 57,563 41,943
----------- ----------- -----------
28,710,777 28,573,127 29,974,082
----------- ----------- -----------
Income before income taxes.......................... 9,777,904 16,537,929 10,876,979
Income taxes........................................ 3,838,933 6,305,996 4,019,521
----------- ----------- -----------
Net income................................ $ 5,938,971 $10,231,933 $ 6,857,458
=========== =========== ===========
</TABLE>
See accompanying notes.
F-80
<PAGE> 162
SUMMIT HOLDING CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
PREFERRED STOCK COMMON STOCK
---------------------- ---------------------- RETAINED
SHARES AMOUNT SHARES AMOUNT EARNINGS TOTAL
--------- ---------- --------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31,
1992.................... 1,000,000 $3,000,000 1,000,000 $1,000,000 $ 3,376,603 $ 7,376,603
Dividends payable to
preferred
stockholders......... -- -- -- -- (1,200,000) (1,200,000)
Net income.............. -- -- -- -- 5,938,971 5,938,971
--------- ---------- --------- ---------- ----------- -----------
Balance, December 31,
1993.................... 1,000,000 3,000,000 1,000,000 1,000,000 8,115,574 12,115,574
Dividends payable to
preferred
stockholders......... -- -- -- -- (600,000) (600,000)
Net income.............. -- -- -- -- 10,231,933 10,231,933
--------- ---------- --------- ---------- ----------- -----------
Balance, December 31, 1994
(Restated).............. 1,000,000 3,000,000 1,000,000 1,000,000 17,747,507 21,747,507
Dividends payable to
preferred
stockholders......... -- -- -- -- (500,000) (500,000)
Net income.............. -- -- -- -- 6,857,458 6,857,458
--------- ---------- --------- ---------- ----------- -----------
Balance, December 31, 1995
(Restated).............. 1,000,000 $3,000,000 1,000,000 $1,000,000 $24,104,965 $28,104,965
========= ========== ========= ========== =========== ===========
</TABLE>
See accompanying notes.
F-81
<PAGE> 163
SUMMIT HOLDING CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------
1993 1994 1995
----------- ----------- -----------
(RESTATED) (RESTATED)
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income.............................................. $ 5,938,971 $10,231,933 $ 6,857,458
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization......................... 4,890,675 4,872,134 5,112,228
Loss on sale of equipment............................. -- -- 10,101
Deferred income taxes................................. 227,489 313,105 13,821
Decrease (increase) in accounts receivable............ (520,004) 505,264 893,999
Decrease (increase) in prepaid expenses and other
current assets..................................... (817,547) 1,129,772 22,205
(Increase) decrease in other assets................... 100,927 (376,696) (93,311)
(Decrease) increase in accrued expenses and other
current liabilities................................ 1,124,372 (643,533) (1,005,124)
Decrease in aggregate reserve......................... (614,228) (3,769,309) (2,925,568)
(Decrease) increase in deferred income................ 1,660,583 328,263 (1,172,511)
----------- ----------- -----------
Net cash provided by operating activities............... 11,991,239 12,590,933 7,713,298
INVESTING ACTIVITIES:
Purchases of held-to-maturity securities and short-term
investments........................................... (1,437) (5,564,135) (300,000)
Maturities of held-to-maturity securities............... -- -- 2,005,793
Purchases of property and equipment..................... (965,099) (1,072,255) (1,068,297)
Payment for businesses acquired and formed.............. -- -- (918,862)
----------- ----------- -----------
Net cash used in investing activities................... (966,536) (6,636,390) (281,366)
FINANCING ACTIVITIES:
Payments on long-term debt.............................. (4,509,845) -- --
Dividends paid on preferred stock....................... -- (1,200,000) (600,000)
----------- ----------- -----------
Net cash used in financing activities................... (4,509,845) (1,200,000) (600,000)
----------- ----------- -----------
Net increase in cash and cash equivalents............... 6,514,858 4,754,543 6,831,932
Cash and cash equivalents at beginning of year.......... 98,972 6,613,830 11,368,373
----------- ----------- -----------
Cash and cash equivalents at end of year................ $ 6,613,830 $11,368,373 $18,200,305
=========== =========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the year for:
Interest expense...................................... $ 109,720 $ 1,558,424 $ 41,943
=========== =========== ===========
Income taxes.......................................... $ 4,171,806 $ 4,918,000 $ 4,760,795
=========== =========== ===========
</TABLE>
See accompanying notes.
F-82
<PAGE> 164
SUMMIT HOLDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
Summit Holding Corporation ("SHC"), a Florida corporation, is the sole
stockholder of Summit Consulting, Inc. ("SCI"). SCI and its subsidiaries are
primarily engaged in providing insurance-related administrative services for
five self-insurance funds, including marketing, policy issuance and servicing,
claims processing and administration, loss control, brokerage, audits, financial
and data processing services, and risk management services. Two of these
self-insurance funds are located in Florida and account for approximately 84% of
gross recurring service fees. The remaining gross service fees are generated by
one Kentucky and two Louisiana self-insurance funds.
During 1995, SHC formed an insurance company that began issuing workers'
compensation policies January 1, 1996, and is in the process of establishing a
North Carolina-based health maintenance organization. Effective July 20, 1995,
SHC acquired substantially all of the assets of a software development company
(see Note 2).
Principles of Consolidation
The consolidated financial statements include the accounts of SHC and its
wholly-owned subsidiaries and are collectively referred to herein as SHC. All
material intercompany transactions have been eliminated in consolidation.
Revenue Recognition
SHC receives as its service fee a specified percentage of premium for the
administration of self-insurance funds. This service fee revenue is recognized
in proportion to the recognition of earned premiums by the self-insurance funds.
SHC is contractually obligated to pay for certain services which are considered
direct expenses and principally include agents' commissions, reinsurance premium
costs, association fees, and administrative taxes. Software consulting fees are
recognized as the services are rendered and invoiced. Maintenance fees are
recognized ratably over the period of the maintenance service contracts which
are generally for a one year duration.
During 1994, SHC received $3.3 million in revenues from one of the
Louisiana self-insurance funds related to SHC's payment of reinsurance premiums
on behalf of the fund prior to 1990.
Cash Equivalents
SHC considers all highly liquid investments having a maturity of three
months or less when purchased to be cash equivalents.
Property and Equipment
Property and equipment are stated at cost. Depreciation is provided using
the straight-line method over the estimated useful lives of the assets (three to
ten years), or the lease period for leasehold improvements.
Depreciation expense in 1993, 1994 and 1995 was $723,994, $730,454 and
$830,408, respectively.
Income Taxes
SHC files consolidated returns. Deferred income taxes provided in the
financial statements relate principally to expenses charged to income for
financial reporting purposes in one period and deducted for income tax purposes
in other periods.
F-83
<PAGE> 165
SUMMIT HOLDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Intangibles
Intangible assets are stated at cost less accumulated amortization and
include purchased software, customer accounts and contracts, noncompete
agreements, deferred financing costs, and the excess of the purchase price over
the fair value of identifiable net assets acquired (goodwill). Purchased
software, customer accounts and contracts, and noncompete agreements are being
amortized on a straight-line basis over the estimated useful lives and contract
period which range from three to five years. Deferred financing costs relate to
the incurrence of debt acquisition costs, and were completely amortized in 1995.
The excess of cost over the fair value of identifiable net assets acquired is
being amortized on a straight-line basis over 20 years. SHC evaluates the
recoverability of intangible assets through a comparison of forecasted operating
income to the remaining asset balances.
Amortization expense in 1993, 1994 and 1995 was $4,166,681, $4,141,680 and
$4,281,820, respectively.
In March 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of." Adoption for
Statement No. 121 is required for all fiscal years beginning after December 15,
1995. SHC does not anticipate that the adoption of Statement No. 121 will have a
material impact on its financial results.
Aggregate Reserve
Under the terms of SHC's service agreements with the self-insurance funds,
SHC is responsible for procuring certain reinsurance coverage for the funds
through independent reinsurers. SHC is required to pay the reinsurance premiums
out of its service fees, and premiums are calculated and paid to the reinsurers
on the basis of the self-insurance funds' earned premiums. The cost of the
reinsurance is recognized as a direct expense by SHC. Under the terms of a
reinsurance agreement for the Florida Retail Federation Self Insurers Fund
("FRF"), SHC is required to pay a certain premium each year, but then may have
to pay an additional premium or may receive a return of premium, if the fund's
losses vary from the loss ratios specified in the reinsurance agreement. SHC has
established an aggregate reserve for this liability and accounts for the reserve
annually utilizing the latest actuarial loss ratios for the fund. As of December
31, 1993, 1994 and 1995, the aggregate reserve decreased by approximately
($289,000), ($2,675,000) and ($1,990,000), respectively. The decreases in 1994
and 1995 are due primarily to return of premium.
Deferred Income
SHC defers a portion of its fees from Employers Self Insurers Fund ("ESIF")
to cover future claims servicing costs pertaining to claims incurred in the year
for which SHC received its fee, and for certain other services which SHC is
contractually required to provide subsequent to the funds' year end.
Major Customers
Significant portions of SHC's gross service fees are derived from three
major customers, ESIF, Florida Retail Federation Self Insurers Fund ("FRFSIF")
and Louisiana Employers Safety Association Self Insurers Fund ("LESASIF"). Gross
service fees for the years ended December 31, 1993, 1994 and 1995 are as
follows:
<TABLE>
<CAPTION>
1993 1994 1995
----------- ----------- -----------
<S> <C> <C> <C>
ESIF............................................ $25,336,689 $26,829,023 $24,867,269
FRFSIF.......................................... 32,195,587 31,103,771 28,990,003
LESASIF......................................... 8,708,425 11,305,177 6,034,794
</TABLE>
F-84
<PAGE> 166
SUMMIT HOLDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Use of Estimates
The preparation of 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.
2. BUSINESS ACQUISITION
Effective August 4, 1995, SHC acquired substantially all of the assets and
assumed certain liabilities of a software development company having a total
value of approximately $1,166,000. SHC has accounted for the acquisition as a
purchase. The effects of the tangible assets acquired and the liabilities
assumed have been excluded from the 1995 statement of cash flows. Pro forma
results of operations as if the acquisition had occurred on January 1, 1994,
were not materially different from the results of operations as presented.
3. LEASES
SHC and its subsidiaries lease office premises and automobiles under
noncancelable operating leases which expire at various dates through the year
2000. These leases generally contain renewal options and escalation clauses
based on increases in lessors' operating expenses and other charges. SHC
anticipates that most leases will be renewed or replaced upon expiration. Future
minimum annual payments at December 31, 1995 for all noncancelable leases are:
<TABLE>
<S> <C>
Years ending December 31:
1996...................................................... $1,468,391
1997...................................................... 1,328,374
1998...................................................... 1,276,504
1999...................................................... 1,174,774
2000...................................................... 395,467
----------
Total minimum future lease payments............... 5,643,510
Income from subleases............................. (132,010)
----------
Net minimum future lease payments................. $5,511,500
==========
</TABLE>
Rental expense in 1993, 1994 and 1995 for operating leases totaled
$1,429,258, $1,496,790 and $1,693,284, respectively. Sublease income for 1993,
1994 and 1995 totaled approximately $108,000, $71,000 and $31,000, respectively.
F-85
<PAGE> 167
SUMMIT HOLDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
4. INCOME TAXES
The provision (benefit) for income taxes for the years ended December 31,
1993, 1994 and 1995 is comprised of the following:
<TABLE>
<CAPTION>
1993 1994 1995
---------- ---------- ----------
<S> <C> <C> <C>
Current:
Federal.................................. $3,083,595 $5,124,170 $3,465,492
State.................................... 527,849 868,721 540,208
---------- ---------- ----------
Total current.................... 3,611,444 5,992,891 4,005,700
Deferred:
Federal.................................. 193,388 267,712 11,957
State.................................... 34,101 45,393 1,864
---------- ---------- ----------
Total deferred................... 227,489 313,105 13,821
---------- ---------- ----------
$3,838,933 $6,305,996 $4,019,521
========== ========== ==========
</TABLE>
SHC's taxes are calculated according to Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes." Deferred taxes are provided
for temporary differences between income before taxes reported in the financial
statements and taxable income. Deferred taxes arise principally from temporary
differences between financial reporting and income tax reporting of
depreciation, aggregate reserves, deferred income and certain start-up costs.
A reconciliation of the differences between the effective income tax rate
and the statutory federal tax rate follows:
<TABLE>
<CAPTION>
1993 1994 1995
---------- ---------- ----------
<S> <C> <C> <C>
Income tax expense at federal statutory rate
(34%)............................................ $3,324,489 $5,674,592 $3,703,942
State income taxes, net of federal benefit......... 370,887 603,315 357,768
Nondeductible goodwill amortization................ 128,922 124,044 127,666
Interest exempt from taxation...................... -- (129,414) (248,508)
Other items, net................................... 14,635 33,459 78,653
---------- ---------- ----------
$3,838,933 $6,305,996 $4,019,521
========== ========== ==========
</TABLE>
5. EMPLOYEE BENEFIT PLAN
SHC has a deferred savings and profit-sharing plan (401(k)) covering
substantially all employees. Under the plan, SHC makes contributions equal to
75% of the participant's contributions, not to exceed 6% of the participant's
annual compensation. SHC's contributions to the plan totaled $251,395, $318,955
and $350,410 in 1993, 1994 and 1995, respectively.
6. PREFERRED STOCK
At December 31, 1993, 1994 and 1995, 1,000,000 shares of Series A preferred
stock were outstanding. Each share of Series A preferred stock is entitled to
cumulative cash dividends of $0.60 per year. The dividends are not payable until
declared by the Board of Directors. During October 1993, the Board of Directors
declared a dividend of $1.20 per share (through February 28, 1994) to
stockholders of record as of December 31, 1993, payable January 15, 1994. During
December 1994, the Board of Directors declared a dividend of $0.60 per share
(through February 28, 1995) to stockholders of record as of December 31, 1994,
payable January 20, 1995. During December 1995, the Board of Directors declared
a dividend of $0.50 per share (for the period March 1 through December 31, 1995)
to stockholders of record as of December 31,
F-86
<PAGE> 168
SUMMIT HOLDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1995, payable January 12, 1996. The Series A preferred stock has a guaranteed
value of $3.00 per share. The shares have a preference in liquidation. The
Series A preferred stock has no voting rights or rights of conversion to any
other class of stock of SHC.
7. STOCK OPTION PLAN
In 1992, the Board of Directors approved the 1992 Stock Incentive Plan (the
"Plan"), which provided for the granting of 225,000 options to directors,
officers and key employees. Options to purchase SHC's common stock are
exercisable at a price of $1 per share. Options granted under the Plan generally
vest over a period of five years subject to certain acceleration provisions and
expire not later than 10 years after grant. As of December 31, 1995, 205,000 of
the 225,000 options which have been granted were vested, none of which had been
exercised.
8. SUBSEQUENT EVENT
Effective January 16, 1996, Employers Self Insurers Fund purchased all of
the outstanding stock of SHC. In connection with this transaction, stock options
that were not previously vested became vested.
9. PREMIUM RETURN ADJUSTMENT
In previously issued financial statements, SHC failed to consider the
return of premium provisions for years 1994 and 1995 related to the reinsurance
arrangement discussed in the "Aggregate Reserve" section of footnote 1. The
financial statements for 1994 and 1995 have been restated to properly reflect
the return of premium provision. The effects of these adjustments are as
follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------
1994 1995
----------- ----------
<S> <C> <C>
Net income, as previously reported.......................... $ 8,883,369 $5,571,389
Adjustment to reflect return of premiums, net of tax
effects................................................... 1,348,564 1,286,069
----------- ----------
Net income, as adjusted..................................... $10,231,933 $6,857,458
=========== ==========
</TABLE>
F-87
<PAGE> 169
REPORT OF INDEPENDENT AUDITORS ON FINANCIAL STATEMENT SCHEDULES
Board of Trustees
Employers Self Insurers Fund
We have audited the consolidated financial statements of Employers Self
Insurers Fund and its subsidiaries as of March 31, 1996 and for the year then
ended and as of September 30, 1996 and for the six months then ended and have
issued our reports thereon dated July 31, 1996 and November 21, 1996 (included
elsewhere in this Registration Statement). Our audits also included the
consolidated financial statement schedules included in the Registration
Statement. These schedules are the responsibility of the Company's management.
Our responsibility is to express an opinion based on our audits.
In our opinion, the financial statement schedules referred to above, 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
Jacksonville, Florida
November 21, 1996
F-88
<PAGE> 170
REPORT OF INDEPENDENT AUDITORS ON FINANCIAL STATEMENT SCHEDULES
Board of Trustees
Employers Self Insurers Fund
We have audited the consolidated financial statements of Employers Self
Insurers Fund and its subsidiaries as of March 31, 1995 and for the years ended
March 31, 1995 and 1994 and have issued our report thereon dated July 26, 1996
(included elsewhere in this Registration Statement). Our audits also included
the consolidated financial statement schedules included in the Registration
Statement. These schedules are the responsibility of the Company's management.
Our responsibility is to express an opinion based on our audits.
In our opinion, the financial statement schedules referred to above, when
considered in relation to the basic financial statements taken as a whole,
present fairly in all material respects the information set forth therein.
Brinton & Mendez
Certified Public Accountants
Lakeland, Florida
July 26, 1996
F-89
<PAGE> 171
EMPLOYERS SELF INSURERS FUND AND SUBSIDIARIES
SCHEDULE I -- SUMMARY OF INVESTMENTS
<TABLE>
<CAPTION>
AMOUNT AT
WHICH SHOWN
IN THE
TYPE OF INVESTMENT COST MARKET BALANCE SHEET
COLUMN A COLUMN B COLUMN C COLUMN D
------------------ -------- -------- -------------
(IN THOUSANDS)
<S> <C> <C> <C>
MARCH 31, 1996
Securities available for sale:
Fixed maturities:
U.S. Government
Non-mortgage backed.................................. $ 57,656 $ 57,233 $ 57,233
Mortgaged backed..................................... 14,320 14,400 14,400
States, municipalities and political subdivisions...... 68,697 69,360 69,360
Corporate obligations.................................. 37,258 37,824 37,824
-------- -------- --------
Total fixed maturities............................ 177,931 178,817 178,817
Equity securities:
Common stocks:
Public utilities..................................... 141 153 153
Banks, trusts and insurance companies................ 579 607 607
Industrial and miscellaneous......................... 8,855 10,334 10,334
-------- -------- --------
Total common stocks............................... 9,575 11,094 11,094
Non redeemable preferred stock......................... 3,167 3,156 3,156
-------- -------- --------
Total equity securities........................... 12,742 14,250 14,250
Short-term investments...................................... 19,770 19,770 19,770
-------- -------- --------
Total investments................................. $210,443 $212,837 $212,837
======== ======== ========
SEPTEMBER 30, 1996
Securities available for sale:
Fixed maturities:
U.S. Government:
Non-mortgage backed.................................. $ 49,286 $ 48,625 $ 48,625
Mortgage backed...................................... 13,603 13,541 13,541
States, municipalities and political subdivisions...... 67,799 68,348 68,348
Corporate obligations.................................. 42,875 42,906 42,906
-------- -------- --------
Total fixed maturities............................ 173,563 173,420 173,420
Equity securities:
Common stocks:
Public utilities..................................... 1,786 2,312 2,312
Banks, trusts and insurance companies................ 579 650 650
Industrial and miscellaneous......................... 8,298 9,336 9,336
-------- -------- --------
Total common stocks............................... 10,665 12,298 12,298
Non redeemable preferred stock......................... 3,759 3,757 3,787
-------- -------- --------
Total equity securities........................... 14,422 16,085 16,085
Short-term investments...................................... 16,713 16,713 16,713
-------- -------- --------
Total investments................................. $204,698 $206,218 $206,218
======== ======== ========
</TABLE>
F-90
<PAGE> 172
EMPLOYERS SELF INSURERS FUND AND SUBSIDIARIES
SCHEDULE I -- SUMMARY OF INVESTMENTS
<TABLE>
<CAPTION>
DECEMBER 31, 1996
-----------------------------------
AMOUNT AT
WHICH SHOWN
IN THE
TYPE OF INVESTMENT COST MARKET BALANCE SHEET
COLUMN A COLUMN B COLUMN C COLUMN D
------------------ -------- -------- -------------
(IN THOUSANDS)
(UNAUDITED)
<S> <C> <C> <C>
Securities available for sale:
Fixed maturities:
U.S. Government
Non-mortgage backed.................................. $ 50,423 $ 50,263 $ 50,263
Mortgaged backed..................................... 10,902 11,004 11,004
States, municipalities and political subdivisions...... 82,937 83,803 83,803
Corporate obligations.................................. 38,973 39,612 39,612
-------- -------- --------
Total fixed maturities............................ $183,235 $184,682 $184,682
Equity securities:
Common stocks:
Public utilities....................................... 402 430 430
Banks, trusts and insurance companies.................. 1,255 1,771 1,771
Industrial and miscellaneous........................... 9,963 11,899 11,899
-------- -------- --------
Total common stocks............................... 11,620 14,100 14,100
Non-redeemable preferred stock......................... 4,452 4,568 4,568
-------- -------- --------
Total equity securities........................... 16,072 18,668 18,668
Short-term investments...................................... 14,536 14,536 14,536
-------- -------- --------
Total investments................................. $213,843 $217,886 $217,886
======== ======== ========
</TABLE>
F-91
<PAGE> 173
EMPLOYERS SELF INSURERS FUND AND SUBSIDIARIES
SCHEDULE IV -- REINSURANCE
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
ASSUMED % OF
CEDED TO FROM AMOUNT
OTHER OTHER ASSUMED
DESCRIPTION DIRECT COMPANIES COMPANIES NET TO NET
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F
----------- -------- --------- --------- -------- --------
<S> <C> <C> <C> <C> <C>
Year Ended March 31, 1994
Premiums -- Workers' Compensation...... $155,559 $7,118 $0 $148,441 0%
Year Ended March 31, 1995
Premiums -- Workers' Compensation...... 135,033 6,544 0 128,489 0%
Year Ended March 31, 1996
Premiums -- Workers' Compensation...... 119,028 4,135 0 114,893 0%
Six Months Ended September 30, 1995
Premiums -- Workers' Compensation...... 66,351 3,207 0 63,145 0%
Six Months Ended September 30, 1996
Premiums -- Workers' Compensation...... 52,402 3,373 0 49,029 0%
Nine Months Ended December 31, 1995
(unaudited)
Premiums -- Workers' Compensation...... 94,493 4,780 0 89,713 0%
Nine Months Ended December 31, 1996
(unaudited)
Premiums -- Workers' Compensation...... 79,201 4,692 0 74,509 0%
</TABLE>
F-92
<PAGE> 174
EMPLOYERS SELF INSURERS FUND AND SUBSIDIARIES
SCHEDULE VI -- SUPPLEMENTAL INFORMATION CONCERNING INSURANCE OPERATIONS
<TABLE>
<CAPTION>
RESERVES
FOR UNPAID
DEFERRED CLAIMS AND
POLICY CLAIM DISCOUNT NET
ACQUISITION SETTLEMENT DEDUCTED UNEARNED NET EARNED INVESTMENT
SEGMENT COSTS EXPENSES IN COL C PREMIUMS PREMIUMS INCOME
YEAR ENDED COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F COLUMN G
---------- -------- ----------- ---------- -------- -------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
March 31, 1994.......... Workers' $0 $392,784 $4,730 $ 0 $148,441 $10,510
Compensation
Insurance
March 31, 1995.......... Workers' 0 367,391 4,875 0 128,489 12,205
Compensation
Insurance
March 31, 1996.......... Workers' 0 387,632 4,668 0 114,893 13,209
Compensation
Insurance
SIX MONTHS ENDED
- ------------------------
September 30, 1995...... Workers' $0 $364,210 $4,775 $51,208 $ 63,145 $ 7,598
Compensation
Insurance
September 30, 1996...... Workers' 0 367,971 4,235 46,000 49,029 6,363
Compensation
Insurance
NINE MONTHS ENDED
- ------------------------
December 31, 1995
(Unaudited)............ Workers' 0 $372,786 $4,618 $25,437 $ 89,713 $10,522
Compensation
Insurance
December 31, 1996
(Unaudited)........... Workers' 0 376,923 4,235 23,506 74,509 9,606
Compensation
Insurance
<CAPTION>
CLAIMS & CLAIMS
SETTLEMENT EXPENSES AMORTIZATION NET PAID
INCURRED RELATED TO OF DEFERRED CLAIMS &
-------------------- POLICY CLAIMS NET
PRIOR ACQUISITION SETTLEMENT PREMIUMS
CURRENT YEARS COSTS EXPENSES WRITTEN
YEAR ENDED YEAR COLUMN H COLUMN I COLUMN J COLUMN K
---------- --------- -------- ------------ ---------- --------
<S> <C> <C> <C> <C> <C>
March 31, 1994.......... $118,889 $10,478 $10,664 $96,753 $156,086
March 31, 1995.......... 94,520 25,404 10,078 88,264 144,427
March 31, 1996.......... 84,058 10,786 9,707 77,436 121,296
SIX MONTHS ENDED
- ------------------------
September 30, 1995...... $ 42,198 $ 167 $ 4,236 $44,953 $117,823
September 30, 1996...... 35,663 (3,528) 4,839 38,008 103,178
NINE MONTHS ENDED
- ------------------------
December 31, 1995
(Unaudited)............ $ 61,955 $ 5,088 $ 6,350 $64,212 $114,125
December 31, 1996
(Unaudited)........... 57,289 (7,053) 7,250 59,060 108,309
</TABLE>
F-93
<PAGE> 175
======================================================
NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS IN CONNECTION WITH THE OFFERING, AND, IF GIVEN OR MADE, SUCH
INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE COMPANY OR THE UNDERWRITERS. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR
ANY SALE MADE HEREUNDER SHALL UNDER ANY CIRCUMSTANCE CREATE ANY IMPLICATION THAT
THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE
DATE HEREOF. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL, OR A
SOLICITATION OF AN OFFER TO BUY, TO ANY PERSON IN ANY JURISDICTION IN WHICH SUCH
OFFER TO SELL OR SOLICITATION IS NOT AUTHORIZED, OR IN WHICH THE PERSON MAKING
SUCH OFFER OR SOLICITATION IS NOT QUALIFIED TO DO SO, OR TO ANY PERSON TO WHOM
IT IS UNLAWFUL TO MAKE SUCH AN OFFER OR SOLICITATION.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary................... 3
Risk Factors......................... 8
The Company.......................... 17
Market for Stock..................... 18
Dividend Policy...................... 18
Use of Proceeds...................... 20
Capitalization....................... 20
Selected Financial Data.............. 21
Pro Forma Financial Data............. 23
Management's Discussion and Analysis
of Financial Condition and Results
of Operations...................... 31
Business............................. 48
Management of the Company............ 62
Certain Transactions................. 69
Principal Shareholders............... 70
The Conversion....................... 71
Description of Capital Stock......... 75
Shares Eligible for Future Sale...... 78
Underwriting......................... 79
Legal Matters........................ 80
Experts.............................. 80
Change in Accountants................ 80
Additional Information............... 81
Index to Financial Statements........ F-1
</TABLE>
------------------------
UNTIL JUNE 15, 1997 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL DEALERS
EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR NOT PARTICIPATING IN THIS
DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN ADDITION TO
THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS
AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
======================================================
======================================================
4,061,013 SHARES
LOGO
SUMMIT HOLDING
SOUTHEAST, INC.
COMMON STOCK
------------------------
PROSPECTUS
------------------------
RAYMOND JAMES &
ASSOCIATES, INC.
ABN AMRO CHICAGO CORPORATION
MAY 21, 1997
======================================================
