<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 1998
Commission File Number 1-9627
ZENITH NATIONAL INSURANCE CORP.
[Exact name of registrant as specified in its charter]
Delaware 95-2702776
[State or other jurisdiction of [I.R.S. Employer
incorporation or organization] Identification No.]
21255 Califa Street, Woodland Hills, California 91367-5021
[Address of principal executive offices] [Zip Code]
(818) 713-1000
[Registrant's telephone number, including area code]
Indicate by check mark whether the registrant [1] has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and [2] has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Number of shares of Common Stock, $1 par value per share, outstanding as of
close of business on October 31, 1998: 17,043,064, net of 7,821,770 shares of
treasury stock.
1
<PAGE>
PART 1, FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
<TABLE>
- -------------------------------------------------------------------------------------------------------------------
September 30, December 31,
(Dollars in thousands, except per share data) 1998 1997
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS: (Unaudited)
(Restated)
Investments:
Fixed maturities:
At amortized cost (fair value $40,100 in 1998 and $48,266 in 1997) $ 38,395 $ 46,948
At fair value (cost $711,519 in 1998 and $534,771 in 1997) 727,028 542,479
Floating rate preferred stocks, at fair value (cost $16,614 in 1998 and
$14,614 in 1997) 17,887 15,670
Convertible and non-redeemable preferred stocks, at fair value (cost
$7,679 in 1998 and $6,672 in 1997) 7,216 6,602
Common stocks, at fair value (cost $30,233 in 1998 and $17,790 in 1997) 30,996 23,439
Short-term investments (at cost, which approximates fair value) 207,544 209,827
Other investments 39,668 35,008
---------- ----------
Total Investments 1,068,734 879,973
Cash 8,581 12,504
Accrued investment income 13,343 9,523
Premiums receivable 144,798 72,813
Receivable from reinsurers, state trust funds and prepaid reinsurance
premiums 393,320 106,067
Deferred policy acquisition costs 22,889 20,840
Properties and equipment, less accumulated depreciation 79,592 54,531
Federal income taxes 25,895 19,940
Intangible assets 20,153 9,600
Land and real estate construction in progress
Other assets 77,634 66,365
---------- ----------
TOTAL ASSETS $1,854,939 $1,252,156
---------- ----------
---------- ----------
</TABLE>
(continued)
2
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET (CONTINUED)
<TABLE>
- ---------------------------------------------------------------------------------------------------------------------------
September 30, December 31,
(Dollars in thousands, except per share data) 1998 1997
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
LIABILITIES: (Unaudited)
(Restated)
Policy liabilities and accruals:
Unpaid loss and loss adjustment expenses $ 1,030,814 $ 613,266
Unearned premiums 168,394 128,469
Policy holders' dividends accrued 7,954 5,360
Other policyholder funds 6,407
Reserves on loss portfolio transfers 9,911 11,054
Payable to banks and other notes payable 10,816 13,742
Senior notes payable, less unamortized issue costs of $435 in 1998 and
$526 in 1997 74,565 74,474
Payable to RISCORP 52,155
Other liabilities 77,959 37,518
----------- -----------
TOTAL LIABILITIES 1,432,568 890,290
----------- -----------
REDEEMABLE SECURITIES:
Company-obligated, mandatorily redeemable capital securities of Zenith
National Insurance Capital Trust I, holding solely 8.55% Subordinated
Deferrable Interest Debentures due 2028, of Zenith National Insurance
Corp., less unamortized issue cost and discount of $1,672 in 1998 73,328
----------- -----------
Commitments and contingent liabilities
STOCKHOLDERS' EQUITY:
Preferred stock, $1 par - 1,000 shares authorized; issued and outstanding, none
in 1999 and 1998
Common stock, $1 par - 50,000 shares authorized ; 24,865 shares issued and
17,043 shares outstanding in 1998, 24,681 shares issued and
17,819 shares outstanding in 1997 24,865 24,681
Additional paid-in capital 268,375 264,098
Retained earnings 191,280 186,268
Net unrealized appreciation on investments, net of deferred tax expense of
$5,955 in 1998 and $5,025 in 1997 11,059 9,332
----------- -----------
495,579 484,379
Less treasury stock, at cost (7,822 shares in 1998 and 6,862 shares in 1997) (146,536) (122,513)
----------- -----------
TOTAL STOCKHOLDERS' EQUITY 349,043 361,866
----------- -----------
TOTAL LIABILITIES, REDEEMABLE SECURITIES AND
STOCKHOLDERS' EQUITY $ 1,854,939 $ 1,252,156
----------- -----------
----------- -----------
</TABLE>
The accompanying notes are an integral part of this statement.
3
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)
<TABLE>
- --------------------------------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
(Dollars in thousands, except per share data) 1998 1997 1998 1997
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
(Restated) (Restated)
CONSOLIDATED REVENUES:
Premiums earned $136,151 $120,475 $392,489 $368,669
Net investment income 14,198 13,272 40,124 39,126
Realized gains on investments 2,164 1,861 8,338 5,733
Real estate sales 8,398 11,480 28,830 32,617
Service fee income 1,206 2,598
-------- -------- -------- --------
Total revenues 162,117 147,088 472,379 446,145
EXPENSES:
Loss and loss adjustment expenses incurred 101,690 81,104 280,199 258,051
Policy acquisition costs 25,707 22,834 74,696 69,196
Other underwriting and operating expenses 19,432 17,902 58,474 49,088
Policyholders' dividends and participation 441 533 378
Real estate construction and operating costs 8,210 11,225 28,248 31,424
Interest expense 1,908 980 3,416 2,932
-------- -------- -------- --------
Total expenses 157,388 134,578 445,411 410,691
Income before federal income tax expense 4,729 12,510 26,968 35,454
Federal income tax expense 1,329 4,510 9,168 12,454
-------- -------- -------- --------
NET INCOME $ 3,400 $ 8,000 $ 17,800 $ 23,000
-------- -------- -------- --------
-------- -------- -------- --------
EARNINGS PER SHARE:
Net income per common share - basic $ 0.20 $ 0.45 $ 1.05 $ 1.30
-------- -------- -------- --------
-------- -------- -------- --------
Net income per common share - diluted $ 0.20 $ 0.45 $ 1.04 $ 1.29
-------- -------- -------- --------
-------- -------- -------- --------
Additional Required Disclosure:
Net income $ 3,400 $ 8,000 $ 17,800 $ 23,000
Change in unrealized appreciation on investments 925 8,539 1,727 8,629
-------- -------- -------- --------
Comprehensive Income $ 4,325 $ 16,539 $ 19,527 $ 31,629
-------- -------- -------- --------
-------- -------- -------- --------
</TABLE>
The accompanying notes are an integral part of this statement.
4
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
<TABLE>
- --------------------------------------------------------------------------------------------------------------
Nine Months Ended
September 30,
(Dollars in thousands) 1998 1997
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C>
(Restated)
CASH FLOWS FROM OPERATING ACTIVITIES:
Premiums collected $ 431,867 $ 393,281
Investment income received 40,379 37,612
Proceeds from sales of real estate 28,830 32,617
Loss and loss adjustment expenses paid (299,178) (256,326)
Underwriting and other operating expenses paid (145,420) (121,470)
Real estate construction costs paid (35,665) (36,612)
Reinsurance premiums paid (24,451) (20,964)
Dividends paid to policyholders (329)
Interest paid (3,706) (3,185)
Income taxes paid (5,352) (4,497)
Net cash from sales of trading porfolio investments 1,416
--------- ---------
Net cash (used in) provided by operating activities,
including cash from trading portfolio (12,696) 21,543
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investments:
Investment securities available-for-sale (252,200) (61,985)
Other investments (7,008) (4,146)
Proceeds from maturities and redemptions of investments:
Fixed maturities held-to-maturity 8,379 4,290
Investment securities available-for-sale 55,073 22,204
Other investments 3,452
Proceeds from sales of investments:
Investment securities available-for-sale 210,448 74,454
Other investments 6,182 5,295
Capital expenditures and other, net (15,233) (11,988)
Cash received from portfolio transfers 4,648
Losses paid on portfolio transfers (1,476)
Net change in short-term investments (6,310) (45,800)
Cash payment to RISCORP (35,000)
RISCORP acquisition costs (7,660)
Cash acquired in RISCORP Acquisition 29,309
--------- ---------
Net cash used in investing activities (14,020) (11,052)
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of note assumed from RISCORP (15,000)
Net cash received from Zenith National Insurance Capital Trust I 8.55%
Capital Securities 73,320
Cash advanced from bank construction loans 23,015 29,751
Cash repaid on bank construction loans (25,941) (30,411)
Cash advanced from bank lines of credit 2,000
Cash repaid on bank lines of credit (2,000)
Cash dividends paid to common stockholders (12,739) (13,275)
Proceeds from exercise of stock options 4,161 3,919
Purchase of treasury shares (24,023) (285)
--------- ---------
Net cash provided by (used in) financing activities 22,793 (10,301)
--------- ---------
Net (decrease) increase in cash (3,923) 190
Cash at beginning of period 12,504 12,125
--------- ---------
Cash at end of period $ 8,581 $ 12,315
--------- ---------
--------- ---------
</TABLE>
(continued)
5
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS (CONTINUED)
(UNAUDITED)
<TABLE>
- --------------------------------------------------------------------------------------------------------------------
Nine Months Ended
September 30,
(Dollars in thousands) 1998 1997
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
RECONCILIATION OF NET INCOME TO NET CASH FLOWS (Restated)
FROM OPERATING ACTIVITIES:
Net Income $ 17,800 $ 23,000
Adjustments to reconcile net income to net cash provided by (used in) operating
activities:
Depreciation and amortization 6,734 4,391
Realized gains on investments (8,338) (5,733)
Net cash from trading protfolio 1,416
Decrease (increase) in:
Accrued investment income 650 (1,260)
Premiums receivable 21,971 (3,851)
Receivable from reinsurers, state trust funds and prepaid
reinsurance premiums 29,132 1,821
Deposits receivable 2,066
Deferred policy acquisition costs 3,643 (1,377)
Federal income taxes (7,362) 7,967
Real estate construction in progress (9,496) (7,045)
Increase (decrease) in:
Unpaid loss and loss adjustment expenses (59,970) (682)
Unearned premiums (3,252) 11,140
Policyholders' dividends accrued (1,940)
Other policyholder funds (6,407) (2,707)
Other 2,199 (5,663)
-------- --------
Net cash (used in) provided by operating activities $(12,696) $ 21,543
-------- --------
-------- --------
</TABLE>
The accompanying notes are an integral part of this statement.
See Note 3 for non-cash activities related to the RISCORP Acquisition.
6
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
- --------------------------------------------------------------------------------
Note 1. Basis of Presentation
In the opinion of management, all adjustments (consisting only of normal
recurring adjustments) necessary for a fair presentation of the financial
position and results of operations of Zenith National Insurance Corp. and
subsidiaries (collectively, "Zenith") for the periods presented have been
included. The results of operations for an interim period are not necessarily
indicative of the results for an entire year. Certain prior year balances have
been reclassified to conform to current year presentation.
RESTATEMENT - The Consolidated Balance Sheet, Consolidated Statement of
Operations and Consolidated Statement of Cash Flows as of and for the quarter
ended September 30, 1998 have been restated to incorporate the resolution of the
purchase price determination for the RISCORP Acquisition (see Note 3). Zenith
has adjusted the April 1, 1998 purchase allocation which was previously based on
an estimated $35 million purchase price to the final purchase price of $92.3
million. The restatement impacted invested assets, accrued investment income,
receivable from reinsurers and state trust funds, deferred policy acquisition
costs, federal income taxes, intangible assets, unpaid losses, policyholder
dividends accrued, other liabilities, net investment income, other underwriting
and operating expenses and federal income tax expense. As a result of the
restatement, net income has decreased $0.1 million and $0.4 million for the
three and nine months ended September 30, 1998 and earnings per share decreased
$0.01 (basic) and $0.00 (diluted) for the three months ended, and decreased
$0.02 (basic) and $0.02 (diluted) for the nine months ended, September 30,
1998.
Notes 2, 3 and 4 have been restated to reflect the above purchase price
determination.
Note 2. Computation of Earnings Per Share (EPS)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
(Dollars in thousands, except per share data) 1998 1997 1998 1997
(Restated) (Restated)
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
(A) Net income $3,400 $8,000 $17,800 $23,000
- ------------------------------------------------------------------------------------------------------------------
(B) Weighted average outstanding
Shares during the period 17,055 17,725 17,018 17,687
Additional common shares issuable
Under employee stock option plans
Using the treasury stock method (1) 113 193 155 169
- --------------------------------------------------------- -------------------------------------------------------
(C) Weighted average number of common
Shares outstanding assuming
Exercise of stock options 17,168 17,918 17,173 17,856
- --------------------------------------------------------- -------------------------------------------------------
(A)/(B) Net income per common share - basic $0.20 $0.45 $1.05 $1.30
- --------------------------------------------------------- -------------------------------------------------------
- --------------------------------------------------------- -------------------------------------------------------
(A)/(C) Net income per common share - diluted $0.20 $0.45 $1.04 $1.29
- --------------------------------------------------------- -------------------------------------------------------
</TABLE>
(1) 1997 per common share data have been restated to conform to the provisions
of Statement of Financial Accounting Standards ("SFAS") No. 128.
7
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
- --------------------------------------------------------------------------------
Note 3. Acquisition of RISCORP
On April 1, 1998, pursuant to an Asset Purchase Agreement dated June 17, 1997
(as amended from time to time, the "Asset Purchase Agreement") between Zenith
Insurance Company, a wholly owned subsidiary of Zenith ("Zenith Insurance"),
and RISCORP, Inc. and certain of its subsidiaries (collectively, "RISCORP"),
Zenith Insurance acquired substantially all of the assets and certain
liabilities of RISCORP related to RISCORP's workers' compensation business
(the "RISCORP Acquisition"). At the closing, Zenith Insurance paid $35
million in cash, of which $10 million was paid into an escrow account, and
assumed and repaid $15 million of indebtedness of RISCORP, Inc. The final
purchase price, which was subject to a three-step determination process, is
the difference between the GAAP book value of assets purchased and the GAAP
book value of the liabilities assumed by Zenith Insurance as of April 1, 1998.
As the first step of the three-step process to determine the final purchase
price, on June 9, 1998, RISCORP provided Zenith Insurance with a "Proposed
Business Balance Sheet" indicating that RISCORP's determination of the final
purchase price would be approximately $141 million. As the second step of
this process, on July 9, 1998, Zenith Insurance provided RISCORP with
proposed adjustments to the Proposed Business Balance Sheet, which
adjustments were prepared in conjunction with Zenith Insurance's external
accounting and actuarial consultants. These proposed adjustments resulted in
large part from differences in the estimation of loss and loss adjustment
expense reserves, primarily related to differences in actuarial methodology
and assumptions, including anticipated loss development. Such adjustments
indicated that the value of the liabilities assumed by Zenith Insurance
exceeded the value of the assets transferred to Zenith Insurance by as much
as $71 million and that the final purchase price would be no greater than the
$35 million already paid by Zenith Insurance at closing. As the final step of
the price determination process, RISCORP and Zenith Insurance submitted all
items in dispute concerning the Proposed Business Balance Sheet to a
nationally recognized independent accounting firm which served as the Neutral
Auditor and Neutral Actuary to resolve all such disputes.
On March 19, 1999, Zenith received the report of the Neutral Auditor and
Neutral Actuary which indicated that the value of the assets transferred to
Zenith Insurance exceeded the value of the liabilities assumed by Zenith
insurance by $92.3 million and that Zenith Insurance owed an additional $57.3
million above the $35 million already paid to RISCORP. On March 26, 1999,
after deducting $6.8 million for the value of assets not transferred to
Zenith Insurance by RISCORP, Zenith Insurance paid $53.7 million to RISCORP
including interest in the amount of $3.1 million computed from April 1, 1998.
Of this amount, $50.9 million was paid directly to RISCORP and $2.8 million
was paid into an escrow account. The escrow account has a balance of $12.8
million and is available to satisfy RISCORP's indemnification obligations to
Zenith under the Asset Purchase Agreement. Although the determination of
"Final Purchase Price" by the Neutral Auditor and Neutral Actuary is to be
final, binding and conclusive under the Asset Purchase Agreement, it is
uncertain whether RISCORP will contest the determination.
The RISCORP Acquisition was accounted for as a purchase by Zenith Insurance
and the assets acquired, liabilities assumed and the results of operations of
RISCORP from April 1, 1998 are included in Zenith's consolidated financial
statements as of and for the quarter ended September 30, 1998.
8
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
- --------------------------------------------------------------------------------
The excess of the purchase price, including acquisition expenses, over the
estimated fair value of net assets acquired is $19.9 million, which is net of
a deferred tax asset of $10.2 million, and is being amortized over 25 years.
Amortization expense from April 1, 1998 was $0.4 million.
Zenith Insurance has provided notice to RISCORP of certain breaches of
representations, warranties and covenants made by RISCORP in the Asset
Purchase Agreement. These breaches may result in recovery by Zenith Insurance
of a portion of the purchase price paid by Zenith Insurance.
On January 11, 1999, Zenith Insurance served RISCORP with a complaint filed
in the United States District Court in the Southern District of New York. The
complaint against RISCORP asserts various claims arising from the RISCORP
Acquisition, including claims seeking recovery of assets that were not
transferred to Zenith Insurance at the closing, as well as damages for
breaches of representations, warranties, and covenants in the Asset Purchase
Agreement. On January 22, 1999, RISCORP served Zenith Insurance with a
complaint in an action that RISCORP had filed against Zenith Insurance in the
United States District Court in the Middle District of Florida. In that
action, RISCORP is seeking damages based on the alleged failure of Zenith
Insurance to comply with certain indemnification provisions of the Asset
Purchase Agreement, as well as damages relating to the allegedly improper
acquisition of certain assets. Zenith is unable to predict the outcome of
these litigations.
9
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
- --------------------------------------------------------------------------------
The following table summarizes the estimated fair value of assets acquired
and liabilities assumed from RISCORP at April 1, 1998.
<TABLE>
<CAPTION>
April 1, 1998
(Dollars in thousands) (Restated)
- ----------------------------------------------------------------------------------------------
<S> <C>
Assets
Invested assets, primarily U.S. Government issues $190,460
Cash 29,309
Premiums receivable 86,575
Receivable from reinsurers and state trust funds 288,483
Intangible assets 7,707
Other assets 46,962
- ----------------------------------------------------------------------------------------------
Total assets 649,496
- ----------------------------------------------------------------------------------------------
Liabilities
Unpaid loss and loss adjustment expense 482,518
Unearned premium reserve 43,177
Other liabilities 31,465
- ----------------------------------------------------------------------------------------------
Total liabilities 557,160
- ----------------------------------------------------------------------------------------------
Purchase price $ 92,336
- ----------------------------------------------------------------------------------------------
</TABLE>
Included in Intangible assets is $1.7 million of costs associated with
termination of employees from the former RISCORP operations.
Pro forma total revenues for Zenith for the three months ended September 30,
1998 and 1997 (after giving effect to the RISCORP Acquisition as if it had been
consummated at the beginning of the respective periods) were $162.9 million and
$196.3 million, respectively. Pro forma net income for such periods was $3.6
million and $9.7 million, respectively. Earnings per share for such periods were
$0.21 (basic) and $0.21 (diluted) and $0.55 (basic) and $0.54 (diluted),
respectively.
Pro forma total revenues for Zenith for the nine months ended September 30, 1998
and 1997 (after giving effect to the RISCORP Acquisition as if it had been
consummated at the beginning of the respective periods) were $504.8 million and
$604 million, respectively. Pro forma net income for such periods was $9.9
million and $28.2 million, respectively. Earnings per share for such periods
were $0.58 (basic) and $0.58 (diluted) and $1.59 (basic) and $1.58 (diluted),
respectively.
Such pro forma data has been derived in part from the historical statement of
operations data of RISCORP, Inc. as reported by RISCORP, Inc. for the three
months ended March 31, 1998 and six months ended September 30, 1997, and Zenith
specifically disclaims any responsibility for the accuracy or completeness of
such historical RISCORP, Inc. data or such pro forma data to the extent it is
based on such historical data. Further, such pro forma data may not necessarily
be indicative of future total revenues or future net income or what they might
have been if the RISCORP Acquisition had been consummated at the beginning of
each of the respective periods.
10
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
- --------------------------------------------------------------------------------
Note 4. Contingencies Surrounding Fair Values of Certain Assets Acquired and
Liabilities Assumed From RISCORP
On April 1, 1998 Zenith Insurance acquired substantially all of the assets
and certain liabilities of RISCORP related to RISCORP's workers' compensation
business. See Note 3 for a full discussion of the RISCORP Acquisition. The
RISCORP Acquisition was accounted for as a purchase and the fair values of
the assets and liabilities acquired are set forth in Note 3. The total
purchase price for such acquired assets and liabilities was determined by a
three-step process in which RISCORP; Zenith Insurance and its external
accounting and actuarial consultants; and a third party, acting as Neutral
Auditor and Neutral Actuary, made certain estimates acquired by Zenith
Insurance. Such estimates varied considerably, particularly with respect to
the value of premiums receivable and the liability for unpaid losses and loss
adjustment expenses.
The carrying values of premiums receivable and the liability for unpaid
losses and loss adjustment expenses at September 30, 1998 reflect
management's estimates using available current information. Different
actuarial assumptions, particularly assumptions about long-lived workers'
compensation claims, suggest that the ultimate liability for unpaid losses
and loss adjustment expenses could be higher than Zenith's carrying value of
reserves for such claims at September 30, 1998. Also, Zenith's claims
handling practices vary in certain respects from those employed by RISCORP.
The ultimate amount of premiums receivable for retrospectively-rated policies
is determined, in part, by the amount and timing of losses sustained under
such policies. Also, certain of Zenith's billing and collections procedures
differ from those employed by RISCORP and Zenith is continuing to ascertain
the impact such differences may have on the collectibility of premiums
receivable. Subsequent re-interpretation of currently available data or any
new information that becomes available with respect to premiums receivable
and liabilities for unpaid losses and loss adjustment expenses acquired from
RISCORP may change the estimates of the carrying values of such amounts and
such changes, if any, will be reflected in the results of operations of the
period in which they occur.
Zenith Insurance has purchased reinsurance protection relating to development of
the loss and loss adjustment expense reserves assumed from RISCORP. Such
reinsurance would allow Zenith Insurance to recover up to $50 million in excess
of $182 million for net unpaid losses and allocated loss adjustment expenses
acquired from RISCORP. After deducting reinsurance premiums of $16 million,
Zenith has recorded reinsurance recoverable of $24.5 million and a deferred
benefit of $8.5 million at September 30, 1998. Future adverse loss development,
if any, of the reserves acquired from RISCORP would be recoverable up to the $50
million limit, although the benefit of such reinsurance recoverable would be
deferred and recognized over the recovery period of such reinsurance.
See Note 3 for litigation concerning the RISCORP Acquisition.
Zenith and its subsidiaries are defendants in various other litigation. In the
opinion of management, after consultation with legal counsel, such litigation is
either without merit or the
11
<PAGE>
ultimate liability, if any, will not have a material adverse effect on the
consolidated financial condition or results of operations of Zenith.
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
- --------------------------------------------------------------------------------
Note 5. Comprehensive Income
As of January 1, 1998, Zenith adopted SFAS No. 130, "Reporting Comprehensive
Income" ("SFAS No. 130"). SFAS No. 130 establishes standards for reporting
and presenting comprehensive income and its components in a full set of
financial statements. Comprehensive income includes net income and all
changes in stockholders' equity (except those arising from transactions with
stockholders) and changes in net unrealized appreciation (depreciation) on
investments. The new standard requires only additional disclosures in the
consolidated financial statements; it does not affect the financial position
or results of operations.
Note 6. Costs of Computer Software Developed or Obtained for Internal Use
Zenith adopted Statement of Position ("SOP") 98-1 "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use" effective January 1,
1998. SOP 98-1 requires capitalization of certain internal and external costs
associated with computer software developed or obtained for internal use. For
the three and nine months ended September 30, 1998, software capitalization was
$3.2 million and $4.8 million, respectively.
Note 7. New Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities". The new
pronouncement, which is effective for all fiscal quarters beginning after June
15, 1999, requires that all companies carry derivatives on the balance sheet at
fair value. Changes in the fair value of derivatives must be recognized in
income when they occur, unless the derivative qualifies for hedge accounting.
Zenith does not currently have any derivatives and therefore does not believe
that there will be any impact on its financial statements as a result of the
adoption of SFAS No. 133.
Note 8. Capital Securities and Subordinated Debentures
On July 30, 1998, Zenith issued $75 million of 8.55% Capital Securities at a
price of $996.24 per security through the Zenith National Insurance Capital
Trust I, a Delaware statutory business trust (the "Trust") all of the voting
securities of which are owned by Zenith. Each Capital Security pays semi-annual
cumulative cash distributions at the annual rate of 8.55% of the $1,000
liquidation amount per security.
The Trust used the proceeds from its offering to purchase $75 million of
Zenith's 8.55% Subordinated Deferrable Interest Debentures due 2028 (the
"Subordinated Debentures"), which constitute the principal asset of the Trust.
The semi-annual interest payments on the Subordinated Debentures may be deferred
by Zenith for up to ten consecutive semi-annual periods. The Subordinated
Debentures are redeemable at any time by Zenith at the then present value of the
remaining scheduled payments of principal and interest. Payments on the Capital
Securities, including distributions and redemptions, follow those of the
Subordinated Debentures. Zenith used $65 million from the net proceeds to make a
capital contribution to
12
<PAGE>
Zenith Insurance. The remaining net proceeds were used for general corporate
purposes. The issue cost and discount on the Subordinated Debentures of $1.7
million are being amortized over the term of the Subordinated Debentures. During
the three months and nine months ended September 30, 1998, approximately $9,000
of such costs were amortized.
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
- --------------------------------------------------------------------------------
Zenith fully and unconditionally guaranteed the distributions on, and the
liquidation amount generally of, the Capital Securities to the extent the Trust
has funds legally available therefor. Zenith's guarantee of the Capital
Securities, as well as the Subordinated Debentures, are subordinated to all
other indebtedness of Zenith.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
Zenith's principal source of consolidated earnings is the income, including
investment income, from the operations of its property-casualty insurance
business. The comparative results of operations are set forth in the table
below, followed by a discussion of significant changes.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
(Dollars in thousands) (Restated) (Restated)
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Investment income, after taxes $ 9,561 $8,799 $26,802 $25,941
Realized gains on investments, after taxes 1,407 1,209 5,420 3,726
- ------------------------------------------------------------------------------------------------------------------
Sub-total 10,968 10,008 32,222 29,667
- ------------------------------------------------------------------------------------------------------------------
Property-casualty underwriting loss, after taxes:
Loss excluding catastrophes (3,347) (677) (4,717) (2,606)
Catastrophe loss (2,600) (65) (5,850) (975)
- ------------------------------------------------------------------------------------------------------------------
Property-casualty underwriting loss, after taxes (5,947) (742) (10,567) (3,581)
- ------------------------------------------------------------------------------------------------------------------
Income from real estate operations, after taxes 122 165 378 764
Interest expense, after taxes (1,240) (637) (2,220) (1,906)
Parent expenses, after taxes (503) (794) (2,013) (1,944)
- ------------------------------------------------------------------------------------------------------------------
Net income $3,400 $8,000 $17,800 $23,000
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
13
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
Premiums earned, underwriting results and combined ratios before taxes for the
three and nine months ended September 30, 1998 and 1997 were as follows:
<TABLE>
Three Months Ended Nine Months Ended
September 30, September 30,
(Restated) (Restated)
(Dollars in thousands) 1998 1997 1998 1997
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Premiums earned:
Workers' Compensation
California $ 31,157 $ 31,283 $ 91,601 $100,520
Outside California 41,024 27,475 110,582 81,861
--------------------------------------------------------
Total Workers' Compensation 72,181 58,758 202,183 182,381
Other Property-Casualty 56,162 53,273 167,317 160,748
Reinsurance 7,808 8,444 22,989 25,540
--------------------------------------------------------
Total $136,151 $120,475 $392,489 $368,669
--------------------------------------------------------
--------------------------------------------------------
Underwriting income (loss) before taxes:
Workers' Compensation $(13,352) $ (6,245) $(29,728) $(19,003)
Other Property-Casualty 3,165 2,246 4,916 4,882
Reinsurance 1,070 3,004 8,963 9,005
--------------------------------------------------------
Total $ (9,117) $ (995) $ (15,849) $ (5,116)
--------------------------------------------------------
--------------------------------------------------------
Combined loss and expense ratios:
Workers' Compensation
Loss and loss adjustment expenses 83.6% 75.7% 78.9% 77.3%
Underwriting expenses 34.3% 34.0% 35.6% 33.1%
Dividends to policyholders 0.6% 0.9% 0.2%
--------------------------------------------------------
Combined ratio 118.5% 110.6% 114.7% 110.4%
Other Property-Casualty
Loss and loss adjustment expenses 64.3% 63.5% 66.2% 65.9%
Underwriting expenses 30.1% 32.3% 30.9% 31.1%
--------------------------------------------------------
Combined ratio 94.4% 95.8% 97.1% 97.0%
Reinsurance
Loss and loss adjustment expenses 67.5% 33.3% 42.4% 43.9%
Underwriting expenses 18.8% 31.1% 18.6% 20.9%
--------------------------------------------------------
Combined ratio 86.3% 64.4% 61.0% 64.8%
Total
Loss and loss adjustment expenses 74.7% 67.3% 71.3% 70.0%
Underwriting expenses 31.7% 33.1% 32.6% 31.4%
Dividends to policyholders 0.3% 0.4% 0.1%
--------------------------------------------------------
Combined ratio 106.7% 100.8% 104.0% 101.4%
--------------------------------------------------------
--------------------------------------------------------
</TABLE>
14
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
RISCORP ACQUISITION
On April 1, 1998, pursuant to an Asset Purchase Agreement dated June 17, 1997
(as amended from time to time, the "Asset Purchase Agreement") between Zenith
Insurance Company, a wholly owned subsidiary of Zenith ("Zenith Insurance"), and
RISCORP, Inc. and certain of its subsidiaries (collectively, "RISCORP"), Zenith
Insurance acquired substantially all of the assets and certain liabilities of
RISCORP related to RISCORP's workers' compensation business (the "RISCORP
Acquisition").
See Note 3 to the Consolidated Financial Statements on pages 7-9 ("Note 3") for
a full discussion of the RISCORP Acquisition which note is herein incorporated
by reference. The RISCORP Acquisition was accounted for as a purchase and the
assets acquired and liabilities assumed are set forth in Note 3. The total
purchase price for such assets acquired and liabilities assumed was the
difference between the generally accepted accounting principles ("GAAP") book
value of assets purchased and the GAAP book value of the liabilities assumed by
Zenith Insurance as of April 1, 1998, or $92.3 million. Such amount was
determined by a three-step process in which RISCORP; Zenith Insurance and its
external accounting and actuarial consultants; and a third party, acting as
Neutral Auditor and Neutral Actuary, made certain estimates of the GAAP values
of the assets and liabilities acquired by Zenith Insurance. Such estimates
varied considerably, particularly with respect to the value of premiums
receivable and the liability for unpaid losses and loss adjustment expenses.
The carrying values of premiums receivable and the liability for unpaid losses
and loss adjustment expenses at September 30, 1998 reflect management's
estimates using available current information. Different actuarial assumptions,
particularly assumptions about long-lived workers' compensation claims, suggest
that the ultimate liability for unpaid losses and loss adjustment expenses could
be higher than Zenith's carrying value of liabilities for such claims at
September 30, 1998. Also, Zenith's claims handling practices vary in certain
respects from those employed by RISCORP. The ultimate amount of premiums
receivable for retrospectively-rated policies is determined, in part, by the
amount and timing of losses under such policies. Also, certain of Zenith's
billing and collections procedures differ from those employed by RISCORP and
Zenith is continuing to ascertain the impact such differences may have had on
the collectibility of premiums receivable. Subsequent re-interpretation of
currently available data or any new information that becomes available with
respect to premiums receivable and liabilities for unpaid losses and loss
adjustment expenses acquired from RISCORP may change the estimates of the
carrying values of such amounts and such changes, if any, will be reflected in
the results of operations of the period in which they occur.
Zenith Insurance has purchased reinsurance protection relating to development of
the loss and loss adjustment expense reserves assumed from RISCORP. Such
reinsurance would allow Zenith Insurance to recover up to $50 million in excess
of $182 million for net unpaid losses and allocated loss adjustment expenses
acquired from RISCORP. After deducting reinsurance premiums of $16 million,
Zenith has recorded reinsurance recoverable of $24.5 million and a deferred
benefit of $8.5 million at September 30, 1998. Future adverse loss development,
if any, of the reserves acquired from RISCORP would be recoverable up to the $50
million limit, although the benefit of such reinsurance recoverable would be
deferred and recognized over the recovery period of such reinsurance.
15
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
PROPERTY-CASUALTY INSURANCE OPERATIONS
The business acquired from RISCORP, effective April 1, 1998, contributed
$22.7 million and $47.4 million of workers' compensation premiums earned in
the three and nine months ended September 30, 1998, respectively. This
business contributed an underwriting loss, before taxes, of $5.7 million and
$10.0 million in the three and nine months ended September 30, 1998,
respectively. The RISCORP Acquisition reduced earnings per share in the three
and nine months ended September 30, 1998 by $0.18 and $0.27, respectively,
due to goodwill amortization and other expenses. Excess costs in the former
RISCORP business will adversely impact the underwriting results in Zenith's
workers' compensation operation, pending the integration of such former
RISCORP business into Zenith's existing workers' compensation operations.
Competition in the workers' compensation business continues to be intense.
Excluding the effect of the additional premiums from the RISCORP Acquisition,
premiums earned by Zenith's workers' compensation written both inside and
outside of California decreased in the three months and nine months ended
September 30, 1998 compared to the corresponding periods in 1997. The
underwriting results for the three and nine months ended September 30, 1998
include $2.0 million, before tax, of losses related to catastrophic workers'
compensation claims in the third quarter.
Profitability is dependent upon the ability to maintain adequate rates, manage
claims costs and keep operating expenses in line with premium volume. Zenith is
unable to predict when its workers' compensation operation will return to
underwriting profitability that is consistent with Zenith's historical
experience.
California wind and storm damage sustained by Zenith's other property-casualty
operations in the first quarter of 1998 also contributed to the decline in the
underwriting results for nine months ended September 30, 1998 compared to the
corresponding period in 1997. Notwithstanding these catastrophe losses and
intense competition, Zenith's other property-casualty operations are achieving
favorable underwriting results.
Reinsurance premiums earned declined in the three months and nine months ended
September 30, 1998 compared to the corresponding periods in 1997 due primarily
to selected non-renewal of certain reinsurance treaties and softening of
property catastrophe rates. The underwriting results for the three and nine
months ended September 30, 1998 include estimated catastrophe losses related to
Hurricane Georges of $2.0 million before taxes in the third quarter. The
decrease in the loss and loss adjustment expense ratio for reinsurance,
excluding the impact of Hurricane Georges, for the nine months ended September
30, 1998 as compared to the corresponding period in 1997 is due to favorable
development for certain treaties in addition to current operations.
Total catastrophe losses reduced earnings per share by $0.15 and $0.34 per share
for the three and nine months ended September 30, 1998, respectively, as
compared to none and $0.05 per share for the corresponding periods in 1997.
16
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
INVESTMENTS
Zenith's invested assets and cash increased by $219.8 million as a result of the
RISCORP Acquisition. The investment portfolio acquired in the RISCORP
Acquisition consists of investment grade U.S. treasury notes, corporate debt and
municipal debt.
Investment income for the three and nine months ended September 30, 1998
increased from the corresponding periods in 1997 primarily due to the increase
in invested assets added by the RISCORP Acquisition.
The yields on invested assets, which vary with the general level of interest
rates, were as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
(Restated) (Restated)
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Investment yield, before taxes 5.7% 6.0% 5.8% 5.9%
Investment yield, after taxes 3.8% 4.0% 3.9% 3.9%
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
Bonds with an investment grade rating represented 97% and 96% of the
consolidated carrying values of fixed maturities at September 30, 1998 and
December 31, 1997, respectively. The average maturity of the investment
portfolio was 4.9 years at September 30, 1998 and 4.2 years at December 31,
1997.
The total fair value of fixed maturity investments, and the unrealized gain on
held-to-maturity and available-for-sale fixed maturity investments, were as
follows:
<TABLE>
<CAPTION>
Unrealized Gain on Fixed Maturities
-----------------------------------
Total Fair Held-to-Maturity Available-for-Sale
Value of ---------------- ------------------
(Dollars in thousands) Fixed Maturities Before Tax Before Tax After Tax
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
At September 30, 1998 $974,672 $1,705 $15,455 $10,045
At December 31, 1997 800,572 1,318 7,744 5,034
At September 30, 1997 788,232 738 3,645 2,369
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
The change in fair value of fixed maturity investments available-for-sale
resulted in an increase in stockholders' equity of $5.0 million, after deferred
taxes, between December 31, 1997 and September 30, 1998. Stockholders' equity
will continue to be affected by volatility in the fixed maturity securities
market.
17
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
The change in the carrying value of Zenith's consolidated investment portfolio
during the nine months ended September 30, 1998 was as follows:
<TABLE>
<CAPTION>
(Dollars in thousands) (Restated)
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Carrying value at December 31, 1997 $879,973
Purchases at cost 259,208
Investments acquired in RISCORP Acquisition 190,460
Maturities and redemptions (63,452)
Proceeds from sales of investments (216,630)
Net realized gain on:
Investments available-for-sale 4,928
Other investments 3,410
Total 8,338
Change in unrealized gains 2,657
Increase in short-term investments 6,310
Net amortization of bonds and preferred stocks and
Other changes 1,870
- ---------------------------------------------------------------------------------------------------------------
Carrying value at September 30, 1998 $1,068,734
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
LIQUIDITY AND CAPITAL RESOURCES
The decrease in net cash provided by operating activities is primarily due to a
decrease in cash flows from workers' compensation operations caused by a
decrease in premium income (net of ceded reinsurance). Also, principally as a
result of the RISCORP Acquisition, there was an increase in workers'
compensation loss and loss adjustment expense payments associated with the
unpaid loss and loss adjustment expense reserves acquired April 1, 1998 and an
increase in operating expenses.
Zenith has three revolving, unsecured lines of credit amounting to $100 million,
all of which is available at September 30, 1998.
Zenith is principally dependent upon its portfolio of marketable securities and
the investment yields thereon; dividends from its insurance subsidiaries, whose
operations are supported by their own cash flows; and available lines of credit
to pay its expenses, service debt and pay any cash dividends which may be
declared to its stockholders.
During the first nine months of 1998, Zenith repurchased 960,180 shares on the
open market for a total purchase price of $24 million. The repurchase was funded
by proceeds from the sale and maturity of certain investment securities.
On July 30, 1998, Zenith issued $75 million of 8.55% Capital Securities at a
price of $996.24 per security through the Zenith National Insurance Capital
Trust I, a Delaware statutory business trust (the "Trust"), all of the voting
securities of which are owned by Zenith. Each Capital Security pays semi-annual
cumulative cash distributions at the annual rate of 8.55% of the $1,000
liquidation amount per security.
18
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
The Trust used the proceeds from its offering to purchase $75 million of
Zenith's 8.55% Subordinated Deferrable Interest Debentures due 2028 (the
"Subordinated Debentures"), which constitute the principal asset of the Trust.
The semi-annual interest payments on the Subordinated Debentures may be deferred
by Zenith for up to ten consecutive semi-annual periods. The Subordinated
Debentures are redeemable at any time by Zenith at the then present value of the
remaining scheduled payments of principal and interest. Payments on the Capital
Securities, including distributions and redemptions, follow those of the
Subordinated Debentures. Zenith used $65 million from the net proceeds to make a
capital contribution to Zenith Insurance. The remaining net proceeds were used
for general corporate purposes. The issue cost and discount on the Subordinated
Debentures of $1.7 million are being amortized over the term of the Subordinated
Debentures. During the three months and nine months ended September 30, 1998,
approximately $9,000 of such costs were amortized.
Zenith fully and unconditionally guaranteed the distributions on, and the
liquidation amount generally of, the Capital Securities to the extent the Trust
has funds legally available therefor. Zenith's guarantee of the Capital
Securities, as well as the Subordinated Debentures, are subordinated to all
other indebtedness of Zenith.
The net proceeds from the Capital Securities were primarily invested by Zenith
in various short-term securities which, in the aggregate, yield less than the
interest cost of the Subordinated Debenture.
On September 28, 1998, the Board of Directors declared a regular quarterly cash
dividend of $0.25 per share on the outstanding shares, payable on November 13,
1998 to stockholders of record at the close of business on October 30, 1998.
On April 1, 1998, in connection with the closing of the RISCORP Acquisition,
Zenith Insurance paid $35 million to RISCORP and subsequently repaid $15 million
in indebtedness assumed from RISCORP, Inc.
19
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
YEAR 2000
The Year 2000 Problem refers to the inability of information technology ("IT")
and non-information technology ("non-IT") systems to accurately process dates
during and after 1999. IT systems include computer hardware and software. Non-IT
systems include equipment that incorporates embedded micro controllers such as
elevators, security systems and HVAC systems. If not corrected, the processes of
IT and non-IT systems that are date sensitive could fail or miscalculate data
resulting in disruptions of operations such as a temporary inability to process
transactions, send and receive electronic data with third parties or otherwise
engage in normal business activities. There may also be a negative impact on the
economic and social infrastructure on which Zenith depends.
In early 1996, Zenith formed a Year 2000 team consisting of staff familiar with
the Company's IT and non-IT systems to coordinate the elimination, to the extent
possible, of Zenith's exposure to the Year 2000 problem. Reports of the Year
2000 team's efforts are presented to Zenith's Board of Directors periodically.
Since 1996, Zenith has been systematically replacing and modifying its internal
systems to function correctly with dates from 1999 forward, thereby rendering
them "Year 2000 Compliant." Internal systems ("Internal Systems") consist of (1)
core information technology systems supporting corporate level accounting and
financial reporting processes ("Core Corporate IT Systems"); (2) core
information technology systems supporting operational processes involving (a)
underwriting, premium collection and claims processes in Zenith's insurance
operations (including those systems acquired in the RISCORP Acquisition) and (b)
land acquisitions, development, construction, sales and escrow
tracking/monitoring in the Real Estate Operations ("Core Operational IT
Systems"); (3) computer networks and communications infrastructure ("IT
Infrastructure"); (4) personal and laptop computers including applications
("Other IT Equipment"); and (5) owned facility systems which rely on
non-computer equipment incorporating embedded microprocessors, such as
elevators, HVAC and security as well as office equipment such as facsimile and
copy machines and postage meters ("Facilities and Other Non-IT Systems"). The
majority of Zenith's Year 2000 compliance efforts have been staffed internally,
although Zenith has engaged and will continue to engage technical consultants to
assist its internal staff, as well as to assist Zenith in reviewing its
progress.
The Internal Systems are being corrected through a process with five phases,
some of which are concurrent: (1) Inventory (listing IT and non-IT systems and
their components); (2) Assessment (identifying possible Year 2000-related
failures and developing strategies to repair, replace, or eliminate them); (3)
Remediation (creating or acquiring corrections to identified deficiencies); (4)
Validation (confirming whether corrections would be successful); and (5)
Implementation (installing corrections into the business operations for general
use).
20
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
The status and scheduled completion dates of efforts to make the Internal
Systems supporting Zenith's operations Year 2000 Compliant are as follows:
<TABLE>
<CAPTION>
Inventory Assessment Remediation Validation Implementation
----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Core Corporate IT Systems: Completed Completed Completed 3/31/99 3/31/99
Core Operational IT Systems:
- ----------------------------------
Workers' Compensation Completed Completed Completed 3/31/99 4/30/99
Other Property-Casualty Completed Completed 3/31/99 3/31/99 4/30/99
Reinsurance Completed Completed Completed Completed Completed
Real Estate Operations Completed Completed Completed 3/31/99 4/30/99
IT Infrastructure:
- ----------------------------------
Workers' Compensation 11/30/98 3/31/99 6/30/99 7/31/99 7/31/99
Other Property-Casualty 11/30/98 3/31/99 6/30/99 7/31/99 7/31/99
Reinsurance 11/30/98 3/31/99 6/30/99 7/31/99 7/31/99
Real Estate Operations Completed Completed Completed 3/31/99 3/31/99
Other IT Equipment:
- ----------------------------------
Workers' Compensation 12/31/98 2/28/99 5/31/99 7/31/99 7/31/99
Other Property-Casualty 12/31/98 2/28/99 5/31/99 7/31/99 7/31/99
Reinsurance 12/31/98 2/28/99 5/31/99 7/31/99 7/31/99
Real Estate Operations 12/31/98 3/31/99 3/31/99 3/31/99 3/31/99
Facilities and Other Non-IT
Systems:
- ----------------------------------
Woodland Hills, CA Completed Completed Completed 11/30/98 12/31/98
Sarasota, FL Completed Completed 5/30/99 8/31/99 8/31/99
Sacramento, CA Completed Completed Completed Completed Completed
</TABLE>
Zenith's Year 2000 efforts also include a systematic assessment of the Year 2000
Compliance status of third parties upon which the Company relies in its business
operations, including major suppliers of services and products, owners of its
leased facilities and principal business partners (collectively, "Key External
Dependencies"). Zenith has used letters, questionnaires, surveys and interviews
to determine whether these Key External Dependencies will achieve Year 2000
Compliance. To date, Zenith has been unable, in most cases, to obtain reliable
information, and is therefore uncertain about the state of readiness of many of
its Key External Dependencies. Although none of the Key External Dependencies
has informed Zenith that it has a Year 2000 issue that would have a material
effect on Zenith, few have provided definitive statements, written assurances or
warranties that they will be Year 2000 Compliant. Zenith intends to continue its
systematic assessment, including follow-ups of its Key External Dependencies.
21
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
All companies are faced with certain unknown risks arising from Year 2000 issues
that may impact them negatively. Zenith's Year 2000 efforts have been designed
to mitigate to the extent possible its risks from Year 2000-related failures
faced by the company. Despite Zenith's Year 2000-related efforts, Zenith
recognizes the possibility of some negative impact on its operations resulting
from Year 2000-related failures. Zenith believes that the most reasonably likely
worst case Year 2000 scenarios could include failures of Zenith's Internal
Systems, a failure of one or more of its critical Key External Dependencies,
such as financial institutions, agents/brokers or reinsurers, and/or the
contamination of Zenith's IT systems due to receipt of corrupted data. Such a
scenario could result in a disruption of Zenith's normal business activities and
could have a material adverse effect on its financial condition and results of
operations. In the quarter ended September 30, 1998, Zenith began developing
contingency plans to substantially reduce material business disruptions from
such risks. Although the contingency plans are in the early process of
formulation, Zenith intends such plans to include measures, such as 1)
acceleration into the last quarter of 1999 the performance of obligations and
duties otherwise owed in the first quarter of 2000; 2) identification of
alternatives to Key External Dependencies that may not be Year 2000 Compliant
and therefore unable to meet Zenith's needs; and 3) certain activities in
Zenith's pre-existing Business Recovery/Resumption Plan designed for Zenith to
operate during, and to recover from, catastrophes. All contingency plans are
expected to be in place by September 30, 1999.
Zenith has been planning to upgrade its IT Infrastructure and its IT Equipment
for some time; however, because of the Year 2000 problem, certain components of
those plans will have to be accelerated. At this time Zenith is still in the
process of determining which components should be accelerated and the costs that
should be treated as Year 2000-related. Zenith does not have an estimate of
these costs and they are not included in the following table under "Estimate to
Complete" and "Total Estimated IT Expenditure" (both of which are expected to
increase due to such acceleration and because Zenith is in the process of
retaining certain consultants to review its progress). The table sets out the
costs for either repairing Zenith's IT systems ("IT Repair Costs") or for
replacing them ("IT Replacement Costs").
<TABLE>
<CAPTION>
Percent
Expenditures Expended Estimate Total
As of as of to Estimated IT
(Dollars in thousands) 9/30/98 9/30/98 Complete Expenditure
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
IT Repair Costs $3,848 88% $529 $4,377
IT Replacement Costs:
Software 197 100% 197
Hardware 191 100% 191
Related Expenditures 248 84% 47 295
- -------------------------------------------------------------------------------------------------------------------
Total $4,484 89% $576 $5,060
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
22
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
IT Costs include external costs and the cost of dedicated information technology
personnel. IT Repair Costs are expensed as they are incurred; IT Replacement
Costs are capitalized in accordance with SOP 98-1. (See Note 5 of Notes to the
Consolidated Financial Statements.) The internal cost of user participation in
acceptance testing has not been measured and is not included in the foregoing
estimates. Although not quantified at this time, costs associated with non-IT
systems and contingency planning are not expected to be significant. All Year
2000-related costs have been, and will continue to be, funded from internal
sources. No planned information technology projects were deferred because of
Year 2000 related efforts.
The reader is directed to the section of this Report entitled "Forward Looking
Information" and cautioned that the foregoing discussion on the Year 2000
Problem must be read in conjunction with such section. The forward looking
information on the Year 2000 Problem, including its impact on Zenith, future
costs, scheduled completion dates, and the success of Zenith's efforts in
preparing for it are based on management's best estimates of future events. Such
estimates, however, are subject is the inherent uncertainty of the ultimate
effect and the extent of the Year 2000 Problem and the availability of technical
resources and hardware.
CODIFICATION OF STATUTORY ACCOUNTING PRINCIPLES
In March of 1998, the National Association of Insurance Commissioners approved
the codification of statutory accounting principles for use by insurance
departments, insurers, and auditors. Currently, it is not known which states
will adopt the comprehensive basis of statutory accounting and reporting.
Therefore, the implementation date cannot be determined. Implementation of the
codified statutory accounting principles may affect the surplus level and the
capitalization requirements of Zenith's insurance subsidiaries on a statutory
basis. Zenith has not determined the impact of this codification.
23
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
FORWARD LOOKING INFORMATION
The Private Securities Litigation Reform Act of 1995 provides a safe harbor
for forward-looking statements if accompanied by meaningful cautionary
statements identifying important factors that could cause actual results to
differ materially from those discussed. Forward-looking statements include
those related to the plans and objectives of management for future
operations, future economic performance, or projections of revenues, income,
earnings per share, capital expenditures, dividends, capital structure, or
other financial items. Statements containing words such as EXPECT,
ANTICIPATE, BELIEVE, or similar words that are used in Management's
Discussion and Analysis of Financial Condition and Results of Operations, in
other parts of this Report or in other written or oral information conveyed
by or on behalf of Zenith are intended to identify forward-looking
statements. Zenith undertakes no obligation to update such forward-looking
statements, which are subject to a number of risks and uncertainties that
could cause actual results to differ materially from those projected. These
risks and uncertainties include but are not limited to the following: (1)
heightened competition, particularly intense price competition; (2) adverse
state and federal legislation and regulation: (3) changes in interest rates
causing a reduction of investment income; (4) general economic and business
conditions which are less favorable than expected; (5) unanticipated changes
in industry trends; (6) adequacy of loss reserves; (7) catastrophic events or
the occurrence of a significant number of storms, and wind and hail losses;
(8) ability to timely and accurately complete the Year 2000 conversion
process; (9) impact of any failure of third parties with whom Zenith does
business to be Year 2000-compliant; (10) uncertainties related to the RISCORP
Acquisition, including (a) the ability of Zenith to integrate on a profitable
basis the business acquired from RISCORP, (b) the value of transferred assets
and transferred liabilities, (c) the ability of Zenith to recover any amounts
from RISCORP for breaches of representations, warranties and covenants under
the Asset Purchase Agreement and (d) whether RISCORP will contest the
determination of the Final Purchase Price for the RISCORP Acquisition, and,
if so, the ability of RISCORP, to prevail on any such attempt, as well as to
recover any amount from Zenith Insurance for the alleged failure to comply
with certain indemnification provisions of the Asset Purchase Agreement; (11)
changing environment for controlling medical, legal and rehabilitation costs,
as well as fraud and abuse; and (12) other risks detailed herein and from
time to time in Zenith's other reports and filings with the Securities and
Exchange Commission.
24
<PAGE>
PART II. OTHER INFORMATION
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Pursuant to the issuance of the Confidential Offering Circular dated July 27,
1998, on July 30, 1998, Zenith sold $75 million of 8.55% Capital Securities at a
price of $996.24 per security through the Zenith National Insurance Capital
Trust I, a Delaware statutory business trust (the "Trust"), all of the voting
securities of which are owned by Zenith to a limited number of institutional
investors in a Rule 144A offering. The Trust used the proceeds from its offering
to purchase $75 million of Zenith's 8.55% Subordinated Deferrable Interest
Debentures due 2028 (the "Subordinated Debentures"), which constitute the
principal asset of the Trust. Zenith fully and unconditionally guaranteed the
distributions on, and the liquidation amount generally of, the Capital
Securities to the extent the Trust has funds legally available therefor.
Zenith's guarantee of the Capital Securities, as well as the Subordinated
Debentures, are subordinated to all other indebtedness of Zenith. (See Note 7 to
the Consolidated Financial Statements).
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
3.1 Certificate of Incorporation of Zenith as in effect immediately prior
to November 22, 1985. (Incorporated herein by reference to Exhibit 3 to
Zenith's amendment on Form 8, date of amendment October 10, 1985, to
Zenith's Current Report on Form 8-K, date of report July 26, 1985.)
Certificate of Amendment to Certificate of Incorporation of Zenith,
effective November 22, 1985. (Incorporated herein by reference to
Zenith's Current Report on Form 8-K, date of report November 22, 1985.)
3.2 By-laws of Zenith, as currently in effect. (Incorporated herein by
reference to Exhibit 3.2 to Zenith's Annual Report on Form 10-K for the
year ended December 31, 1988.)
10.1 Loan Revision Agreement, dated June 26,1998, to the promissory note,
dated July 1, 1997, between Zenith National Insurance Corp. and City
National Bank (Herein incorporated by reference to Exhibit 10.1 to
Zenith's Quarterly Report on Form 10-Q for the nine months ended
September 30, 1998).
10.2 Second Amendment, dated July 23, 1998, to the Credit Agreement, dated
July 24, 1997, between Zenith National Insurance Corp. and Bank of
America National Trust and Savings Association. (Herein incorporated by
reference to Exhibit 10.2 to Zenith's Quarterly Report on Form 10-Q for
the nine months ended September 30, 1998).
10.3 Restated Tranche A Note, dated July 23, 1998 between Zenith National
Insurance Corp. and Bank of America National Trust and Savings
Association. (Herein incorporated by reference to Exhibit 10.3 to
Zenith's Quarterly Report on Form 10-Q for the nine months ended
September 30, 1998).
10.4 Third Amendment, dated August 21, 1998, to the Credit Agreement, dated
July 24, 1997, between Zenith National Insurance Corp. and Bank of
America National Trust and Savings Association. (Herein incorporated by
reference to Exhibit 10.4 to Zenith's Quarterly Report on Form 10-Q for
the nine months ended September 30, 1998).
10.5 Fourth Amendment, dated September 15, 1998, to the Line of Credit
Agreement, dated December 15, 1994, between Zenith National Insurance
Corp. and Sanwa Bank California. (Herein incorporated by reference to
Exhibit 10.5 to Zenith's Quarterly Report on Form 10-Q for the nine
months ended September 30, 1998).
10.6 Indenture, dated July 30, 1998, between Zenith National Insurance Corp.
and Norwest Bank Minnesota, National Association. (Herein incorporated
by reference to Exhibit 10.6 to Zenith's Quarterly Report on Form 10-Q
for the nine months ended September 30, 1998).
10.7 Capital Securities Guarantee Agreement, dated July 30, 1998, between
Zenith National Insurance Corp. and Norwest Bank Minnesota, National
Association. (Herein
25
<PAGE>
incorporated by reference to Exhibit 10.7 to Zenith's Quarterly Report
on Form 10-Q for the nine months ended September 30, 1998).
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
10.8 Amended and Restated Declaration of Trust of Zenith National Insurance
Capital Trust I, dated July 30, 1999, between Zenith National Insurance
Corp., the trustees and the holders. (Herein incorporated by reference
to Exhibit 10.8 to Zenith's Quarterly Report on Form 10-Q for the nine
months ended September 30, 1998).
10.9 Purchase Agreement between Zenith National Insurance Corp., Zenith
National Insurance Capital Trust I, Credit Suisse First Boston
Corporation, BancAmerica Robertson Stephens and Donaldson, Lufkin &
Jenrette Securities Corporation, dated July 27, 1998, for $75,000,000
Zenith National Insurance Capital Trust I 8.55% Capital Securities.
(Herein incorporated by reference to Exhibit 10.9 to Zenith's Quarterly
Report on Form 10-Q for the nine months ended September 30, 1998).
10.10 Workers' Compensation Quota Share Reinsurance Agreement, dated October
13, 1998, between Zenith Insurance Company and American Re-Insurance
Company. (Herein incorporated by reference to Exhibit 10.10 to Zenith's
Quarterly Report on Form 10-Q for the nine months ended September 30,
1998).
11 Statement re computation of per share earnings. (Note 2 of the
Consolidated Financial Statements included in Item 1 of Part I of this
Quarterly Report on Form 10-Q/A is incorporated herein by reference.)
27 Restated financial data schedule
(b) Reports on Form 8-K
The Registrant filed a Current Report on Form 8-K dated July 9, 1998 on July 9,
1998 in connection with the acquisition by Zenith Insurance of substantially all
the assets and certain of the liabilities of RISCORP.
26
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
ZENITH NATIONAL INSURANCE CORP.
Registrant
Date: April 9, 1999 /s/ Stanley R. Zax
------------------------------------
Stanley R. Zax
Chairman of the Board and President
(Principal Executive Officer)
Date: April 9, 1999 /s/ Fredricka Taubitz
------------------------------------
Fredricka Taubitz
Executive Vice President
& Chief Financial Officer
(Principal Accounting Officer)
27
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