As filed with the Securities and Exchange Commission on September 4, 1998
REGISTRATION NO. 333-
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------
FORM SB-2
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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NORTH EAST INSURANCE COMPANY
(Name of small business issuer in its charter)
MAINE 6331 01-0278387
(State of (Primary Standard Industrial (IRS Employer
Incorporation) Classification Code Number) I.D. Number)
482 PAYNE ROAD
SCARBOROUGH, MAINE 04074
(207) 883-2232
(Address and Telephone Number of Principal Executive Office
and Principal Place of Business)
ROBERT G. SCHATZ
PRESIDENT AND CHIEF EXECUTIVE OFFICER
482 PAYNE ROAD
SCARBOROUGH, MAINE 04074
(207) 883-2232
(Name, Address and Telephone Number of Agent for Service)
Copies to:
GREGORY S. FRYER, ESQ.
VERRILL & DANA, LLP
ONE PORTLAND SQUARE
PORTLAND, MAINE 04112-0586
(207) 774-4000
APPROXIMATE DATE OF PROPOSED SALE TO THE PUBLIC: As soon as practicable after
this Registration Statement becomes effective.
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act please check the following
<PAGE>
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ] __________
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ] __________
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ] __________
If delivery of the prospectus is expected to be made pursuant to
Rule 434, please check the following box. [ ]
CALCULATION OF REGISTRATION FEE
PROPOSED
MAXIMUM PROPOSED
TITLE OF EACH CLASS AMOUNT OFFERING MAXIMUM
OF SECURITIES TO BE PRICE AGGREGATE AMOUNT OF
TO BE REGISTERED REGISTERED PER SHARE OFFERING PRICE REGISTRATION FEE
- ------------------------------------------------------------------------------
Common Stock,
$1.00 par value 3,049,089 $2.50 (1) $7,622,722.50 (1) $2,248.70
(1) Estimated solely for purposes of calculating the registration fee in
accordance with Rule 457(a) under the Securities Act of 1933.
----------------
The Registrant hereby amends this Registration Statement on such date or dates
as may be necessary to delay its effective date until the Registrant shall
file a further amendment which specifically states that this Registration
Statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until the Registration Statement shall become
effective on such date as the Commission, acting pursuant to said Section
8(a), may determine.
==============================================================================
<PAGE>
[This prospectus is subject to completion, and no offering of the securities
will be made before the effective date of the Registration Statement.
The date of this draft is September 1, 1998.]
[LOGO] NORTH EAST INSURANCE COMPANY
RIGHTS OFFERING PROSPECTUS
North East Insurance Company ("NEIC") is offering 3,049,089 shares of
its Common Stock to qualified shareholders. To be a qualified shareholder,
you must have owned NEIC Common Stock on [RecDate], 1998. If you are a
qualified shareholder, you may buy one share of Common Stock at a price of
$[OffPrc] per share for every share of Common Stock you owned on that date.
This right is called the "Basic Subscription Privilege." Subject to certain
other conditions, you also may offer to buy additional Common Stock at that
same price. This right is called the "Oversubscription Privilege."
<TABLE>
<S> <C>
Offering Price Per Share . . . . . . . . . . . . . . . . $_________
Total Proceeds to NEIC (if all shares are sold) . . . . $_________
</TABLE>
Trading prices of the Common Stock are quoted on the NASDAQ SmallCap
Market under the symbol "NEIC." On [PriceDate], 1998, the last reported sales
price for the Common Stock was $[StkPrice] per share.
THIS RIGHTS OFFERING WILL EXPIRE AT 5:00 P.M., EASTERN TIME, ON
[EXPDATE], 1998. IF YOU WANT TO PARTICIPATE IN THIS RIGHTS OFFERING, WE
RECOMMEND THAT YOU SUBMIT YOUR SUBSCRIPTION DOCUMENTS TO YOUR BROKER OR BANK
AT LEAST 10 DAYS BEFORE THAT DEADLINE. See page __ of this Prospectus for
further instructions on submitting subscriptions. All subscriptions will be
held in escrow by our Subscription Agent (American Stock Transfer & Trust
Company) through the Expiration Date of the Rights Offering. We reserve the
right to extend the Expiration Date. We also reserve the right to cancel the
offering at any time before the Expiration Date.
We are conducting this Rights Offering in order to raise more capital
for NEIC. There is no minimum number of shares that we must sell in order to
complete the offering. Shareholders who do not participate in the Rights
Offering will continue to own their same number of shares, but will own a
smaller percentage of the total shares outstanding. The purchase rights
themselves are not transferable.
SEE "RISK FACTORS" ON PAGE __ FOR A DISCUSSION OF CERTAIN FACTORS THAT
YOU SHOULD CONSIDER IN CONNECTION WITH THIS RIGHTS OFFERING.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE
ADEQUACY OR ACCURACY OF THE PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS
A CRIMINAL OFFENSE.
THIS PROSPECTUS IS NOT AN OFFER TO SELL THESE SHARES (NOR DOES IT
SOLICIT ANY OFFERS TO BUY THE SHARES) IN ANY STATE WHERE THIS OFFER OR SALE IS
PROHIBITED.
The date of this Prospectus is _________, 1998.
<PAGE>
TABLE OF CONTENTS
Page
----
Summary 1
Risk Factors 4
Competition
Loss Reserves
Insurance Pricing and Profitability
Cyclical Nature of Industry
Geographic Concentration
Reinsurance
Regulation
Factors Affecting Change of Control
Dependence on Key Personnel
Volatility of Stock Price
Irrevocability of Subscriptions
Determination of Offering Price
Use of Proceeds 6
Terms of the Rights Offering 6
Determination of Offering Price 8
Subscription Procedures 9
Certain Ownership Limits and Reporting Requirements 10
State and Foreign Securities Laws 10
No Board Recommendation 10
Federal Income Tax Consequences 10
Description of Business 11
Management's Discussion and Analysis 17
Forward-Looking Information 26
Management 26
Certain Relationships and Related-Party Transactions 29
Principal Shareholders 29
Description of Capital Stock 31
Legal Matters 32
Experts 32
Financial Statements F-1
<PAGE>
NORTH EAST INSURANCE COMPANY
482 Payne Road, 4th Floor
P.O. Box 1418
Scarborough, Maine 04074-1418
Telephone: 207-883-2232
SUMMARY
This summary highlights some information from this Prospectus. We
recommend that you read the entire Prospectus carefully.
The Company
North East Insurance Company has been writing property and casualty
insurance in Maine since 1966. NEIC has a wholly-owned insurance company
subsidiary, American Colonial Insurance Company ("ACIC"), which formerly wrote
insurance in New York State.
Our principal products are personal and commercial automobile insurance,
including both automobile liability and automobile physical damage. We also
offer other types of insurance, such as general liability, commercial multi-
peril, inland marine and fire. We no longer write homeowners insurance,
having withdrawn from this market in 1995.
Reasons for the Rights Offering
Through the Rights Offering, we are seeking additional capital to
support future growth of NEIC. The desire for more capital is due both to
regulatory and business reasons.
Capital Requirements. State law requires insurers to maintain certain
amounts of capital in relation to the net amount of insurance premiums
written. Under guidelines of the National Association of Insurance
Commissioners, the ratio of net premiums written to statutory surplus
should not exceed 3 to 1. Our net premiums written for 1997
($14,225,224) were 2.24 times our statutory surplus ($6,358,763) at the
end of that year -- well within the guidelines. Thus, our surplus is
already sufficient to permit considerable growth in the business. By
raising additional capital now, however, we would have even greater
leeway to increase our premium revenues in the future.
Insurance Rating. In early 1997 A.M. Best (a prominent rating agency
for insurance companies) upgraded NEIC's rating five full levels, from a
D+ to a B-. We are now seeking a further increase in our Best rating,
based on continued strengthening of NEIC's financial position. Our
management believes that the addition of new capital through a
successful stock offering may increase the likelihood of an increase in
this rating. A further improvement in the Best rating could strengthen
NEIC's competitive position in the marketplace.
Agency Relationships. NEIC distributes its insurance products through a
network of independent agents. Our management believes that the
addition of new capital through a successful stock offering may make
NEIC's product line more appealing to agents, even before any increase
in our Best rating.
Available Resources. If the Rights Offering succeeds, our management
intends to accelerate its plans for seeking growth in the business. We
intend to use a portion of the new proceeds to hire additional personnel
and to buy additional equipment and software. Given the right
opportunities, we might also use the proceeds to expand our business
outside Maine, perhaps by purchasing
<PAGE>
insurers or insurance agencies in other states. There is no assurance
that this strategy would be successful.
Dilution
Through the Rights Offering, we are offering Common Stock at a price
determined by the Board of Directors. This price is less than NEIC's book value
per share, and therefore the sale of the stock will immediately reduce the
book value per share. Also, if all of the offered shares are sold, the number
of outstanding shares will double, and therefore a nonsubscribing shareholder's
percentage ownership will be one-half of his or her former percentage
ownership. Shareholders who exercise their Basic Subscription Privileges in
full will not incur a decline in percentage ownership.
Risk Factors
An investment in NEIC Common Stock involves substantial risks that each
prospective purchaser should consider. See RISK FACTORS at page __ below.
Terms of the Rights Offering
<TABLE>
<S> <C>
Eligible Shareholders................ You will not be eligible to purchase stock through this Rights
Offering unless you already owned NEIC Common Stock on
[RecDate], 1998.
Subscription Rights.................. If you are an eligible shareholder, you will have two different
subscription rights:
Basic Subscription Privilege. First, you will have the right
to purchase one share of Common Stock for each share you owned
as of [RecDate], 1998. You may also purchase a smaller number
of shares through the Rights Offering, if you wish. The
offering price is $[OffPrc] per share.
Oversubscription Privilege. If you exercise your Basic
Subscription Privilege in full, you also may offer to buy
additional shares. In exercising this right, you will specify
the maximum number of shares that you are willing to buy from
NEIC at $[OffPrc] per share.
Ownership Limits..................... Maine and New York insurance laws prohibit any person or
group from acquiring 10% or more of the outstanding stock
of any insurer, unless that person or group first obtains
permission from state insurance regulators.
As a condition of the Rights Offering, we are limiting each
subscriber to an ownership position of no more than 9.9% of the
total outstanding shares. Each subscriber must state in writing
that he or she owned NEIC stock on [RecDate], 1998 and will not
be acquiring more shares than are permitted under the terms of the
Rights Offering. Moreover, each subscriber who currently owns more
than 5% of the outstanding NEIC stock or who subscribes for more
than 100,000 shares must agree to provide us, upon request,
with reasonable evidence of his or her total share ownership.
Finally, every subscriber must state in writing that he or she has
read carefully the description of ownership limits under
<PAGE> 2
Maine and New York insurance laws and agrees not to engage
in any intentional violation of those limits.
Allocation of Shares................. If we receive proper subscriptions for more shares than are
being offered, we will first fill all exercises of the Basic
Subscription Privilege. We will then allocate the remaining
shares among those who exercise the Oversubscription Privilege,
in proportion to the maximum number of shares that each offers
to purchase within the permitted limit.
Nontransferability of Rights......... The subscription rights may only be exercised by persons
who owned NEIC stock on [RecDate], 1998 and are
nontransferable to others.
Expiration Date...................... [ExpDate], 1998, at 5:00 p.m., Eastern time, unless extended.
Subscription Procedures.............. To subscribe for shares, you should carefully complete and
sign the Subscription Agreement for this Rights Offering and
forward it to our Subscription Agent (American Stock Transfer &
Trust Company). Be sure to include a check or money order for
the full amount of your subscription price. Checks and money
orders will not be cashed until your subscription has been
accepted. If your subscription is accepted in part and rejected
in part (for example, due to oversubscription), the Subscription
Agent will send you a check for the difference. No interest will
be paid on subscription funds. With only limited exceptions,
once a holder has submitted subscription documents, his or her
exercise of subscription right may not be revoked.
Persons Wishing to Exercise
Rights for the Benefit of Others..... Brokers, banks, trustees, and other individuals or entities
that hold NEIC Common Stock for the account of others may,
if authorized by the beneficial owner, complete the Subscription
Agreement and submit it to the Subscription Agent with the proper
payment.
Completion of the Offering........... Certificates representing shares of the Common Stock will be
delivered to subscribers as soon as practicable after the
Expiration Date of the Rights Offering. We expect that this
may take two weeks or longer, due to the need to allow checks
to clear and to confirm compliance with stock ownership limits.
Subscription Agent................... Subscription Agreements may be delivered to American
Stock Transfer & Trust Company as follows:
By Hand, Mail or Overnight Courier By Facsimile Transmission
---------------------------------- ---------------------------------
(For Eligible Institutions Only):
40 Wall Street, 46th Floor (718) 234-5001
New York, NY 10005 Confirm Facsimile by
Telephone: (718) 921-8200
Questions ?.......................... If you have any question about this Rights Offering (including
questions about subscription procedures and requests for
additional copies of this Prospectus or other documents), please
contact Robert G. Schatz (President and Chief Executive Officer)
or Mary M. Crawford (Shareholder Relations). Either of them may
be reached by telephone at
<PAGE> 3
207-883-2232, or by fax at 207-883-1523. Ms. Crawford may
also be reached by e-mail at ________.
</TABLE>
Amendment, Extension
and Termination
We reserve the right to amend or extend the Rights Offering at any time
prior to the Expiration Date. If we make an important change in the terms of
the Rights Offering, we will attempt to notify all shareholders in writing.
Following any important change in terms by us, anyone who had previously
subscribed for shares will have the right to withdraw or modify the prior
subscription. This revocation right will expire 10 business days after
mailing of the notice of the change in terms.
RISK FACTORS
An investment in the Common Stock involves substantial risks.
Prospective purchasers should carefully consider the following risk factors.
Competition. The property and casualty insurance industry is intensely
competitive. The competitive nature of the industry extends as well to non-
standard automobile insurance, NEIC's largest source of revenues. NEIC
competes with many regional and national insurers (including direct sellers of
insurance products, insurers having their own agency organizations and other
insurers represented by independent agents), many of which have greater
financial resources than NEIC. NEIC depends on independent agents to generate
premium income and competes with other insurance companies for the services of
and the business placed by such independent agents. This competition includes
pricing pressures and one-time agent incentives.
Insurance Pricing and Profitability. The pricing of insurance policies is
determined by an insurer on the basis of projected future claims. The actual
losses and expenses experienced on such policies may exceed the costs
anticipated. Changes in statutory law and case law can also dramatically
affect the liabilities associated with insurance policies that have already
been sold. Competitive factors, as well as regulatory constraints, may limit
the insurer's ability to increase prices in response to declines in
profitability.
Loss Reserves. The profit and loss reported by a property and casualty
insurer is determined, in part, by setting and adjusting reserves to reflect
management's estimates of future claim expense. The actual liability of the
insurer for such policies will likely be greater or less than these estimates.
An underestimate of these expenses will cause lower profitability in future
periods. Conversely, an overestimate of these expenses will cause greater
profitability in future periods.
Cyclical Nature of the Industry. The property and casualty insurance industry
is affected by many factors that cause fluctuations in revenues and profit.
Prices for insurance coverage may vary according to the level of surplus in
the industry. Increases in surplus have generally been accompanied by lower
prices among competing property and casualty insurers. Profitability may
depend on unpredictable factors such as natural disasters (such as storms,
floods and fires), fluctuating interest rates and other changes affecting
insurance companies' investments and the income from those investments,
inflationary pressures affecting the size of losses, and judicial decisions
affecting the scope of insurers' liabilities.
Geographic Concentration. For several years, neither NEIC nor ACIC has
written new insurance business outside Maine. Our results of operations may
therefore be adversely affected by any catastrophic occurrence, destructive
weather pattern, general economic trend or other condition that
disproportionately affects losses or business conditions in Maine.
<PAGE> 4
Reinsurance. NEIC relies upon reinsurance treaties to limit its maximum net
loss from large single risks or risks in concentrated areas, and to increase
its capacity to write insurance. Reinsurance does not relieve NEIC from
liability to its policyholders. Even if the reinsurer is unable to pay its
share of losses under the reinsurance agreement, we remain exposed to the risk
of continued liability for those losses.
Regulation. The administration of state insurance regulations is vested in
state agencies that have broad discretionary powers and that are concerned
primarily with the protection of policyholders, not shareholders. NEIC and
ACIC are subject to regulation under Maine and New York law. These laws and
regulations cover many aspects of our business, including the pricing of our
insurance policies, the volume of business we may write, the manner in which
we settle claims, mandatory participation in risk pools, the composition of
our investment portfolio, payment of dividends to shareholders, and the
ownership and exercise of control over the corporation. Future changes in
such laws and regulations could have a material adverse effect on the
operations of insurance companies, including NEIC and ACIC.
Factors Affecting Change of Control. Certain factors could delay or impede
the removal of incumbent directors and could make more difficult a merger,
tender offer or proxy contest involving NEIC, even if these steps would
otherwise be beneficial to shareholders. Maine and New York insurance laws
and regulations generally prohibit any person from acquiring 10% or more of
the voting stock of a domestic insurance company without the prior approval of
insurance regulators in those states. The Maine Business Corporation Act
contains certain provisions that restrict business combination transactions
under certain circumstances. The Articles of Incorporation requires
supermajority shareholder approval of certain business combinations and other
related-party transactions. NEIC has entered into agreements that would
provide certain key executives with additional severance compensation if their
employment were terminated or materially altered after a change in control.
Dependence on Key Personnel. NEIC relies upon the personal efforts and
abilities of its principal executives, particularly Robert G. Schatz,
President and Chief Executive Officer, and Ronald A. Libby, Chief Operating
Officer. NEIC has entered into employment and option arrangements that
provide these executives with incentives to remain in NEIC's employ. There is
no assurance that these executives will remain with NEIC or that the business
strategies pursued by them will succeed.
Volatility of Stock Price. The market for NEIC Common Stock is thinly traded,
and we expect it to remain so even after completion of the Rights Offering.
Due in part to this limited liquidity, the trading price of the stock tends to
be quite volatile. Factors such as quarterly variations in NEIC's results of
operations and changes in general market conditions could cause the market
price of NEIC's Common Stock to fluctuate significantly. There is no
assurance that the trading price of the Common Stock will remain stable during
the subscription period or that, after completion of the Rights Offering, a
subscribing shareholder will be able to sell the purchased shares at a price
equal to or greater than the offering price.
Irrevocability of Subscriptions. Subscriptions for shares in the Rights
Offering will be irrevocable, except in limited circumstances. Subscribers
will not receive interest on their subscription funds.
Determination of Offering Price. The offering price was determined by NEIC's
Board of Directors without any independent appraisal of value of the Common
Stock. The offering price does not necessarily bear any relationship to the
book value of NEIC's assets, past operations, cash flow, earnings, financial
condition or any other established criteria for value and should not be
considered an indication of the underlying values of NEIC.
<PAGE> 5
USE OF PROCEEDS
If the Rights Offering is fully subscribed, the net proceeds to NEIC are
expected to be approximately $___ million, after payment of related fees and
expenses.
<TABLE>
<S> <C>
Maximum number of shares offered x,xxx,xxx shares
Offering price $ x.xx per share
Gross proceeds $x,xxx,xxx
Estimated costs of the offering $ xx,xxx
Estimated maximum net proceeds $x,xxx,xxx
</TABLE>
Over the next 12 months, we expect to use a portion of the net proceeds
as follows:
<TABLE>
<S> <C>
Software upgrades $ xx,xxx
New equipment $ xx,xxx
Additional personnel $ xxx,xxx
</TABLE>
We expect that the remaining proceeds will remain available as additional
working capital and, in the meantime, will be invested as part of NEIC's
portfolio of bonds and stocks. If the Rights Offering is successful, we plan
to accelerate somewhat our existing plans for growth of the business. One
element of that plan would be to expand our operations outside Maine, perhaps
through acquisitions of insurers or insurance agencies in other states.
Presently, we have no specific plans for such an acquisition.
The increase in our capital will provide us with further leeway to write
more insurance business, while maintaining compliance with applicable capital
requirements.
TERMS OF THE RIGHTS OFFERING
General
Through the Rights Offering, NEIC is offering Common Stock at $[OffPrc]
per share. The offer is open only to those who owned NEIC Common Stock on
[RecDate], 1998. The offer is not open to persons who did not own Common
Stock on that date.
We are offering NEIC shareholders the opportunity to purchase 3,049,089
shares of NEIC Common Stock, which equals the same number of shares as are
presently outstanding. If all the offered shares are purchased, the total
number of outstanding shares will therefore double.
The purchase rights offered to shareholders are of two types:
Basic Subscription Privilege. Each qualified shareholder has the right
to purchase one share of Common Stock for each share he or she owned at
the close of business on [RecDate], 1998.
Oversubscription Privilege. Any qualified shareholder who fully
exercises the Basic Subscription Privilege may subscribe for additional
shares of NEIC Common Stock. In doing so, the holder will specify the
maximum number of shares he or she is willing to purchase at the offering
price, and will submit a check or money order for the full subscription
price. The Oversubscription Privilege is subject to a 9.9% limitation,
described below.
<PAGE> 6
If NEIC receives subscriptions for more than 3,049,089 shares, then we
will allocate the available shares as follows: first, to subscribing
shareholders according to their exercises of the Basic Subscription Privilege;
and second to subscribing shareholders in proportion to their exercise of the
Oversubscription Privilege. Each shareholder's subscription rights will be
subject to the 9.9% limit described below.
Ownership Limits;
Subscription Agreement
Maine and New York laws prohibit any person or group from acquiring 10%
or more of the outstanding stock of NEIC without first obtaining permission
from insurance regulators in those states. To avoid inadvertent violations of
these requirements, we are limiting the number of shares that anyone can
purchase through the Rights Offering. Specifically, no shareholder may
purchase shares if he or she would own more than 9.9% of the outstanding
Common Stock upon completion of the Rights Offering.
The Subscription Agreement for the Rights Offering contains certain
provisions designed to enforce the terms of the offering and to prevent
inadvertent violations of the ownership limit. For example:
(1) Each subscriber must state in writing the number of shares of
NEIC stock that he or she owned NEIC stock on [RecDate], 1998;
(2) Each subscriber must state in writing that he or she has read
carefully the section of this Prospectus entitled CERTAIN OWNERSHIP
LIMITS AND REPORTING REQUIREMENTS and agrees not to acquire NEIC shares
through or in connection with the Rights Offering in violation of those
ownership limits and reporting requirements; and
(3) Each subscriber who currently owns more than 5% of the
outstanding NEIC stock or who subscribes for more than 100,000 shares
must agree to provide NEIC (if so requested within 60 days after the
Expiration Date) reasonable evidence of his or her total share
ownership.
Plan of Distribution
In order to reduce costs, NEIC is making this offering directly to
shareholders. We have not hired an underwriter to conduct this offering for
us, and we will not be paying any commissions or finders fees. However, where
shares are held indirectly through a broker, bank, or other institution, we
will reimburse the institutions' reasonable out-of-pocket costs in
distributing this Prospectus and other materials to beneficial owners of the
stock.
We have retained NEIC's transfer agent (American Stock Transfer & Trust
Company) to assist with the offering in the role of Subscription Agent. The
Subscription Agent will hold all subscriptions received from shareholders, and
will be responsible for delivering stock certificates and refunds (in case of
oversubscription or cancellation of the offering) to shareholders. NEIC will
pay all fees and expenses of the Subscription Agent.
Expiration Date; Extension
The Rights Offering will expire at 5:00 p.m., Eastern time, on
[ExpDate], 1998, unless extended. After the Expiration Date, all unexercised
subscription rights will be null and void. The Company will notify
shareholders of any extension of the Expiration Date, by issuing a press
release indicating such extension and by amending its Registration Statement
that is on file with the Securities and Exchange Commission.
NEIC may reject any subscription documents that the Subscription Agent
receives after 5:00 p.m. on the Expiration Date, regardless of when the
documents were originally mailed. We recommend that
<PAGE> 7
shareholders submit all subscription documents to their broker or bank at
least 10 days before the scheduled Expiration Date, to allow the broker or
bank sufficient time to carry out those instructions.
The Rights Offering is not conditioned upon our receipt of subscriptions
for any minimum number of shares.
Subscription Payments
Each Subscription Agreement must be accompanied by the full amount of
the purchase price for the shares. If a subscriber submits less than the full
purchase price, we will limit his or her maximum subscription to the number of
shares purchasable with those funds (rounded down to the nearest whole number
of shares).
If a subscription is rejected in whole or in part, the Subscription
Agent will promptly refund payment for any unpurchased shares. No interest
will be paid on any subscription funds.
Delivery of Certificates
The Subscription Agent will mail certificates for Common Stock as soon
as practicable after the Expiration Date. We expect that this may take two
weeks or longer, due to the need to confirm compliance with stock ownership
limits.
NEIC will not permit the purchase of fractional shares.
Amendment, Extension and Termination
We reserve the right to amend the terms and conditions of the Rights
Offering. If we make an amendment that we consider significant, NEIC will (i)
mail notice of the amendment to all shareholders of record, (ii) extend the
Expiration Date by at least 14 days and (iii) offer all subscribers not less
than 10 days to revoke any prior subscriptions, in whole or in part. In all
other cases, subscriptions will be irrevocable.
We also reserve the right to extend the Expiration Date, in our
discretion, although we presently do not intend to do so. An extension of the
Expiration Date will not, in and of itself, be treated as a significant
amendment for purposes of the preceding paragraph.
We also reserve the right to terminate the Rights Offering at any time,
in our discretion, in which case all subscriptions will be cancelled and all
subscription payments will be returned to subscribers.
Upon the occurrence of any change in or cancellation of the Rights
Offering, or any extension of the Expiration Date, we will issue a press
release to that effect and will file a post-effective amendment to the
Registration Statement covering this Prospectus.
DETERMINATION OF OFFERING PRICE
NEIC's Board of Directors set the offering price at a level that it
judged to be fair to NEIC and its shareholders. In doing so, the Board's
objective was to raise the targeted proceeds, and provide all NEIC
shareholders with an opportunity to make an additional investment in NEIC and
minimize the involuntary dilution of their ownership and voting percentage in
NEIC.
In approving the offering price, the Board of Directors considered such
factors as the trading price of the Common Stock in recent months,
alternatives available to NEIC for raising capital, the pro rata nature
<PAGE> 8
of the offering, the business prospects for NEIC and the general condition of
the securities markets. The Board chose not to obtain independent appraisal
of value of the Common Stock.
SUBSCRIPTION PROCEDURES
To participate in the Rights Offering, a shareholder must submit a
properly completed Subscription Agreement, together with full payment of the
offering price for all shares subscribed for. Those who hold NEIC Common
Stock for the account of others (such as brokers, banks, trustees or
depositaries) should notify the beneficial owners of such shares as soon as
possible to ascertain the beneficial owners' intentions and to obtain
instructions with respect to the Rights Offering.
The Subscription Agreement and payment must be received by the
Subscription Agent before 5:00 P.M. on the Expiration Date. Payment of the
offering price must be made:
(1) by check or bank draft drawn upon a U.S. bank or postal,
telegraphic, or express money order payable to "American Stock Transfer
& Trust Company, as Subscription Agent," or
(2) by wire transfer of same day funds to the account maintained
by the Subscription Agent for such purpose at "[Wire Address] (North
East Insurance Company)."
Payment of the offering price will be deemed made only upon (i) the
Subscription Agent's receipt of a certified check or bank draft drawn upon a
U.S. bank or any postal, telegraphic or express money order, (ii) the
clearance of any uncertified check, or (iii) the receipt of good funds in the
wire transfer account designated above. Holders who wish to pay by
uncertified personal check should note that such a check may take five
business days or more to clear and should therefore make payment sufficiently
in advance of the Expiration Date to ensure that payment is received and
clears by such date.
Subscription Agreements and any checks in payment of the subscription
price should be delivered (whether by mail, hand delivery, or overnight
courier) to:
American Stock Transfer & Trust Company
40 Wall Street, 46th Floor
New York, NY 10005
Eligible institutions may deliver documents to American Stock Transfer & Trust
Company by facsimile transmission to (718) 234-5001, and should call (718)
921-8200 to confirm such receipt. Do not send subscription documents or
payments to NEIC.
If an exercising holder does not indicate the number of shares to be
purchased or does not forward full payment of the subscription price, then the
Holder will be deemed to have exercised the Basic Subscription Privilege to
the full extent of the payment received and, if any funds remain, will be
deemed to have exercised the Oversubscription Privilege to the extent of the
remaining funds. In each case, share amounts will be rounded down to the
nearest whole number.
The method of delivery of subscription documents and payment of the
subscription price will be at the election and risk of holders. If sent by
mail, it is recommended that such subscription documents and payments be sent
by registered mail, properly insured, with return receipt requested, and that
a sufficient number of days be allowed to ensure delivery to the Subscription
Agent and clearance of payment prior to the Expiration Date. Because
uncertified personal checks may take at least five business days to clear,
holders are urged to arrange for payment by certified or cashier's check,
money order or wire transfer of funds.
<PAGE> 9
All questions concerning the timeliness, validity, form and eligibility
of any subscription will be determined by NEIC, which determinations will be
final and binding. NEIC may, in its sole discretion, waive any defect or
irregularity, permit a defect or irregularity to be corrected within such time
as it may determine, or reject the purported exercise of any right.
Subscriptions will not be deemed to have been received or accepted until all
irregularities have been waived or cured within such time as NEIC determines
in its sole discretion. Neither NEIC nor the Subscription Agent will be under
any duty to give notification of any defect or irregularity in connection with
the submission of Subscription Agreements or incur any liability for failure
to give notification.
If you have any questions concerning the Rights Offering or these
subscription procedures, or if you would like additional copies this
Prospectus or other documents, please contact Robert G. Schatz, (President and
Chief Executive Officer) or Mary M. Crawford (Shareholder Relations). Either
of them may be reached by telephone at 207-883-2232, or by fax at 207-883-
1523. Ms. Crawford may also be reached by e-mail at ________.
CERTAIN OWNERSHIP LIMITS
AND REPORTING REQUIREMENTS
Any person or group that acquires direct or indirect beneficial
ownership of more than 5% of the outstanding shares of NEIC will be subject to
special reporting requirements under Section 13(d) or 13(g) of the Securities
Exchange Act of 1934. Any person or group that acquires direct or indirect
beneficial ownership of more than 10% of the outstanding NEIC shares will be
subject to special reporting requirements under Section 16(a) of that Act and
may become liable under Section 16(b) of the Act for reimbursement of any
"short-swing profits."
The Maine Insurance Code and the New York Insurance Law generally
prohibit any person or group from acquiring direct or indirect ownership of
10% or more of the outstanding shares of NEIC, except with prior permission
from the Maine Bureau of Insurance and the New York Insurance Department.
FAILURE TO COMPLY WITH THESE PROVISIONS OF FEDERAL OR STATE LAW MAY
CONSTITUTE A CRIMINAL OFFENSE OR OTHERWISE SUBJECT THE RELEVANT PERSON OR
GROUP (AND THEIR CONTROLLING PERSONS) TO SUBSTANTIAL LIABILITY.
STATE AND FOREIGN SECURITIES LAWS
The Rights Offering is being made in reliance on securities registration
exemptions in various states for offers and sales of securities to existing
security holders.
The Rights Offering is not being made in any state or foreign country in
which it is unlawful to do so, nor will NEIC accept subscriptions from holders
who are residents of any such state or country.
NO BOARD RECOMMENDATION
An investment in the Common Stock must be made pursuant to each
shareholder's evaluation of his or her best interests. The NEIC Board of
Directors makes no recommendation to any shareholder on whether to exercise
the subscription rights.
FEDERAL INCOME TAX CONSEQUENCES
The following summary of federal income tax consequences is for general
information only and is based upon the Internal Revenue Code as amended to
date (the "Code"), the regulations promulgated or proposed thereunder,
positions of the Internal Revenue Service (the "Service") set forth in
published revenue rulings,
<PAGE> 10
revenue procedures and other announcements, and court decisions as in effect
on the date of this Prospectus. Future legislative or administrative actions
or decisions could significantly affect the following discussion. This
summary does not discuss all aspects of federal income taxation that may be
relevant to a particular investor or to certain types of investors subject to
special treatment under the federal income tax laws (for example, banks,
securities dealers, life insurance companies, tax exempt organizations and
foreign taxpayers), and does not discuss any aspect of state, local or foreign
tax laws. The following discussion is limited to holders who intend to
acquire and hold Common Stock as capital assets (i.e., generally, for
investment).
Receipt or Lapse of Rights. A holder should not recognize income for
federal income tax purposes by reason of (i) the receipt of subscription
rights or (ii) the lapse of such rights.
Exercise of Rights. Holders will not recognize any gain or loss upon the
exercise of subscription rights. The basis of the shares of the Common Stock
acquired through exercise of these rights generally will be equal to the sum
of the subscription price paid therefor. The holding period for the shares of
the Common Stock acquired through exercise of the rights will begin on the
date such rights are exercised.
Disposition of Common Stock. The sale or other disposition of the Common
Stock acquired on exercise of these rights will result in the recognition of
capital gain or loss by the holder in an amount equal to the difference
between the amount realized and the holder's basis in such Common Stock.
Capital gain recognized by a noncorporate holder will be subject to a reduced
rate of tax if the holding period of the Common Stock sold or disposed of is
greater than 12 months and will be subject to a further reduced rate of tax if
the holding period for such Common Stock is greater than 18 months. Capital
gains recognized by corporations currently are subject to tax at the same rate
as ordinary income.
THE FOREGOING DISCUSSION OF CERTAIN FEDERAL INCOME TAX CONSEQUENCES IS
INCLUDED FOR GENERAL INFORMATION ONLY. ACCORDINGLY, EACH HOLDER OF RIGHTS AND
COMMON STOCK SHOULD CONSULT WITH HIS, HER OR ITS OWN TAX ADVISOR WITH RESPECT
TO THE TAX CONSEQUENCES OF ACQUISITION, OWNERSHIP AND DISPOSITION OF THE
RIGHTS AND COMMON STOCK, INCLUDING THE APPLICABILITY AND EFFECT OF STATE,
LOCAL, FOREIGN AND INCOME TAX LAWS.
DESCRIPTION OF BUSINESS
General
North East Insurance Company was organized as a Maine corporation on
August 9, 1965 and began writing insurance in 1966. In 1981, North East's
securities became publicly traded (Symbol: NEIC). The Company has a wholly-
owned subsidiary, American Colonial Insurance Company ("ACIC"), a New York
corporation, which began business in 1982. In addition to ACIC, North East
owns 100% of North Atlantic Underwriters, Inc. ("NAU"), a dormant Maine
corporation, originally intended to assist North East in marketing its
insurance products to independent brokers. The consolidated financial results
of North East and its subsidiaries (the "Group") for 1997 and prior years are
presented and discussed elsewhere in this report. See "Consolidated Financial
Statements" and "Management's Discussion and Analysis."
The Group is engaged in the business of underwriting and accepting
property and casualty insurance risks. Its principal insurance products
consist of personal and commercial automobile coverage (including automobile
liability and automobile physical damage) and other general lines including
but not limited to homeowners, general liability, commercial multi-peril,
inland marine, fire and allied lines. In 1995, management made the decision
to withdraw its homeowner program from the market due to an inadequate premium
base, market pressure on homeowner pricing and the ever broadening of
coverages.
<PAGE> 11
North East or its subsidiary, ACIC, is licensed to write business in the
states of Louisiana, Maine, Mississippi, Nevada, New York, Rhode Island,
Texas, Utah and in the District of Columbia. In addition, either North East
or ACIC is approved to write business as a surplus lines carrier on a non-
admitted basis in several other states. These licenses and approvals are
subject to regulatory limitations in certain of the named jurisdictions.
North East has limited its writing of insurance products to the State of Maine
since 1986. Under an agreement with the Insurance Department of the State of
New York, ACIC has not written any new or renewed any existing business since
March 1990.
The following is a summary of selected consolidated financial
information for each of the three years in the period ended December 31, 1997.
This information should be read in conjunction with the Consolidated Financial
Statements and the Notes presented elsewhere in this report.
<TABLE>
<CAPTION>
Year Ended December 31
-------------------------------------------
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Total Assets $32,811,570 $32,558,905 $34,483,828
Total Liabilities 22,825,916 23,233,944 28,062,777
Shareholders' Equity 9,985,654 9,324,961 6,421,051
Net Premiums Written 14,225,224 6,065,741 5,798,259
Net Premiums Earned 11,493,483 6,232,856 6,871,074
Net Investment Income 763,438 1,041,762 1,298,601
Realized Capital
Gains (Losses) 35,321 57,617 (225,726)
Total Revenue 12,292,242 7,332,235 7,943,949
Underwriting Gain (Loss) (332,753) 206,981 (310,057)
Income Before Provision
for Income Taxes 466,006 1,306,360 762,818
Provision (Benefit) for
Income Taxes 177,326 (2,069,136) 14,500
Net Income 288,680 3,375,496 748,318
</TABLE>
Underwriting
The Group experienced a net loss and loss adjustment expense ratio of
59.2% and an expense ratio of 35.3% in 1997. The combined ratio for the Group
in 1997 was 94.5%, meaning that premium income exceeded loss and loss
adjustment expenses and underwriting expenses by 5.5%. The combined ratios
for 1996 and 1995 were 97.8% and 113.1%, respectively. The combined ratio is
a key measure of underwriting profitability traditionally used in the property
and casualty insurance business. It equals the sum of the ratio of net losses
and loss adjustment expenses to net premiums earned and the ratio of
underwriting expenses incurred to net premiums written. For further
information on computation of the combined ratio and the
<PAGE> 12
effect of recent changes in the Group's reinsurance arrangements, see
"Management's Discussion and Analysis."
Net premiums written and earned by the Group by line of business for
fiscal 1997 and 1996 were as follows:
<TABLE>
<CAPTION>
1997 1996
--------------------------- ------------------------
Net Net Net Net
Premiums Premiums Premiums Premiums
Written Earned Written Earned
----------- ----------- ---------- ----------
<S> <C> <C> <C> <C>
Auto Liability
Private Passenger $ 7,307,788 $ 5,851,371 $3,501,049 $3,532,327
Commercial 1,587,390 1,260,032 492,574 529,764
Auto Physical Damage 3,710,398 3,029,121 1,532,008 1,522,866
Other Liability 538,385 421,860 76,466 27,162
Inland Marine 377,569 311,688 206,858 213,115
All Other Lines 703,694 619,411 256,786 407,622
-------------------------------------------------------
Total $14,225,224 $11,493,483 $6,065,741 $6,232,856
=======================================================
</TABLE>
The auto programs represent approximately 88.6% of the total premium
written by the Group. This book includes private passenger and commercial
policies. The private passenger products include non-standard, standard and
preferred auto coverages as well as snowmobiles. The commercial product is
focused on small, single vehicle, commercial enterprises including logging,
garages, refuse haulers and snow plowers. Approximately 71% of the auto
written premium is for liability coverage with the remaining 29% providing
physical damage protection.
The balance of the Group's book of business is composed of Inland marine
(2.7%); other liability (3.8%); companion or adjunct commercial coverages
(4.8%). The homeowner program, discontinued in 1995, accounted for slightly
more than 0.1% of the total premium.
Marketing
The Group markets its insurance products through a network of
independent insurance agents. The Company believes the agency system provides
the best system for its products and programs, and is an important part of the
Company's business strategy. The use of independent agents allows North East
to obtain high quality marketing coverage over a broader geographic area in
Maine than could be accomplished by other means. Agents' return on book,
profit contingencies and reliable products have become key ingredients in
developing stronger ties to agents representing NEIC. An agents advisory
board provides a forum through which the Group can respond in an effective and
timely manner to its agents' needs.
Management annually reviews the performance of its agents, utilizing
quantitative and qualitative measures. Factors in the review include written
premium volume, historical loss ratios, geographic location, mix of products,
North East's rank in agent's office, other carriers represented by the agency,
and the agent's plans and needs.
At year end 1997 there were 163 active agents who represented North
East. Certain agents and brokers are under common ownership. Although no
single agency produced more than 5% of North East's direct premiums written in
1997, one affiliated group of agents was responsible for 11.4%, a second group
<PAGE> 13
accounted for 9.2% and a third group accounted for 5.0%. Twenty-three agents
provided North East with direct premiums written in excess of $200,000, and
nine agents provided North East with direct premiums written between $100,000
and $200,000. While the loss of any individual producing agent could have an
impact on North East's business, management believes it has a good
relationship with its existing agents.
In recognition of the agents' key role in selecting profitable business,
NEIC compensates its agents with both commissions and a profit sharing plan.
The profit sharing plan formula considers a combination of volume and
profitability in determining the amount of additional compensation. Certain
minimum targets, in both categories, must be reached in order to qualify for
profit sharing under the formula. The amount of profit sharing is dependent
on the degree each component betters the minimum target. Profit sharing
expense amounted to $85,000, $81,571 and $48,640 in 1997, 1996 and 1995,
respectively, and is expected to increase as agents recognize the heightened
incentives under the plan.
Reinsurance
The Group operates under the philosophy of retaining as much risk as is
prudent for its size. A key aspect of this approach is that the Group seeks
to establish stable, long-term arrangements with high quality reinsurers who
meet the Group's criteria for financial integrity. In formulating its
reinsurance arrangements, the Group complies with both Maine and New York
insurance laws prohibiting the retention of any individual risk in an amount
exceeding 10% of its surplus. The Group's current reinsurance is placed
through MIC Reinsurance Corporation, rated "A" by A.M. Best.
The Group manages its risk exposure through individual and aggregate
risk excess of loss reinsurance arrangements (treaties), casualty clash excess
of loss treaties and property catastrophe excess of loss reinsurance in which
the reinsurers assume that portion of the risk not retained by the Group. The
Group utilized quota share reinsurance until September 30, 1997.
The maximum gross policy limits offered by NEIC during 1997, 1996 and
1995 were $1,000,000. The Company's maximum net retention was $65,000 for the
period covering January 1, 1995 through December 1, 1995, $32,850 for the
period covering December 1, 1995 through December 31, 1996 and $50,000 for the
period covering January 1, 1997 through December 31, 1997.
Current reinsurance protection is provided through two layers of excess
of loss reinsurance. The first layer, considered to be the working layer,
assumes $150,000 of coverage beyond the first $50,000. The second layer,
allows NEIC to offer policy limits up to $1,000,000 by assuming $800,000 of
coverage beyond the first $200,000. The casualty clash excess of loss treaty
provides coverage for $1,000,000 in excess of $1,000,000 in the event more
than one insured is involved in a single loss occurrence exposing the coverage
limits of the policies. The property catastrophe coverage provides for
$1,500,000 of coverage in excess of $500,000 in the event of a catastrophe.
The 35% quota share treaty in effect for 1996 and 1995 was cancelled on a
runoff basis effective January 1, 1997 and subsequently commuted on September
30, 1997.
Investments
At December 31, 1997, based on current market values, 41% of the fixed
maturities were invested in U.S. Treasuries or U.S. Government guaranteed
instruments, 8% were invested in public utilities and 51% were invested in
corporate securities. The Group does not purchase securities with the
intention of holding such securities through their maturity date and therefore
does not match the maturation dates to the expected settlement of its claim
liabilities.
The Group also maintains short-term investments, primarily U.S.
Government backed funds, which are immediately available for operating
activities should cash outflow suddenly exceed incoming cash from
<PAGE> 14
premium collections and investment income. At December 31, 1997, short-term
investments amounted to $3,397,581.
The gross average investment yield based on amortized cost of the
investment portfolio was 5.9% and 6.6% for the years ended December 31, 1997
and 1996, respectively. The total return, including realized capital gains
(losses) was 6.1% and 6.9% for the years ended December 31, 1997 and 1996,
respectively. Realized gains (losses) for the year ended 1997 included a loss
of $62,705 pertaining to the write down of NEIC's investment in Memorex which
NEIC considers fully impaired.
The table below summarizes the credit quality of fixed maturities, based
on Standard and Poor's rating system, as of December 31, 1997:
<TABLE>
<CAPTION>
Bond Credit Quality Rating
--------------------------
<S> <C>
AAA 41.0%
A 1.9
A 45.6
BAA 11.5
-----
100.0%
=====
</TABLE>
Bond credit quality ratings are based on the capacity of the borrower to
meet interest and principal payments as they become due. Capacity is
considered extremely strong for AAA rated issues; very strong for AA rated
issues; strong for A rated issues; and adequate for BAA rated issues. At
December 31, 1997 the Group did not hold any fixed maturities considered to be
below investment grade (rated below BAA).
Competition
The Group currently does not write any business outside the State of
Maine. The Company competes with national and regional insurers that market
their products directly as well as through the independent agency system.
Over the past several years, the direct writers have significantly increased
their market share, at the expense of independent agents. Management
continues to believe, however, NEIC's products are best marketed through a
network of independent agents.
The Company also faces competition from certain insurers that focus on
non-standard markets, particularly with regard to automobile insurance. This
competition includes pricing pressures and one-time agent incentives.
Regulation
The Group is subject to regulation and supervision by the Maine
Superintendent of Insurance or similar official in each of the jurisdictions
in which it is authorized to transact insurance business. Such regulation and
supervision includes, among other things, requirements as to capital and
surplus, solvency standards, granting and revoking licenses to transact
business, the licensing of agents, approval of policy forms and rates,
restrictions on the amount of risk assumed, deposits of securities, methods of
computing reserves and the types and concentration of investments permitted.
The Group is required to file detailed annual and other reports of its
financial condition, affairs and management with such regulatory agencies and
is subject to periodic examination by them.
Statutory surplus, after audit adjustments, at December 31, 1997 was
$6,358,763. Based on guidelines established by the National Association of
Insurance Commissioners, the ratio of net premiums written to
<PAGE> 15
statutory surplus should not exceed 3 to 1. Under this formula, the Group may
retain approximately $19,076,289 of net written premiums for its own account
(by comparison, 1997 net written premiums amounted to $14,225,224). The Group
expects to remain well within the constraints of this guideline in 1998.
The National Association of Insurance Commissioners requires the
reporting of Risk Based Capital for Property and Casualty Insurance Companies.
Risk based capital is a method of measuring the minimum amount of capital
appropriate for an insurance company to support its overall business
operations in consideration of its size and risk profile. It provides a
flexible means of setting the capital requirement in which the degree of risk
taken by the insurer is the primary determinant. The four major categories of
risks involved are:
* Asset Risk - This is the risk of assets' default of
principal/interest or fluctuation in market value.
* Credit Risk - This is the risk of default on amounts due from
reinsurers, policyholders, or other creditors.
* Underwriting Risk - This is the risk of under-estimating
liabilities from business already written or inadequately pricing
business in the coming year.
* Off-Balance Sheet Risk - This is the risk associated with items,
such as excessive premium growth, contingent liabilities and other
items not reflected on the balance sheet.
The results of the risk based capital computation provide regulators
with a tool from which they can base regulatory action. Based on trigger
points included in the risk based capital computation, the following actions
could result should a company's surplus level be less than predetermined
multiples of the authorized control level amount as determined by the formula.
<TABLE>
<CAPTION>
Action % of Authorized Control Level Risk Based Capital
------ ------------------------------------------------
<S> <C>
None Greater than 200%
Company Action Less than 200%, but Greater than 150%
Regulatory Action Less than 150%, but Greater than 100%
Authorized Control Less than 100%, but Greater than 70%
Mandatory Control Less than 70%
</TABLE>
Under the risk based capital formula, the authorized control level risk
based capital for North East Insurance Company and American Colonial Insurance
Company at December 31, 1997 was $2,008,187 and $271,124, respectively. The
statutory surplus at December 31, 1997, after audit adjustments, was
$6,358,763 or 316.6% of authorized control level risk based capital for North
East Insurance Company and $5,168,970 or 1906.5% of authorized control level
risk based capital for American Colonial Insurance Company. Accordingly, the
statutory surplus levels of North East Insurance Company and American Colonial
Insurance Company were adequate under the risk based capital formula.
Employees
At December 31, 1997 the Group employed forty full-time employees and
two part-time employees. The Company believes that its employee relations are
good. The Company also has engaged the services of consultants when
appropriate.
<PAGE> 16
Description of Property
The Company currently leases approximately 10,000 square feet of office
space at 482 Payne Road, Scarborough, Maine pursuant to a lease expiring
December 31, 2000. Upon expiration North East has an option to extend the
lease for an additional 10 years. Management believes that the premises are
adequate for its current needs.
Legal Proceedings
The Company has no pending legal proceedings other than ordinary routine
litigation incidental to the business, for which (in the opinion of
management) adequate reserves have been taken.
MANAGEMENT'S DISCUSSION AND ANALYSIS
This section reviews the consolidated financial condition of the Group
at December 31, 1997 and 1996, the consolidated results of operations for the
past three years and, where appropriate, factors that may affect future
financial performance. This section also contains a discussion of the Group's
financial condition at June 30, 1998 and 1997 and its and results of
operations for the six and three-month periods ended on such dates. This
discussion should be read in conjunction with Consolidated Financial
Statements, which appear at pages ____ below
General Discussion - 1997
North East continues to pursue a course of action set into motion in
1994 under which it has produced consistent gross written premium. For the
second consecutive year NEIC's combined ratio has been below 100% (94.5% and
97.8% in 1997 and 1996, respectively). The blending of premium volume,
product development, consistent and focused risk selection philosophy and
refining agency relationships contributed to the progress. In early 1997,
after several discussions and meetings with AM Best, NEIC's rating was
upgraded five full levels to a B-, thus according it new stature with its
agents and credibility from regulators and reinsurers. During 1997, NEIC
appointed five new agencies representing an expanded geographic base in Maine,
east and west of the Interstate 95, an area lacking in representation in prior
years. In addition NEIC introduced several enhancements to current programs
while marking significant progress in the final development of its totally
revised auto product scheduled for introduction in the first half of 1998.
Operating results for 1997 fell short of expectations due to higher than
expected frequency of losses in the first and fourth quarters specifically
related to poor weather conditions. The early onset of storms in November and
December 1997 carried a significant negative impact of claims activity from
both frequency and severity perspectives.
In the fall of 1997 it became apparent to both NEIC and it's reinsurer
that the treaties negotiated in early 1997 were not providing the loss relief
commensurate with the premium charge. Through collective negotiations the
treaty terms were amended to provide a more timely matching of reinsurance
premium, expense and loss recovery under the treaty terms. Further, the first
excess of loss treaty was endorsed to provide for experience rated premium
adjustments. The process is reflective of the relationship NEIC has with its
reinsurer and the result is indicative of the support afforded to it.
Results of Operations in 1997 Compared
With 1996, and 1996 Compared with 1995
The Group's operations for the each of three years ended December 31,
1997 comprise two major components. Direct business represents insurance
income and expenses associated with policies issued directly by the Group to
its policyholders. Ceded business, commonly referred to as reinsurance,
includes
<PAGE> 17
excess of loss, catastrophe and clash reinsurance arrangements which provide
the Group with insurance protection against excessive losses and quota share
reinsurance in which the reinsurer assumes a contractually agreed percentage
share or limit of each risk insured by the Group, after all other reinsurance.
Direct. The following comparative table illustrates the components of
direct business (including assumed business) written by the Group for each of
the three years ended December 31, 1997:
<TABLE>
<CAPTION>
Year ended December 31,
-------------------------------------------
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Premiums Written $12,314,676 $11,193,557 $11,250,681
===========================================
Premiums Earned $11,759,548 $11,536,429 $11,876,468
Losses and Loss Adjustment
Expenses Incurred 8,358,886 5,775,929 6,855,949
Underwriting Expenses Incurred 4,907,733 4,997,272 4,536,420
-------------------------------------------
Underwriting (Loss) Income $(1,507,071) $ 763,228 $ 484,099
===========================================
Loss Ratio 71.1% 50.1% 57.7%
Expense Ratio 39.8 44.6 40.3
-------------------------------------------
Combined Ratio 110.9% 94.7% 98.0%
===========================================
</TABLE>
Direct premiums written in 1997 increased 10% compared with 1996.
Direct earned premiums increased approximately 2% over 1996 indicating direct
written premium growth occurred in the latter half of 1997. Direct premiums
written and earned in 1996 were marginally less than those reported in 1995.
Increased market presence resulting in written premium growth, experienced in
latter half of 1997, is encouraging in a market which has been experiencing
substantial price competition and agent volume incentives.
Direct losses and loss adjustment expenses incurred increased
substantially in 1997 to $8,358,886 compared with $5,775,929 incurred in 1996
and $6,855,949 incurred in 1995. Direct losses and loss adjustment expenses
for the years 1997, 1996 and 1995 include $638,000, $2,012,000 and $1,899,000
of favorable loss development, respectively (refer to "Loss and Loss
Adjustment Expense Reserves" - this section). Without this development the
loss ratios would approximate 77%, 68%, and 74% for 1997, 1996 and 1995,
respectively. The 1997 results included weather-related loss frequency in
both the first and fourth quarters and 1996 includes adverse loss experience
for auto physical damage during the first quarter due to the severe winter
storms.
Underwriting expenses decreased $89,539 or 1.8% in 1997 compared with
1996, whereas 1996 expenses increased by $460,852 or 10.2% compared with 1995.
Expenses for 1996 included higher data processing costs associated with our
new information system and employee incentive awards not present in either
1997 or 1995.
<PAGE> 18
Ceded. The following comparative table illustrates the components of
ceded business written by the Group for each of the three years ended December
31, 1997:
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------------------------
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Premiums Written $(1,910,548) $5,127,816 $5,452,422
==========================================
Premiums Earned $ 266,065 $5,303,573 $5,005,394
Losses and Loss Adjustment
Expenses Incurred 1,558,084 2,270,542 2,868,984
Underwriting Expenses
(Credit) Incurred (117,701) 2,476,784 1,342,254
------------------------------------------
Underwriting (Loss) Income $(1,174,318) $ 556,247 $ 794,156
==========================================
Loss Ratio n/m% 42.8% 57.3%
Expense Ratio n/m 48.3 24.6
------------------------------------------
Combined Ratio n/m% 91.1% 81.9%
==========================================
</TABLE>
<n/m> - not meaningful
The Group manages its risk exposure through individual and aggregate
risk excess of loss reinsurance arrangements (treaties), casualty clash excess
of loss treaties and property catastrophe excess of loss reinsurance in which
the reinsurers assume that portion of the risk not retained by the Group. The
Group utilized quota share reinsurance until September 30, 1997.
The maximum gross policy limits offered by NEIC during 1997, 1996 and
1995 were $1,000,000. The Company's maximum net retention was $65,000 for the
period covering January 1, 1995 through December 1, 1995, $32,850 for the
period covering December 1, 1995 through December 31, 1996 and $50,000 for the
period covering January 1, 1997 through December 31, 1997.
Current reinsurance protection is provided through two layers of excess
of loss reinsurance. The first layer, considered to be the working layer,
assumes $150,000 of coverage beyond the first $50,000. The second layer,
allows NEIC to offer policy limits up to $1,000,000 by assuming $800,000 of
coverage beyond the first $200,000. The casualty clash excess of loss treaty
provides coverage for $1,000,000 in excess of $1,000,000 in the event more
than one insured is involved in a single loss occurrence exposing the coverage
limits of the policies. The property catastrophe coverage provides for
$1,500,000 of coverage in excess of $500,000 in the event of a catastrophe.
The 35% quota share treaty in effect for 1996 and 1995 was cancelled on a
runoff basis effective January 1, 1997 and subsequently commuted on September
30, 1997. For further information, see "Description of Business."
During the third quarter of 1997 management determined that NEIC's
reinsurance program was not performing as originally intended. A review of
the underwriting results indicated that the terms of the first layer excess of
loss treaty required revision, either through a rate reduction or lower
retention, in order to achieve timely matching of premiums and losses (the
original treaty included a profit sharing formula under which NEIC would
participate in any excess profits, the recording of which would occur in years
subsequent
<PAGE> 19
to 1997). In meetings with its reinsurer an agreement was reached to revise
the premium rate and eliminate the profit sharing. In addition, the treaty
was further endorsed to provide an experience rated premium adjustment in the
event the North East's direct loss and loss expense ratio exceeded 57% for the
1997 accident year.
As a result of these changes, ceded values for 1997 are distorted
compared with prior years. Ceded premiums written include the effect of the
rate reduction and the experience rated premium adjustment under the excess of
loss treaty. In addition to the above changes for ceded written premium,
ceded earned premium includes the runoff of earned premium for the 35% quota
share treaty through September 30, 1997. Losses and loss expenses incurred
for 1997 consist primarily of claims associated with the runoff of the quota
share treaty through September 30, 1997.
Net. The following comparative table illustrates the components of net
business written by the Group for each of the three years ended December 31,
1997:
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------------------------
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Premiums Written $14,225,224 $6,065,741 $5,798,259
=========================================
Premiums Earned $11,493,483 $6,232,856 $6,871,074
Losses and Loss Adjustment
Expenses Incurred 6,800,802 3,505,387 3,986,965
Underwriting Expenses Incurred 5,025,434 2,520,488 3,194,166
-----------------------------------------
Underwriting Income (Loss) $ (332,753) $ 206,981 $ (310,057)
=========================================
Loss Ratio 59.2% 56.2% 58.0%
Expense Ratio 35.3 41.6 55.1
-----------------------------------------
Combined Ratio 94.5% 97.8% 113.1%
=========================================
</TABLE>
Underwriting activities for 1997 generated a loss of $332,753. This
compares to underwriting profit in 1996 of $206,981 and a underwriting loss of
$310,057 in 1995. For the three year period losses and loss adjustment
expense represented 59.2% (1997), 56.2% (1996) and 58.0% (1995) of net earned
premium. The ratios, for the periods represented, include the favorable
development which is not likely to occur in 1998 (refer to "Loss and Loss
Adjustment Expense Reserves"). Without this favorable development the three
year period losses and loss adjustment expense represented 69.1% (1997), 93.4%
(1996) and 89.1% (1995) of net earned premium. Earned premium for 1997 also
includes the benefit derived from the endorsements to the excess of loss
treaty not in effect for either 1996 or 1995 and the termination of the quota
share treaty in 1997.
Underwriting expenses incurred amounted to $5,025,434 in 1997,
$2,520,488 in 1996 and $3,194,166 in 1995. The higher expenses in 1997 is
primarily attributable to the significant restructuring of our reinsurance
treaties leading to lower reinsurance commission offsets. Underwriting profit
(loss) by major category for each of the years ended December 31, 1997, 1996
and 1995 were as follows:
<PAGE> 20
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------------------------
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Auto Liability $(284,099) $ (151,833) $ 212,021
Auto Physical Damage (775,261) (1,094,897) (318,783)
Commercial Multi Peril 377,315 680,289 169,229
Other Liability 227,023 625,140 (61,280)
All Other 122,269 148,282 (311,244)
-----------------------------------------
Underwriting (Loss) Income $(332,753) $ 206,981 $(310,057)
=========================================
</TABLE>
The underwriting loss for auto physical damage in 1997 is directly
related to the severe winter experience in the first and fourth quarters.
Underwriting income (loss) in the all other category includes experience for
NEIC's homeowner product which was discontinued in 1995. Homeowners business
produced a net underwriting gain in 1997 and 1996 of $25,353 and $50,958,
respectively compared with a net underwriting loss of $245,525 in 1995.
Investment Results. Net investment income was $763,438 for 1997
compared with $1,041,762 in 1996 and $1,298,601 in 1995. The gross average
yield of the investment portfolio was 5.9%, 6.6% and 7.1% for 1997, 1996 and
1995, respectively. The Company realized investment gains of $35,321 and
$57,617 for 1997 and 1996, respectively compared with realized investment
losses of $225,726 in 1995. Total return from investment activities
(including realized gains or losses) was 6.1%, 6.9% and 5.2% for 1997, 1996,
and 1995, respectively.
Net Income. Net income before the provision for federal income taxes
was $466,006, $1,306,360 and $762,818 in 1997, 1996 and 1995, respectively.
The provision for income taxes includes the effect of a reassessment in
1996 of NEIC's position relative to NEIC's ability to utilize the value of its
loss carry forwards based on the future income and capital gains of NEIC. In
accordance with FAS 109 ("Accounting for Income Taxes"), a portion of the
change in the valuation allowance has been included in net income for the year
ended December 31, 1997 and 1996 and a deferred tax asset has been reported in
NEIC's balance sheet. The 1996 provision for income taxes included a benefit
of approximately $2,500,000 resulting from this reassessment.
Net income after the provision for income taxes was $288,680 in 1997,
compared with $3,375,496 in 1996 and $748,318 in 1995.
Liquidity and Capital Resources - 1997
Cash used in operating activities for the years ended December 31, 1997
and 1996 amounted to $1,469,805 and $2,470,856, respectively. Cash provided
from investing activities amounted to $1,883,561 for the year ended December
31, 1997 compared with $3,593,622 for the year ended December 31, 1996.
The Company's investment portfolio, carried at fair value, was $243,162
higher than amortized acquisition cost. Federal Reserve interest rate
adjustments have a significant impact on the fair value of fixed maturity
investments. In order to reduce its exposure to interest rate fluctuations,
management and the board of directors have reduced the average maturity of
securities in its investment portfolio. The Company believes that the current
level of short-term investments is adequate to meet any shortfall resulting
from its immediate operating activities.
<PAGE> 21
Derivatives. The Company's investment policy is to invest in investment
grade securities only and does not permit NEIC to participate in the
derivatives market for either hedging or speculative purposes. This policy
has been adhered to for the year ended December 31, 1997. The Company has no
open derivative financial instrument position as of the balance sheet date.
Losses and Loss Adjustment Expense Reserves. Reserves for losses and
loss adjustment expenses (LAE) represent estimates of the ultimate net cost of
all unpaid losses and loss adjustment expenses incurred through December 31 of
each year. The reserves are determined using adjusters' individual case
estimates and statistical projections. These projections are subject to the
effects of trends in claims severity and frequency. Statistical projections
are employed in four specific areas: (1) to calculate the incurred but not
reported (IBNR) reserves; (2) to calculate the adequacy of case basis
estimates of loss reserves; (3) to calculate the allocated LAE reserves; and
(4) to calculate the unallocated LAE reserves.
These projections are reviewed on a quarterly basis, and as experience
develops and new information becomes known, they are adjusted as necessary.
Such adjustments are reflected in the current year's consolidated statement of
operations.
In the determination of ultimate losses and loss adjustment expense,
NEIC utilizes historic paid and incurred loss patterns. Over the most recent
three year period, these patterns have indicated changes which are
characterized by a shortened loss tail; this is in contrast to NEIC's prior
experience. The change in the character was not recognized by NEIC in the
projection of ultimate losses until there was ample evidence that a trend had
been established. Reliable evidence of this change was recognized in the
favorable development commencing with accident year 1994.
The following table provides a reconciliation of the changes in loss and
LAE reserves, after deducting amounts recoverable from reinsurers for 1997 and
1996.
Reconciliation of Liability for Losses and
Loss Adjustment Expenses
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Reserves for losses and LAE:
Beginning of year $15,205,583 $19,006,725
Amounts recoverable from reinsurers
on unpaid losses 4,828,760 4,703,238
---------------------------
Beginning of year, net 10,376,823 14,303,487
Add:
Provision for losses and LAE for
claims arising in:
Current year 7,909,126 5,823,867
Prior years (1,108,324) (2,318,480)
Less:
Losses and LAE paid on claims arising in:
Current year 4,555,270 3,826,876
Prior years 1,633,475 3,605,175
---------------------------
End of year, net 10,988,880 10,376,823
Amounts recoverable from reinsurers
<PAGE> 22
on unpaid losses 3,668,346 4,828,760
- ---------------------------
Losses and loss adjustment expenses
per Consolidated Balance Sheet $14,657,226 $15,205,583
===========================
</TABLE>
The following table illustrates the original ultimate reserve established and
the reestimated reserve after deducting amounts recoverable from reinsurers
over each of the subsequent years through the balance sheet date.
Analysis of Ultimate Losses and Loss Adjustment Expenses Development
(in Thousands)
<TABLE>
<CAPTION>
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Ultimate Net Liability for unpaid claims
and claim adjustment expenses $21,749 $24,062 $20,085 $18,342 $18,661 $18,705 $17,472 $14,303 $10,377 $10,989
Cumulative amount paid
- - ----------------------
One year later 7,402 7,521 5,048 4,619 3,899 5,019 3,843 3,605 1,633
Two years later 11,515 11,212 8,503 7,004 7,460 7,595 6,625 5,769
Three years later 13,479 14,039 10,212 9,931 9,590 9,516 8,287
Four years later 15,147 15,373 12,718 11,685 11,131 10,756
Five years later 15,363 16,995 14,254 12,833 12,213
Six years later 16,559 18,483 15,278 13,835
Seven years later 17,764 19,356 16,195
Eight years later 18,365 20,177
Nine years later 18,956
<CAPTION>
Ultimate Net reserves reestimated as of
end of year
- ---------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
One year later $22,310 $24,653 $20,605 $18,329 $17,974 $17,685 $15,340 $11,985 $ 9,268
Two years later 22,193 24,743 20,676 18,823 18,087 16,829 13,748 11,825
Three years later 22,103 24,316 21,009 19,022 17,457 15,318 13,469
Four years later 21,882 25,108 21,247 18,675 16,463 14,986
Five years later 22,379 24,624 20,902 17,848 16,063
Six years later 22,012 24,581 20,205 17,417
Seven years later 22,147 23,971 19,731
Eight years later 21,864 21,538
Nine years later 21,552
Redundancy (deficiency) $ 197 $ 2,524 $ 354 $ 925 $ 2,598 $ 3,719 $ 4,003 $ 2,478 $ 1,109
</TABLE>
<TABLE>
<CAPTION>
Gross Reserves
----------------------------------------
1994 1995 1996 1997
------- ------- ------- -------
<S> <C> <C> <C> <C>
Ultimate gross liability for unpaid
claims and claim adjustment expenses $21,517 $19,007 $15,206 $14,657
<CAPTION>
Cumulative Amount Paid
- ----------------------
One Year Later 4,766 5,077 3,716
Two Years Later 8,625 7,836
Three Years Later 10,338
<CAPTION>
Ultimate Gross Reserves reestimated as of
- -----------------------------------------
One Year Later 19,618 16,995 14,568
Two Years Later 18,181 16,469
Three Years Later 17,499
Redundancy (Deficiency) $ 4,018 $ 2,538 $ 638
</TABLE>
The top line shows the original reserves at the balance sheet date for
each of the indicated years. These amounts represent initial reserve
estimates for the current and all prior accident years. The lower portion of
the table shows the Group's re-estimated values for the previously recorded
reserves based on the experience at the end of each succeeding year. The
upper portion of the table shows the cumulative amounts paid on claims settled
subsequent to the end of each calendar year.
<PAGE> 23
The cumulative redundancy (deficiency) represents the total change in
initial estimates over all subsequent calendar years. For example, the 1988
net reserve developed a redundancy of approximately $197,000 over nine years.
That amount is reflected in income over the nine year period. Its full impact
was not reflected in any one calendar year. New or modified products can
produce different results from historical trends of similar product lines
utilized in forecasting their ultimate loss exposure.
Claim payment patterns can be affected by numerous circumstances, such
as changes in reinsurance retention or changes in claim practices that could
lead to a speeding up or slowing of claim settlement rates.
In evaluating the information contained in the reserve development
table, it should be noted that each entry includes the effects of all changes
in amounts for prior periods. For example, the redundancy or deficiency
related to losses settled in 1997, but incurred in 1988, will be included in
the cumulative deficiency amounts for 1988 through 1997. Conditions and
trends, such as inflation, that have affected reserve development in the past
may not necessarily occur in the future. Therefore, it is not appropriate to
extrapolate future deficiencies or redundancies from this table.
At December 31, 1997 and 1996, the loss and loss adjustment expense
reserves as reported under generally accepted accounting principles (GAAP)
were identical to those reported under statutory accounting principles.
Results of Operations - Six Months Ended
June 30, 1998
Gross premiums earned for the six months ended June 30, 1998 amounted to
$6,274,216 representing a growth of 10.7% over the $5,668,596 recorded in the
first six months of 1997. Net premiums earned amounted to $5,336,633 for the
six months ended June 30, 1998 compared with $3,827,784 for the six months
ended June 30, 1997. The increase in gross premiums is consistent with the
growth experienced in 1997. The increase in net earned premiums reflects
differences in the company's reinsurance programs for the respective years.
Results for 1997 included the effect of terminating a quota share reinsurance
treaty on a run off basis effective January 1, 1997. Reinsurance treaties for
1998 remained unchanged from those in effect at December 31, 1997; however,
the first half of 1998 includes an endorsement to the first layer excess of
loss treaty for a net premium cost of approximately $140,000 not present in
1997.
Loss and loss adjustment expense represented 75.9% and 78.7% of net
earned premium for the six months ended June 30, 1998 and 1997, respectively.
Both of these ratios show significant improvement from the 97.6% and 83.7%
reported for the three month periods ending March 31,1998 and 1997,
respectively. The improvement primarily reflects the seasonality of the
business wherein loss frequency is higher during the winter months.
Underwriting expenses incurred represented 35.8% and 19.1% of net
premiums written for the six months ended June 30, 1998 and 1997,
respectively. The lower expense ratio for 1997 was directly attributable to
favorable loss experience of the quota share reinsurance program, in run off,
which generated additional expense recoveries.
Investment income, including realized gains, amounted to $481,733 for
the six months ended June 30, 1998 compared with $460,846 for the six months
ended June 30, 1997. The return on invested assets, based on amortized cost,
net of allocated expenses was 5.6% for the six months ended June 30, 1998
compared with 5.4% for the six months ended June 30, 1997.
Net loss for the six months ended June 30, 1998 amounted to $268,373 or
$0.09 per share compared with net income of $77,674 or $0.03 per share for the
six months ended June 30, 1997.
<PAGE> 24
Shareholders' equity at June 30, 1998 amounted to $9,731,199 or $3.19
per share compared with $9,985,654 or $3.28 per share at December 31, 1997.
Results of Operations -Three Months Ended
June 30, 1998
Gross premiums earned for the three months ended June 30, 1998 and 1997
amounted to $3,252,859, representing a growth of 11.7% over the $2,911,799
recorded in the three months ended June 30, 1997. Net premiums earned amounted
to $2,797,676 for the three months ended June 30, 1998 compared with
$1,736,434 for the three months ended June 30, 1997. The increase in net
earned premiums reflects the aforementioned reinsurance changes. In the latter
part of the second quarter the Company introduced a new personal automobile
insurance program ("Automatic") to replace both its existing non- standard and
standard/preferred personal automobile insurance programs. Policies issued
under the previous non-standard and standard/preferred programs will be
renewed under the new Automatic program. Key features of the new program
include assignment of drivers to specific vehicles and Company initiated mid
term premium credits upon eligibility date as opposed to policy renewal date.
The Company anticipates personal automobile premium volume to increase as a
result of this new program.
Loss and loss adjustment expense represented 56.3% and 72.7% of net
earned premium for the three months ended June 30, 1998 and 1997,
respectively. The Company's second quarter 1998 loss experience was excellent
with both severity and frequency posting near record lows.
Underwriting expenses incurred amounted to $1,110,864 and $344,526 for
the three months ended June 30, 1998 and 1997, respectively. Expenses incurred
in 1997 benefited from favorable loss experience of the quota share
reinsurance program, in run off, which generated additional expense
recoveries.
Investment income, including realized gains, amounted to $224,778 for
the three months ended June 30, 1998 compared with $240,234 for the three
months ended June 30, 1997.
Net income for the three months ended June 30, 1998 amounted to $222,441
or $0.07 per share compared with net income of $297,806 or $0.10 per share
for the three months ended June 30, 1997.
Shareholders' equity at June 30, 1998 amounted to $9,731,199 or $3.19
per share compared with $9,493,138 or $3.12 per share at March 31, 1998.
Liquidity and Capital Resources - June 30, 1998
Cash provided by operating activities amounted to $1,420,280 for the six
months ended June 30, 1998 compared with cash used by operating activities of
$1,197,209 for the six months ended June 30, 1997. Cash flow for the six
months ended June 30, 1998 included receipt of approximately $2,841,243 due
the Company under its reinsurance treaties. Cash used in investing activities
amounted to $2,380,612 for the six months ended June 30, 1998 compared with
cash used by investing activities of $191,241 for the six months ended June
30,1997.
The fair value of the Company's fixed maturities available for sale was
$296,445 more than the amortized cost at June 30,1998 compared with $243,162
more than amortized cost at December 31,1997. During the six months ended June
30, 1998 the Company used $169,979 for the purchase of equity securities.
The Company maintains short-term investments to provide a cash resource
should the demands from operations exceed incoming cash flow. Short-term
investments amounted to $2,324,764 at June 30, 1998
<PAGE> 25
compared with $3,397,581 at December 31, 1997. The Company believes that the
level short-term investments is adequate to meet any shortfall resulting from
its immediate operating activities.
Year 2000
The year 2000 issue relates to whether computer systems will properly
recognize date-sensitive information when the year changes to 2000. North
East has determined that it will be required to modify certain portions of its
software so its computer systems will properly function using dates beyond
December 31, 1999. Management presently believes that with modifications to
existing software the year 2000 issue can be rectified. North East will
initiate formal communications with its critical suppliers to determine the
extent to which it is vulnerable to the possibility of third parties' failing
to remediate their own year 2000 issues. Management is utilizing both
internal and external resources to reprogram and test the software for year
2000 modifications and plans to have its computer systems compliant by year
2000. The financial impact of addressing the year 2000 issue has not had, and
is not anticipated to have, a material adverse impact on North East's results
of operations, liquidity or capital resources.
FORWARD-LOOKING INFORMATION
From time to time, NEIC publishes information that includes forward-
looking statements, as defined in Section 21E of the Securities Exchange Act
of 1934. The "Management's Discussion and Analysis" section and "Description
of Business" section of this Prospectus contain forward-looking statements,
such as those concerning estimated future costs of agency profit-sharing and
Year 2000 issues. In addition, many of the items reflected in the Group's
financial statements are based in large part on estimates of future revenues
and losses.
The Company cautions readers that numerous factors could cause actual
results and business conditions to differ materially from those reflected in
North East's forward-looking statements, including changes in interest rates
and the performance of financial markets, changes in laws, regulations and
taxes, competition, industry consolidation, competitor demutualization, credit
risks and other factors. Insurance loss reserve liabilities can fluctuate as
a result of changes in numerous factors, and such fluctuations can have a
material positive or negative effect on the net result. The factors include,
but are not limited to, claim frequency and severity rates. These rates may
be influenced by many factors, including but not limited to, climate, new
trends and developments in technology, general economic and societal
conditions of the insurance market in which North East has exposure.
MANAGEMENT
Under NEIC's bylaws, officers are elected annually by the Board of
Directors and serve at the pleasure of the Board. There are no family
relationships between any of the executive officers of NEIC, nor were there
any special arrangements by which any of them was elected to his or her
position.
Robert G. Schatz, age 52, has served as President and Chief Executive
Officer of NEIC since March 1988. He was elected as a Director in December
1987.
Ronald A. Libby, age 55, joined NEIC in December 1994 and serves as its
Chief Operating Officer. From 1987 to 1994 he was President of Maine Mutual
Fire Insurance Company.
Samuel M. Koren, age 57, is Senior Vice President and Secretary of
NEIC. He joined NEIC in 1977 and has been an Officer since 1978.
Graham S. Payne, age 53, has been Treasurer and Chief Financial Officer
of NEIC since 1987.
<PAGE> 26
Rebecca J. Cerny, age 45, has held the position of Vice President of
NEIC since 1989. From 1986 to 1995 she also served as a Director of NEIC.
Executive Compensation
Set forth below is certain information concerning the compensation of
Robert G. Schatz, the President and Chief Executive Officer of NEIC, and each
other executive officer of NEIC who received more than $100,000 of salary and
bonus compensation for the prior fiscal year.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
NAME AND ANNUAL COMPENSATION ALL OTHER
PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION(1)
- ------------------ ---- ------ ----- ---------------
<S> <C> <C> <C> <C>
Robert G. Schatz 1997 $175,012 $28,276 $ 7,505
President and Chief 1996 $155,289 $96,216 $73,960
Executive Officer 1995 $150,000 $30,000 $ 3,982
Ronald A. Libby 1997 $110,319 $25,293 $ 3,116
Chief Operating 1996 $101,173 $36,707 $ 7,740
Officer 1995 $ 90,346 $ -0- $ 3,557
Samuel M. Koren 1997 $ 82,351 $33,442 $ 2,680
Sr. Vice President, 1996 $ 82,351 $22,361 $ 6,937
Secretary, and Clerk 1995 $ 82,351 $ -0- $ 3,847
- --------------------
<F1> For Mr. Schatz, other compensation in 1997 consists of $3,365 in
retroactive salary adjustments, $2,540 for Company-paid insurance
premiums, and $1,600 of matching contributions under the 401(k) Plan;
other compensation in 1996 consists of a $60,000 special bonus in lieu
of prior year payments, $9,590 of vacation pay, $2,540 for Company-paid
insurance premiums, and $1,830 of matching contributions under the
401(k) Plan; and other compensation in 1995 consists of $2,540 for
Company-paid insurance premiums and $1,442 of matching contributions
under the 401(k) Plan. For Mr. Libby, other compensation in 1997
consists of $2,116 of vacation pay and $1,200 of matching contributions
under the 401(k) Plan; other compensation in 1996 consists of $7,740 of
vacation pay; other compensation in 1995 consists of $3,357 of vacation
pay. For Mr. Koren, other compensation in 1997 consists of $1,584 of
vacation pay and $1,096 of matching contributions under the 401(k) Plan;
other compensation in 1996 consists of $5,845 of vacation pay and $1,092
of matching contributions under the 401(k) Plan; other compensation in
1995 consists of $2,833 of vacation pay and $1,014 of matching
contributions under the 401(k) Plan.
</TABLE>
OPTION GRANTS IN LAST FISCAL YEAR
INDIVIDUAL GRANTS
<TABLE>
<CAPTION>
PERCENT OF
TOTAL OPTIONS
NUMBER OF SECURITIES GRANTED TO EXERCISE
UNDERLYING OPTIONS EMPLOYEES IN OR BASE EXPIRATION
GRANTED FISCAL YEAR PRICE($/SH) DATE
-------------------- ------------ ----------- ----------
<S> <C> <C> <C> <C>
Robert G. Schatz 0 0% - -
Ronald A. Libby 100,000(1) 100% $2.375 6/10/07
Samuel M. Koren 0 0% - -
Graham S. Payne 0 0% - -
<F1> Mr. Libby's option is subject to vesting requirements and becomes
exercisable in five equal installments of 20,000 shares each on the
grant date (June 10, 1997) and the next four anniversary dates
<PAGE> 27
thereafter. Upon termination of employment, the unvested portion of the
option will expire unless termination results from death or disability
or (under certain circumstances) occurs within one year after a Change
in Control (as defined).
</TABLE>
Schatz Employment Agreement
The Company is a party to a new Employment Agreement with Mr. Schatz
that became effective January 1, 1998. The Agreement provides for (i) a base
salary of $175,000 per annum (subject to annual adjustments based on increases
in the Consumer Price Index) and (ii) a three-year profit sharing bonus
calculated on After-Tax Profit, as described below.
If the Company's After-Tax Profit (as defined) over a three-year period
exceeds a threshold amount of After-Tax Profit, then Mr. Schatz will be
entitled to a bonus under the Agreement. Specifically, if After-Tax Profit
over the three-year period exceeds approximately $3.3 million, then the bonus
will equal 5% of the excess over such target; to the extent that After-Tax
Profit exceeds approximately $5.2 million, he will be entitled to a bonus of
approximately $94,800 plus 10% of the excess over such higher threshold. (The
lower and higher thresholds represent a 10% and 15% compounded growth rate,
respectively, in shareholders equity over the three-year period.) The
targeted growth rates are subject to change, to account for capital influxes
into the Company or to account for dividends or distributions of capital to
shareholders.
In October 1996, the Board of Directors had awarded Mr. Schatz a stock
option for 200,000 shares of Common Stock, at the then prevailing market price
per share, subject to shareholder approval of a contemplated Stock Option
Plan. The Stock Option Plan was approved by shareholders in June 1997.
The Employment Agreement provides Mr. Schatz with a lump-sum severance
payment of $175,000, in the event that the Company terminates his employment
"without cause" or Mr. Schatz terminates his employment "for good reason" (as
such terms are defined in the Agreement). Furthermore, if Mr. Schatz complies
with a non-competition covenant for one year from the date of termination of
his employment, he will be entitled to additional severance payments totaling
$175,000 plus interest at the federal long-term rate (as defined), which
amount payable in 108 monthly installments commencing one year after
termination of employment. These payments were previously negotiated with Mr.
Schatz in 1996, in settlement of his claims for unpaid bonuses and options
under his 1991 Employment Agreement.
Employment Continuity Agreements
In October 1996 the Board approved Employment Continuity Agreements with
Mr. Libby and one other executive officer. Under these Agreements, if the
executive's employment is terminated within twelve months after the occurrence
of a Change in Control Event (as defined), then NEIC agrees to provide the
executive with special severance compensation equal to 200% of the sum of his
current annual base salary plus any profit sharing award for the prior year,
provided that the payment will be reduced if and to the extent necessary to
keep the payment from becoming non-deductible under Section 280G of the
Internal Revenue Code. This same benefit accrues if the executive terminates
his employment for "good reason," which is defined to include a reduction in
his responsibilities or certain other events. The Employment Continuity
Agreement also provides for a stay-on bonus equal to 100% of his annual base
salary if the executive remains employed for six months after the Change in
Control Event, subject to the condition that he not compete with NEIC for the
following six months. These special severance benefits do not apply if NEIC
terminates the executive's employment for "good cause," including a
substantial neglect of duties after written notice and an opportunity to
correct.
In October 1996 the Board also approved an Employment Continuity
Agreement with Mr. Schatz. This Agreement becomes effective only once the
1991 Employment Agreement (which contains Change of Control provisions, as
described above) is no longer in effect. The Employment Continuity Agreement
with
<PAGE> 28
Mr. Schatz has terms equivalent to those for Mr. Libby and the other executive
officer, except that his special severance compensation equals 300% of the sum
of his current annual base salary plus any profit sharing award for the prior
year (subject, however, to the Section 280G limitation).
CERTAIN RELATIONSHIPS AND RELATED-PARTY TRANSACTIONS
In January 1997, following receipt of regulatory approval in Maine and
New York, Ballantrae Partners, L.L.C. purchased 810,000 shares of NEIC Common
Stock, representing more than 27% of the shares then outstanding. In
connection with such purchase, Ballantrae entered into a Standstill Agreement
with NEIC governing certain matters relating to control of the Company. In
July 1998, Ballantrae sold its shares to four purchasers, each of which
thereby acquired an ownership position of less than 10% of the outstanding
NEIC shares. In connection with that sale, Ballantrae gave notice of
termination of the Standstill Agreement. Following the sale, the three
principals of Ballantrae resigned from the NEIC Board of Directors.
The firm of Monaghan, Leahy, Hochadel & Libby provides legal services to
NEIC. Mr. Hochadel, a Director of NEIC, is a partner in that firm. Fees paid
to that firm in 1997 and 1996 were approximately $135,000 and $165,000,
respectively.
The Company received legal services in 1997 and 1996 from two firms in
which Mr. Cummings was or is now a Partner. Fees paid to such firms by NEIC
did not exceed $60,000 in either 1997 or 1996.
During each of the past two years, Batal Agency has been an independent
insurance agent for NEIC. Mr. Batal, a Director of NEIC, is President of
that agency. Commissions paid to the agency were based on NEIC's standard
rates and did not exceed $60,000 in either 1997 or 1996.
PRINCIPAL SHAREHOLDERS
As of the date of this Prospectus, a total of 3,049,089 shares of NEIC's
Common Stock are outstanding. The Common Stock is entitled to one vote per
share and is the only class of NEIC stock outstanding. Set forth below, as of
the record date, is information concerning the only persons known to NEIC to
beneficially own more than five percent of the outstanding shares.
<TABLE>
<CAPTION>
Number of Shares Percent of
Name and Address Beneficially Owned Outstanding
- ---------------- ------------------ -----------
<S> <C> <C>
The Foothold Fund, L.P. 299,000 9.8%
c/o Fairholme Capital Management
51 JFK Parkway, Short Hills, NJ 07078.
Richard H. Konrad 299,000 9.8%
c/o Lincluden Management Limited
1275 North Service Road West, Suite 607
Oakville, Ontario, Canada L6M 3G4
Capitol Indemnity Corporation 299,000 9.8%
4610 University Ave.
Madison, WI 53705
Everest Partners, L.P. 154,000 5.1%
Job's Peak Ranch
<PAGE> 29
P.O. Box 3178
Gardnerville, Nevada 89410
- --------------------
<F1> Information regarding the stock ownership of The Foothold Fund, L.P. is
given on the basis of its Schedule 13D report, filed August 6, 1997 and
most recently amended July 7, 1998. Foothold's sole general partner is
The Foothold Management Corp. Peter A. Russ is the President, sole
director and sole shareholder of Foothold Management. Foothold's
Schedule 13D report states that it was purchasing the Common Shares for
investment purposes and not for the purpose of acquiring control of
North East.
<F2> Information regarding the stock ownership of Mr. Conrad is given on the
basis of his Schedule 13G report filed on July 2, 1998. The Schedule
13G report states that the NEIC shares were not acquired and are not
held for the purpose of or with the effect of changing or influencing
the control of North East and were not acquired and are not held in
connection with or as a participant in any transaction having that
purpose or effect.
<F3> Information regarding the stock ownership of Capitol Indemnity
Corporation is given on the basis of a partial Schedule 13D report filed
on July 16, 1998. Capitol Indemnity is an insurer and surety company
located in Madison, Wisconsin. It is a wholly-owned subsidiary of
Capitol Transamerica Corporation, a publicly traded company of which
George A. Fait is President and Chairman of the Board.
<F4> Information regarding the stock ownership of Everest Partners, L.P. is
given on the basis of its Schedule 13G report filed on July 13, 1998.
The general partner of Everest Partners is Everest Partners, Inc. The
manager of Everest Partners is Everest Managers, L.L.C. David M.W.
Harvey is the sole principal of the general partner and the manager.
The Schedule 13G report states that the NEIC shares were not acquired
and are not held for the purpose of or with the effect of changing or
influencing the control of North East and were not acquired and are not
held in connection with or as a participant in any transaction having
that purpose or effect.
</TABLE>
The following table shows, as of the record date, the number of shares
of NEIC Common Stock which, to NEIC's knowledge, were beneficially owned by
the directors and certain executive officers of NEIC, and by each other
nominee for election as a director. Except as otherwise indicated, each
person named owned less than one percent of the outstanding Common Stock of
NEIC.
<TABLE>
<CAPTION>
NUMBER OF SHARES PERCENT OF
NAME BENEFICIALLY OWNED(1) OUTSTANDING
---- --------------------- -----------
<S> <C> <C>
Robert G. Schatz 295,859 9.1%
Ronald A. Libby 40,063 1.5%
Samuel M. Koren 9,500
Edward B. Batal 6,500
Terence P. Cummings 0
Robert A. Hancock 2,500
Wilson G. Hess 0
Joseph M. Hochadel 0
Bruce H. Suter 500
Peter A. Russ 299,000 9.8%
All directors and executive
officers as a group 653,922 21.4%
- --------------------
<PAGE> 30
<F1> Includes shares owned by spouses or other relatives residing in the same
household, and by entities owned or controlled by the person named.
Also includes the following shares purchasable within the next 60 days
under outstanding stock options: Mr. Schatz, 200,000; Mr. Libby, 40,000.
</TABLE>
DESCRIPTION OF CAPITAL STOCK
The Company is authorized to issue 12,000,000 shares of Common Stock,
the only authorized class of capital stock. As of the date of this
Prospectus, a total of 3,049,089 shares of Common Stock were outstanding. In
addition, ________ shares of Common Stock were reserved for issuance upon the
exercise of outstanding warrants and options.
Each outstanding share of Common Stock entitles the holder to one vote
on all matters requiring a vote of shareholders. Since the Common Stock does
not have cumulative voting rights, the holders of shares having more than 50%
of the voting power, if they choose to do so, may elect all the directors of
NEIC and the holders of the remaining shares would not be able to elect any
directors.
Subject to the rights of holders of any series of preferred stock that
may be issued in the future, the holders of the Common Stock are entitled to
receive dividends when, as and if declared by the Board of Directors out of
funds legally available therefor. See "Price Range of Common Stock and
Dividend Policy." In the event of a voluntary or involuntary liquidation of
NEIC, all shareholders are entitled to a pro rata distribution of the assets
of NEIC remaining after payment of claims of creditors and liquidation
preferences of any preferred stock. Holders of the Common Stock have no
conversion, redemption, sinking fund or preemptive rights.
Additionally, certain provisions of NEIC's Articles of Incorporation and
Bylaws could delay or impede the removal of incumbent directors and could make
more difficult a merger, tender or proxy contest involving NEIC, even if such
events would be beneficial to the interests of the shareholders, or could
discourage a third party from attempting to acquire control of NEIC. In
particular, NEIC's Articles of Incorporation requires supermajority
shareholder approval of certain business combinations and other related-party
transactions.
Transfer Agent
The transfer agent for the Common Stock is American Stock Transfer &
Trust Company, 40 Wall Street, 46th Floor, New York, New York 10005. This
firm will be acting as our Subscription Agent for purposes of the Rights
Offering.
Price Range of Common Stock; Dividend Policy
The Common Stock common shares are traded over the NASDAQ SmallCap
Market under the symbol "NEIC." As of _________, 1998, there were ______
holders of record of NEIC's Common Stock. The high and low closing bid prices
(as quoted by NASDAQ) for the Common Stock for each quarterly period for the
two most recent fiscal years and the first two quarters of 1998 were as
follows:
<TABLE>
<CAPTION>
1998 1997 1996
------------- --------------- --------------
HIGH LOW HIGH LOW HIGH LOW
<S> <C> <C> <C> <C> <C> <C>
First Quarter $2.88 $2.44 $2.94 $2.00 $1.81 $1.00
Second Quarter $3.13 $2.63 2.81 1.94 2.00 1.25
Third Quarter 3.50 2.06 2.13 1.50
Fourth Quarter 3.19 2.00 2.25 1.50
</TABLE>
<PAGE> 31
These figures reflect prices without retail mark-up, mark-down or commission
and may not represent actual transactions.
The Company has never paid and does not anticipate paying dividends in
the foeseeable future.
Based on its current accumulated statutory unassigned deficit, NEIC
currently is prohibited from paying dividends. Under Maine insurance laws,
cash dividends may only be paid out of that part of the available accumulated
statutory unassigned deficit which is derived from realized net operating
profits on NEIC's insurance business and from net realized capital gains. In
addition to other statutory restrictions, policyholders' surplus following any
dividends or distributions to shareholders must be reasonable in relation to
the insurer's outstanding liabilities and its financial needs. Furthermore,
NEIC may not pay "extraordinary" dividends or make any other distribution
(i.e. dividends or distributions made within the next 12 months) which exceed
the greater of (i) 10% of NEIC's surplus to policyholders or (ii) NEIC's net
investment income, in either case, as of the preceding year end) unless the
Maine Superintendent of Insurance has been notified of the declaration and has
either approved it or has failed to disapprove it within 60 days. Any payment
of cash dividends would reduce NEIC's capacity to write new premiums, since
the volume of insurance that can be written is determined by the available
statutory surplus.
COMMISSION POSITION ON INDEMNIFICATION
OF CERTAIN LIABILITIES
Under its bylaws and separate indemnity agreements, NEIC has agreed to
indemnify its directors and officers against liabilities and expenses arising
in connection with their activities on behalf of North East. Insofar as
indemnification for liabilities arising under the Securities Act of 1933 may
be permitted to directors and officers of North East pursuant to such
provisions, or otherwise, North East has been advised that in the opinion of
the Securities and Exchange Commission such indemnification is against public
policy as expressed in such Act and is, therefore, unenforceable.
LEGAL MATTERS
Certain legal matters in connection with this offering will be passed
upon for NEIC by Verrill & Dana LLP, Portland, Maine.
EXPERTS
The consolidated financial statements and the related financial
statement schedule included and incorporated by reference in this Prospectus
by reference from NEIC's Annual Report on Form 10-K for the years ended
December 31, 1996 and 1997, and for each of the three years in the period
ended December 31, 1997, have been audited by PricewaterhouseCoopers LLC,
independent auditors, as stated in their report, which is included and
incorporated by reference herein, and has been so included and incorporated in
reliance upon such report of such firm given upon their authority as experts
in accounting and auditing.
<PAGE> 32
FINANCIAL STATEMENTS
ITEM 7 - CONSOLIDATED FINANCIAL STATEMENTS
NORTH EAST INSURANCE COMPANY AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE(S)
-------
<S> <C>
Report of Independent Accountants 22
Financial Statements:
Consolidated Balance Sheet as of December 31, 1997 23
Consolidated Statements of Operations for the years ended
December 31, 1997 and 1996 24
Consolidated Statements of Changes in Shareholders' Equity
for the years ended December 31, 1997 and 1996 25
Consolidated Statements of Cash Flows for the years ended
December 31, 1997 and 1996 26
Notes to Consolidated Financial Statements 28
</TABLE>
Coopers Coopers & Lybrand L.L.P
& Lybrand
a professional services firm
REPORT OF INDEPENDENT ACCOUNTANTS
To the Stockholders and Directors of
North East Insurance Company:
We have audited the consolidated balance sheet of North East Insurance Company
and subsidiaries, as of December 31, 1997 and the related consolidated
statements of operations, changes in shareholders' equity and cash flows for
each of the two years in the period ended December 31, 1997. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of North
East Insurance Company and subsidiaries as of December 31, 1997 and the
consolidated results of its operations and its cash flows for each of the two
years in the period ended December 31, 1997 in conformity with generally
accepted accounting principles.
/S/ Coopers & Lybrand L.L.P.
Portland, Maine
March 31, 1998
NORTH EAST INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
as of December 31, 1997
<TABLE>
<CAPTION>
1997
-----------
<S> <C>
ASSETS
- ------
Investments (Note F):
Fixed maturities available for sale, at fair value (amortized cost
$12,817,492) $13,060,654
Equity securities available for sale, at fair value (cost $92,263) 92,263
Short-term investments, at fair value 3,397,581
-----------
Total investments 16,550,498
Reinsurance (loss and loss adjustment expense reserves and paid
recoverables (Note D)) 5,226,919
Premium balances receivable 4,478,724
Reinsurance premium balances receivable 2,139,973
Deferred policy acquisition costs (Note B) 1,029,488
Prepaid reinsurance premiums (ceded unearned premium (Note D)) 373,319
Cash on hand 375,157
Investment income due and accrued 209,904
Property and equipment, net of accumulated depreciation (Note G) 425,429
Deferred tax asset (Note C) 1,790,393
Prepaid expenses 11,487
Prepaid federal income tax 9,242
Other assets 191,037
-----------
Total Assets $32,811,570
===========
LIABILITIES
- -----------
Losses and loss adjustment expenses (Note D and H) $14,657,226
Unearned premiums 6,272,130
Reinsurance balances payable 790,456
Reserve for unpaid expenses and other liabilities 608,287
Book overdraft, net 397,123
Other liabilities 100,694
-----------
Total Liabilities 22,825,916
-----------
Commitments and contingent liabilities (Notes D and J)
SHAREHOLDERS' EQUITY (Note E)
- -----------------------------
Common stock $1.00 par value, authorized 6,000,000 shares, issued
and outstanding 3,046,842 shares 3,046,842
Additional paid-in capital 6,403,621
Unrealized appreciation of investments 160,487
Accumulated retained earnings 374,704
-----------
Total Shareholders' Equity 9,985,654
-----------
Total Liabilities and Shareholders' Equity $32,811,570
===========
</TABLE>
The accompanying notes are an integral part
of the consolidated financial statements.
NORTH EAST INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
for the years ended December 31, 1997 and 1996
<TABLE>
<CAPTION>
1997 1996
----------- -----------
<S> <C> <C>
Revenues:
Premiums earned $11,759,548 $11,536,429
Premiums ceded (Note D) (266,065) (5,303,573)
---------------------------
Net premiums earned 11,493,483 6,232,856
Net investment income (Note F) 763,438 1,041,762
Realized capital gains (losses) (Note F) 35,321 57,617
---------------------------
Total revenues 12,292,242 7,332,235
Expenses:
Losses and loss adjustment expenses 8,358,886 5,775,929
Reinsurance recoveries (Note D) (1,558,084) (2,270,542)
---------------------------
Net losses and loss adjustment expenses 6,800,802 3,505,387
Underwriting expenses incurred 5,025,434 2,520,488
---------------------------
Total expenses 11,826,236 6,025,875
---------------------------
Income before provision for income taxes 466,006 1,306,360
Provision (benefit) for income taxes (Note C) 177,326 (2,069,136)
---------------------------
Net income $ 288,680 $ 3,375,496
===========================
Net income per common share:
Basic $0.10 $1.13
===========================
Diluted $0.09 $1.13
===========================
</TABLE>
The accompanying notes are an integral part
of the consolidated financial statements.
NORTH EAST INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
for the years ended December 31, 1997 and 1996
<TABLE>
<CAPTION>
1997 1996
----------- -----------
<S> <C> <C>
Common stock, par value:
Balance at beginning of year $ 3,002,375 $ 2,992,314
Change during year 44,467 10,061
---------------------------
Balance at end of year 3,046,842 3,002,375
---------------------------
Additional paid-in capital:
Balance at beginning of year 6,348,039 6,346,156
Change during year 55,582 1,883
---------------------------
Balance at end of year 6,403,621 6,348,039
---------------------------
Unrealized appreciation (depreciation):
Balance at beginning of year (111,477) 377,053
Change during year, net 271,964 (488,530)
---------------------------
Balance at end of year 160,487 (111,477)
---------------------------
Accumulated retained earnings (deficit):
Balance at beginning of year 86,024 (3,289,472)
Net income 288,680 3,375,496
---------------------------
Balance at end of year 374,704 86,024
---------------------------
Treasury stock, at cost:
Balance at beginning of year 0 (5,000)
Change during year 0 5,000
---------------------------
Balance at end of year 0 0
---------------------------
Total shareholders' equity at end of year $ 9,985,654 $ 9,324,961
===========================
</TABLE>
The accompanying notes are an integral part
of the consolidated financial statements.
NORTH EAST INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
for the years ended December 31, 1997 and 1996
<TABLE>
<CAPTION>
1997 1996
----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Insurance premiums received $11,123,501 $ 5,542,279
Loss and loss adjustment expenses paid (7,668,046) (7,132,600)
Operating expenses paid (5,763,145) (1,961,730)
Investment income received 837,885 1,086,195
Federal income taxes paid 0 (5,000)
---------------------------
Net cash used in operating activities (1,469,805) (2,470,856)
---------------------------
Cash flows from investing activities:
Fixed maturities - sold 3,863,582 7,514,127
Fixed maturities - matured 0 1,200,000
Fixed maturities - purchased (1,850,675) (5,597,243)
Purchase of property and equipment (223,730) (129,234)
Mortgage note repaid 0 459,139
Investment property sold 76,160 120,000
Sale of property and equipment 18,224 26,833
---------------------------
Net cash provided by investing activities 1,883,561 3,593,622
---------------------------
Cash flows from financing activities:
Proceeds from issuance of common shares 100,049 16,944
Increase (decrease) in book overdraft 390,058 (139,093)
---------------------------
Net cash provided (used) by financing activities 490,107 (122,149)
---------------------------
Net increase in cash and short-term investments 903,863 1,000,617
Cash and short-term investments at beginning of year 2,868,875 1,868,258
---------------------------
Cash and short-term investments at end of year $ 3,772,738 $ 2,868,875
===========================
</TABLE>
The accompanying notes are an integral part
of the consolidated financial statements.
(Continued)
NORTH EAST INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED RECONCILIATION OF CASH USED IN
OPERATING ACTIVITIES TO NET INCOME
for the years ended December 31, 1997 and 1996
<TABLE>
<CAPTION>
1997 1996
----------- -----------
<S> <C> <C>
Net income $ 288,680 $ 3,375,496
Decrease in loss and loss adjustment expense reserve (548,357) (3,801,142)
Increase (decrease) in unearned premium reserve, net 2,731,741 (167,115)
Increase (decrease) in expense accruals and other liabilities (350,338) 375,666
Loss on disposal of property and equipment 63,238 0
Loss (gain) on investment activities (18,974) 20,399
Decrease (increase) in deferred policy acquisition costs (630,893) (86,372)
Depreciation and amortization expense 195,115 190,489
Increase in net premium and ceded reinsurance balances (3,405,610) (249,533)
Decrease in allowance for doubtful accounts (15,000) (100,000)
Decrease in investment income due and accrued 74,447 44,433
Amortization of bond premium, net 72,030 80,491
Loss (gain) on mortgage note in default 0 (79,139)
Loss (gain) on sale of real estate (16,347) 1,123
Increase in other assets (86,863) (1,516)
Increase (decrease) in federal income tax payable 0 (14,500)
Decrease (increase) in prepaid federal income tax 0 (9,242)
Decrease (increase) in deferred tax asset 177,326 (2,050,394)
---------------------------
Net cash used in operating activities $(1,469,805) $(2,470,856)
===========================
</TABLE>
The accompanying notes are an integral part
of the consolidated financial statements.
NORTH EAST INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
A. Summary of Significant Accounting Policies:
- -----------------------------------------------
Basis of Presentation
- ---------------------
North East Insurance Company and Subsidiaries' ("the Company") consolidated
financial statements have been prepared on the basis of generally accepted
accounting principles. The consolidated financial statements include the
Company and its wholly-owned subsidiaries American Colonial Insurance Company
(ACIC) and North Atlantic Underwriters, Inc. (NAU). Intercompany transactions
have been eliminated.
The Company is engaged in the business of underwriting and accepting property
and casualty insurance risks in the State of Maine. Its principal insurance
products consist of personal and commercial automobile coverage (including
automobile liability and automobile physical damage) and other general lines,
including but not limited to, general liability, commercial multi-peril, inland
marine, fire and allied lines. ACIC, licensed to write property and casualty
insurance risks in the states of New York and Texas, has not written or renewed
any insurance risks since March 1990 and is in runoff. NAU, a Maine domiciled
brokerage company, is dormant.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities at the date of the
financial statements, and the reported revenues and expenses during the
reporting period. Actual results could differ from these estimates.
Certain 1996 amounts have been reclassified in 1997 for comparative purposes.
Premiums and Unearned Premiums
- ------------------------------
Premium revenues are reported as earned, principally on a monthly pro rata
basis over the terms of the respective policies. Unearned premiums represent
the portion of premiums written applicable to the unexpired terms of the
policies.
Premium balances receivable represent amounts to be collected from agents and
insureds. The Company offers insureds installment plans under which insureds
may remit amounts due, in accordance with a predetermined schedule, over the
term of the policy. Premium balances receivable are recorded for the full
premium amount when the policy is written. These receivables include amounts
not currently due under the installment plan. Premium balances receivable
include $3,712,405 for amounts not yet due at December 31, 1997. The allowance
for doubtful accounts at December 31, 1997 was $15,000.
Losses and Loss Adjustment Expenses
- -----------------------------------
The reserve for losses and loss adjustment expenses includes unpaid losses and
loss adjustment expenses and a provision for incurred but not reported losses.
Unpaid losses and loss adjustment expenses are based primarily on loss
adjusters' evaluations, estimates for losses incurred but not reported and an
estimate for salvage and subrogation recoverable. Reserves are continually
reviewed and modified, and any resulting adjustments are reflected in current
operating results.
Deferred Policy Acquisition Costs
- ---------------------------------
Policy acquisition costs, such as commissions, underwriting salaries and other
costs incurred in connection with acquiring new business, have been capitalized
to the extent that the related costs are recoverable and are being amortized
over the period in which the related premiums are earned. Anticipated losses
and loss adjustment expenses and investment income attributable to the related
premiums are considered in determining the amount of costs to be deferred.
Reinsurance
- -----------
Premiums ceded are reported as earned, principally on a monthly pro rata basis
over the terms of the respective policies. Unearned premiums ceded represent
the portion of premiums written applicable to the unexpired terms of the
policies.
Ceded premium adjustments for loss sensitive reinsurance contracts are reported
immediately as ceded earned premium based on the Company's best estimate of the
ultimate loss exposure for the contract as of the balance sheet date.
Property and Equipment
- ----------------------
Property and equipment are stated at cost, net of accumulated depreciation. The
Company provides for depreciation on the straight-line method by charges to
expense which are sufficient to write off the cost of the assets over their
estimated useful lives. Maintenance and repairs are charged to expense as
incurred; expenditures for improvements are capitalized. Upon sale or
retirement, the cost and related accumulated depreciation are eliminated from
their respective accounts and any resulting gain or loss is included in the
results of operations.
Employee Benefits
- -----------------
The Company maintains a 401(k) Profit Sharing Plan (the "Plan") covering all
employees. The Plan is intended to provide funds for participants' use at
retirement. Employees may elect to contribute up to 10% of their pre-tax
earnings to the Plan. The Company provides a matching contribution of 25% of
the first 4% of an employee's elective contribution. The Plan also provides
that the Company may make an additional contribution subject to the
profitability of the Company for the related calendar year. For the years ended
December 31, 1997 and 1996, the Company contributed $9,401 and $7,652,
respectively, pursuant to the matching formula. The Company contributed $0 and
$9,820 under the profitability formula as of December 31, 1997 and 1996,
respectively.
The Company does not provide any post-retirement benefits to its employees.
Income Taxes
- ------------
The provision for income taxes includes amounts currently payable and deferred
income taxes, which result from differences between financial reporting and tax
basis reporting of assets and liabilities, and are measured using enacted tax
rates and laws. Deferred tax assets are recognized to the extent future
realization of the tax benefit is more likely than not.
Investments
- -----------
Fixed maturities and equity securities, all of which are available for sale,
are stated at fair value. Short-term investments are carried at cost which
approximates fair value. The Company, at times, may be at risk on short-term
investments as the values on deposit may exceed the amount protected through
federally guaranteed insurance programs; however, the Company has never
experienced a loss of this nature.
Realized capital gains and losses from the sale of investments are determined
on the basis of identified cost and are credited or charged to income.
Unrealized capital gains and losses from the valuation of fixed maturities and
equity securities at fair value are credited or charged directly to
shareholders' equity. If a decline in fair value of an invested asset is
considered to be other than temporary, the investment is reduced to its net
realizable fair value and the reduction is accounted for as a realized loss.
The following methods and assumptions were used in estimating fair value
disclosure for financial instruments:
* Fixed Maturities Available for Sale: Fair values for fixed
maturities available for sale are based on quoted market prices,
where available. If quoted market prices are not available, fair
values are estimated using values obtained from independent pricing
services.
* Equity Securities Available for Sale: Fair values for equity
securities available for sale are based on quoted market prices.
* Short-term Investments: Fair values for these instruments are the
amounts reported in the Consolidated Balance Sheet.
Capital Structure
- -----------------
The Company's capital consists of 6,000,000 authorized common shares, par value
$1.00, of which 3,046,842 are issued and outstanding.
Earnings per Share
- ------------------
Effective December 31, 1997, North East adopted Financial Accounting Standards
("FAS") No. 128, "Earnings Per Share" which requires dual presentation of basic
and diluted earnings per share ("EPS") . Basic EPS is computed by dividing net
income available to common stockholders by the weighted average number of
common shares outstanding. The weighted average number of shares outstanding
used to calculate basic EPS was 3,022,898 and 2,994,265 in 1997 and 1996,
respectively. The weighted average number of shares outstanding used to
calculate diluted EPS was 3,098,235 and 2,994,265 in 1997 and 1996,
respectively. Diluted EPS is computed by dividing net income available to
common stockholders by the weighted average number of common shares outstanding
while giving effect to all dilutive potential common shares outstanding.
Statements of Cash Flows
- ------------------------
The Company utilizes the direct method of presenting cash flows from operating
activities. For purposes of the statements of cash flows, cash was determined
to include cash and short-term (highly liquid) investments with original
maturities less than three months
Accounting Pronouncements Adopted
- ---------------------------------
Effective December 31, 1997 the Company adopted FAS No. 128 which changed the
computation of EPS and requires dual presentation of "basic" and "diluted" EPS.
FAS 128 supersedes Accounting Principles Board ("APB") Opinion No. 15,
"Earnings Per Share".
Effective December 31, 1997 the Company adopted FAS No. 129, "Disclosures of
Information About Capital Structure", which consolidates disclosure
requirements related to the type and nature of securities contained in an
entity's capital structure. FAS 129 does not add or change any of North East's
disclosures.
Effective January 1, 1997 the Company adopted FAS No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities", which established accounting and reporting standards for
transfers and servicing of financial assets and extinguishments of
liabilities. The statement provides guidiance for recognition or
derecognition of assets and liabilities, focusing on the concepts of control
and extinguishment. The adoption of FAS 125 did not have a material effect on
North East's results of operations or financial position.
New Accounting Pronouncements
- -----------------------------
In June 1997, the Financial Accounting Standards Board ("FASB") issued FAS No.
130, "Reporting Comphrehensive Income", which establishes standards for
reporting and display of comprehensive income and its components in a financial
statement with the same prominence as other financial statements. Comprehensive
income is defined as net income adjusted for changes in stockholders' equity
resulting from events other than net income or transactions related to an
entity's capital instruments. North East is required to adopt FAS 130 effective
January 1, 1998, with reclassification of financial statements for earlier
years required.
In June 1997, the FASB issued FAS No. 131, "Disclosure about Segments of an
Enterprise and Related Information", which establishes standards for reporting
information about operating segments. Generally, FAS 131 requires that
financial information be reported on the basis that is used internally for
evaluating performance. The Company is required to adopt FAS 131 effective
January 1, 1998 and comparative information for earlier years must be restated.
This statement does not need to be applied to interim financial statements in
the initial year of application. The Company is currently considering what
impact, if any, FAS 131 will have on its current reporting format.
In February 1998, the FASB issued FAS No. 132, Employers' Disclosures about
Pensions and Other Postretirement Benefits", which revises current disclosure
requirements for employers' pension and other retiree benefits. FAS 132 does
not change the measurement or recognition of pension or other postretirement
benefit plans. The Company is required to adopt FAS 132 effective January 1,
1998, with restatement of disclosure for earlier years required.
In December 1997, the Accounting Standards Executive Committee issued Statement
of Position ("SOP") 97-3, "Accounting by Insurance and Other Enterprises for
Insurance-Related Assessments", which provides guidance on accounting for
insurance-related assessments. North East is required to adopt SOP 97-3
effective January 1, 1998. Previously issued financial statements should not be
restated unless the SOP is adopted prior to the effective date and during an
interim period. The adoption of SOP 97-3 is not expected to have a material
impact on North East's results of operation, liquidity or financial position.
B. Deferred Policy Acquisition Costs:
- --------------------------------------
Deferred policy acquisition costs ($1,029,488 at December 31,1997) represent
the Company's best estimate of amounts expected to be recovered against future
earned premium from policies currently inforce and anticipated investment
income. The estimates take into account an estimate for anticipated future loss
experience of these policies. While the Company believes that the recovery of
this asset is likely, it is remotely possible that the assumptions used will
prove inappropriate and the Company's estimate that it will recover the
carrying amount of this asset could change.
The following table reconciles the change in deferred policy acquisition costs
for the years ended December 31, 1997 and 1996:
<TABLE>
<CAPTION>
1997 1996
---------- ---------
<S> <C> <C>
Balance, beginning of year $ 398,595 $ 312,223
Deferral of policy acquisition costs during year 3,570,811 733,051
Amortization of deferred policy acquisition costs
during year (2,939,918) (646,679)
------------------------
Balance, end of year $1,029,488 $ 398,595
========================
</TABLE>
C. Federal Income Taxes:
- -------------------------
A reconciliation of income taxes computed by applying the federal income tax
rate to income before income taxes and the provision (benefit) for income
taxes for the year ended December 31, 1997 and 1996 is as follows:
<TABLE>
<CAPTION>
1997 1996
-------- -----------
<S> <C> <C>
Tax at federal statutory rate of 34% $158,442 $ 444,162
Utilization of net operating loss carryforwards (106,938) (467,357)
Timing differences between GAAP basis income
and tax basis income 116,320 4,453
Change in valuation allowance 9,492 (2,050,394)
------------------------
Provision (benefit) for income taxes $177,326 $(2,069,136)
========================
</TABLE>
Details of the components of the deferred tax asset and liabilities and the
valuation allowance at December 31, 1997 are as follows:
<TABLE>
<S> <C>
Deferred Tax Assets
- -------------------
Tax based on net operating loss carryforward $1,236,164
Loss reserve adjustments 509,855
Unearned premium adjustments 401,119
Capital loss carryforward 230,007
Other 75,956
----------
Gross deferred tax assets 2,453,101
Less Valuation allowance (230,007)
----------
Gross deferred tax asset after valuation allowance 2,223,094
----------
Deferred Tax Liabilities
- ------------------------
Deferred policy acquisition costs 350,026
Unrealized appreciation of investments 82,675
----------
Gross deferred tax liabilities 432,701
----------
Net deferred tax asset $1,790,393
==========
</TABLE>
The Company's unused net operating loss carryforwards of $3,635,777 expire in
varying amounts between 2001 and 2011. The Company also has unused capital loss
carryforwards of approximately $264,000 expiring by 2001.
D. Commitments and Contingent Liabilities:
- -------------------------------------------
Reinsurance
- -----------
The Company cedes various risks to other insurers and reinsurers. The Company
utilizes excess of loss and quota share reinsurance as well as catastrophe and
clash coverage. Ceding of insurance does not discharge the Company's obligation
to the policyholder in the event the reinsurer is unable to fulfill its
obligation.
Current reinsurance protection is provided through two layers of excess of loss
reinsurance. The first layer, considered to be the working layer, assumes
$150,000 of coverage beyond the first $50,000. The second layer, allows the
Company to offer policy limits up to $1,000,000 by assuming $800,000 of
coverage beyond the first $200,000. The casualty clash excess of loss treaty
provides coverage for $1,000,000 in excess of $1,000,000 in the event more than
one of our insureds is involved in a single loss occurrence exposing the
coverage limits of the policies. The property catastrophe coverage provides for
$1,500,000 of coverage in excess of $500,000 in the event of a catastrophe. The
first layer excess of loss treaty was endorsed in 1997 to revise the premium
rate, eliminate the profit sharing and provide a experience rated premium
adjustment in the event the North East's direct loss and loss expense ratio
exceeded 57% for the 1997 accident year. The 35% quota share treaty in effect
for 1996 and 1995 was cancelled on a runoff basis effective January 1, 1997
and subsequently commuted on September 30, 1997.
The reinsurance balances receivable include $2,208,756 from Motors Insurance
Corporation on behalf of a wholly owned subsidiary, MIC Reinsurance
Corporation. No other reinsurer accounts for more than 10% of the total balance
at December 31, 1997.
Reinsurance balances payable represent unpaid ceded premiums of $182,811 and
funds held under reinsurance contracts of $607,645 at December 31,1997. Paid
loss and loss adjustment expenses recoverable from reinsurers at December 31,
1997 amounted to $1,694,573. The allowance for uncollectible reinsurance
balances at December 31, 1997 was $136,000.
Ceded loss and loss adjustment expense reserves include estimates of the
reinsurers share of the ultimate cost for all unpaid losses and loss adjustment
expenses incurred as of the balance sheet date. The ceded reserves are
determined using statistical projections based on the historical development of
past incurred and paid claims. Management believes these reserves are adequate
to cover all future loss settlements and represent the best estimate of the
total ceded reserves as of the balance sheet date; however, management is also
cognizant that the final ultimate ceded reserves may yield a different result.
Management will continue to monitor the Company's claim settlements closely in
order to provide timely adjustments to this ceded reserve when appropriate.
Written premium amounts reflected in the financial statements are as follows:
<TABLE>
<CAPTION>
1997 1996
----------- -----------
<S> <C> <C>
Direct Written Premiums $12,304,640 $11,126,794
Assumed Written Premiums 10,036 66,763
Ceded Return (Written) Premiums 1,910,548 (5,127,816)
---------------------------
Net Written Premiums $14,225,224 $ 6,065,741
===========================
</TABLE>
Ceded return (written) premiums for the year ended December 31, 1997 includes
$793,697 in return premium due to retroactive rate adjustments to the Company's
first layer excess of loss treaty currently in force, $175,503 of return
premium due to experience rating adjustments for various treaties now in runoff
and $71,005 in return premium due rate adjustments to the Company's second
layer excess of loss treaty currently inforce. In addition, the aggregate limit
excess endorsement to the first layer excess of loss treaty provided $1,800,000
in ceded return adjustment premium. Without these adjustments, ceded written
premium for the year ended December 31, 1997 was $929,657.
Earned premium amounts reflected in the financial statements are as follows:
<TABLE>
<CAPTION>
1997 1996
----------- -----------
<S> <C> <C>
Direct Earned Premiums $11,742,870 $11,442,307
Assumed Earned Premiums 16,678 94,122
Ceded Earned Premiums (266,065) (5,303,573)
---------------------------
Net Earned Premiums $11,493,483 $ 6,232,856
===========================
</TABLE>
Other ceded reinsurance amounts reflected in the financial statements are as
follows:
<TABLE>
<CAPTION>
1997 1996
----------- ----------
<S> <C> <C>
Reinsurance commission recovered (returned) $(1,194,463) $2,890,101
Loss and loss adjustment expense reserves 3,668,346 4,828,761
Prepaid reinsurance premiums (ceded unearned premium) $ 373,319 $2,549,932
</TABLE>
Reinsurance commission returned to the reinsurer in 1997 includes commission on
the returned written premium, mentioned above, and a commission adjustment
pursuant to the quota share treaty commuted September 30, 1997 wherein the
deductible was reduced from $1,000 to $100 increasing loss recoveries and
reducing expense recoveries by approximately $900,000.
Other
- -----
The Company has an Employment Agreement with Mr. Schatz, dated December 1, 1997
commencing January 1, 1998 and expiring December 31, 2000. The agreement
provides for a base salary of $175,000 per annum commencing in 1998 (subject to
annual adjustments based on increases in the Consumer Price Index). The
agreement also entitles Mr. Schatz to a bonus in the event aggregate after tax
net profit exceeds targeted growth expectations as determined by the Board of
Directors. The agreement contains certain non-renewal and termination clauses
which if triggered could result in compensation awards ranging from $175,000 to
$350,000 depending on the circumstances. The Company has accrued a 1997 bonus
award of $10,500 pursuant to Mr. Schatz's prior Employment Agreement.
As of October 28, 1996 the Company entered into a letter agreement with Mr.
Schatz, in which it agreed to pay him a special cash bonus of $60,000 in
1996,and cash bonuses of $33,997 per year in 1997 through 2006 (totaling
$339,970). These annual cash bonuses will terminate if Mr. Schatz voluntarily
terminates his employment other than for "Good Reason" as defined in his
Employment Continuity Agreement (described below), or if the Company
terminates his employment for "Good Cause" as defined in the Employment
Continuity Agreement. In exchange for these payments, Mr. Schatz has agreed
to release any and all claims he may have had for non-payments under his
Employment Agreement for 1991 through October 1996.
As of October 28, 1996 the Company entered into letter agreements with two
other senior executives, Messrs. Libby and Koren. Among other things, these
agreements provide for special one-time cash bonuses if Mr. Libby or Koren
remain employed with the Company through September 30, 1997 or 1998,
respectively, or if either person terminates his employment for "Good Reason"
prior to such date. The Company paid $48,088 pursuant to these agreements in
1997 and at December 31, 1997 the Company has accrued $17,715 relating to its
remaining obligation.
As of October 28, 1996 the Company entered into Employment Continuity
Agreements with each of Messrs. Schatz, Libby, and Koren. These Agreements
provide for special severance compensation if, within 12 months after a "Change
in Control Event," the executive's employment terminates at the instigation of
the Company (other than for "Good Cause") or at the instigation of the
executive for "Good Reason." The maximum benefit payable under these Agreements
is 300% (for Mr. Schatz) or 200% (for Messrs. Libby or Koren) of the
executive's annual base salary then in effect plus profit-sharing award for the
prior year, subject however to a cap of 299% of the executive's "Base Amount"
as defined in Section 280G of the Internal Revenue Code.
The following tables reconcile statutory surplus and net income amounts
reported under statutory accounting principles to those reported herein under
GAAP at December 31, 1997 and 1996 and for the years then ended.
<TABLE>
<CAPTION>
As of December 31,
--------------------------
1997 1996
----------- ----------
<S> <C> <C>
Statutory surplus, as reported by the Company $ 6,457,206 $6,738,116
Statutory basis adjustments (98,443) 0
--------------------------
Statutory surplus, as adjusted herein 6,358,763 6,738,116
Reconciliation to GAAP basis:
Deferred policy acquisition costs 1,029,488 398,595
Provision for unauthorized reinsurance 126,600 128,600
Deferred tax asset 1,790,393 2,050,394
Excess of statutory reserve over statement reserves 145,400 46,600
Other non-admitted assets
Data processing equipment 62,500 95,715
Other 380,115 308,031
Premiums receivable 233 849
Adjustment for difference in valuation method for
certain fixed maturities 243,162 (52,717)
GAAP basis reserves in lieu of provision for unauthorized
and other statutorily non-admitted assets (151,000) (389,222)
--------------------------
GAAP basis, surplus $ 9,985,654 $9,324,961
==========================
Statutory net income (loss), as reported $ (266,788) $ 669,006
Statutory basis adjustments (161,148) 0
--------------------------
As adjusted herein (427,936) 669,006
Reconciliation to GAAP basis:
Change in deferred policy acquisition costs 630,893 86,372
Equity in net income (loss) on non insurance subsidiary 13,339 (8,540)
GAAP basis reserves in lieu of provision for unauthorized
and other statutorily non-admitted assets
Statutory write down of uncollectible agent receivable
written down in 1990 on a GAAP basis 0 652,484
Other 290,507 (115,017)
Federal income tax adjustment (40,797) 40,797
Deferred tax credit (expense) (177,326) 2,050,394
--------------------------
GAAP basis, net income $ 288,680 $3,375,496
==========================
</TABLE>
F. Investments:
- ----------------
The amortized cost and fair value of investments in fixed maturities available
for sale at December 31, 1997 were as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
U.S. Treasury Securities and Obligations of
U.S. Government agencies $ 5,145,550 $213,462 $ 6,443 $ 5,352,569
Public Utilities 1,001,918 13,082 0 1,015,000
Corporate Securities 6,670,024 30,610 7,549 6,693,085
---------------------------------------------------------
Total Fixed Maturities $12,817,492 $257,154 $13,992 $13,060,654
=========================================================
</TABLE>
During 1997 the Company determined that the diminution in value of its
investment in Memorex common stock was more permanent than temporary.
Accordingly the Company wrote down this equity security investment through a
charge to realized losses of $62,705. At December 31, 1997, the cost of equity
securities available for sale approximated the fair value of $92,263.
The investment concentration of corporate fixed maturities for each investment
category which in the aggregate exceeds 10% of shareholders' equity at December
31,1997 is as follows:
<TABLE>
<CAPTION>
Estimated
Fair
Value %
---------- -----
<S> <C> <C>
Category:
- ---------
Bank & Finance $3,112,287 46.5
Retail & Consumer 1,535,798 22.9
Industrial 2,045,000 30.6
--------------------
$6,693,085 100.0
====================
</TABLE>
The amortized cost and estimated fair value of all fixed maturities available
for sale at December 31, 1997 are shown below by contractual maturity. Actual
dates for realization of such proceeds will differ from the contractual
maturity date because the borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.
<TABLE>
<CAPTION>
Amortized Estimated
Cost Fair Value
----------- ------------
<S> <C> <C>
Due to Mature:
- --------------
Within one year $ 754,398 $ 757,493
After one year through five years 7,619,406 7,710,698
After five years through ten years 1,215,729 1,217,365
After ten years through fifteen years 1,237,556 1,245,000
After fifteen years 1,990,403 2,130,098
----------------------------
$12,817,492 $13,060,654
============================
</TABLE>
Proceeds from sales of investments in fixed maturities available for sale
during 1997 and 1996 were $3,863,582 and $7,514,127, respectively. There were
no maturities of fixed maturities available for sale in 1997. During 1996,
fixed maturities with par value of $1,200,000 matured. Gross gains of $3,320
and $70,066 and gross losses of $4,849 and $90,815 were realized on sales of
fixed maturities in 1997 and 1996, respectively.
The Company maintains deposits with various states in which the Company is
licensed. These deposits are subject to certain regulatory restrictions. The
aggregate amortized cost of such investments was $2,860,716 at December 31,
1997.
The estimated fair value of the Company's investment portfolio is based on
market values as at the balance sheet date. The majority of the Company's
investment portfolio is sensitive to movement in the interest rate regulated by
the Federal Reserve. Generally, an increase in the interest rate by the Federal
Reserve would result in a lower market value and a decline in the rate should
result in a higher market value for the Company's investment portfolio. The
value of these assets is adjusted according to the market conditions as of the
balance sheet date.
Realized capital gains (losses) for the years ended December 31, 1997 and 1996
consisted of the following:
<TABLE>
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
Fixed maturities $(1,529) $(20,749)
Gain on sale of real estate 16,347 0
Gain from equity securities 20,870 0
Gain on mortgage note repayment 0 78,015
Other (367) 351
----------------------
Total gain (loss) $35,321 $57,617
======================
</TABLE>
The change in unrealized appreciation (depreciation), before provision for
income taxes, on fixed maturities available for sale and equity securities
was as follows:
<TABLE>
<CAPTION>
1997 1996
-------- ---------
<S> <C> <C>
Fixed maturities $295,880 $(479,985)
Equity securities 58,759 (8,545)
----------------------
Total $354,639 $(488,530)
======================
</TABLE>
Net investment income for the years ended December 31, 1997 and 1996 consisted
of the following:
<TABLE>
<CAPTION>
1997 1996
-------- ----------
<S> <C> <C>
Interest on fixed maturities $943,477 $1,175,135
Interest on short-term investments 105,330 124,679
Rental income, investment property 7,250 17,850
Dividends on equity securities 451 451
Amortization of bond premium, net (70,537) (80,491)
Other 9,575 7,751
Total investment income 995,546 1,245,375
-----------------------
Investment expenses 232,108 203,613
-----------------------
Net investment income $763,438 $1,041,762
=======================
</TABLE>
Investment expense in 1997 and 1996 includes $12,296 and $2,371, respectively,
of interest expense due reinsurers on funds withheld.
G. Property and Equipment:
- ---------------------------
Property and equipment, which are stated at cost, consist of the following as
of December 31, 1997:
<TABLE>
<CAPTION>
Estimated
Amount Useful Life
---------- --------------------
<S> <C> <C>
Leasehold Improvements $ 74,104 lease term - expires
year 2000
Equipment, furniture and fixtures and automobiles 242,814 3-5 years
Computer software & hardware 699,903 3-10 years
----------
1,016,821
Less accumulated depreciation and amortization 591,392
----------
$ 425,429
==========
</TABLE>
Depreciation and amortization expense for the years ended December 31, 1997 and
1996 was $195,115 and $190,489, respectively.
The unamortized value of computer software was $123,931 and $108,690 for the
years ended December 31, 1997 and 1996, respectively. Depreciation expense of
computer software was $38,213 and $35,948 for the years ended December 31, 1997
and 1996, respectively. During 1996, $1,989 of previously capitalized software
was written off.
H. Reserve for loss and loss adjustment expenses:
- --------------------------------------------------
The following table provides a reconciliation of the changes in loss and loss
adjustment expense reserves, after deducting amounts recoverable from
reinsurers for 1997 and 1996.
Reconciliation of Liability for Loss and
Loss Adjustment Expenses (LAE)
<TABLE>
<CAPTION>
1997 1996
----------- -----------
<S> <C> <C>
Reserves for losses and LAE:
Beginning of year $15,205,583 $19,006,725
Amounts recoverable from reinsurers on unpaid losses 4,828,760 4,703,238
----------------------------
Beginning of year, net 10,376,823 14,303,487
Add:
Provision for losses and LAE for claims arising in:
Current year 7,909,126 5,823,867
Prior years (1,108,324) (2,318,480)
Less:
Losses and LAE paid on claims arising in:
Current year 4,555,270 3,826,876
Prior years 1,633,475 3,605,175
----------------------------
End of year, net 10,988,880 10,376,823
Amounts recoverable from reinsurers on unpaid losses 3,668,346 4,828,760
----------------------------
Losses and loss adjustment expenses per Consolidated
Balance Sheet $14,657,226 $15,205,583
============================
</TABLE>
Reserves for losses and loss adjustment expenses represent estimates of the
ultimate cost of all unpaid losses and loss adjustment expenses incurred
through to the balance sheet date. These estimates are reviewed on a quarterly
basis and as experience develops and new information becomes known, they are
adjusted as necessary and are reflected in current operating results.
For the years ending December 31, 1997 and 1996 the actuarial estimate
indicated that the prior year reserve for losses and loss adjustment expenses
were redundant by $1,108,324 and $2,318,480 respectively.
I. Stock Options:
- ------------------
At the Annual Shareholders Meeting, June 10, 1997, shareholders approved the
North East Insurance Company Stock Option Plan. The Plan provides for awards of
Incentive Stock Options (ISOs), nonqualified Stock Options (NSOs), and Stock
Appreciation Rights (SARs). ISOs and NSOs represent the right to purchase
North East common stock at a designated option price per share. SARs represent
the right to receive a future payment in an amount which is determined by
reference to the value of a share of common stock. Common stock issuable under
the Plan is limited to 600,000 shares in the aggregate. The Plan is
administered by a committee of two or more non-employee directors appointed by
the Board of Directors.
Employees may be awarded either ISOs or NSOs, in each case carrying an option
price of not less than 100% of the fair market value per share on the date of
grant. No ISO may be exercised more than ten years after the date of grant, and
no ISO may be granted to any employee who, at the time of grant, owns more than
10% of the outstanding voting stock of the Company.
On October 28, 1996 the Board of Directors granted Robert G. Schatz a Non
statutory Stock Option for 200,000 shares of common stock, at an exercise price
of $1.625 per share. The option was subject to shareholder approval of the Plan
at the Annual Shareholders Meeting, June 10, 1997. These options are fully
excercisable.
On June 10, 1997 the Board of Directors granted Ronald A. Libby a Incentive
Stock Option for 100,000 shares of common stock, at an exercise price of $2.375
per share. Under the option 20 percent become exercisable on the date of grant
and on the anniversary date of each of the four years following the date of
grant.
Options granted and remaining unexercised at December 31, 1997 represented
300,000 shares of common stock at a weighted average price of $2.42 per share.
Options excercisable at December 31, 1997 represented 220,000 shares of common
stock at a weighted average price of $1.69 per share.
All options expire ten years from the date of grant. No options were exercised,
forfeited or expired in 1997.
The Company uses Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees", to recognize compensation cost. If the Company had
adopted the provisions of FAS No. 123, "Accounting for Stock Based
Compensation", net income and earnings per share for 1997 would have been
reduced to the pro forma amounts indicated below:
<TABLE>
<S> <C>
Net income (Loss)
-----------------
As reported $288,680
Pro forma (4,848)
Earnings per common share:
--------------------------
As reported
Basic $0.10
Diluted $0.09
Pro forma
Basic $0.00
Diluted 0.00
</TABLE>
The fair value of each option granted is estimated on the effective date of
grant using a Black-Scholes option-pricing model assuming a seven year life
expectancy, a stock price volatility of 80%, a dividend yield of 0% and a
risk-free interest rate of 6.56%.
J. Dividend Restriction:
- -------------------------
Under Maine Law, dividends may only be paid from available and accumulated
statutory surplus funds which have been derived from net operating income and
net realized capital gains. At the present time the Company has an accumulated
statutory unassigned deficit and does not expect to be in a position to pay
dividends in the near future. The Company has never paid a dividend.
K. Legal Proceedings:
- ----------------------
The Company for many years has been a party-in-interest in The Official
Committee of Unsecured Creditors of American Motor Club, Inc v. Bernard D.
Gershuny, et al (U.S. District Court for the Eastern District of New York,
1992). Certain defendants in this action had brought third-party claims against
NEIC. During 1997 two large sales of NEIC common stock were consummated on
behalf of Mr. Gershuny and First National Life & Casualty Assurance Company,
pursuant to prior settlement arrangements. Net proceeds of these sales were
paid to the Creditors Committee and certain others. The proceeds to the
Creditors Committee were less than the full settlement amount, and the
Committee takes the position that it is free to pursue the defendants for the
remaining deficiency. Despite the potential continuation of this action and
related claims, Management of the Company believes that sufficient payment has
been received by the Committee to effect a release of counterclaims and
third-party claims by the defendants. Management therefore considers all claims
against NEIC to have been resolved without liability to the Company.
Other than ordinary routine litigation incidental to the business, there are
no other material legal proceedings pending with regard to NEIC or its
wholly-owned subsidiary ACIC.
L. Leases:
- -----------
The Company has various operating leases, including the lease of its home
office building, required in the day to day operations of the Company. Lease
payments under these agreements were not material, except for the home office
lease which expires December 31, 2000 at an annual cost of $134,483 for 1997,
increasing gradually to $144,823 for the year ending December 31, 2000. The
expense incurred for lease and lease related items for the years ended December
31, 1997 and 1996 was $210,934 and $186,112, respectively.
The following table is a schedule of future minimum lease payments:
<TABLE>
<CAPTION>
Lease Payment
-------------
<S> <C>
Year 1998 137,845
Year 1999 141,291
Year 2000 144,823
</TABLE>
M. Adjustments Made in the Fourth Quarter
- ------------------------------------------
As discussed below, the Company made certain pre-tax adjustments in the fourth
quarter of 1997, which have been included in the December 31, 1997 financial
statements.
(a) Investments
A review was completed of investment assets for permanent impairment, in
connection with the fair valuation of investments as of December 31, 1997. As a
result of this review, an equity security was written down to a fair value of
$0, realizing a loss of $62,705.
(b) Reinsurance
The Company made significant revisions to its various reinsurance contracts
throughout 1997. The impact of these revisions were to; (1) charge off
reinsurance profit sharing commission receivable of $121,352; (2) charge off
ceding commission receivable of $66,141, associated with the commutation of the
Company's quota share treaty effective September 30, 1997; and (3) increase the
allowance for doubtful reinsurance recoverables by $36,000.
(c) Reserve for Unpaid Expenses and Other Liabilities
A detailed assessment was completed in 1998 of liabilities for general
administrative and salary-related expenses existing as of December 31, 1997. A
net adjustment to reduce the Reserve for Unpaid expenses and Other Liabilities
in the financial statements for the year ending December 31, 1997, was $64,069.
(d) Property and Equipment
The Company continued to implement its new computer system throughout 1997. The
policy processing component was installed in late 1995 for policies effective
January 1996 and the loss processing component was activated in May 1997. As a
result of this ongoing implementation, certain computer hardware and software
became obsolete. A review of its computer-related assets in 1998 and
determined that as of December 31, 1997, assets costing $25,100, with
accumulated depreciation of $18,829, had no ongoing useful economic life. A net
charge to earnings of $6,271 was taken in the financial statements for the year
ending December 31, 1997 to reduce property and equipment asset values to that
reflecting their future economic value to the Company.
NORTH EAST INSURANCE COMPANY
AND SUBSIDIARIES
INDEX
-----
Part I. - Financial Information
Item 1 - Financial Statements
Consolidated Balance Sheet
As of June 30, 1998 3
Consolidated Statements of Operations and
Comprehensive Income for the
Six Months Ended June 30,1998 and 1997 4
Consolidated Statements of Operations and
Comprehensive Income for the
Three Months Ended June 30,1998 and 1997 5
Consolidated Statements of Cash Flows for the
Six Months Ended June 30,1998 and 1997 6
Notes to Consolidated Financial Statements 8
Management's Discussion and Analysis of
the Financial Condition and Results of Operations 10
Part II - Other Information
Item 4 - Submission of Matters to a Vote of
Security Holders 13
Item 5 - Other Information 14
Item 6 - Exhibits and Reports on Form 8-K 14
Exhibit Index 15
North East Insurance Company and Subsidiaries
Part I: FINANCIAL INFORMATION
- -----------------------------
Item 1. Financial Statements
Consolidated Balance Sheet
As of June 30, 1998
<TABLE>
<CAPTION>
ASSETS 1998
-----------
<S> <C>
Investments:
Fixed maturities available for sale, at
fair value (amortized cost $15,020,837 ) $15,317,281
Equity securities available for sale,
at fair value (cost $262,241) 221,323
Short-term investments 2,324,764
-----------
Total investments 17,863,368
Reinsurance (loss and loss adjustment expense
reserves and paid recoverables) 3,373,983
Premium balances receivable 5,433,921
Reinsurance premium balances receivable 816,543
Deferred policy acquisition costs 1,164,044
Cash 346,798
Prepaid reinsurance premiums (ceded unearned premium) 981,371
Investment income due and accrued 244,247
Property and equipment, net of accumulated depreciation 337,948
Deferred tax asset 1,941,605
Prepaid federal income tax 9,242
Other assets 161,740
-----------
Total Assets $32,674,810
===========
LIABILITIES
Losses and loss adjustment expenses $13,565,719
Unearned premiums 7,652,118
Ceded reinsurance balances payable 769,287
Reserve for unpaid expenses 615,976
Book overdraft 250,521
Other liabilities 89,990
-----------
Total Liabilities 22,943,611
SHAREHOLDERS' EQUITY
Common stock $1.00 par value,
authorized 6,000,000 shares, issued
and outstanding 3,049,089 shares 3,049,089
Additional paid-in capital 6,407,132
Unrealized appreciation of investments 168,647
Accumulated retained earnings 106,331
-----------
Total Shareholders' Equity 9,731,199
-----------
Total Liabilities and Shareholders' Equity $32,674,810
===========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
North East Insurance Company and Subsidiaries
Consolidated Statements of Operations and Comprehensive Income (Loss)
for the Six Months ended June 30,
Consolidated Statements of Operations
-------------------------------------
<TABLE>
<CAPTION>
1998 1997
------------------------
<S> <C> <C>
Revenues:
Premiums earned $6,274,216 $5,668,596
Premiums ceded 937,583 1,840,812
------------------------
Net premiums earned 5,336,633 3,827,784
Net investment income 448,417 381,534
Realized capital gains 33,316 79,312
------------------------
Total revenues 5,818,366 4,288,630
Expenses:
Losses and loss adjustment expenses 4,375,950 3,994,508
Reinsurance recoveries (323,150) (980,741)
------------------------
Net losses and loss adjustment
expenses 4,052,800 3,013,767
Underwriting expenses incurred 2,189,355 1,182,921
------------------------
Total expenses 6,242,155 4,196,688
------------------------
Income (loss) before provision for
income taxes (423,789) 91,942
Provision (credit) for income taxes (155,416) 14,268
------------------------
Net income (loss) $ (268,373) $ 77,674
========================
Net income (loss) per common share:
Basic $ (0.09) $ 0.03
========================
Diluted $ (0.09) $ 0.03
========================
</TABLE>
Consolidated Statements of Comprehensive Income (Loss)
------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997
--------------------
<S> <C> <C>
Net income (loss) $(268,373) $77,674
Other comprehensive income (loss):
Change in unrealized appreciation (depreciation)
of securities (provision for income taxes
1998 - $4,204; 1997 -$0) 8,160 (61,540)
--------------------
Comprehensive income (loss) $(260,213) $16,134
====================
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
North East Insurance Company and Subsidiaries
Consolidated Statements of Operations and Comprehensive Income (Loss)
for the Three Months ended June 30,
Consolidated Statements of Operations
-------------------------------------
<TABLE>
<CAPTION>
1998 1997
------------------------
<S> <C> <C>
Revenues:
Premiums earned $3,252,859 $2,911,799
Premiums ceded 455,183 1,175,365
------------------------
Net premiums earned 2,797,676 1,736,434
Net investment income 224,654 243,346
Realized capital gains (losses) 124 (3,112)
------------------------
Total revenues 3,022,454 1,976,668
Expenses:
Losses and loss adjustment expenses 1,731,261 1,878,410
Reinsurance recoveries (156,637) (615,795)
------------------------
Net losses and loss adjustment
expenses 1,574,624 1,262,615
Underwriting expenses incurred 1,110,863 344,526
------------------------
Total expenses 2,685,487 1,607,141
------------------------
Income before provision for
income taxes 336,967 369,527
Provision for income taxes 114,526 71,721
------------------------
Net income $ 222,441 $ 297,806
========================
Net income per common share:
Basic $ 0.07 $ 0.10
========================
Diluted $ 0.07 $ 0.10
========================
</TABLE>
Consolidated Statements of Comprehensive Income
-----------------------------------------------
<TABLE>
<CAPTION>
1998 1997
--------------------
<S> <C> <C>
Net income $222,441 $297,806
Other comprehensive income:
Change in unrealized appreciation (depreciation)
of securities (provision for income taxes
1998-$5,081; 1997-$0) 9,862 255,632
--------------------
Comprehensive income $232,303 $553,438
====================
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
North East Insurance Company And Subsidiaries
Consolidated Statements of Cash Flows
for the Six Months ended June 30,
<TABLE>
<CAPTION>
1998 1997
------------------------
<S> <C> <C>
Cash flow from operating activities:
Insurance premium received $6,455,633 $5,379,126
Loss and loss adjustment expenses paid (3,291,371) (4,962,879)
Operating expenses paid (2,158,056) (2,032,904)
Investment income received 414,074 419,448
------------------------
Net cash provided (used)
in operating activities 1,420,280 (1,197,209)
------------------------
Cash flows from investing activities:
Fixed maturities available for sale, sold 2,839,734 1,731,194
Fixed maturities available for sale, purchased (5,040,919) (1,850,675)
Equity securities available for sale, purchased (169,979) 0
Sale of furniture, fixtures and equipment 14,530 0
Purchase of furniture, fixtures and
equipment (23,978) (71,760)
------------------------
Net cash used in investing activities (2,380,612) (191,241)
------------------------
Cash flows from financing activities:
Proceeds from issuance of common stock 5,758 100,049
Decrease in book overdraft (146,602) 0
------------------------
Net cash provided
(used) in financing activities (140,844) 100,049
Net decrease in cash,
and short-term investments (1,101,176) (1,288,401)
Cash and short-term
investments at beginning of year 3,772,738 2,861,810
------------------------
Cash and short-term
investments at end of period $2,671,562 $1,573,409
========================
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
North East Insurance Company And Subsidiaries
Consolidated Reconciliation of Cash Used In
Operating Activities to Net Income (Loss)
for the Six Months ended June 30,
<TABLE>
<CAPTION>
1998 1997
-------------------------
<S> <C> <C>
Net income (loss) $ (268,373) $ 77,674
Decrease (increase) in net premium and ceded
reinsurance balances 347,064 (1,799,689)
Increase in unearned
premium reserve 771,936 2,374,507
Increase (decrease) in net loss and loss
adjustment expense reserve 761,429 (972,588)
Decrease (increase) in investment income
due and accrued (34,343) 37,914
Decrease (increase) in deferred tax asset (155,416) 14,268
Increase in deferred policy
acquisition costs (134,556) (377,226)
Increase (decrease) in expense accruals 37,769 (609,910)
Amortization of bond premium, net 32,152 40,337
Depreciation and amortization expense 96,929 97,183
Gain on investment activities (34,311) (79,679)
-------------------------
Net cash provided
(used) in operating activities $1,420,280 $(1,197,209)
=========================
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
North East Insurance Company and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 1998
1. The condensed financial statements included herein have been prepared by
the Registrant, without audit, pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain information and footnote
disclosure normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to such rules and regulations, although the Registrant believes
that the disclosures which are made are adequate to make the information
presented not misleading, particularly when read in conjunction with the
financial statements and the notes thereto included in the Registrant's
latest annual report on Form 10-KSB. In Management's opinion, the attached
interim financial statements reflect all adjustments which are necessary for
a fair statement of the results for the periods presented.
2. In June 1997, the Financial Accounting Standards Board ("FASB") issued
FAS No. 130, "Reporting Comprehensive Income", which establishes standards
for reporting and display of comprehensive income and its components in a
financial statement with the same prominence as other financial statements.
Comprehensive income is defined as net income adjusted for changes in
shareholders' equity resulting from events other than net income or
transactions related to an entity's capital instruments. North East adopted
the provisions of FAS 130 effective January 1, 1998.
In June 1997, the FASB issued FAS No. 131, "Disclosure about Segments of an
Enterprise and Related Information", which establishes standards for
reporting information about operating segments. Generally, FAS 131 requires
that financial information be reported on the basis that is used internally
for evaluating performance. The Company is required to adopt FAS 131
effective January 1, 1998 and comparative information for earlier years must
be restated. This statement does not need to be applied to interim financial
statements in the initial year of application. The Company is currently
considering what impact, if any, FAS 131 will have on its year end reporting
format.
In June 1998, the FASB issued FAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes accounting and
reporting standards for derivative instruments, including certain
derivatives embedded in other contracts, and for hedging activities.
Generally, FAS 133 requires recognition of all derivatives, at fair value,
as either assets or liabilities in the statement of financial position. The
Company is required to adopt the provisions of FAS 133 effective January 1,
2000. Adoption of FAS 133 is not expected to have a material effect on the
Company's consolidated results of operations or financial position as the
Company presently does not hold any derivative instruments nor does it
participate in any hedging transactions.
3. North East Insurance Company owns 100% of American Colonial Insurance
Company and North Atlantic Underwriters, Inc. whose results are consolidated
herein.
4. Earnings per share are computed in accordance with the provisions of FAS
No. 128 "Earnings Per Share" which requires the dual presentation of basic
and diluted earnings per share. The weighted average number of shares
outstanding used to calculate basic earnings per share was 3,046,949 and
3,008,727 for the six months ended June 30, 1998 and 1997, respectively. The
weighted average number of shares outstanding used to calculate diluted
earnings per share was 3,140,601 and 3,069,241 for the six months ended June
30, 1998 and 1997, respectively.
NORTH EAST INSURANCE COMPANY
RIGHTS OFFERING PROSPECTUS
__________, 1998
UNDER THE SECURITIES EXCHANGE ACT OF 1934, WE MUST FILE REPORTS, PROXY
STATEMENTS AND OTHER INFORMATION WITH THE SECURITIES AND EXCHANGE COMMISSION
("SEC"). YOU MAY OBTAIN COPIES OF OUR RECENT REPORTS AND PROXY STATEMENT IN
THE FOLLOWING WAYS: (1) BY WRITING US AT NORTH EAST INSURANCE COMPANY, P.O.
BOX 1418, SCARBOROUGH, ME 04070-1418; (2) THROUGH THE EDGAR DATABASE ON THE
SEC'S WEBSITE ON THE INTERNET (HTTP://WWW.SEC.GOV); OR (3) BY INSPECTION OR
COPYING AT PUBLIC REFERENCE ROOMS AT THE SEC'S PRINCIPAL OFFICE AT JUDICIARY
PLAZA BUILDING, 450 FIFTH STREET, N.W., WASHINGTON, DC 20549, OR AT ITS
REGIONAL OFFICES AT NORTHWESTERN ATRIUM CENTER, 500 WEST MADISON STREET, SUITE
1400, CHICAGO, ILLINOIS 60661 OR 7 WORLD TRADE CENTER, 13TH FLOOR, NEW YORK,
NEW YORK 10048, OR (4) BY WRITTEN REQUEST TO THE PUBLIC REFERENCE SECTION OF
THE COMMISSION AT JUDICIARY PLAZA, 450 FIFTH STREET, N.W., WASHINGTON, D.C.
20549, AT PRESCRIBED RATES.
THIS PROSPECTUS IS PART OF A REGISTRATION STATEMENT ON FORM SB-2, WHICH
WE HAVE FILED AS REQUIRED BY THE SECURITIES ACT OF 1933. THE REGISTRATION
STATEMENT CONTAINS CERTAIN INFORMATION AND EXHIBITS THAT DO NOT APPEAR IN THE
PROSPECTUS ITSELF. YOU MAY OBTAIN A COPY OF THE REGISTRATION STATEMENT
(INCLUDING EXHIBITS) BY WRITING US AT THE ADDRESS SET FORTH ABOVE, OR FROM THE
SEC THROUGH ITS WEBSITE OR AT THE ADDRESSES SET FORTH ABOVE.
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS DOCUMENT OR
THAT WE HAVE REFERRED YOU TO. WE HAVE NOT AUTHORIZED ANYONE TO PROVIDE YOU
WITH INFORMATION THAT DIFFERS FROM THAT IN THE PROSPECTUS.
UNTIL ________, ALL DEALERS THAT EFFECT TRANSACTIONS IN THESE
SECURITIES, WHETHER OR NOT PARTICIPATING IN THIS OFFERING, MAY BE REQUIRED TO
DELIVER A PROSPECTUS.
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 24. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Sections 719 of the Maine Business Corporation Act (the "MBCA") grants
the Registrant broad powers to indemnify and insure its directors and officers
against liabilities they may incur in such capacities. In accordance
therewith, the Registrant's By-Laws generally provide for the fullest
indemnification of an officer or director of the Registrant permitted under
the MBCA.
The Registrant has entered into agreements with its directors and
certain of its officers that require the Registrant to indemnify such persons
against expenses, including attorneys' fees, judgments, fines, settlements and
other amounts incurred directly or indirectly in connection with any
proceeding, whether actual or threatened, to which any such person may be made
a party by reason of the fact that such person served as a director or officer
of the Registrant or any of its affiliated enterprises, provided that such
indemnification is consistent with applicable law.
ITEM 25. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The expenses incurred by the Registrant in connection with the Rights Offering
are:
<TABLE>
<S> <C>
SEC registration fee......................................... $ [ ]
Accounting fees and expenses*................................ $ [ ]
Legal fees and expenses*..................................... $ [ ]
Subscription Agent fees*..................................... $ [ ]
Printing costs*.............................................. $ [ ]
Miscellaneous*............................................... $ [ ]
---------
Total........................................................ $ [ ]
</TABLE>
* Estimated
ITEM 26. RECENT SALES OF UNREGISTERED SECURITIES.
The Registrant has not made any sale of unregistered securities during
the past three years.
ITEM 27. EXHIBITS.
<PAGE> II-1
A list of the exhibits included as part of this Registration Statement
is set forth in the Exhibit Index that immediately precedes such exhibits and
is incorporated herein by reference.
ITEM 28. UNDERTAKINGS.
Insofar as indemnification for liabilities arising under the Securities Act of
1933 (the "Act") may be permitted to directors, officers and controlling
persons of the Registrant pursuant to the provisions of its bylaws or any
indemnification agreement, or otherwise, the Registrant has been advised that
in the opinion of the Securities and Exchange Commission such indemnification
is against public policy as expressed in the Act and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the Registrant of expenses incurred or
paid by a director, officer or controlling person of the Registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities
being registered, the Registrant will, unless in the opinion of its counsel
the matter has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the Act and will be governed by the
final adjudication of such issue.
<PAGE> II-2
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the
Registrant certifies that it has reasonable grounds to believe that it meets
all of the requirements for filing on Form SB-2 and has duly caused this
Registration Statement to be signed on its behalf by the undersigned,
thereunto duly authorized, in the City of Portland, State of Maine on this 3rd
day of September, 1998.
NORTH EAST INSURANCE COMPANY
By: /s/ Robert G. Schatz
Robert G. Schatz
President and Chief Executive Officer
Signature Title Date
- --------- ----- ----
/s/ Robert G. Schatz President, Chief Executive September 3, 1998
- -----------------------
Robert G. Schatz Officer and Director
/s/ Ronald A. Libby Chief Operating Officer September 3, 1998
- -----------------------
Ronald A. Libby
/s/ Graham S. Payne Treasurer, Chief Financial Officer September 3, 1998
- -----------------------
Graham S. Payne [principal accounting officer]
Director
- -----------------------
Edward B. Batal
/s/ Terence C. Cummings* Director September 3, 1998
- -----------------------
Terence C. Cummings
Director
- -----------------------
Robert A. Hancock
/s/ Wilson G. Hess* Director September 3, 1998
- -----------------------
Wilson G. Hess
/s/ Joseph M. Hochadel* Director September 3, 1998
- -----------------------
Joseph M. Hochadel
/s/ Peter A. Russ* Director September 3, 1998
- -----------------------
Peter A. Russ
/s/ Bruce H. Suter* Director September 3, 1998
- -----------------------
Bruce H. Suter
* By: /s/ Robert G. Schatz
----------------------------------
Robert G. Schatz, Attorney in Fact
<PAGE> II-3
EXHIBIT INDEX
3.1* Certificate of Organization, as amended to date.
3.2 Bylaws of North East Insurance Company, as amended to date, is
incorporated herein by reference to Exhibit 3.2 to NEIC's Annual
Report on Form 10-KSB for the fiscal year ended December 31, 1995
4.1 Instruments Defining the Rights of Security Holders; see Exhibits
3.1 and 3.2
5.1* Opinion of Verrill & Dana, LLP
10.1 Lease, dated August 14, 1990, of North East's home office,
incorporated herein by reference to Exhibit 10.1 to NEIC's Annual
Report on Form 10-KSB for the fiscal year ended December 31, 1994
10.2 Employment Agreement dated December 1, 1997 between North East
and Robert G. Schatz is incorporated herein by reference to Exhibit
10.3 to NEIC's Annual Report on Form 10-KSB for the fiscal year
ended December 31, 1997
10.3 Letter Agreement dated October 28, 1996 between the Company and
Robert G. Schatz, regarding bonus compensation arrangements is
incorporated herein by reference to Exhibit 10.4 to NEIC's Annual
Report on Form 10-KSB for the fiscal year ended December 31, 1996
10.4 Letter Agreement dated October 28, 1996 between the Company and
Ronald A. Libby, regarding terms of employment is incorporated
herein by reference to Exhibit 10.5 to NEIC's Annual Report on
Form 10-KSB for the fiscal year ended December 31, 1996
10.5 Letter Agreement dated October 28, 1996 between the Company and
Samuel M. Koren, regarding terms of employment is incorporated
herein by reference to Exhibit 10.6 to NEIC's Annual Report on
Form 10-KSB for the fiscal year ended December 31, 1996
10.6 Employment Continuity Agreement dated as of October 28, 1996
between the Company and Robert G. Schatz is incorporated herein by
reference to Exhibit 10.7 to NEIC's Annual Report on Form 10-KSB
for the fiscal year ended December 31, 1996
10.7 Employment Continuity Agreement dated as of October 28, 1996
between the Company and Ronald A. Libby Schatz is incorporated
herein by reference to Exhibit 10.8 to NEIC's Annual Report on
Form 10-KSB for the fiscal year ended December 31, 1996
10.8 Employment Continuity Agreement dated as of October 28, 1996
between the Company and Samuel M. Koren is incorporated herein by
reference to Exhibit 10.9 to NEIC's Annual Report on Form 10-KSB
for the fiscal year ended December 31, 1996
<PAGE> II-4
10.9 North East Insurance Company Stock Option Plan is incorporated herein
by reference to Exhibit 10.10 to NEIC's Annual Report on Form 10-KSB
for the fiscal year ended December 31, 1997
21 List of Subsidiaries of North East is incorporated by reference
to Exhibit 21 to NEIC's Annual Report on Form 10-KSB for the fiscal
year ended December 31, 1993.
23.1* Consent of PricewaterhouseCoopers LLP
23.2* Consent of Verrill & Dana, LLP (included in its opinion filed as
Exhibit 5.1 hereto)
24.1 Form of power of Attorney as executed by Terence C. Cummings,
Wilson G. Hess, Joseph M. Hochadel, Peter A. Russ, and
Bruce H. Suter
99.1 Form of Subscription Agreement
99.2* Instructions for use of Subscription Agreement
__________
* To be filed by amendment
<PAGE> II-5
II-46
NORTH EAST INSURANCE COMPANY
POWER OF ATTORNEY
KNOW ALL BY THESE PRESENTS, that I hereby constitute and appoint Robert G.
Schatz, Graham S. Payne, and Samuel M. Koren my true and lawful attorneys-
in-fact and agents, each acting alone, with full powers of substitution and
resubstitution, for me and in my name, place and stead, in any and all
capacities, from time to time, to sign a registration statement on Form SB-2
relating to a rights offering of not more than 3,200,000 shares of Common
Stock of North East Insurance Company, and any amendments and supplements
thereto, and to file the same, with all exhibits thereto, and other
documents in connection therewith, with the Securities and Exchange
Commission and state securities administrators, granting unto said
attorneys-in-fact and agents full power and authority to do and perform each
and every act and thing requisite and necessary to be done in and about the
premises, as fully to all intents and purposes as I might or could do in
person, and hereby ratifies and confirms all that said attorneys-in-fact and
agents, each acting alone, or their substitute or substitutes, may lawfully
do or cause to be done by virtue thereof.
Witness my signature on the date set forth below:
Date:
Name:
EXHIBIT 99.1
NORTH EAST INSURANCE COMPANY
RIGHTS OFFERING OF COMMON STOCK
SUBSCRIPTION AGREEMENT
To: North East Insurance Company
482 Payne Road, 4th Floor
P.O. Box 1418
Scarborough, Maine 04074-1418
Attention: Board of Directors
______________________________________________________________________________
The undersigned shareholder ("Subscriber") of North East Insurance
Company, a Maine corporation ("NEIC"), hereby subscribes to purchase shares
of NEIC's Common Stock, $1 par value ("Common Stock"), on the terms set
forth below. Subscriber hereby represents, warrants, agrees, and
acknowledges as follows:
Existing Ownership:
As of [RecDate], 1998 (the "Record Date"), Subscriber owned shares of
Common Stock as follows (mark all that apply):
[ ] Indirectly, through the following broker or bank: ________________
________________________________ located in _______________(city),
___________________________ (state).
[ ] Directly, through ownership of an NEIC stock certificate in the
name of Subscriber.
[ ] Other (please describe): _________________________________________
________________________________________________________________.
The total number of shares of Common Stock owned by Subscriber on the
Record Date was ______________________ shares. For these purposes, a person
is considered to "own" shares of Common Stock if (i) he or she has the right
to vote the shares or otherwise control the voting of the shares or (ii) he
or she has the right to sell the shares or otherwise order a sale or other
transfer of the shares. If two or more persons jointly hold the power to
vote or sell any shares of Common Stock (or have otherwise agreed to act in
concert for purposes of voting or disposing of the shares), then each will
be considered to own all of those shares.
<PAGE> 1
Basic Subscription Privilege:
Subscriber elects to exercise his or her Basic Subscription Privilege
as follows: (check one)
[ ] EXERCISE IN FULL to purchase one new share for each share owned
on the Record Date.
[NOTE: If you already own more than 150,000 shares, the Company
reserves the right to limit this purchase if and to the extent
necessary to keep your percentage ownership from exceeding 9.9%
of the outstanding shares.]
[ ] PARTIAL EXERCISE to purchase ______________ shares.
Oversubscription Privilege:
[Fill in this section only if you have exercised the Basic Subscription
Privilege in full.]
In addition to exercising the Basic Subscription Privilege in full, the
undersigned elects to exercise his or her Oversubscription Privilege as
follows:
[ ] PURCHASE _______________ ADDITIONAL SHARES, subject to proration
and applicable limits on purchase
[NOTE: If you want to purchase the maximum possible number of
shares, it is suggested that you subscribe for that number of
shares which will increase your beneficial ownership to 603,720
shares. This is the maximum ownership that will be permitted if
all of the offered shares are sold. If fewer than all of the
offered shares are sold, NEIC will reduce the subscription such
that your beneficial ownership will not exceed 9.9% of the total
outstanding shares of Common Stock.]
Calculation of Total Subscription Price:
This subscription must be accompanied by payment of the total subscription
price in the amount of $x.xx per share subscribed for, as follows:
Total shares subscribed for: ________ x $x.xx per share = $___________.
<PAGE> 2
Method of Payment:
The total subscription price is being paid as follows:
[ ] By check, bank draft or money order payable to "American Stock
Transfer & Trust Company, as Subscription Agent" or
[ ] By wire transfer directed to ____________________________.
Other Representations and Agreements by Subscriber:
Subscriber hereby represents to NEIC that he or she has read carefully the
section of this Prospectus entitled "Certain Ownership Limits and Reporting
Requirements" and agrees not to acquire NEIC shares through or in connection
with the Rights Offering in violation of those ownership limits and
reporting requirements.
not to engage in any intentional violation of those ownership limits and
reporting requirements. he or she understands that Maine and New York
insurance laws generally prohibit any person from acquiring beneficial
ownership of 10% or more of the outstanding voting stock of NEIC, unless
that person or group first obtains permission from state insurance
regulators. Subscriber agrees not to acquire NEIC shares through or in
connection with the Rights Offering in violation of those prohibitions.
If the Subscriber currently owns more than 150,000 NEIC shares (5% of the
outstanding stock) or is subscribing for more than 100,000 shares, then
Subscriber agrees (if NEIC so requests within 60 days of expiration of the
Rights Offering) to provide reasonable evidence of the total number of
shares beneficially owned by him or her and those on whose behalf Subscriber
holds shares.
Subscriber agrees that, until the date he or she receives a stock
certificate from NEIC for the shares subscribed for in this Subscription
Agreement, Subscriber will promptly inform NEIC if any of the
representations in this Agreement become untrue.
Subscriber's principal residence address (or business address if Subscriber
is an entity) is as follows:
____________________________________________________________
____________________________________________________________
____________________________________________________________
____________________________________________________________
<PAGE> 3
* * *
EXECUTED BY SUBSCRIBER on the ____________ day of ______________________, 1998,
at ______________________, ______________________ [city, state].
NAME OF SUBSCRIBER: _______________________________
(Joint owners: all Signature _______________________________
owners must sign) Title _______________________________
(Entities: specify
titles of signing Signature _______________________________
officers) Title _______________________________
<PAGE> 4
