U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Form 10-KSB
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1997
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from .................. to ................
Commission File No. 0-11184
NORTH EAST INSURANCE COMPANY
(Name of small business issuer in its charter )
Maine 01-0278387
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification number)
482 Payne Road, Scarborough, Maine 04074
(Address of principal executive offices) (Zip code)
Issuer's telephone number: (207) 883-2232
Securities registered under Section 12(b) of the Exchange Act: None
Securities registered under Section 12(g) of the Exchange Act:
Common Stock, Par Value $1.00
(Title of class)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months, and (2) has been
subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Check if no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is contained in this form, and no disclosure will be contained,
to the best of registrant's knowledge, in any definitive proxy or information
statement incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [ ]
The issuer's revenues for its most recent fiscal year: $12,292,242
The aggregate market value of the voting stock held by non-affiliates as of
March 10, 1998 was $7,713,080.
There were 3,046,842 common shares outstanding as of March 10, 1998.
Documents Incorporated by Reference: Portions of the Proxy Statement for 1998
Annual Meeting of Shareholders (to be filed by April 30, 1998) are incorporated
into Part III. Transitional Small Business Disclosure Format: Yes [ ] No [X]
Page 1 of 81
Exhibit index on Page 56
PART I
ITEM 1 - DESCRIPTION OF BUSINESS
GENERAL
North East Insurance Company ("North East" or "NEIC") was organized as a Maine
corporation on August 9, 1965 and began writing insurance in June, 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 designed 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."
At December 31, 1997 the Group employed forty full-time employees and two
part-time employees.
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.
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. ACIC, under an
agreement with the Insurance Department of the State of New York, 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 (Loss) 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 (Loss) $ 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 effect of recent changes in the
Group's reinsurance arrangements, see "Management's Discussion and Analysis" at
page 12.
Net premiums written and earned by the Group by line of business for 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 snowplowers. 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 supports the Independent Agency System and believes the Agency System
provides the best system for its products and programs. North East chooses to
utilize independent agents in order to maximize its geographical service and
marketing coverage. Management believes that the development of strong agency
relationships must be instigated by the Group. Agents' return on book, profit
contingencies and reliable products have become key ingredients in developing
stronger ties to agents representing North East Insurance Company. 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 - one and three year analyses, mix of
products, North East's rank in agent's office, other carriers represented by
the agency, long term plans of agency, geographic location and agent's plans or
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
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 the business of North East, management believes it has a good
relationship with its agents.
Agents, in recognition of North East's reliance on them for the selection of
profitable business, are compensated 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 the Company 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 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 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 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 the Company's investment in Memorex which the
Company 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:
Bond Credit Quality Rating
- --------------------------
<TABLE>
<S> <C>
AAA 41.0%
AA 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).
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 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.
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, the Company'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.
ITEM 2 - DESCRIPTION OF PROPERTY
North East 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.
ITEM 3 - 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.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to shareholders in the fourth quarter of 1997.
EXECUTIVE OFFICERS OF THE REGISTRANT
Set forth below is information concerning the executive officers of North East
Insurance Company.
Under the Company'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 the
Company, 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 the Company since March 1988. He was elected as a Director in December 1987.
RONALD A. LIBBY, age 54, joined the Company 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 the Company in 1977 and has been an Officer since 1978.
GRAHAM S. PAYNE, age 52, has been Treasurer and Chief Financial Officer of the
Company since 1987.
REBECCA J. CERNY, age 45, has held the position of Vice President of the
Company since 1989. From 1986 to 1995 she also served as a Director of the
Company.
Part II
ITEM 5 - MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
North East's common shares are traded on the NASDAQ Stock Market under the
symbol NEIC. Quotations are available from the National Quotation Bureau Inc.
As of March 10, 1998, there were 191 holders of record of North East's common
shares.
The high and low closing bid prices (as quoted by the NASDAQ Stock Market) for
North East's common shares for each quarterly period for the two most recent
fiscal years are as follows:
<TABLE>
<CAPTION>
1997 1996
--------------- ---------------
HIGH LOW HIGH LOW
<S> <C> <C> <C> <C>
First Quarter $2.94 $2.00 $1.81 $1.00
Second Quarter 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>
Such prices reflect prices without retail mark-up, mark-down or commission and
may not represent actual transactions.
DIVIDENDS
North East has never paid and does not anticipate paying dividends in the
foreseeable future. Based on the current accumulated statutory unassigned
deficit of North East, the Company currently is prohibited from paying
dividends.
Under the insurance laws of the State of Maine, cash dividends may only be paid
out of that part of the available accumulated statutory unassigned deficit
which are derived from realized net operating profits on North East's insurance
business and from net realized capital gains. In addition, amongst other
statutory restrictions, a Maine insurer's 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,
North East 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 North East's surplus to policyholders or (ii) North
East's net investment income, in either case, as of the December 31 preceding)
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 the capacity to write new
premiums since the volume of insurance that can be written is determined by the
available statutory surplus of North East.
ITEM 6 - MANAGEMENT'S DISCUSSION AND ANALYSIS
Refer to Item 1 "Description of Business" for additional information on the
operations of the Group.
Management's discussion and analysis reviews the consolidated financial
condition of North East 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 discussion should be read in
conjunction with the Consolidated Financial Statements.
FORWARD-LOOKING INFORMATION
From time to time, the Company 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 report 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, the climate, new trends and
developments in technology, general economic and societal conditions of the
insurance market in which North East has exposure. North East disclaims any
obligation to publicly update or revise any forward-looking statements, whether
as a result of new information, future developments or otherwise.
GENERAL DISCUSSION
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 the Company'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, the Company'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, the Company 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 the Company introduced several enhancements to current programs while
marking significant progress in the final development of its totaly 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 the Company 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 the Company 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
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.
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%
=================================
<FN>
<Fn/m> - not meaningful
</FN>
</TABLE>
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 the Company 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 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 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 Part I, Item1 "Description of Business -
Reinsurance".
During the third quarter of 1997 management determined that the Company'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 the Company would participate in
any excess profits, the recording of which would occur in years subsequent 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" -
this section). 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:
<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 the Company'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 and1996, 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
the Company's position relative to the Company's ability to utilize the value
of its loss carryforwards based on the future income and capital gains of the
Company. 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 the Company'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.
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.
ACCOUNTING POLICIES ADOPTED
Refer to Item 7 Note A under the caption "Accounting Pronouncements Adopted"
for information.
NEW ACCOUNTING PRONOUNCEMENTS
Refer to Item 7 Note A under the caption "New Accounting Pronouncements" for
information.
LIQUIDITY AND CAPITAL RESOURCES
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.
DERIVATIVES
The Company's investment policy is to invest in investment grade securities
only and does not permit the Company 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, the
Company 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 the Company's
prior experience. The change in the character was not recognized by the Company
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 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 table on the page following 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
Ultimate Net reserves reestimated as of
end of year
- ---------------------------------------
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
<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
Cumulative Amount Paid
- ----------------------
One Year Later 4,766 5,077 3,716
Two Years Later 8,625 7,836
Three Years Later 10,338
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.
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.
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.
ITEM 8 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
Part III
ITEM 9 - DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
This item, except for certain information pertaining to executive officers
included in Part I, is incorporated by reference to the Registrant's definitive
proxy statement for the Annual Meeting of Shareholders to be held in June 1998.
ITEM 10 - EXECUTIVE COMPENSATION
This item is incorporated by reference to the Registrant's definitive proxy
statement for the Annual Meeting of Shareholders to be held in June 1998.
ITEM 11 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
CHANGES IN CONTROL
This item is incorporated by reference to the Registrant's definitive proxy
statement for the Annual Meeting of Shareholders to be held in June 1998.
ITEM 12 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
This item is incorporated by reference to the Registrant's definitive proxy
statement for the Annual Meeting of Shareholders to be held in June 1998.
ITEM 13 - EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
3.1 Certificate of Organization, as amended to date, is incorporated
herein by reference to Exhibits 3.1 through 3.13 to NEIC's Annual
Report on Form 10-KSB for the fiscal year ended December 31, 1993.
3.2 Bylaws of North East Insurance Company, 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: is
incorporated herein by reference to Exhibits 3.1 and 3.2 to NEIC's
Annual Report on Form 10-KSB for the fiscal year ended December 31,
1996.
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 Standstill Agreement, dated August 22, 1996, between the Company
and Ballantrae Partners, L.L.C., incorporated herein by reference
to Exhibit 99.1 to NEIC's Form 8-K report filed August 28, 1996.
NOTE: Compensatory plans and arrangements and management contracts are filed
as Exhibits 10.3 through 10.9 below.
10.3 Employment Agreement dated December 1, 1997 between North East and
Robert G. Schatz.
10.4 Letter Agreement dated October 28, 1996 between the Company and
Robert G. Schatz, regarding bonus compensation arrangements is
incorporated herein by reference to Exhibits 10.4 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
Ronald A. Libby, regarding terms of employment is incorporated
herein by reference to Exhibits 10.5 to NEIC's Annual Report on
Form 10-KSB for the fiscal year ended December 31, 1996.
10.6 Letter Agreement dated October 28, 1996 between the Company and
Samuel M. Koren, regarding terms of employment is incorporated
herein by reference to Exhibits 10.6 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 Robert G. Schatz is incorporated herein by
reference to Exhibits 10.7 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 Ronald A. Libby Schatz is incorporated
herein by reference to Exhibits 10.8 to NEIC's Annual Report on
Form 10-KSB for the fiscal year ended December 31, 1996.
10.9 Employment Continuity Agreement dated as of October 28, 1996
between the Company and Samuel M. Koren is incorporated herein by
reference to Exhibits 10.9 to NEIC's Annual Report on Form 10-KSB
for the fiscal year ended December 31, 1996.
10.10 North East Insurance Company Stock Option Plan
21 A 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.
27 Financial Data Schedule.
28 Information from Reports Furnished to State Insurance Regulatory
Authorities: Schedule P for NEIC and its subsidiary, American
Colonial Insurance Company, are filed herewith under cover of Form
SE.
(b) Reports on Form 8-K
The Company filed a report on Form 8-K on December 22, 1997,
announcing significant adjustments to its reinsurance arrangements.
SIGNATURES
In accordance with Section 13 of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Date: March 30, 1998 NORTH EAST INSURANCE COMPANY
By: /S/ Robert G. Schatz
--------------------------------
Robert G. Schatz, President
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
- ----------------------------- ------------------------------------- --------------
<S> <C> <C>
/S/ Robert G. Schatz President, Chief Executive Officer March 30, 1998
- ----------------------------- and Director
Robert G. Schatz
/S/ Graham S. Payne Treasurer and Chief Financial Officer March 30, 1998
- -----------------------------
Graham S. Payne
/S/ Edward B. Batal Director March 30, 1998
- -----------------------------
Edward B. Batal
/S/ Terence P. Cummings Director March 30, 1998
- -----------------------------
Terence P. Cummings
/S/ Robert A. Hancock Director March 30, 1998
- -----------------------------
Robert A. Hancock
/S/ Deborah L. Harmon Director March 30, 1998
- -----------------------------
Deborah L. Harmon
/S/ Wilson G. Hess Director March 30, 1998
- -----------------------------
Wilson G. Hess
/S/ Joseph M. Hochadel Director March 30, 1998
- -----------------------------
Joseph M. Hochadel
Director March , 1998
- -----------------------------
Jonathan S. Kern
/S/ Bruce H. Suter Director March 30, 1998
- -----------------------------
Bruce H. Suter
</TABLE>
NORTH EAST INSURANCE COMPANY AND SUBSIDIARIES
INDEX TO CONSOLIDATED EXHIBITS
<TABLE>
<CAPTION>
PAGE(S)
Exhibit No.
<S> <C> <C>
10.3 Employment Agreement dated December 1, 1997 between the
Company and Robert G. Schatz. 57
10.10 North East Insurance Company Stock Option Plan 71
27 Financial Data Schedule 78
</TABLE>
Exhibit 10.3
Employment Agreement dated December 1, 1997
between the Company and Robert G. Schatz
NORTH EAST INSURANCE COMPANY
EMPLOYMENT AGREEMENT
AGREEMENT, effective as of January 1, 1998 between NORTH EAST INSURANCE
COMPANY, a Maine corporation (the "Company"), and ROBERT G. SCHATZ (the
"Executive").
WHEREAS, the Company wishes to obtain the continued services of the
Executive; and
WHEREAS, the Executive wishes to continue in employment with the Company
on the terms herein provided;
NOW, THEREFORE, in consideration of the premises and mutual covenants and
agreements of the parties herein contained, the parties hereto (the "Parties")
agree as follows:
1. Term.
Subject to the provisions for termination hereinafter provided, the
Executive's employment hereunder shall be for a term (the "Employment Term")
commencing on January 1, 1998 (the "Employment Date") and ending on December
31, 2000 (the "Termination Date").
2. Positions and Duties.
During the Employment Term the Executive shall serve as President and
Chief Executive Officer of the Company. The Executive shall report to the Board
of Directors of the Company (the "Board") and perform such employment duties,
consistent with his position, as are specified by the Board, with duties and
responsibilities including, but not limited to, primary general supervision and
authority over the business and affairs of the Company and such additional
duties as may be assigned from time to time by the Board. It is intended that
the Executive shall be elected to the Board, and that the Executive shall serve
as a member of the Executive Committee thereof and of any other committee to
which substantial functions of the Executive Committee have been delegated. The
Executive shall devote his full productive time, energy and ability to the
proper and efficient conduct of the Company's business. The Executive may (i)
devote reasonable periods of time to passive investment of his personal assets,
and (ii) engage in community activities (including, with the Board's consent,
service on one or more boards of nonprofit institutions) so long as such
activities do not interfere with the performance of his obligations hereunder.
The Executive shall observe and comply with all lawful and reasonable rules of
conduct set by the Board for executives of the Company, and shall endeavor to
promote the business, reputation and interests of the Company.
3. Salary.
For his services hereunder the Company shall pay the Executive a base
salary of One Hundred Seventy-Five Thousand Dollars ($175,000) per annum (the
"Base Salary"). After 1998, Base Salary shall be increased annually to reflect
the increase, if any, in the cost of living for such year versus 1998, as
measured by the CPI. For purposes hereof, "CPI" shall mean the United States
Bureau of Labor Statistics Consumer Price Index All Urban Consumers (CPI-U),
(1982 - 4 = 100) Base Year, or any comparable successor index designated by
such agency.
4. Bonus.
(a) General.
The Executive shall be entitled to a bonus for his services during the
Term equal to
(i) 5% of the amount, if any, by which Aggregate After-Tax Net Profit
exceeds the Ten Percent Growth Amount, but does not exceed the Fifteen Percent
Growth Amount, plus
(ii) 10% of the amount, if any, by which Aggregate After-Tax Net Profit
exceeds the Fifteen Percent Growth Amount.
(b) "Aggregate After-Tax Net Profit" shall equal the sum of the "net
income" of the Company for the years 1998, 1999, and 2000, as shown on the
consolidated statements of operations for such years.
(c) Ten Percent Growth Amount.
(i) General: The Ten Percent Growth Amount shall equal the targeted three
year growth in the Company's shareholder's equity from January 1, 1998 at a 10%
annual rate, determined based on "Beginning Equity" as defined below, using the
following formula:
(Beginning Equity * (1.1^3)) - Beginning Equity
adjusted for each Cash Inflow and each Cash Outflow as provided in Clause
(ii) below.
(ii) Adjustment to Ten Percent Growth Amount for Cash Inflow and Cash
Outflow. The Ten Percent Growth Amount shall be adjusted for each Cash Inflow
and Cash Outflow as follows:
(A) Cash Inflows. If the Company receives a Cash Inflow at any time
during the Bonus Term, the Ten Percent Growth Amount shall be increased by the
targeted growth in the equity value of that Cash Inflow (that is, the amount by
which the Cash Inflow would grow at an annual growth rate of 10% compounded
monthly for the remainder of the term), determined by the following formula:
(CI * (1.00834^M))-CI Where:
CI = the amount of the Cash Inflow, and
M = the remaining months in the Bonus Term, inclusive of the
month in which the Cash Inflow is received.
(B) Cash Outflows. If the Company incurs a Cash Outflow at any time
during the Bonus Term, the Ten Percent Growth Amount shall be decreased by the
loss of targeted growth in the equity value of that Cash Outflow (that is, the
amount by which the Cash Outflow would have grown at an annual growth rate of
10% compounded monthly for the remainder of the term) determined by the
following formula:
(CO / (1.00834^M))-CO
Where:
CO = the amount of the Cash Outflow, and
M = the remaining months in the Bonus Term, inclusive of the
month in which the Cash Outflow occurs.
(d) Fifteen Percent Growth Amount.
(i) General. The Fifteen Percent Growth Amount shall equal the targeted
three year growth in the Company's Shareholder's Equity from January 1, 1998 at
a 15% annual rate, calculated as:
(Beginning Equity * 1.52) - Beginning Equity
adjusted for each Cash Inflow and each Cash Outflow as provided in Clause
(ii) below.
(ii) Adjustment to Fifteen Percent Growth Amount for Cash Inflow and Cash
Outflow. The Fifteen Percent Growth Amount shall be adjusted for each Cash
Inflow and Cash Outflow as provided below:
(A) Cash Inflows. If the Company receives a Cash Inflow at any time
during the Bonus Term, the Fifteen Percent Growth Amount shall be increased by
the targeted growth in the equity value of that Cash Inflow (that is, the
amount by which the Cash Inflow would grow at an annual growth rate of 15%
compounded monthly for the remainder of the term), determined by the following
formula:
(CI * (1.0125^M))-CI
Where:
CI = the amount of the Cash Inflow, and
M = the remaining months in the Bonus Term, inclusive of the
month in which the Cash Inflow is received.
(B) Cash Outflows. If the Company incurs a Cash Outflow at any time
during the Bonus Term, the Fifteen Percent Growth Amount shall be decreased by
the loss of targeted growth in the equity value of that Cash Outflow (that is,
the amount by which the Cash Outflow would have grown at an annual growth rate
of 10% compounded monthly for the remainder of the term) determined by the
following formula:
(CO / (1.0125^M))-CO
Where:
CO = the amount of the Cash Outflow, and
M = the remaining months in the Bonus Term, inclusive of the
month in which the Cash Outflow occurs.
(e) "Capital Inflow" shall mean the value of a contribution made during
the applicable year of money or property to the equity capital of the Company.
The value of a contribution of property shall be the fair market value of such
property on the date of such contribution.
(f) "Capital Outflow" shall mean the value of a distribution of money or
property made by the Company during the applicable year to one or more of its
shareholders with respect to its capital stock.
(g) "Beginning Equity" shall mean "total shareholders' equity" of the
Company as of December 31, 1997, as shown on the Company's consolidated balance
sheet.
(h) "Bonus Term" shall mean the period beginning January 1, 1998 and
ending December 31, 2000.
(i) Board
The Board/Committee shall have discretion to adjust the Aggregate
After-Tax Net Profit and Aggregate Targeted Shareholders Equity as the
Board/Committee in good faith deems appropriate in respect of any
extraordinary, unusual or non-recurring financial (including tax) item, it
being intended that the Bonus calculation shall apply to Company results in the
ordinary course. The Board/Committee shall consult with the Executive before
making any such adjustment.
(j) Example.
An example of the operation of the bonus formula is attached as Exhibit[].
5. Stock Options.
The Executive may receive grants of options exercisable into Shares as
determined by the Board from time to time in accordance with the Company's
Stock Option Plan, as in effect from time to time.
6. Expenses.
The Executive shall be entitled to receive prompt reimbursement for all
reasonable expenses incurred by him in the course of his employment by the
Company hereunder, as per Company policies currently in effect, provided that
the Executive properly accounts therefor.
7. Other Benefits.
During his employment the Executive shall be entitled to:
(a) participate in the Company's benefit plans and arrangements on terms
at least as favorable as the terms generally applicable to senior management
from time to time;
(b) the exclusive use of an automobile to be provided by the Company
during the term of his employment;
(c) up to four (4) weeks paid vacation in any calendar year; and
(d) the continuation, at Company expense, of the presently existing life
insurance program for the benefit of the Executive's designated beneficiary.
The Company agrees to pay the premiums to maintain the existing program in
force during the Executive's employment hereunder.
8. Renewal of Agreement.
(a) Renewal. If the Executive gives the Company notice of his willingness
to renew this Agreement, then the Agreement shall be deemed renewed for an
additional one-year period unless the Company gives the Executive notice of its
intention not to renew the Agreement. To be effective, such notice must be
given in writing by the Executive or the Company (as the case may be) at least
one hundred twenty (120) days or ninety (90) days, respectively, prior to the
Termination Date. Any such renewal of this Agreement shall extend the
Employment Term, Bonus Term, and Termination Date under this Agreement by one
(1) year.
(b) Non-Renewal Payment. If, prior to the Termination Date, the Company
does not offer the Executive employment with the Company for the period
commencing immediately after the Termination Date under terms and conditions at
least as favorable to the Executive as those contained herein, including, but
not limited to, the terms and conditions of Sections 2 through 7 hereof, then,
the Executive shall be entitled to a payment of One Hundred Seventy-Five
Thousand Dollars ($175,000) (the "Non-Renewal Payment"); provided, however,
that should the Executive's employment with the Company be terminated prior to
the Termination Date under the terms of Section 9 herein, this Section 8 shall
have no effect, and the Executive shall not be entitled to the Non-Renewal
Payment. The Company shall pay the Non-Renewal Payment in one hundred twenty
(120) equal fully amortizing monthly installments of principal plus interest at
the Federal Long-term Rate (as defined below), such payments to commence within
ten (10) business days following the Termination Date. The "Federal Long-term
Rate" means the Applicable Federal Rate, in effect on the date of such
termination, for debt instruments with a term of greater than nine (9) years as
determined under Section 1274(d) of the Internal Revenue Code of 1986, as
amended.
9. Termination of Employment.
The Executive's employment by the Company pursuant hereto is subject to
termination during the Employment Term only as follows:
(a) Death. The Executive's employment shall terminate as of the date of
his death, in which case:
(i) The Company shall pay to the Executive's estate the Base Salary
accrued through the date of the Executive's death;
(ii) The Company shall pay the Bonus for the Bonus Year in which
termination occurs, the amount of such Bonus to be determined under the terms
of the applicable plan (without regard to any provision requiring ongoing
employment), prorated to reflect the portion of the Bonus Term through the end
of the month of the Executive's death. Notwithstanding any contrary provision
of Section 4 above, the amount of Bonus so determined shall be paid to the
Executive's estate in cash promptly following the date such amount is
determinable; and
(iii) All other compensation and benefits shall be as determined under
the terms and conditions of any applicable plans, programs or other coverages
maintained by the Company.
(b) Disability. The Company may terminate the Executive's employment due
to disability, as determined under the Company's long-term disability plan as
in effect from time to time, in which case:
(i) The Company shall continue to pay the Base Salary for one year
following termination of employment, such period ending on the last day of the
payroll period during which the first anniversary of such termination occurs;
(ii) The Company shall pay the Bonus for the Bonus Year in which
termination occurs, the amount of such Bonus to be determined under the terms
of the applicable plan (without regard to any provision requiring ongoing
employment), prorated to reflect the portion of the Bonus Term through the end
of the month of the Executive's termination of employment. Notwithstanding any
contrary provision of Section 4 above, the amount of Bonus so determined shall
be paid to the Executive in cash promptly following the date such amount is
determinable; and
(iii) All other compensation and benefits shall be as determined under
the terms and conditions of any applicable plans, programs or other coverages
maintained by the Company.
(c) Termination by the Company Without Cause or Termination by the
Executive for Good Reason. The Company may terminate the Executive's employment
without Cause, as defined below, and the Executive may terminate his employment
for Good Reason, as defined below. In either case:
(i) The Company shall pay the Executive One Hundred Seventy-Five Thousand
Dollars ($175,000) within ten (10) business days following the Termination
Date;
(ii) If the Executive complies with all of the requirements of Section 10
and 11 during the "Restricted Period," as defined in Section 11, the Company
shall pay the Executive an additional One Hundred Seventy-Five Thousand Dollars
($175,000) payable in one-hundred eight (108) equal fully amortizing monthly
installments of principal plus interest at the Federal Long-term Rate (as
defined in Section 8(b) hereof), such payments to commence on the first
anniversary of the Termination Date;
(iii) Medical, hospitalization and any other health benefits, as
applicable on the date of termination of the Executive's employment, shall
continue to be provided until the earlier of (i) the first anniversary of
termination of the Executive's employment, or (ii) the date the Executive is
entitled to comparable benefits under any plan maintained by a subsequent
employer of the Executive; and
(iv) All other compensation and benefits shall be as determined under the
terms and conditions of any applicable plans, programs or other coverages
maintained by the Company.
(d) Termination by the Company for Cause. The Company shall be entitled
to terminate the Executive's employment at any time under this Section 9(d), by
written notice to the Executive if it has "Cause" to do so, which shall mean:
(i) The Executive's indictment for or plea of nolo contendere to, (A) a felony,
or (B) a misdemeanor materially injurious to the Company;
(ii) The Executive's continued substantial neglect of duties, after
written notice and an opportunity to correct;
(iii) Gross misconduct in the performance of duties hereunder, materially
injurious to the reputation, business or operation of the Company; or
(iv) The issuance of an order from an insurance regulatory body of any
state or other jurisdiction in which the Company does business that
(A) finds that the Executive violated statutory requirements of
applicable insurance laws or regulations, and
(B) prohibits the Executive from exercising any material portion of his
duties as Chief Executive Officer of the Company.
If the Company terminates the Executive's employment for Cause, the
Executive's Base Salary and other benefits shall be paid through the date of
termination and the Executive shall have no further rights to compensation or
benefits other than as determined by the terms of any applicable plan or
program.
The Executive must be notified in writing of any termination of his
employment for Cause. The Executive shall then have the right, exercisable only
within ten (10) days following receipt of such notice, to file a written
request for review by the Company. In such case, the Executive shall be given
the opportunity to be heard, personally or through counsel, by those members of
the Board who are not employees (the "Independent Directors") and a majority of
the Independent Directors must thereafter confirm that such termination is for
Cause. If the Independent Directors do not provide such confirmation, the
termination shall be treated as other than for Cause.
If, following a termination of the Executive's employment for reasons
other than Cause, the Independent Directors become aware of facts clearly
demonstrating the existence, at the time of such termination, of grounds for
terminating the Executive's employment for Cause, such termination shall be
treated as a termination for Cause, subject to the Executive's right to be
heard, and to have such determination confirmed, as provided immediately above.
Such right of post-effective termination for Cause shall be deemed waived
unless written notice of the basis therefor is given to the Executive (i)
within one year from the Termination Date of his employment or (ii) by June 30
of the calendar year following the year in which such termination occurred,
whichever is later.
(e) Termination by the Executive for Good Reason. The Executive shall be
entitled to terminate his employment at any time under this Section 9(e) by
written notice to the Company if he has "Good Reason" to do so, which shall
mean (i) the Company's breach of this Agreement, including, but not limited to:
(A) a breach of this Agreement caused by the Company's attempt to reduce the
Executive's compensation; (B) the Company's attempt to remove the Executive
from the position of Chief Executive Officer, or (ii) a move of the Company's
headquarters to a location more than 50 miles from Portland, Maine.
(f) Voluntary Termination of Employment. The Executive may terminate
employment voluntarily, in which case the Base Salary and other benefits shall
be paid through the date of termination and the Executive shall have no further
rights to compensation or benefits other than as determined by the terms of any
applicable plan or program.
10. Confidential Information.
(a) The Executive recognizes that the services to be performed by him
hereunder are special, unique and extraordinary and that, by reason of his
employment with the Company, he may acquire Confidential Information (as
hereinafter defined) concerning the operation of the Company the use or
disclosure of which would cause the Company substantial, irreparable loss and
damage which could not be readily calculated and for which no remedy at law
would be adequate. Accordingly, the Executive agrees that he shall not
(directly or indirectly) at any time, whether during or after the Employment
Term:
(i) knowingly use for an improper personal benefit any Confidential
Information that he may learn or has learned by reason of his employment with
the Company or
(ii) disclose any such Confidential Information to any person except (A)
in the good faith performance of his obligations to the Company hereunder, (B)
in connection with the enforcement of his rights under this Agreement or (C)
with the prior consent of the Board.
As used herein "Confidential Information" includes information with
respect to the Company's facilities and methods, trade secrets and other
intellectual property, systems, patents and patent applications, procedures,
manuals, confidential reports, financial information, business plans, prospects
or opportunities, personnel information or lists of customers and suppliers;
provided, however, that such term shall not include any information which is or
becomes generally known or available publicly other than as a result of
disclosure by the Executive which is not permitted as described in clause (ii)
above.
(b) The Executive confirms that all Confidential Information is the
exclusive property of the Company. All business records, papers and documents
and electronic materials kept or made by the Executive relating to the business
of the Company which comprise Confidential Information shall be and remain the
property of the Company during the Employment Term and all times thereafter.
Upon the termination of his employment with the Company or upon the request of
the Company at any time, the Executive shall promptly deliver to the Company,
and shall retain no copies of, any written or electronic materials, records and
documents made by the Executive or coming into his possession concerning the
business or affairs of the Company and which constitute Confidential
Information.
11. Non-Competition.
(a) During the term of his employment and for the period commencing on
the date the Executive's employment terminates and ending on the first
anniversary thereof (the "Restricted Period"), the Executive shall not (i)
directly or indirectly, for his own account or for the account of others, as an
officer, director, stockholder, owner, partner, employee, promoter, consultant,
manager or otherwise participate in the promotion, financing, ownership,
operation, or management of, or assist in or carry on through a proprietorship,
corporation, partnership or other form of entity, the business of automobile
insurance (the "Business") within Maine or any other state in which the Company
was conducting, or was actively planning to conduct, the Business as of the
date of such termination of employment, (ii) solicit or contact in an effort to
do business with any person who was a customer or agent of the Company during
the period of the Executive's employment, or any affiliate of any such person,
if such solicitation or contact is directly or indirectly in competition with
the Company, or (iii) interfere in a similar manner with the business of the
Company. Nothing in this Section 11 shall prohibit the Executive from acquiring
or holding any issue of stock or securities of any person that has any
securities registered under Section 12 of the Securities Exchange Act of 1934
as amended, listed on a national securities exchange or quoted on the automated
quotation system of the National Association of Securities Dealers, Inc. so
long as (x) the Executive is not deemed to be an "affiliate" of such person as
such term is used in paragraphs (c) and (d) of Rule 145 under the Securities
Act of 1933, as amended, and (y) the Executive, members of his immediate family
or persons under his control do not own or hold more than five percent (5%) of
any voting securities of any such person.
(b) During the Restricted Period, the Executive shall not, whether for
his own account or for the account of any other person (excluding the Company),
(i) solicit or induce any of the Company's employees to leave their employment
with the Company or to accept employment with anyone else or (ii) hire any such
employees.
(c) The Executive has carefully read and considered the provisions of
this Section 11 and, having done so, agrees that the restrictions set forth in
this Section 11 (including the Restricted Period, the scope of activity to be
restrained and the geographical scope) are fair and reasonable and are
reasonably required for the protection of the interests of the Company, its
officers, directors, employees, creditors and shareholders. The Executive
understands that the restrictions contained in this Section 11 may limit his
ability to engage in a business similar to the Company's business, but
acknowledges that he will receive sufficiently high remuneration and other
benefits from the Company hereunder to justify such restrictions.
12. Breach of Section 10 or Section 11.
The Executive acknowledges that a breach of any of the covenants
contained in Section 10 or Section 11 hereof may result in material,
irreparable injury to the Company for which there is not adequate remedy at
law, that it will not be possible to measure damages for such injuries
precisely and that, in the event of such a breach, any payments remaining under
the terms of this Agreement shall cease and the Company shall be entitled to
obtain a temporary restraining order and a preliminary or permanent injunction
restraining the Executive from engaging in activities prohibited by Section 10
or Section 11 hereof or such other relief as may be required to enforce any of
the covenants contained in Section 10 or Section 11 hereof.
13. Arbitration.
The Parties agree that any controversy or claim arising out of or
relating to this Agreement, or the breach of any provision hereof, or the terms
or conditions of employment, including whether such controversy or claim is
arbitrable, and excepting any claim or controversy arising out of the
provisions of Section 10 or Section 11 hereof, shall be settled by arbitration
in the City of Portland, Maine, in accordance with the rules for commercial
arbitration of the American Arbitration Association as in effect at the time a
demand for arbitration under the rules is made, and judgment upon the award
rendered by the arbitrators may be entered in any court having jurisdiction
thereof. The decision of the arbitrators, including determination of the amount
of any damages suffered, shall be conclusive, final and binding on both
Parties, their heirs, executors, administrators, successors and assigns. The
cost of arbitration incurred by either Party shall be borne by that party
unless otherwise determined by the arbitrators.
14. Withholding.
Anything to the contrary notwithstanding, all payments required to be
made by the Company hereunder to the Executive, his spouse, his estate or
beneficiaries, shall be subject to withholding of such amounts relating to
taxes as the Company may reasonably determine it should withhold pursuant to
any applicable law or regulation. In lieu of withholding such amounts, in whole
or in part, the Company may, in its sole discretion, accept other provisions
for payment of taxes, provided it is satisfied that all requirements of law
affecting its responsibilities to withhold such taxes have been satisfied.
15. Assignability; Binding Nature.
This Agreement is binding upon, and shall inure to the benefit of, the
Parties hereto and their respective successors, heirs, administrators,
executors and assigns. No rights or obligations of the Executive under this
Agreement may be assigned or transferred by the Executive except that (a) his
rights to compensation and benefits hereunder may be transferred by will or
operation of law, subject to the limitations of this Agreement, and (b) his
rights under employee benefit plans or programs may be assigned or transferred
in accordance with such plans, programs. No rights or obligations of the
Company under this Agreement may be assigned or transferred except that such
rights or obligations may be assigned or transferred by operation of law in the
event of a merger or consolidation in which the Company is not the continuing
entity, or the sale or liquidation of all or substantially all of the assets of
the Company, provided that the assignee or transferee is the successor to all
or substantially all of the assets of the Company and such assignee or
transferee assumes the liabilities, obligations and duties of the Company, as
contained in this Agreement, either contractually or as a matter of law.
16. Entire Agreement.
This Agreement contains the entire agreement between the Parties
concerning the subject matter hereof and supersedes all prior agreements,
understandings, discussions, negotiations, and undertakings, whether written or
oral, between the Parties with respect thereto, specifically including, but not
limited to, the Employment Agreement between the Company and the Executive
dated as of March 26, 1991, and the ECA or that letter agreement of October 28,
1996 from the Company to the Executive captioned "Re: Special Payments" (the
"Letter Agreement"). Notwithstanding the foregoing, this Agreement shall not
supersede the provisions contained in the first two (2) sentences of Paragraph
(2) of the Letter Agreement concerning the Company's obligations to make
special bonus payments through the year 2006 ("Special Bonus Provisions"). A
copy of the Letter Agreement is attached hereto and the Special Bonus
Provisions are incorporated herein.
17. Notice.
For the purposes of this Agreement, notices and all other communications
provided for in this Agreement shall be in writing and shall be deemed to have
been duly given when delivered by hand or mailed by United States overnight
express mail, or nationally recognized private delivery service on an overnight
basis, return receipt requested, postage prepaid. All such notices to the
Executive shall be marked clearly "Personal and Confidential."
If to the Executive:
Office Address: Robert G. Schatz
North East Insurance Company
482 Payne Road
Scarborough, Maine 04074
Home Address: PO Box 218
Cape Cottage Branch
Cape Elizabeth, Maine 04107
If to the Company: North East Insurance Company
482 Payne Road
Scarborough, Maine 04074
Attn: Secretary
With a Copy to: Chair -- Compensation Committee
c/o North East Insurance Company
482 Payne Road
Scarborough, Maine 04074
Notices may also be sent to such other address as either Party may have
furnished to the other in writing in accordance herewith, except that notice of
change of address shall be effective only upon receipt.
18. Miscellaneous.
No provision of this Agreement may be modified, waived, or discharged
unless such waiver, modification or discharge is agreed to in writing and
signed by the Executive and such officer of the Company as may be specifically
designated by the Board. No waiver by either Party at any time of any breach by
the other Party of, or compliance with, any condition or provision of this
Agreement to be performed by such other Party shall be deemed a waiver of
similar or dissimilar provisions or conditions at the same or at any prior or
subsequent time. No agreements or representations, oral or otherwise, express
or implied, with respect to the subject matter hereof have been made by either
Party which are not expressly set forth in this Agreement. The validity,
interpretation, construction, and performance of this Agreement shall be
governed by the laws of the State of Maine.
19. Validity.
The invalidity or unenforceability of any provision of this Agreement
shall not affect the validity or enforceability of any other provision of this
Agreement, which shall remain in full force and effect.
20. Counterparts.
This Agreement may be executed in several counterparts, each of which
shall be deemed to be an original, but all of which together shall constitute
one and the same instrument.
IN WITNESS WHEREOF, the Parties have executed this Agreement as of the
date and year first above written.
NORTH EAST INSURANCE COMPANY
By: /s/ Samuel M. Koren Date: 12/1/97
Title: Secretary
The Executive:
/s/ Robert G. Schatz Date: 12/1/97
EXAMPLE OF OPERATION OF BONUS FORMULA
The calculation of the Ten Percent Growth Amount and the Fifteen Percent Growth
Amount can be illustrated as follows:
Assume:
Beginning Shareholders Equity is $9,000,000.
Cash Inflows occur as follows:
$1,000,000 in November of 1998; and
$750,000 in February of 2000.
A Cash Outflow occurs as follows:
$500,000 in July 1999.
The Ten Percent Growth Amount is calculated as follows:
$2,979,000 (($9,000,000*(1.33))-$9,000,000).
plus $ 240,816 (in respect of the first Cash Inflow)
plus $ 71,687 (in respect of the second Cash Inflow)
less ($ 80,556)(in respect of the Cash Outflow)
------------
$3,210,947
The Fifteen Percent Growth Amount is calculated as follows:
$4,687,875 (($9,000,000*(1.52))-$9,000,000).
plus $ 381,245 (in respect of the first Cash Inflow)
plus $ 109,818 (in respect of the second Cash Inflow)
less ($ 125,289)(in respect of the Cash Outflow)
------------
$5,053,650
In such case:
If Aggregate After-Tax Net Profit is $3,200,000, there is no bonus.
If Aggregate After-Tax Net Profit is $4,000,000, bonus is 5% of the
amount in excess over the Ten Percent Growth Amount, or $39,453.
If Aggregate After-Tax Net Profit is $6,000,000, bonus is 5% of the
amount in excess of the Ten Percent Growth Amount but not in excess of the
Fifteen Percent Growth Amount, plus 10% of the amount in excess of the Fifteen
Percent Growth Amount, or $186,770.
Exhibit 10.10
NORTH EAST INSURANCE COMPANY
STOCK OPTION PLAN
1. Purpose. The purpose of this Plan is to promote the profitability of North
East Insurance Company and its Subsidiaries by providing Directors and selected
employees and with additional incentives to contribute to the success of the
Company and by helping the Company to attract and retain qualified employees
and Directors.
2. Definitions. As used in this Plan, the following words and phrases wherever
capitalized shall have the following meanings, unless the context clearly
indicates that a different meaning is intended:
(a) "Award" shall mean any Option or Stock Appreciation Right granted
pursuant to the Plan.
(b) "Award Agreement" shall mean a written instrument that specifies the
terms, conditions and restrictions of an Award and incorporates the applicable
provisions of the Plan and such additional provisions not inconsistent
therewith as the Committee shall determine.
(c) "Board" shall mean the Board of Directors of the Company.
(d) "Code" shall mean the Internal Revenue Code of 1986, as from time to
time amended.
(e) "Committee" shall mean a committee appointed by the Board of
Directors with authority to administer the Plan and consisting solely of
Non-Employee Directors. In its discretion, the Board may, from time to time,
perform any duty of the Committee or exercise any power of the Committee.
(f) "Common Stock" shall mean common stock, par value $1.00 per share, of
the Company.
(g) "Company" shall mean North East Insurance Company.
(h) "Director" shall mean any member of the Board of Directors of the
Company, whether or not an Employee. "Non-Employee Director" shall mean a
Director who is a Non-Employee Director within the meaning of Rule 16b- 3 or
who meets such other criteria as the Committee may establish from time to time.
(i) "Disability" shall mean a participant's inability to engage in any
substantial gainful activity by reason of any medically determinable physical
or mental impairment that can be expected to result in death or that has lasted
or can be expected to last for a continuous period of not less than twelve (12)
months. A participant shall not be considered disabled unless he or she
furnishes proof of the existence of such Disability in such form and manner,
and at such times, as the Committee may require.
(j) "Employee" shall mean any person who is employed by the Company or
any Parent or Subsidiary.
(k) "Fair Market Value" per Share as of a given date shall mean the
average of the closing bid and asked prices of the Common Stock as quoted on
NASDAQ, or such other determination of fair market value as the Committee may
designate. If there are no sales of Common Stock reported for the day on which
Fair Market Value is to be determined, then Fair Market Value shall be
determined as of the last previous day on which sales were reported. Provided,
however, that the Fair Market Value of Shares to be issued under any Incentive
Stock Option shall in all events be determined in a manner that meets the
applicable requirements of subsections 422(b)(5) and (c)(7) of the Code and the
regulations issued thereunder.
(l) "Incentive Stock Option" shall mean an option granted to an
individual for any reason connected with his or her employment by a
corporation, if granted by the employer corporation or its parent or subsidiary
corporation, to purchase stock of any of such corporations, but only if such
option meets the requirements of Section 422 of the Code.
(m) "Nonqualified Stock Option" shall mean an Option granted under the
Plan which is not an Incentive Stock Option.
(n) "Option" shall mean a right granted under the Plan to purchase
Shares.
(o) "Optionee" shall mean an Employee or Director who is granted an
Option.
(p) "Parent" shall mean a parent corporation within the meaning of
subsections 424(e) and (g) of the Code.
(q) "Participant" shall mean a person who is eligible to receive Awards
under this Plan or who holds one or more outstanding Awards under this Plan.
(r) "Plan" shall mean this North East Insurance Company Stock Option
Plan.
(s) "Rule 16b-3" shall mean Rule 16b-3 of the Securities and Exchange
Commission, as from time to time amended, and any successor regulation thereto.
(t) "Share" shall mean a share of Common Stock of the Company, as
adjusted in accordance with subsection 4(b) below.
(u) "Stock Appreciation Right" shall mean a right granted under Section 8
to receive a payment, the amount of which shall be determined by reference to
the value of a Share.
(v) "Subsidiary" shall mean, for purposes of the Incentive Stock Option
provisions of the Plan, a subsidiary corporation within the meaning of
subsections 424(f) and (g) of the Code, and for all other purposes of the Plan,
a corporation of which North East Insurance Company owns directly or indirectly
at least fifty percent (50%) of the total combined voting power of all classes
of stock entitled to vote.
3. Administration.
(a) Committee. The Plan shall be administered by the Committee (subject,
however, to the discretion of the Board under Section 2(e) above). A majority
of the members of the Committee shall constitute a quorum, and the action of a
majority of the members present at any meeting at which a quorum is present
shall be deemed the action of the Committee. Any member may participate in a
meeting of the Committee by means of a conference telephone or similar
communications equipment by means of which all persons participating in the
meeting can hear each other. Further, any action of the Committee may be taken
without a meeting if all of the members of the Committee sign written consents,
setting forth the action taken or to be taken, at any time before or after the
intended effective date of such action.
(b) Powers. Except as otherwise provided by the Plan, the Committee shall
have authority to administer all aspects of the Plan, including the power:
(i) to determine the persons eligible for Awards under the Plan;
(ii) to determine the time or times at which Awards shall be
granted;
(iii) to determine the type or types of Awards to be granted;
(iv) to determine the terms, conditions and restrictions of each
Award;
(v) to make adjustments in accordance with subsection 4(b) below;
(vi) to prescribe, amend and rescind rules and regulations relating
to the Plan; and
(vii) to interpret the Plan and make all other determinations
deemed necessary or advisable for the administration of the Plan.
Decisions of the Committee on all matters relating to the Plan shall be in the
Committee's sole discretion and shall be conclusive and binding on all parties
(including the Company), and their heirs, assigns and beneficiaries.
(c) Signatures. The Committee may authorize any member thereof to execute
all instruments required in the administration of the Plan, and such
instruments may be executed by facsimile signature.
4. Stock Subject to the Plan.
(a) Limitations. Subject to the provisions of subsection (b) below, the
maximum number of Shares available for issuance under the Plan, and the
aggregate number of Shares which may be issued pursuant to Incentive Stock
Options, shall be six hundred thousand (600,000) Shares.
In the event that any Award granted under the Plan expires, is forfeited,
or otherwise terminates without the issuance of Shares or payment of other
consideration in lieu of such Shares, the unissued Shares subject to such Award
shall, unless the Plan has been terminated, become available for other Awards.
In the event that a Participant transfers stock issued by the Company in
full or partial payment of the option price of an Option granted under the
Plan, only the difference between (i) the number of Shares issued upon exercise
of the Option and (ii) the number of Shares transferred in payment of the
option price shall be counted for purposes of the foregoing limitation on the
maximum number of Shares available for grant under the Plan. Notwithstanding
the foregoing, the total number of Shares issued pursuant to the exercise of an
Incentive Stock Option shall be counted for purposes of the foregoing special
limitation on Shares issued pursuant to Incentive Stock Options.
(b) Adjustments. If the number of Shares outstanding changes as a result
of a stock split or stock dividend, the Committee shall proportionately adjust:
(i) the maximum number of Shares available for grant and the maximum aggregate
number of shares which may be issued under Incentive Stock Options; (ii) the
number of Shares to be issued under Awards; (iii) the option price with respect
to Options; and (iv) the grant price with respect to Stock Appreciation Rights.
In the event of a merger or consolidation in which the Company is the
surviving corporation, or the acquisition by the Company of property or stock
of another corporation, or any reorganization of the Company, the Committee
shall appropriately adjust: (i) the number and class of Shares to be issued
under Awards; (ii) the option price of Shares subject to Options; and (iii) the
grant price with respect to Stock Appreciation Rights. Any adjustments under
this subsection (b) affecting Incentive Stock Options shall be made so as to
comply with the applicable provisions of Sections 422 and 424 of the Code.
Upon the occurrence of a merger or consolidation in which the Company is
not the surviving company, all Awards shall become exercisable to the extent
provided in Section 10 below.
Any Shares issued hereunder may consist, in whole or in part, of
authorized and unissued Shares or treasury Shares, and upon issuance shall be
deemed fully paid and nonassessable.
5. Eligibility.
(a) Awards to Employees. The Committee may, from time to time, grant
Options or Stock Appreciation Rights to any Employee. The Committee may, from
time to time, limit the class of Employees eligible to receive Awards under the
Plan.
(b) Awards to Directors. The Committee may, from time to time, grant
Nonqualified Stock Options or Stock Appreciation Rights to any Non-Employee
Director. The Committee may, from time to time, limit the class of Non-Employee
Directors eligible to receive Awards under the Plan.
(c) Eligibility for Incentive Stock Options. Employees who own ten
percent (10%) or more of the total combined voting power of all classes of
stock of the Company or its Parent or Subsidiary are ineligible to receive
Incentive Stock Options under the Plan. Non-Employee Directors are ineligible
to receive Incentive Stock Options.
6. Granting of Awards.
(a) Discretionary Awards. The Committee may grant more than one Award and
more than one type of Award to any eligible Participant. A person who has been
granted an Award may, if he or she is otherwise eligible, be granted additional
Awards before exercising such prior Award.
The Committee may condition a Participant's receipt of an Award and his
or her exercise of an Option or Stock Appreciation Right on the attainment of
performance goals. Performance goals may be expressed in terms of earnings per
Share, stock price, total shareholder return, return on equity, or any similar
quantifiable measures.
(b) Formula Awards. The Committee shall have authority to grant Awards at
designated intervals on predetermined terms. The terms on which such formula
awards are to be granted may be changed by the Committee from time to time,
provided that (i) no such change shall affect the terms of Awards previously
granted and (ii) no such change may be made in a manner that would contravene
any conditions of Rule 16b-3 that are specific to formula awards.
7. Options.
(a) Option Agreement. Each Option granted under the Plan shall be
evidenced by an Award Agreement ("Option Agreement"), specifying the option
price, the number of Shares subject to the Option and such other terms,
conditions and restrictions as the Committee shall determine. In addition, each
Option shall be clearly identified as either an Incentive Stock Option or a
Nonqualified Stock Option.
(b) Term of Option. The term of each Option shall be set forth in the
Option Agreement, but in no event shall an Incentive Stock Option be
exercisable after the expiration of ten (10) years from the date such Option is
granted.
(c) Option Price. The option price at which Shares may be purchased under
the Option shall not be less than one hundred percent (100%) of the Fair Market
Value of a Share on the date the Option is granted.
(d) Nontransferability of Options. Options may not be sold, pledged,
assigned, hypothecated, transferred or disposed of in any manner, other than by
will or by the laws of descent and distribution, and may be exercised during
the lifetime of the Optionee only by such Optionee. Notwithstanding the
preceding sentence, the transfer of Nonqualified Stock Options to family
members or family trusts (and exercise by the transferee) shall be permissible
if and to the extent permitted under Rule 16b-3.
(e) Manner of Exercise. An Option granted under the Plan shall be
exercisable at such times and under such circumstances as shall be permissible
under the terms of the Plan and the Option Agreement. An Option shall be deemed
to be exercised when the Optionee gives written notice of such exercise to the
Company in accordance with the terms of the Option Agreement and the Company
receives full payment of the exercise price for the Shares with respect to
which the Option is exercised. Except as the Option Agreement otherwise
provides, payment shall be made in cash or by delivery of Company stock owned
by the Optionee, in a form suitable for transfer, or a combination thereof, as
the Optionee may elect. Stock transferred to the Company in full or partial
payment of the exercise price shall be valued at Fair Market Value on the date
of exercise of the Option. Where permitted by the Option Agreement or the
Committee as a means of payment of the exercise price, the forfeiture of an
otherwise exercisable Option (or any portion thereof) shall be valued at the
excess of (i) the Fair Market Value of the underlying Shares over (ii) the
exercise price of the forfeited Option (or portion thereof).
8. Stock Appreciation Rights.
(a) SAR Agreement. Any Stock Appreciation Rights granted under the Plan
shall be evidenced by an Award Agreement ("SAR Agreement"), specifying the
grant price, the number of such rights, and such other terms, conditions and
restrictions as the Committee shall determine.
(b) Amount of Payment. A participant to whom a Stock Appreciation Right
has been granted shall be entitled to receive payment of an amount equal to the
excess of (i) the Fair Market Value of one (1) Share on the date of exercise of
such right over (ii) the grant price of the right; provided that, if so
specified in the SAR Agreement, the Fair Market Value of a Share with respect
to a Stock Appreciation Right that is not related to an Incentive Stock Option
may be determined as of any given date prior to the date of exercise.
(c) Grant Price. The grant price of a Stock Appreciation Right shall not
be less than one hundred percent (100%) of the Fair Market Value of a Share on
the date the Stock Appreciation Right is granted.
(d) Nontransferability of Rights. Stock Appreciation Rights may not be
sold, pledged, assigned, hypothecated, transferred or disposed of in any
manner, other than by will or by the laws of descent and distribution, and may
be exercised during the lifetime of the recipient. Notwithstanding the
preceding sentence, the transfer of Stock Appreciation Rights to family members
or family trusts (and exercise by the transferee) shall be permissible if and
to the extent permitted under Rule 16b-3.
(e) Manner of Exercise. A Stock Appreciation Right granted under the Plan
shall be exercisable at such times and under such circumstances as shall be
permissible under the terms of the Plan and of the SAR Agreement. A Stock
Appreciation Right shall be deemed exercised when the recipient gives written
notice of such exercise to the Company in accordance with the terms of the SAR
Agreement.
(f) Form of Payment. Payment with respect to the exercise of a Stock
Appreciation Right may be made in cash, Shares or a combination thereof, as the
Committee shall determine. To the extent that such payment is made in Shares,
the Shares shall be valued at Fair Market Value on the date of payment.
(g) Related Options. A Stock Appreciation Right may, but need not, relate
to an Option granted under the Plan. A Stock Appreciation Right related to a
Nonqualified Stock Option may be granted simultaneously with the granting of
such Option or at any time thereafter before the exercise or termination of
such Option. A Stock Appreciation Right related to an Incentive Stock Option
must be granted at the same time such Option is granted.
A Stock Appreciation Right related to the full number of Shares subject
to an Option shall terminate upon exercise or termination of the Option to the
extent such Option is exercised or terminated. A Stock Appreciation Right
related to less than the full number of Shares subject to an Option shall not
be affected by the exercise or termination of the Option until such exercise or
termination exceeds the number of Shares not related to the Stock Appreciation
Right; thereafter such right shall terminate to the extent such Option is
further exercised or terminated.
To the extent that a Stock Appreciation Right related to an Option has
been exercised, such Option shall no longer be exercisable.
9. Termination of Employment. In the event that an Employee ceases to be
employed by the Company or any Parent or Subsidiary and is no longer employed
by any of them, for any reason other than death or Disability, and except as
the Award Agreement otherwise expressly provides, each outstanding Award to the
Employee will expire unless duly exercised within three (3) months after the
date employment ceases or, if earlier, the original expiration date of the
Award). Except as the Award Agreement otherwise expressly provides, termination
of a Non-Employee Director's status as a Director shall not affect the term of
any Award granted to him or her.
In the event that, by reason of his or her death or Disability, an
Employee ceases to be employed by the Company or any Parent or Subsidiary, and
is no longer employed by any of them, then except as the Award Agreement
otherwise expressly provides, each outstanding Award to the Employee will
expire unless duly exercised within one (1) year after the date employment
ceases or, if earlier, the original expiration date of the Award.
10. Change in Control. Upon the occurrence of a Change in Control Event of the
Company, and except as the Award Agreement otherwise expressly provides, all
then outstanding Options and Stock Appreciation Rights not previously
exercisable shall be become exercisable. For purposes of this Section, each of
the following events shall constitute a Change in Control Event:
(a) The Company's shareholders approve:
(i) any consolidation or merger of the Company in which the Company
is not the continuing or surviving corporation or pursuant to which all or a
portion of the shares of Common Stock would be converted into cash, securities
or other property; or
(ii) any sale, lease, exchange, liquidation or other transfer (in
one transaction or a series of transactions) of all or substantially all of the
assets of the Company.
Notwithstanding subparagraphs (i) and (ii) above, the term "Change in Control
Event" shall not include a consolidation, merger or other reorganization if
upon consummation of such transaction (x) all of the outstanding voting stock
of the Company is owned, directly or indirectly, by a holding company, (y) the
holders of Common Stock immediately prior to the transaction have substantially
the same proportionate ownership and voting control of the holding company and
(z) the holding company agrees to assume the Company's obligations under all
outstanding Awards and to issue, upon exercise of any Award payable in Shares,
holding company securities which the Committee determines to be equivalent in
value and voting power to the consideration that the holder of a like number of
Shares would receive pursuant to the reorganization.
(b) Within any twenty-five (25) month period, individuals who were
Independent Directors at the beginning of such period, together with any other
Independent Directors first elected as directors of the Company pursuant to
nominations approved or ratified by at least two-thirds (2/3) of the
Independent Directors in office immediately prior to such respective elections,
cease to constitute a majority of the Board.
For purposes of the Plan, an "Independent Director" as of a given date
shall mean a member of the Board who has been a director of the Company
throughout the six (6) months prior to such date, has not been an employee of
the Company at any time during such six (6) month period, has not at any time
during such six (6) month period beneficially owned more than ten percent (10%)
of the outstanding Shares, and none of whose affiliates or associates has at
any time during such six (6) month period beneficially owned more than ten
percent (10%) of the outstanding Shares. For purposes of this paragraph, the
terms "affiliate" and "associate" shall have the meanings ascribed to them by
regulations promulgated under Section 12(b) of the Securities Exchange Act of
1934, as amended, and the term "beneficial ownership" shall have the meaning
ascribed to it by regulations promulgated under Section 13(d) of that Act.
11. Amendment and Termination.
(a) Amendment. The Board of Directors or the Committee, without further
approval of the shareholders of the Company, may amend the Plan from time to
time in such respects as the Board or the Committee may deem advisable,
provided that no amendment shall become effective prior to approval of the
shareholders of the Company if such amendment:
(i) increases the maximum number of Shares for which Awards may be
granted; or
(ii) modifies the class of persons eligible to participate in the
Plan.
Notwithstanding the foregoing, the provisions of the Plan under which formula
awards are to be made to Directors may be amended only by the Board, subject to
shareholder approval if required. The terms under which formula awards are to
be made shall not be changed except as permitted by subsection 6(b) above or
except as the shareholders may otherwise approve.
(b) Termination. The Board or the Committee, without further approval of
the shareholders of the Company, may at any time terminate the Plan.
(c) Effect of Amendment or Termination. No amendment or termination of
the Plan shall adversely affect Awards already granted to an Employee or
Director, without such person's prior written consent, and such Awards shall
remain in full force and effect as if the Plan had not been amended or
terminated. 12. Effective Date of Plan. The Plan shall be effective as of
October 1, 1996, if approved by the shareholders of the Company within one (1)
year of such date.
13. Term of Plan. No Award shall be granted pursuant to the Plan after ten (10)
years from the effective date of the Plan. Awards granted prior to the end of
such period may extend beyond such period, except as otherwise provided herein
or in the Award Agreement.
14. Miscellaneous.
(a) Award Agreement. Upon executing an Award Agreement, an Employee or
Director shall be bound by such Agreement and by the applicable provisions of
the Plan.
(b) Employment. The granting of an Award to an Employee shall not give
the Employee any right to be retained in the employ of the Company or any
Parent or Subsidiary.
(c) Tax Withholding. The Company shall be authorized to withhold from any
Award granted, or payment due, under the Plan the amount of any taxes required
by law to be withheld because of such Award or payment, and to take such other
action as may be necessary in the opinion of the Company to satisfy all
obligations for the payment of such taxes.
(d) Headings. Paragraph headings are included solely for convenience and
shall in no event affect, or be used in connection with, the interpretation of
the Plan.
(e) Construction. The validity, construction and effect of the Plan and
regulations relating to the Plan shall be determined in accordance with the
laws of the State of Maine and applicable Federal law.
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