<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 1999
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 [ ]
At July 31, 1999, there were 17,209,000 shares of Zenith Common Stock
outstanding, net of 7,916,000 shares of treasury stock.
1
<PAGE>
PART L
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------------
June 30, December 31,
(Dollars in thousands, except per share data) 1999 1998
- -----------------------------------------------------------------------------------------------------------------------------------
(Unaudited)
<S> <C> <C>
ASSETS:
Investments:
Fixed maturities:
At amortized cost (fair value $30,247 in 1999 and $36,712 in 1998) $ 29,949 $ 35,143
At fair value (cost $679,652 in 1999 and $725,397 in 1998) 667,017 735,284
Floating rate preferred stocks, at fair value (cost $14,614 in 1999 and
$16,614 in 1998) 14,973 17,324
Convertible and non-redeemable preferred stocks, at fair value (cost
$5,005 in 1999 and $7,679 in 1998) 4,278 7,350
Common stocks, at fair value (cost $34,256 in 1999 and $22,402 in 1998) 39,235 26,935
Short-term investments (at cost, which approximates fair value) 158,248 187,123
Other investments 41,765 39,522
------------- ---------------
TOTAL INVESTMENTS 955,465 1,048,681
Cash 7,551 1,998
Accrued investment income 12,703 13,646
Premiums receivable 95,335 133,631
Receivable from reinsurers, state trust funds and
prepaid reinsurance premiums 344,328 373,045
Deferred policy acquisition costs 9,087 23,941
Properties and equipment, less accumulated depreciation 56,991 79,908
Net deferred tax asset 28,432 22,611
Federal income taxes receivable 2,740
Intangible assets 22,935 25,744
Other assets 92,821 92,781
------------- ---------------
TOTAL ASSETS $ 1,625,648 $ 1,818,726
============= ===============
</TABLE>
(continued)
2
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET (CONTINUED)
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------------
June 30, December 31,
(Dollars in thousands, except per share data) 1999 1998
- -----------------------------------------------------------------------------------------------------------------------------------
(Unaudited)
<S> <C> <C>
LIABILITIES:
Policy liabilities and accruals:
Unpaid loss and loss adjustment expenses $ 840,524 $ 997,647
Unearned premiums 60,982 157,965
Policyholders' dividends accrued 4,182 4,763
Reserves on loss portfolio transfers 8,900 9,689
Payable to banks and other notes payable 16,741 19,255
Senior notes payable, less unamortized issue costs of $344
in 1999 and $404 in 1998 74,656 74,596
Federal income taxes payable 46,184
Payable to RISCORP 52,952
Other liabilities 73,519 81,566
------------- ---------------
TOTAL LIABILITIES 1,125,688 1,398,433
------------- ---------------
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 $1,630 in 1999 and $1,659 in 1998. 73,370 73,341
------------- ---------------
Commitments and contingent liabilities
STOCKHOLDERS' EQUITY:
Preferred stock, $1 par - shares authorized 1,000; issued and outstanding, none
in 1999 and 1998
Common stock, $1 par - shares authorized 50,000; issued 25,119,
outstanding 17,209 in 1999; issued 24,970, outstanding 17,148 in 1998 25,119 24,970
Additional paid-in capital 274,114 270,679
Retained earnings 280,741 188,243
Accumulated other comprehensive income - net unrealized (depreciation)
appreciation on investments, net of deferred tax (benefit) expense of
$(2,542) in 1999 and $5,167 in 1998 (4,721) 9,596
------------- ---------------
575,253 493,488
Less treasury stock at cost (7,910 shares in 1999 and 7,822 shares in 1998) (148,663) (146,536)
------------- ---------------
TOTAL STOCKHOLDERS' EQUITY 426,590 346,952
------------- ---------------
TOTAL LIABILITIES, REDEEMABLE SECURITIES AND
STOCKHOLDERS' EQUITY $ 1,625,648 $ 1,818,726
============= ===============
</TABLE>
The accompanying notes are an integral part of this financial statement.
3
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME
(UNAUDITED)
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
(Dollars in thousands, except per share data) 1999 1998 1999 1998
- -----------------------------------------------------------------------------------------------------------------------------------
(Restated) (Restated)
<S> <C> <C> <C> <C>
CONSOLIDATED REVENUES:
Premiums earned $ 75,977 $ 137,554 $ 211,554 $ 256,338
Net investment income 12,946 13,583 26,271 25,926
Realized gains on investments 2,531 3,754 4,065 6,174
Real estate sales 14,438 8,684 25,206 20,432
Service fee income 585 1,392 1,544 1,392
----------- ------------- ------------ -------------
Total revenues 106,477 164,967 268,640 310,262
EXPENSES:
Loss and loss adjustment expenses incurred 65,983 94,581 171,473 178,509
Policy acquisition costs 13,604 26,710 40,834 48,989
Other underwriting and operating expenses 15,816 23,196 33,015 39,042
Policyholders' dividends and participation 507 (120) 942 (63)
Real estate construction and operating costs 13,628 8,544 23,389 20,038
Interest expense 2,116 515 4,136 1,508
----------- ------------- ------------ -------------
Total expenses 111,654 153,426 273,789 288,023
Gain on sale of CalFarm Insurance Company (see Note 3) 160,335
------------
(Loss) income before federal income tax expense (5,177) 11,541 155,186 22,239
Federal income tax (benefit) expense, including expense of
$56,000 related to the sale of CalFarm Insurance Company
in the six months ended June 30, 1999 (1,777) 4,241 54,186 7,839
----------- ------------- ------------ -------------
NET (LOSS) INCOME $ (3,400)$ 7,300 $ 101,000 $ 14,400
=========== ============= ============ =============
EARNINGS PER SHARE:
Net (loss) income per common share -
Basic $ (0.20)$ 0.43 $ 5.89 $ 0.85
=========== ============= ============ =============
Diluted $ (0.20)$ 0.42 $ 5.89 $ 0.84
=========== ============= ============ =============
Additional Required Disclosure:
Net (loss) income $ (3,400)$ 7,300 $ 101,000 $ 14,400
Change in unrealized appreciation/(depreciation) on investments (7,073) 403 (14,317) 802
----------- ------------- ------------ -------------
Comprehensive (Loss) Income $ (10,473)$ 7,703 $ 86,683 $ 15,202
=========== ============= ============ =============
</TABLE>
The accompanying notes are an integral part of this financial statement.
4
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------
Six Months Ended
June 30,
(Dollars in thousands) 1999 1998
- ----------------------------------------------------------------------------------------------------------------------------
(Restated)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Premiums and service fee income collected $ 222,787 $ 266,717
Investment income received 27,477 23,654
Proceeds from sales of real estate 25,206 20,432
Loss and loss adjustment expenses paid (195,619) (203,893)
Underwriting and other operating expenses paid (53,249) (75,496)
Real estate construction costs paid (25,633) (29,917)
Reinsurance premiums paid (26,547) (15,824)
Dividends paid to policyholders (1,623) 413
Interest paid (9,642) (3,453)
Income taxes (paid) refunded (2,814) 644
--------------- -------------
Net cash used in operating activities (39,657) (16,723)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investments:
Investment securities available-for-sale (192,565) (165,269)
Other investments (6,303) (1,403)
Proceeds from maturities and redemptions of investments:
Fixed maturities held-to-maturity 5,114 5,688
Investment securities available-for-sale 68,451 42,203
Proceeds from sales of investments:
Investment securities available-for-sale 47,152 131,178
Other investments 5,515
Capital and other expenditures (6,777) (8,272)
Net change in short-term investments (21,658) 62,469
Cash paid to RISCORP (54,308) (35,000)
Cash acquired in RISCORP Acquisition 29,309
Net proceeds from sale of CalFarm 211,068
Other (786) (5,880)
--------------- -------------
Net cash provided by investing activities 54,903 55,023
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of note assumed from RISCORP (15,000)
Cash advanced from bank construction loans 24,412 20,222
Cash repaid on bank construction loans (21,926) (18,280)
Cash advanced from bank lines of credit 7,400
Cash repaid on bank lines of credit (12,400)
Cash dividends paid to common stockholders (8,564) (8,484)
Proceeds from exercise of stock options 3,512 3,777
Purchase of treasury shares (2,127) (23,301)
--------------- -------------
Net cash used in financing activities (9,693) (41,066)
--------------- -------------
Net increase (decrease) in cash 5,553 (2,766)
Cash at beginning of period 1,998 12,504
--------------- -------------
Cash at end of period $ 7,551 $ 9,738
=============== =============
(continued)
</TABLE>
5
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS (CONTINUED)
(UNAUDITED)
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------
Six Months Ended
June 30,
(Dollars in thousands) 1999 1998
- -------------------------------------------------------------------------------------------------------
(Restated)
RECONCILIATION OF NET INCOME TO NET CASH FLOWS
FROM OPERATING ACTIVITIES:
<S> <C> <C>
Net Income $ 101,000 $ 14,400
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization 4,292 4,637
Realized gain on sale of CalFarm Insurance Company (160,335)
Realized gains on investments (4,065) (6,174)
Decrease (increase) in:
Accrued investment income (1,052) (1,809)
Premiums receivable 1,779 (2,276)
Receivable from reinsurers, state trust funds and
prepaid reinsurance premiums 5,715 8,741
Federal income taxes 51,386 8,483
Deferred policy acquisition costs (766) (1,191)
Increase (decrease) in:
Unpaid loss and loss adjustment expenses (31,582) (34,850)
Unearned premiums (6,019) (693)
Policyholders' dividends accrued (581) (200)
Other policyholder funds (3,732) (3,869)
Other 4,303 (1,922)
----------- -------------
Net cash used in operating activities $ (39,657) $ (16,723)
=========== =============
</TABLE>
The accompanying notes are an integral part of this financial statement.
6
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Zenith
National Insurance Corp. ("Zenith National") and subsidiaries (collectively,
"Zenith") have been prepared in accordance with generally accepted accounting
principles ("GAAP") for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities
Exchange Act of 1934, as amended. Accordingly, they do not include all of the
information and footnotes required by GAAP for complete financial statements.
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 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. For further
information, refer to the financial statements and footnotes included in the
Zenith Annual Report on Form 10-K for the year ended December 31, 1998.
Certain prior year balances have been reclassified to conform to the current
year presentation. Zenith has elected to round to the nearest thousand
dollars, except for share and per share data, in reporting amounts in this
statement.
The comparability of the three months and six months ended June 30, 1999 as
compared to the corresponding periods in 1998 is affected by the purchase of
substantially all of the assets and certain liabilities of the former operations
of RISCORP, Inc. and certain of its subsidiaries (collectively, "RISCORP")
effective April 1, 1998 (see Note 4), and by the sale of CalFarm Insurance
Company ("CalFarm"), a wholly-owned subsidiary of Zenith Insurance Company
("Zenith Insurance"), a wholly-owned subsidiary of Zenith National, to
Nationwide Mutual Insurance Company effective March 31, 1999 (see Note 3).
RESTATEMENT - As previously reported, the Consolidated Balance Sheet,
Consolidated Statement of Operations and Consolidated Statement of Cash Flows as
of and for the quarter ended June 30, 1998 have been restated to incorporate the
resolution of the purchase price determination for the RISCORP Acquisition (see
Note 4). The restatement impacted invested assets, accrued investment income,
receivable from reinsurers, 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.
7
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 2. EARNINGS AND DIVIDENDS PER SHARE
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
(In thousands, except per share data) 1999 1998 1999 1998
- ---------------------------------------------------------------- -------------- ------------- -------------- -------------
(Restated) (Restated)
- --------------- ------------------------------------------------ -------------- ------------- -------------- -------------
<C> <S> <C> <C> <C> <C>
(A) Net (loss) income $(3,400) $7,300 $101,000 $ 14,400
- --------------- ------------------------------------------------ -------------- ------------- -------------- -------------
(B) Weighted average outstanding
shares during the period 17,140 17,049 17,138 16,999
Additional common shares issuable
under employee stock option plans
using the treasury stock method 17 220 16 176
- --------------- ------------------------------------------------ -------------- ------------- -------------- -------------
(C) Weighted average number of common
shares outstanding
assuming exercise
of stock options 17,157 17,269 17,154 17,175
- --------------- ------------------------------------------------ -------------- ------------- -------------- -------------
- --------------- ------------------------------------------------ -------------- ------------- -------------- -------------
Net (loss) income per common share -
(A)/(B) Basic $ (0.20) $ 0.43 $5.89 $ 0.85
(A)/(C) Diluted (0.20) 0.42 5.89 0.84
- --------------- ------------------------------------------------ -------------- ------------- -------------- -------------
Dividends per common share 0.25 0.25 0.50 0.50
- --------------- ------------------------------------------------ -------------- ------------- -------------- -------------
</TABLE>
NOTE 3. SALE OF CALFARM INSURANCE COMPANY
Effective March 31, 1999, Zenith Insurance completed the sale of all of the
issued and outstanding capital stock of CalFarm for approximately $273,000,000
in cash to Nationwide Mutual Insurance Company. CalFarm wrote Zenith's Other
Property-Casualty business, principally in California, through March 31, 1999.
The gain on the sale, net of tax, was approximately $104,000,000.
Approximately $59,000,000 of cash was transferred from Zenith Insurance to
CalFarm in connection with the cessation of CalFarm's participation in the
intercompany reinsurance pooling agreement to which Zenith Insurance and its
wholly-owned property-casualty insurance subsidiaries are parties. Zenith
Insurance and its wholly-owned property-casualty subsidiaries, other than
CalFarm, will continue to participate in an intercompany reinsurance pooling
agreement.
After accounting for applicable taxes and expenses, the net proceeds from the
sale that are available to Zenith Insurance for investment are approximately
$211,000,000, compared to cash and investments of approximately $226,000,000
that are excluded from Zenith's Consolidated Balance Sheet with the sale of
CalFarm.
8
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 3. SALE OF CALFARM INSURANCE COMPANY (CONTINUED)
The following table summarizes the assets and liabilities of CalFarm at March
31, 1999:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------
(Dollars in thousands) March 31, 1999
- --------------------------------------------------------------------------------------------------------------
<S> <C>
Assets:
Investments $ 170,050
Cash 1,904
Receivable from Zenith Insurance Company 59,256
Premiums receivable 36,517
Receivable from reinsurers 23,002
Deferred policy acquisition costs 15,620
Properties and equipment 20,505
Other assets 6,874
- --------------------------------------------------------------------------------------------------------------
Total assets $ 333,728
- --------------------------------------------------------------------------------------------------------------
Liabilities:
Unpaid loss and loss adjustment expense $ 125,589
Unearned premium reserve 90,964
Other liabilities 10,617
- --------------------------------------------------------------------------------------------------------------
Total liabilities $ 227,170
- --------------------------------------------------------------------------------------------------------------
</TABLE>
Pro forma total revenues for Zenith for the three months ended June 30, 1999
and 1998 (after giving effect to the sale of CalFarm as if it had been
consummated at the beginning of the respective periods) would have been
$106,477,000 and $106,399,000, respectively. Pro forma results of operations
after taxes for such periods would have been a net loss of $3,400,000 and net
income of $4,100,000, respectively. Pro forma earnings per share for such
periods would have been a net loss of $0.20 (basic and diluted) and net
income of $0.24 (basic and diluted), respectively.
Pro forma total revenues for Zenith for the six months ended June 30, 1999
and 1998 (after giving effect to the sale of CalFarm as if it had been
consummated at the beginning of the respective periods) would have been
$211,488,000 and $192,772,000, respectively. Pro forma results of operations
after taxes for such periods would have been a net loss of $5,300,000 and net
income of $9,100,000, respectively. Pro forma earnings per share for such
periods would have been a net loss of $0.31 (basic and diluted) and net
income of $0.54 (basic) and $0.53 (diluted), respectively.
9
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 3. SALE OF CALFARM INSURANCE COMPANY (CONTINUED)
Since CalFarm was acquired by Zenith Insurance in 1985, CalFarm's cumulative
combined ratio was approximately 100% and its cumulative underwriting income
was approximately zero. In addition to the loss of any underwriting income
provided by CalFarm, Zenith's consolidated net income would be reduced by the
investment income associated with the net reduction of approximately
$15,000,000 of consolidated investments caused by the sale of CalFarm.
Estimated investment income after tax on such decrease would have been
$139,000 for the six month period ended June 30, 1999, $278,000 for the
comparable period ended June 30, 1998 and $139,000 for the three months ended
June 30, 1998. Using such change in investment income, the underwriting
income previously reported by CalFarm and the gain on the sale of CalFarm,
pro forma net (loss) income would be as follows:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
(Dollars in thousands) 1999 1998 1999 1998
- --------------------------------------------------------------- --------------- --------------- -------------- ---------------
<S> <C> <C> <C> <C>
Net (loss) income as reported (1998 restated) $(3,400) $7,300 $ 101,000 $ 14,400
Less: underwriting income of CalFarm after tax (1,661) (26) (1,122)
Less: gain on sale of CalFarm after tax (104,335)
Less: change in investment income after tax (139) (139) (278)
- --------------------------------------------------------------- --------------- --------------- -------------- ---------------
Pro forma net (loss) income $(3,400) $ 5,500 $ (3,500) $ 13,000
- --------------------------------------------------------------- --------------- --------------- -------------- ---------------
Net (loss) income per common share -
Basic $(0.20) $0.32 $ (0.20) $0.76
Diluted (0.20) 0.32 (0.20) 0.76
- --------------------------------------------------------------- --------------- --------------- -------------- ---------------
</TABLE>
NOTE 4. COMMITMENTS AND CONTINGENT LIABILITIES
CONTINGENCIES SURROUNDING FAIR VALUES OF RISCORP ASSETS ACQUIRED AND LIABILITIES
ASSUMED AND SETTLEMENT OF CERTAIN LITIGATION BETWEEN ZENITH INSURANCE AND
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 and RISCORP, Zenith Insurance acquired substantially all of the
assets and certain liabilities of RISCORP related to RISCORP's workers'
compensation business (the "RISCORP Acquisition"). The total purchase price for
such acquired assets and liabilities was determined by a three-step process in
which RISCORP and its external accounting and actuarial consultants and Zenith
Insurance and its external accounting and actuarial consultants made and
presented their estimates of the GAAP values of the assets and liabilities
acquired by Zenith Insurance to an independent third-party, acting as a Neutral
Auditor and Neutral Actuary. Such estimates varied considerably, particularly
with respect to the value of premiums receivable and the liability for unpaid
losses and loss adjustment expenses. On March 19, 1999, the Neutral Auditor and
Neutral Actuary issued its report determining the disputes between the parties.
10
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 4. COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED)
The carrying values of premiums receivable and the liability for unpaid
losses and loss adjustment expenses at June 30, 1999 and December 31, 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 June 30, 1999 and December 31, 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 $50,000,000 in
excess of $182,000,000 for net unpaid losses and allocated loss adjustment
expenses acquired from RISCORP. Future adverse loss development, if any, of
the reserves acquired from RISCORP is recoverable up to the $50,000,000
limit, although the benefit of such reinsurance recoverable would be deferred
and recognized over the recovery period of such reinsurance, whereas future
loss development, if any, would be a non-cash charge to operations in the
period in which it occurs. After deducting reinsurance premiums of
$16,000,000, Zenith has recorded reinsurance recoverable of $26,887,000 and a
deferred benefit of $10,887,000 at June 30, 1999.
11
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 4. COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED)
Zenith Insurance and RISCORP have entered into a settlement agreement, dated
July 7, 1999 (the "Settlement Agreement"), providing for the resolution of
certain claims arising out of the RISCORP Acquisition. Pursuant to the
Settlement Agreement, Zenith Insurance and RISCORP (i) have dismissed
litigation pending between them in the United States District Courts for the
Middle District of Florida, Tampa Division, and the Southern District of New
York; (ii) have agreed that RISCORP may request that the Neutral Auditor and
Neutral Actuary review an alleged error concerning the proper treatment of
certain reinsurance treaties in its determinations with respect to the
purchase price for the RISCORP Acquisition, without waiving whatever rights
they may have to litigation of such issue, determine whether the issue was
properly in dispute before the Neutral Auditor and Neutral Actuary and, if
so, determine the merits of the issue and whether a correction is
appropriate; (iii) have agreed that any other disputes arising under the
Asset Purchase Agreement or the Settlement Agreement, including any future
claims for indemnification by either Zenith Insurance or RISCORP, are to be
resolved by binding arbitration; (iv) have agreed that Zenith is to receive
$6,000,000 from an escrow account established pursuant to the Asset Purchase
Agreement, with RISCORP to receive the balance of the escrow account; and (v)
have agreed to an allocation between them of any recovery received as a
result of refund claims that RISCORP has made to the Florida Department of
Labor and Employment Security, Division of Workers' Compensation. In a
submission made to the Neutral Auditor and Neutral Actuary, RISCORP has
claimed that the purchase price for the RISCORP Acquisition should be
adjusted by either $5,872,000 or $23,365,000 as a result of alleged errors in
the Neutral Auditor and Neutral Actuary's original computation with respect
to the purchase price. Zenith disputes RISCORP's claim. In the third quarter
of 1999, a certain portion of the $6,000,000 proceeds from the settlement of
the RISCORP litigation may be accounted for as a reduction of operating
expenses to the extent that such proceeds represent compensation to Zenith
Insurance for certain of the expenses incurred to operate the former RISCORP
business.
OTHER LITIGATION
Zenith National and its subsidiaries are defendants in various other litigation
in the ordinary course of business. In the opinion of management, after
consultation with legal counsel, such litigation is either without merit or the
ultimate liability, if any, will not have a material adverse effect on the
consolidated financial condition or results of operations of Zenith.
NOTE 5. CODIFICATION OF STATUTORY ACCOUNTING PRINCIPLES
In 1998, the National Association of Insurance Commissioners ("NAIC") adopted
the Codification of Statutory Accounting Principles guidance (the
"Codification"), which will replace the current Accounting Practices and
Procedures manual as the NAIC's primary guidance on statutory accounting
(statutory accounting is a comprehensive basis of accounting based on prescribed
accounting practices, which include state laws, regulations and general
administrative rules, as well as a variety of publications of the NAIC). The
NAIC is now considering amendments to the Codification that would also be
effective upon implementation. The NAIC has recommended an effective date of
January 1, 2001. The Codification provides guidance for the areas where
statutory accounting has been silent and changes current statutory accounting in
some areas.
It is not known whether the state of California Department of Insurance will
adopt the Codification, and whether the Department of Insurance will make any
changes to that guidance. Implementation of the Codification may affect the
surplus level and the capitalization requirements of Zenith National's insurance
subsidiaries on a statutory basis. Zenith has not determined the impact of the
Codification.
12
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 6. SEGMENT INFORMATION
Zenith classifies its business into six segments: Workers' Compensation,
Reinsurance, Other Property-Casualty, Real Estate Operations, Investment and
Parent. Segments are designated based on the types of products and services
provided and based on the risks associated with the products and services.
Workers' Compensation represents insurance coverage for the statutorily
prescribed benefits that employers are required to pay to their employees
injured in the course of employment. The Workers' Compensation segment
information includes the former RISCORP operations acquired effective April
1, 1998. Reinsurance represents the book of assumed reinsurance of
accumulated losses from catastrophes and the reinsurance of large property
risks. Other Property-Casualty (which includes the gain on the sale of
CalFarm) represents multiple product line direct insurance other than
workers' compensation, primarily in California through March 31, 1999, the
effective date of the sale of CalFarm. Real Estate Operations develop land
and primarily construct private residences for sale in Las Vegas, Nevada.
Investment represents investment income and realized gains on investments,
primarily from debt securities. Parent represents the holding company
operations of Zenith National owning, directly or indirectly, all of the
capital stock of the property and casualty insurance and non-insurance
companies.
13
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 6. SEGMENT INFORMATION (CONTINUED)
The accounting policies of the segments are consistent with GAAP. Zenith
evaluates insurance segment performance based on the combined ratios and income
or loss from operations before income taxes, not including investment income or
realized gains or losses.
<TABLE>
<CAPTION>
- ---------------------------------- -------------- ------------ ------------ ------------ ------------- --------- --------------
Other Real
Workers' Property- Estate
(Dollars in thousands) Compensation Casualty Reinsurance Operations Investments Parent Total
- ---------------------------------- -------------- ------------ ------------ ------------ ------------- --------- --------------
For the Six Months Ended June 30, 1999
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues:
Premiums earned $139,767 $54,108 $17,679 $211,554
Net investment income $26,271 26,271
Realized gains on
investments 4,065 4,065
Real estate sales $25,206 25,206
Service fee income 1,544 1,544
- ---------------------------------- -------------- ------------ ------------ ------------ ------------- --------- --------------
Total revenues 141,311 54,108 17,679 25,206 30,336 286,640
- ---------------------------------- -------------- ------------ ------------ ------------ ------------- --------- --------------
Segment (loss) income,
before taxes (29,868) (22) (1,366) 1,817 30,336 $ (6,046) (5,149)
Gain on sale of CalFarm 160,335 160,335
Interest expense (4,136) (4,136)
Income tax benefit (expense) 10,014 (55,993) 458 (636) (10,145) 2,116 (54,186)
Segment assets 531,310 33,454 74,582 975,719 10,583 1,625,648
Combined ratios 121.4% 100.0% 107.7% 114.8%
- ---------------------------------- -------------- ------------ ------------ ------------ ------------- --------- --------------
- -------------------------------------------------------------------------------------------------------------------------------
For the Six Months Ended June 30, 1998
- -------------------------------------------------------------------------------------------------------------------------------
Revenues:
Premiums earned $ 130,002 $ 111,155 $15,181 $ 256,338
Net investment income $ 25,926 25,926
Realized gains on
investments 6,174 6,174
Real estate sales 20,432 20,432
Service fee income 1,392 1,392
- ---------------------------------- -------------- ------------ ------------ ------------ ------------- --------- --------------
Total revenues 131,394 111,155 15,181 20,432 32,100 310,262
- ---------------------------------- -------------- ------------ ------------ ------------ ------------- --------- --------------
Segment (loss) income,
before taxes (16,177) 1,751 7,893 394 32,100 $ (3,722) 22,239
Interest expense (1,508) (1,508)
Income tax benefit (expense) 4,737 (513) (2,311) (138) (10,846) 1,232 (7,839)
Segment assets 591,991 96,951 30,698 62,378 1,026,824 10,528 1,819,370
Combined ratios 112.6% 98.4% 48.0% 102.6%
- ---------------------------------- -------------- ------------ ------------ ------------ ------------- --------- --------------
</TABLE>
14
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The principal source of consolidated earnings of Zenith National Insurance
Corp. ("Zenith National") and subsidiaries (collectively, "Zenith") is the
income, including investment income, from the operations of its
property-casualty insurance operations and its investment portfolio. The
property-casualty insurance operations comprise Workers' Compensation,
Reinsurance and, through March 31, 1999, Other Property-Casualty. Zenith's
Real Estate Operations develop land and primarily construct private
residences for sale in Las Vegas, Nevada. Zenith National owns, directly or
indirectly, all of the capital stock of its subsidiaries. The comparative
results of such operations are set forth in the table below, followed by a
discussion of significant changes.
The comparability of the three months and six months ended June 30, 1999 as
compared to the corresponding periods in 1998 is affected by the purchase of
substantially all of the assets and certain liabilities of the former
operations of RISCORP, Inc. and certain of its subsidiaries (collectively,
"RISCORP") effective April 1, 1998, and by the sale of CalFarm Insurance
Company ("CalFarm"), a wholly-owned subsidiary of Zenith Insurance Company
("Zenith Insurance"), a wholly-owned subsidiary of Zenith National, to
Nationwide Mutual Insurance Company effective March 31, 1999.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------------------
Three Months Ended Six months Ended
June 30, June 30,
(Dollars in thousands) 1999 1998 1999 1998
- -------------------------------------------------------------------------------------------------------------------------------
(Restated) (Restated)
<S> <C> <C> <C> <C>
Net investment income, after taxes $ 8,661 $ 8,959 $ 17,549 $ 17,241
Realized gains on investments, after taxes 1,645 2,440 2,642 4,013
- -------------------------------------------------------------------------------------------------------------------------------
Sub-total 10,306 11,399 20,191 21,254
- -------------------------------------------------------------------------------------------------------------------------------
Property-casualty underwriting results, after taxes:
Loss excluding catastrophes (9,420) (3,002) (16,812) (1,370)
Catastrophe losses (2,730) (3,965) (3,250)
- -------------------------------------------------------------------------------------------------------------------------------
Property-casualty underwriting loss, after taxes (12,150) (3,002) (20,777) (4,620)
- -------------------------------------------------------------------------------------------------------------------------------
Income from Real Estate Operations, after taxes 526 104 1,181 256
Interest expense, after taxes (1,375) (335) (2,688) (980)
Parent expenses, after taxes (707) (866) (1,242) (1,510)
- -------------------------------------------------------------------------------------------------------------------------------
Net (loss) income before gain on sale of CalFarm
Insurance Company (3,400) 7,300 (3,335) 14,400
- -------------------------------------------------------------------------------------------------------------------------------
Gain on sale of CalFarm Insurance Company after tax 104,335
- -------------------------------------------------------------------------------------------------------------------------------
Net (loss) income $ (3,400) $ 7,300 $ 101,000 $ 14,400
- -------------------------------------------------------------------------------------------------------------------------------
</TABLE>
15
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
Premiums earned, underwriting results and combined ratios before taxes for the
three and six months ended June 30, 1999 and 1998 were as follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
(Dollars in thousands) 1999 1998 1999 1998
- ------------------------------------------------------------------------------------------------------------------------
(Restated) (Restated)
<S> <C> <C> <C> <C>
Premiums earned:
Workers' Compensation
California $ 27,593 $ 30,548 $ 56,143 $ 60,444
Outside California 40,417 43,659 83,624 69,558
----------------------------------------------------------
Total Workers' Compensation 68,010 74,207 139,767 130,002
Other Property-Casualty 56,079 54,108 111,155
Reinsurance 7,967 7,268 17,679 15,181
----------------------------------------------------------
Total $ 75,977 $137,554 $211,554 $256,338
==========================================================
Underwriting income (loss) before taxes:
Workers' Compensation $ (16,699) $(11,055) $(29,868) $(16,376)
Other Property-Casualty 2,472 (22) 1,751
Reinsurance (1,560) 4,187 (1,366) 7,893
----------------------------------------------------------
Total $ (18,259) $ (4,396) $(31,256) $ (6,732)
==========================================================
Combined loss and expense ratios:
Workers' Compensation
Loss and loss adjustment expenses 84.6% 76.7% 85.1% 76.4%
Underwriting expenses 40.0% 38.2% 36.3% 36.2%
----------------------------------------------------------
Combined ratio 124.6% 114.9% 121.4% 112.6%
Other Property-Casualty
Loss and loss adjustment expenses 64.6% 66.5% 67.2%
Underwriting expenses 31.0% 33.5% 31.2%
--------------------------------------------
Combined ratio 95.6% 100.0% 98.4%
Reinsurance
Loss and loss adjustment expenses 106.7% 19.7% 93.6% 29.5%
Underwriting expenses 12.9% 22.7% 14.1% 18.5%
----------------------------------------------------------
Combined ratio 119.6% 42.4% 107.7% 48.0%
Total
Loss and loss adjustment expenses 86.9% 68.8% 81.1% 69.6%
Underwriting expenses 37.1% 34.4% 33.7% 33.0%
----------------------------------------------------------
Combined ratio 124.0% 103.2% 114.8% 102.6%
==========================================================
</TABLE>
16
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
The profitability of the property-casualty insurance operations is
principally dependent upon the adequacy of rates charged to the insured for
insurance protection; the frequency and severity of claims; the ability to
accurately estimate and accrue reported and unreported losses in the correct
period; the level of dividends paid to policyholders; the ability to manage
claims costs and keep operating expenses in line with premium volume; and the
ability to service claims, maintain policies and acquire business
efficiently. Some of the factors that continue to impact the business and
economic environment in which Zenith operates include: an uncertain political
and regulatory environment, both state and federal; the outlook for economic
growth in geographic areas where Zenith operates; the expansion of the
Workers' Compensation business outside of California; the use by others in
the industry of creative reinsurance; a highly competitive insurance
industry; and the changing environment for controlling medical; legal and
rehabilitation costs, as well as fraud and abuse. Although management is
currently unable to predict the effect of any of the foregoing, these factors
and related trends and uncertainties could have a material effect of Zenith's
future operations and financial condition.
ACQUISITION OF ZENITH'S COMMON STOCK BY FAIRFAX FINANCIAL HOLDINGS LIMITED
Pursuant to a Stock Purchase Agreement, dated June 25, 1999 (the "Stock
Purchase Agreement"), between Fairfax Financial Holdings Limited, a Canada
corporation ("Fairfax"), and Reliance Insurance Company ("Reliance"), Fairfax
has agreed to purchase the 6,574,445 shares of the common stock of Zenith
National owned by Reliance and its affiliates (the "Transaction"). Fairfax
reported that consummation of the Transaction is expected to occur in the
second half of 1999 and is subject to various closing conditions, including
the receipt of applicable insurance and other regulatory approvals. Reliance
has covenanted that, effective on consummation of the Transaction, it will
arrange for the resignation from the Zenith's Board of Directors of each of
Messrs. Saul P. Steinberg, Robert M. Steinberg and George E. Bello.
17
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
In connection with the Transaction, Zenith National and Fairfax have entered
into a standstill agreement, dated June 30, 1999 (the "Standstill
Agreement"), pursuant to which Fairfax has agreed that, without the prior
written consent of a majority of the Board of Directors of Zenith National
who are not affiliates, officers, directors or employees of Fairfax or any
corporation or other entity controlled by or affiliated with Fairfax
(collectively, the "Purchaser Group"), the Purchaser Group will not, (a)
participate in (i) any acquisition of any securities (or beneficial ownership
thereof) or assets of Zenith, except by way of distributions or offerings
made available to holders of Zenith securities generally, (ii) any business
combination involving Zenith, except to the extent of selling Zenith common
stock owned or acquired pursuant to the Transaction or by way of other
distributions made available to holders of Zenith securities generally, (iii)
any recapitalization, restructuring, liquidation, dissolution or other
extraordinary transaction with respect to Zenith, or (iv) any solicitation of
proxies or consents to vote any securities of Zenith, (b) seek to acquire or
affect control of Zenith or influence the management, Board of Directors or
policies of Zenith, (c) enter into any arrangements with any third party
regarding any of the foregoing, or (d) take any action which would force
Zenith to make a public announcement regarding the types of matters set forth
in clause (a) above. The Purchaser Group also has agreed not to ask, subject
to a limited exception, Zenith (or its directors, officers, employees, or
agents) directly or indirectly, to amend, waive or terminate any of the
foregoing provisions of the Standstill Agreement. The Standstill Agreement
will remain in effect until the earlier of (i) five years from the
consummation of the Transaction, or (ii) the date on which Stanley R. Zax is
no longer the full-time Chairman of the Board and President of Zenith.
The effectiveness of the covenants and agreements of Fairfax under the
Standstill Agreement was conditioned on the execution and delivery to Fairfax
and Zenith of waivers, with respect to the Transaction, of rights held by
certain employees of Zenith or one of its affiliates pursuant to such
employees' employment agreements. In a letter dated July 8, 1999, Fairfax
acknowledged the receipt of waivers; waived the condition as to any not
received; and indicated that its covenants and agreements in the Standstill
Agreement are in full force and effect.
SALE OF CALFARM INSURANCE COMPANY
Effective March 31, 1999, Zenith Insurance completed the sale of all of the
issued and outstanding capital stock of CalFarm for approximately $273,000,000
in cash to Nationwide Mutual Insurance Company. CalFarm wrote Zenith's Other
Property-Casualty business, principally in California, through March 31, 1999.
The gain on the sale, net of tax, was approximately $104,000,000.
Approximately $59,000,000 of cash was transferred from Zenith Insurance to
CalFarm in connection with the cessation of CalFarm's participation in the
intercompany reinsurance pooling agreement to which Zenith Insurance and its
wholly-owned property-casualty insurance subsidiaries are parties (the
"de-pooling transaction"). Zenith Insurance and its wholly-owned
property-casualty subsidiaries, other than CalFarm, will continue to
participate in an intercompany reinsurance pooling agreement.
After accounting for applicable taxes and expenses, the net proceeds from the
sale that are available to Zenith Insurance for investment are approximately
$211,000,000, compared to cash and investments of approximately $226,000,000
that are excluded from Zenith's Consolidated Balance Sheet with the sale of
CalFarm.
18
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
Since CalFarm was acquired by Zenith Insurance in 1985, CalFarm's cumulative
combined ratio was approximately 100% and its cumulative underwriting income
was approximately zero. In addition to the loss of any underwriting income
provided by CalFarm, Zenith's consolidated net income would be reduced by the
investment income associated with the net reduction of approximately
$15,000,000 of consolidated investments caused by the sale of CalFarm.
Estimated investment income after tax on such decrease would have been
$139,000 for the six month period ended June 30, 1999 and 1998, respectively,
and $278,000 for the comparable period ended June 30, 1998 and $139,000 for
the three months ended June 30, 1998. Using such change in investment income,
the underwriting income previously reported by CalFarm and the gain on the
sale of CalFarm, pro forma net (loss) income would be as follows:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
(Dollars in thousands) 1999 1998 1999 1998
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net (loss) income as reported (1998 restated) $(3,400) $ 7,300 $ 101,000 $ 14,400
Less: underwriting income of CalFarm after tax (1,661) (26) (1,122)
Less: gain on sale of CalFarm after tax (104,335)
Less: change in investment income (139) (139) (278)
- ------------------------------------------------------------------------------------------------------------------------------
Pro forma net (loss) income $(3,400) $ 5,500 $ (3,500) $ 13,000
- ------------------------------------------------------------------------------------------------------------------------------
Net (loss) income per common share -
Basic $ (0.20) $ 0.32 $ (0.20) $ 0.76
Diluted (0.20) 0.32 (0.20) 0.76
- ------------------------------------------------------------------------------------------------------------------------------
</TABLE>
CONTINGENCIES SURROUNDING FAIR VALUES OF RISCORP ASSETS ACQUIRED AND
LIABILITIES ASSUMED AND SETTLEMENT OF CERTAIN LITIGATION BETWEEN ZENITH
INSURANCE AND 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 and RISCORP, Zenith Insurance acquired substantially all of the
assets and certain liabilities of RISCORP related to RISCORP's workers'
compensation business (the "RISCORP Acquisition"). The total purchase price
for such acquired assets and liabilities was determined by a three-step
process in which RISCORP and its external accounting and actuarial
consultants and Zenith Insurance and its external accounting and actuarial
consultants made and presented their estimates of the GAAP values of the
assets and liabilities acquired by Zenith Insurance to an independent
third-party, acting as a Neutral Auditor and Neutral Actuary. Such estimates
varied considerably, particularly with respect to the value of premiums
receivable and the liability for unpaid losses and loss adjustment expenses.
On March 19, 1999, the Neutral Auditor and Neutral Actuary issued its report
determining the disputes between the parties.
19
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
The carrying values of premiums receivable and the liability for unpaid
losses and loss adjustment expenses at June 30, 1999 and December 31, 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 June 30, 1999 and December 31, 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 $50,000,000 in
excess of $182,000,000 for net unpaid losses and allocated loss adjustment
expenses acquired from RISCORP. Future adverse loss development, if any, of
the reserves acquired from RISCORP is recoverable up to the $50,000,000
limit, although the benefit of such reinsurance recoverable would be deferred
and recognized over the recovery period of such reinsurance, whereas future
loss development, if any, would be a non-cash charge to operations in the
period in which it occurs. After deducting reinsurance premiums of
$16,000,000, Zenith has recorded reinsurance recoverable of $26,887,000 and a
deferred benefit of $10,887,000 at June 30, 1999.
20
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
Zenith Insurance and RISCORP have entered into a settlement agreement, dated
July 7, 1999 (the "Settlement Agreement"), providing for the resolution of
certain claims arising out of the RISCORP Acquisition. Pursuant to the
Settlement Agreement, Zenith Insurance and RISCORP (i) have dismissed
litigation pending between them in the United States District Courts for the
Middle District of Florida, Tampa Division, and the Southern District of New
York; (ii) have agreed that RISCORP may request that the Neutral Auditor and
Neutral Actuary review an alleged error concerning the proper treatment of
certain reinsurance treaties in its determinations with respect to the
purchase price for the RISCORP Acquisition, without waiving whatever rights
they may have to litigation of such issue, determine whether the issue was
properly in dispute before the Neutral Auditor and Neutral Actuary and, if
so, determine the merits of the issue and whether a correction is
appropriate; (iii) have agreed that any other disputes arising under the
Asset Purchase Agreement or the Settlement Agreement, including any future
claims for indemnification by either Zenith Insurance or RISCORP, are to be
resolved by binding arbitration; (iv) have agreed that Zenith is to receive
$6,000,000 from an escrow account established pursuant to the Asset Purchase
Agreement, with RISCORP to receive the balance of the escrow account; and (v)
have agreed to an allocation between them of any recovery received as a
result of refund claims that RISCORP has made to the Florida Department of
Labor and Employment Security, Division of Workers' Compensation. In a
submission made to the Neutral Auditor and Neutral Actuary, RISCORP has
claimed that the purchase price for the RISCORP Acquisition should be
adjusted by either $5,872,000 or $23,365,000 as a result of alleged errors in
the Neutral Auditor and Neutral Actuary's original computation with respect
to the purchase price. Zenith disputes RISCORP's claim. In the third quarter
of 1999, a certain portion of the $6,000,000 proceeds from the settlement of
the RISCORP litigation may be accounted for as a reduction of operating
expenses to the extent that such proceeds represent compensation to Zenith
Insurance for certain of the expenses incurred to operate the former RISCORP
business.
WORKERS' COMPENSATION
Premiums earned in the Workers' Compensation operation increased in the six
months ended June 30, 1999 compared to the corresponding period in 1998,
principally as a result of the RISCORP Acquisition, which contributed
$48,172,000 of workers' compensation premiums earned in the six months ended
June 30, 1999 as compared to $24,770,000 in the six months ended June 30,
1998.
Excluding the effect of the additional premiums from the RISCORP Acquisition,
premiums earned in the Workers' Compensation operation, both inside and
outside of California, decreased in the three and six months ended June 30,
1999 compared to the corresponding periods in 1998, principally as a result
of Zenith's endeavoring to maintain rate adequacy in the face of intense
competition in the national workers' compensation insurance industry.
21
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Underwriting losses in the Workers' Compensation operation increased in the
three and six months ended June 30, 1999 compared to the corresponding
periods in 1998. The increase in such underwriting losses was attributable,
principally, to the following reasons: First, the three and six months ended
June 30, 1999 include the results of the former RISCORP business, which was
acquired effective April 1, 1998. Loss ratios in the former RISCORP
operations, except in Florida, are considerably higher than those experienced
elsewhere in Zenith's Workers' Compensation operations. Excess costs
associated with operating and integrating the former RISCORP business also
adversely impacted underwriting results in the periods that include the
former RISCORP operations. Second, Zenith's estimate of the incurred loss
ratio for its workers' compensation business, excluding the former RISCORP
operations and other Florida business, in the three and six months ended June
30, 1999 was higher than such estimate for both the three and six months
ended June 30, 1998. Third, Zenith has reduced expenses during 1999 and 1998,
principally through reductions in the number of employees, throughout its
Workers' Compensation operations. However, such reductions have been offset
by a reduction of premium income for the three and six months ended June 30,
1999 compared to the three and six months ended June 30, 1998. Zenith is
unable to predict when its Workers' Compensation operation will return to
underwriting profitability that is consistent with Zenith's historical
experience.
OTHER PROPERTY-CASUALTY
Zenith's Other Property-Casualty business was operated primarily by CalFarm,
which was sold effective March 31, 1999. In the first quarter of 1999, the
Other Property-Casualty underwriting results were adversely impacted by
continuing losses in the Health line of business, increased severity and
frequency of weather related property losses and increased expenses
attributable to improvements in information systems. The first six months of
1998 were adversely impacted by approximately $5,000,000 before taxes
attributable to California wind and storm damage.
REINSURANCE
Reinsurance premiums earned increased in the six months ended June 30, 1999,
compared to the corresponding period in 1998, due principally to additional
premiums in the first quarter of 1999 for reinstatement of treaties impacted
by catastrophes. The underwriting results for the three and six months ended
June 30, 1999 were adversely impacted by catastrophe losses of approximately
$4,200,000 and $6,100,000, before taxes, respectively, of additional losses
from Hurricane Georges, and other catastrophe losses that occurred in 1998 as
compared to no such catastrophe losses, in the corresponding periods in 1998.
22
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
REAL ESTATE OPERATIONS
Zenith recognized total revenues from its Real Estate Operations of
$14,438,000 and $25,206,000 for the three and six months ended June 30, 1999,
respectively, and $8,684,000 and $20,432,000 for the three and six months
ended June 30, 1998, respectively. The results of operations for the three
and six months ended June 30, 1999 benefited from a higher number of home
sales as compared to the corresponding periods in 1998 in addition to a gain
from a land sale of $472,000 in the first six months of 1999. Construction in
progress, including undeveloped land, was $73,119,000 and $69,387,000 at June
30, 1999 and December 31, 1998, respectively. In addition to continuing home
construction, Zenith may use some land presently owned for commercial and
multi-family dwelling construction. Increased interest rates or other factors
could affect the rate of home sales.
INVESTMENTS
The yields on invested assets, which vary with the general level of interest
rates, the average life of invested assets and the amount of funds available
for investment, were as follows:
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------------------------------------------
1999 1998 1999 1998
- ----------------------------------------------------------------------------------------------------------------
(Restated) (Restated)
<S> <C> <C> <C> <C>
Investment yield, before taxes 5.4% 5.8% 5.4% 5.8%
Investment yield, after taxes 3.6% 4.0% 3.6% 3.9%
- ----------------------------------------------------------------------------------------------------------------
</TABLE>
Bonds with an investment grade rating represented 93% and 96% of the
consolidated carrying values of fixed maturities at June 30, 1999 and
December 31, 1998, respectively. The average maturity of the investment
portfolio was 5.5 years at June 30, 1999 and 5.2 years at December 31, 1998.
The total fair value of fixed maturity investments and the unrealized gain
(loss) on held-to-maturity and available-for-sale fixed maturity investments,
were as follows:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------
Unrealized Gain (Loss) 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 June 30, 1999 $855,512 $ 298 $(12,599) $(8,189)
At December 31, 1998 959,119 1,569 9,864 6,412
- ------------------------------------------------------------------------------------------------------------------
* Includes short-term investments
</TABLE>
23
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
INVESTMENTS (CONTINUED)
At June 30, 1999 and December 31, 1998, 96% of Zenith's consolidated
portfolio of fixed maturity investments were classified as available-for sale
with the unrealized appreciation or depreciation recorded as a separate
component of stockholders' equity. The change in fair value of fixed maturity
investments available-for-sale resulted in a decrease in stockholders' equity
of $14,601,000 after deferred taxes from December 31, 1998 to June 30, 1999.
Stockholders' equity will continue to be affected by volatility in the fixed
maturity securities market and fluctuations in interest rates through changes
in the values of fixed maturity securities, which are classified as
available-for-sale.
The change in the carrying value of Zenith's consolidated investment
portfolio during the six months ended June 30, 1999 was as follows:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Carrying value at the beginning of the year $1,048,681
Purchases at cost 198,868
Investments of CalFarm at date of sale (170,050)
Maturities and redemptions (73,565)
Proceeds from sales of investments:
Investments available-for-sale (47,152)
Other investments (5,515)
Total proceeds from sales of investments --------- (52,667)
Net realized gains:
Investments available-for-sale 1,801
Other investments 2,264
Total net realized gains --------- 4,065
Change in unrealized gains (22,026)
Increase in short-term investments 21,658
Net accretion of bonds and preferred stocks and other changes 501
- --------------------------------------------------------------------------------- -------------- --------------------
Carrying value at June 30, 1999 $ 955,465
- --------------------------------------------------------------------------------- -------------- --------------------
</TABLE>
LIQUIDITY AND CAPITAL RESOURCES
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 outstanding debt, pay any cash
dividends which may be declared to its stockholders and fund the land
acquisitions by the Real Estate Operations.
On March 26, 1999, Zenith Insurance paid the remaining balance of
approximately $53,700,000, including interest, due to RISCORP pursuant to the
RISCORP Acquisition. On April 1, 1999, Zenith Insurance received
approximately $273,000,000 from Nationwide Mutual Insurance Company in
connection with the sale of the capital stock of CalFarm and paid
approximately $59,000,000 to CalFarm in connection with the de-pooling
transaction.
24
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Net cash used in operations in the six months ended June 30, 1999 was
$39,657,000 as compared to net cash used in operations of $16,723,000 for the
six months ended June 30, 1998. During the three and six months ended June
30, 1999, cash was used principally to pay loss and loss adjustment expense
reserves in the former RISCORP operation. Net cash flows from operations will
continue to be adversely affected by the payment of reserves in the former
RISCORP operations.
Zenith has three revolving, unsecured lines of credit amounting to
$100,000,000, all of which was available at June 30, 1999.
At June 30, 1999, Zenith was authorized to repurchase up to 1,036,000 shares
of Zenith common stock pursuant to a share purchase program authorized by its
Board of Directors. These purchases are discretionary and can be adequately
funded from Zenith's existing sources of liquidity.
Zenith's Real Estate Operations maintain certain bank credit facilities to
provide financing for development and construction of private residences for
sale. At June 30, 1999, the maximum permitted under facilities was
$34,613,000, although in practice, such amount will not be outstanding. The
agreements provide that funding and repayment of development and construction
loans are made in tandem for each project. A development loan will always
precede a construction loan for a project and the proceeds of the
construction loan are required to first be used to pay off the respective
development loan. The balance outstanding under the borrowing is $15,374,000.
Zenith's Real Estate Operations are obligated under various notes arising
from its purchase of several parcels of land. The amount outstanding for such
notes at June 30, 1999 was $1,367,000.
In June of 1999, Zenith Insurance declared a dividend of $100,000,000 payable
to Zenith National. The dividend was approved by the California Department of
Insurance on June 24, 1999. The dividend was paid on July 6, 1999. Subject to
working capital needs, Zenith National currently intends to add such funds
to, and invest them as part of, its investment portfolio. Zenith has been
informed by A.M. Best Company ("Best") that the payment of the dividend will
result in a downgrade of Best's rating of Zenith`s insurance company
affiliates from A+ to A.
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.
25
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
In early 1996, Zenith formed a Year 2000 team consisting of staff familiar with
Zenith'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).
26
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
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 Completed Completed
Core Operational IT Systems:
- ---------------------------------------------
Workers' Compensation Completed Completed Completed Completed Completed
Reinsurance Completed Completed Completed Completed Completed
Real Estate Operations Completed Completed Completed Completed Completed
IT Infrastructure:
- ---------------------------------------------
Workers' Compensation Completed Completed Completed 8/31/99 8/31/99
Reinsurance Completed Completed Completed 8/31/99 8/31/99
Real Estate Operations Completed Completed Completed Completed Completed
Other IT Equipment:
- ---------------------------------------------
Workers' Compensation Completed Completed Completed Completed Completed
Reinsurance Completed Completed Completed Completed Completed
Real Estate Operations Completed Completed Completed Completed Completed
Facilities and Other Non-IT Systems:
- ---------------------------------------------
Woodland Hills, CA Completed Completed Completed Completed Completed
Sarasota, FL Completed Completed Completed Completed Completed
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
The above table excludes the scheduled completion dates for the Other Property &
Casualty Operations which were disposed of through the sale of the capital stock
of CalFarm on March 31, 1999.
Zenith plans to further test and refine the Internal Systems during the second
half of 1999, to assure that they function in Zenith's operating environment on
an interconnected basis. Also during this period, Zenith will limit software
changes into its production operating environment to minimize risk of
invalidating remediation efforts.
Zenith's Year 2000 efforts also include a systematic assessment of the Year 2000
Compliant status of third parties upon which Zenith 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
Compliant status. 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.
27
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
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 Zenith. 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. 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. Contingency plan testing
commenced in the quarter ended June 30, 1999. Additional testing is scheduled
through September 30, 1999.
Zenith has been planning to upgrade its IT Infrastructure and its other IT
equipment for some time; however, because of the Year 2000 problem, certain
components of those plans were accelerated and completed by mid-1999. The
table below 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) 6/30/99 6/30/99 Complete Expenditure
- ----------------------------------------- ------------------ ------------------- ------------------ ------------------
<S> <C> <C> <C> <C>
IT Repair Costs $ 6,363 91% $ 600 $ 6,963
IT Replacement Costs:
Software 881 100% 881
Hardware 2,234 100% 2,234
Related Expenditures 417 63% 246 663
- --------------------------------------------------------------------------------------------------------------------
Total $ 9,895 92% $ 846 $10,741
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
The above table includes amounts incurred for the Other Property & Casualty
Operations through March 31, 1999 and does not include any estimates to complete
for the Other Property & Casualty Operations since they were disposed of through
the sale of the capital stock of CalFarm on March 31, 1999.
IT Repair Costs and IT Replacement 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 Statement
of Position 98-1. 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.
28
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
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 to 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 1998, the National Association of Insurance Commissioners ("NAIC") adopted
the Codification of Statutory Accounting Principles guidance (the
"Codification"), which will replace the current Accounting Practices and
Procedures manual as the NAIC's primary guidance on statutory accounting
(statutory accounting is a comprehensive basis of accounting based on prescribed
accounting practices, which include state laws, regulations and general
administrative rules, as well as a variety of publications of the NAIC). The
NAIC is now considering amendments to the Codification that would also be
effective upon implementation. The NAIC has recommended an effective date of
January 1, 2001. The Codification provides guidance for the areas where
statutory accounting has been silent and changes current statutory accounting in
some areas.
It is not known whether the state of California Department of Insurance will
adopt the Codification, and whether the Department of Insurance will make any
changes to that guidance. Implementation of the Codification 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 the
Codification.
29
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
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; (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, and (c) the resolution of
RISCORP's claim that the Neutral Auditor and Neutral Actuary allegedly made an
error in its determinations with respect to the purchase price for the RISCORP
Acquisition; (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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As of June 30, 1999, approximately 96% of the carrying value of fixed maturity
investments are categorized as available-for-sale, for which category changes in
fair value are reflected in stockholders' equity. The fair value of the fixed
income investment portfolio is exposed to interest rate risk - the risk of loss
in fair value resulting from adverse changes in prevailing market rates of
interest for similar financial instruments. In addition, certain mortgage-backed
securities are exposed to accelerated prepayment risk in that a decline in
interest rates could prompt mortgage holders to refinance existing mortgages at
lower rates. However, Zenith has the ability to hold fixed income investments to
maturity.
Zenith relies on the experience and judgment of senior management to monitor
and control market risk. Zenith does not utilize financial instrument hedges
or derivative financial instruments to manage risks, nor does it enter into
any swap, forward or options contracts, but will attempt to mitigate its
exposure through active portfolio management. The allocation among various
types of securities is adjusted from time to time based on market conditions,
credit conditions, tax policy, fluctuations in interest rates and other
factors. In addition, Zenith places the majority of its investments in high
quality, marketable securities and limits the amount of credit exposure with
respect to any single issuer.
30
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (CONTINUED)
The table below provides information about Zenith's financial instruments as
of June 30, 1999 for which fair values are subject to changes in interest
rates. For fixed maturity investments, the table presents fair value and
weighted average interest rates by expected maturity dates. Such investments
include preferred stocks that are redeemable or have sinking fund provisions,
corporate bonds, municipal bonds, government bonds and mortgage backed
securities. For debt obligations, the table presents principal cash flows by
expected maturity dates.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------------------
Expected Maturity Date
-----------------------------------------------------------------------------------------
(Dollars in thousands) 1999 2000 2001 2002 2003 Thereafter Total
- ------------------------------------- ------------ ------------ ------------ ------------ ------------ ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Fixed maturities:
Held-to-maturity and
available-for-sale securities:
Fixed rate $26,801 $113,828 $60,696 $67,585 $57,774 $367,634 $694,318
Weighted average interest
rate 5.2% 5.5% 5.8% 6.4% 7.1% 7.8%
Trading Securities:
Fixed rate $2,946 2,946
Weighted average interest
rate 6.5%
Short-term investments $158,248 158,248
Debt obligations:
9% senior notes payable 3,375 $6,750 $6,750 $78,375 95,250
8.55% redeemable securities 3,207 6,413 6,413 6,413 $6,413 $235,325 264,184
Payable to banks and other
notes payable 4,646 13,033 130 81 34 406 18,330
- ------------------------------------- ------------ ------------ ------------ ------------ ------------ ----------- ------------
</TABLE>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Stockholders' Meeting of Zenith was held on May 20, 1999. Two
matters were presented to a vote of the Stockholders.
One matter was the election of Directors. The tabulation of votes for the
nominees, all of whom were elected, follows:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------
Director Votes For Votes Withheld
- ----------------------------------------- ----------------------------------- -----------------------------------
<S> <C> <C>
George E. Bello 14,207,988 73,602
Max M. Kampelman 13,531,243 750,347
Robert J. Miller 14,208,120 73,470
William Steele Sessions 14,189,397 92,193
Harvey J. Silbert 14,107,711 173,879
Robert M. Steinberg 14,023,487 258,103
Saul P. Steinberg 13,632,146 649,444
Gerald Tsai, Jr. 14,190,653 90,937
Michael Wm. Zavis 14,208,232 73,358
Stanley R. Zax 14,205,232 76,358
- ----------------------------------------- ----------------------------------- -----------------------------------
</TABLE>
With respect to the election of Directors, there were no votes cast against
any Directors, no abstentions and no broker non-votes.
31
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS (CONTINUED)
The second matter was a vote to approve Amendment No. 1 to the 1996 Employee
Stock Option Plan, a non-qualified stock option plan for officers and
employees of Zenith and its subsidiaries. Amendment No. 1 increases by
250,000 the number of shares available for issuance pursuant to new awards.
The matter was approved by the Stockholders. A tabulation of votes follows:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------
For Against Abstain Brokers' Non-Votes
- ------------------------------ --------------------------- --------------------------- ---------------------------
<S> <C> <C> <C>
12,194,147 682,353 1,405,089 1
- ------------------------------ --------------------------- --------------------------- ---------------------------
</TABLE>
PART II, OTHER INFORMATION
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 Amendment No. 1, dated December 8, 1998, to Zenith National Insurance
Corp. 1996 Employee Stock Option Plan.
10.2 Loan Revision Agreement, dated June 30, 1999, to the promissory note,
dated July 1, 1997, between Zenith National Insurance Corp. and City
National Bank.
10.3 Standstill Agreement, dated June 30, 1999, between Zenith National
Insurance Corp. and Fairfax Financial Holdings Limited.
10.4 Settlement Agreement, dated July 7, 1999, between Zenith Insurance
Company, RISCORP, Inc., RISCORP Management Services, Inc., 1390 Main
Street Services, Inc., RISCORP of Illinois, Inc., Independent
Association Administrators Incorporated, RISCORP Insurance Services,
Inc., RISCORP Managed Care Services, Inc., CompSource, Inc., RISCORP
Real Estate Holdings, Inc., RISCORP Acquisition, Inc., RISCORP West,
Inc., RISCORP of Florida, Inc., RISCORP Insurance Company, RISCORP
Property & Casualty Insurance Company, RISCORP National Insurance
Company, RISCORP Services, Inc., RISCORP Staffing Solutions Holding
Company, RISCORP Staffing Solutions, Inc. I and RISCORP Staffing
Solutions, Inc., II.
32
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (CONTINUED)
(a) Exhibits (continued)
11 Statement re computation of per share earnings. (Note 2 of the
Consolidated Financial Statements (unaudited) included in Item 1 of
Part I of this Quarterly Report on Form 10-Q is incorporated herein by
reference.)
27 Financial data schedule
(b) Reports on Form 8-K
Zenith filed a Current Report on Form 8-K, dated July 6, 1999, on
July 12, 1999 in connection with (1) the acquisition of Zenith common
stock by Fairfax Financial Holdings Limited, (2) the settlement
agreement between Zenith Insurance Company and RISCORP, Inc. and (3)
the dividend from Zenith Insurance to Zenith.
33
<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: August 13, 1999 /s/ Stanley R. Zax
--------------------------------------
Stanley R. Zax
Chairman of the Board and President
(Principal Executive Officer)
Date: August 13, 1999 /s/ Fredricka Taubitz
---------------------------------------
Fredricka Taubitz
Executive Vice President
& Chief Financial Officer
(Principal Accounting Officer)
34
<PAGE>
EXHIBIT 10.1
AMENDMENT NO. 1
TO
ZENITH NATIONAL INSURANCE CORP.
1996 EMPLOYEE STOCK OPTION PLAN
-------------------------------
Subject to and effective upon approval of this Amendment No. 1 by the
Company's stockholders, Section 3 of the Zenith National Insurance Corp. 1996
Employee Stock Option Plan (the "Plan") is hereby amended by increasing the
total number of shares of Stock reserved and available for grant pursuant to
new awards under the Plan by 250,000 shares.
Date: December 8, 1998 ZENITH NATIONAL INSURANCE CORP.
By: /s/ STANLEY R. ZAX
----------------------------------
Stanley R. Zax
Its Chairman and President
<PAGE>
EXHIBIT 10.2
[LETTERHEAD OF CITY NATIONAL BANK] LOAN REVISION AGREEMENT
(Unsecured or Secured by Personal Property Only)
Note No. 209600/11552
This LOAN REVISION AGREEMENT ("Agreement") refers to the loan evidenced by a
promissory note ("Note") dated July 1, 1997, in favor of CITY NATIONAL BANK,
a national banking association ("CNB") executed by ZENITH NATIONAL INSURANCE
CORP., A DELAWARE CORPORATION ("Borrower") in the original principal amount
of $20,000,000.00, payable in full on July 1, 1999, subject to any
installment maturities in the Note.
The principal balance of the Note as of June 30, 1999, is $0.00.
Each Borrower hereby requests that CNB revise the terms of the Note and that
CNB accept payment of the Note at the time, or times, and in the manner
following:
MATURITY DATE OF THE NOTE IS HEREBY EXTENDED TO JULY 1, 2000.
In consideration of CNB's acceptance of the revision of the Note, including
the time for payment thereof, all as set forth above, each Borrower does
hereby acknowledge and admit to such indebtedness, and further does
unconditionally agree to pay such indebtedness together with interest thereon
within the time and in the manner as revised in accordance with this
Agreement.
This Agreement is a revision of the terms of repayment only, and not a
novation; and except as herein provided, all of the terms and conditions of
the Note shall remain unchanged and in full force and effect.
When more than one Borrower signs this Agreement, all agree:
a. That breach of any covenant by any Borrower may, at CNB's option, be
treated as a breach by all Borrowers; and
b. That the liability and obligations of each Borrower are joint and
several.
Dated at Beverly Hills, California, this 30th day of June, 1999.
ZENITH NATIONAL INSURANCE CORP., a
Delaware corporation
By: /s/ STANLEY R. ZAX
-----------------------------------------------
Stanley R. Zax, Chairman of the Board/President
<PAGE>
GUARANTORS
I hereby join in the foregoing request and agree that any and all of my
obligations relating to the above described Note shall remain in effect and
shall relate fully to such Note as it is hereby modified, extended and/or
revised.
- ------------------------------------------------------------------------------
- ------------------------------------------------------------------------------
Accepted and revision and/or extension granted in reliance upon each of the
representations and agreements hereinabove contained.
Dated: June 30, 1999. CITY NATIONAL BANK
By: /s/ FERNANDO BUESA
------------------------------------
Fernando Buesa, Vice President
2
<PAGE>
STANDSTILL AGREEMENT
THIS STANDSTILL AGREEMENT ("Standstill Agreement") is made as of this
30th day of June, 1999, by and between Zenith National Insurance Corp., a
Delaware corporation (the "Company") and Fairfax Financial Holdings Limited,
a Canada corporation (the "Purchaser").
RECITALS
WHEREAS, Reliance Group Holdings, Inc. (the "Seller") beneficially owns
as of the date of this agreement an aggregate of 6,574,445 shares (the
"Shares") of the common stock of the Company ("Zenith Common Stock");
WHEREAS, the Seller and the Purchaser, have entered into a Stock
Purchase Agreement, dated June 25, 1999 (the "Stock Purchase Agreement"),
which provides, among other things, that the Purchaser shall purchase the
Shares from the Seller (the "Transaction");
WHEREAS, in order to induce the Purchaser to enter into this Standstill
Agreement, the Company is willing to facilitate the Transaction on the terms
described herein by cooperating in seeking all necessary approval of the
Transaction as shall be required (i) under applicable insurance laws and with
the appropriate insurance commission(s), and (ii) under the Hart-Scott-Rodino
Antitrust Improvements Act of 1976 (the "H-S-R Act");
NOW THEREFORE, in consideration of the aforesaid and mutual promises
hereinafter made, the parties hereto agree as follows:
1. STANDSTILL
1.1 Subject to the provisions of Section 1.2 below, and except in
connection with the consummation of the Transaction, the Purchaser and any
corporation or other entity controlled by or affiliated with the Purchaser
(collectively, the "Purchaser Group") hereby covenants and agrees that,
without the prior written consent of the Board of Directors of the Company
specifically expressed in a resolution adopted by a majority of the
directors of the Company who are not affiliates of, and are neither officers,
directors nor employees of, any member of the Purchaser Group, the Purchaser
Group will not in any manner, directly or indirectly, or in connection with
any other person or entity, (a) effect or seek, offer, encourage or
<PAGE>
propose (whether publicly or otherwise) to effect or participate in, (i) any
acquisition of any securities (or beneficial ownership thereof) or assets of
the Company, except by way of stock dividends or other distributions or
offerings made available to holders of Company securities generally, (ii) any
tender or exchange offer, merger or other business combination involving the
Company, except to the extent that the Purchaser is selling Zenith Common
Stock owned on the date hereof or acquired pursuant to the Transaction or by
way of stock dividends or other distributions or offerings made available to
holders of Company securities generally, (iii) any recapitalization,
restructuring, liquidation, dissolution or other extraordinary transaction
with respect to the Company, or (iv) any "solicitation" of "proxies" (as such
terms are defined in Rule 14a-1 under the Exchange Act) or consents to vote
any securities of the Company, (b) form, join or in any way participate in a
"group" (as such term is used in Section 13(d)(3) of the Exchange Act)
(except insofar as the Purchaser Group acts to consummate the Transaction),
or otherwise act, alone or with others, to seek to acquire or affect control
or influence the management, Board of Directors or policies of the Company,
(c) enter into any arrangements with any third party regarding any of the
foregoing, or (d) take any action which would force the Company to make a
public announcement regarding the types of matters set forth in (a) of this
Section 1.1. The Purchaser Group also agrees not to ask, subject to the
provisions of Section 1.2 hereof, the Company (or its directors, officers,
employees, or agents) directly or indirectly, to amend, waive or terminate
any of the provisions of this Section 1.1, including this sentence. The
covenants and agreements contained in this Section 1.1 shall survive until
the earlier of (i) the fifth anniversary of the consummation of the
Transaction and (ii) the date on which Stanley R. Zax is no longer the
full-time Chairman of the Board and President of the Company. Nothing herein
shall affect the Purchaser Group's ability to dispose of its Zenith Common
Stock and, except as set forth above, nothing herein shall limit the
Purchaser Group's ability to exercise the rights attaching to the Shares.
1.2 Notwithstanding Section 1.1 above, the Purchaser Group shall
not be prohibited from proposing a transaction to the Company or its Board of
Directors or from having discussions with officers, directors, employees or
agents of the Company in the ordinary course with respect to the Company or
the conduct of the Company's business
2. COMPANY COVENANTS.
2.1 The Company covenants that it will use its commercially
reasonable efforts to cooperate in seeking all necessary approvals of the
Transaction
2
<PAGE>
as shall be required (i) under applicable insurance law and with the
appropriate insurance commission(s) and (ii) under the H-S-R Act.
2.2 The Company hereby consents to the assignment by the Seller to
the Purchaser of the registration rights embodied in Article IX of the
Purchase Agreement, made as of February 4, 1981 among Reliance Insurance
Company, the Company, and certain other parties.
3. CONDITIONS TO PURCHASER'S OBLIGATIONS. The Purchaser's covenants and
agreements set forth herein are subject to the receipt by the Purchaser of
waivers, with respect to the Transaction, from Stanley R. Zax, Fredricka
Taubitz, John J. Tickner, Jack D. Miller, Robert E. Meyer, Kenneth I.
Wuelfing and Corey A. Ingber substantially in the form of Exhibit A hereto.
4. MISCELLANEOUS
4.1 MERGER CLAUSE. This Agreement constitutes the complete
agreement between the parties hereto with respect to the subject matter
hereof and shall continue in full force and effect until terminated by mutual
agreement of the parties hereto or pursuant to the terms hereof. The section
headings used herein are for reference purposes only and shall not in any way
affect the meaning or interpretation of this Agreement.
4.2 CHOICE OF LAW. This Agreement shall be construed, performed
and enforced in accordance with, and governed by the internal laws of the
State of Delaware, without giving effect to the principles of conflicts of
law thereof, and each party consents to personal jurisdiction in such state
and voluntarily submits to the jurisdiction of the courts of such state in
any action or proceeding relating to this Agreement. Whenever possible, each
provision of this Agreement shall be interpreted in such a manner as to be
effective and valid under applicable law, but if any provision hereof is held
to be invalid, illegal or unenforceable under any applicable law or rule in
any jurisdiction, such provision will be ineffective only to the extent of
such invalidity, illegality, or unenforceability, without invalidating the
remainder of this Agreement. This Agreement may not be modified or amended
and no provision hereof may be waived, in whole or in part, except by a
written agreement signed by the parties hereto. No waiver of any breach or
default hereunder shall be considered valid unless in writing, and no such
waiver shall be deemed a waiver of any subsequent breach or default.
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<PAGE>
4.3 REMEDY. The Purchaser acknowledges that the Company would
not have an adequate remedy at law for money damages in the event that this
agreement is not performed in accordance with its terms and therefore the
Purchaser agrees that the Company shall be entitled to specific enforcement
of the terms hereof in addition to any other remedy to which it may be
entitled, at law or in equity.
4.4 NOTICES. Every notice or other communication required or
contemplated by this Agreement by either party shall be delivered by (i)
personal delivery, (ii) postage prepaid, return receipt requested, registered
or certified mail (airmail if available), or the equivalent of registered or
certified mail under the laws of the country where mailed, (iii)
internationally recognized express courier, such as Federal Express, UPS or
DHL, or (iv) facsimile with a confirmation copy sent simultaneously in the
manner contemplated by clauses (i), (ii) or (iii) of this Section 4.4, in
each case addressed to the party for whom intended at the following address
or at such other address of which notice has been given in accordance with
this Section 4.4:
(1) If to the Company:
Zenith National Insurance Corp.
21255 Califa Street
Woodland Hills, CA 91367
Facsimile No.: 818-713-0177
Attn: Stanley R. Zax, Chairman of the Board and President
With a copy to:
Skadden, Arps, Slate, Meagher & Flom LLP
300 South Grand Avenue, Ste. 3400
Los Angeles, CA 90071
Facsimile No.: 213-687-5600
Attn: Jerome L. Coben
(2) If to the Purchaser:
Fairfax Financial Holdings Limited
95 Wellington Street West, Ste. 800
Toronto, Canada M5J 2N7
Facsimile No.: 416-367-2201
Attn: Eric Salsberg, Vice President, Corporate Affairs
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<PAGE>
4.5 COUNTERPARTS. This Agreement may be executed in counterparts,
all of which shall be taken together as one and the same instrument.
Please acknowledge your agreement with the terms of this Agreement where
indicated below and return an executed copy of this Agreement to the
undersigned, whereupon this will be a binding agreement between us.
Zenith National Insurance Corp.
By: /s/ Stanley R. Zax
--------------------------------
Name: Stanley R. Zax
Title: Chairman of the Board and
President
ACCEPTED AND AGREED to by:
Fairfax Financial Holdings Limited
By: /s/ Eric Salsberg
-----------------------------
Name: Eric Salsberg
Title: Vice President, Corporate Affairs
5
<PAGE>
EXHIBIT A
, 1999
Zenith Insurance Company
21255 Califa Street
Woodland Hills, CA 91367
Fairfax Financial Holdings Limited
95 Wellington Street West, Ste. 800
Toronto, Canada M5J 2N7
Dear Sirs:
Reference is made to the Employment Agreement, effective as of June 8,
1998, between Zenith Insurance Company, a California corporation and wholly
owned subsidiary of Zenith National Insurance Corp., a Delaware corporation
("Zenith") and the undersigned.
Pursuant to Section 9(c)(iii) of the Employment Agreement, the
undersigned was granted certain rights in the event of a Change in Control
(as defined in the Employment Agreement).
The undersigned has been informed that Fairfax Financial Holdings
Limited has entered into a Stock Purchase Agreement, dated as of June 25,
1999, with Reliance Insurance Company ("Reliance"), pursuant to which Fairfax
will purchase all of the shares of the common stock of Zenith held by
Reliance and its affiliates (the "Transaction"). In connection with the
Transaction, Fairfax has entered into a Standstill Agreement, dated June 30,
1999 (the "Standstill Agreement"), with Zenith. Under the terms of the
Employment Agreement, as a result of the Transaction, a Change in Control
will have occurred and, accordingly, the undersigned would be entitled to
exercise the rights specified in Section 9(c)(iii) of the Employment
Agreement. Section 3 of the Standstill Agreement provides that the covenants
and agreements of Fairfax thereunder are conditioned on the waiver of such
rights by the undersigned.
<PAGE>
The undersigned hereby waives his rights to terminate under Section
9(c)(iii) of the Employment Agreement with respect to the Transaction. In so
doing, however, the undersigned is not waiving any other rights under the
Employment Agreement, including any rights that may arise in the event of any
future or different transaction that would constitute a Change in Control.
Very truly yours,
Witness,
___________________________
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<PAGE>
SETTLEMENT AGREEMENT
This SETTLEMENT AGREEMENT, dated as of July 7, 1999, is entered into by
and among Zenith Insurance Company, a California Corporation ("Zenith"),
RISCORP, Inc., a Florida corporation ("RISCORP, Inc."), RISCORP Management
Services, Inc., a Florida corporation ("RMS"), 1390 Main Street Services,
Inc., a Florida corporation ("1390 Main Street"), RISCORP of Illinois, Inc.,
an Illinois corporation ("RI"), Independent Association Administrators
Incorporated, an Alabama corporation ("IAA"), RISCORP Insurance Services,
Inc., a Florida corporation ("RIS"), RISCORP Managed Care Services, Inc.
("RMCS"), a Florida corporation, CompSource, Inc., a North Carolina
corporation ("CompSource"), RISCORP Real Estate Holdings, Inc., a Florida
corporation ("RRE"), RISCORP Acquisition, Inc., a Florida corporation ("RA"),
RISCORP West, Inc., an Oklahoma corporation ("RW"), RISCORP of Florida, Inc.,
a Florida corporation ("RF"), RISCORP Insurance Company, a Florida
corporation ("RIC"), RISCORP Property & Casualty Insurance Company, a Florida
corporation ("RP&C"), RISCORP National Insurance Company, a Missouri
corporation ("RNIC"), RISCORP Services, Inc., a Florida corporation ("RS"),
RISCORP Staffing Solutions Holding Company, a Florida corporation ("RSS
Holding"), RISCORP Staffing Solutions, Inc. I, a Florida corporation ("RSSI")
and RISCORP Staffing Solutions, Inc. II, a Florida corporation ("RSSII").
RISCORP, Inc., RMS, 1390 Main Street, RI, IAA, RIS, RMCS, CompSource, RRE,
RA, RW, RF, RIC, RP&C, RNIC, RS, RSS Holding, RSSI and RSSII are from time to
time hereinafter referred to collectively as "RISCORP" or the "RISCORP
Companies."
<PAGE>
WITNESSETH:
WHEREAS:
A. Zenith and RISCORP are parties to (a) an Asset Purchase Agreement,
dated as of June 17, 1997, as subsequently amended on June 26, 1997, July 11,
1997, and March 30, 1998 (the "Asset Purchase Agreement"); (b) an Escrow
Agreement with First Union National Bank as Escrow Agent dated April 1, 1998
(the "Escrow Agreement"); (c) a letter agreement dated April 1, 1998 (the
"Letter Agreement"); and (d) those documents and instruments listed on
Exhibit A hereto (together with the Escrow Agreement and the Letter
Agreement, the "Transaction Documents"). Capitalized terms used herein and
not otherwise defined shall have the meanings ascribed to them in the Asset
Purchase Agreement;
B. Pursuant to the Asset Purchase Agreement, on April 1, 1998, Zenith
acquired substantially all of RISCORP's assets and assumed certain of
RISCORP's liabilities (the "Asset Sale") for a purchase price equal to the
amount by which the book value of the Transferred Assets exceeded the book
value of the Transferred Liabilities as set forth on a Final Business Balance
Sheet to be determined in accordance with the procedures set forth in the
Asset Purchase Agreement;
C. On April 1, 1998, in connection with the closing of the Asset Sale,
Zenith paid RISCORP $35 million to be applied toward the final Purchase Price
payable pursuant to the Asset Purchase Agreement, $10 million of which was
deposited with the Escrow Agent to be distributed pursuant to the terms of
the Asset Purchase Agreement and the Escrow Agreement;
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<PAGE>
D. The Letter Agreement contained certain provisions pursuant to which
certain of RISCORP's Assets would be deemed not to be Transferred Assets for
purposes of determining the Final Business Balance Sheet and the Purchase
Price payable pursuant to the Asset Purchase Agreement.
E. On October 16, 1998, RISCORP commenced an action against Zenith in
the United States District Court for the Middle District of Florida, Tampa
Division, captioned RISCORP, INC., ET AL. V. ZENITH INSURANCE CO., Case No.
98-2122-CIV-T-25E (the "Florida Action"), in which RISCORP alleged various
claims against Zenith, including claims relating to Zenith's alleged breaches
of the Asset Purchase Agreement and the Letter Agreement;
F. On January 8, 1999, Zenith commenced an action in the United States
District Court for the Southern District of New York, captioned ZENITH
INSURANCE CO. V. RISCORP, INC., ET AL., Case No. 99 Civ. 0171 (WHP) (the "New
York Action"), in which Zenith asserted various claims against RISCORP,
including claims relating to RISCORP's alleged breaches of the Asset Purchase
Agreement;
G. On March 19, 1999, Arthur Andersen LLP ("Arthur Andersen"), acting as
Neutral Auditor and Neutral Actuary pursuant to the Asset Purchase Agreement,
issued (i) a report containing its determinations of certain issues that
Arthur Andersen found to be in dispute between the parties regarding the
manner in which certain items should be treated in the preparation of the
Final Business Balance Sheet; and (ii) its determination of the Final
Business Balance Sheet;
H. As a result of the issuance of the Final Business Balance Sheet, (i)
on or about March 26, 1999, Zenith wire transferred to RISCORP, Inc. the sum
of $50,853,182, and wire
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<PAGE>
transferred to the Escrow Agent the sum of $2,835,723; and (ii) on April 14,
1999, Zenith wire transferred to RISCORP, Inc. the sum of $619,173.32;
I. The parties agree that in determining the final Purchase Price to be
paid by Zenith in connection with the Asset Sale certain adjustments to the
Final Business Balance Sheet are required based on (i) certain provisions of
the Letter Agreement; (ii) the value of certain assets identified on Exhibit
F-1 included among the Transferred Assets on the Final Business Balance Sheet
that in fact were not transferred to Zenith, and (iii) the value of a
treasury note acquired by Zenith that was not included among the Transferred
Assets on the Final Business Balance Sheet. In addition, certain adjustments
to the Final Balance Sheet may be required based on certain errors that were
allegedly made by Arthur Anderson in determining the Final Business Balance
Sheet; and
J. Zenith and RISCORP desire to compromise and settle the claims and all
pending and potential litigation between them (except as otherwise expressly
provided herein), and they have therefore agreed to enter into this
Settlement Agreement to settle and resolve, on the terms specified herein,
all such claims and disputes.
NOW, THEREFORE, in consideration of the premises and mutual covenants
hereinafter set forth, it is hereby agreed as follows:
1. THE FINAL BUSINESS BALANCE SHEET. Zenith and RISCORP agree not to
commence or prosecute any action or proceeding, or to take any other action,
that seeks to confirm, modify, vacate, challenge or otherwise review the
Final Business Balance Sheet or the Revised Final Business Balance Sheet (as
defined herein) except as provided below in this paragraph 1.
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<PAGE>
(a) The parties agree that RISCORP may request that Arthur Andersen
review and/or correct any alleged errors made in its determination of the
Final Business Balance Sheet with respect to its failure to make appropriate
adjustment for certain reinsurance treaties in effect during accident years
1991 through 1993, inclusive, including, without limitation, whether issues
relating to Arthur Andersen's adjustment to reinsurance recoverable were in
dispute between the parties (the "RISCORP Reinsurance Claims").
(b) Within five business days after the date of this Settlement
Agreement, Zenith may make a submission to Arthur Andersen regarding the
RISCORP Reinsurance Claims in respect of (i) correspondence from Buttner
Hammock & Company to Arthur Andersen dated May 17, 1999; (ii) correspondence
from Alston & Bird LLP to Arthur Andersen dated May 24, 1999; and (iii)
correspondence from Alston & Bird LLP to Arthur Andersen dated June 4, 1999.
Zenith's submission to Arthur Andersen shall be to the effect that the
RISCORP Reinsurance Claims were not "in dispute" under Section 2.02(b) of the
Asset Purchase Agreement and that Arthur Andersen did not make an error with
respect to this issue in the Final Business Balance Sheet. On or before July
27, 1999, RISCORP may make an additional submission to Arthur Andersen
addressing the RISCORP Reinsurance Claims or any issues raised in Zenith's
submission to Arthur Andersen pursuant to this paragraph 1(b).
(c) Zenith and RISCORP agree that, in reviewing the RISCORP
Reinsurance Claims, Arthur Andersen may: (i) determine whether such claims
were "in dispute" under Section 2.02(b) of the Asset Purchase Agreement; (ii)
resolve such claims on the merits by applying the standards for review by the
Neutral Auditors and Neutral Actuary under Section 2.02(b) of the Asset
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<PAGE>
Purchase Agreement; and (iii) if appropriate, issue a revised or corrected
Final Business Balance Sheet reflecting any resolution of such claims (the
"Revised Final Business Balance Sheet").
(d) If Arthur Andersen issues the Revised Final Business Balance
Sheet, then (i) RISCORP shall pay to Zenith the amount of the net reduction,
if any, in the Net Assets Transferred reflected on the Revised Final Business
Balance Sheet; or (ii) Zenith shall pay to RISCORP on behalf of the Sellers
the amount of the net increase, if any, in the Net Assets Transferred
reflected on the Revised Final Business Balance Sheet. RISCORP or Zenith, as
the case may be, shall pay interest on any amounts due under this paragraph 1
at the rate of 6.25% per annum from (and including) April 1, 1998 to (but
excluding) the date of payment. Any such payment shall be made within five
business days after receipt of the Revised Final Business Balance Sheet by
wire transfer of immediately available funds to an account designated by the
party entitled to receive such payment.
(e) Notwithstanding anything to the contrary in this Settlement
Agreement, including, without limitation, the foregoing provisions of this
paragraph 1, neither Zenith nor RISCORP has waived any right to commence
legal action in any court of competent jurisdiction: (i) to seek correction
of alleged errors with respect to the RISCORP Reinsurance Claims that were
not corrected by Arthur Andersen in a Revised Final Business Balance Sheet
pursuant to this paragraph 1; or (ii) to correct, modify, vacate or set aside
any revision of the Final Business Balance Sheet made in the Revised Final
Business Balance Sheet.
2. DISBURSEMENTS FROM ESCROW. (a) Zenith and RlSCORP agree to cause
all funds currently on deposit with the Escrow Agent to be distributed as
soon as reasonably practicable, but in no event later than 20 business days
after execution of this Settlement Agreement, as follows:
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<PAGE>
(i) Six million dollars ($6,000,000) to Zenith; and
(ii) the balance of all principal and interest to RISCORP, Inc.
(b) Following the foregoing disbursement of funds, the Escrow
Agreement shall be terminated and the parties shall execute such documents or
instruments as may be reasonably necessary to evidence such termination.
(c) RISCORP acknowledges that Zenith intends to treat the amounts
received under this paragraph 2 as reimbursement for unexpected expenses
incurred by Zenith in connection with carrying on the Business acquired from
RISCORP.
3. CLAIMS FOR REFUNDS. The parties agree that RISCORP's claims for
refunds made to the Florida Department of Labor and Employment Security,
Division of Workers' Compensation Administrative and Field Support Unit will
be divided between them as follows:
(a) RISCORP, Inc. shall be the sole owner of and is entitled to any
refund granted in connection with its request for a refund for Five Million
Two Hundred Ninety Two Thousand, One Hundred Eighty-Three Dollars
($5,292,183) related to deductions for commissions against gross premiums
(the "Commission Refund"); and
(b) Of the approximate balance of Twenty-Seven Million Dollars
($27,000,000) of potential additional refunds related to deduction for
premiums ceded to others (the "Reinsurance Refunds"), RISCORP, Inc. shall
receive the first Ten Million Dollars ($10,000,000) of any Reinsurance
Refunds recovered, and should the Reinsurance Refunds recovery exceed Ten
Million Dollars ($10,000,000), RISCORP and Zenith will share equally in any
excess proceeds.
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<PAGE>
(c) The fees and expenses incurred in connection with RISCORP's
efforts to seek recovery of the Reinsurance Refunds shall be shared by Zenith
and RISCORP in the same ratio as the amounts which each ultimately recovers.
All such fees and expenses shall initially be borne by RISCORP, which shall
be entitled to reimbursement for Zenith's share of such fees and expenses
only if Zenith shares in any Reinsurance Refunds. RISCORP shall have the
right to direct and control the prosecution of any attempts to recover the
Reinsurance Refunds. RISCORP shall not compromise or settle such claims
without the prior written approval of Zenith, which approval shall not be
unreasonably withheld. At RISCORP's request, Zenith shall jointly prosecute
the claims to recovery of the Reinsurance Refunds, but RISCORP shall retain
the right to direct and control the prosecution in such event. RISCORP may
cease prosecuting such claims at any time in its sole discretion, provided,
however, that RISCORP first offers in writing to assign such claims to Zenith
without consideration, and Zenith does not accept such assignment within ten
business days of receipt of such offer. If Zenith does accept such
Assignment, RISCORP shall be dismissed as a party, and Zenith, as assignee of
RISCORP, shall be substituted. Zenith shall thereafter bear all fees and
expenses incurred in connection with its prosecution of such claim.
4. RELEASE BY ZENITH. Effective with the execution of this Settlement
Agreement, Zenith and its affiliates, subsidiaries, parents, shareholders,
agents, employees, attorneys, accountants, representatives, directors, and
officers (the "Zenith Releasors") hereby release, acquit and forever
discharge RISCORP and its affiliates, subsidiaries, parents, shareholders,
agents, employees, attorneys, accountants, representatives, directors and
officers (the "RISCORP Releasees") from any and all claims, causes of action,
debts, accounts, contracts, torts, demands, judgments, whether at law
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<PAGE>
or in equity, accrued or contingent, known or unknown, discovered or
undiscovered, in the past or in the future, which the Zenith Releasors had,
have, or may in the future have, of any form or nature, from the beginning of
time through and including the date of this Settlement Agreement
(collectively, "Zenith Claims"), except for any Zenith Claims that arise
from, relate to, or are based on (i) any of the obligations contained within
this Settlement Agreement; (ii) the surviving provisions of the Asset
Purchase Agreement; and (iii) the surviving provisions of the Transaction
Documents.
5. RELEASE BY RISCORP. Effective with the execution of this Settlement
Agreement, the RISCORP Releasees hereby release, acquit and forever discharge
the Zenith Releasors from any and all claims, causes of action, debts,
accounts, contracts, torts, demands, judgments, whether at law or in equity,
accrued or contingent, known or unknown, discovered or undiscovered, in the
past or in the future, which the RISCORP Releasees had, have, or may in the
future have, of any form or nature, from the beginning of time through and
including the date of this Settlement Agreement (collectively, "RISCORP
Claims"), except for any RISCORP Claims that arise from, relate to, or are
based on (i) any of the obligations contained within this Settlement
Agreement including, without limitation, any claims arising out of or related
to any alleged errors made by Arthur Andersen as provided in paragraph 1
hereof; (ii) the surviving provisions of the Asset Purchase Agreement; (iii)
the surviving provisions of the Transaction Documents; and (iv) RISCORP's
right to seek indemnification from Zenith with respect to BRISTOL HOTEL
MANAGEMENT CORPORATION, ET AL. V. AETNA CASUALTY & SURETY COMPANY, A/K/A
AETNA GROUP, ET AL. (the "Bristol Hotel Action").
6. COVENANT NOT TO SUE OR ARBITRATE BY ZENITH. Except as contemplated
by paragraphs 1 and 14 hereof, effective with the execution of this
Settlement Agreement Zenith and its affiliates,
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<PAGE>
subsidiaries, parents, shareholders, agents, employees, attorneys,
accountants, representatives, directors, and officers (the "Zenith
Convenantors") hereby covenant not to sue and covenant not to arbitrate
against RISCORP and its affiliates, subsidiaries, parents, shareholders,
agents, employees, attorneys, accountants, representatives, directors and
officers (the "RISCORP Covenantees") as to any and all claims, causes of
action, debts, accounts, contracts, torts, demands, and judgments, whether at
law or in equity, which the Zenith Covenantors had, have, or may have in the
future, of any form or nature, based in whole or in substantial part on facts
actually known to the officers or former officers of Zenith identified on
Exhibit B attached hereto, or which should have been known to such officers
of Zenith after reasonable inquiry, from the beginning of time up to the date
of this Settlement Agreement.
7. COVENANT NOT TO SUE OR ARBITRATE BY RISCORP. Except as contemplated
by paragraphs 1 and 14 hereof and as to the Bristol Hotel Action, effective
with the execution of this Settlement Agreement the RISCORP Covenantees
hereby covenant not to sue and covenant not to arbitrate against the Zenith
Covenantors as to any and all claims, causes of action, debts, accounts,
contracts, torts, demands, and judgments, whether at law or in equity, which
the RISCORP Covenantees had, have, or may have in the future, of any form or
nature, based in whole or in substantial part on facts actually known to the
officers of RISCORP, or which should have been known to the officers of
RISCORP after reasonable inquiry, from the beginning of time up to the date
of this Settlement Agreement.
8. DISMISSAL OF FLORIDA ACTION. Within five business days of the
execution of this Settlement Agreement, Zenith and RISCORP agree to submit a
Stipulation in the form annexed
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hereto as EXHIBIT C to the United States District Court for the Middle
District of Florida, Tampa Division, for filing in the action captioned
RISCORP. INC., ET AL. V. ZENITH INSURANCE CO., Case No. 98-2122-CIV-T-25E.
9. DISMISSAL OF NEW YORK ACTION. Within five business days of the
execution of this Settlement Agreement, Zenith and RISCORP agree to submit a
Stipulation in the form annexed hereto as EXHIBIT D to the United States
District Court for the Southern District of New York for filing in the action
captioned ZENITH INSURANCE CO. V. RISCORP, INC., ET AL., Case No. 99 Civ.
0171 (WHP).
10. RELEASE OF SECURITIES. Zenith agrees promptly to execute upon
RISCORP's request letters in substantially the form attached as EXHIBIT E
evidencing Zenith's acknowledgment that it has no right, title or interest in
or to certain funds on deposit with various state regulatory agencies and its
consent to the release of such funds or securities to RISCORP. Zenith
further covenants and agrees that it shall execute any additional documents
or instruments as may be reasonably necessary to assist RISCORP in the
recovery of such funds. The funds or securities currently on deposit with
various state agencies to which Zenith acknowledges RISCORP's full
entitlement are set forth on Exhibit F.
11. ASSESSMENTS. Responsibility for satisfaction of assessments,
including those assessments at issue in the Florida Action and the New York
Action and those arising in the future, from state insurance departments and
other state and federal regulatory agencies will be borne by the parties as
follows:
(a) The parties have set forth on EXHIBIT G those assessments
currently known to the parties and have identified whether or the extent to
which each such assessment is the
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responsibility of RISCORP or Zenith. Unless otherwise specifically provided
on EXHIBIT G, the parties will each satisfy their respective obligations as
reflected on EXHIBIT G within 15 days of the execution of this Settlement
Agreement and shall provide to the other party evidence of such satisfaction.
(b) Any other assessment or Tax attributable to the Business for a
period prior to April 1, 1998 will be the responsibility of RISCORP.
(c) Any other assessment or Tax attributable to the Business for a
period on or after April 1, 1998 will be the responsibility of Zenith,
regardless of whether the premiums or other amounts used to calculate such
assessment or Tax relate to a period before or after April 1, 1998.
(d) Any other assessment or Tax attributable to the Business for a
period both prior to and following April 1, 1998 shall be prorated between
RISCORP and Zenith, respectively, by following the methodology described in
paragraphs (b) and (c) above based on the ratio of (i) the number of days in
the period prior to April 1, 1998, to (ii) the number of days in the period
on and after April 1, 1998 in the period being assessed.
12. AMENDMENT TO ASSET PURCHASE AGREEMENT. The parties hereto agree
that the Asset Purchase Agreement is hereby amended as follows:
(a) The following Sections or Articles of the Asset Purchase
Agreement shall have no further force or effect: Sections 3.03, 3.04, 3.05,
3.06, 3.07, 3.09, 3.10, 3.11, 3.12, 3.13, 3.14, 3.15, 3.15 A, 3.18, 3.19,
3.20, 3.21, 3.22, 4.03, 4.04; Article V; Article VI; Article VII; and Article X.
(b) The following Sections of the Asset Purchase Agreement are
amended as set forth below:
-12-
<PAGE>
(i) SECTION 8.01. Section 8.01 of the Asset Purchase Agreement
is amended to provide as follows:
Section 8.01: SURVIVAL OF REPRESENTATIONS AND WARRANTIES. All
representations and warranties contained in Sections 3.01, 3.02,
3.08, 3.16, 3.17, 4.01, and 4.02 of the Asset Purchase Agreement
shall survive the Closing and shall terminate and expire at the
close of business on April 1, 2000.
(ii) SECTION 11.06. Section 11.06 of the Asset Purchase
Agreement is hereby amended by deleting subpart (b) thereof
in its entirety.
(c) To the extent that any provisions of this Settlement Agreement
may conflict with any surviving provisions of the Asset Purchase Agreement or
the Transaction Documents, the provisions of this Settlement Agreement shall
control.
13. PENDING LITIGATION. Attached as Exhibit H is a schedule of pending
litigation, along with a designation as to which party shall be responsible
for the defense of, and satisfaction of any judgment or settlement arising
from, each suit.
14. VOIDED CHECKS/STOP PAYMENT ORDERS. (a) Zenith and RISCORP agree
that Zenith shall have 60 days from the date of this Settlement Agreement to
submit to RISCORP the following: (i) a Schedule of Unpaid Checks listing
checks that were issued by any RISCORP company prior to April 1, 1998 that
either (A) were voided by Zenith, or (B) are subject to stop payment orders
issued by Zenith; and (ii) copies of canceled checks, reasonable proof of
reissuance or other documentation demonstrating Zenith's right to
reimbursement for checks listed on the Schedule of Unpaid Checks
-13-
<PAGE>
(collectively, the "Check Documentation"); PROVIDED, HOWEVER, Zenith's right
to reimbursement shall be limited to the lesser of (A) the amount actually
paid by Zenith in connection with the reissuance of a check listed on the
Schedule of Unpaid Checks, or (B) the amount RISCORP carried on its
outstanding check list for such check as of April 1, 1998.
(b) Within ten business days after RISCORP's receipt of the Check
Documentation, RISCORP shall (i) provide Zenith a written schedule listing
its objections, if any, to reimbursing Zenith for checks listed on the
Schedule of Unpaid Checks, and (ii) reimburse Zenith, by wire transfer to an
account designated by Zenith, in an aggregate amount equal to the amount of
all checks as to which RISCORP is not objecting to reimbursement.
(c) Except for checks for which Check Documentation has been
provided to RISCORP within 60 days of the date of this Settlement Agreement,
Zenith agrees that it has no right to assert any claim against RISCORP or any
RISCORP company for reimbursement of any check that was issued by any RISCORP
company prior to April 1, 1998 whether or not such check was included on the
Schedule of Unpaid Checks.
(d) Any disputes between the parties concerning Zenith's right to
reimbursement for unpaid checks that are the subject of this paragraph 14
shall be resolved by arbitration pursuant to paragraph 15 hereof.
15. SUBMISSION OF MATTERS TO ARBITRATION. (a) The parties expressly agree
that, except as otherwise set forth in paragraph 1 hereof or as to any claim
or controversy that is subject to the agreement not to sue or arbitrate as
provided in paragraphs 6 or 7 hereof, any claim or controversy arising out of
or in connection with (i) the surviving provisions of the Asset Purchase
Agreement, (ii)
-14-
<PAGE>
the surviving provisions of the Transaction Documents, (iii) the enforcement
or interpretation of this Settlement Agreement, or (iv) any of the
obligations contained within this Settlement Agreement, shall be resolved by
binding arbitration before the Honorable Clinton A. Curtis, unless he is
unavailable or unwilling to serve. In the event the Honorable Clinton A.
Curtis is unavailable or unwilling to serve, an arbitrator shall be selected
in accordance with the Commercial Arbitration Rules of the American
Arbitration Association. Any arbitration pursuant to this Settlement
Agreement shall be conducted in accordance with the Commercial Arbitration
Rules of the American Arbitration Association except as modified by this
paragraph 15. The arbitration shall take place in Tampa, Florida. The
Honorable Clinton A. Curtis or other arbitrator selected in accordance with
this paragraph shall be hereinafter referred to as the "Arbitrator." The
decision or award of the Arbitrator shall be final, binding and conclusive.
Either party may seek confirmation of any award or decision entered pursuant
to this paragraph 15 by any court of competent jurisdiction.
(b) The parties expressly waive any right to file a civil action and
any right to a jury trial as to any claim or controversy between them, except
as to the potential claims described in paragraph 1 above.
(c) Except as expressly authorized in this Settlement Agreement, the
parties agree that it shall be a breach of this Settlement Agreement for any
party hereto to file against any other party any civil action or arbitration
proceeding relating to (i) any of the Zenith Claims or RISCORP Claims that
are released pursuant to paragraphs 4 and 5 of this Settlement Agreement,
(ii) the claims in respect of which the parties have agreed not to sue or
arbitrate pursuant to paragraphs 6 and 7 of this Settlement Agreement, (iii)
the enforcement or interpretation of this Settlement Agreement, or
-15-
<PAGE>
(iv) any dispute that may arise between the parties relating to the Asset
Purchase Agreement, the Transaction Documents, or the transactions
contemplated by the Asset Purchase Agreement. In the event of such a breach,
the non-breaching party or parties shall be entitled to recover any
consequential damages as well as its reasonable attorneys' fees and expenses
from the breaching party or parties.
(d) As a condition precedent to the submission of any dispute for
determination by the Arbitrator, a party shall serve upon the other party to
this Settlement Agreement, in the manner provided for notices pursuant to
Section 11.03 of the Asset Purchase Agreement, a written statement of the
matter in dispute, and thereafter the parties shaft negotiate in good faith
to attempt to resolve the matter in dispute for a time period not to exceed
ten (10) days (unless the parties mutually agree in writing to extend this
time period).
(e) Within twenty (20) days following the end of the period of good
faith negotiations set forth in the immediately preceding paragraph, any
party to this Settlement Agreement who desires to arbitrate a claim shall
submit to the other party and to the Arbitrator a demand for arbitration
setting forth with reasonable specificity the nature and amount of the claim,
and the parties shall follow the following procedures:
(i) The party receiving the demand for arbitration shall have
ten business days from receipt of the other party's
demand to dispute the claim in writing. If the claim is
not disputed, the amount claimed in the arbitration demand
will be the award of the Arbitrator.
-16-
<PAGE>
(ii) Should the party receiving the claim dispute it, the party
asserting the claim shall submit, no later than ten
business days after receipt of its adversary's notice of
dispute, a position paper, setting forth its position as
to why it should prevail on its claim, including any
appropriate evidentiary material.
(iii) The party disputing the demand for arbitration will have
ten business days after its receipt of its adversary's
position paper to submit a response, including any
appropriate evidentiary material.
(iv) The Arbitrator shall issue his award within thirty days of
his receipt of the response of the party opposing the
claim.
(v) For purposes of this paragraph 15, all claims, responses,
notices, position papers or other papers of any kind shall
be served by facsimile and overnight delivery (next
business day) to the persons identified in paragraph 11.03
of the Asset Purchase Agreement and upon the Arbitrator,
except that exhibits, appendices, and other lengthy
documents need only be served by overnight delivery
service. The time for any party to take any action
pursuant to this paragraph after receipt of notice or
written material shall commence to run from receipt of
such notice or written material by overnight delivery
service.
-17-
<PAGE>
16. TERMINATION OF LETTER AGREEMENT AND POWER OF ATTORNEY. The parties
expressly agree that the Letter Agreement and the Power of Attorney executed
by RISCORP in connection with the closing of the Asset Sale are hereby
terminated and shall be of no further force or effect.
17. FURTHER ASSURANCES. On and after execution of this Settlement
Agreement, Zenith and RISCORP shall take all reasonably appropriate action
and execute any additional documents, instruments or conveyances of any kind
which may be reasonably necessary to carry out any of the provisions of this
Settlement Agreement or the surviving provisions of the Asset Purchase
Agreement and the Transaction Documents.
18. ENTIRE AGREEMENT. This Settlement Agreement contains the entire
agreement among the parties with respect to the subject matter hereof and
supersedes all prior agreements and understandings, written or oral, with
respect thereto.
19. AMENDMENTS AND WAIVERS. This Agreement may be amended, superseded,
cancelled, renewed or extended, and the terms hereof may be waived, only by a
written instrument signed by each of the parties or, in the case of a waiver,
by the party waiving compliance. No delay on the part of any party in
exercising any right, power or privilege hereunder shall operate as a waiver
thereof, nor shall any waiver on the part of any party of any right, power or
privilege, nor any single or partial exercise of any such right, power or
privilege, preclude any further exercise thereof or the exercise of any other
such right, power or privilege.
20. BINDING EFFECT. This Agreement shall be binding upon and inure to
the benefit of the parties and their respective successors, permitted assigns
and legal representatives.
-18-
<PAGE>
21. GOVERNING LAW. This settlement agreement shall be governed by and
construed in accordance with the laws of the State of Florida, without giving
effect to the principles of conflicts of laws thereof.
22. NO ADMISSION OF LIABILITY. Zenith and RISCORP agree (a) that
neither this Settlement Agreement nor the fact of settlement are an admission
of any liability or wrongdoing whatsoever; (b) that neither this Settlement
Agreement nor the fact of settlement shall be used or construed as an
admission of any fault, liability or wrongdoing by any person; and (c) that
neither this Settlement Agreement, the fact of settlement, the settlement
negotiations, nor any related document shall be offered or received in
evidence as an admission, concession, presumption or inference against any
party in any action or proceeding other than an action or proceeding to
enforce this Settlement Agreement.
23. REPRESENTATIONS OF RISCORP. RISCORP, Inc., RMS, 1390 Main Street,
RI, IAA, RIS, RMCS, CompSource, RRE, RA, RW, RF, RIC, RP&C, RNIC, RS, RSS
Holding, RSSI and RSSII each represent and warrant that (a) each such entity
has the requisite corporate power and authority to execute, deliver and
perform its obligations under this Settlement Agreement; (b) the execution
and delivery of this Settlement Agreement and the performance of the
obligations thereunder have been duly authorized by all necessary corporate
action; (c) this Settlement Agreement constitutes the legal, valid and
binding obligation of each such entity, enforceable in accordance with its
terms, except as such enforceability may be limited by bankruptcy,
insolvency, fraudulent transfer, reorganization, moratorium or other similar
laws affecting the enforcement of creditors' rights generally and by general
equitable principles (regardless of whether such
-19-
<PAGE>
enforceability is considered in a proceeding in equity or in law); and (d)
after giving effect to the transactions contemplated by this Settlement
Agreement, the RISCORP Companies, individually and on a consolidated basis,
will be solvent, able to pay their debts as they mature, have capital
sufficient to carry on their businesses and all businesses in which they are
about to engage, and:
(i) the assets of the RISCORP Companies, individually and on a
consolidated basis, at a fair evaluation, exceed the total
liabilities (including contingent, subordinated, unmatured
and unliquidated liabilities) of the RISCORP Companies;
(ii) current projections which are based on underlying
assumptions which provide a reasonable basis for the
projections and which reflect the RISCORP Companies'
judgment based on present circumstances, the most likely
set of conditions and the RISCORP Companies' most likely
course of action for the period projected, demonstrate
that the RISCORP Companies, individually and on a
consolidated basis, will have sufficient cash flow to
enable them to pay their debts as they mature or the
RISCORP Companies are reasonably satisfied that they will
be able to refinance such debt at or prior to maturity on
commercial reasonable terms; and
(iii) the RISCORP Companies, individually and on a consolidated
basis, do not have unreasonably small capital base with
which to engage in their anticipated businesses.
-20-
<PAGE>
24. REPRESENTATIONS OF ZENITH. Zenith represents and warrants that (a)
it has the requisite corporate power and authority to execute, deliver and
perform its obligations under this Settlement Agreement (b) the execution and
delivery of this Settlement Agreement and the performance of its obligations
thereunder have been duly authorized by all necessary corporate action, and
(c) this Settlement Agreement constitutes the legal, valid and binding
obligation of Zenith, enforceable in accordance with its terms, except as
such enforceability may be limited by bankruptcy, insolvency, fraudulent
transfer, reorganization, moratorium or other similar laws affecting the
enforcement of creditors' rights generally and by general equitable
principles (regardless of whether such enforceability is considered in a
proceeding in equity or in law).
25. COUNTERPARTS. This Settlement Agreement may be executed in two or
more counterparts, each of which shall be deemed an original, but all of
which together shall constitute one and the same instrument.
-21-
<PAGE>
IN WITNESS WHEREOF, the parties have executed this Agreement as of the
date first above written.
ZENITH INSURANCE COMPANY
By: /s/ Stanley R. Zax
-----------------------
Name: Stanley R. Zax
Title: Chairman & President
RISCORP, INC.
RISCORP MANAGEMENT SERVICES, INC.
1390 MAIN STREET SERVICES, INC.
RISCORP OF ILLINOIS, INC.
INDEPENDENT ASSOCIATION
ADMINISTRATORS INCORPORATED
RISCORP INSURANCE SERVICES, INC.
RISCORP MANAGED CARE SERVICES, INC.
COMPSOURCE, INC.
RISCORP REAL ESTATE HOLDINGS, INC.
RISCORP ACQUISITION, INC,
RISCORP WEST, INC.
RISCORP OF FLORIDA, INC.
RISCORP INSURANCE COMPANY
RISCORP PROPERTY & CASUALTY
INSURANCE COMPANY
RISCORP NATIONAL INSURANCE COMPANY
RISCORP SERVICES, INC.
RISCORP STAFFING SOLUTIONS
HOLDING COMPANY
RISCORP STAFFING SOLUTIONS, INC. I
RISCORP STAFFING SOLUTIONS, INC. II
By: /s/ Walter E. Riehemann
------------------------------
Name: Walter E. Riehemann
Title: Vice President
-22-
Exhibits A, B, C, D, E, F, G and H to the Settlement Agreement are not included.
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<DEBT-HELD-FOR-SALE> 667,017
<DEBT-CARRYING-VALUE> 696,966
<DEBT-MARKET-VALUE> 697,264
<EQUITIES> 58,486
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 955,465
<CASH> 7,551
<RECOVER-REINSURE> 344,328
<DEFERRED-ACQUISITION> 9,087
<TOTAL-ASSETS> 1,625,648
<POLICY-LOSSES> 840,524
<UNEARNED-PREMIUMS> 60,982
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 91,397
0
0
<COMMON> 24,119
<OTHER-SE> 401,471
<TOTAL-LIABILITY-AND-EQUITY> 1,625,648
211,554
<INVESTMENT-INCOME> 26,271
<INVESTMENT-GAINS> 4,065
<OTHER-INCOME> 26,750
<BENEFITS> 171,473
<UNDERWRITING-AMORTIZATION> 40,834
<UNDERWRITING-OTHER> 33,015
<INCOME-PRETAX> 155,186
<INCOME-TAX> 54,186
<INCOME-CONTINUING> 101,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 101,000
<EPS-BASIC> 5.89
<EPS-DILUTED> 5.89
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
