<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 September 30, 2000
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 Identification No.]
incorporation or organization]
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 November 2, 2000, there were 17,203,000 shares of Zenith National Insurance
Corp. common stock outstanding, net of 8,009,000 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>
---------------------------------------------------------------------------------------------------------------------------
September 30, December 31,
(In thousands) 2000 1999
---------------------------------------------------------------------------------------------------------------------------
(Unaudited)
<S> <C> <C>
ASSETS:
Investments:
Fixed maturities:
At amortized cost (fair value $25,012 in 2000 and $27,186 in 1999) $ 25,172 $ 27,526
At fair value (cost $598,052 in 2000 and $657,129 in 1999) 573,511 627,375
Floating rate preferred stocks, at fair value (cost $6,799 in 2000 and
1999) 5,790 6,420
Convertible and non-redeemable preferred stocks, at fair value (cost
$3,733 in 2000 and $4,300 in 1999) 3,200 3,405
Common stocks, at fair value (cost $33,565 in 2000 and $25,428 in 1999) 32,879 25,634
Short-term investments (at cost, which approximates fair value) 116,893 179,748
Other investments 32,853 31,626
---------------- -----------------
Total investments 790,298 901,734
Cash 26,727 15,714
Accrued investment income 11,026 11,832
Premiums receivable, less allowance for doubtful accounts of $9,968 in
2000 and $10,172 in 1999 74,730 74,586
Receivable from reinsurers and state trust funds for paid and unpaid losses 307,306 343,671
Deferred policy acquisition costs 10,041 7,892
Deferred tax asset 37,081 34,601
Current federal income tax receivable 22,540
Properties and equipment, less accumulated depreciation 50,075 54,981
Intangible assets 22,641 23,207
Other assets 107,752 105,568
---------------- -----------------
TOTAL ASSETS $ 1,460,217 $ 1,573,786
================ =================
</TABLE>
(continued)
2
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET (CONTINUED)
<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------------------------
September 30, December 31,
(In thousands) 2000 1999
----------------------------------------------------------------------------------------------------------------------------------
(Unaudited)
<S> <C> <C>
LIABILITIES:
Policy liabilities and accruals:
Unpaid loss and loss adjustment expenses $ 870,988 $ 880,929
Unearned premiums 58,609 50,906
Policyholders' dividends accrued 4,322 3,375
Reserves on loss portfolio transfers 14,913 17,658
Payable to banks and other notes payable 18,934 20,238
Senior notes payable, less unamortized issue costs of $150 in 2000
and $283 in 1999 (Note 6) 58,350 74,717
Federal income tax payable 23,793
Other liabilities 59,177 74,214
---------------- -----------------
TOTAL LIABILITIES 1,085,293 1,145,830
---------------- -----------------
REDEEMABLE SECURITIES:
Company-obligated, mandatorily redeemable 8.55% 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 $1,394 in 2000 and $1,603 in 1999 (Note 6) 65,606 73,397
---------------- -----------------
Commitments and contingent liabilities (Note 3)
STOCKHOLDERS' EQUITY:
Preferred stock, $1 par - shares authorized 1,000; issued and outstanding, none
in 2000 and 1999
Common stock, $1 par - shares authorized 50,000; issued 25,212,
outstanding 17,203 in 2000; issued 25,157, outstanding 17,150 in 1999 25,212 25,157
Additional paid-in capital 276,091 274,897
Retained earnings 176,136 225,229
Accumulated other comprehensive loss - net unrealized depreciation on
investments, net of deferred tax benefit of $9,346 in 2000 and $10,768 in 1999 (17,357) (19,998)
---------------- -----------------
460,082 505,285
Treasury stock at cost (8,009 shares in 2000 and 8,007 shares in 1999) (150,764) (150,726)
---------------- -----------------
TOTAL STOCKHOLDERS' EQUITY 309,318 354,559
---------------- -----------------
TOTAL LIABILITIES, REDEEMABLE SECURITIES AND STOCKHOLDERS' EQUITY $ 1,460,217 $ 1,573,786
================ =================
</TABLE>
The accompanying notes are an integral part of this financial statement.
3
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
(In thousands, except per share data) 2000 1999 2000 1999
-------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
REVENUES:
Premiums earned $ 87,692 $ 87,110 $ 243,137 $ 298,664
Net investment income 12,861 14,229 39,422 40,500
Realized (losses) gains on investments (10,913) 2,322 (10,247) 6,387
Real estate sales 23,278 14,034 61,811 39,240
Service fee income 802 2,346
------------- ------------- ----------- -------------
Total revenues 112,918 118,497 334,123 387,137
EXPENSES:
Loss and loss adjustment expenses incurred 81,143 116,563 248,734 288,036
Policy acquisition costs 16,037 13,165 44,308 53,999
Other underwriting and operating expenses (Note 5) 10,677 31,813 34,219 64,828
Policyholders' dividends and participation 217 (954) 1,241 (12)
Real estate construction and operating costs 21,963 13,446 57,601 36,835
Interest expense 1,317 2,141 4,414 6,277
------------- ------------- ----------- -------------
Total expenses 131,354 176,174 390,517 449,963
Gain on sale of CalFarm Insurance Company 160,335
------------- ------------- ----------- -------------
(Loss) income before federal income tax (benefit)
expense and extraordinary item (18,436) (57,677) (56,394) 97,509
Federal income tax (benefit) expense, including expense of
$56,000 related to the sale of CalFarm Insurance
Company in the nine months ended September 30, 1999 (6,216) (20,377) (19,201) 33,809
------------- ------------- ----------- -------------
Net (loss) income before extraordinary item (12,220) (37,300) (37,193) 63,700
Extraordinary item - gain on extinguishment of debt,
net of federal income tax expense of $10 in the three months
and $534 in the nine months of 2000 (Note 6) 20 993
------------- ------------- ----------- -------------
NET (LOSS) INCOME $ (12,200) $ (37,300) $ (36,200) $ 63,700
============= ============= =========== =============
NET (LOSS) INCOME PER COMMON SHARE (NOTE 2) -
Basic:
Net (loss) income before extraordinary item $ (0.71) $ (2.17) $ (2.16) $ 3.71
Extraordinary item - gain on extinguishment of debt,
net of federal income tax expense 0.05
------------- ------------- ----------- -------------
Net (loss) income $ (0.71) $ (2.17) $ (2.11) $ 3.71
============= ============= =========== =============
Diluted:
Net (loss) income before extraordinary item $ (0.71) $ (2.17) $ (2.16) $ 3.71
Extraordinary item - gain on extinguishment of debt,
net of federal income tax expense 0.06
------------- ------------- ----------- -------------
Net (loss) income $ (0.71) $ (2.17) $ (2.10) $ 3.71
============= ============= =========== =============
Disclosure regarding comprehensive (loss) income:
Net (loss) income $ (12,200) $ (37,300) $ (36,200) $ 63,700
Change in unrealized depreciation on investments 10,980 (8,793) 2,641 (23,110)
------------- ------------- ----------- -------------
Comprehensive income (loss) $ (1,220) $ (46,093) $ (33,559) $ 40,590
============= ============= =========== =============
</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>
--------------------------------------------------------------------------------------------------------------------------
Nine Months Ended
September 30,
(In thousands) 2000 1999
--------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Premiums and service fee income collected $ 258,403 $ 316,259
Investment income received 38,183 38,084
Proceeds from sales of real estate 61,811 39,240
Loss and loss adjustment expenses paid (220,449) (251,323)
Underwriting and other operating expenses paid (87,407) (104,286)
Real estate construction costs paid (55,534) (46,574)
Reinsurance premiums paid (7,440) (29,320)
Interest paid (10,509) (9,584)
Income taxes paid (31,518) (2,830)
---------------- ---------------
Net cash used in operating activities (54,460) (50,334)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investments:
Investment securities available-for-sale (143,791) (349,081)
Other investments (3,872) (8,306)
Proceeds from maturities and redemptions of investments:
Fixed maturities held-to-maturity 2,321 6,371
Investment securities available-for-sale 30,275 87,276
Proceeds from sales of investments:
Investment securities available-for-sale 154,726 189,844
Other investments 2,307 6,285
Net change in short-term investments 65,545 (5,047)
Cash payment to RISCORP (54,308)
Net proceeds from sale of CalFarm Insurance Company 211,068
Capital expenditures and other, net (6,311) (11,021)
---------------- ---------------
Net cash provided by investing activities 101,200 73,081
CASH FLOWS FROM FINANCING ACTIVITIES:
Repurchase of redeemable securities (Note 6) (6,164)
Repurchase of senior notes payable (Note 6) (16,585)
Cash advanced from bank construction loans 57,430 40,433
Cash repaid on bank construction loans (58,690) (35,253)
Cash advanced from bank lines of credit 7,400
Cash repaid on bank lines of credit (12,400)
Cash dividends paid to common stockholders (12,880) (12,865)
Proceeds from exercise of stock options 1,200 3,625
Purchase of treasury shares (38) (3,126)
---------------- ---------------
Net cash used in financing activities (35,727) (12,186)
---------------- ---------------
Net increase in cash 11,013 10,561
Cash at beginning of period 15,714 1,998
---------------- ---------------
CASH AT END OF PERIOD $ 26,727 $ 12,559
================ ===============
</TABLE>
(continued)
5
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS (CONTINUED)
(UNAUDITED)
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------
Nine Months Ended
September 30,
(In thousands) 2000 1999
-------------------------------------------------------------------------------------------------------------
<S> <C> <C>
RECONCILIATION OF NET (LOSS) INCOME TO NET CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income $ (36,200) $ 63,700
Adjustments to reconcile net (loss) income to net cash used in operating
activities:
Depreciation and amortization 4,296 6,716
Realized gain on sale of CalFarm Insurance Company (160,335)
Realized losses (gains) on investments 10,247 (6,387)
Gain on extinguishment of debt (Note 6) (1,527)
Amortization of deferred gain on retroactive reinsurance contract (6,255) (9,000)
Decrease (increase) in:
Premiums receivable (144) 11,604
Receivable from reinsurers and state trust funds on paid and
unpaid losses 36,365 (13,663)
Real estate construction in progress and land held for development (5,044) (14,422)
Increase (decrease) in:
Unpaid loss and loss adjustment expenses (9,941) 43,884
Unearned premiums 7,703 (9,151)
Policyholders' dividends accrued 947 (1,749)
Federal income tax (50,186) 30,992
Other (4,721) 7,477
------------ -------------
NET CASH USED IN OPERATING ACTIVITIES $ (54,460) $ (50,334)
============ =============
</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 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 notes thereto included in the Zenith Annual Report on Form 10-K
for the year ended December 31, 1999. 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 per share data, in reporting
amounts in this statement.
Net charges in the third quarter of 1999 of $50.0 million before tax ($32.5
million after tax, or $1.89 per share) associated with an increase in the net
liabilities for unpaid losses and loss adjustment expenses acquired from RISCORP
(see Notes 3 and 4) affect the comparability of the three and nine months ended
September 30, 2000 compared to the corresponding periods in 1999. The sale of
CalFarm Insurance Company ("CalFarm"), a wholly-owned subsidiary of Zenith
Insurance Company ("Zenith Insurance"), a wholly-owned subsidiary of Zenith
National, effective March 31, 1999 affects the comparability of the nine months
ended September 30, 2000 to the corresponding period in 1999. CalFarm operated
Zenith's Other Property-Casualty Operations.
NOTE 2. EARNINGS AND DIVIDENDS PER SHARE
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
(In thousands, except per share data) 2000 1999 2000 1999
-------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
(A) Net (loss) income $(12,200) $(37,300) $(36,200) $63,700
-------------------------------------------------------------------------------------------------------------------------
(B) Weighted average outstanding
shares during the period 17,203 17,188 17,182 17,155
Additional common shares issuable
under employee stock option plans
using the treasury stock method 35 9 34 14
-------------------------------------------------------------------------------------------------------------------------
(C) Weighted average number of common
shares outstanding assuming
exercise of stock options 17,238 17,197 17,216 17,169
-------------------------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------------------------
Net (loss) income per common share -
(A)/(B) Basic $ (0.71) $ (2.17) $ (2.11) $ 3.71
(A)/(C) Diluted (0.71) (2.17) (2.10) 3.71
-------------------------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------------------------
Dividends per common share 0.25 0.25 0.75 0.75
-------------------------------------------------------------------------------------------------------------------------
</TABLE>
7
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 3. CONTINGENT LIABILITIES
RISCORP LITIGATION
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 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. That report indicated that
the value of the assets transferred to Zenith Insurance exceeded the value of
the liabilities assumed by Zenith Insurance by $92.3 million.
Zenith Insurance and RISCORP 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 agreed, among other things, that
RISCORP may request that the Neutral Auditor and Neutral Actuary (a) 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 RISCORP may have to
litigation of such issue, (b) determine whether the issue was properly in
dispute before the Neutral Auditor and Neutral Actuary and (c), if so,
determine the merits of the issue and whether a correction is appropriate. In
a submission made to the Neutral Auditor and Neutral Actuary, RISCORP claimed
that the purchase price for the RISCORP Acquisition should be adjusted by
either $5.9 million or $23.4 million as a result of alleged errors in the
original determination of the Neutral Auditor and Neutral Actuary with
respect to the purchase price. On October 7, 1999, the Neutral Auditor and
Neutral Actuary informed Zenith Insurance and RISCORP that it would not
consider the issue raised by RISCORP because the issue had not previously
been raised as a dispute pursuant to the procedures set forth in the
engagement letter. On January 13, 2000, RISCORP filed a complaint against
Zenith Insurance and the Neutral Auditor and Neutral Actuary in the Superior
Court of Fulton County in the State of Georgia. On October 9, 2000, RISCORP
filed a First Amended Complaint in the Superior Court of Fulton County.
RISCORP's First Amended Complaint alleges causes of action for breach of
contract against the Neutral Auditor and Neutral Actuary and, in conjunction,
seeks a declaration that could have the effect of requiring Zenith to pay
either $18.1 million (and related charges) or $5.9 million. RISCORP also has
asserted causes of action for professional negligence solely against the
Neutral Auditor and Neutral Actuary in which it seeks damages of either $18.1
million (and related charges) or $5.9 million. Zenith is unable to predict
the outcome of this litigation.
8
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 3. CONTINGENT LIABILITIES (CONTINUED)
CONTINGENCIES SURROUNDING RECOVERABILITY OF STATE DISABILITY TRUST FUND
RECEIVABLES
In Florida, the Special Disability Trust Fund (the "Fund") assesses workers'
compensation insurers to pay for what are commonly referred to as "Second
Injuries". Historic assessments have been inadequate to completely fund
obligations of the Fund. In late 1997, the Florida statute was amended so that
the Fund will not be liable for and will not reimburse employers or carriers for
Second Injuries occurring on or after January 1, 1998. Zenith Insurance has
recorded its receivable from the Fund for Second Injuries based on specific
claims and historical experience prior to January 1, 1998. At September 30, 2000
and December 31, 1999, the receivable from the Fund was $32.2 million and $37.0
million, respectively.
OTHER LITIGATION
Other than the RISCORP litigation described above, Zenith National and its
subsidiaries are defendants in various other litigation. In the opinion of
management, after consultation with legal counsel, such litigation is either
without merit or the ultimate liability, if any, will not have a material
adverse effect on the consolidated financial condition or results of operations
of Zenith.
NOTE 4. RISCORP-RELATED ADJUSTMENT
In October of 1999, Zenith Insurance completed a review of the liabilities
for unpaid losses and loss adjustment expenses in its Southeast Operations,
which principally consists of the operations acquired from RISCORP. The
review was conducted with assistance from independent actuarial consultants.
As a result of the review, Zenith Insurance recorded, in the third quarter of
1999, net charges of $50.0 million before tax ($32.5 million after tax)
associated with an increase in the estimated net liabilities for unpaid
losses and loss adjustment expenses acquired from RISCORP. See Note 11 of the
Notes to Consolidated Financial Statements included in the Zenith Annual
Report on Form 10K for the year ended December 31, 1999 for a full
description of the RISCORP-Related Adjustment recorded in 1999.
9
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 5. TERMINATION COSTS
The nine months ended September 30, 2000 include $1.8 million before tax of
severance costs incurred in the first quarter associated with the termination
provisions of an employment contract of a company officer.
NOTE 6. EXTRAORDINARY ITEM - GAIN ON EXTINGUISHMENT OF DEBT
In 2000, Zenith National paid $22.8 million to repurchase $16.5 million
aggregate principal amount of the outstanding 9% Senior Notes due 2002 (the "9%
Notes") and $8.0 million aggregate liquidation amount of the outstanding 8.55%
Capital Securities (the "Redeemable Securities") of the Zenith National
Insurance Capital Trust I, a Delaware statutory business trust, all of the
voting securities of which are owned by Zenith National. The repurchases
resulted in an extraordinary gain before tax of $1.5 million, principally in the
first quarter. Zenith National used its available cash balances to fund these
purchases.
NOTE 7. RECENTLY ISSUED ACCOUNTING STANDARDS
On June 15, 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 ("SFAS No. 133"), "Accounting for
Derivative Instruments and Hedging Activities". SFAS No. 133 is effective for
all fiscal years beginning after June 15, 2000. SFAS No. 133 requires, among
other things, that companies record all derivative instruments on the balance
sheet at fair value. Changes in the fair value of derivatives will be required
to be recorded each period in current earnings or other comprehensive income,
depending on the nature of the derivative. Zenith believes that adoption of SFAS
No. 133 will not have a material effect on its results of operations or
financial position.
10
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 8. SEGMENT INFORMATION
Segment information is set forth below:
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------
Other Real
Workers' Property- Estate
(Dollars in thousands) Compensation Casualty (1) Reinsurance Operations Investments Parent Total
------------------------------------------------------------------------------------------------------------------------------------
For the Nine Months Ended September 30, 2000
------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues:
Premiums earned $216,045 $27,092 $ 243,137
Net investment income $ 39,422 39,422
Realized losses on investments (10,247) (10,247)
Real estate sales $ 61,811 61,811
------------------------------------------------------------------------------------------------------------------------------------
Total revenues 216,045 27,092 61,811 29,175 334,123
------------------------------------------------------------------------------------------------------------------------------------
Interest expense $ (4,414) (4,414)
------------------------------------------------------------------------------------------------------------------------------------
(Loss) income before income
tax and extraordinary item (66,629) (14,003) 4,210 29,175 (9,147) (56,394)
Federal income tax (benefit)
expense (22,563) (4,742) 1,473 9,832 (3,201) (19,201)
------------------------------------------------------------------------------------------------------------------------------------
Net (loss) income before
extraordinary item (44,066) (9,261) 2,737 19,343 (5,946) (37,193)
Extraordinary item - gain on
extinguishment of debt (net
of income tax of $534) 993 993
------------------------------------------------------------------------------------------------------------------------------------
Net (loss) income (44,066) (9,261) 2,737 19,343 (4,953) (36,200)
------------------------------------------------------------------------------------------------------------------------------------
Combined ratios 130.8% 151.7% 133.2%
------------------------------------------------------------------------------------------------------------------------------------
Total assets $502,753 $31,032 $ 91,814 $ 828,051 $ 6,567 $1,460,217
------------------------------------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------------------------------
For the Nine Months Ended September 30, 1999
------------------------------------------------------------------------------------------------------------------------------------
Revenues:
Premiums earned $217,461 $ 54,108 $27,095 $ 298,664
Net investment income $ 40,500 40,500
Realized gains on investments 6,387 6,387
Real estate sales $39,240 39,240
Service fee income 2,346 2,346
------------------------------------------------------------------------------------------------------------------------------------
Total revenues 219,807 54,108 27,095 39,240 46,887 387,137
------------------------------------------------------------------------------------------------------------------------------------
Interest expense $ (6,277) (6,277)
------------------------------------------------------------------------------------------------------------------------------------
(Loss) income before income
tax and gain on sale of (22) (2,447) 2,406 46,887 (9,276) (62,826)
CalFarm (100,374)
Gain on sale of CalFarm
before income tax 160,335 160,335
Federal income tax (benefit)
expense (34,590) 55,993 (830) 842 15,640 (3,246) 33,809
------------------------------------------------------------------------------------------------------------------------------------
Net (loss) income (65,784) 104,320 (1,617) 1,564 31,247 (6,030) 63,700
------------------------------------------------------------------------------------------------------------------------------------
Combined ratios 146.2% 100.0% 109.0% 134.4%
------------------------------------------------------------------------------------------------------------------------------------
Total assets $558,826 $30,137 $ 81,663 $ 948,833 $ 9,532 $1,628,991
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) The Other Property-Casualty Operations were operated by CalFarm which was
sold, effective March 31, 1999.
11
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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 National Insurance Corp. ("Zenith National") and
subsidiaries (collectively, "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 fluctuations of investment income and fair values of
investments; (4) changes in the frequency and severity of claims and
catastrophes; (5) adequacy of loss reserves; (6) changing environment for
controlling medical, legal and rehabilitation costs, as well as fraud and
abuse; and (7) other risks detailed herein and from time to time in Zenith's
other reports and filings with the Securities and Exchange Commission.
OVERVIEW
The comparative components of net (loss) income after tax are set forth in the
following table:
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
(In thousands) 2000 1999 2000 1999
-----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net investment income $ 8,473 $ 9,546 $ 26,003 $ 27,095
Realized (losses) gains on investments (7,093) 1,510 (6,660) 4,152
-----------------------------------------------------------------------------------------------------------------------------
Sub-total 1,380 11,056 19,343 31,247
-----------------------------------------------------------------------------------------------------------------------------
Property-casualty underwriting results:
Loss excluding catastrophes (11,721) (11,018) (40,002) (27,831)
Catastrophe losses (1,300) (3,120) (13,325) (7,085)
RISCORP-Related Adjustment (32,500) (32,500)
-----------------------------------------------------------------------------------------------------------------------------
Property-casualty underwriting loss (13,021) (46,638) (53,327) (67,416)
-----------------------------------------------------------------------------------------------------------------------------
Income from Real Estate Operations 856 383 2,737 1,564
Interest expense (856) (1,392) (2,869) (4,080)
Parent expenses (579) (709) (3,077) (1,950)
-----------------------------------------------------------------------------------------------------------------------------
Net loss before gain on sale of CalFarm Insurance
Company and extraordinary item (12,220) (37,300) (37,193) (40,635)
Gain on sale of CalFarm Insurance Company 104,335
Extraordinary item - gain on extinguishment of debt 20 993
-----------------------------------------------------------------------------------------------------------------------------
Net (loss) income $(12,200) $(37,300) $(36,200) $ 63,700
-----------------------------------------------------------------------------------------------------------------------------
</TABLE>
12
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
Net charges in the third quarter of 1999 of $50.0 million before tax ($32.5
million after tax, or $1.89 per share) associated with an increase in the net
liabilities for unpaid losses and loss adjustment expenses acquired from RISCORP
(the "RISCORP-Related Adjustment") affect the comparability of the three and
nine months ended September 30, 2000 compared to the corresponding periods in
1999. The sale of CalFarm Insurance Company ("CalFarm"), a wholly-owned
subsidiary of Zenith Insurance Company ("Zenith Insurance"), a wholly-owned
subsidiary of Zenith National, effective March 31, 1999 affects the
comparability of the nine months ended September 30, 2000 to the corresponding
period in 1999. CalFarm operated Zenith's Other Property-Casualty Operations.
The comparative results of the property-casualty operations (the "P&C
Operations") before tax were as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
(Dollars in thousands) 2000 1999 2000 1999
------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Premiums earned:
Workers' Compensation:
California $ 36,472 $ 25,652 $ 97,397 $ 81,795
Outside California 40,987 52,042 118,648 135,666
---------------- ---------------- -------------- ---------------
Total Workers' Compensation 77,459 77,694 216,045 217,461
Other Property-Casualty 54,108
Reinsurance 10,233 9,416 27,092 27,095
---------------- ---------------- -------------- ---------------
Total $ 87,692 $ 87,110 $ 243,137 $ 298,664
================ ================ ============== ===============
Underwriting (loss) income before tax:
Workers' Compensation $ (19,556) $ (70,506) $ (66,629) $(100,374)
Other Property-Casualty (22)
Reinsurance 63 (1,081) (14,003) (2,447)
---------------- ---------------- -------------- ---------------
Total $ (19,493) $ (71,587) $ (80,632) $(102,843)
================ ================ ============== ===============
Combined loss and expense ratios:
Workers' Compensation:
Loss and loss adjustment expenses 93.9% 138.5% 97.8% 104.2%
Underwriting expenses 31.3% 52.2% 33.0% 42.0%
---------------- ---------------- -------------- ---------------
Combined ratio 125.2% 190.7% 130.8% 146.2%
Other Property-Casualty:
Loss and loss adjustment expenses 66.5%
Underwriting expenses 33.5%
---------------
Combined ratio 100.0%
Reinsurance:
Loss and loss adjustment expenses 82.4% 94.6% 138.1% 93.9%
Underwriting expenses 17.0% 16.9% 13.6% 15.1%
---------------- ---------------- -------------- ---------------
Combined ratio 99.4% 111.5% 151.7% 109.0%
Total:
Loss and loss adjustment expenses 92.6% 133.8% 102.3% 96.4%
Underwriting expenses 29.6% 48.4% 30.9% 38.0%
---------------- ---------------- -------------- ---------------
Combined ratio 122.2% 182.2% 133.2% 134.4%
================ ================ ============== ===============
</TABLE>
13
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
The comparative results of the P&C Operations before tax and excluding the
RISCORP-Related Adjustment were as follows:
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
(Dollars in thousands) 2000 1999 2000 1999
------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Premiums earned:
Workers' Compensation:
California $ 36,472 $ 25,652 $ 97,397 $ 81,795
Outside California 40,987 45,442 118,648 129,066
---------------- ---------------- -------------- ---------------
Total Workers' Compensation 77,459 71,094 216,045 210,861
Other Property-Casualty 54,108
Reinsurance 10,233 9,416 27,092 27,095
---------------- ---------------- -------------- ---------------
Total $ 87,692 $ 80,510 $ 243,137 $ 292,064
================ ================ ============== ===============
Underwriting (loss) income before tax:
Workers' Compensation $ (19,556) $ (20,506) $ (66,629) $ (50,374)
Other Property-Casualty (22)
Reinsurance 63 (1,081) (14,003) (2,447)
---------------- ---------------- -------------- ---------------
Total $ (19,493) $ (21,587) $ (80,632) $ (52,843)
================ ================ ============== ===============
Combined loss and expense ratios:
Workers' Compensation:
Loss and loss adjustment expenses 93.9% 90.9% 97.8% 87.1%
Underwriting expenses 31.3% 37.9% 33.0% 36.8%
---------------- ---------------- -------------- ---------------
Combined ratio 125.2% 128.8% 130.8% 123.9%
Other Property-Casualty:
Loss and loss adjustment expenses 66.5%
Underwriting expenses 33.5%
---------------
Combined ratio 100.0%
Reinsurance:
Loss and loss adjustment expenses 82.4% 94.6% 138.1% 93.9%
Underwriting expenses 17.0% 16.9% 13.6% 15.1%
---------------- ---------------- -------------- ---------------
Combined ratio 99.4% 111.5% 151.7% 109.0%
Total:
Loss and loss adjustment expenses 92.6% 91.4% 102.3% 83.9%
Underwriting expenses 29.6% 35.4% 30.9% 34.2%
---------------- ---------------- -------------- ---------------
Combined ratio 122.2% 126.8% 133.2% 118.1%
================ ================ ============== ===============
</TABLE>
Results of the P&C Operations are being adversely impacted by intense
competition and increasing average claim costs, or severity of losses, in the
Workers' Compensation Operations and by adverse development of estimates of
the impact of 1999 catastrophe losses in the Reinsurance Operations.
14
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
WORKERS' COMPENSATION
Following is a discussion of results of the Workers' Compensation Operations as
set forth on page 14 excluding the impact of the RISCORP-Related Adjustment in
the three and nine months ended September 30, 1999.
Intense competition and inadequate premium rates are adversely affecting the
national workers' compensation industry. Industry data indicates a national
trend of increasing claims severity. To date, premium rates have not kept pace
with the trend of increasing severity. Industry organizations such as the
National Council on Compensation Insurance, Inc. and the California Workers'
Compensation Insurance Rating Bureau have reported that their analyses of the
data show that the liabilities for unpaid loss and loss adjustment expenses as
estimated and reported by the industry are significantly inadequate. The
estimated accident year combined ratio in 1999 was about 135% for the national
workers' compensation industry and about 153% for the California workers'
compensation industry, including a 1999 accident year loss ratio of about 115%.
Zenith's inforce workers' compensation premiums decreased consistently in the
several years ended December 31, 1999 as a result of Zenith's endeavors
during that period to maintain rate adequacy in the face of intense
competition in the national workers' compensation insurance industry.
Competitive pricing conditions improved in California and Zenith has steadily
increased its inforce premiums in California by about 10% at September 30,
2000 compared to June 30, 2000 and by about 44% at September 30, 2000
compared to December 31, 1999. Outside of California, where competition and
pricing are improving only moderately and only in certain geographical areas,
Zenith's inforce premiums increased by about 5%, principally during the third
quarter of 2000. As a result, premiums earned in the Workers' Compensation
Operations increased in the three and nine months ended September 30, 2000
compared to the corresponding periods in 1999.
Underwriting losses in the Workers' Compensation Operations were comparable
between the third quarter of 2000 and the third quarter of 1999 and increased in
the nine months ended September 30, 2000 compared to the corresponding period in
1999, principally because of a higher loss ratio in 2000. The increase in the
loss ratio is due to the trend of increasing severity of claims in Zenith's
Workers' Compensation Operations over the past two years, offset partially by a
decrease in frequency of claims and by rate increases in California, effective
January 1, 2000. Zenith continually monitors loss development trends and data to
establish adequate rates and loss reserves. In the second quarter of 2000,
Zenith increased its estimate of California losses for prior years, principally
for 1999, and about $4.5 million of reserve strengthening is included in the
loss ratio and underwriting loss for the nine months ended September 30, 2000.
Calendar year and accident year loss ratios for the third quarter of 2000 are
consistent with each other.
15
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
In California, Zenith increased workers' compensation rates by approximately 10%
effective September 1, 2000. Elsewhere, Zenith is continuing to monitor trends
in loss costs and will take appropriate action on rates when necessary. Zenith
expects that the profitability of its Workers' Compensation Operations will be
dependent upon general levels of competition, industry pricing and management's
ability to estimate the impact of any continuing adverse claim severity trends
on the adequacy of loss reserves and premium rates.
OTHER PROPERTY-CASUALTY
The Other Property-Casualty Operations were 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 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.
REINSURANCE
The Reinsurance Operations principally consist of world-wide assumed reinsurance
of property losses from catastrophes and large property risks. The Reinsurance
Operations for the three and nine months ended September 30, 2000 were adversely
impacted by $2.0 million and $20.5 million, respectively, of catastrophe losses
before tax compared to catastrophe losses of $4.8 million and $10.9 million,
respectively, for the corresponding periods in 1999. Catastrophe losses
impacting the results in 2000 were attributable to increased estimates of losses
that occurred in 1999, in particular the storms at the end of December 1999 in
France. In addition to the French storms, 1999 was characterized by frequent,
global catastrophes of a moderate size. Estimates of the impact of the 1999
catastrophes on the Reinsurance Operations are based on the information that is
currently available and such estimates could change based on new information
that becomes available or based upon reinterpretation of existing information.
REAL ESTATE OPERATIONS
The Real Estate Operations recognized total revenues for the three and nine
months ended September 30, 2000 of $23.3 million and $61.8 million,
respectively, as compared to total revenues of $14.0 million and $39.2
million, respectively, for the corresponding periods in 1999. Revenues and
operating income for the three and nine months ended September 30, 2000
benefited from an increase in the number of home sales compared to the
corresponding periods in 1999 (number of sales were 129 and 341 for the three
and nine months ended September 30, 2000, respectively, compared to 86 and
255, respectively, for the corresponding periods in 1999). The Real Estate
Operations' revenues in 2000 also benefited from a higher average selling
price per home compared to 1999. Construction in progress, including
undeveloped land, was $92.5 million and $87.9 million at September 30, 2000
and December 31, 1999, respectively.
16
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
INVESTMENTS
The change in the carrying value of Zenith's investment portfolio in 2000 was as
follows:
<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------
(In thousands)
----------------------------------------------------------------------------------------------------
<S> <C>
Carrying value at the beginning of the year $ 901,734
Purchases at cost 147,663
Maturities and redemptions (32,596)
Proceeds from sales of investments (157,033)
Net realized losses (10,247)
Change in unrealized gains and losses, net 4,063
Net change in short-term investments (65,545)
Net accretion of bonds and preferred stocks and other changes 2,259
----------------------------------------------------------------------------------------------------
Carrying value at September 30, 2000 $ 790,298
----------------------------------------------------------------------------------------------------
</TABLE>
Zenith's investment portfolio decreased in the nine months ended September 30,
2000 principally to fund the use of cash in operations and the repurchases of
outstanding debt described below.
In 2000, Zenith National paid $22.8 million to repurchase $16.5 million
aggregate principal amount of the outstanding 9% Senior Notes due 2002 (the "9%
Notes") and $8.0 million aggregate liquidation amount of the outstanding 8.55%
Capital Securities (the "Redeemable Securities") of the Zenith National
Insurance Capital Trust I, a Delaware statutory business trust, all of the
voting securities of which are owned by Zenith National. The repurchases
resulted in an extraordinary gain before tax of $1.5 million.
Bonds with an investment grade rating represented 94% and 95% of the carrying
values of bonds at September 30, 2000 and December 31, 1999, respectively. The
average maturity of the investment portfolio was 5.7 years at September 30, 2000
and December 31, 1999.
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 Nine Months Ended
September 30, September 30,
2000 1999 2000 1999
--------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Investment yield before tax 6.1% 6.0% 6.0% 5.6%
Investment yield after tax 4.0% 4.0% 3.9% 3.7%
--------------------------------------------------------------------------------------------------------------------
</TABLE>
17
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
At September 30, 2000 and December 31, 1999, 96% of Zenith's portfolio of fixed
maturity investments, including short-term investments, was 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 classified as available-for-sale resulted in an increase in
stockholders' equity of $3.4 million after deferred tax from December 31, 1999
to September 30, 2000. The unrealized loss on held-to-maturity and
available-for-sale fixed maturity investments were as follows:
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------
HELD-TO-MATURITY AVAILABLE-FOR-SALE
---------------- ------------------
(In thousands) BEFORE TAX BEFORE TAX AFTER TAX
---------------------------------------------------------------------------------------
<S> <C> <C> <C>
At September 30, 2000 $ (160) $ (24,497) $ (15,924)
At December 31, 1999 (340) (29,698) (19,304)
---------------------------------------------------------------------------------------
</TABLE>
When, in the opinion of management, a decline in the fair value of an investment
is considered to be "other than temporary", such investment is written down to
its net realizable value. The determination of "other than temporary" includes,
in addition to other relevant factors, a presumption that if the market value is
below cost by a significant amount for a period of time, a write down is
necessary. During the three and nine months ended September 30, 2000, Zenith
wrote-down $11.1 million and $15.2 million, respectively, before tax related to
such other than temporary declines.
PARENT
The nine months ended September 30, 2000 include $1.8 million before tax of
severance costs incurred in the first quarter associated with the termination
provisions of an employment contract of a company officer.
LIQUIDITY AND CAPITAL RESOURCES
The P&C Operations generally create liquidity because insurance premiums are
collected prior to disbursements for claims and other policy benefits. Collected
premiums may be invested, principally in fixed maturity securities, prior to
their use in such disbursements and investment income provides additional cash
receipts. Claim payments may take place many years after the collection of
premiums and in certain periods in which disbursements for claims and benefits,
current acquisition costs and current operating and other expenses exceed
operating cash receipts, cash flow is negative. Such negative cash flow is
offset by cash flow from investments, principally from short-term investments
and maturities of longer-term investments. The exact timing of the payment of
claims and benefits cannot be predicted with certainty and the P&C Operations
maintain portfolios of invested assets with varying maturities and a substantial
amount of short term investments to provide adequate cash for the payment of
claims. At September 30, 2000 and December 31, 1999, cash and short term
investments in the P&C Operations amounted to $70.1 million and $92.1 million,
respectively.
18
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
In the nine months ended September 30, 2000, payment of income taxes for 1999,
including $56.0 million associated with the gain on sale of CalFarm, reduced
cash flow from operations. In the corresponding period in 1999, $54.3 million of
cash was used to pay the balance of the purchase price for the RISCORP
Acquisition and net proceeds of approximately $211.0 million were received from
Nationwide Mutual Insurance Company in connection with the sale of CalFarm.
Zenith National requires cash to pay any dividends declared to its stockholders,
pay interest and principal on its outstanding debt obligations and pay its
operating expenses. Such cash requirements are generally funded in the long run
by dividends received from Zenith Insurance and financing or refinancing
activities by Zenith National. In 2000, Zenith National received $10.0 million
of such dividend payments. In 1999, Zenith National received $130.0 million of
such dividend payments, including a dividend of $100.0 million paid from the
gain on the sale of CalFarm and with the prior approval of the California
Department of Insurance. As a result of such dividend payments, Zenith National
has available cash and short-term investments, which currently significantly
exceed its short-term cash requirements. Cash, short-term investments and other
available assets in Zenith National amounted to $100.7 million and $128.3
million at September 30, 2000 and December 31, 1999, respectively. Investment
income from its investment portfolio also provides a current source of cash to
Zenith National.
The level of capital in the P&C Operations is maintained relative to
standardized capital adequacy measures such as risk based capital where
ratios such as net premiums written to statutory surplus measure capital
adequacy. Risk based capital is used by regulators for regulatory financial
surveillance purposes and by rating agencies to assign financial strength
ratings to the P&C Operations and ratings for the debt issued by Zenith
National. From time to time, the level of capitalization of the P&C
Operations may be increased by contributions from Zenith National, for
example to support an acquired business such as the RISCORP Acquisition in
1998, or reduced through an approved dividend payment such as the dividend in
1999 that followed the sale of CalFarm. In the first quarter of 2000,
Zenith's financial strength and debt ratings were reduced by Moody's and
Standard & Poor's ("S&P"), principally over concerns about continuing
operating losses in the P&C Operations. In August 2000, S&P affirmed its
ratings of Zenith, but changed its outlook for Zenith to "negative" and
Moody's also changed its outlook for Zenith to "negative" at the same time
making no changes to Zenith's ratings. Both rating agencies cited continuing
concerns about the operating performance of the P&C Operations. In the second
quarter of 2000, A. M. Best Company reduced the rating of the P&C Operations
from A+ (Superior) to A (Excellent). The actions of such rating agencies have
had no material impact on Zenith's operations. Because of the available cash
and short-term investments and available lines of credit in Zenith National,
Zenith National has the flexibility, if necessary, to contribute capital to
the P&C Operations.
19
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
From time to time, Zenith may make repurchases of its outstanding common shares
or outstanding debt. At September 30, 2000, Zenith National was authorized to
repurchase up to 938,000 shares of its 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 National's existing sources of
liquidity. In 2000, Zenith National paid $22.8 million to repurchase $16.5
million aggregate principal amount of the outstanding 9% Notes and $8.0 million
aggregate liquidation amount of the outstanding Redeemable Securities. Zenith
National used its available cash balances to fund these purchases.
At September 30, 2000, Zenith National had two revolving, unsecured lines of
credit in an aggregate amount of $70.0 million, all of which was available at
September 30, 2000. Under these agreements, certain restrictive covenants apply,
including the maintenance of certain financial ratios.
The Real Estate Operations maintain certain bank credit facilities to provide
financing for development and construction of single-family residences for
sale. At September 30, 2000 and December 31, 1999, $17.1 million and $17.7
million, respectively, was outstanding under these facilities. The Real
Estate Operations are obligated under various loans and notes payable arising
from the purchase of several parcels of property. The balance outstanding
with respect to these loans and notes was $1.9 million and $2.5 million at
September 30, 2000 and December 31, 1999, respectively. Zenith National also
finances the land acquisitions of its Real Estate Operations through
inter-company loans.
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
Codification provides guidance for the areas where statutory accounting has been
silent and changes current statutory accounting in some areas. The NAIC
established January 1, 2001 as the effective date of the Codification.
The California Department of Insurance has adopted the Codification. Zenith
believes that the Codification, as currently constituted, will not have a
material impact on the statutory capital and surplus of the P&C Operations.
20
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
RECENTLY ISSUED ACCOUNTING STANDARDS
On June 15, 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 ("SFAS No. 133"), "Accounting for
Derivative Instruments and Hedging Activities". SFAS No. 133 is effective for
all fiscal years beginning after June 15, 2000. SFAS No. 133 requires, among
other things, that companies record all derivative instruments on the balance
sheet at fair value. Changes in the fair value of derivatives will be required
to be recorded each period in current earnings or other comprehensive income,
depending on the nature of the derivative. Zenith believes that adoption of SFAS
No. 133 will not have a material effect on its results of operations or
financial position.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The table below provides information about financial instruments as of
September 30, 2000 for which fair values are subject to changes in interest
rates. For fixed maturity investments, the table presents fair value of
investments held and weighted average interest rates on such investments by
expected maturity dates. Such investments include redeemable preferred stock,
corporate bonds, municipal bonds, government bonds and mortgage backed
securities. For debt obligations, the table presents principal cash flows by
expected maturity dates and interest.
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------------------------
Expected Maturity Date
-----------------------------------------------------------------------------------------
(Dollars in thousands) 2000 2001 2002 2003 2004 Thereafter Total
-------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Fixed maturities:
Held-to-maturity and
available-for-sale securities:
Fixed rate $ 13,597 $116,169 $62,369 $38,677 $35,203 $329,561 $595,576
Weighted average interest rate 5.9% 6.4% 6.5% 9.5% 7.7% 8.5% 7.9%
Trading securities:
Fixed rate $ 2,947 $2,947
Weighted average interest rate 7.3% 7.3%
Short-term investments $116,893 $116,893
Debt and interest obligations:
Payable to banks and other
notes payable 5,440 $ 11,906 $ 2,829 $ 34 $ 406 20,615
Senior notes payable 2,633 5,265 61,133 69,031
Redeemable securities 5,729 5,729 5,729 5,729 $204,496 227,412
-------------------------------------------------------------------------------------------------------------------------------
</TABLE>
21
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
PART II, OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
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 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. That report indicated that
the value of the assets transferred to Zenith Insurance exceeded the value of
the liabilities assumed by Zenith Insurance by $92.3 million.
Zenith Insurance and RISCORP 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 agreed, among other things, that RISCORP
may request that the Neutral Auditor and Neutral Actuary (a) 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 RISCORP may have to litigation of such issue,
(b) determine whether the issue was properly in dispute before the Neutral
Auditor and Neutral Actuary and (c), if so, determine the merits of the issue
and whether a correction is appropriate. In a submission made to the Neutral
Auditor and Neutral Actuary, RISCORP claimed that the purchase price for the
RISCORP Acquisition should be adjusted by either $5.9 million or $23.4 million
as a result of alleged errors in the original determination of the Neutral
Auditor and Neutral Actuary with respect to the purchase price. On October 7,
1999, the Neutral Auditor and Neutral Actuary informed Zenith Insurance and
RISCORP that it would not consider the issue raised by RISCORP because the issue
had not previously been raised as a dispute pursuant to the procedures set forth
in the engagement letter. On January 13, 2000, RISCORP filed a complaint against
Zenith Insurance and the Neutral Auditor and Neutral Actuary in the Superior
Court of Fulton County in the State of Georgia. On October 9, 2000, RISCORP
filed a First Amended Complaint in the Superior Court of Fulton County.
RISCORP's First Amended Complaint alleges causes of action for breach of
contract against the Neutral Auditor and Neutral Actuary and, in conjunction,
seeks a declaration that could have the effect of requiring Zenith to pay
either $18.1 million (and related charges) or $5.9 million. RISCORP also has
asserted causes of action for professional negligence solely against the
Neutral Auditor and Neutral Actuary in which it seeks damages of either $18.1
million (and related charges) or $5.9 million. Zenith is unable to predict
the outcome of this litigation.
22
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
<TABLE>
<S> <C>
3.1 Certificate of Incorporation of Zenith National Insurance Corp., dated
May 28, 1971. (Incorporated by reference to Exhibit 3.1 to Zenith's
Quarterly Report on Form 10-Q for the quarter ended June 30, 2000.)
3.2 Certificate of Amendment of Certificate of Incorporation of Zenith
National Insurance Corp., dated September 12, 1977. (Incorporated by
reference to Exhibit 3.2 to Zenith's Quarterly Report on Form 10-Q for
the quarter ended June 30, 2000.)
3.3 Certificate of Amendment of Certificate of Incorporation of Zenith
National Insurance Corp., dated May 31, 1979. (Incorporated by
reference to Exhibit 3.3 to Zenith's Quarterly Report on Form 10-Q for
the quarter ended June 30, 2000.)
3.4 Certificate of Amendment of Certificate of Incorporation of Zenith
National Insurance Corp., dated September 6, 1983. (Incorporated by
reference to Exhibit 3.4 to Zenith's Quarterly Report on Form 10-Q for
the quarter ended June 30, 2000.)
3.5 Certificate of Designation of Zenith National Insurance Corp., dated
September 10, 1985. (Incorporated by reference to Exhibit 3.5 to
Zenith's Quarterly Report on Form 10-Q for the quarter ended June 30,
2000.)
3.6 Certificate of Amendment of Certificate of Incorporation of Zenith
National Insurance Corp., dated November 22, 1985. (Incorporated by
reference to Exhibit 3.6 to Zenith's Quarterly Report on Form 10-Q for
the quarter ended June 30, 2000.)
3.7 Certificate of Amendment of Certificate of Incorporation of Zenith
National Insurance Corp., dated May 19, 1987. (Incorporated by
reference to Exhibit 3.7 to Zenith's Quarterly Report on Form 10-Q for
the quarter ended June 30, 2000.)
3.8 Certificate of Change of Address of Registered Office and of Registered
Agent of Zenith National Insurance Corp., dated October 10, 1989.
(Incorporated by reference to Exhibit 3.8 to Zenith's Quarterly Report
on Form 10-Q for the quarter ended June 30, 2000.)
3.9 By-laws of Zenith National Insurance Corp., as currently in effect
(incorporated by reference to Exhibit 3.3 to Zenith National Insurance
Corp.'s Annual Report on Form 10-K for the year ended December 31,
1999).
10.1 Seventh Amendment to Credit Agreement, dated September 19, 2000, between
Zenith National Insurance Corp. and Bank of America, N. A.
11 Statement re computation of per share earnings. (Note 2 to Consolidated
Financial Statements (Unaudited) included in Item 1 of Part I of this
Quarterly Report on Form 10-Q is incorporated herein by reference.)
</TABLE>
23
<PAGE>
ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (CONTINUED)
27 Financial data schedule
(b) Reports on Form 8-K
Zenith filed no Current Reports on Form 8-K during the quarter ended September
30, 2000.
24
<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: November 13, 2000 /s/ STANLEY R. ZAX
------------------------------------
Stanley R. Zax
Chairman of the Board and President
(Principal Executive Officer)
Date: November 13, 2000 /s/ WILLIAM J. OWEN
------------------------------------
William J. Owen
Senior Vice President
& Chief Financial Officer
(Principal Accounting Officer)
25
