<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 March 31, 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 April 30, 1999, there were 17,116,000 shares of Zenith Common Stock
outstanding, net of 7,855,000 shares of treasury stock.
1
<PAGE>
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
March 31, December 31,
(Dollars in thousands, except per share data) 1999 1998
- --------------------------------------------------------------------------------------------------------------------
(Unaudited)
<S> <C> <C>
ASSETS:
Investments
Fixed maturities:
At amortized cost (fair value $33,426 in 1999 and $36,712 in 1998) $ 32,262 $ 35,143
At fair value (cost $572,378 in 1999 and $725,397 in 1998) 574,060 735,284
Floating rate preferred stocks, at fair value (cost $14,614 in 1999
and $16,614 in 1998) 15,312 17,324
Convertible and non-redeemable preferred stocks, at fair value
(cost $4,014 in 1999 and $7,679 in 1998) 3,119 7,350
Common stocks, at fair value (cost $31,175 in 1999 and $22,402 in 1998) 33,324 26,935
Short-term investments (at cost, which approximates fair value) 69,199 187,123
Net receivable from Nationwide Mutual Insurance Company (see Note 3) 213,787
Other investments 43,869 39,522
------------- ----------------
TOTAL INVESTMENTS 984,932 1,048,681
Cash 8,186 1,998
Accrued investment income 11,198 13,646
Premiums receivable 89,009 133,631
Receivable from reinsurers, state trust funds and
prepaid reinsurance premiums 359,037 373,045
Deferred policy acquisition costs 9,249 23,941
Properties and equipment, less accumulated depreciation 57,307 79,908
Net deferred tax asset 26,010 22,611
Federal income taxes receivable 2,740
Intangible assets 23,213 25,744
Other assets 87,646 92,781
------------- ----------------
TOTAL ASSETS $ 1,655,787 $ 1,818,726
------------- ----------------
------------- ----------------
</TABLE>
(continued)
2
<PAGE>
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET (CONTINUED)
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------
March 31, 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 $ 867,925 $ 997,647
Unearned premiums 62,115 157,965
Policyholders' dividends accrued 4,513 4,763
Reserves on loss portfolio transfers 9,326 9,689
Payable to banks and other notes payable 16,188 19,255
Senior notes payable, less unamortized issue costs of
$374 in 1999 and $404 in 1998 74,626 74,596
Federal income taxes payable (See Note 3) 51,280
Payable to RISCORP 619 52,952
Other liabilities 56,732 81,566
---------- ----------
TOTAL LIABILITIES 1,143,324 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 $1,645 in 1999 and
$1,659 in 1998 73,355 73,341
---------- ----------
Commitments and contingent liabilities
STOCKHOLDERS' EQUITY:
Preferred stock, $1 par - shares authorized 1,000; issued and outstanding,
none in 1998 and 1997
Common stock, $1 par - shares authorized 50,000; issued 24,971,
outstanding 17,116 in 1999; issued 24,970, outstanding 17,148 in 1998 24,971 24,970
Additional paid-in capital 270,710 270,679
Retained earnings 288,422 188,243
Accumulated other comprehensive income - net unrealized appreciation
on investments, net of deferred tax expense of $1,266 in 1999
and $5,167 in 1998 2,352 9,596
---------- ----------
586,455 493,488
Less treasury stock at cost (7,855 shares in 1999 and 7,822 shares in 1998) (147,347) (146,536)
---------- ----------
TOTAL STOCKHOLDERS' EQUITY 439,108 346,952
---------- ----------
TOTAL LIABILITIES, REDEEMABLE SECURITIES AND
STOCKHOLDERS' EQUITY $1,655,787 $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
March 31,
(Dollars in thousands, except per share data) 1999 1998
- ------------------------------------------------------------------------------------
<S> <C> <C>
CONSOLIDATED REVENUES:
Premiums earned $135,577 $118,784
Net investment income 13,325 12,343
Realized gains on investments 1,534 2,420
Real estate sales 10,768 11,748
Service fee income 959
-------- --------
Total revenues 162,163 145,295
EXPENSES:
Loss and loss adjustment expenses incurred 105,490 83,928
Policy acquisition costs 27,230 22,279
Other underwriting and operating expenses 17,199 15,846
Policyholders' dividends and participation 435 57
Real estate construction and operating costs 9,761 11,494
Interest expense 2,020 993
-------- --------
Total expenses 162,135 134,597
Gain on sale of CalFarm Insurance Company 160,335
--------
Income before federal income tax expense 160,363 10,698
Federal income tax expense, including expense of $56,000
related to the sale of CalFarm Insurance Company in 1999 55,963 3,598
-------- --------
NET INCOME $104,400 $ 7,100
-------- --------
-------- --------
EARNINGS PER SHARE:
Net income per common share - basic $ 6.09 $ 0.42
-------- --------
-------- --------
Net income per common share - diluted $ 6.09 $ 0.42
-------- --------
-------- --------
Additional Required Disclosure:
Net income $104,400 $ 7,100
Change in unrealized appreciation/(depreciation) on investments (7,244) 399
-------- --------
Comprehensive Income $ 97,156 $ 7,499
-------- --------
-------- --------
</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>
- -----------------------------------------------------------------------------------------
Three Months Ended
March 31,
(Dollars in thousands) 1999 1998
- -----------------------------------------------------------------------------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Premiums and service fee income collected $ 152,441 $121,822
Investment income received 15,373 12,128
Proceeds from sales of real estate 10,768 11,748
Loss and loss adjustment expenses paid (119,660) (81,356)
Underwriting and other operating expenses paid (43,005) (38,062)
Real estate construction costs paid (14,580) (15,775)
Reinsurance premiums paid (23,321) (7,213)
Dividends paid to policyholders (591) (157)
Interest paid (3,294)
Income taxes paid (950) (50)
-------- -------
Net cash (used in) provided by operating activities (26,819) 3,085
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investments:
Investment securities available-for-sale (37,940) (74,794)
Other investments (5,233) (870)
Proceeds from maturities and redemptions of investments:
Fixed maturities held-to-maturity 2,841 2,528
Investment securities available-for-sale 49,249 32,501
Other investments 83
Proceeds from sales of investments:
Investment securities available-for-sale 22,330 81,542
Other investments 570
Capital and other expenditures (595) (1,144)
Net change in short-term investments 65,875 (9,024)
Cash paid to RISCORP (53,689)
Other (2,267) (437)
-------- -------
Net cash provided by investing activities 41,141 30,385
CASH FLOWS FROM FINANCING ACTIVITIES:
Cash advanced from bank construction loans 2,666 10,446
Cash repaid on bank construction loans (734) (10,041)
Cash advanced from bank lines of credit 7,400
Cash repaid on bank lines of credit (12,400)
Cash dividends paid to common stockholders (4,286) (4,225)
Proceeds from exercise of stock options 31 2,910
Purchase of treasury shares (811) (23,301)
-------- -------
Net cash used in financing activities (8,134) (24,211)
-------- -------
Net increase in cash 6,188 9,259
Cash at beginning of period 1,998 12,504
-------- -------
Cash at end of period $ 8,186 $ 21,763
-------- -------
-------- -------
(continued)
</TABLE>
5
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS (CONTINUED)
(UNAUDITED)
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------
Three Months Ended
March 31,
(Dollars in thousands) 1999 1998
- -----------------------------------------------------------------------------------------
<S> <C> <C>
RECONCILIATION OF NET INCOME TO NET CASH FLOWS
FROM OPERATING ACTIVITIES:
Net Income $ 104,400 $ 7,100
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 2,640 1,074
Realized gain on sale of CalFarm Insurance Company (160,335)
Realized gains on investments (1,534) (2,420)
Decrease (increase) in:
Accrued investment income 453 206
Premiums receivable 8,105 (823)
Receivable from reinsurers, state trust funds and
prepaid reinsurance premiums (8,994) (2,038)
Federal income taxes 55,025 5,315
Deferred policy acquisition costs (928) 521
Increase (decrease) in:
Unpaid loss and loss adjustment expenses (4,181) 3,870
Unearned premiums (4,886) (1,018)
Policyholders' dividends accrued (250) (100)
Other policyholder funds (1,825)
Other (16,334) (6,777)
--------- -------
Net cash (used in) provided by operating activities $ (26,819) $ 3,085
--------- -------
--------- -------
</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. 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 and 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. The three months ended March
31, 1999 include the results of operations from the RISCORP Acquisition (see
Note 4). 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 current year presentation. Zenith has elected to use rounding
to the nearest thousand dollars in reporting amounts in this statement.
NOTE 2. EARNINGS AND DIVIDENDS PER SHARE
<TABLE>
<CAPTION>
Three Months Ended
March 31,
--------------------------------
(In thousands, except per share data) 1999 1998
- -------------------------------------------------------------------------------------------------------
<S> <C> <C>
(A) Net income $104,400 $ 7,100
- -------------------------------------------------------------------------------------------------------
(B) Weighted average outstanding
shares during the period 17,137 16,948
- -------------------------------------------------------------------------------------------------------
Additional common shares issuable
under employee stock option plans
using the treasury stock method 15 132
- -------------------------------------------------------------------------------------------------------
(C) Weighted average number of common
shares outstanding assuming
exercise of stock options 17,152 17,080
- -------------------------------------------------------------------------------------------------------
(A)/(B) Net income per common share - basic $ 6.09 $ 0.42
- -------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------
(A)/(C) Net income per common share - diluted $ 6.09 $ 0.42
- -------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------
Dividends per common share $ 0.25 $ 0.25
- -------------------------------------------------------------------------------------------------------
</TABLE>
7
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 3. SALE OF CALFARM INSURANCE COMPANY
Effective March 31, 1999, Zenith Insurance Company ("Zenith Insurance"), a
wholly-owned subsidiary of Zenith National Insurance Corp. ("Zenith
National"), completed the sale of all of the issued and outstanding capital
stock of CalFarm Insurance Company ("CalFarm"), a wholly-owned subsidiary of
Zenith Insurance, for approximately $273,000,000 in cash, subject to
post-closing adjustments in certain circumstances, to Nationwide Mutual
Insurance Company. The gain on the sale, net of tax, is 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 (the "pooling agreement") to which
Zenith Insurance and its wholly-owned property-casualty insurance
subsidiaries are parties. Zenith Insurance and its wholly-owned
property-casualty affiliates, 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 will be available to Zenith Insurance for investment are
approximately $211,000,000 compared to cash and investments of approximately
$226,000,000 that was excluded from Zenith's Consolidated Balance Sheet with
the sale of CalFarm.
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 March 31, 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
$105,011,000 and $86,373,000, respectively. Pro forma results of operations for
such periods would have been a loss of $1,900,000 and income of $5,000,000,
respectively. Pro forma earnings per share for such periods would have been a
loss of $0.11 (basic and diluted) and income of $0.30 (basic) and $0.29
(diluted), respectively.
8
<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 consolidated
investments of approximately $15,000,000 caused by the sale of CalFarm.
Estimated investment income after tax on such decrease would have been
$140,000 for the three months ended March 31, 1999 and 1998. Based on an
increase in underwriting income after tax of $15,000 and $505,000 in the
three months ended March 31, 1999 and 1998, respectively, associated with
underwriting losses recorded by CalFarm in those periods, and a reduction in
investment income after taxes of $140,000 in the same periods, pro forma net
earnings for the three months ended March 31, 1999 and 1998 would have been a
loss of $100,000 and income of $7,500,000, respectively. Pro forma earnings
per share for such periods would have been a loss of $0.01 (basic and
diluted) and income of $0.44 (basic and diluted), respectively.
NOTE 4. COMMITMENTS AND CONTINGENT LIABILITIES
CONTINGENCIES SURROUNDING FAIR VALUES OF CERTAIN ASSETS ACQUIRED AND LIABILITIES
ASSUMED FROM 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, Inc. and certain of its subsidiaries (collectively,
"RISCORP"), Zenith Insurance acquired substantially all of the assets and
certain liabilities of RISCORP related to RISCORP's workers' compensation
business (the "RISCORP Acquisition"). The total purchase price for such
acquired assets and liabilities was determined by a three-step process in
which RISCORP; Zenith Insurance and its external accounting and actuarial
consultants; and a third party, acting as a Neutral Auditor and Neutral
Actuary, made certain estimates of the GAAP values of the assets and
liabilities acquired by Zenith Insurance. Such estimates varied considerably,
particularly with respect to the value of premiums receivable and the
liability for unpaid losses and loss adjustment expenses.
The carrying values of premiums receivable and the liability for unpaid losses
and loss adjustment expenses at March 31, 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 March 31, 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.
9
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 4. COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED)
CONTINGENCIES SURROUNDING FAIR VALUES OF CERTAIN ASSETS ACQUIRED AND LIABILITIES
ASSUMED FROM RISCORP (CONTINUED)
Zenith Insurance has purchased reinsurance protection relating to development of
the loss and loss adjustment expense reserves assumed from RISCORP. Such
reinsurance would allow Zenith Insurance to recover up to $50 million in excess
of $182 million for net unpaid losses and allocated loss adjustment expenses
acquired from RISCORP. After deducting reinsurance premiums of $16 million,
Zenith has recorded reinsurance recoverable of $24.5 million and a deferred
benefit of $8.5 million at March 31, 1999 and December 31, 1998. Future adverse
loss development, if any, of the reserves acquired from RISCORP would be
recoverable up to the $50 million limit, although the benefit of such
reinsurance recoverable would be deferred and recognized over the recovery
period of such reinsurance.
Zenith Insurance has provided notice to RISCORP of certain breaches of
representations, warranties and covenants made by RISCORP in the Asset Purchase
Agreement. These breaches may result in recovery by Zenith Insurance of a
portion of the purchase price paid by Zenith Insurance.
On January 11, 1999, Zenith Insurance served RISCORP with a complaint filed
in the United States District Court in the Southern District of New York. The
complaint against RISCORP asserts various claims arising from the RISCORP
Acquisition, including claims seeking recovery of assets that were not
transferred to Zenith Insurance at the closing, as well as damages for
breaches of representations, warranties, and covenants in the Asset Purchase
Agreement. On January 22, 1999, RISCORP served Zenith Insurance with a
complaint in an action that RISCORP had filed against Zenith Insurance in the
United States District Court in the Middle District of Florida. In that
action, RISCORP is seeking damages based on the alleged failure of Zenith
Insurance to comply with certain indemnification provisions of the Asset
Purchase Agreement, as well as damages relating to the allegedly improper
acquisition of certain assets. Zenith is unable to predict the outcome of
these litigations. Although the determination of the "Final Purchase Price"
by the Neutral Auditor and Neutral Actuary is final, binding and conclusive
under the Asset Purchase Agreement it is uncertain whether RISCORP will
contest the determination. Negotiations are pending to settle all litigation
and disputes between Zenith and RISCORP, but there can be no assurance such
negotiations will result in any definitive agreement.
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.
10
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
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.
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 1999 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. Real Estate Operations
develop land and primarily construct private residences for sale in Las
Vegas, Nevada. Investment provides 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.
11
<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 the same as those of Zenith. 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 Reinsurance Casualty Operations Investments Parent Total
- ---------------------------- ---------------- --------------- -------------- --------------- -------------- ------------ -----------
For the Three Months Ended March 31, 1999
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues:
Premiums earned $71,757 $9,712 $54,108 $ 135,577
Net investment income $13,325 13,325
Realized gains on
investments 1,534 1,534
Real estate sales $10,768 10,768
Service fee income 959 959
- ---------------------------- ---------------- --------------- -------------- --------------- -------------- ------------ -----------
Total revenues 72,716 9,712 54,108 10,768 14,859 162,163
- ---------------------------- ---------------- --------------- -------------- --------------- -------------- ------------ -----------
Segment (loss) income,
before taxes (13,169) 194 (22) 1,008 14,859 $(2,842) 28
Gain on sale of CalFarm 160,335 160,335
Interest expense (2,020) (2,020)
Income tax benefit (expense) 4,428 (65) (55,993) (353) (4,974) 994 (55,963)
Segment assets 818,703 19,913 73,476 731,273 12,422 1,655,787
Combined ratios 118.4% 98.0% 100.0% 109.6%
- ------------------------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------------
For the Three Months Ended March 31, 1998
- ------------------------------------------------------------------------------------------------------------------------------------
Revenues:
Premiums earned $ 55,796 $7,913 $55,075 $ 118,784
Net investment income $12,343 12,343
Realized gains on
investments 2,420 2,420
Real estate sales $ 11,748 11,748
- ---------------------------- ---------------- --------------- -------------- --------------- -------------- ------------ -----------
Total revenues 55,796 7,913 55,075 11,748 14,763 145,295
- ---------------------------- ---------------- --------------- -------------- --------------- -------------- ------------ -----------
Segment (loss) income,
before taxes (5,321) 3,706 (721) 254 14,763 $(1,983) 10,698
Interest expense (993) (993)
Income tax benefit (expense) 1,646 (1,152) 224 (102) (4,908) 694 (3,598)
Segment assets 163,754 22,104 95,933 57,701 881,957 13,520 1,234,969
Combined ratios 109.5% 53.2% 101.3% 102.0%
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
12
<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. and subsidiaries (collectively "Zenith") is the income, including
investment income, from the operations of its property-casualty insurance
business and its investment portfolio. Property-casualty insurance business
comprises Workers' Compensation, Other Property-Casualty (principally
automobile, homeowners, farmowners and commercial coverages and group health
insurance) and Reinsurance. Zenith's Real Estate Operations develop land and
primarily construct private residences for sale in Las Vegas, Nevada. Zenith
National Insurance Corp. ("Zenith National") as a holding company, 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. 1999 includes the former
RISCORP operations acquired effective April 1, 1998.
<TABLE>
<CAPTION>
Three Months Ended
March 31,
(Dollars in thousands) 1999 1998
- -------------------------------------------------------------------------------------------------------
<S> <C> <C>
Net investment income, after taxes $8,888 $8,282
Realized gains on investments, after taxes 997 1,573
- -------------------------------------------------------------------------------------------------------
Sub-total 9,885 9,855
- -------------------------------------------------------------------------------------------------------
Property-casualty underwriting results, after taxes:
(Loss) income excluding catastrophes (7,392) 1,632
Catastrophe losses (1,235) (3,250)
- -------------------------------------------------------------------------------------------------------
Property-casualty underwriting loss, after taxes (8,627) (1,618)
- -------------------------------------------------------------------------------------------------------
Income from Real Estate Operations, after taxes 655 152
Interest expense, after taxes (1,313) (645)
Parent expenses, after taxes (535) (644)
- -------------------------------------------------------------------------------------------------------
Net income before gain on sale of CalFarm Insurance Company 65 7,100
- -------------------------------------------------------------------------------------------------------
Gain on sale of CalFarm Insurance Company after tax 104,335
- -------------------------------------------------------------------------------------------------------
Net income $ 104,400 $7,100
- -------------------------------------------------------------------------------------------------------
</TABLE>
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.
13
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
Premiums earned, underwriting results and combined ratios before taxes for
the three months ended March 31, 1999 and 1998 were as follows:
<TABLE>
<CAPTION>
Three Months Ended
March 31,
(Dollars in thousands) 1999 1998
- -----------------------------------------------------------------------------------------
<S> <C> <C>
Premiums earned:
Workers' Compensation
California $ 28,550 $ 29,897
Outside California 43,207 25,899
--------------------
Total Workers' Compensation 71,757 55,796
Other Property-Casualty 54,108 55,075
Reinsurance 9,712 7,913
--------------------
Total $ 135,577 $118,784
--------------------
--------------------
Underwriting income (loss) before taxes:
Workers' Compensation $ (13,169) $ (5,321)
Other Property-Casualty (22) (721)
Reinsurance 194 3,706
--------------------
Total $ (12,997) $ (2,336)
--------------------
--------------------
Combined loss and expense ratios:
Workers' Compensation
Loss and loss adjustment expenses 85.6% 76.0%
Underwriting expenses 32.2% 33.4%
Dividends to policyholders 0.6% 0.1%
--------------------
Combined ratio 118.4% 109.5%
Other Property-Casualty
Loss and loss adjustment expenses 66.5% 69.8%
Underwriting expenses 33.5% 31.5%
--------------------
Combined ratio 100.0% 101.3%
Reinsurance
Loss and loss adjustment expenses 82.9% 38.6%
Underwriting expenses 15.1% 14.6%
--------------------
Combined ratio 98.0% 53.2%
Total
Loss and loss adjustment expenses 77.8% 70.7%
Underwriting expenses 31.5% 31.3%
Dividends to policyholders 0.3% 0.0%
--------------------
Combined ratio 109.6% 102.0%
--------------------
--------------------
</TABLE>
14
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
SALE OF CALFARM INSURANCE COMPANY
Effective March 31, 1999, Zenith Insurance Company ("Zenith Insurance"), a
wholly-owned subsidiary of Zenith National, completed the sale of all of the
issued and outstanding capital stock of CalFarm Insurance Company
("CalFarm"), a wholly-owned subsidiary of Zenith Insurance, for approximately
$273,000,000 in cash, subject to post-closing adjustments in certain
circumstances, to Nationwide Mutual Insurance Company. CalFarm writes
Zenith's Other Property-Casualty business, principally in California. The
gain on the sale, net of tax, is 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 affiliates, 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 will be available to Zenith Insurance for investment are
approximately $211,000,000 compared to cash and investments of approximately
$226,000,000 that will be excluded from Zenith's Consolidated Balance Sheet
with the sale of CalFarm.
Since CalFarm was acquired by Zenith 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 consolidated
investments of approximately $15,000,000 caused by the sale of CalFarm.
Estimated investment income after tax on such decrease would have been
$140,000 for the three months ended March 31, 1999 and 1998. Based on an
increase in underwriting income after tax of $15,000 and $505,000 in the
three months ended March 31, 1999 and 1998, respectively, associated with
underwriting losses recorded by CalFarm in those periods, and a reduction in
investment income after taxes of $140,000 in the same periods, pro forma net
earnings for the three months ended March 31, 1999 and 1998 would have been a
loss of $100,000 and income of $7,500,000, respectively. Pro forma earnings
per share for such periods would have been a loss of $0.01 (basic and
diluted) and income of $0.44 (basic and diluted), respectively.
CONTINGENCIES SURROUNDING FAIR VALUES OF CERTAIN ASSETS ACQUIRED AND LIABILITIES
ASSUMED FROM 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, Inc. and certain of its subsidiaries (collectively,
"RISCORP"), Zenith Insurance acquired substantially all of the assets and
certain liabilities of RISCORP related to RISCORP's workers' compensation
business (the "RISCORP Acquisition"). The total purchase price for such
acquired assets and liabilities was determined by a three-step process in
which RISCORP; Zenith Insurance and its external accounting and actuarial
consultants; and a third party, acting as a Neutral Auditor and Neutral
Actuary, made certain estimates of the GAAP values of the assets and
liabilities acquired by Zenith Insurance. Such estimates varied considerably,
particularly with respect to the value of premiums receivable and the
liability for unpaid losses and loss adjustment expenses.
15
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
CONTINGENCIES SURROUNDING FAIR VALUES OF CERTAIN
ASSETS ACQUIRED AND LIABILITIES ASSUMED FROM RISCORP (CONTINUED)
The carrying values of premiums receivable and the liability for unpaid losses
and loss adjustment expenses at March 31, 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 March 31, 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 million in excess
of $182 million for net unpaid losses and allocated loss adjustment expenses
acquired from RISCORP. After deducting reinsurance premiums of $16 million,
Zenith has recorded reinsurance recoverable of $24.5 million and a deferred
benefit of $8.5 million at March 31, 1999 and December 31, 1998. Future adverse
loss development, if any, of the reserves acquired from RISCORP would be
recoverable up to the $50 million limit, although the benefit of such
reinsurance recoverable would be deferred and recognized over the recovery
period of such reinsurance.
Zenith Insurance has provided notice to RISCORP of certain breaches of
representations, warranties and covenants made by RISCORP in the Asset Purchase
Agreement. These breaches may result in recovery by Zenith Insurance of a
portion of the purchase price paid by Zenith Insurance.
On January 11, 1999, Zenith Insurance served RISCORP with a complaint filed
in the United States District Court in the Southern District of New York. The
complaint against RISCORP asserts various claims arising from the RISCORP
Acquisition, including claims seeking recovery of assets that were not
transferred to Zenith Insurance at the closing, as well as damages for
breaches of representations, warranties, and covenants in the Asset Purchase
Agreement. On January 22, 1999, RISCORP served Zenith Insurance with a
complaint in an action that RISCORP had filed against Zenith Insurance in the
United States District Court in the Middle District of Florida. In that
action, RISCORP is seeking damages based on the alleged failure of Zenith
Insurance to comply with certain indemnification provisions of the Asset
Purchase Agreement, as well as damages relating to the allegedly improper
acquisition of certain assets. Zenith is unable to predict the outcome of
these litigations. Although the determination of the "Final Purchase Price"
by the Neutral Auditor and Neutral Actuary is final, binding and conclusive
under the Asset Purchase Agreement it is uncertain whether RISCORP will
contest the determination. Negotiations are pending to settle all litigation
and disputes between Zenith and RISCORP, but there can be no assurance such
negotiations will result in any definitive agreement.
16
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
WORKERS' COMPENSATION
Premiums earned in the Workers' Compensation operation increased in the three
months ended March 31, 1999 compared to the corresponding period in 1998,
principally as a result of the RISCORP Acquisition, which contributed
$25,626,000 of workers' compensation premiums earned in the three months ended
March 31, 1999.
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 months ended March 31, 1999
compared to the corresponding period in 1998, principally as a result of
intense competition in the national workers' compensation insurance industry.
Underwriting losses in the Workers' Compensation operation increased in the
first three months of 1999 compared to the first three months of 1998. The
increase in such underwriting losses was attributable, principally, to the
following reasons: First, Zenith's estimate of the incurred loss ratio for
its business principally outside California, except Florida, in the first
quarter of 1998 was lower than such estimate for both the first quarter of
1999 and the full year 1998. The additional available data for the full year
1998 indicated the need for a higher estimate of the loss ratio outside of
California, except in Florida. Second, the first quarter of 1999 reflects the
operations 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. Third, Zenith has reduced expenses during 1998 and
the first quarter of 1999, 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 first
quarter of 1999 compared to the first quarter of 1999 and additional expenses
associated with operating and integrating the former RISCORP business. 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 by Zenith 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. Underwriting
results in the first quarter of 1998 were adversely impacted by approximately
$5,000,000 before taxes attributable to California wind and storm damage as
compared to none in the first quarter of 1999.
REINSURANCE
Reinsurance premiums earned increased in the three months ended March 31, 1999
compared to the corresponding period in 1998 due principally to additional
premiums for reinstatement of treaties impacted by catastrophes. The
underwriting results for the three months ended March 31, 1999 were adversely
impacted by catastrophe losses related to Hurricane Georges of $1,900,000 before
taxes as compared to none in the three months ended March 31, 1998.
17
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
REAL ESTATE OPERATIONS
Zenith recognized total revenues of $10,768,000 and $11,748,000 for the three
months ended March 31, 1999 and 1998, respectively from its Real Estate
Operations. Income from the Real Estate Operations before taxes was $1,008,000
and $254,000 for the three months ended March 31, 1999 and 1998, respectively.
The first quarter 1999 results benefited from decreased costs and non-recurring
gain from a land sale which produced net income before tax of $461,000.
Construction in progress, including undeveloped land, was $39,961,000 and
$42,142,000 at March 31, 1999 and December 31, 1998, respectively. In addition
to continuing home construction, Zenith may use some land presently owned for
commercial construction. Increased interest rates or other factors could affect
the rate of home sales.
INVESTMENTS
Investment income for the three months ended March 31, 1999 increased from the
corresponding period in 1998 primarily due to the increase in invested assets
added by the RISCORP Acquisition and the proceeds from the sale of $75,000,000
of 8.55% Capital Securities on July 30, 1998. 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
March 31,
----------------------------------
1998 1997
- -------------------------------------------------------------- -----------------
<S> <C> <C>
Investment yield, before taxes 5.5% 5.7%
Investment yield, after taxes 3.7% 3.8%
- -------------------------------------------------------------- -----------------
</TABLE>
Bonds with an investment grade rating represented 95% and 96% of the
consolidated carrying values of fixed maturities at March 31, 1999 and December
31, 1998, respectively. The average maturity of the investment portfolio was 5.6
years at March 31, 1999 and 5.2 years at December 31, 1998.
The total fair value of fixed maturity investments and the unrealized gain on
held-to-maturity and available-for-sale fixed maturity investments, were as
follows:
<TABLE>
<CAPTION>
Unrealized Gain on Fixed Maturities
-----------------------------------------------------
Total Fair Held-to-Maturity Available-for-Sale
Value of --------------------- -------------------------------
(Dollars in thousands) Fixed Maturities* Before Tax Before Tax After Tax
- -------------------------------- -------------------------- --------------------- --------------- ---------------
<S> <C> <C> <C> <C>
At March 31, 1999 $ 890,472 $1,164 $1,672 $1,087
At December 31, 1998 959,119 1,569 9,864 6,412
</TABLE>
* Includes short-term investments and the net receivable due from Nationwide
Mutual Insurance Company on March 31, 1999.
At March 31, 1999 and December 31, 1998, 93% and 96%, respectively, 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 $5,325,000 after deferred taxes between March 31, 1999 and December
31, 1998. 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.
18
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
INVESTMENTS (CONTINUED)
The change in the carrying value of Zenith's consolidated investment portfolio
during the three months ended March 31, 1999 was as follows:
<TABLE>
(Dollars in thousands)
- ------------------------------------------------------------------------------------------------------
<S> <C> <C>
Carrying value at the beginning of the year $ 1,048,681
Purchases at cost 43,173
Investments of CalFarm at date of sale (170,050)
Net receivable from Nationwide Mutual Insurance Company 213,787
Maturities and redemptions (52,090)
Proceeds from sales of investments:
Investments available-for-sale (22,330)
Other investments (570)
--------
Total proceeds from sales of investments (22,900)
Net realized gains:
Investments available-for-sale 1,376
Other investments 158
--------
Total net realized gains 1,534
Change in unrealized gains (8,656)
Decrease in short-term investments (65,875)
Net amortization of bonds and preferred stocks and other changes (2,672)
- -------------------------------------------------------------------------------------------------------
Carrying value at March 31, 1999 $ 984,932
- -------------------------------------------------------------------------------------------------------
</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.
Net cash used in operations in the three months ended March 31, 1999 was
$26,819,000 as compared to net cash provided by operations of $3,085,000 as of
March 31, 1998. During 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 operation.
Zenith has three revolving, unsecured lines of credit amounting to $100,000,000,
all of which was available at March 31, 1999.
At March 31, 1999, Zenith was authorized to repurchase up to 1,092,000 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.
19
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
Zenith's Real Estate Operations maintain certain bank credit facilities to
provide financing for development and construction of private residences for
sale. At March 31, 1999, the maximum permitted borrowing under facilities was
$35,275,000, with a balance outstanding of $14,710,000. 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 March 31,
1999 was $1,478,000.
YEAR 2000
The Year 2000 Problem refers to the inability of information technology
("IT") and non-information technology ("non-IT") systems to accurately
process dates during and after 1999. IT systems include computer hardware and
software. Non-IT systems include equipment that incorporates embedded micro
controllers such as elevators, security systems and HVAC systems. If not
corrected, the processes of IT and non-IT systems that are date sensitive
could fail or miscalculate data resulting in disruptions of operations such
as a temporary inability to process transactions, send and receive electronic
data with third parties or otherwise engage in normal business activities.
There may also be a negative impact on the economic and social infrastructure
on which Zenith depends.
In early 1996, Zenith formed a Year 2000 team consisting of staff familiar with
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 Perma-Bilt operations ("Core Operational IT
Systems"); (3) computer networks and communications infrastructure ("IT
Infrastructure"); (4) personal and laptop computers including applications
("Other IT Equipment"); and (5) owned facility systems which rely on
non-computer equipment incorporating embedded microprocessors, such as
elevators, HVAC and security as well as office equipment such as facsimile and
copy machines and postage meters ("Facilities and Other Non-IT Systems"). The
majority of Zenith's Year 2000 compliance efforts have been staffed internally,
although Zenith has engaged and will continue to engage technical consultants to
assist its internal staff, as well as to assist Zenith in reviewing its
progress.
The Internal Systems are being corrected through a process with five phases,
some of which are concurrent: (1) Inventory (listing IT and non-IT systems and
their components); (2) Assessment (identifying possible Year 2000-related
failures and developing strategies to repair, replace, or eliminate them); (3)
Remediation (creating or acquiring corrections to identified deficiencies); (4)
Validation (confirming whether corrections would be successful); and (5)
Implementation (installing corrections into the business operations for general
use).
20
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
YEAR 2000 (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 6/30/99 6/30/99
Reinsurance Completed Completed Completed Completed Completed
Real Estate Operations Completed Completed Completed 5/31/99 5/31/99
IT Infrastructure:
- ---------------------------------------------
Workers' Compensation Completed Completed 6/30/99 7/31/99 7/31/99
Reinsurance Completed Completed 6/30/99 7/31/99 7/31/99
Real Estate Operations Completed Completed Completed Completed Completed
Other IT Equipment:
- ---------------------------------------------
Workers' Compensation Completed Completed 7/31/99 7/31/99 7/31/99
Reinsurance Completed Completed 7/31/99 7/31/99 7/31/99
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 6/30/99 8/31/99 8/31/99
</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.
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.
21
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
YEAR 2000 (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.
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 will have to be 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) 3/31/99 3/31/99 Complete Expenditure
- ----------------------------------------- ------------------ ----------------- ---------------- -------------------
<S> <C> <C> <C> <C>
IT Repair Costs $ 5,297 95% $ 300 $ 5,597
IT Replacement Costs:
Software 197 13% 1,277 1,474
Hardware 788 34% 1,528 2,316
Related Expenditures 341 51% 322 663
- ----------------------------------------- ------------------ ----------------- ---------------- -------------------
Total $ 6,623 66% $ 3,427 $10,050
- ----------------------------------------- ------------------ ----------------- ---------------- -------------------
</TABLE>
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.
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.
22
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
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.
FORWARD-LOOKING INFORMATION
The Private Securities Litigation Reform Act of 1995 provides a safe harbor for
forward-looking statements if accompanied by meaningful cautionary statements
identifying important factors that could cause actual results to differ
materially from those discussed. Forward-looking statements include those
related to the plans and objectives of management for future operations, future
economic performance, or projections of revenues, income, earnings per share,
capital expenditures, dividends, capital structure, or other financial items.
Statements containing words such as EXPECT, ANTICIPATE, BELIEVE, or similar
words that are used in Management's Discussion and Analysis of Financial
Condition and Results of Operations, in other parts of this report or in other
written or oral information conveyed by or on behalf of Zenith are intended to
identify forward-looking statements. Zenith undertakes no obligation to update
such forward-looking statements, which are subject to a number of risks and
uncertainties that could cause actual results to differ materially from those
projected. These risks and uncertainties include but are not limited to the
following: (1) heightened competition, particularly intense price competition;
(2) adverse state and federal legislation and regulation; (3) changes in
interest rates causing a reduction of investment income; (4) general economic
and business conditions which are less favorable than expected; (5)
unanticipated changes in industry trends; (6) adequacy of loss reserves; (7)
catastrophic events or the occurrence of a significant number of storms, and
wind and hail losses; (8) ability to timely and accurately complete the Year
2000 conversion process; (9) impact of any failure of third parties with whom
Zenith does business to be Year 2000 compliant; (10) uncertainties related to
the RISCORP Acquisition, including (a) the ability of Zenith to integrate on a
profitable basis the business acquired from RISCORP, (b) the value of
transferred assets and transferred liabilities, (c) the ability of Zenith to
recover any amounts from RISCORP for breaches of representations, warranties and
covenants under the Asset Purchase Agreement and (d) whether RISCORP will
contest the determination of the Final Purchase Price for the RISCORP
Acquisition and, if so, the ability of RISCORP, to prevail on any such attempt,
as well as to recover any amount from Zenith Insurance for the alleged failure
to comply with certain indemnification provisions of the Asset Purchase
Agreement; (11) changing environment for controlling medical, legal and
rehabilitation costs, as well as fraud and abuse; and (12) other risks detailed
herein and from time to time in Zenith's other reports and filings with the
Securities and Exchange Commission.
23
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As of March 31, 1999, approximately 93% 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. 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, liquid
securities and limits the amount of credit exposure to any one issuer.
The table below provides information about Zenith's financial instruments as of
March 31, 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
sinking fund preferreds, redeemable preferreds, 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 $39,470 $115,458 $69,699 $66,741 $52,570 $260,288 $604,496
Weighted average interest
rate 5.3% 5.1% 5.5% 6.0% 6.2% 7.2%
Trading Securities:
Fixed rate $2,990 $2,990
Weighted average interest
rate 5.8%
Short-term investments $69,199 $69,199
Receivable from Nationwide
Mutual Insurance Company 213,787 213,787
Debt obligations:
9% senior notes payable 6,750 $6,750 $6,750 $77,250 97,500
8.55% redeemable securities 3,207 6,413 6,413 6,413 $6,413 $232,638 261,497
Payable to banks and other
notes payable 10,279 5,600 101 59 16 397 16,452
</TABLE>
24
<PAGE>
PART II, OTHER INFORMATION
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
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)
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.)
21 Subsidiaries of Zenith.
27 Financial data schedule
(b) Reports on Form 8-K
The Registrant filed a Current Report on Form 8-K, dated February 22,
1999, on March 9, 1999 in connection with the sale by Zenith Insurance
Company of CalFarm Insurance Company to Nationwide Mutual Insurance
Company.
The Registrant filed a Current Report on Form 8-K, dated March 26,
1999, on March 30, 1999 in connection with the receipt of the report
from a neutral third party resolving certain disputed items
representing a material uncertainty with respect to the final
purchase price of the RISCORP Acquisition made by a Zenith subsidiary
on April 1, 1998.
The Registrant filed a Current Report on Form 8-K, dated March 31,
1999, on April 15, 1999 in connection with the sale by Zenith Insurance
Company of CalFarm Insurance Company to Nationwide Mutual Insurance
Company.
25
<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: May 17, 1999 /s/ Stanley R. Zax
------------------------------------
Stanley R. Zax
Chairman of the Board and President
(Principal Executive Officer)
Date: May 17, 1999 /s/ Fredricka Taubitz
------------------------------------
Fredricka Taubitz
Executive Vice President
& Chief Financial Officer
(Principal Accounting Officer)
26
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
(As of April 30, 1999)
Zenith National Insurance Corp.
Perma-Bilt, a Nevada Corporation
Zenith National Insurance Capital Trust I
Zenith Development Corp., a Nevada Corporation
Cal-Ag Insurance Service, Inc.
Zenith Insurance Company
CalRehab Services, Inc.
Zenith Star Insurance Company
ZNAT Insurance Company
Zenith Insurance Management Services, Inc.
1390 Main Street LLC, a Delaware Corporation
Each subsidiary shown is wholly-owned by the subsidiary shown in the
tier above it.
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<DEBT-HELD-FOR-SALE> 574,060
<DEBT-CARRYING-VALUE> 606,322
<DEBT-MARKET-VALUE> 607,486
<EQUITIES> 51,755
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 984,932
<CASH> 8,186
<RECOVER-REINSURE> 359,037
<DEFERRED-ACQUISITION> 9,249
<TOTAL-ASSETS> 1,655,787
<POLICY-LOSSES> 867,925
<UNEARNED-PREMIUMS> 62,115
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 90,814
0
0
<COMMON> 24,971
<OTHER-SE> 414,137
<TOTAL-LIABILITY-AND-EQUITY> 1,655,787
135,577
<INVESTMENT-INCOME> 13,325
<INVESTMENT-GAINS> 1,534
<OTHER-INCOME> 11,727
<BENEFITS> 105,490
<UNDERWRITING-AMORTIZATION> 27,230
<UNDERWRITING-OTHER> 17,199
<INCOME-PRETAX> 160,363
<INCOME-TAX> 55,963
<INCOME-CONTINUING> 104,400
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 104,400
<EPS-PRIMARY> 6.09
<EPS-DILUTED> 6.09
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
