<PAGE>
================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K/A
AMENDMENT NO. 1
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(D)
OF THE
SECURITIES EXCHANGE ACT OF 1934
DATE OF REPORT (DATE OF EARLIEST EVENT REPORTED): AUGUST 1, 1997
FREMONT GENERAL CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
NEVADA
(State or Other Jurisdiction of Incorporation)
1-8007 95-2815260
(Commission File Number) (I.R.S. Employer Identification No.)
2020 SANTA MONICA BOULEVARD - SUITE 600 SANTA MONICA, CA 90404
(Address of Principal Executive Offices) (Zip Code)
(310) 315-5500
(Registrant's Telephone Number, Including Area Code)
N/A
(Former Name or Former Address, if Changes Since Last Report)
================================================================================
<PAGE>
ITEM 2. ACQUISITION OR DISPOSITION OF ASSETS.
On August 1, 1997, Fremont General Corporation, a Nevada corporation (the
"Company"), completed the acquisition of Industrial Indemnity Holdings, Inc., a
Delaware corporation ("Industrial Indemnity"), pursuant to a Stock Purchase
Agreement dated as of May 16, 1997 by and among the Company, Fremont Indemnity
Company, a California corporation and wholly-owned subsidiary of the Company
("Fremont Indemnity") and Talegen Holdings, Inc., a Delaware corporation and
subsidiary of Xerox Corporation ("Talegen"), whereby Fremont Indemnity purchased
from Talegen all of the issued and outstanding capital stock of Industrial
Indemnity. The purchase price paid by the Company consisted of $365 million in
cash and the pay-off of approximately $79 million of an outstanding debt
obligation that Industrial Indemnity owed to Talegen. Financing for the
transaction was provided by internal funds and bank borrowings. The aggregate
purchase price was determined pursuant to arms-length negotiations among the
constituent corporations. The acquisition will be treated as a purchase for
accounting purposes.
Industrial Indemnity, which specializes in underwriting workers'
compensation insurance and providing risk management services, has a strong
presence in the western United States dating back over 70 years. In 1996,
Industrial Indemnity had gross premiums of $242 million, with invested assets of
approximately $1.1 billion.
There were, and are to date, no material relationships between the Company,
its subsidiaries, officers, or directors, and Talegen or Xerox Corporation,
other than the previously described $79 million pay-off of an outstanding debt
obligation negotiated as part of the purchase price.
ITEM 7. FINANCIAL STATEMENTS AND EXHIBITS.
Page
Number
------
(a) Financial statements of business acquired.
The following financial statements of Industrial Indemnity Holdings,
Inc. and subsidiaries are filed as part of this report:
Consolidated Balance sheet at June 30, 1997 (Unaudited) .......... 4
Consolidated Statements of Earnings for the Six Months Ended
June 30, 1997 and 1996 (Unaudited) ............................... 5
Consolidated Statements of Cash Flows for the Six Months Ended
June 30, 1997 and 1996 (Unaudited) ............................... 6
Notes to June 30, 1997 Consolidated Financial Statements
(Unaudited) ...................................................... 7
Independent Auditors' Report ..................................... 8
Consolidated Balance Sheets at December 31, 1995 and 1996 ........ 9
Consolidated Statements of Earnings for the Years ended
December 31, 1994, 1995 and 1996 ................................. 10
Consolidated Statements of Shareholder's Equity for Years
Ended December 31, 1994, 1995 and 1996 ........................... 11
2
<PAGE>
ITEM 7. FINANCIAL STATEMENTS AND EXHIBITS. (CONTINUED)
Page
Number
------
Consolidated Statements of Cash Flows for the
Years Ended December 31, 1994, 1995 and 1996 ..................... 12
Notes to Consolidated Financial Statements ....................... 13
(b) Pro forma financial information.
The following pro forma condensed consolidated financial statements
of the Registrant are filed as part of this report:
Introduction ..................................................... 33
Pro Forma Condensed Consolidated Balance Sheet at
June 30, 1997 (Unaudited) ........................................ 34
Pro Forma Condensed Consolidated Statements of Income
for the Year Ended December 31, 1996 (Unaudited) ................. 35
Pro Forma Condensed Consolidated Statements of Income
for the Six Months Ended June 30, 1997 (Unaudited) ............... 36
Note to Pro Forma Condensed Consolidated Financial Statements .... 37
(c) Exhibits.
<TABLE>
<CAPTION>
Sequentially
Exhibit Numbered
Number Description Page
------- ------------------------------------------------------------ ------------
<C> <S> <C>
2.1 Stock Purchase Agreement by and among Talegen Holdings,
Inc., Fremont Indemnity Company and Fremont General
Corporation dated as of May 16, 1997 including exhibits
thereto. (Filed as Exhibit 2.1 to Current Report on Form
8-K, as of August 11, 1997, Commission file No. 1-8007, and
incorporated herein by reference.)
2.2 Tax Allocation and Indemnification Agreement, dated as of
May 16, 1997 by and among Xerox financial Services, Inc.,
Talegen Holdings, Inc., Industrial Indemnity Holdings, Inc.,
Fremont General Corporation, and Fremont Indemnity
Corporation, a California corporation. (Filed as Exhibit 2.2
to Current Report on Form 8-K, as of August 11, 1997,
Commission file No. 1-8007, and incorporated herein by
reference.)
23.1 Consent of KPMG Peat Marwick LLP Independent Auditors
</TABLE>
3
<PAGE>
INDUSTRIAL INDEMNITY HOLDINGS, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN MILLIONS)
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1996 1997
------------ ------------
(Audited) (Unaudited)
ASSETS
<S> <C> <C>
Investments:
Fixed maturities, at fair value (cost 1996 - $482; 1997 - $538) ......... $ 487 $ 542
Equity securities, at fair value (cost: 1996 -$2; 1997 - $1) ............ 3 1
Short-term investments, at amortized cost which approximates
fair value ............................................................ 618 520
------------- -----------
TOTAL INVESTMENTS .................................................... 1,108 1,063
Accrued investment income ................................................... 8 16
Receivables:
Premiums (net of allowance for uncollectible receivables:
1996 - $.4; 1997 - $.4) ............................................... 128 125
Other ................................................................... 113 106
Reinsurance recoverables .................................................... 177 154
Prepaid reinsurance premiums ................................................ 4 2
Deferred policy acquisition costs ........................................... 6 5
Current income taxes ........................................................ 1 (2)
Deferred income taxes ....................................................... 105 104
Land, buildings and equipment ............................................... 68 68
Due from affiliates ......................................................... 44 43
Other assets ................................................................ 13 13
------------ ------------
TOTAL ASSETS ......................................................... $ 1,775 $ 1,697
============ ============
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities:
Unearned premiums ....................................................... $ 32 $ 29
Unpaid losses and loss expenses ......................................... 1,129 1,072
Debt (due to affiliate) ................................................. 79 79
Dividends to policyholders .............................................. 27 23
Accounts payable and accrued liabilities ................................ 139 120
Net liability due to discontinued operations ............................ 23 23
------------ ------------
TOTAL LIABILITIES .................................................... 1,429 1,346
Shareholder's equity:
Common stock and additional paid-in capital ............................. 233 233
Retained earnings ....................................................... 109 115
Net unrealized gain on investment securities ............................ 4 3
------------ ------------
TOTAL SHAREHOLDER'S EQUITY ........................................... 346 351
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDER'S EQUITY ........................... $ 1,775 $ 1,697
============ ============
See notes to June 30, 1997 consolidated financial statements
</TABLE>
4
<PAGE>
INDUSTRIAL INDEMNITY HOLDINGS, INC.
AND SUBSIDIARIES
Consolidated Statements of Earnings
(in millions)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
1996 1997
---------- ----------
(Unaudited)
<S> <C> <C>
REVENUES:
Net premiums earned ...................................................... $ 119 $ 133
Net investment income .................................................... 35 34
Net realized investment gains ............................................ - 1
---------- ---------
Total revenues ...................................................... 154 168
LOSSES AND EXPENSES:
Losses and loss expenses ................................................. 99 110
Underwriting, acquisition and other insurance expenses ................... 33 36
Dividends to policyholders ............................................... 3 4
Other expenses ........................................................... 1 1
Interest expenses ........................................................ 3 3
---------- ---------
Total losses and expenses ........................................... 139 154
---------- ---------
Earnings from operations before income taxes ................................. 15 14
Provision for income taxes ................................................... 5 5
---------- ---------
NET EARNINGS ........................................................ $ 10 $ 9
========== =========
See notes to June 30, 1997 consolidated financial statements
</TABLE>
5
<PAGE>
INDUSTRIAL INDEMNITY HOLDINGS, INC.
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in millions)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
1996 1997
---------- ----------
(Unaudited)
<S> <C> <C>
Cash flows from operating activities:
Net earnings ............................................................ $ 10 $ 9
Adjustments to reconcile net earnings to net cash used in
operating activities:
Net realized investment gains (losses) ............................. - (1)
Depreciation and amortization ....................................... 2 7
Changes in:
Unpaid losses and loss expenses .................................. (56) (45)
Unearned premiums ................................................ 4 (1)
Other liabilities ................................................ 51 (23)
Underwriting assets .............................................. (84) 15
Deferred policy acquisition costs ................................ (1) 1
Payments for discontinued operations ............................. (3) -
Income taxes ..................................................... 8 7
---------- ----------
Total adjustments ............................................ (79) (40)
---------- ----------
Net cash used in operating activities ............................ (69) (31)
---------- ----------
Cash flows from investing activities:
Purchase of fixed maturities and equity securities ...................... (314) (77)
Proceeds from sale of fixed maturities and equity securities ............ 17 14
Proceeds from maturity of fixed maturities .............................. 48 7
Decrease (increase) in short-term investments, net ...................... 341 98
Purchase of fixed assets ................................................ (12) (7)
---------- ----------
Net cash provided by investing activities ........................ 80 35
---------- ----------
Cash flows from financing activities:
Dividends to shareholder ................................................ (4) (4)
Repayment of debt ....................................................... (7) -
---------- ----------
Net cash used in financing activities ............................ (11) (4)
---------- ----------
Net change in cash .......................................................... - -
Cash at beginning of year ................................................... - -
---------- ----------
Cash at June 30, ............................................................ $ - $ -
========== ==========
See notes to June 30, 1997 consolidated financial statements
</TABLE>
6
<PAGE>
INDUSTRIAL INDEMNITY HOLDINGS, INC.
AND SUBSIDIARIES
NOTES TO JUNE 30, 1997 CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE A --- BASIS OF PRESENTATION OF FINANCIAL STATEMENTS
These statements have been prepared in accordance with generally
accepted accounting principles and, accordingly, adjustments (consisting of
normal accruals) have been made as management considers necessary for fair
presentations. For further information, refer to the audited consolidated
financial statements and notes thereto filed as part of this Form 8-K/A.
NOTE B --- SUBSEQUENT EVENT
On August 1, 1997, Fremont General Corporation, a Nevada Corporation,
("Fremont General"), completed the acquisition of Industrial Indemnity Holdings,
Inc., a Delaware corporation ("Industrial Indemnity"), pursuant to a Stock
Purchase Agreement dated as of May 16, 1997 by and among the Fremont General,
Fremont Indemnity Company, a California corporation and wholly-owned subsidiary
of the Fremont General ("Fremont Indemnity") and Talegen Holdings, Inc., a
Delaware corporation and subsidiary of Xerox Corporation ("Talegen"), whereby
Fremont Indemnity purchased from Talegen all of the issued and outstanding
capital stock of Industrial Indemnity. The purchase price paid consisted of $365
million in cash and the pay-off of approximately $79 million of an outstanding
debt obligation that Industrial Indemnity owed to Talegen.
7
<PAGE>
Independent Auditors' Report
The Board of Directors and Shareholder
of Industrial Indemnity Holdings, Inc.:
We have audited the accompanying consolidated balance sheets of Industrial
Indemnity Holdings, Inc. and subsidiaries as of December 31, 1995 and 1996, and
the related consolidated statements of earnings, shareholder's equity and cash
flows for each of the years in the three-year period ended December 31, 1996.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
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 financial position of Industrial Indemnity
Holdings, Inc. and subsidiaries as of December 31, 1995 and 1996, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1996, in conformity with generally accepted
accounting principles.
KPMG Peat Marwick LLP
San Francisco, California
January 14, 1997
8
<PAGE>
INDUSTRIAL INDEMNITY HOLDINGS, INC.
AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 1995 and 1996
(in millions)
<TABLE>
<CAPTION>
ASSETS
1995 1996
-------- --------
<S> <C> <C>
Investments:
Fixed maturities, at fair value (cost: 1995-$272; 1996-$482) ............. $ 271 $ 487
Equity securities, at fair value (cost: 1995 -$8; 1996 - $2) ............. 7 3
Short-term investments, at amortized cost which approximates
fair value ............................................................. 1,026 618
-------- --------
Total investments .................................................... 1,304 1,108
Accrued investment income .................................................. 20 8
Receivables:
Premiums (net of allowance for uncollectible receivables:
1995-$0.4; 1996-$0.4) .................................................. 134 128
Other .................................................................. 156 113
Reinsurance recoverables ................................................... 218 177
Prepaid reinsurance premiums ............................................... 31 4
Deferred policy acquisition costs .......................................... 5 6
Current income taxes ....................................................... 2 1
Deferred income taxes ...................................................... 111 105
Land, buildings and equipment .............................................. 54 68
Due from affiliates ........................................................ 44 44
Other assets ............................................................... 14 13
-------- --------
Total assets ......................................................... $ 2,093 $ 1,775
======== ========
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities:
Unearned premiums ........................................................ $ 60 $ 32
Unpaid losses and loss expenses .......................................... 1,283 1,129
Debt (due to affiliate in 1996) .......................................... 90 79
Dividends to policyholders ............................................... 30 27
Accounts payable and accrued liabilities ................................. 195 139
Net liability due to discontinued operations ............................. 26 23
-------- --------
Total liabilities .................................................... 1,684 1,429
Shareholder's equity:
Common stock and additional paid-in capital .............................. 233 233
Retained earnings ........................................................ 178 109
Net unrealized (loss) gain on investment securities ...................... (2) 4
-------- --------
Total shareholder's equity ........................................... 409 346
-------- --------
Total liabilities and shareholder's equity ........................... $ 2,093 $ 1,775
======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
9
<PAGE>
INDUSTRIAL INDEMNITY HOLDINGS, INC.
AND SUBSIDIARIES
Consolidated Statements of Earnings
Years ended December 31, 1994, 1995 and 1996
(in millions)
<TABLE>
<CAPTION>
1994 1995 1996
------ ------ ------
<S> <C> <C> <C>
Revenues:
Net premiums earned ...................................................... $ 332 $ 230 $ 234
Net investment income .................................................... 71 70 69
Net realized investment gains ............................................ 2 1 1
Other income ............................................................. 8 7 3
------ ------ ------
Total revenues ......................................................... 413 308 307
------ ------ ------
Losses and expenses:
Losses and loss expenses ................................................. 248 177 191
Underwriting, acquisition and other insurance expenses ................... 65 65 66
Dividends to policyholders ............................................... 36 14 5
Other expenses ........................................................... 2 4 11
Interest expense ......................................................... 1 7 5
------ ------ ------
Total losses and expenses .............................................. 352 267 278
------ ------ ------
Earnings from operations before income taxes ............................... 61 41 29
Provision for income taxes ................................................. 23 13 10
------ ------ ------
Net earnings ........................................................... $ 38 $ 28 $ 19
====== ====== ======
</TABLE>
See accompanying notes to consolidated financial statements.
10
<PAGE>
INDUSTRIAL INDEMNITY HOLDINGS, INC.
AND SUBSIDIARIES
Consolidated Statements of Shareholder's Equity
Years ended December 31, 1994, 1995 and 1996
(in millions, except share data)
<TABLE>
<CAPTION>
1994 1995 1996
------ ------ ------
<S> <C> <C> <C>
Common stock and additional paid-in capital:
(includes $1 par value common stock, 1,000 shares
authorized, issued and outstanding):
Balance at beginning of year ............................................. $ 232 $ 233 $ 233
Increase in capital ...................................................... 1 - -
------ ------ ------
Balance at end of year ................................................. 233 233 233
------ ------ ------
Retained earnings:
Balance at beginning of year ............................................. 236 161 178
Net earnings ............................................................. 38 28 19
Dividends to shareholder ................................................. (112) (10) (89)
Minimum pension liability adjustment ..................................... (1) (1) 1
------ ------ ------
Balance at end of year ................................................. 161 178 109
------ ------ ------
Net unrealized (loss) gain on investment securities:
Balance at beginning of year ............................................. (9) (78) (2)
Change in unrealized (losses) gains ...................................... (69) 76 8
Change in deferred income taxes .......................................... - - (2)
------ ------ ------
Balance at end of year ................................................. (78) (2) 4
------ ------ ------
Total shareholder's equity ............................................. $ 316 $ 409 $ 346
====== ====== ======
</TABLE>
See accompanying notes to consolidated financial statements.
11
<PAGE>
INDUSTRIAL INDEMNITY HOLDINGS, INC.
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended December 31, 1994, 1995 and 1996
(in millions)
<TABLE>
<CAPTION>
1994 1995 1996
------ ------ ------
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings ............................................................. $ 38 $ 28 $ 19
Adjustments to reconcile net earnings to net cash used in
operating activities:
Net realized investment gains .......................................... (2) (1) (1)
Depreciation and amortization .......................................... 21 22 11
Changes in:
Unpaid losses and loss expenses ...................................... (122) (109) (154)
Unearned premiums .................................................... (21) (3) (28)
Other liabilities .................................................... 3 42 (52)
Underwriting assets .................................................. 78 (15) 125
Deferred policy acquisition costs .................................... 1 (2) (1)
Payments for discontinued operations ................................. (19) (26) (3)
Income taxes ......................................................... 23 13 10
Payments for income taxes ............................................ (59) (7) (7)
------ ------ -----
Total adjustments .................................................. (97) (86) (100)
------ ------ -----
Net cash used in operating activities ................................ (59) (58) (81)
------ ------ -----
Cash flows from investing activities:
Purchase of fixed maturities and equity securities ....................... (278) (63) (475)
Proceeds from sale of fixed maturities and equity securities ............. 80 970 37
Proceeds from maturity of fixed maturities ............................... 96 147 231
Decrease (increase) in short-term investments, net ....................... 150 (944) 408
Purchase of fixed assets ................................................. (5) (32) (20)
Proceeds from note receivable ............................................ 27 - -
------ ------ -----
Net cash provided by investing activities ............................ 70 78 181
------ ------ -----
Cash flows from financing activities:
Dividends to shareholder ................................................. (112) (10) (89)
Proceeds from issuance of debt ........................................... 100 - 79
Repayment of debt ........................................................ - (10) (90)
Increase in capital ...................................................... 1 - -
------ ------ -----
Net cash used in financing activities ................................. (11) (20) (100)
------ ------ -----
Net change in cash ......................................................... - - -
Cash at beginning of year .................................................. - - -
------ ------ -----
Cash at end of year ........................................................ $ - $ - $ -
====== ====== =====
</TABLE>
See accompanying notes to consolidated financial statements.
12
<PAGE>
INDUSTRIAL INDEMNITY HOLDINGS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(1) BASIS OF CONSOLIDATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF CONSOLIDATION
Industrial Indemnity Holdings, Inc. (the "Company") is a wholly-owned subsidiary
of Talegen Holdings, Inc. ("Talegen"). Talegen is a wholly-owned subsidiary of
Xerox Financial Services, Inc. ("XFSI"), which is a wholly-owned subsidiary of
Xerox Corporation ("Xerox"). In January 1993, Xerox announced its intention to
disengage from its insurance and other financial services businesses. During
1992 and 1993, Talegen completed a major recapitalization and restructuring of
its business operations into seven stand-alone insurance operating groups (one
of which is the Company), each with an independent holding company that, in
turn, owns one or more insurance companies.
The consolidated financial statements include the accounts of the Company and
its subsidiaries that include the following wholly-owned insurance companies:
Industrial Indemnity Company, Industrial Indemnity Company of the Northwest,
Industrial Indemnity Company of Idaho, Industrial Indemnity Company of Alaska,
Industrial Insurance Company and Employers First Insurance Company ("EFI")
(collectively referred to as the "Insurance Companies"). All significant
intercompany transactions have been eliminated.
OPERATIONS
The Insurance Companies specialize in providing workers compensation insurance
and risk management services on a nationwide basis with an emphasis on the
western states. For the year ended December 31, 1996, direct premiums written
from California, Alaska and Arizona made up 31%, 14% and 10% of the total,
respectively. The Insurance Companies write primarily medium to large workers
compensation accounts where expertise in risk management, risk funding and
medical cost containment are valued by policyholders. The Insurance Companies
distribute their products and services through a select network of agents and
brokers.
The Insurance Companies are organized into strategic business units to address
the diversified workers compensation marketplace. The operating business units
are California, Western States (focuses on western states excluding California),
National Programs (focuses on national and regional association employer groups)
and EFI (focuses on small employers).
INVESTMENTS
All fixed maturities, equity securities and short-term investments are
classified as available-for-sale securities and reported at fair value, with
unrealized investment gains and losses net of tax credited or charged as a
separate component of shareholder's equity.
(CONTINUED)
13
<PAGE>
INDUSTRIAL INDEMNITY HOLDINGS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(1) CONTINUED
Fair values for fixed maturities and equity securities are based on quoted
market prices or dealer quotations. Where quoted market prices or dealer
quotations are not available, as is the case for certain mortgage and other
asset-backed securities, fair values are measured utilizing quoted market prices
for similar securities or by using discounted cash flow methods. Amortized cost
for fixed maturities is historical cost adjusted for the amortization of
premiums and discounts, which are amortized using the effective interest method
over the estimated remaining term of the securities, adjusted for anticipated
prepayments.
Short-term investments are carried at amortized cost which approximates fair
value due to the short-term maturity of these investments.
Realized investment gains and losses on the sale of investments are determined
on a specific identification basis. A provision in the consolidated statement of
earnings is made only when the decline in the fair value of fixed maturities and
equity securities is other than temporary. Investment income is recorded when
earned.
PREMIUMS
Premiums are generally earned pro-rata over the period in which the coverages
are provided. Unearned premiums represent the portion of premiums written that
are applicable to the unexpired terms of policies in force. Premiums earned
include estimates of certain premiums due but not yet billed, including
adjustments on retrospectively rated policies as well as anticipated premium and
related expenses primarily related to future premium audits of policies
currently in force, net of the cost of reinsurance. Prepaid reinsurance premiums
represent the unexpired portion of premiums ceded to reinsurers.
POLICY ACQUISITION COSTS
Policy acquisition costs, primarily commissions, premium taxes and a portion of
internal expenses represent those costs that vary with and are primarily related
to the acquisition of new and renewal insurance policies. These costs are
deferred and amortized over the life of the policy in proportion to premium
revenue recognized. Policy acquisition costs in excess of recoverable amounts,
including investment income, are charged to expense. Acquisition costs include
$48 million, $46 million and $41 million of policy acquisition costs which were
amortized during 1994, 1995 and 1996, respectively.
LOSSES AND LOSS EXPENSES
Losses and loss expenses are charged to income as incurred. The reserve for
unpaid losses and loss expenses is determined on the basis of claim adjusters'
evaluations and other estimates, including those for incurred but not reported
losses and for anticipated salvage and future
(CONTINUED)
14
<PAGE>
INDUSTRIAL INDEMNITY HOLDINGS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(1) CONTINUED
subrogation recoveries. Overall reserve levels are impacted primarily by the
types and amounts of insurance coverage written, trends developing from newly
reported claims and claims which have been paid and closed. The determination of
estimates for losses and loss expenses and the establishment of the related
reserves for business written in both the current and prior years are
continually reviewed by senior management. Adjustments are made to reserves in
the period they can be reasonably estimated to reflect evolving changes in loss
development patterns and various other factors such as social and economic
trends and judicial interpretation of legal liability.
REINSURANCE
Reinsurance recoverable includes the balances due from other insurance companies
for paid losses and loss expenses and estimates of the portion of unpaid losses
and policy liabilities that will be recovered from reinsurers, determined in a
manner consistent with the liabilities associated with the reinsured policies.
The reserve for uncollectible reinsurance is determined principally on the basis
of past collection experience, review of the financial condition of reinsurers
and an assessment of other available information. The reserve for uncollectible
reinsurance is further discussed in Note 5.
PENSION, POSTRETIREMENT AND POSTEMPLOYMENT BENEFITS
The cost of pension, postretirement and postemployment benefits is recognized in
the consolidated financial statements during the active working career of
employees.
INCOME TAXES
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to temporary differences between the financial
statement carrying amounts and the tax bases of the Company's assets and
liabilities. Such differences are primarily due to tax basis discount on unpaid
losses, uncollectible reinsurance, severance and leasehold provisions, gain on
sale-leaseback, and depreciation and amortization. Additionally, the effect on
deferred tax assets and liabilities of a change in tax rates is recognized in
earnings in the period that includes the enactment date. A valuation allowance
against deferred tax assets is recorded if it is more likely than not that all
or some portion of the benefits related to deferred tax assets will not be
realized.
DIVIDENDS TO POLICYHOLDERS
The Company issues certain participating insurance policies which, based on the
profitability of a given policy and approval by the Board of Directors, provide
for the payment of dividends to the policyholder.
(CONTINUED)
15
<PAGE>
INDUSTRIAL INDEMNITY HOLDINGS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(1) CONTINUED
Participating policies account for approximately 83%, 65%, and 56% of the net
premiums written for the three years ended December 31, 1994, 1995 and 1996,
respectively. Net premiums earned on such policies represent approximately 83%,
66% and 59% of the Company's total earned premium for the years ended December
31, 1994, 1995 and 1996, respectively.
Dividends to policyholders are charged to operations as the related premiums are
earned and include a provision for undeclared dividends.
LAND, BUILDINGS AND EQUIPMENT
Land, buildings and equipment are carried at cost and are shown net of
accumulated depreciation. Buildings and equipment are depreciated on a
straight-line basis over their estimated service lives (buildings - 40 years;
equipment - 3 to 5 years). Capital improvements to leased property are amortized
over the life of the improvement or the life of the lease, whichever is shorter.
As of December 31, 1995 and 1996, accumulated depreciation on buildings and
equipment was $21 million and $19 million, respectively.
USE OF ESTIMATES
The preparation of the consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported financial statement balances as well as
the disclosure of contingent assets and liabilities. Actual results could differ
from those estimates.
Similar to other companies with property and casualty insurance operations, the
reserve for unpaid losses and loss expenses, the reserve for uncollectible
reinsurance and deferred acquisition costs, although supported by actuarial
science and other supportive data, are ultimately based on management's reasoned
expectations of future events. In addition, the Company's realization of
deferred income tax assets is dependent on generating sufficient future taxable
income. It is reasonably possible that expectations associated with these
accounts can change in the near term (i.e., one year) and that the effect of
those changes could be material to the consolidated financial statements.
RECLASSIFICATION
Certain amounts in the accompanying financial statements for 1994 and 1995 have
been reclassified to conform with the 1996 financial statement presentation. The
reclassifications were not material.
(CONTINUED)
16
<PAGE>
INDUSTRIAL INDEMNITY HOLDINGS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(2) INVESTMENTS AND INVESTMENT INCOME
The components of the investment portfolio at December 31, 1995 and 1996 follow
(in millions):
<TABLE>
<CAPTION>
Gross Gross
unrealized unrealized Estimated
Amortized investment investment fair
cost gains losses value
---------- ----------- ----------- -----------
1995
----
<S> <C> <C> <C> <C>
Fixed maturities:
U.S. government and government
agencies and authorities ................... $ 245 $ - $ - $ 245
States, municipalities and political
subdivisions ............................... 27 - (1) 26
---------- ----------- ----------- -----------
Total fixed maturities ................... 272 - (1) 271
Equity securities .............................. 8 - (1) 7
Short-term investments ......................... 1,026 - - 1,026
---------- ----------- ----------- -----------
Total investments
available-for-sale ..................... $ 1,306 $ - $ (2) $ 1,304
========== =========== =========== ===========
1996
----
Fixed maturities:
U.S. government and government
agencies and authorities ................... $ 94 $ 1 $ - $ 95
States, municipalities and political
subdivisions ............................... 18 - - 18
Mortgage and other asset-backed
securities ................................. 183 3 - 186
Corporate bonds .............................. 170 2 (1) 171
Foreign governments .......................... 17 - - 17
---------- ----------- ----------- -----------
Total fixed maturities ..................... 482 6 (1) 487
Equity securities .............................. 2 1 - 3
Short-term investments ......................... 618 - - 618
---------- ----------- ----------- -----------
Total investments
available-for-sale ....................... $ 1,102 $ 7 $ (1) $ 1,108
========== =========== =========== ===========
</TABLE>
(CONTINUED)
17
<PAGE>
INDUSTRIAL INDEMNITY HOLDINGS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(2) CONTINUED
At December 31, 1996, approximately 71% of the Company's total investments
available-for-sale were comprised of U.S. Treasury securities and other
securities issued by U.S. Government agencies and authorities.
During 1996, the Company made certain investments in mortgage and other
asset-backed securities. Included in mortgage-backed securities as of December
31, 1996 are $78 million of collateral mortgage obligations ("CMOs") and $68
million of pass-through securities issued by GNMA, FNMA or FHLMC. Approximately
85% of the Company's CMO holdings are fully collateralized by GNMA, FNMA or
FHLMC securities. The Company generally purchases CMOs that are protected
against prepayment risk through purchasing planned amortization class ("PAC")
tranches. The Company does not purchase residual interests in mortgage-backed
securities. The Company generally purchases asset-backed securities whose
underlying collateral experiences stable prepayment characteristics. Virtually
all of these securities are rated AAA.
Securities carried at $1,043 million and $938 million at December 31, 1995 and
1996, respectively were deposited by the Company with governmental authorities
or designated custodian banks as required by law.
The amortized cost and estimated fair value of the Company's fixed maturities at
December 31, 1996 by contractual maturity follows (in millions):
<TABLE>
<CAPTION>
Estimated
Amortized fair
cost value
-------------- -------------
<S> <C> <C>
Contractual maturity:
Within one year ............................................... $ 9 $ 9
After one year but within five ................................ 129 130
After five years but within ten ............................... 118 119
After ten years ............................................... 43 43
Mortgage and other asset-backed securities .................... 183 186
-------------- -------------
Total fixed maturities ...................................... $ 482 $ 487
============== =============
</TABLE>
Actual maturities will differ from contractual maturities because borrowers may
have the right to call or prepay obligations with or without call or prepayment
penalties, and changing interest rates, tax considerations and other factors may
result in portfolio sales prior to maturity.
(CONTINUED)
18
<PAGE>
INDUSTRIAL INDEMNITY HOLDINGS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(2) Continued
The components of net investment income for each of the three years ended
December 31 follow (in millions):
<TABLE>
<CAPTION>
1994 1995 1996
------ ------ ------
<S> <C> <C> <C>
Interest on fixed maturities ........................... $ 65 $ 51 $ 26
Dividends on equity securities ......................... 1 - -
Interest on short-term investments and other ........... 9 23 48
Investment expenses .................................... (4) (4) (5)
------ ------ ------
Net investment income ................................ $ 71 $ 70 $ 69
====== ====== ======
</TABLE>
The components of net pre-tax realized investment gains (losses) for each of the
three years ended December 31 follow (in millions):
<TABLE>
<CAPTION>
1994 1995 1996
------ ------ ------
<S> <C> <C> <C>
Fixed maturities:
Gross gains .......................................... $ - $ 13 $ -
Gross losses ......................................... - (17) -
Equity securities:
Gross gains .......................................... 1 6 1
Gross losses ......................................... - (1) -
Other .................................................. 1 - -
------ ------ ------
Net realized investment gains ........................ $ 2 $ 1 $ 1
====== ====== ======
</TABLE>
(CONTINUED)
19
<PAGE>
INDUSTRIAL INDEMNITY HOLDINGS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(3) INCOME TAXES
Talegen and the Company are included in the Xerox consolidated federal income
tax return. Accordingly, Xerox and Talegen and, in turn, the Company and its
subsidiaries, entered into a tax sharing agreement effective in 1983, which
provides that the Company will pay or be reimbursed for the Company's tax
liabilities or benefits generated. The right to reimbursement for these tax
benefits does not expire due to any statutory period of limitation under the
Internal Revenue Code. The agreement generally provides that subsidiaries shall
compute their tax liability on a separate return basis and any benefit on the
basis of actual benefits utilized in offsetting the liabilities of the other
companies in the Talegen group. Income taxes reflected in the statement of
earnings are the Company's share of the Xerox consolidated tax provision.
The components of the Federal income tax provision for each of the three years
ended December 31 follow (in millions):
<TABLE>
<CAPTION>
1994 1995 1996
------ ------ -----
<S> <C> <C> <C>
Current expense (benefit) .............................. $ 24 $ (6) $ 7
Deferred (benefit) expense ............................. (1) 19 3
------ ------ ------
Total provision for income taxes .................... $ 23 $ 13 $ 10
====== ====== ======
</TABLE>
A reconciliation from the U.S. Federal statutory income tax rate to the
effective income tax rate for each of the three years ended December 31 follows
(in millions):
<TABLE>
<CAPTION>
1994 1995 1996
------ ------ ------
<S> <C> <C> <C>
U.S. Federal statutory income tax rate ................ 35.0% 35.0% 35.0%
Tax exempt income ..................................... (2.2) (4.4) (0.7)
Dividends received deduction .......................... (0.2) (0.3) -
Other, net ............................................ 5.1 1.4 0.2
----- ----- -----
Effective income tax rate ............................. 37.7% 31.7% 34.5%
===== ===== =====
</TABLE>
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which temporary differences
are expected to be recovered or settled. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in earnings in the period
that includes the enactment date.
(CONTINUED)
20
<PAGE>
INDUSTRIAL INDEMNITY HOLDINGS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(3) CONTINUED
The tax effects of temporary differences that give rise to significant portions
of the deferred tax assets and deferred tax liabilities at December 31, 1995 and
1996 follow (in millions):
<TABLE>
<CAPTION>
1995 1996
----- -----
<S> <C> <C>
Deferred tax assets:
Tax basis discount on unpaid losses and loss
expenses ................................................... $ 99 $ 91
Ceded premiums ............................................... - 7
Uncollectible reinsurance .................................... 4 4
Leasehold provisions ......................................... 4 3
Gain on sale-leaseback ....................................... 6 5
Policyholder dividends ....................................... 3 5
Unrealized investment losses ................................. 1 -
Other ........................................................ 14 14
----- -----
Total gross deferred tax assets ............................ 131 129
Less valuation allowance ..................................... 1 -
----- -----
Deferred tax assets ........................................ 130 129
----- -----
Deferred tax liabilities:
Adjustment for unearned premiums ............................. (3) (3)
Depreciation and amortization ................................ (10) (12)
Unrealized investment gain ................................... - (2)
Other ........................................................ (6) (7)
----- -----
Total gross deferred tax liabilities ....................... (19) (24)
----- -----
Net deferred tax assets .................................... $ 111 $ 105
===== =====
</TABLE>
Deferred tax assets and valuation allowances and deferred tax liabilities
resulting from unrealized investment loss or gain are recorded directly to
shareholder's equity.
(CONTINUED)
21
<PAGE>
INDUSTRIAL INDEMNITY HOLDINGS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(4) UNPAID LOSSES AND LOSS EXPENSES
Activity related to unpaid losses and loss expenses for each of the three years
ended December 31 follows (in millions):
<TABLE>
<CAPTION>
1994 1995 1996
------- ------- -------
<S> <C> <C> <C>
Gross unpaid losses and loss expenses, January 1 ................. $ 1,515 $ 1,392 $ 1,283
Reinsurance recoverable .......................................... 212 188 213
------- ------- -------
Net unpaid losses and loss expenses, January 1 ................. 1,303 1,204 1,070
------- ------- -------
Incurred losses and loss expenses related to:
Current year accident losses ................................... 313 214 191
Prior years accident losses .................................... (65) (37) -
------- ------- -------
Total incurred losses and loss expenses ...................... 248 177 191
------- ------- -------
Paid losses and loss expenses related to:
Current year accident losses .................................... 63 56 64
Prior year accident losses ..................................... 284 255 237
------- ------- -------
Total paid losses and loss expenses ............................ 347 311 301
------- ------- -------
Net unpaid losses and loss expenses,
December 31 ................................................ 1,204 1,070 960
Reinsurance recoverable .......................................... 188 213 169
------- ------- -------
Gross unpaid losses and loss expenses, December 31 ............. $ 1,392 $ 1,283 $ 1,129
======= ======= =======
Incurred losses and loss expenses ceded to Ridge Re .............. $ - $ 42 $ (42)
======= ======= =======
Incurred losses and loss expenses ceded to other
insurers ....................................................... $ 32 $ 5 $ 15
======= ======= =======
</TABLE>
During 1995, 1992 and prior accident year gross unpaid losses and loss expenses
for the Company were strengthened by $50 million. After consideration of $42
million ceded to Ridge Reinsurance Limited ("Ridge Re"), a wholly-owned
subsidiary of XFSI (see Note 5), net unpaid losses and loss expenses were
strengthened by a total of $8 million for these accident years. In addition,
during 1995 unpaid losses and loss expenses for 1993 and 1994 accident years
were reduced in total by $45 million, of which $30 million was offset by net
increases to retrospective premium payables.
(CONTINUED)
22
<PAGE>
INDUSTRIAL INDEMNITY HOLDINGS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1994, 1995 and 1996
(4) CONTINUED
During 1996, the Company reduced gross losses by $50 million for 1992 and prior
accident years, which resulted in a reversal of the $42 million ceded to Ridge
Re in 1995. Additionally, in 1996, gross and net losses were reduced by $10
million for the 1994 accident year and $9 million for the 1995 accident year.
The 1995 accident year reduction was attributable to the favorable development
from the national workers compensation mandatory pool. Loss expense reserves
attributable to certain prior accident year policies that are in runoff were
strengthened by $27 million. After consideration of these items, there was no
change to net prior accident year losses and loss expenses.
(5) REINSURANCE
The Company reinsures, in the ordinary course of business, certain risks with
other insurance companies. These arrangements provide the means for greater
diversification of business and serve to limit the Company's net loss potential
for catastrophes and large or unusually hazardous risks. Although the Company
does not write property insurance, the Company does have insurance exposure for
injuries to workers caused by catastrophe, primarily earthquake. Annually, the
Company determines its probable maximum loss from such an event and purchases
reinsurance limits which exceed the estimated maximum loss. As of December 31,
1996, the Company's reinsurance program was $98 million of reinsurance coverage
in excess of a $2 million retention per occurrence.
The ceding of insurance does not discharge the original insurer from its primary
liability to the policyholder; however, the reinsurance company that accepted
the risk assumes an obligation to the original insurer. The ceding insurer
retains contingent risk with respect to reinsurance ceded to the extent that any
reinsuring company might not be able to meet its obligations.
(CONTINUED)
23
<PAGE>
INDUSTRIAL INDEMNITY HOLDINGS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(5) CONTINUED
The components of the Company's net premiums written and net premiums earned for
each of the three years ended December 31 follow (in millions):
<TABLE>
<CAPTION>
1994 1995 1996
------ ------ ------
<S> <C> <C> <C>
Premiums written:
Direct .......................................................... $ 371 $ 263 $ 242
Assumed from other companies, pools or associations ............. 13 28 3
Ceded to other companies, pools or associations ................. (60) (64) (11)
------ ------ ------
Net premiums written .......................................... $ 324 $ 227 $ 234
====== ====== ======
Premiums earned:
Direct .......................................................... $ 389 $ 258 $ 275
Assumed from other companies, pools or associations ............. 15 14 8
Ceded to other companies, pools or associations ................. (72) (42) (49)
------ ------ ------
Net premiums earned ........................................... $ 332 $ 230 $ 234
====== ====== ======
</TABLE>
The components of the Company's total reinsurance recoverable at December 31,
1995 and 1996 follow (in millions):
<TABLE>
<CAPTION>
1995 1996
------ ------
<S> <C> <C>
Reinsurance receivable on paid losses ..................................... $ 5 $ 8
Reinsurance recoverable on unpaid losses and loss expenses ................ 213 169
------ ------
Total reinsurance recoverable ........................................... $ 218 $ 177
====== ======
</TABLE>
Reinsurance recoverable reflected above is net of an $8 million and $7 million
reserve for uncollectible reinsurance as of December 31, 1995 and 1996,
respectively.
As of December 31, 1995 and 1996, the Company had outstanding reinsurance
recoverables of $92 million and $64 million, respectively, due from affiliated
companies. As of December 31, 1996, the three unaffiliated reinsurers with the
highest share of reinsurance recoverable accounted for 12%, 12%, and 7% of the
total reinsurance recoverables, respectively.
(CONTINUED)
24
<PAGE>
INDUSTRIAL INDEMNITY HOLDINGS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(5) CONTINUED
The Company actively monitors and evaluates the financial condition of its
reinsurers and prepares estimates of the uncollectible amounts due from troubled
reinsurers. The evaluation focuses on financial and other available data such as
whether or not the reinsurer is in rehabilitation or in liquidation proceedings
and produces an estimate of the amount that ultimately will be collected from
these troubled reinsurers. In addition to the reinsurers' ability to pay claims,
from time to time disputes arise over amounts and reinsurance coverage.
The Company pursues its remedies in these cases and recognizes the impact of
developments in these situations as disputes are resolved. Management believes
the reinsurance recoverable, net of the reserve for uncollectible reinsurance,
to be valid and collectible.
Effective December 31, 1992, Ridge Re has provided aggregate excess of loss
reinsurance to the Insurance Companies. Under the terms of the reinsurance
coverage, which is guaranteed by XFSI and subject to stated limits, Ridge Re
will reimburse the Insurance Companies for 85% of any and all aggregate ultimate
net losses, if any, in excess of the retention amount until Ridge Re has paid
$127,500,000 to the Insurance Companies. Coverage is provided for adverse
development on 1992 and prior accident year losses, allocated loss adjustment
expenses and uncollectible reinsurance, net of all salvage, subrogation and
other recoverables. A premium amount of $27 million, all of which was provided
by XFSI and guaranteed by Xerox, was ceded by the Company to Ridge Re as
consideration for the risk assumed by Ridge Re. Subject to certain commutation
provisions, this agreement remains in effect until all 1992 and prior accident
year claims are paid. As of December 31, 1996, the Company had no cessions to
Ridge Re.
(6) SALVAGE AND SUBROGATION
Estimates of salvage and subrogation recoveries on unpaid losses have been
recorded as a reduction of unpaid losses amounting to $9 million and $7 million
at December 31, 1995 and 1996, respectively.
(7) PENSIONS
Talegen sponsors one principal noncontributory defined benefit pension plan (the
"Plan") that covers substantially all employees of Talegen and its subsidiaries
who meet eligibility requirements. Effective July 1, 1993, the Plan was amended
with the effect of limiting the accrual of further benefits under the terms of
the Plan. Contributions are made to the Plan in an amount deductible and in
accordance with funding standards established under the Internal Revenue Code as
amended by the Employee Retirement Income Security Act of 1974. During 1996, the
Company and Talegen's other operating subsidiaries made contributions to bring
the Plan to a fully funded status.
Pension expense allocated to the Company for each of the three years ended
December 31, 1994, 1995 and 1996, was less than $1 million.
(CONTINUED)
25
<PAGE>
INDUSTRIAL INDEMNITY HOLDINGS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(7) CONTINUED
The following table sets forth the Plan's funded status and the amounts
recognized in Talegen's consolidated financial statements at December 31 (in
millions):
<TABLE>
<CAPTION>
1994 1995 1996
------- ------- -------
<S> <C> <C> <C>
Actuarial present value of benefit obligations:
Vested benefits ................................................. $ 64 $ 76 $ 83
Nonvested benefits .............................................. 5 7 3
------- ------- -------
Accumulated benefit obligation .................................... 69 83 86
Effect of projected future compensation levels .................... 2 - -
------- ------- -------
Projected benefit obligation .................................... 71 83 86
Fair value of plan assets, primarily listed
stocks and government securities .............................. 56 69 94
------- ------- -------
Projected benefit obligation in excess of (less
than) plan assets ............................................. 15 14 (8)
Unrecognized net loss ............................................. (7) (9) (8)
------- ------- -------
Accrued pension expense (benefit) ............................... 8 5 (16)
Adjustment required to recognize minimum
pension liability ............................................. 5 7 -
------- ------- -------
Net liability (asset) recognized in
consolidated balance sheets ................................... $ 13 $ 12 $ (16)
======= ======= =======
Assumptions used in the accounting were:
Discount rates .................................................. 8.5% 7.25% 7.25%
Rates of increase in compensation levels ........................ 5.5% 5.5% -
Expected long-term rate of return on plan assets ................ 8.5% 8.5% 8.5%
Net periodic pension cost includes the following components:
Interest cost on projected benefit obligation ................... $ 6 $ 6 $ 6
Actual return on plan assets .................................... - (14) (11)
Net amortization and deferrals .................................. (5) 9 6
------- ------- -------
Net periodic defined benefit pension cost ......................... $ 1 $ 1 $ 1
======= ======= =======
</TABLE>
(CONTINUED)
26
<PAGE>
INDUSTRIAL INDEMNITY HOLDINGS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(7) CONTINUED
The accumulated benefit obligation pertaining to the Company was $19 million at
December 31, 1995 and 1996. The accrued pension cost was $2 million, $1 million,
and $3 million at December 31, 1994, 1995 and 1996, respectively.
Talegen also sponsors a defined contribution pension plan (the "Savings Plan")
covering substantially all the employees of Talegen and its subsidiaries. The
Savings Plan provides for a basic contribution equal to 3% of an employee's
compensation, a matching contribution based on participants' contributions, and
a discretionary performance-related basic and/or matching contribution made at
the discretion of Talegen or its designee for any operating group. Certain
employees also have the opportunity to participate in a non-qualified
arrangement that permits contributions that would otherwise be limited under the
qualified plan by IRS regulations. The Company's total Savings Plan expense for
each of the three years ended December 31, 1994, 1995 and 1996 was $2 million.
(8) POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
Talegen provides certain medical and life insurance benefits for retirees of
Talegen and its subsidiaries. Prior to 1993, substantially all employees were
eligible for these benefits if they reached normal retirement age (or age
fifty-five under certain circumstances) with a defined minimum period of
service, while still working for the Company. In 1993, Talegen announced its
intention to limit retiree medical benefits to those employees who reached age
50 on January 1, 1994 and who ultimately retire with at least 15 years of
service.
On July 1, 1994, Industrial Indemnity Company ("Industrial"), a subsidiary of
the Company, instituted a stand-alone Retiree Medical Plan (the "Industrial
Plan") at terms substantially similar to the Talegen Retiree Medical Plan (the
"Talegen Plan") except that the future Company expense is limited to the per
capita level achieved at year end 1995. The Industrial Plan was established to
provide medical benefits to eligible employees of the Company and its
subsidiaries. Concurrently, the Company withdrew from its participation in the
Talegen Plan. The Company continued its participation in the Talegen
postretirement life insurance benefits plan. As of December 31, 1996, the
accumulated postretirement medical obligation under the Industrial Plan was $6
million, of which $4 million was accrued at December 31, 1996 and the remaining
amount represents deferred items. As of December 31, 1996, the total accumulated
postretirement life benefit obligation under the Talegen Plan was $14 million,
of which a net $8 million was accrued by Talegen after consideration of deferred
items. The accumulated postretirement life benefit obligation and accrued costs
pertaining to the Company as of December 31, 1996 were $4 million and $2
million, respectively.
(CONTINUED)
27
<PAGE>
INDUSTRIAL INDEMNITY HOLDINGS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(8) CONTINUED
As of December 31, 1995, the accumulated postretirement medical obligation under
the Industrial Plan was $7 million, of which $4 million was accrued at December
31, 1995 and the remaining amount represents deferred items. As of December 31,
1995, the total accumulated postretirement life benefit obligation under the
Talegen Plan was $13 million, of which a net $7 million was accrued by Talegen
after consideration of deferred items. The accumulated postretirement life
benefit obligation and accrued costs pertaining to the Company as of December
31, 1995 were $4 and $1 million, respectively.
The total postretirement medical and life benefit expense for the Company was $2
million, $1 million and $1 million for 1994, 1995, and 1996 respectively.
(9) DEBT
In November, 1996, the Company borrowed $79 million from Talegen in exchange for
an unsecured promissory note in that amount. Interest on the promissory note is
payable quarterly in arrears at 7.4% per annum and the principal is due November
27, 2006. The debt will be due and payable at any date on which Talegen ceases
to own 80% or more of the Company's outstanding voting stock. The proceeds of
the note were used to prepay the unsecured term loan which the Company entered
into in 1994.
Cash payments for interest made on the unsecured term loan and the promissory
note to Talegen amounted to $1 million, $7 million and $6 million for 1994, 1995
and 1996, respectively.
(10) RELATED PARTY TRANSACTIONS
Included in due from affiliates are promissory notes held by the Company which
aggregate $43 million and were issued by XFSI and guaranteed by Xerox. Notes
amounting to $18 million issued on December 31, 1992, mature on December 31,
1997, and bear a variable rate of interest which is subject to change annually
on the anniversary of the issue date. These notes at December 31, 1996 carried
an interest rate of 6.56%. Notes amounting to $25 million issued on September 1,
1993, mature on August 31, 1998, and bear a variable rate of interest which is
subject to change annually on the anniversary of the issue date. These notes at
December 31, 1996 carried an interest rate of 7.09%. Interest earned on the
above notes included in other income was $4 million, $3 million and $3 million
for the years ended December 31, 1994, 1995 and 1996, respectively.
(CONTINUED)
28
<PAGE>
INDUSTRIAL INDEMNITY HOLDINGS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(10) CONTINUED
The Company, with certain other Talegen subsidiaries (the "Lessors"), owns a
training facility located in Loudoun County, Virginia. The Company has a 25%
interest in the ownership of the facility. Talegen, on behalf of the Lessors,
entered into a long-term operating lease dated December 1, 1985 with XFSI. The
primary term of the lease expires on November 30, 2010 and is renewable at
XFSI's option. Rental income recorded by the Company under the terms of the
lease amounted to $5 million in each of the years ended December 31, 1994, 1995
and 1996.
The Company receives various data processing, claims settlement and other
services from affiliates under various service agreements. Fees incurred under
these agreements for each of the three years ended December 31, 1994, 1995 and
1996 were $16 million. The Company received $7 million, $4 million and $3
million from Talegen in 1994, 1995 and 1996, respectively, related to the
reimbursement of expenses pertaining to the restructuring.
The Company has a software development contract with Filoli Information Systems
Company (Filoli) which is 76% owned by Talegen as of December 31, 1996. Under
this contract and related agreements, the Company paid Filoli $4 million in 1994
and $17 million in 1995. No payments were made to Filoli in 1996.
(11) STATUTORY INFORMATION
The Insurance Companies are restricted by insurance laws as to the amount of
dividends they may pay without the approval of regulatory authorities. The
amount of restricted shareholder's equity of the Insurance Companies plus the
amount of shareholder's equity of the Company's non-insurance entities (which is
not restricted by insurance laws) at December 31, 1996 approximates $313
million. There are additional restrictions regarding the amount of loans and
advances that these subsidiaries may make to the Company. These restrictions
indirectly limit the payment of dividends and the making of loans and advances
by the Company to Talegen.
(CONTINUED)
29
<PAGE>
INDUSTRIAL INDEMNITY HOLDINGS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(11) CONTINUED
Generally accepted accounting principles differ in certain respects from the
statutory accounting practices prescribed or permitted by insurance regulatory
authorities for the Insurance Companies. Prescribed statutory accounting
practices include state laws, regulations, and general administrative rules, as
well as a variety of publications of the National Association of Insurance
Commissioners (NAIC). Permitted statutory accounting practices encompass all
accounting practices that are not prescribed; such practices differ from state
to state, may differ from company to company within a state, and may change in
the future. Furthermore, the NAIC has a project to codify statutory accounting
practices, the result of which is expected to constitute the only source of
"prescribed" statutory accounting practices. Accordingly, that project will
likely change the definitions of what comprises prescribed versus permitted
statutory accounting practices, and may result in changes to the accounting
policies that insurance enterprises use to prepare their statutory financial
statements.
Statutory net income of the insurance companies amounted to $36 million, $48
million and $30 million for each of the years ended December 31, 1994, 1995 and
1996, respectively. Statutory policyholders' surplus of these insurance
companies amounted to $338 million, $329 million and $249 million at December
31, 1994, 1995 and 1996, respectively. The principal differences between
statutory policyholders' surplus and shareholder's equity, determined in
accordance with generally accepted accounting principles, are deferred federal
income taxes and non-admitted assets.
(12) FAIR VALUE OF FINANCIAL INSTRUMENTS AND CONCENTRATIONS OF CREDIT RISK
FASB Statement No. 107, Disclosures about Fair Value of Financial Instruments,
defines the fair value of a financial instrument as the amount at which the
instrument could be exchanged in a current transaction between willing parties.
The following table presents the carrying amounts and estimated fair values of
the Company's financial instruments at December 31, 1995 and 1996 (in millions):
<TABLE>
<CAPTION>
1995 1996
-------------------- --------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
--------- --------- ---------- --------
<S> <C> <C> <C> <C>
Investments ........................ $ 1,304 $ 1,304 $ 1,108 $ 1,108
Debt ............................... $ 90 $ 90 $ 79 $ 77
</TABLE>
(CONTINUED)
30
<PAGE>
INDUSTRIAL INDEMNITY HOLDINGS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(12) CONTINUED
The fair value of investments is based on quoted market prices or dealer quotes
at the reporting date for those or similar investments.
The fair value of the Company's debt for 1995 approximated the carrying value.
For 1996, the fair value is based on current market rates for debt with similar
terms and maturities.
The carrying value of other receivables and payables that are financial
instruments approximate fair value.
Included in receivables at December 31, 1996 are amounts due from McDonnell
Douglas Corporation totaling $116 million ($56 million in premiums receivable
and $60 million in other receivables).
See Notes 2 and 5 regarding concentrations of investment and reinsurance
recoverable balances, respectively.
(13) LEASES
The Company leases certain land, buildings and equipment under operating leases
which expire through 2009. The total rent expense under operating leases
amounted to $7 million, $10 million and $15 million for each of the three years
ended December 31, 1994, 1995 and 1996, respectively. Future unaccrued minimum
lease payments required under operating leases that have initial or remaining
noncancelable lease terms in excess of one year at December 31, 1996 are
summarized below (in millions):
1997 ....................................... $ 14
1998 ....................................... 13
1999 ....................................... 13
2000 ....................................... 13
2001 ....................................... 11
Later years ................................ 73
--------
Total minimum lease payments ......... $ 137
========
(CONTINUED)
31
<PAGE>
INDUSTRIAL INDEMNITY HOLDINGS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(13) CONTINUED
Approximately $101 million of the future unaccrued minimum lease payments
results from a lease that was entered into in 1984 by Industrial Indemnity
Company, the principal insurance company, in conjunction with sale-leaseback
transactions. The lease terminates in 2009 although extensions are available.
The minimum lease payments shown in the preceding table do not include possible
future rental adjustments based on inflation. Industrial's performance under
this lease has been guaranteed by Talegen. The property sale was financed in
part by purchase money notes that have an aggregate carrying value of $15
million at December 31, 1996.
(14) CONTINGENT LIABILITIES
In 1985, Industrial discontinued the operations of Resolution Credit Services
Corporation ("RCSC") (formerly Industrial Indemnity Financial Corporation). RCSC
primarily wrote financial guarantee and contract surety business on behalf of
the Company. The phaseout period will be lengthy due to the long term nature of
RCSC's outstanding financial guarantees. At December 31, 1996, Industrial
remained contingently liable for approximately $41 million, which represents the
aggregate par value, net of reinsurance of $10 million, of the guarantee
contracts in force, but before consideration of approximately $4 million of
securities pledged as collateral under these contracts. The aggregate par value,
net of reinsurance of these contingent liabilities expires as follows (in
millions): 1997-2001 - $13 million; 2002-2006 - $6 million; and thereafter, $22
million.
The Company is party to various lawsuits arising in the ordinary course of
business. Management believes the outcome of these lawsuits will not have a
material adverse effect on the Company's liquidity or financial position.
32
<PAGE>
PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
INTRODUCTION
The following unaudited Pro Forma Condensed Consolidated Balance Sheet of
the Company as of June 30, 1997 gives effect to the acquisition of Industrial
Indemnity Holdings, Inc. ("Industrial") as if it had occurred on June 30, 1997.
The unaudited Pro Forma Condensed Consolidated Statements of Income for the year
ended December 31, 1996 and the six months ended June 30, 1997 present operating
results of the Company as if the acquisition of Industrial had occurred at the
beginning of each period presented, January 1, 1996 and January 1, 1997,
respectively. Pro forma adjustments to reflect the acquisition have been applied
to the historical statements of income of the Company. These adjustments are
based upon available information and certain assumptions that management of the
Company believes are reasonable in the circumstances. The Pro Forma Condensed
Consolidated Financial Statements should be read in conjunction with the
consolidated financial statements of the Company, including the notes thereto,
and the other financial information pertaining to the Company included in the
Annual Report on Form 10-K, for the year ended December 31, 1996, filed on March
31, 1997 and the audited financial statements including the notes thereto of
Industrial included elsewhere in this Form 8-K/A. The Pro Forma Condensed
Consolidated Financial Statements are not intended to be indicative of the
consolidated results of operations or financial position of the Company that
would have been reported if the acquisition had occurred at the dates indicated
or of the consolidated results of future operations or of future financial
position.
The acquisition of Industrial is accounted for as a purchase in accordance
with Accounting Principles Board Opinion No. 16, entitled "Business
Combinations." Under purchase accounting, the total purchase price is allocated
to the acquired assets and liabilities based on their fair values. Allocation of
the purchase price is subject to valuations and other studies which are not yet
complete. Accordingly, the final allocation may be different from the amounts
reflected herein. However, management of the Company does not believe such
differences will have a material impact on the results of operations or
stockholders' equity.
33
<PAGE>
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET AT JUNE 30, 1997 (UNAUDITED)
(MILLIONS OF DOLLARS)
<TABLE>
<CAPTION>
FREMONT
GENERAL
CORPORATION PRO FORMA ADJUSTMENTS (NOTE 1)
AND INDUSTRIAL ------------------------------------- PRO FORMA
SUBSIDIARIES INDEMNITY ( a ) ( b ) ( c ) ( d ) TOTAL CONSOLIDATED
------------ ---------- ------------------------------------- ------------
ASSETS
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Cash, investments and
accrued investment income ................. $ 1,780 $ 1,056 $ 26 $ (225) $ - $ 9 $(190) $ 2,646
Loans receivable ............................ 1,857 - - - - - - 1,857
Premiums receivable and agents' balances .... 114 125 4 - - (10) (6) 233
Reinsurance recoverable ..................... 427 156 - - - - - 583
Deferred policy acquisition costs ........... 28 5 - - - - - 33
Costs in excess of net assets acquired ...... 65 - - 26 10 43 79 144
Deferred income taxes ....................... 56 104 5 - - 10 15 175
Other assets ................................ 133 228 (49) - (2) 10 (41) 320
Assets held for discontinued operations ..... 261 23 - - - - - 284
------------ ---------- ------------------------------------- -----------
TOTAL ASSETS ........................ $ 4,721 $ 1,697 $ (14) $ (199) $ 8 $ 62 $(143) $ 6,275
============ ========== ===================================== ===========
LIABILITIES
Losses and loss adjustment expenses ......... $ 1,196 $ 1,072 $ (1) $ - $ - $ 60 $ 59 $ 2,327
Life insurance benefits and liabilities ..... 189 - - - - - - 189
Unearned premiums ........................... 103 29 (1) - - - (1) 131
Dividends to policyholders .................. 28 23 - - - - - 51
Other liabilities ........................... 89 120 - - 8 2 10 219
Thrift deposits ............................. 1,294 - - - - - - 1,294
Short-term debt ............................. 232 79 - - - - - 311
Long-term debt .............................. 573 - - 140 - - 140 713
Liabilities of discontinued operations ...... 228 23 - - - - - 251
------------ --------- ------------------------------------- -----------
TOTAL LIABILITIES ................... 3,932 1,346 (2) 140 8 62 208 5,486
Company-obligated mandatorily redeemable
preferred securities of subsidiary
Trust holding solely Company junior
subordinated debentures ................... 100 - - - - - - 100
Stockholders' Equity
Common Stock ................................ 33 - - - - - - 33
Additional paid-in capital .................. 268 233 25 (258) - - (233) 268
Retained earnings ........................... 459 115 (34) (81) - - (115) 459
Deferred compensation ....................... (84) - - - - - - (84)
Net unrealized gain on investments,
net of deferred taxes ..................... 13 3 (3) - - - (3) 13
------------ --------- ------------------------------------- -----------
TOTAL STOCKHOLDERS' EQUITY .......... 689 351 (12) (339) - - (351) 689
------------ --------- ------------------------------------- -----------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY .............. $ 4,721 $ 1,697 $ (14) $ (199) $ 8 $ 62 $(143) $ 6,275
============ ========= ===================================== ===========
</TABLE>
See Note to Pro Forma Financial Statements
34
<PAGE>
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 1996 (UNAUDITED)
(MILLIONS OF DOLLARS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
FREMONT
GENERAL
CORPORATION PRO FORMA
AND INDUSTRIAL ADJUSTMENTS PRO FORMA
SUBSIDIARIES INDEMNITY (NOTE 1) CONSOLIDATED
------------ ---------- ----------- ------------
REVENUES
<S> <C> <C> <C> <C>
Property and casualty premiums earned ........... $ 487 $ 234 $ - $ 721
Net investment income ........................... 124 69 (4) f
1 g 190
Loan interest ................................... 164 - - 164
Realized investment gains (losses) .............. (2) 1 - (1)
Other revenue ................................... 23 3 - 26
------------ ---------- ----------- ------------
Total Revenues ........................... 796 307 (3) 1,100
EXPENSES
Losses and loss adjustment expenses ............. 336 191 - 527
Policy acquisition costs ........................ 96 44 - 140
Provision for loan losses ....................... 14 - - 14
Other operating costs and expenses .............. 107 33 4 h 144
Dividends to policyholders ...................... - 5 - 5
Interest expense ................................ 115 5 11 e 131
------------ ---------- ----------- ------------
Total Expenses ........................... 668 278 15 961
------------ ---------- ----------- ------------
Income before taxes ............................. 128 29 (18) 139
Income tax expense .............................. 41 10 (5) i 46
------------ ---------- ----------- ------------
Net income ............................. $ 87 $ 19 $ (13) $ 93
============ ========== =========== ============
PER SHARE DATA:
Primary:
Net income ............................. $ 3.26 $ 3.48
============= ============
Weighted average shares ................ 27 27
============= ============
Fully diluted:
Net income ............................. $ 2.73 $ 2.90
============= ============
Weighted average shares ................ 34 34
============= ============
</TABLE>
See Note to Pro Forma Financial Statements
35
<PAGE>
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF INCOME
FOR THE SIX MONTHS ENDED JUNE 30, 1997 (UNAUDITED)
(MILLIONS OF DOLLARS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
FREMONT
GENERAL
CORPORATION PRO FORMA
AND INDUSTRIAL ADJUSTMENTS PRO FORMA
SUBSIDIARIES INDEMNITY (NOTE 1) CONSOLIDATED
------------ ---------- ----------- ------------
REVENUES
<S> <C> <C> <C> <C>
Property and casualty premiums earned ........... $ 236 $ 133 $ - $ 369
Net investment income ........................... 61 34 (2) f 93
(1) g
Loan interest ................................... 92 - - 92
Realized investment gains (losses) .............. (1) 1 - -
Other revenue ................................... 13 - - 13
------------ --------- ----------- ------------
Total Revenues ........................... 401 168 (3) 566
EXPENSES
Losses and loss adjustment expenses ............. 149 110 - 259
Policy acquisition costs ........................ 49 36 - 85
Provision for loan losses ....................... 4 - - 4
Other operating costs and expenses .............. 63 1 (4) f 60
2 h
Dividends to policyholders ...................... - 4 - 4
Interest expense ................................ 64 3 6 e 73
------------ ---------- ----------- ------------
Total Expenses ........................... 329 154 4 487
------------ ---------- ----------- ------------
Income before taxes ............................. 72 14 (7) 79
Income tax expense .............................. 23 5 (3) i 25
------------ ---------- ----------- ------------
Net income .......................... $ 49 $ 9 $ (4) $ 54
============ ========== =========== ============
PER SHARE DATA:
Primary:
Net income $ 1.70 $ 1.86
============ ============
Weighted average shares 29 29
============ ============
Fully diluted:
Net income $ 1.50 $ 1.63
============ ============
Weighted average shares 34 34
============ ============
</TABLE>
See Note to Pro Forma Financial Statements
36
<PAGE>
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
NOTE TO PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. PRO FORMA ADJUSTMENTS
The accompanying Pro Forma Condensed Consolidated Financial Statements give
effect to the following pro forma adjustments necessary to reflect the
acquisition outlined in the preceding Introduction as if the acquisition
occurred at the dates indicated in the Introduction:
a) To record adjustments to certain assets, liabilities, and stockholders'
equity as per specific provisions of the Stock Purchase Agreement.
b) To record the purchase of Industrial Indemnity by the Company.
c) To record the effect of the following estimated acquisition-related
costs:
(Millions of dollars)
Financial advisor fees ............................. $ 3
Financing costs and fees ........................... 5
Other professional fees including legal,
auditing, and consulting ........................ 1
Other net costs .................................... 1
-------
Total acquisition-related costs .................... $ 10
=======
Included in the above total are $2 million in costs which were prepaid as
of June 30, 1997 and were included in other assets. The remaining $8 million is
established as an other liability.
d) To record estimated purchase accounting adjustments at August 1, 1997,
including adjustments to reflect estimated fair values of assets, the
establishment of certain intangible assets acquired, costs of exiting certain
activities, accruals for certain contingencies, and adjustments to conform
methods for liability recognition. These purchase accounting adjustments
represent approximate values and are based upon preliminary evaluations of data
currently available. The amounts of similar adjustments to be made when the
final valuations are determined may vary from these estimated purchase
accounting adjustments. However, management of the company does not believe any
such differences will have a material impact on the results of operations or
stockholders' equity.
e) To record the estimated interest expense on $140 million in
acquisition-related debt as if the borrowings had occurred at the beginning of
the periods indicated.
f) To eliminate income and expense derived from certain assets that were
eliminated by Talegen pursuant to the Stock Purchase Agreement.
g) To record the net impact on investment income due to acquisition-related
adjustments as if the acquisition had occurred at the beginning of the periods
indicated.
h) To record amortization of costs in excess of net assets acquired on a
straight line basis over a 25 year period, and to amortize certain intangible
assets acquired on a straight line basis over a 40 year period.
i) To record the tax effect of taxable pro forma adjustments at an
effective tax rate of 35%.
37
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FREMONT GENERAL CORPORATION
Date: October 14, 1997 BY: /s/ JOHN A. DONALDSON
-----------------------------------------
John A. Donaldson, Senior Vice President,
Controller and Chief Accounting Officer
38
Independent Auditors' Consent
The Board of Directors
Industrial Indemnity Holdings, Inc.:
We consent to the inclusion of our report dated January 14, 1997, with respect
to the consolidated balance sheets of Industrial Indemnity Holdings, Inc. and
subsidiaries as of December 31, 1996 and 1995, and the related consolidated
statements of earnings, shareholder's equity, and cash flows for each of the
years in the three-year period ended December 31, 1996, which report appears in
the Form 8-K/A of Fremont General Corporation dated August 1, 1997.
KPMG Peat Marwick LLP
San Francisco, California
October 13, 1997
