<PAGE> 1
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K/A
------------------------
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 0-3565
CAPSURE HOLDINGS CORP.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
------------------------
<TABLE>
<S> <C>
DELAWARE 34-1010356
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
TWO NORTH RIVERSIDE PLAZA,
CHICAGO, ILLINOIS 60606
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
</TABLE>
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) (312) 879-1900
------------------------
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, $0.05 PAR VALUE
(TITLE OF CLASS)
------------------------
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No ____
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of voting stock held by nonaffiliates was $121.1
million based upon the closing price of $11.50 per share on March 7, 1997, using
beneficial ownership of stock rules adopted pursuant to Section 13 of the
Securities Exchange Act of 1934 to exclude voting stock owned by Directors and
Officers, some of whom may not be held to be affiliates upon judicial
determination.
At March 7, 1997, 15,807,622 shares of the Registrant's Common Stock were
outstanding.
================================================================================
<PAGE> 2
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PART I.
Item 1. Business......................................... 3
General....................................... 3
Pending Business Combination.................. 4
Summary of Insurance Operations............... 4
A.M. Best Ratings............................. 5
Surety and Fidelity Bond Operations........... 5
Reinsurance................................... 10
Unpaid Losses and Loss Adjustment Expenses.... 10
Regulation.................................... 12
Investments................................... 13
Net Operating Tax Loss Carryforwards.......... 13
Employees..................................... 13
Item 2. Properties....................................... 13
Item 3. Legal Proceedings................................ 14
Item 4. Submission of Matters to a Vote of Security
Holders.......................................... 14
PART II.
Item 5. Market for the Registrant's Common Equity and
Related Stockholder Matters...................... 14
Item 6. Selected Financial Data.......................... 15
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.............. 16
Item 8. Financial Statements and Supplementary Data...... 25
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure.............. 25
PART III.
Item 10. Directors and Executive Officers of the
Registrant....................................... 25
Item 11. Executive Compensation........................... 28
Item 12. Security Ownership of Certain Beneficial Owners
and Management................................... 34
Item 13. Certain Relationships and Related Transactions... 36
PART IV.
Item 14. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K.............................. 37
</TABLE>
2
<PAGE> 3
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
PART I
ITEM 1. BUSINESS
GENERAL
Capsure Holdings Corp. and its subsidiaries ("Capsure" or the "Company")
provide surety and fidelity bonds in all 50 states through a combined network of
120,000 independent agents. Capsure is one of the premier, national property
casualty franchises in the U.S. with a dominant position in the miscellaneous
surety and fidelity bond business and a growing presence in the contractor
bonding market. Capsure's principal subsidiaries are Western Surety Company
("Western Surety"), acquired in August 1992, and Universal Surety of America
("Universal Surety"), acquired in September 1994. Western Surety writes small
fidelity and noncontract surety bonds, referred to as "miscellaneous" bonds, and
errors and omissions ("E&O") liability insurance, as a licensed insurer in all
50 states and the District of Columbia. Western Surety's sister company, Surety
Bonding Company of America ("SBCA"), writes similar business and is licensed in
17 states. Universal Surety specializes in the underwriting of small contract
and miscellaneous surety bonds. Universal Surety is licensed in 37 states and
the District of Columbia with most of its business generated in Texas.
The Company's business strategy has been to continue the underwriting focus
of each of its operating companies and achieve growth in these segments from
cross-marketing opportunities. At Western Surety, whose business is relatively
low risk and relatively insensitive to industry pricing cycles, delivery of
excellent service to its vast network of agents has been emphasized. At
Universal Surety, whose business includes both miscellaneous surety and the
comparatively more risky contract surety, responsiveness to agents coupled with
sound, conservative underwriting have been the guiding principles. Contract
bonds are more affected by prevailing market and general economic conditions
than are noncontract bonds.
Universal Surety has been a highly successful regional underwriter of
small- to medium-sized contract surety bonds in Texas and adjacent states. The
alliance of Universal Surety and Western Surety represents a unique opportunity
for Capsure to capitalize on Western Surety's vast distribution network and
national prominence and Universal Surety's contract bond underwriting expertise
to (1) increase Universal Surety's geographic penetration and growth and (2)
provide Western Surety agents with a more complete and competitive line of
surety products.
This joint venture of Capsure's surety companies has been named USAWestern.
USAWestern acts as the contract bond division of Western Surety. Universal
Surety personnel underwrite contract surety bonds submitted by Western Surety
agents on Western Surety's bond forms. Contract bonds written through the
USAWestern program are generally reinsured 100% by Universal Surety.
The USAWestern program showed significant growth in 1996 as expansion of
the program continued to Western Surety agents across the country. Gross written
premiums for the program have grown from approximately $1.6 million in 1995 to
approximately $3.4 million in 1996. The USAWestern program was marketed to
Western Surety agents in 30 states as of December 31, 1996. The further
expansion of Universal Surety's contract bond business through Western Surety's
broad distribution network will be dependent on Universal Surety's ability to
attract qualified underwriting and claims personnel and maintain distinctive
service to agents.
Western Surety's vast agency force is also being leveraged by the gradual
expansion of an insurance agents' and brokers' E&O product. This product is
marketed directly to Western Surety agents without third-party commissions and,
as a result, provides a significant competitive advantage. Gross written
premiums for this product have grown from $0.8 million in 1995 to $1.9 million
in 1996. This product offering had expanded to 38 states as of December 31,
1996. Effective October 1, 1996, Western Surety modified its reinsurance
agreements to increase its net retention on this business from 10% to 20%.
3
<PAGE> 4
On May 22, 1996, the Company consummated the sale of United Capitol Holding
Company ("UCHC") and its subsidiaries, United Capitol Insurance Company ("United
Capitol"), United Capitol Managers, Inc. and Fischer Underwriting Group,
Incorporated, to a subsidiary of Frontier Insurance Group, Inc. The operating
results of UCHC and its subsidiaries are reflected in Capsure's results through
the closing date. Net proceeds to Capsure of $77 million, which included the
purchase price for the capital stock of UCHC and the release of United Capitol's
excess statutory surplus at closing, approximated Capsure's carrying value. The
goodwill associated with the 1990 acquisition of United Capitol was previously
reduced to estimated net realizable value as of December 31, 1995, resulting in
a $13.2 million impairment of goodwill in 1995.
On September 11, 1996, the Company declared a special cash distribution in
the amount of $10 per share of common stock, payable to all holders of record as
of September 25, 1996. The declaration of the special distribution was the
result of the previously announced review of strategic alternatives undertaken
by Capsure's Board of Directors. The special distribution was paid on October 4,
1996 and was funded from $62 million of borrowings under Capsure's revolving
credit agreement and approximately $94 million from available cash and
marketable securities accumulated at the parent company level. In connection
with the payment of the special distribution, the Board of Directors also
authorized a corresponding repricing of all outstanding stock options. This
resulted in a new measurement date for the stock options under applicable
accounting pronouncements and required the Company to record in the third
quarter of 1996 a non-recurring compensation charge of $4.1 million, after
applicable income taxes, or 25 cents per share of which $3.6 million, or 22
cents per share, was non-cash.
PENDING BUSINESS COMBINATION
On December 19, 1996, Capsure and certain direct and indirect subsidiaries
of CNA Financial Corporation ("CNAF") entered into a definitive Reorganization
Agreement pursuant to which Capsure will merge with a wholly-owned subsidiary of
CNA Surety Corporation ("CNA Surety"). CNAF, through its subsidiaries, will be
the majority stockholder of CNA Surety, owning 61.75 percent of the shares on a
fully diluted basis. The remaining shares will be issued to the existing Capsure
stockholders (a portion of these shares will be reserved for issuance to the
existing holders of Capsure options who will receive CNA Surety options in the
merger) in a tax-free exchange for their Capsure shares on a one-for-one basis.
The CNA Surety shares are expected to be traded on the New York Stock Exchange.
Equity Capsure Limited Partnership ("Equity Capsure"), Capsure's largest
stockholder with a 25.6 percent ownership interest, and certain other directors
of the Company have agreed to vote their shares in favor of the merger. The
agreement and the transactions contemplated thereby are subject to several
conditions, including ratification by the affirmative vote of Capsure
stockholders and approval by governmental and insurance regulatory authorities.
The completion of the merger pursuant to the Reorganization Agreement will
cause an ownership change under Section 382 of the Internal Revenue Code of
1986, as amended (the "Code") and significantly limit the future utilization of
Capsure's net operating tax loss carryforwards ("NOLs"). If the Reorganization
Agreement and transactions contemplated thereby are approved, Capsure
stockholders will be asked to approve an amendment to its Certificate of
Incorporation to delete a provision designed to facilitate the Company's ability
to preserve and utilize its NOLs.
SUMMARY OF INSURANCE OPERATIONS
On August 14, 1992, the Company acquired Western Surety. Founded in 1900,
Western Surety is one of the largest writers of miscellaneous bonds in the
United States. Bonds underwritten by Western Surety are relatively low-risk,
low-premium products where prompt service, easy-to-use forms and availability of
an extensive array of bond products are emphasized. Western Surety's success is
attributable to its product specialization, underwriting expertise and broad
distribution network. Substantially all of Western Surety's bonds are mandated
by various state statutes and local ordinances.
On September 22, 1994, the Company acquired Universal Surety. Founded in
1984, Universal Surety specializes in writing miscellaneous and small- to
medium-sized contract surety bonds primarily in the southern United States.
Contract bonds underwritten by Universal Surety, including those underwritten on
4
<PAGE> 5
behalf of Western Surety under the USAWestern program, are primarily contractor
performance and payment bonds in amounts under $3.0 million for which
underwriting expertise and distinctive service to agents are emphasized.
Universal Surety underwrites primarily standard and some specialty accounts for
which it will utilize supplemental collateral arrangements and excess rates for
contractors not qualified for standard surety rates. Universal Surety also
reduces its exposure through participation in the Small Business Administration
("SBA") Surety Bond Guarantee Program. Under this program, the SBA will
generally reimburse Universal Surety for between 80% and 90% of losses and loss
adjustment expenses incurred on any SBA guaranteed bond in exchange for 20% of
the premium. In addition, a significant portion of Universal Surety's premiums
consist of miscellaneous bonds underwritten in the same geographic area.
A.M. BEST RATINGS
Western Surety and Universal Surety are currently rated A+ (Superior) and A
(Excellent), respectively, by A.M. Best Company, Inc. ("A.M. Best"). A.M. Best's
letter ratings range from A++ (Superior) to C- (Fair) with A++ being highest. An
A+ (Superior) rating is assigned to those companies which A.M. Best believes
have achieved superior overall performance when compared to the norms of the
property and casualty insurance industry. A+ (Superior) rated insurers have been
shown to be among the strongest in ability to meet policyholder and other
contractual obligations. A rating of A (Excellent) is assigned to those
companies which A.M. Best believes have achieved excellent overall performance
when compared to the norms of the property and casualty insurance industry and
generally have demonstrated a strong ability to meet their respective
policyholder and other contractual obligations.
As is its practice upon announcement of a proposed merger, A.M. Best placed
the ratings of Western Surety and Universal Surety under review in December
1996. If the insurance subsidiaries' ratings are downgraded below A by A.M.
Best, sales of the insurance subsidiaries' products could be adversely affected.
Based upon conversations with A.M. Best, management has no reason to believe
that Western Surety and Universal Surety will not retain their current ratings.
However, there can be no assurance that the ratings of Western Surety and
Universal Surety will be maintained following the proposed merger or, if
maintained, would not be changed in subsequent periodic reviews by A.M. Best.
SURETY AND FIDELITY BOND OPERATIONS
According to 1995 statistics published by the Surety Association of America
("SAA"), the surety and fidelity bond market had direct written premiums of
approximately $2.7 billion, of which the miscellaneous and contract bond
segments accounted for approximately $0.8 billion and $1.3 billion,
respectively. Capsure targets subsets of the miscellaneous bond segment and
contract bond segment of the surety and fidelity market because of their
favorable risk characteristics.
PRODUCTS AND POLICIES
Surety and fidelity bonds differ in some respects from conventional
insurance policies. A surety bond is a three-party arrangement wherein the
issuer of the bond (the surety) guarantees to a third party (the obligee) an
obligation made by another entity (the principal). The surety is the party who
guarantees fulfillment of the principal's obligation to the obligee. In
addition, sureties are generally entitled to recover from the principal any
losses and expenses paid to third parties. The surety's responsibility is to
evaluate the risk and determine if the principal meets the underwriting
requirements for the bond. Accordingly, surety bond premiums primarily reflect
the type and class of risk and related costs associated with both processing the
bond transaction and investigating the applicant including, if necessary, an
analysis of the applicant's creditworthiness and ability to perform.
5
<PAGE> 6
Capsure issues thousands of different bond forms representing the many
types of noncontract and contract bonds available in each of the jurisdictions
in which it operates. The terms of such bonds in many cases are prescribed by
state and local laws or regulations. The principal types of surety and fidelity
bonds underwritten are as follows:
License and Permit -- Bonds required by statutes or ordinances for a
number of purposes including guaranteeing the payment of certain taxes and
fees and providing consumer protection as a condition to granting licenses
related to selling real estate or motor vehicles and contracting services.
Judicial and Fiduciary -- Bonds required by statutes, courts or legal
documents for the protection of those on whose behalf a fiduciary acts.
Examples of such fiduciaries include executors and administrators of
estates, and guardians of minors and incompetents.
Fidelity -- Bonds which cover losses arising from employee dishonesty.
Examples of purchasers of fidelity bonds are law firms, insurance agencies
and janitorial service companies.
Public Official -- Bonds required by statutes and ordinances to
guarantee the lawful and faithful performance of the duties of office by
public officials.
Notary Public -- Bonds required by statutes to protect against losses
resulting from the improper actions of notaries public.
Contract -- Bonds which secure the payment and/or performance of an
obligation under a written contract.
Capsure also writes E&O policies for three classes of insureds: notaries
public, tax preparers and insurance agents and brokers. The notary public E&O
policy is marketed as a companion product to the notary public bond and the tax
preparer E&O policy is marketed to small tax return preparation firms. Western
Surety introduced an insurance agents' and brokers' E&O insurance product in
1994 and expanded this product to 38 states as of December 31, 1996.
The following tables set forth, for each principal class of bonds, combined
Western Surety/SBCA and Universal Surety gross written premiums, net written
premiums, net earned premiums and number of bonds and policies in force and the
respective percentages of the total for the past three years. All tables in this
section contain information reflecting the operations of Universal Surety prior
to its acquisition by Capsure. As
6
<PAGE> 7
such, the financial information is not necessarily indicative of the financial
results that would have occurred under the ownership and management of Capsure
(amounts in thousands, except average bond amounts):
<TABLE>
<CAPTION>
GROSS WRITTEN PREMIUMS
--------------------------------------------------------
% OF % OF % OF
1996 TOTAL 1995 TOTAL 1994 TOTAL
------- ----- ------- ----- ------- -----
<S> <C> <C> <C> <C> <C> <C>
Surety and fidelity bonds:
License and permit................. $28,112 29.2% $28,742 31.7% $28,160 32.5%
Judicial and fiduciary............. 13,555 14.1 13,007 14.4 13,116 15.2
Fidelity........................... 15,134 15.7 14,357 15.9 13,821 16.0
Public official.................... 7,029 7.3 7,351 8.1 6,874 7.9
Notary public...................... 8,193 8.5 7,770 8.6 7,989 9.2
Contract........................... 16,347 17.0 12,448 13.7 10,393 12.0
Other.............................. 1,764 1.9 1,905 2.1 1,935 2.3
------- ----- ------- ----- ------- -----
90,134 93.7 85,580 94.5 82,288 95.1
E&O policies......................... 6,072 6.3 4,984 5.5 4,261 4.9
------- ----- ------- ----- ------- -----
$96,206 100.0% $90,564 100.0% $86,549 100.0%
======= ===== ======= ===== ======= =====
Premiums by company:
Western Surety/SBCA................ $75,119 78.1% $73,703 81.4% $71,286 82.4%
Universal Surety................... 21,087 21.9 16,861 18.6 15,263 17.6
------- ----- ------- ----- ------- -----
$96,206 100.0% $90,564 100.0% $86,549 100.0%
======= ===== ======= ===== ======= =====
Premiums generated by largest agency:
Western Surety..................... 1.4% 1.2% 1.2%
======= ======= =======
Universal Surety................... 4.1% 4.1% 4.0%
======= ======= =======
Percentage of premiums in the top
five states:
Western Surety..................... 25.8% 26.2% 26.5%
======= ======= =======
Universal Surety................... 89.6% 93.1% 92.0%
======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
NET WRITTEN PREMIUMS
--------------------------------------------------------
% OF % OF % OF
1996 TOTAL 1995 TOTAL 1994 TOTAL
------- ----- ------- ----- ------- -----
<S> <C> <C> <C> <C> <C> <C>
Surety and fidelity bonds:
License and permit................. $27,788 30.4% $28,588 33.0% $28,003 33.3%
Judicial and fiduciary............. 12,665 13.9 12,329 14.2 12,379 14.7
Fidelity........................... 15,090 16.5 14,322 16.5 13,786 16.4
Public official.................... 6,902 7.6 7,204 8.3 6,731 8.0
Notary public...................... 8,193 9.0 7,683 8.8 7,922 9.4
Contract........................... 14,823 16.2 11,148 12.9 9,623 11.5
Other.............................. 1,400 1.5 1,244 1.4 1,421 1.7
------- ----- ------- ----- ------- -----
86,861 95.1 82,518 95.1 79,865 95.0
E&O policies......................... 4,421 4.9 4,228 4.9 4,186 5.0
------- ----- ------- ----- ------- -----
$91,282 100.0% $86,746 100.0% $84,051 100.0%
======= ===== ======= ===== ======= =====
Premiums by company:
Western Surety/SBCA................ $71,949 78.8% $71,069 81.9% $69,738 83.0%
Universal Surety................... 19,333 21.2 15,677 18.1 14,313 17.0
------- ----- ------- ----- ------- -----
$91,282 100.0% $86,746 100.0% $84,051 100.0%
======= ===== ======= ===== ======= =====
</TABLE>
7
<PAGE> 8
<TABLE>
<CAPTION>
NET EARNED PREMIUMS
--------------------------------------------------------
% OF % OF % OF
1996 TOTAL 1995 TOTAL 1994 TOTAL
------- ----- ------- ----- ------- -----
<S> <C> <C> <C> <C> <C> <C>
Surety and fidelity bonds:
License and permit................. $27,761 31.1% $28,039 33.0% $27,692 33.4%
Judicial and fiduciary............. 12,443 13.9 12,396 14.6 12,476 15.1
Fidelity........................... 14,701 16.5 14,082 16.6 13,402 16.2
Public official.................... 7,053 7.9 7,045 8.3 7,017 8.5
Notary public...................... 8,162 9.1 7,883 9.3 7,561 9.1
Contract........................... 13,534 15.2 10,228 12.0 9,331 11.3
Other.............................. 1,267 1.4 1,191 1.4 1,426 1.7
------- ----- ------- ----- ------- -----
84,921 95.1 80,864 95.2 78,905 95.3
E&O policies......................... 4,340 4.9 4,119 4.8 3,917 4.7
------- ----- ------- ----- ------- -----
$89,261 100.0% $84,983 100.0% $82,822 100.0%
======= ===== ======= ===== ======= =====
Premiums by company:
Western Surety/SBCA................ $71,341 79.9% $70,332 82.8% $69,212 83.6%
Universal Surety................... 17,920 20.1 14,651 17.2 13,610 16.4
------- ----- ------- ----- ------- -----
$89,261 100.0% $84,983 100.0% $82,822 100.0%
======= ===== ======= ===== ======= =====
</TABLE>
<TABLE>
<CAPTION>
BONDS AND POLICIES IN FORCE
--------------------------------------------------------
% OF % OF % OF
1996 TOTAL 1995 TOTAL 1994 TOTAL
------- ----- ------- ----- ------- -----
<S> <C> <C> <C> <C> <C> <C>
Surety and fidelity bonds:
License and permit................. 460 28.1% 463 29.2% 460 29.3%
Judicial and fiduciary............. 61 3.7 63 4.0 64 4.1
Fidelity........................... 94 5.7 91 5.7 88 5.6
Public official.................... 60 3.7 62 3.9 64 4.1
Notary public...................... 784 47.9 747 47.0 758 48.2
Contract........................... 8 .5 8 0.5 7 0.5
Other.............................. 14 .8 11 0.7 10 0.6
------- ----- ------- ----- ------- -----
1,481 90.4 1,445 91.0 1,451 92.4
E&O policies......................... 157 9.6 143 9.0 120 7.6
------- ----- ------- ----- ------- -----
1,638 100.0% 1,588 100.0% 1,571 100.0%
======= ===== ======= ===== ======= =====
Bonds/policies in force by company:
Western Surety/SBCA................ 1,424 86.9% 1,416 89.2% 1,389 88.4%
Universal Surety................... 214 13.1 172 10.8 182 11.6
------- ----- ------- ----- ------- -----
1,638 100.0% 1,588 100.0% 1,571 100.0%
======= ===== ======= ===== ======= =====
Average bond penalty/policy limit:
Western Surety..................... $10,944 $10,030 $ 9,470
======= ======= =======
Universal Surety................... $11,122 $13,317 $11,507
======= ======= =======
</TABLE>
MARKETING
Western Surety enjoys broad national distribution of its products, which
are marketed through approximately 37,000 of the approximately 44,000
independent property and casualty insurance agencies in the United States. These
independent agencies are paid an average commission of approximately 30% of a
miscellaneous bond's premium. Western Surety also employs 58 full-time salaried
marketing representatives whose principal duties are to continually service
their producer network on a local basis.
8
<PAGE> 9
Since miscellaneous fidelity and surety bonds typically account for a small
portion of an independent agency's revenues and are generally applied for under
rush circumstances, Western Surety emphasizes one-day response service,
easy-to-use forms and an extensive array of miscellaneous bond products. In
addition, independent agents are provided pre-executed bond forms, powers of
attorney, and facsimile authorizations that allow them to issue many standard
bonds in their offices.
Western Surety's marketing strategy is concentrated on increasing its share
of the miscellaneous bond market. In addition, Western Surety devotes
considerable time and effort educating legislators as to the need for and value
of miscellaneous bonds and challenging attempts to repeal certain bonding
requirements.
Universal Surety markets its products through approximately 1,000
independent property and casualty insurance agencies through its headquarters in
Houston, Texas, and branch offices in Austin, Dallas, and San Antonio, Texas;
Overland Park, Kansas; Golden, Colorado; and Seattle, Washington. Universal
Surety emphasizes innovative, flexible underwriting, product specialization and
distinctive agent service backed by highly qualified, experienced employees.
Of Universal Surety's gross written premiums in 1996, 73% related to
contract bonds, including 5% that qualified for the SBA guarantee. The remaining
27% related to noncontract bonds, including 12% for notary public bonds.
Universal Surety has concentrated its marketing efforts in expanding its
share of the small contract bond market. Contract bonds underwritten by
Universal Surety, including those underwritten on behalf of Western Surety under
the USAWestern program, are primarily contractor performance and payment bonds
in amounts under $3.0 million. Universal Surety underwrites principally standard
accounts and some specialty accounts for which it will utilize supplemental
collateral arrangements and excess rates or SBA guarantees for contractors not
generally considered standard risks. The Company has utilized Western Surety's
existing diverse agency relationships to expand the geographic and agency
distribution of Universal Surety's contract surety business under the USAWestern
joint venture. The USAWestern program was marketed to Western Surety agents in
30 states as of December 31, 1996. Western Surety has generally ceded 100% of
each such contract surety bond written on Western bond forms to Universal Surety
pursuant to a Surety Bond Quota Share Reinsurance Agreement. Gross written
premiums for this coverage were $3.4 million in 1996 compared to $1.6 million in
1995. In 1994, these activities were not material.
In addition, Western Surety has been gradually expanding its product line
by offering insurance agents' and brokers' E&O insurance directly to a majority
of its vast agency force. Effective October 1, 1996, Western Surety modified its
reinsurance agreements to increase its net retention on this business from 10%
to 20%, reflecting the relative maturation and favorable underwriting margins of
this book of business. The increased net retention is not expected to have a
material impact on the Company's results of operations. Gross written premiums
for this coverage were $1.9 million in 1996 compared to $0.8 million in 1995. In
1994, these activities were not material.
UNDERWRITING
Western Surety and Universal Surety target various products in the surety
and fidelity bond market which are characterized by relatively low-risk exposure
and small bond amounts. Their underwriting criteria, including the extent of
bonding authority granted to independent agents, vary depending on the class of
business and the type of bond. For example, relatively little underwriting
information is required of certain low-exposure risks such as notary bonds.
Other bonds, such as fiduciary or probate bonds, are subjected to greater
individual risk scrutiny, including verification of the credit history and
financial resources of an applicant. Contract bonds underwritten by Universal
Surety, which have higher bond amounts and inherent risk, are subject to
stringent financial analysis and credit review. Both companies grant authority
to independent agents to issue certain low-risk bonds subject to underwriting
guidelines.
COMPETITION
The surety and fidelity market is highly competitive. The largest market
shares are held by large diversified insurance companies; however, the single
largest writer nationally in 1995, according to the SAA,
9
<PAGE> 10
controlled only 7% of the $2.7 billion market. The small fidelity and
noncontract surety or miscellaneous segment of this market is competitive on the
basis of service, price, and commissions paid to producers. No single competitor
has a significant market position in the broad geographic range and lines of
business in which Western Surety conducts its operations. Certain of Western
Surety's existing and potential competitors are larger and have greater
financial and other resources than Western Surety. The Company believes that
Western Surety's principal competitive strengths include its expertise in
writing miscellaneous bonds, distribution network of independent agencies,
timely customer response and service, and admitted status in every state and the
District of Columbia.
The market in which Universal Surety competes, primarily small contract
bonds, has seen additional competition as both large and small insurance
companies are competing and expanding in this area. Certain of Universal
Surety's existing and potential competitors are larger and have greater
financial resources than Universal Surety. Universal Surety believes that its
principal competitive strengths include its underwriting expertise in both
contract and miscellaneous bonds, its distinctive service and its strong
relationship with its agents.
REINSURANCE
The Company's insurance subsidiaries, in the ordinary course of business,
cede reinsurance to other insurance companies to limit their exposure to loss.
The reinsurance coverages and terms are tailored to the specific risk
characteristics of the underlying product line. Reinsurance contracts do not
relieve the Company of its primary obligations to claimants. A contingent
liability exists with respect to reinsurance ceded to the extent that any
reinsurer is unable to meet the obligations assumed under the reinsurance
agreements. Capsure places reinsurance with other carriers only after careful
review of the nature of the contract and a thorough assessment of the
reinsurers' credit quality and claim settlement performance. At December 31,
1996, Capsure's largest reinsurance receivable, including prepaid reinsurance
premiums of $0.8 million, was approximately $2.3 million with Transatlantic
Reinsurance Company. Transatlantic Reinsurance Company is rated A+ (Superior) by
A.M. Best.
UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
The liability for unpaid losses and loss adjustment expenses ("LAE") is
based on estimates of (a) the ultimate settlement value of reported claims, (b)
incurred but not reported ("IBNR") claims, (c) future expenses to be incurred in
the settlement of claims and (d) claim recoveries. These estimates are
determined based on the Company's and industry loss experience as well as
consideration of current trends and conditions. The liability for unpaid losses
and LAE is an accounting estimate and, similar to other accounting estimates,
there is the potential that actual future loss payments will differ
significantly from the initial estimate. The methods of determining such
estimates and the resulting estimated liability are continually reviewed and
updated. Changes in the estimated liability are reflected in operating income in
the year in which such changes are determined.
Capsure's insurance subsidiaries employ prudent reserving approaches in
establishing the estimated liability for unpaid loss and LAE due to the inherent
difficulty and variability in the estimation process. In addition, Capsure
utilizes independent actuarial firms of national standing to conduct periodic
reviews of claim procedures and loss reserving practices, and annually obtains
actuarial certification as to the reasonableness of actuarial assumptions used
and the sufficiency of year-end reserves for each of its principal insurance
subsidiaries.
A table is included in both Management's Discussion and Analysis of
Financial Condition and Results of Operations and Note 6 to the Consolidated
Financial Statements which presents a reconciliation of beginning and ending
consolidated loss reserve balances for the three years ended December 31, 1996.
Such tables highlight the impact of favorable development of the estimated
liability established in prior years.
10
<PAGE> 11
The following table sets forth a reconciliation of the consolidated loss
reserves reported in accordance with generally accepted accounting principles
("GAAP"), and the reserves reported to state insurance regulatory authorities in
accordance with statutory accounting principles ("SAP") (dollars in thousands):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------
1996 1995 1994
------- -------- --------
<S> <C> <C> <C>
Reserves at end of year, GAAP basis................. $38,874 $126,061 $149,041
Estimated salvage and subrogation recoverable (gross
of reinsurance), not anticipated under SAP........ 6,805 7,141 6,881
Estimated reinsurance recoverable netted against
gross reserves for SAP............................ (6,062) (39,735) (38,606)
------- -------- --------
Reserves at end of year, SAP basis.................. $39,617 $ 93,467 $117,316
======= ======== ========
</TABLE>
The following table presents the development under GAAP of combined balance
sheet reserves for surety and fidelity operations only for 1987 through 1996,
including periods prior to Capsure's ownership. It does not include the reserve
development data with respect to the Company's former excess and surplus lines
subsidiary, United Capitol. The top line of the table shows the combined
reserves at the balance sheet date for each of the indicated periods. The amount
of the reserves represents the estimated amount of losses and LAE arising in all
prior years that are unpaid at the balance sheet date, including IBNR reserves.
The upper portion of the table shows the reestimated amount of the previously
recorded reserves based on experience as of the end of each succeeding year. The
estimates change as more information becomes known about the frequency and
severity of claims for individual periods. The cumulative redundancy
(deficiency) represents the aggregate change in the estimates over all prior
years. It should be noted that the table presents a "run off" of balance sheet
reserves rather than accident or policy year loss development. Therefore, each
amount in the table includes the effects of changes in reserves for all prior
years (dollars in thousands):
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
-------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992 1991 1990 1989 1988 1987
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Reserves for unpaid losses
and LAE.................... $38,874 $39,846 $40,251 $35,522 $31,274 $29,054 $27,801 $26,940 $22,188 $19,651
Reserves re-estimated as of:
One year later............. -- 32,493 33,685 33,788 30,356 28,087 26,269 24,829 22,636 19,992
Two years later............ -- -- 27,920 29,231 28,905 28,061 26,633 24,175 21,470 19,817
Three years later.......... -- -- -- 24,946 25,322 25,872 27,404 24,948 20,751 19,550
Four years later........... -- -- -- -- 21,701 22,696 25,675 24,969 22,285 18,801
Five years later........... -- -- -- -- -- 21,976 23,138 23,507 22,083 20,210
Six years later............ -- -- -- -- -- -- 22,602 21,213 20,790 20,575
Seven years later.......... -- -- -- -- -- -- -- 20,151 19,389 19,561
Eight years later.......... -- -- -- -- -- -- -- -- 18,672 18,745
Nine years later........... -- -- -- -- -- -- -- -- -- 18,280
Cumulative redundancy
(deficiency)............... $ -- $ 7,353 $12,331 $10,576 $ 9,573 $ 7,078 $ 5,199 $ 6,789 $ 3,516 $ 1,371
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
Cumulative redundancy
(deficiency) as a
percentage of original
estimate................... -- 18.5% 30.6% 29.8% 30.6% 24.4% 18.7% 25.2% 15.8% 7.0%
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
Cumulative amount of
liability paid through:
One year later............. $ -- $ 8,612 $ 8,252 $ 8,194 $ 7,116 $ 8,803 $ 7,801 $ 7,408 $ 7,130 $ 6,302
Two years later............ -- -- 12,275 13,085 11,594 13,114 13,705 12,442 11,469 10,826
Three years later.......... -- -- -- 14,885 14,534 15,816 16,621 16,164 13,973 13,388
Four years later........... -- -- -- -- 15,232 17,047 18,534 17,688 16,357 15,014
Five years later........... -- -- -- -- -- 17,287 19,145 18,816 17,319 16,982
Six years later............ -- -- -- -- -- -- 19,081 18,752 18,064 17,433
Seven years later.......... -- -- -- -- -- -- -- 18,563 18,131 17,951
Eight years later.......... -- -- -- -- -- -- -- -- 18,012 17,861
Nine years later........... -- -- -- -- -- -- -- -- -- 17,766
</TABLE>
11
<PAGE> 12
REGULATION
Capsure's insurance subsidiaries are subject to varying degrees of
regulation and supervision in the jurisdictions in which they transact business
under statutes which delegate regulatory, supervisory and administrative powers
to state insurance regulators. In general, an insurer's state of domicile has
principal responsibility for such regulation which is designed generally to
protect policyholders rather than investors and relates to matters such as the
standards of solvency which must be maintained; the licensing of insurers and
their agents; the examination of the affairs of insurance companies, including
periodic financial and market conduct examinations; the filing of annual and
other reports, prepared on a statutory basis, on the financial condition of
insurers or for other purposes; establishment and maintenance of reserves for
unearned premiums and losses; and requirements regarding numerous other matters.
Licensed or admitted insurers generally must file with the insurance regulators
of such states, or have filed on its behalf, the premium rates and bond and
policy forms used within each state. In some states, approval of such rates and
forms must be received from the insurance regulators in advance of their use.
Western Surety is domiciled in South Dakota and licensed in all other
states and the District of Columbia. SBCA is domiciled in South Dakota and
licensed in 17 states. Universal Surety is domiciled in Texas and licensed in 37
other states and the District of Columbia.
Insurance regulations generally also require registration and periodic
disclosure of certain information concerning ownership, financial condition,
capital structure, general business operations and any material transactions or
agreements by or among affiliates. Such regulation also typically restricts the
ability of any one person to acquire 10% or more, either directly or indirectly,
of a company's stock without prior approval of the applicable insurance
regulatory authority. In addition, dividends and other distributions to
stockholders generally may be paid only out of unreserved and unrestricted
statutory earned surplus. Such distributions may be subject to prior regulatory
approval, including a review of the implications on Risk-Based Capital
requirements. A discussion of Risk-Based Capital requirements for property and
casualty insurance companies is included in both Management's Discussion and
Analysis of Financial Condition and Results of Operations and Note 9 to the
Consolidated Financial Statements. Without prior regulatory approval in 1997,
Capsure's insurance subsidiaries may pay stockholder dividends of $18.0 million
in the aggregate. In 1996, 1995 and 1994, Capsure received $65.7 million
(including $50.2 million of dividends requiring prior approval), $40.9 million
(including $21.6 million of dividends requiring prior approval), and $21.0
million (including $5.0 million of dividends requiring prior approval),
respectively, in dividends from its insurance subsidiaries. Capsure received
$15.6 million, $21.9 million and $9.5 million in dividends from its surety and
fidelity subsidiaries in 1996, 1995 and 1994, respectively.
Capsure's insurance subsidiaries are subject to periodic financial and
market conduct examinations. These examinations are generally performed by the
domiciliary state insurance regulatory authorities. The South Dakota Department
of Commerce and Regulation - Division of Insurance conducted its last
examination of Western Surety as of December 31, 1991. This examination covered
both financial and market conduct procedures. The Texas Department of Insurance
conducted its last examination of Universal Surety as of September 30, 1992.
This examination included both financial and market conduct procedures. There
were no significant issues noted which required corrective action by any of
Capsure's insurance subsidiaries.
Certain states in which Capsure conducts its business require insurers to
join a guaranty association. Guaranty associations provide protection to
policyholders of insurers licensed in such states against the insolvency of
those insurers. In order to provide the associations with funds to pay certain
claims under policies issued by insolvent insurers, the guaranty associations
charge members assessments based on the amount of direct premiums written in
that state. To date, such assessments have not been material to Capsure's
results of operations.
Western Surety and Universal Surety each qualifies as an acceptable surety
for federal and other public works project bonds pursuant to U.S. Department of
Treasury regulations. The underwriting limitations of Western Surety and
Universal Surety, based on each insurer's statutory surplus, are currently $3.3
million and $0.9 million, respectively.
12
<PAGE> 13
INVESTMENTS
Insurance company investment practices must comply with insurance laws and
regulations and must also comply with certain covenants under Capsure's $100
million revolving credit facility. Generally, insurance laws and regulations
prescribe the nature and quality of, and set limits on, the various types of
investments which may be made by Capsure's insurance subsidiaries. Capsure's
insurance subsidiaries invest funds provided by operations predominately in
high-quality, taxable, fixed income securities.
Management believes that its investment strategy is conservative, with
preservation of capital being the foremost objective. Its investment strategy is
also influenced by the terms of the insurance coverages written, its
expectations as to the timing of claim payments, debt service requirements, and
tax considerations, in particular the existence of the Company's NOLs, as
described below.
A separate investment committee of the Board of Directors of each insurance
company establishes investment policy and oversees the management of each
portfolio. A professional independent investment adviser is engaged to assist in
the management of each company's investment portfolio pursuant to established
investment committee guidelines. The insurance companies pay an advisory fee
based on the market value of the assets under management.
NET OPERATING TAX LOSS CARRYFORWARDS
In July 1986, the Company emerged from voluntary bankruptcy proceedings
under Chapter 11 of the United States Bankruptcy Code. Prior to its emergence,
the Company was primarily involved in oil and gas production, exploration and
development and providing supplies to the oil and gas industry. Due to a
significant downturn in the oil and gas industry in the early 1980s, the Company
generated significant losses and was unable to meet its obligations, resulting
in its voluntary bankruptcy filing. Upon emergence from bankruptcy, the Company
had oil and gas interests and approximately $300 million in NOLs. Approximately
$143 million of these NOLs were available at December 31, 1996, to reduce the
Company's future federal taxable income. The Company believes that there is
currently no restriction on the ability of the Company to utilize its NOLs. If
the previously discussed pending business combination is consummated, an
ownership change of the Company will occur. This will result in significant
restrictions of the Company's ability to utilize NOLs during all taxable periods
after the date of the business combination.
EMPLOYEES
As of December 31, 1996, the Company employed approximately 550 persons.
Since its emergence from bankruptcy in 1986, the Company has not experienced any
work stoppages and believes its relations with its employees are good.
ITEM 2. PROPERTIES
The Company subleases its executive offices for an annual rent of
approximately $0.1 million from Equity Group Investments, Inc. ("EGI"), a
company affiliated with certain directors, officers, and stockholders of the
Company. The executive offices are located at Two North Riverside Plaza,
Chicago, Illinois 60606. The Company also leases a corporate office in Atlanta,
Georgia, for certain executives with an annual rent of approximately $0.1
million. Western Surety leases office space for its executive offices at 101
South Phillips Avenue, Sioux Falls, South Dakota 57102, under a lease expiring
in 2002. Western Surety's office space, consisting of approximately 81,600
square feet, is leased from a partnership in which Western Surety owns a 50%
interest. The annual rent, which is subject to annual adjustments, was $1.4
million as of December 31, 1996. Western Surety also leases a 7,900 square foot
branch office in Dallas, Texas. Annual rent for the branch office was $0.1
million and the lease expires in 1999. Universal Surety leases office space for
its executive offices at 950 Echo Lane, Suite 250, Houston, Texas 77024, under a
lease terminating October 31, 1999 with an annual rent of $0.2 million.
Universal Surety also leases space for branch offices in Austin, Dallas and San
Antonio, Texas; Overland Park, Kansas; Golden, Colorado; and Seattle,
Washington, for an additional annual rent of approximately $0.1 million.
13
<PAGE> 14
ITEM 3. LEGAL PROCEEDINGS
The Company and its subsidiaries are parties to numerous lawsuits arising
in the normal course of business, some seeking material damages. The Company
believes the resolution of these lawsuits will not have a material adverse
effect on its financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5.MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock ("Common Stock") trades on the New York Stock
Exchange under the symbol CSH. On March 7, 1997, the last reported sale price
for the Common Stock was $11.50 per share. The following table shows the range
of high and low sales prices for shares of the Common Stock as reported on the
New York Stock Exchange for each calendar quarter of the past two years:
<TABLE>
<CAPTION>
HIGH LOW
------ ------
<S> <C> <C>
1996
4th Quarter.......................................... $18.38 $ 8.00
3rd Quarter.......................................... 18.88 16.63
2nd Quarter.......................................... 18.75 15.75
1st Quarter.......................................... 17.63 15.00
1995
4th Quarter.......................................... $17.88 $13.13
3rd Quarter.......................................... 14.88 13.00
2nd Quarter.......................................... 14.88 12.50
1st Quarter.......................................... 14.38 12.38
</TABLE>
The number of stockholders of record of Common Stock on March 7, 1997, was
approximately 2,300.
On September 11, 1996, the Company declared a special cash distribution in
the amount of $10 per share of common stock, payable to all holders of record as
of September 25, 1996. The special distribution was paid on October 4, 1996. On
the first business day following payment of the distribution, the Common Stock
opened at a price $10 per share less than the previous business day's closing
price.
Prior to the special cash distribution, Capsure had not paid any dividends
to its stockholders. The Company does not anticipate paying any additional
dividends prior to the consummation of the previously discussed pending business
combination with CNAF.
14
<PAGE> 15
ITEM 6. SELECTED FINANCIAL DATA
The following financial information has been derived from the audited
Consolidated Financial Statements and notes thereto which appear elsewhere in
this or previously filed Annual Reports on Form 10-K and should be read in
conjunction with such financial statements and related notes thereto.
The Company acquired Western Surety in August 1992 and Universal Surety in
September 1994 and disposed of United Capitol on May 22, 1996. The inclusion of
the results of United Capitol through May 22, 1996, and of Western Surety and
Universal Surety from their respective dates of acquisition affects the
comparability of financial information. Such results are not necessarily
indicative of future results. Effective January 1, 1994, the Company adopted
SFAS No. 115. For a more detailed description of these transactions and their
effects on the Company's financial data, see the audited Consolidated Financial
Statements and related notes thereto and Management's Discussion and Analysis of
Financial Condition and Results of Operations appearing in this or previously
filed Annual Reports on Form 10-K.
The following information for the Company is as of and for the years ended
December 31 (dollars in thousands, except per share data):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------------------------
1996 1995 1994 1993 1992
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Total revenues............................ $110,650 $117,510 $112,555 $107,915 $ 57,133
======== ======== ======== ======== ========
Gross written premiums.................... $107,269 $111,398 $102,356 $100,775 $ 50,105
======== ======== ======== ======== ========
Net written premiums...................... $ 95,109 $ 97,728 $ 90,578 $ 88,306 $ 40,310
======== ======== ======== ======== ========
Net earned premiums....................... $ 92,491 $ 98,692 $ 92,481 $ 86,029 $ 41,249
======== ======== ======== ======== ========
Underwriting income....................... $ 19,233 $ 44,831 $ 15,233 $ 15,224 $ 9,932
Net investment income..................... 16,444 20,471 19,129 19,815 15,504
Net investment gains (losses)............. 1,715 (1,653) 945 2,071 380
Interest expense.......................... (1,717) (4,103) (4,726) (6,280) (4,838)
Write-off of unamortized deferred loan
fees.................................... (700) -- (1,556) -- --
Non-recurring compensation and merger
costs................................... (7,865) -- -- -- --
Amortization and impairment of goodwill
and intangibles......................... (2,761) (16,853) (3,365) (3,407) (1,592)
Other expenses, net....................... (2,789) (2,442) (1,881) (1,905) (1,914)
-------- -------- -------- -------- --------
Income before income taxes................ 21,560 40,251 23,779 25,518 17,472
Income taxes.............................. 8,181 19,721 9,401 9,234 6,777
-------- -------- -------- -------- --------
Net income................................ $ 13,379 $ 20,530 $ 14,378 $ 16,284 $ 10,695
======== ======== ======== ======== ========
Weighted average common shares
outstanding............................. 16,395 15,404 15,160 15,036 12,214
======== ======== ======== ======== ========
Earnings per common share................. $ .82 $ 1.33 $ .95 $ 1.08 $ .88
======== ======== ======== ======== ========
Cash distributions and dividends per
common share............................ $ 10.00 $ -- $ -- $ -- $ --
======== ======== ======== ======== ========
Book value per share...................... $ 7.76 $ 16.70 $ 14.61 $ 13.80 $ 12.25
======== ======== ======== ======== ========
Loss ratio................................ 10.9% (7.5)% 25.2% 23.2% 25.8%
Expense ratio............................. 68.3% 62.1% 58.3% 59.1% 50.1%
-------- -------- -------- -------- --------
Combined ratio............................ 79.2% 54.6% 83.5% 82.3% 75.9%
======== ======== ======== ======== ========
Invested assets and cash.................. $165,268 $307,556 $305,898 $317,077 $297,974
Intangible assets and goodwill, net of
amortization............................ 75,956 84,158 102,130 85,566 94,006
Total assets.............................. 313,139 514,768 553,370 530,075 507,574
Insurance reserves........................ 108,444 202,842 225,671 205,188 194,357
Long-term debt............................ 60,000 25,000 71,000 85,214 103,214
Total liabilities......................... 190,556 257,464 328,505 322,450 323,653
Stockholders' equity...................... 122,583 257,304 224,865 207,625 183,921
</TABLE>
15
<PAGE> 16
ITEM 7.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
The following is a discussion and analysis of Capsure Holdings Corp. and
its subsidiaries' ("Capsure" or the "Company") operating results, financial
condition, liquidity and capital resources. This discussion should be read in
conjunction with the audited Consolidated Financial Statements and notes
thereto, which contain additional information regarding the Company's operating
results and financial condition.
The Company, through its principal subsidiaries, Western Surety Company
("Western Surety"), acquired in August 1992, and Universal Surety of America
("Universal Surety"), acquired in September 1994, provides surety and fidelity
bonds in all 50 states through a combined network of 120,000 independent agents.
Western Surety specializes in writing small fidelity and noncontract surety
bonds, referred to as "miscellaneous" bonds, and errors and omissions ("E&O")
liability insurance and is licensed to write fidelity, surety and casualty
insurance in all 50 states and the District of Columbia. Western Surety is rated
A+ (Superior) by A.M. Best Company, Inc. ("A.M. Best"). Bonds underwritten by
Western Surety are relatively low-risk, low-premium products where prompt
service, easy-to-use forms and availability of an extensive array of bond
products are emphasized. One of the largest writers of miscellaneous bonds in
the United States, Western Surety has experienced overall growth in gross
written premiums since 1990 in spite of the soft market. This growth is
attributable to its product specialization, including new products and programs,
underwriting expertise and broad distribution network as well as to
legislatively mandated bond limit increases, and to bonding requirements
legislated by various states and municipalities. Substantially all of Western
Surety's bonds are mandated by various state statutes and local ordinances. Such
factors have largely insulated Western Surety from the effects of prevailing
market conditions in the broader commercial property and casualty insurance
industry. Management believes, with respect to Western Surety's products, that
the Company's results of operations will not be significantly affected by new
miscellaneous bond requirements or by the repeal of any existing legislated
bonding requirements.
Universal Surety specializes in the underwriting of small contract and
miscellaneous surety bonds. Universal Surety is rated A (Excellent) by A.M. Best
and is licensed in 37 states and the District of Columbia with most of its
business generated in Texas (74% of 1996 gross written premiums). Contract bonds
underwritten by Universal Surety, including those underwritten on behalf of
Western Surety under the USAWestern program, are primarily contractor
performance and payment bonds in amounts under $3.0 million for which
underwriting expertise and distinctive service to agents are emphasized.
Universal Surety underwrites primarily standard accounts and some specialty
accounts for which it utilizes supplemental collateral arrangements and excess
rates for contractors not qualified for standard surety rates. Universal Surety
also reduces its exposure through participation in the Small Business
Administration ("SBA") Surety Bond Guarantee Program. Under this program, the
SBA will generally reimburse Universal Surety for between 80% and 90% of losses
and loss adjustment expenses incurred on any SBA guaranteed bond in exchange for
20% of the premium. Contract bonds are more affected by prevailing market and
general economic conditions than noncontract bonds.
On May 22, 1996, the Company consummated the sale of United Capitol Holding
Company ("UCHC") and its subsidiaries, United Capitol Insurance Company ("United
Capitol"), United Capitol Managers, Inc. and Fischer Underwriting Group,
Incorporated ("Fischer"), to a subsidiary of Frontier Insurance Group, Inc. The
operating results of UCHC and its subsidiaries are reflected in Capsure's
results through the closing date. Net proceeds to Capsure of $77 million, which
included the purchase price for the capital stock of UCHC and the release of
United Capitol's excess statutory surplus at closing, approximated Capsure's
carrying value. The goodwill associated with the 1990 acquisition of United
Capitol was previously reduced to estimated net realizable value as of December
31, 1995, resulting in a $13.2 million impairment of goodwill in 1995.
On September 11, 1996, the Company declared a special cash distribution in
the amount of $10 per share of common stock, payable to all holders of record as
of September 25, 1996. The special distribution was paid on October 4, 1996 and
was funded from $62 million of borrowings under Capsure's revolving credit
16
<PAGE> 17
agreement and approximately $94 million from available cash and marketable
securities accumulated at the parent company level. In connection with the
payment of the special distribution, the Board of Directors also authorized a
corresponding repricing of all outstanding stock options. This resulted in a new
measurement date for the stock options under applicable accounting
pronouncements and required the Company to record in the third quarter of 1996 a
non-recurring compensation charge of $4.1 million, after applicable income
taxes, or 25 cents per share of which $3.6 million, or 22 cents per share, was
non-cash.
PENDING BUSINESS COMBINATION
On December 19, 1996, Capsure and certain direct and indirect subsidiaries
of CNA Financial Corporation ("CNAF") entered into a definitive Reorganization
Agreement pursuant to which Capsure will merge with a wholly-owned subsidiary of
CNA Surety Corporation ("CNA Surety"). CNAF, through its subsidiaries, will be
the majority stockholder of CNA Surety, owning 61.75 percent of the shares on a
fully diluted basis. The remaining shares will be issued to the existing Capsure
stockholders (a portion of these shares will be reserved for issuance to the
existing holders of Capsure options who will receive CNA Surety options in the
merger) in a tax-free exchange for their Capsure shares on a one-for-one basis.
The CNA Surety shares are expected to be traded on the New York Stock Exchange.
Equity Capsure Limited Partnership ("Equity Capsure"), Capsure's largest
stockholder with a 25.6 percent ownership interest, and certain other directors
of the Company have agreed to vote their shares in favor of the merger. The
agreement and the transactions contemplated thereby are subject to several
conditions, including ratification by the affirmative vote of Capsure
stockholders and approval by governmental and insurance regulatory authorities.
The completion of the merger pursuant to the Reorganization Agreement will
cause an ownership change under Section 382 of the Internal Revenue Code of
1986, as amended (the "Code") and significantly limit the future utilization of
Capsure's net operating tax loss carryforwards ("NOLs"). If the Reorganization
Agreement and transactions contemplated thereby are approved, Capsure
shareholders will be asked to approve an amendment to its Certificate of
Incorporation to delete a provision designed to facilitate the Company's ability
to preserve and utilize its NOLs.
RESULTS OF OPERATIONS
The components of income are summarized as follows (dollars in thousands):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------
1996 1995 1994
------- -------- -------
<S> <C> <C> <C>
Underwriting income.......................... $19,233 $ 44,831 $15,233
Net investment income........................ 16,444 20,471 19,129
Net investment gains (losses)................ 1,715 (1,653) 945
Interest expense............................. (1,717) (4,103) (4,726)
Write-off of unamortized deferred loan
fees....................................... (700) -- (1,556)
Non-recurring compensation and merger
costs...................................... (7,865) -- --
Amortization and impairment of goodwill and
intangibles................................ (2,761) (16,853) (3,365)
Other expenses, net.......................... (2,789) (2,442) (1,881)
------- -------- -------
Income before income taxes................... 21,560 40,251 23,779
Income taxes................................. 8,181 19,721 9,401
------- -------- -------
Net income......................... $13,379 $ 20,530 $14,378
======= ======== =======
</TABLE>
17
<PAGE> 18
INSURANCE UNDERWRITING
Underwriting results are summarized in the following table (dollars in
thousands):
<TABLE>
<CAPTION>
SURETY AND FIDELITY EXCESS AND SURPLUS LINES CONSOLIDATED
--------------------------- ---------------------------- ------------------------------
1996 1995 1994 1996 1995 1994 1996 1995 1994
------- ------- ------- ------- -------- ------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Gross written premiums.... $96,206 $90,564 $75,324 $11,063 $ 20,834 $27,032 $107,269 $111,398 $102,356
======= ======= ======= ======= ======== ======= ======== ======== ========
Net written premiums...... $91,282 $86,746 $73,527 $ 3,827 $ 10,982 $17,051 $ 95,109 $ 97,728 $ 90,578
======= ======= ======= ======= ======== ======= ======== ======== ========
Net earned premiums....... $89,261 $84,983 $73,255 $ 3,230 $ 13,709 $19,226 $ 92,491 $ 98,692 $ 92,481
------- ------- ------- ------- -------- ------- -------- -------- --------
Net losses and loss
adjustment.............. 8,444 7,579 11,592 1,610 (15,030) 11,752 10,054 (7,451) 23,344
Underwriting expenses..... 63,070 58,170 49,583 134 3,142 4,321 63,204 61,312 53,904
------- ------- ------- ------- -------- ------- -------- -------- --------
Total losses and
expenses................ 71,514 65,749 61,175 1,744 (11,888) 16,073 73,258 53,861 77,248
------- ------- ------- ------- -------- ------- -------- -------- --------
Underwriting income....... $17,747 $19,234 $12,080 $ 1,486 $ 25,597 $ 3,153 $ 19,233 $ 44,831 $ 15,233
======= ======= ======= ======= ======== ======= ======== ======== ========
Loss ratio................ 9.5% 8.9% 15.8% 49.8% (109.6)% 61.1% 10.9% (7.5)% 25.2%
Expense ratio............. 70.6% 68.5% 67.7% 4.2% 22.9% 22.5% 68.3% 62.1% 58.3%
------- ------- ------- ------- -------- ------- -------- -------- --------
Combined ratio............ 80.1% 77.4% 83.5% 54.0% (86.7)% 83.6% 79.2% 54.6% 83.5%
======= ======= ======= ======= ======== ======= ======== ======== ========
</TABLE>
Surety and fidelity represents the combined results of Western Surety and
Universal Surety, since its September 1994 acquisition. Surety and fidelity are
the principal lines of business of Western Surety and Universal Surety. Excess
and surplus lines represents the results of United Capitol through May 22, 1996.
United Capitol's principal lines of business were other liability, product
liability and commercial property primarily written on an excess and surplus
lines basis.
Gross written premiums decreased 3.7%, or $4.1 million, for the year ended
December 31, 1996. Surety and fidelity gross written premiums increased 6.2%, or
$5.6 million, reflecting strong growth in the contract surety and insurance
agents' and brokers' E&O businesses. Gross written premiums at Universal Surety
increased 25.1% to $21.1 million in 1996 due to an increase of $4.1 million in
contract surety premiums. Gross written premiums at Western Surety increased
1.9% to $75.1 million in 1996, reflecting strong growth in agents' E&O business,
and modest growth in core miscellaneous surety bond business. United Capitol's
gross written premiums decreased $9.8 million in 1996 as compared to a full year
in 1995.
Net earned premiums decreased 6.3%, or $6.2 million, for the year ended
December 31, 1996, reflecting a decrease of $10.5 million at United Capitol,
partially offset by an increase of $4.3 million in surety and fidelity
operations, primarily attributable to strong growth in contract surety. Net
earned premiums at Universal Surety increased 22.3% to $17.9 million in 1996.
Net earned premiums at Western Surety increased 1.4% to $71.3 million in 1996.
Gross written premiums increased 8.8%, or $9.0 million, for the year ended
December 31, 1995, primarily due to an increase of $12.8 million for the
inclusion of the full year results of Universal Surety in 1995, partially offset
by reduced premium volume at United Capitol. Universal Surety contributed $16.9
million of gross written premiums in 1995. Western Surety experienced a 2.0%
increase in gross written premiums, primarily due to the growth in the new
agents' and brokers' E&O product introduced in 1994. United Capitol's gross
written premiums decreased 22.9%, or $6.2 million, in 1995 as its premium
volume, particularly in the increasingly competitive asbestos abatement line,
continued to be significantly affected by prolonged soft market conditions.
Significant declines in the asbestos abatement and other primary casualty
business were partially offset by an increase in property writings.
Net earned premiums increased $6.2 million for the year ended December 31,
1995, principally due to the inclusion of the full year results of Universal
Surety in 1995. Universal Surety contributed net earned premiums of $14.7
million in 1995. Western Surety's net earned premiums increased 1.6% in 1995
compared to 1994. United Capitol's net earned premiums decreased 28.7%, or $5.5
million in 1995, reflecting decreases in both gross written premiums and net
retentions. The lower net retentions were due primarily to the increased use of
reinsurance for primary casualty risks in an effort to limit the potential loss
volatility associated with a diminished premium base. United Capitol's net
earned premiums for the years ended
18
<PAGE> 19
December 31, 1995 and 1994 were increased by $2.6 million and $2.5 million,
respectively, for contingent premiums recognized under its reinsurance
agreements.
Underwriting income decreased $25.6 million for the year ended December 31,
1996, reflecting a decrease of $1.5 million in surety and fidelity underwriting
income, and a decrease of $24.1 million for United Capitol. The consolidated
combined ratio increased to 79.2% in 1996 from 54.6% in 1995. The consolidated
loss ratio increased to 10.9% in 1996 from (7.5)% in 1995. The surety and
fidelity loss ratio increased moderately to 9.5% in 1996 from 8.9% in 1995,
principally due to a higher level of net favorable development of prior years'
loss reserves in 1995. Generally, the favorable loss trends recognized in the
fourth quarter of 1995 continued in 1996.
The consolidated expense ratio increased to 68.3% in 1996, compared to
62.1% in 1995. The surety and fidelity expense ratio increased to 70.6% in 1996
from 68.5% in 1995, reflecting costs associated with ongoing re-engineering and
automation efforts.
Underwriting income increased $29.6 million for the year ended December 31,
1995, primarily due to significant net favorable development of prior years'
loss reserves. The consolidated combined ratio decreased to 54.6% in 1995 from
83.5% in 1994. The consolidated loss ratio decreased to (7.5)% in 1995 from
25.2% in 1994. The surety and fidelity loss ratio decreased to 8.9% in 1995 from
15.8% in 1994, primarily due to $4.0 million in fourth quarter net favorable
development of prior years' loss reserves at Western Surety. United Capitol's
loss ratio decreased to (109.6)% in 1995 from 61.1% in 1994. Excluding the
effects of favorable development, United Capitol would have reported loss ratios
of 59.3% and 98.3% in 1995 and 1994, respectively.
United Capitol's claims development through December 31, 1995, had been
favorable relative to expectations based on industry experience. Due to the
limited prior operating experience of United Capitol and the long-tail nature of
its business, management previously relied principally upon industry development
patterns and expected loss ratios in estimating incurred but not reported
("IBNR") losses. Given the availability of nine full years of experience and the
growing evidence of favorable loss trends relative to industry indications,
management concluded in the fourth quarter of 1995 that it was appropriate to
place greater reliance on United Capitol's own development patterns and emerging
loss ratios in estimating IBNR. United Capitol reduced loss and loss adjustment
expenses by $23.2 million in 1995 for net favorable development related to prior
years, substantially all of which pertains to this change in estimate. This loss
reserve reduction increased Capsure's consolidated income before taxes by $23.2
million, and net income by $15.1 million, or $0.98 per share.
The consolidated expense ratio increased to 62.1% in 1995, compared to
58.3% in 1994. The surety and fidelity expense ratio increased slightly to 68.5%
in 1995 from 67.7% in 1994, reflecting increased operating expenses,
particularly, wage and postal expense increases. United Capitol's expense ratio
increased to 22.9% in 1995 compared to 22.5% in 1994.
INVESTMENT INCOME
Net investment income for the years ended December 31, 1996, 1995 and 1994
was $16.4 million, $20.5 million and $19.1 million, respectively. The decrease
in 1996 primarily reflected a net decrease in invested assets as a result of the
sale of United Capitol. The average pretax yields of the portfolio for the years
ended December 31, 1996, 1995 and 1994 were 7.0%, 6.8% and 6.5%, respectively.
Capsure's insurance companies invest funds provided by operations
predominantly in high-quality, short-duration, taxable fixed income securities.
The preservation of capital and utilization of the Company's available NOLs are
Capsure's principal investment objectives.
ANALYSIS OF OTHER OPERATIONS
Net investment gains (losses) were $1.7 million, $(1.7) million and $0.9
million for the years ended December 31, 1996, 1995 and 1994, respectively. Net
investment gains on securities held at the parent company level were $0.8
million in 1996, $1.0 million in 1995 and $1.3 million in 1994. Net investment
gains
19
<PAGE> 20
(losses) were $0.9 million, $(2.7) million and $(0.4) million, respectively,
from the insurance operations. The net investment losses from the insurance
operations in 1995 reflected the write-down of the carrying value for two
asset-backed securities from the same issuer which experienced an other than
temporary decline in fair value.
Amortization expense was $2.8 million for the year ended December 31, 1996,
$16.9 million in 1995 and $3.4 million in 1994. Amortization expense in 1996,
1995 and 1994 included $1.1 million, $1.2 million and $1.3 million,
respectively, of amortization of intangible assets and $1.7 million, $15.7
million and $2.1 million, respectively, of amortization of excess cost over net
assets acquired related to the acquisitions of Western Surety, Universal Surety,
United Capitol and Fischer. Amortization expense was not recorded in 1996 for
the goodwill associated with the United Capitol operations. Amortization expense
for 1995 included a $13.2 million write-down of goodwill associated with the
1990 United Capitol acquisition to reflect the estimated net realizable value on
the sale of those operations. Excess cost over net assets acquired is amortized
substantially over 40 years. Other intangible assets are amortized over periods
ranging from three to 20 years.
Interest expense decreased by 58.2%, or $2.4 million, to $1.7 million for
the year ended December 31, 1996, reflecting the effect of reduced average debt
outstanding. The Company's average debt outstanding for the year ended December
31, 1996, was approximately $20.4 million compared to $49.6 million in 1995. The
weighted average interest rates on outstanding balances were 6.3% and 6.9% for
the years ended December 31, 1996 and 1995, respectively. In connection with the
amendment of the Credit Facility (as herein defined) during the second quarter
of 1996, the Company incurred a $0.7 million write-off of unamortized deferred
loan fees in the year ended December 31, 1996. Interest expense decreased by
13.2%, or $0.6 million, to $4.1 million for the year ended December 31, 1995,
reflecting the effect of reduced debt. The Company's average debt outstanding
for the year ended December 31, 1995, was approximately $49.6 million compared
to $70.5 million in 1994. The weighted average interest rate on outstanding
balances was 5.7% for the year ended December 31, 1994. The Company incurred a
$1.6 million write-off of unamortized deferred loan fees in the year ended
December 31, 1994, associated with the early retirement of bank term loans.
In connection with the payment of the $10 per share special cash
distribution on October 4, 1996, the Board of Directors also authorized a
corresponding repricing of all outstanding stock options. This resulted in a new
measurement date for the stock options under applicable accounting
pronouncements and required the Company to record in the third quarter of 1996 a
non-recurring compensation charge of $4.1 million, after applicable income
taxes, or 25 cents per share of which $3.6 million, or 22 cents per share, was
non-cash.
In the fourth quarter of 1996, the Company incurred $1.1 million, after
applicable income taxes, or 7 cents per share, in merger-related costs
associated with the previously discussed pending business combination with CNAF.
INCOME TAXES
Income taxes were $8.2 million, $19.7 million and $9.4 million for the
years ended December 31, 1996, 1995 and 1994, respectively. The effective income
tax rates were 37.9%, 49.0% and 39.5%, respectively. The decrease in the 1996
effective tax rate was principally attributable to a decreased level of
nondeductible goodwill amortization. The increase in the 1995 effective tax rate
over 1994 was primarily due to the $13.2 million write-down of nondeductible
goodwill associated with the 1990 United Capitol acquisition. The Company's
income tax expense does not approximate actual taxes paid, primarily due to the
utilization of the Company's NOLs. Actual income taxes paid were $1.2 million
for the year ended December 31, 1996, $0.7 million for the year ended December
31, 1995 and $0.6 million for the year ended December 31, 1994.
LIQUIDITY AND CAPITAL RESOURCES
The Company's insurance subsidiaries are highly liquid. The insurance
operations derive liquidity from net premium collections, reinsurance recoveries
and investment earnings and use these funds to pay claims and operating
expenses. The operations of an insurance company generally result in cash being
collected from customers in the form of premiums in advance of cash outlays for
claims. Each insurance company invests its
20
<PAGE> 21
collected premiums, generating investment income, until such time cash is needed
to pay claims and associated expenses.
The Company believes total invested assets, including cash and short-term
investments, are sufficient in the aggregate and have suitably scheduled
maturities to satisfy all policy claims and other operating liabilities,
including anticipated income tax sharing payments of its insurance operations.
Management believes the duration of each insurance subsidiary's portfolio is
properly matched with the expected duration of its liabilities. At December 31,
1996, the carrying value of the Company's invested assets of the insurance
operations was comprised of $135.9 million of fixed maturities, $15.9 million of
short-term investments, $4.5 million of equity securities, $2.7 million of other
investments and $1.4 million of cash. At December 31, 1995, the carrying value
of the Company's invested assets of the insurance operations was comprised of
$235.7 million of fixed maturities, $33.1 million of short-term investments,
$16.2 million of equity securities, $3.2 million of other investments and $2.7
million of cash. The decrease in investments at December 31, 1996 compared to
the prior year primarily related to the net decrease in investments as a result
of the sale of United Capitol.
Cash flow at the parent company level is derived principally from dividend
and tax sharing payments from its insurance subsidiaries. The principal
obligations at the parent company level are to service debt and pay operating
expenses. At December 31, 1996, the carrying value of the Company's invested
assets of the non-insurance operations, principally at the parent company level,
was comprised of $3.5 million of short-term investments and $1.3 million of
cash. At December 31, 1995, the carrying value of the Company's invested assets
of the non-insurance operations, principally at the parent company level, was
comprised of $11.6 million of equity securities, $4.7 million of short-term
investments and $0.3 million of cash. The decrease in investments at December
31, 1996 compared to the prior year related to the payment of the special cash
distribution on October 4, 1996.
The Company's consolidated net cash flow provided by operating activities
was $31.1 million, $30.7 million and $29.3 million for the years ended December
31, 1996, 1995 and 1994, respectively. Consolidated operating cash flow (pretax
income excluding the write-off of deferred loan fees, non-recurring compensation
and merger costs, net investment gains (losses) and amortization and impairment
of goodwill and intangibles) for the year ended December 31, 1996, was $31.2
million as compared to $58.8 million in 1995 and $27.8 million in 1994.
On March 29, 1994, the Company entered into a senior reducing revolving
credit agreement with a syndicate of banks for $135 million (the "Credit
Facility"). At closing, $68 million of funds drawn under the Credit Facility,
together with a portion of the Company's cash, were used to repay $84.6 million
of previously existing bank term debt. The Company borrowed $28 million for the
acquisition of Universal Surety in September 1994.
Concurrent with the sale of UCHC and its subsidiaries, Capsure and its
lenders entered into an agreement to amend and restate the Credit Facility. The
amendment reduced the commitment to $100 million from $135 million and permitted
an initial draw of up to $70 million for a special distribution to stockholders.
The remaining availability may be used for additional dividends, stock
repurchases, acquisitions, and for general corporate purposes. Transaction costs
totaled approximately $0.5 million. The credit available under the Credit
Facility reduces semi-annually commencing March 31, 1997 and expires March 31,
2003. Interest on borrowings under the facility varies based on leverage.
On September 11, 1996, the Company declared a special cash distribution in
the amount of $10 per share of common stock, payable to all holders of record as
of September 25, 1996. The special distribution was paid on October 4, 1996 and
was funded from $62 million of borrowings under the Credit Facility and
approximately $94 million from available cash and marketable securities
accumulated at the parent company level.
Principal and interest payments required under the Credit Facility are
funded principally by dividend and intercompany tax sharing payments received
from Capsure's insurance subsidiaries.
21
<PAGE> 22
Capsure's insurance subsidiaries are subject to regulation and supervision
by the various state insurance regulatory authorities in which they conduct
business, including regulations with respect to the payment of dividends.
Without prior regulatory approval in 1997, Capsure's insurance subsidiaries may
pay stockholder dividends of $18.0 million in the aggregate. In 1996, 1995 and
1994, Capsure received $65.7 million (including $50.2 million of dividends
requiring prior approval), $40.9 million (including $21.6 million of dividends
requiring prior approval) and $21.0 million (including $5.0 million of dividends
requiring prior approval), respectively, in dividends from its insurance
subsidiaries. Capsure received $15.6 million, $21.9 million and $9.5 million in
dividends from its surety and fidelity subsidiaries in 1996, 1995 and 1994,
respectively.
Intercompany tax sharing agreements between Capsure and its subsidiaries
provide that income taxes shall be allocated based upon separate return
calculations in accordance with the Internal Revenue Code of 1986, as amended
(the "Code"). Intercompany tax payments are remitted at such times as estimated
tax payments would be required to be made to the Internal Revenue Service
("IRS"). Capsure received tax sharing payments from its subsidiaries of $17.3
million, $12.8 million and $12.3 million in 1996, 1995 and 1994, respectively,
of which $10.8 million, $8.3 million and $7.3 million, respectively, were from
its surety and fidelity subsidiaries.
On May 24, 1995, the Board of Directors of the Company approved a stock
repurchase plan. The plan authorizes the Company to repurchase up to 500,000
shares of its common stock. These shares may be purchased from time to time in
the public market or through privately negotiated transactions. As of December
31, 1996, no shares had been repurchased under this plan.
FINANCIAL CONDITION
A significant factor affecting the Company's financial condition is the
Company's policy with respect to investing insurance-related funds. The
Company's policy is to invest a substantial portion of such funds in
high-quality, short-duration mortgage pass-through instruments, collateralized
mortgage obligations ("CMOs") and other asset-backed securities. CMOs differ
from traditional fixed maturities in that they may expose the investor to yield
variability and even principal risk due to such factors as high mortgage
prepayment rates and defaults and delinquencies in the underlying asset pool.
Management believes it has reduced prepayment variability by investing only in
short tranches and by owning a substantial amount of planned amortization class
("PAC") tranches which have been structured largely to insulate the investor
from prepayment risk. A PAC tranche is structured to amortize in a predictable
manner and, therefore, the risk of prepayment of the underlying collateral is
shifted to other tranches, whose owners are willing to accept such risk.
Further, management believes it has minimized credit risk primarily by
purchasing only securities rated A or better on the date of acquisition and
which are collateralized or guaranteed by U.S. Government agencies or have
substantial credit enhancement in the form of financial guarantees, mortgage
insurance, letters of credit, over-collateralization, subordinated structures
and excess servicing spreads. Management monitors the investment portfolio of
the insurance subsidiaries and the current rating of each security owned on a
monthly basis.
The following table sets forth the composition by ratings assigned by The
Standard & Poors Corporation ("S&P") or Moody's Investor Services, Inc.
("Moody's") of the fixed income portfolio of the Company as of December 31, 1996
(dollars in thousands):
<TABLE>
<CAPTION>
AMORTIZED
CREDIT RATING COST PERCENT
------------- --------- -------
<S> <C> <C>
AAA/Aaa....................... $124,448 91.9%
AA/Aa......................... 757 .6
A/A........................... 10,215 7.5
-------- -----
Total............... $135,420 100.0%
======== =====
</TABLE>
Another critical factor affecting the Company's financial condition is the
Company's policies with respect to loss and loss adjustment expense reserves.
Each of Capsure's insurance subsidiaries employs prudent reserving approaches in
establishing the estimated liability for unpaid loss and loss adjustment
expenses due to
22
<PAGE> 23
the inherent difficulty and variability in the estimation process. The liability
for unpaid losses and loss adjustment expenses is based on estimates of (a) the
ultimate settlement value of reported claims, (b) IBNR claims, (c) future
expenses to be incurred in the settlement of claims and (d) claim recoveries.
The liability for unpaid losses and loss adjustment expenses is an accounting
estimate and, similar to other accounting estimates, there is the potential that
actual future loss payments will differ significantly from the initial estimate.
The methods of determining such estimates and the resulting estimated liability
are continually reviewed and updated. Changes in the estimated liability are
reflected in operating income in the year in which such changes are determined.
The following table presents selected loss and loss adjustment expense
information and highlights the impact of revisions to the estimated liability
established in prior years (dollars in thousands):
<TABLE>
<CAPTION>
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Gross balance at January 1................. $126,061 $149,041 $135,825
Balance at date of acquisition
(disposition)............................ (84,823) -- 2,738
Incurred related to:
Current year............................... 23,685 34,073 46,206
Prior years................................ (10,579) (34,559) (14,522)
-------- -------- --------
Total incurred................... 13,106 (486) 31,684
-------- -------- --------
Paid related to:
Current year............................... 3,390 4,150 3,003
Prior years................................ 12,080 18,344 18,203
-------- -------- --------
Total paid....................... 15,470 22,494 21,206
-------- -------- --------
Gross balance at December 31............... $ 38,874 $126,061 $149,041
======== ======== ========
Balance net of reinsurance at December
31....................................... $ 33,378 $ 87,078 $111,164
======== ======== ========
</TABLE>
As a result of favorable claim settlements and changes in estimates of
insured events in prior years, the provision for losses and loss adjustment
expenses decreased by $10.6 million ($6.9 million, net of reinsurance) in 1996,
$34.6 million ($29.1 million, net of reinsurance) in 1995 and $14.5 million
($8.3 million, net of reinsurance) in 1994. As described within Results of
Operations -- Insurance Underwriting, United Capitol reduced loss and loss
adjustment expenses by $23.2 million in 1995 for net favorable development
related to prior years.
The National Association of Insurance Commissioners ("NAIC") has
promulgated Risk-Based Capital ("RBC") requirements for property and casualty
insurance companies to evaluate the adequacy of statutory capital and surplus in
relation to investment and insurance risks such as asset quality, asset and
liability matching, loss reserve adequacy, and other business factors. The RBC
information will be used by state insurance regulators as an early warning tool
to identify, for the purpose of initiating regulatory action, insurance
companies that potentially are inadequately capitalized. In addition, the
formula defines new minimum capital standards that will supplement the current
system of fixed minimum capital and surplus requirements on a state-by-state
basis. Regulatory compliance is determined by a ratio (the "Ratio") of the
enterprise's regulatory total adjusted capital, as defined by the NAIC, to its
authorized control level RBC, as defined by the NAIC. Generally, a Ratio in
excess of 200% of authorized control level RBC requires no corrective actions on
the behalf of the company or regulators. As of December 31, 1996, each of
Capsure's insurance subsidiaries had a Ratio that was substantially in excess of
the minimum RBC requirements.
Capsure's insurance subsidiaries require capital to support premium
writings. In accordance with industry and regulatory guidelines, the net written
premiums to surplus ratio of a property and casualty insurer should not exceed 3
to 1 (the terms of the Credit Facility limit this ratio further to 2.75 to 1 for
Western Surety and Universal Surety). On December 31, 1996, Western Surety's
statutory surplus was $37.2 million and its net written premiums to surplus
ratio was 1.9 to 1. On December 31, 1996, Universal Surety's statutory surplus
was $11.7 million and its net written premiums to surplus ratio was 1.7 to 1.
The Company believes that each insurance company's statutory surplus is
sufficient to support its current and anticipated premium levels.
23
<PAGE> 24
The NAIC has developed a rating system (the Insurance Regulatory
Information System ("IRIS")), primarily intended to assist state insurance
departments in overseeing the financial condition of all insurance companies
operating within their respective states. IRIS consists of eleven key financial
ratios that address various aspects of each insurer's financial condition and
stability. In 1996, each of Western Surety's and USA's IRIS ratios fell within
all of the "usual ranges."
On July 31, 1986, the Company emerged from voluntary bankruptcy proceedings
under Chapter 11 of the United States Bankruptcy Code. As a result of operating
losses from oil and gas operations prior to the Company's bankruptcy, the
Company emerged from bankruptcy with approximately $300 million in NOLs.
Approximately $143 million of these NOLs were available at December 31, 1996 to
reduce the Company's future federal taxable income.
The IRS has not examined the Company's tax returns for the years in which
the Company reported net operating losses. Under Section 382 of the Code,
certain restrictions on the utilization of NOLs will apply if there is an
ownership change of a corporation entitled to use such carryovers. The Company
believes that there is currently no restriction on the ability of the Company to
utilize its NOLs. If the previously discussed pending business combination is
consummated, an ownership change of the Company will occur. This will result in
significant restrictions of the Company's ability to utilize NOLs during all
taxable periods after the date of the business combination.
ENVIRONMENTAL LIABILITIES
The Company was engaged in oil and gas production, exploration and
development until mid-1993. In connection with the sale of substantially all of
the Company's oil and gas properties, the buyers assumed all material
environmental liabilities. The Company is not aware of any federal, state or
local investigation nor has it received any notice or claim or entered into any
negotiations or agreements with any third parties relating to any material
liability or remedial action or potential material liability or potential
remedial action relating to environmental matters as a potentially responsible
party or otherwise. Accordingly, based upon (i) the absence of any notice of any
claim or action, (ii) the limited nature of the activities and interests
previously conducted by the Company in connection with its oil and gas interests
through its subsidiary Pin Oak Petroleum, Inc. following the Company's emergence
from bankruptcy in 1986, and (iii) the assumption by the purchasers of the
Company's oil and gas interests of all liabilities relating to such oil and gas
interests purchased, including environmental liabilities, and the agreement of
such purchasers to indemnify and hold the Company harmless from all such
liabilities, the Company does not believe that it has any material liability
under the environmental laws as a potentially responsible party.
IMPACT OF ADOPTING STATEMENTS OF FINANCIAL ACCOUNTING STANDARDS ("SFAS")
In October 1995, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 123, "Accounting for Stock-Based Compensation." SFAS No. 123 is
effective for fiscal years beginning after December 15, 1995. SFAS No. 123
introduces a preferable fair value-based method of accounting for stock-based
compensation. SFAS No. 123 encourages, but does not require, companies to
recognize compensation expense for grants of stock, stock options, and other
equity instruments to employees based on the new fair value-based method of
accounting. As permitted under SFAS No. 123, the Company has continued to apply
the existing accounting rules contained in Accounting Principles Board ("APB")
Opinion No. 25, "Accounting for Stock Issued to Employees," and related
interpretations, and has disclosed net income and earnings per share on a pro
forma basis, based on the new fair value-based method of accounting in Note 13
to the Consolidated Financial Statements.
IMPACT OF ACCOUNTING PRONOUNCEMENTS NOT YET ADOPTED
In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share." SFAS
No. 128 is effective for both interim and annual periods ending after December
15, 1997. SFAS No. 128 replaces APB Opinion No. 15, "Earnings Per Share." APB
Opinion No. 15 required that entities with simple capital structures present a
single earnings per common share ("EPS") on the face of the income statement,
whereas those with
24
<PAGE> 25
complex capital structures had to present both primary and fully diluted EPS.
SFAS No. 128 simplifies the computation of EPS by replacing the presentation of
primary EPS with a presentation of basic EPS and requires dual presentation of
basic and diluted EPS by entities with complex capital structures. Basic EPS
includes no dilution and is computed by dividing income available to common
stockholders by the weighted average number of common shares outstanding for the
period, whereas primary EPS includes the dilutive effect of common stock
equivalents, such as stock options. Diluted EPS reflects the potential dilution
of securities that could share in the earnings of an entity, similar to fully
diluted EPS. The Company intends to present basic and diluted EPS in financial
statements issued after the effective date.
25
<PAGE> 26
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
FINANCIAL:
Report of Independent Accountants........................... 38
Consolidated Balance Sheets as of December 31, 1996 and
1995...................................................... 39
Consolidated Statements of Income for the Years Ended
December 31, 1996, 1995 and 1994.......................... 40
Consolidated Statements of Changes in Stockholders' Equity
for the Years Ended December 31, 1996, 1995 and 1994...... 41
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1996, 1995 and 1994.......................... 42
Notes to Consolidated Financial Statements.................. 43
FINANCIAL STATEMENT SCHEDULES:
Schedule I -- Summary of Investments........................ 60
Schedule II -- Condensed Financial Information of
Registrant................................................ 61
Schedule III -- Supplementary Insurance Information......... 65
Schedule IV -- Reinsurance.................................. 66
Schedule V -- Valuation and Qualifying Accounts............. 67
Schedule VI -- Supplemental Information Concerning
Property -- Casualty Insurance Operations................. 68
</TABLE>
ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following sets forth the name, age, position and offices with the
Company, present principal occupation or employment and material occupations and
employment for the past five years of each person who is presently a director,
or an executive officer of the Company.
ROD F. DAMMEYER, age 56; Director of the Company since January 19, 1993;
Managing Director of EGI Corporate Investments, a division of Equity Group
Investments, Inc. ("EGI"), since January 1996; President and a director since
1985 and Chief Executive Officer since 1993 of Anixter International Inc.
("Anixter"); Director since 1992 and President and Chief Executive Officer since
1994 of Great American Management and Investment, Inc. ("GAMI"). Director of
ANTEC Corporation, Falcon Building Products, Inc. ("Falcon"), IMC Global Inc.,
Jacor Communications, Inc. ("Jacor"), Lukens Inc., Revco D.S., Inc. ("Revco"),
Sealy Corporation ("Sealy") and TeleTech Holdings, Inc. ("TeleTech"); Trustee of
several Van Kampen Merritt, Inc. Closed End Mutual Funds and Series Trusts.
HERBERT A. DENTON, age 49; Director of the Company since August 2, 1988;
President of Providence Capital, Inc. since February 1991.
BRADBURY DYER, III, age 54; Director of the Company since August 13, 1986;
General Partner, Paragon Associates and Paragon Associates II; Managing Agent,
Paragon Joint Venture; Director of Falcon and Roosevelt Financial Group, Inc.
TALTON R. EMBRY, age 50; Director of the Company since August 1, 1986;
Investment Advisor, Magten Asset Management Corp. ("Magten"); Co-Chairman of the
Board of Revco; Director of Anacomp, Inc., Combined Broadcasting Corporation,
BDK Holdings, Inc., Thermadyne Holdings Corp., and VARCO International Inc. See
"Litigation Relating to Director."
BRUCE A. ESSELBORN, age 54; Director of the Company since February 20, 1990
and President since June 24, 1992; Chairman of the Board from 1988 until May 22,
1996 and President and Chief Executive Officer from 1986 until May 22, 1996 of
UCHC and United Capitol.
26
<PAGE> 27
DAN L. KIRBY, age 50; Director of the Company since May 27, 1993; Executive
Vice President, General Counsel and Secretary of Western Surety since 1974.
JOE P. KIRBY, age 43; Director of the Company since May 27, 1993; President
from 1979 until 1995 and Chief Executive Officer of Western Surety since 1979.
DONALD W. PHILLIPS, age 48; Director of the Company since May 9, 1990;
President of the Company from March 28, 1990 until June 24, 1992; Senior Partner
of EGI Capital Markets, L.L.C. since January 2, 1997; Executive Vice President
of Equity Financial and Management Company ("Equity") since March 1990; Chairman
of the Board of Equity Institutional Investors, Inc. from July 1990 until
December 31, 1996; Director of SIT Investments Mutual Fund Group.
SHELI Z. ROSENBERG, age 55; Director of the Company since May 15, 1987;
Vice President since February 20, 1990; General Counsel of the Company from
February 20, 1990 until September 8, 1994; President and Chief Executive Officer
since November 1994, Executive Vice President from 1986 until 1994 and Director
of EGI; President and Chief Executive Officer since November 1994, Executive
Vice President from 1980 until 1994 and a Director of Equity; Principal of the
law firm of Rosenberg & Liebentritt, P.C.; Board Chair of Jacor; Chairman of the
Board of CFI Industries, Inc. ("CFI") from January 1994 until September 1994 and
Co-Chairman from September 1994 until March 1995; Director of American Classic
Voyages Co. ("American Classic"), Anixter, Falcon, Manufactured Home
Communities, Inc. ("MHC"), Revco and Sealy; Trustee of Equity Residential
Properties Trust ("Equity Residential"); Vice President of First Capital Benefit
Administrators, Inc. ("Benefits Administrators") from July 22, 1987 until
November 15, 1995. Benefits Administrators filed for a petition under the
Federal bankruptcy laws on January 3, 1995 which resulted in its liquidation on
November 15, 1995.
L.G. SCHAFRAN, age 58; Director of the Company since August 1, 1986;
Managing General Partner of L.G. Schafran & Associates; Director of Crown Books
Corporation, Dart Group Corporation, Delta - Omega Technologies, Inc.,
Glasstech, Inc., OXiGENE, Inc., Publicker Industries, Inc. and Trak-Auto
Corporation.
RICHARD I. WEINGARTEN, age 46; Director of the Company since March 2, 1994;
President of Richard Weingarten & Company, Inc. since 1991.
SAMUEL ZELL, age 55; Director of the Company since August 13, 1986;
Chairman of the Board and Chief Executive Officer of the Company since October
15, 1987; President of the Company from July 25, 1989 until March 27, 1990;
Chairman of the Board of Anixter, American Classic, Equity, EGI, Equity
Residential, and MHC; Co-Chairman of the Board of Revco; Director of Chart House
Enterprises, Inc., Quality Food Centers, Inc., Sealy, TeleTech and Ramco Energy,
p.l.c.; Trustee and beneficiary of the general partner of Equity Capsure, owner
of 25.6% of the Company's Common Stock.
ARTHUR A. GREENBERG, age 56; Senior Vice President of the Company since
January 1, 1989, and Treasurer of the Company since February 5, 1990; Chief
Financial Officer of the Company from July 25, 1989 until May 27, 1993;
Executive Vice President of EGI and Equity; President of Greenberg & Pociask,
Ltd.; Director of American Classic.
JOHN T. KNOX, JR., age 42; President and Chief Executive Officer of
Universal Surety Holding Corporation since 1986 and of Universal Surety since
1983.
STEPHEN T. PATE, age 50; President of Western Surety since May 1995;
Executive Vice President of Western Surety from October 1994 until May 1995;
employed at Continental Insurance Company from 1975 until 1994, most recently
serving as President of Continental Guaranty, the surety division of Continental
Insurance Company.
MARY JANE ROBERTSON, age 43; Senior Vice President and Chief Financial
Officer of the Company since May 27, 1993; Executive Vice President and Chief
Financial Officer of United Capitol from August 20, 1991 until May 22, 1996.
KELLY L. STONEBRAKER, age 42; Vice President and General Counsel of the
Company since September 8, 1994; officer at Rosenberg & Liebentritt, P.C. since
September 1990.
27
<PAGE> 28
LITIGATION RELATING TO DIRECTOR
On September 9, 1993, Mr. Embry and Magten, without admitting or denying
the allegations in a complaint by the SEC, consented to the entry of judgments
enjoining them from violating (and, in the case of Mr. Embry, aiding and
abetting violations of) anti-fraud and other provisions of the Securities
Exchange Act of 1934, as amended, the Investment Advisers Act of 1940, as
amended, and the Investment Company Act of 1940, as amended. The SEC's complaint
alleged principally that Mr. Embry failed to advise clients of certain personal
trades relevant to the clients' holdings, to obtain certain consents required
under applicable law in connection therewith and to comply with certain
reporting requirements. The complaint did not involve the securities of the
Company. As part of the settlement, Mr. Embry made a $1 million payment for the
benefit of certain of Magten's clients.
BOARD AND COMMITTEE MEETINGS
The Board has an Executive Committee which consists of Messrs. Dyer,
Esselborn and Zell. The Executive Committee did not hold any meetings in 1996.
The Executive Committee possesses and may exercise the full and complete
authority of the Board in the management and business affairs of the Company
during the intervals between the meetings of the Board. All action by the
Executive Committee is reported to the Board at its next meeting and such action
is subject to revision and alteration by the Board, provided that no rights of
third persons can be prejudicially affected by the subsequent action of the
Board. Vacancies on the Executive Committee are filled by the Board. However,
during the temporary absence of a member of the Executive Committee, due to
illness or inability to attend a meeting or for other cause, the remaining
member(s) of the Executive Committee may appoint a member of the Board to act in
the place and with all the authority of such absent member. The current members
of the Executive Committee will continue in office until the Committee is
dissolved, terminated or reorganized, or if such members are replaced.
The Company also has an Audit Committee which consists of Messrs. Denton,
Embry and Schafran. During 1996, the Audit Committee held two (2) meetings. The
Audit Committee has the power to (i) recommend to the Board the independent
certified public accountants to be selected to serve the Company, (ii) review
with the independent certified public accountants the planned scope and results
of the annual audit, their reports and recommendations, (iii) review with the
independent certified public accountants matters relating to the Company's
system of internal controls, and (iv) review the Company's policies with respect
to corporate governance, including policies relating to compliance with laws and
regulations and conflicts of interest.
The Company also has a Compensation Committee which consists of Messrs.
Dammeyer, Denton and Schafran. During 1996, the Compensation Committee held one
(1) meeting. The Compensation Committee reviews and makes recommendations
concerning proposals by management with respect to compensation, bonuses, stock
option grants, employment agreements and other benefits and policies regarding
such matters for the Company.
The Company also has an Investment Committee which consists of Messrs.
Dyer, Embry, Esselborn and Phillips. During 1996, the Investment Committee held
four (4) meetings. The Investment Committee establishes investment policies and
oversees the management of the Company's investment portfolio.
During 1996, six (6) meetings of the Board were held. All directors were
present at least for 75% of the meetings of the Board and the committees that
they were eligible to attend.
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
Under the rules of the SEC, the Company is required to report, based on its
review of reports to the SEC about transactions in its Common Stock furnished to
the Company and written representations of its directors, executive officers and
10% stockholders, that for 1996: 1) Arthur A. Greenberg filed a Form 4 late for
December 1996 on January 13, 1997 which reported the contribution of shares of
Common Stock to Equity Capsure by Equity Capsure's partners; and 2) Bruce A.
Esselborn filed a Form 4 late for December 1996 on
28
<PAGE> 29
February 13, 1997 which reported the exercise by Mr. Esselborn's wife of options
to purchase 5,000 shares of Common Stock.
ITEM 11. EXECUTIVE COMPENSATION
The following tables show information with respect to the annual
compensation (including option grants) for services rendered to the Company for
the years ended December 31, 1996, 1995 and 1994 by the chief executive officer
and those persons who were, at December 31, 1996, the other four most highly
compensated executive officers of the Company.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
OTHER ANNUAL ALL OTHER
SALARY BONUS COMPENSATION OPTIONS COMPENSATION
NAME AND PRINCIPAL POSITION YEAR ($) ($) ($) (#) ($)
--------------------------- ---- ------- ------- ------------ ------- ------------
<S> <C> <C> <C> <C> <C> <C>
Samuel Zell 1996 0 0 150,000(1) 5,000 0
Chairman of the Board 1995 0 0 150,000(1) 5,000 0
and Chief Executive 1994 0 0 150,000(1) 25,000 0
Officer of the Company
Bruce A. Esselborn 1996 387,500 751,250(2) 9,699(3) 0 767,105(4)
President of the Company 1995 387,500 300,000 441(3) 30,000 27,835(4)
1994 387,500 112,500 854(3) 5,000 24,828(4)
Mary Jane Robertson 1996 225,000 424,500(2) 0 0 149,331(5)
Senior Vice President and 1995 225,000 150,000 0 15,000 14,888(5)
Chief Financial Officer of 1994 200,000 30,000 0 8,500 14,914(5)
the Company
Dan L. Kirby 1996 250,000 125,000 432(6) 0 40,352(7)
Executive Vice President, 1995 250,000 125,000 420(6) 5,000 9,000(7)
General Counsel and 1994 250,000 250,000 408(6) 5,000 9,000(7)
Secretary of Western Surety
Joe P. Kirby 1996 250,000 125,000 372(8) 0 40,352(9)
President and Chief 1995 250,000 125,000 360(8) 5,000 9,000(9)
Executive Officer of 1994 250,000 250,000 0 5,000 9,000(9)
Western Surety
</TABLE>
- ---------------
(1) Mr. Zell received $150,000 in 1996, 1995 and 1994 for his services as
Chairman of the Board, Chief Executive Officer and Chairman of the Executive
Committee.
(2) Included a bonus related to the pending business combination negotiations of
$581,250 and $337,500 for Mr. Esselborn and Ms. Robertson, respectively.
(3) Included $9,699 in 1996, $441 in 1995 and $854 in 1994 of reimbursements of
personal investment advisory fees.
(4) Included (i) $8,724 in 1996, $13,700 in 1995 and $11,760 in 1994 of
Company-paid premiums on a life insurance policy owned by him; (ii) $4,500
in 1996, 1995 and 1994 of 401(k) plan Company matching contributions; (iii)
$8,881 in 1996, $9,635 in 1995 and $8,568 in 1994 of Company contributions
under a defined contribution retirement plan; (iv) $495,000 in 1996 paid in
connection with stock option repricing; and (v) $250,000 in 1996 paid in
consideration for signing a non-compete agreement with Frontier Insurance
Group, Inc. ("Frontier") related to the sale of United Capitol.
(5) Included (i) $4,500 in 1996, 1995 and 1994 of 401(k) plan Company matching
contributions; (ii) $10,323 in 1996, $10,388 in 1995 and $10,414 in 1994 of
Company contributions under a defined contribution retirement plan; and
(iii) $134,508 in 1996 paid in connection with stock option repricing.
(6) Included $432 in 1996, $420 in 1995 and $408 in 1994 of reimbursements of
health club dues.
(7) Included (i) $9,000 in 1996, 1995 and 1994 of 401(k) plan Company matching
and profit-sharing contributions; and (ii) $31,352 in 1996 paid in
connection with stock option repricing.
(8) Included $372 in 1996 and $360 in 1995 of reimbursements of health club
fees.
(9) Included (i) $9,000 in 1996, 1995 and 1994 of 401(k) plan Company matching
and profit-sharing contributions; and (ii) $31,352 in 1996 paid in
connection with stock option repricing.
29
<PAGE> 30
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
-------------------------
% OF POTENTIAL REALIZABLE
TOTAL VALUE AT ASSUMED
NUMBER GRANTED ANNUAL RATES OF STOCK
OF SECURITIES TO PRICE APPRECIATION
UNDERLYING EMPLOYEES EXERCISE OR FOR OPTION TERM
OPTIONS FISCAL BASE PRICE EXPIRATION --------------------------
NAME GRANTED(#)(1) YEAR (2) ($/SH) DATE 5%($)(3)(5) 10%($)(4)(5)
---- ------------- --------- ----------- ---------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C>
Samuel Zell............... 5,000 N/A 18.00(5) 5/23/06 28,971 67,924
Bruce A. Esselborn........ 0 -- -- -- 0 0
Mary Jane Robertson....... 0 -- -- -- 0 0
Dan L. Kirby.............. 0 -- -- -- 0 0
Joe P. Kirby.............. 0 -- -- -- 0 0
</TABLE>
- ---------------
(1) The Options granted during 1996 were exercisable after May 23, 1996.
(2) No employees were granted options in 1996.
(3) Assumes a price of $13.79 at the end of ten years.
(4) Assumes a price of $21.58 at the end of ten years.
(5) Option was repriced on October 7, 1996 to $8.00 per share as part of
Company-wide repricing of options as a result of the $10.00 per share
special distribution. The calculation for Potential Realizable Value is
based upon such repriced amount.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTION VALUE
<TABLE>
<CAPTION>
VALUE OF UNEXERCISED
NUMBER OF IN-THE-MONEY OPTIONS
UNEXERCISED OPTIONS AT
AT FY-END(#) FY-END($)
SHARES ACQUIRED VALUE EXERCISABLE/ EXERCISABLE/
NAME ON EXERCISE (#) REALIZED($) UNEXERCISABLE UNEXERCISABLE
---- ---------------- ----------- ------------------- --------------------
<S> <C> <C> <C> <C>
Samuel Zell....................... 0 0 50,000/15,000 389,750/125,000
Bruce A. Esselborn................ 0 0 176,250/18,750 1,937,094/157,031
Mary Jane Robertson............... 67,240 772,791 40,760/15,500 466,702/130,344
Dan L. Kirby...................... 10,810 97,290 54,190/0 558,726/0
Joe P. Kirby...................... 10,810 97,290 54,190/0 558,726/0
</TABLE>
COMPENSATION OF DIRECTORS
Samuel Zell, Chairman of the Board and Chief Executive Officer of the
Company, was compensated at the annual rate of $150,000 for his services as a
Director, Chairman of the Board, Chief Executive Officer and Member of the
Executive Committee during 1996. Such amount has been included in the Summary
Compensation Table. Other Directors, except for employees of the Company or its
subsidiaries, were compensated at the annual rate of $15,000 and received $500
for each meeting of the Board and committees of the Board of the Company which
they attended. Additionally, as of the date of the first Directors' meeting
following each Annual Meeting, each non-employee Director receives options to
purchase 5,000 shares at the fair market value as of the grant date.
Western Surety Company pays its non-Company or subsidiary employee
directors an annual retainer of $12,000. Mr. Greenberg and Mrs. Rosenberg, who
are members of such Board, each were compensated pursuant to this policy for
1996.
30
<PAGE> 31
EMPLOYMENT CONTRACTS AND TERMINATION
OF EMPLOYMENT AND CHANGE-IN-CONTROL ARRANGEMENTS
The Company and Mr. Esselborn have an agreement providing for the
continuation of Mr. Esselborn's employment on a rolling, two-year basis
commencing September 30, 1995, and continuing for a minimum period of two years
thereafter subject to automatic extension. On October 1, 1995 and on each day
thereafter, the employment period shall be extended automatically by one day
unless the Company or Mr. Esselborn notifies the other party that the employment
period will not be further extended. Thus, after October 1, 1995, until written
notice is received by either party, the employment period at any point in time
shall be two years. The agreement provides for a minimum salary of $387,500 with
annual salary adjustments determined by the Company, an annual bonus that is
mutually agreed upon by Mr. Esselborn and the Company and Company-paid premiums
for a $2,000,000 life insurance policy with Mr. Esselborn designating the
beneficiary and certain other employee benefits.
The Company and Mr. Esselborn had another agreement which paid Mr.
Esselborn $250,000 upon the consummation of the sale of UCHC and its
subsidiaries to Frontier. The Company and Mr. Esselborn entered into this
agreement as an inducement for Mr. Esselborn to personally enter into a two-year
non-competition and five-year employee non-solicitation agreement with Frontier.
Such amount is included in the "All Other Compensation" column of the Summary
Compensation Table.
The Company and United Capitol entered into an executive change in control
and termination benefits agreement with Lorraine Esselborn, the wife of Mr.
Esselborn and an employee of United Capitol from 1986 until its sale to
Frontier, which provided Mrs. Esselborn with certain payments upon the sale of
United Capitol. Mrs. Esselborn received a severance payment of $64,500 which was
equal to 150% of the sum of her 1996 base salary and 1995 bonus.
In 1996, the Company paid Mr. Esselborn $581,250, as a bonus in recognition
of his efforts in negotiating and executing the definitive Reorganization
Agreement and related transactions with certain subsidiaries of CNAF. Such
amount is included in the "Bonus" column of the Summary Compensation Table.
The Company and Ms. Robertson have an agreement providing for the
continuation of Ms. Robertson's employment on a rolling, two-year basis
commencing September 30, 1995, and continuing for a minimum period of two years
thereafter subject to automatic extension. On October 1, 1995 and on each day
thereafter, the employment period shall be extended automatically by one day
unless the Company or Ms. Robertson notifies the other party that the employment
period will not be further extended. Thus, after October 1, 1995, until written
notice is received by either party, the employment period at any point shall be
two years. The agreement provides for a minimum salary of $225,000 with annual
salary adjustments determined by the Company, an annual bonus that is mutually
agreed upon by Ms. Robertson and the Company and certain other employee
benefits.
In 1996, the Company paid Ms. Robertson $337,500, as a bonus in recognition
of her efforts in negotiating and executing the definitive Reorganization
Agreement and related transactions with certain subsidiaries of CNAF. Such
amount is included in the "Bonus" column of the Summary Compensation Table.
31
<PAGE> 32
COMPENSATION COMMITTEE INTERLOCKS AND
INSIDER PARTICIPATION
The members of the Company's Compensation Committee are Messrs. Dammeyer,
Denton and Schafran.
The following relationships existed during 1996:
Mrs. Rosenberg and Mr. Zell are executive officers and directors of the
Company and Mrs. Rosenberg is a director and member of the Compensation
Committee of Anixter, and Mr. Zell is an executive officer and director of
Anixter. Mr. Dammeyer is an executive officer and director of Anixter and is a
director and member of the Compensation Committee of the Company.
Mrs. Rosenberg is an executive officer and director of the Company and is a
trustee and member of the Compensation Committee of Equity Residential. Mr. Zell
is an executive officer and trustee of Equity Residential and an executive
officer and director of the Company.
For the year ended December 31, 1996, the Company paid approximately
$106,000 in fees for legal services to the law firm of Rosenberg & Liebentritt,
P.C. of which Mrs. Rosenberg and Mr. Stonebraker are members. For the year ended
December 31, 1996, the Company paid Seyfarth Shaw Fairweather & Geraldson
("Seyfarth") approximately $276,000. Mrs. Rosenberg's husband is a partner at
Seyfarth. Additionally, see "Certain Relationships and Related Transactions."
COMPENSATION COMMITTEE REPORT
ON EXECUTIVE COMPENSATION
The compensation policy of the Company for its executive officers
(including those named in the Summary Compensation Table) has been to pay base
salaries and annual bonuses that are both competitive and recognize the
accomplishment of the Company's stated goals of building a financial services
business primarily focusing on insurance. In addition, the Company established
the 1990 Stock Option Plan to provide long-term incentive opportunities for
employees, officers and directors of the Company.
The Chairman of the Board and Chief Executive Officer of the Company
received a $150,000 fee for serving in such capacities. This fee is not directly
tied to the performance of the Company but rather reflects the commencement of
the Company's strategic plan, the initial implementation of this plan and Mr.
Zell's contributions to it.
During 1995, the Company entered into new employment agreements with Mr.
Esselborn and Ms. Robertson. See "Employment Contracts and Termination of
Employment and Change-In-Control Arrangements" for a description of the
agreements. The Company entered into these agreements after the Company began
pursuing the sale of UCHC and its subsidiaries. The Company wanted to
incentivize Mr. Esselborn and Ms. Robertson to remain with the Company both
during the sale's process and after the sale was completed and to insure the
stability and efficient operation of the Company.
During 1996, the Company paid Mr. Esselborn and Ms. Robertson bonuses equal
to 18 months of their base salary in recognition of their efforts in negotiating
and executing the definitive Reorganization Agreement and related transactions
with certain subsidiaries of CNAF. Additionally, in connection with the possible
sale or merger of the Company, a plan was adopted pursuant to which the Company
will provide severance benefits and transaction or retention bonuses to be paid,
under certain circumstances, to certain other officers and employees. This plan
was designed to (i) incentivize key employees to effectuate the consummation of
the merger with CNA Surety; (ii) keep employees in place during the failure or
completion of the merger with CNA Surety; and (iii) compensate employees for the
loss of their employment.
Long-term incentive opportunities were made available to each of the
executive officers (other than the Chief Executive Officer) in the form of
significant grants of stock options at the time of the Company's respective
acquisitions of United Capitol and Western Surety. These options were designed
to promote the long-term interests between such individuals and the Company's
stockholders and to assist in the retention of
32
<PAGE> 33
such officers. During 1996, given the sale discussions underway at the Company,
no options were granted to any employees.
Also, during 1996, the Board of Directors authorized the repricing of all
outstanding stock options due to the $10.00 per share special cash distribution
paid to stockholders. Options with exercise prices less than $10.00 per share
were repriced to $.05 per share, the par value of the Common Stock, and the
optionee received a cash payment for the difference. The Board of Directors
authorized the repricing of all of the options because it felt the reduction in
the stock price caused by the distribution would be a permanent reduction and
would reduce the value of the options to the optionees. For tax purposes, over
90% of the distribution was return of capital. On Friday, October 4, 1996, the
date of the distribution, the Common Stock closed at $18.00 per share. On
Monday, October 7, 1996, the Common Stock opened for trading at $8.00 per share.
It is the policy of the Company to structure its compensation in a manner
which will avoid the limitations imposed by the Omnibus Budget Reconciliation
Act of 1993 on the deductibility of executive compensation under Section 162 (m)
of the Internal Revenue Code of 1986, as amended, to the extent it can
reasonably do so consistent with its goal of retaining and motivating its
executives in a cost effective manner.
Rod F. Dammeyer
Herbert A. Denton
L.G. Schafran
33
<PAGE> 34
PERFORMANCE GRAPH
Below is a graph comparing total stockholder return on the Company's Common
Stock over the last five years with a broad equity market index, the S&P
Property and Casualty Insurance Index, and a published industry index, the S&P
500, as required by the rules of the SEC.
<TABLE>
<CAPTION>
Measurement Period Capsure Holdings S&P 500 ($) S&P Property &
(Fiscal Year Covered) Corp. ($) Casualty ($)
<S> <C> <C> <C>
1991 100.00 100.00 100.00
1992 191.23 107.62 117.11
1993 189.47 118.46 115.04
1994 205.26 120.03 120.67
1995 247.37 165.13 165.39
1996 340.74 203.05 198.53
</TABLE>
34
<PAGE> 35
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of March 7, 1997, except as noted,
certain information with respect to each person or entity who is known by the
management of the Company to be the beneficial owner of more than 5% of the
outstanding shares of the Company's Common Stock:
<TABLE>
<CAPTION>
NAME AND ADDRESS OF AMOUNT AND NATURE PERCENT
BENEFICIAL OWNER OF BENEFICIAL OWNERSHIP(1) OF CLASS
------------------- -------------------------- --------
<S> <C> <C>
Equity Capsure Limited Partnership(2)........... 4,039,622(3) 25.6%
Two N. Riverside Plaza
Chicago, IL 60606
Shapiro Capital Management Company Inc.(4)...... 1,253,698(4) 7.9%
3060 Peachtree Road N.L.P.
Atlanta, GA 30305
</TABLE>
- ---------------
(1) The number of shares of the Company's Common Stock indicated as beneficially
owned is reported on the basis of regulations of the SEC governing the
determination of beneficial ownership of securities.
(2) Equity Capsure Limited Partnership, an Illinois limited partnership ("Equity
Capsure"), is comprised of five partners: the Samuel Zell Revocable Trust
with Samuel Zell as Trustee; the Ann Lurie Revocable Trust with Ann Lurie
and Mark Slezak as Co-Trustees; LFT Partnership; Alphabet Partners and ZFT
Partnership. The Samuel Zell Revocable Trust, of which Samuel Zell, Chairman
of the Board and Chief Executive Officer of the Company, is trustee and
beneficiary, is the sole general partner of Equity Capsure. Sheli Z.
Rosenberg is the sole trustee of the 10 trusts which are the partners of ZFT
Partnership and Arthur A. Greenberg is the sole trustee of the 15 trusts
which are the partners of Alphabet Partners. Messrs. Zell and Greenberg and
Ms. Rosenberg may be deemed to be the beneficial owner of the shares of the
Company's Common Stock owned by Equity Capsure but they each disclaim
beneficial ownership of these shares.
(3) The shares are held by three institutions as collateral for loans to Equity
Capsure. Under the loan agreements, the institutions cannot vote or exercise
any ownership rights relating to the pledged shares unless there is an event
of default thereunder.
(4) Pursuant to a Schedule 13G filed with the SEC for calendar year 1996,
Shapiro Capital Management Company, Inc. ("Shapiro") is a registered
investment advisor. One or more of Shapiro's advisory clients is the legal
owner of 861,998 shares of Common Stock. Pursuant to the investment advisory
agreements with its clients, Shapiro has the authority to direct the
investments of its advisory clients. Samuel R. Shapiro is the president,
director and majority shareholder of Shapiro. Mr. Shapiro's wife was also
the beneficial owner of 38,000 shares of Common Stock. Additionally, the
Kaleidoscope Fund, L.P. ("Kaleidoscope") was the beneficial owner of 353,700
shares of Common Stock. Shapiro is the general partner of Kaleidoscope.
35
<PAGE> 36
SECURITY OWNERSHIP OF MANAGEMENT
The following information is furnished as of March 7, 1997, with respect to
the shares of the Company's Common Stock beneficially owned by each director and
by those executive officers named in the Summary Compensation Table and by all
directors and executive officers (17 persons) as a group. Information concerning
the directors and officers and their security holdings has been furnished by
them to the Company.
<TABLE>
<CAPTION>
SHARES UPON
NAME OF SHARES OF EXERCISE OF STOCK PERCENT OF
BENEFICIAL OWNER COMMON STOCK OPTIONS(1) TOTAL(2) CLASS
---------------- ------------ ----------------- --------- ----------
<S> <C> <C> <C> <C>
Rod F. Dammeyer.................. 0 20,000 20,000 *
Herbert A. Denton................ 27,860 20,000 47,860 *
Bradbury Dyer, III............... 546,158(3) 40,000 586,158 3.7%
Talton R. Embry.................. 32,175(4) 40,000 72,175 *
Bruce A. Esselborn............... 83,507(5) 182,500 266,007 1.7%
Dan L. Kirby..................... 66,365 54,190 120,555 *
Joe P. Kirby..................... 51,885 54,190 106,075 *
Donald W. Phillips............... 0 40,000 40,000 *
Mary Jane Robertson.............. 68,740 52,510 121,250 *
Sheli Z. Rosenberg............... 4,062,328(6) 40,000 4,102,328 26.0%
L.G. Schafran.................... 13,768(7) 40,000 53,768 *
Richard I. Weingarten............ 0 15,000 15,000 *
Samuel Zell...................... 4,039,622(6) 50,000 4,089,622 25.9%
All directors and executive
officers as a group (17
persons) including the
above-named persons............ 5,272,881 678,608 5,951,489 37.6%
</TABLE>
- ---------------
* Less than 1%
(1) Represents beneficial ownership of shares that may be acquired by the
exercise of stock options which are currently exercisable or exercisable
within sixty days of the date of this table.
(2) The amounts of the Company's Common Stock and stock options beneficially
owned are reported on the basis of regulations of the SEC governing the
determination of beneficial ownership of securities.
(3) Includes 544,258 shares of the Company's Common Stock owned by Paragon Joint
Venture ("Paragon"). Paragon is a joint venture formed by Paragon Associates
and Paragon Associates II, both Texas limited partnerships. Mr. Dyer is the
sole general partner of Paragon Associates and Paragon Associates II. Under
the terms of the joint venture agreement of Paragon, each partner has
beneficial ownership in proportion to its respective account in Paragon. Mr.
Dyer does not have full direct ownership; however, as the general partner of
the partners of Paragon, he may be deemed to have beneficial ownership.
(4) The 32,175 shares are owned as follows: 300 shares are owned by Mr. Embry;
14,400 shares are owned by the Magten Asset Management Corp. Pension Plan &
Trust; 1,675 shares are owned by Mr. Embry's minor children; 300 shares are
owned by Mr. Embry's wife; and 15,500 shares are owned by the Magten Asset
Management Profit Sharing Plan.
(5) Includes 8,500 shares beneficially owned by Mr. Esselborn's wife.
(6) Includes 4,039,622 shares of the Company's Common Stock owned by Equity
Capsure. Under regulations of the SEC, Mr. Zell and Mrs. Rosenberg may be
deemed to be the beneficial owners of the shares of the Company's Common
Stock owned by Equity Capsure (see notes (2) and (3) under "Security
Ownership of Certain Beneficial Owners"), but they each disclaim beneficial
ownership of these shares.
(7) Shares are beneficially owned by Mr. Schafran's spouse. Mr. Schafran
disclaims beneficial ownership of such shares.
36
<PAGE> 37
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company subleases office space from EGI, a company affiliated with
Equity Capsure, at Two North Riverside Plaza, Chicago, Illinois 60606. In
addition, EGI provides the Company with certain administrative and office
facility services and charges for such services are included in the rent. The
Company paid approximately $86,000 during 1996 for such services.
Various affiliates of Equity Capsure have provided services with respect to
certain aspects of the Company's business including, but not limited to,
financial and accounting services, tax services, computer services, investor
relations services and support services and expenses. During 1996, the Company
paid or was billed approximately $189,000 for such services.
The Company also provides financial management services to various
affiliates of Equity Capsure. During 1996, the Company received approximately
$20,000 for such services which also included reimbursement of overhead charges.
The executive officers listed below were indebted to the Company in 1996 as
a result of the Company lending the executive officers money to exercise
incentive stock options. The loans, which were outstanding from September 25 to
October 4, 1996, bore imputed interest only at 6.02% which was the applicable
federal rate, as defined in the Code, at the time the loans were made.
<TABLE>
<CAPTION>
LARGEST PRINCIPAL
AMOUNT OWED PRINCIPAL BALANCE AT
NAME IN 1996 DECEMBER 31, 1996
---- ----------------- --------------------
<S> <C> <C>
Mary Jane Robertson..................... $504,338.75 $0
Dan L. Kirby............................ 99,992.50 0
Joe P. Kirby............................ 99,992.50 0
</TABLE>
37
<PAGE> 38
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
(a)(1) FINANCIAL:
Report of Independent Accountants........................... 38
Consolidated Balance Sheets as of December 31, 1996 and
1995...................................................... 39
Consolidated Statements of Income for the Years Ended
December 31, 1996, 1995 and 1994.......................... 40
Consolidated Statements of Changes in Stockholders' Equity
for the Years Ended December 31, 1996, 1995 and 1994...... 41
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1996, 1995 and 1994.......................... 42
Notes to Consolidated Financial Statements.................. 43
(a)(2) FINANCIAL STATEMENT SCHEDULES:
Schedule I -- Summary of Investments...................... 60
Schedule II -- Condensed Financial Information of
Registrant................................................ 61
Schedule III -- Supplementary Insurance Information......... 65
Schedule IV -- Reinsurance................................. 66
Schedule V -- Valuation and Qualifying Accounts............ 67
Schedule VI -- Supplemental Information Concerning
Property -- Casualty Insurance Operations................. 68
(a)(3) EXHIBITS.................................................... 69
(b) REPORTS ON FORM 8-K:
December 27, 1996: Capsure and certain direct and indirect
subsidiaries of CNA Financial Corporation entered into a
definitive Reorganization Agreement to merge
Capsure with a wholly-owned subsidiary of CNA
Surety Corporation.
</TABLE>
38
<PAGE> 39
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
Capsure Holdings Corp.
We have audited the accompanying consolidated financial statements and
financial statement schedules of Capsure Holdings Corp. and Subsidiaries listed
in the index contained in Item 8 of this Form 10-K. These consolidated financial
statements and financial statement schedules are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements and financial statement schedules 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 consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
the significant estimates made by management, as well as evaluating the overall
consolidated 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
Capsure Holdings Corp. and Subsidiaries as of December 31, 1996 and 1995, and
the consolidated results of their operations and their cash flows for each of
the three years in the period ended December 31, 1996 in conformity with
generally accepted accounting principles. In addition, in our opinion, the
financial statement schedules referred to above, when considered in relation to
the basic consolidated financial statements taken as a whole, present fairly, in
all material respects, the information required to be included therein.
COOPERS & LYBRAND L.L.P.
Chicago, Illinois
February 20, 1997
39
<PAGE> 40
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1996 1995
-------- --------
<S> <C> <C>
ASSETS
Invested assets and cash:
Fixed maturities, at fair value (amortized cost: $135,420;
$233,276).............................................. $135,895 $235,718
Equity securities, at fair value (cost: $3,687;
$27,124)............................................... 4,526 27,753
Short-term investments, at cost which approximates fair
value.................................................. 19,416 37,865
Other investments, at fair value.......................... 2,695 3,219
Cash...................................................... 2,736 3,001
-------- --------
165,268 307,556
Deferred policy acquisition costs........................... 28,523 27,057
Reinsurance receivable...................................... 5,642 40,097
Intangible assets, net of amortization...................... 14,024 15,715
Excess cost over net assets acquired, net of amortization... 61,932 68,443
Deferred income taxes, net of valuation allowance........... 16,019 29,293
Other assets................................................ 21,731 26,607
-------- --------
Total assets...................................... $313,139 $514,768
======== ========
LIABILITIES
Reserves:
Unpaid losses and loss adjustment expenses................ $ 38,874 $126,061
Unearned premiums......................................... 69,570 76,781
-------- --------
108,444 202,842
Long-term debt.............................................. 60,000 25,000
Other liabilities........................................... 22,112 29,622
-------- --------
Total liabilities................................. 190,556 257,464
-------- --------
Commitments and contingencies
STOCKHOLDERS' EQUITY
Preferred stock, par value $.01 per share, 5,000,000 shares
authorized;
none issued and outstanding............................... -- --
Common stock, par value $.05 per share, 25,000,000 shares
authorized; 15,804,749 shares issued at December 31, 1996;
15,408,749 shares issued at December 31, 1995............. 790 770
Additional paid-in capital.................................. 118,413 179,276
Retained earnings from August 1, 1986 (date of
reorganization)........................................... 2,297 75,286
Unrealized gain on securities, net of deferred income
taxes..................................................... 1,083 1,972
-------- --------
Total stockholders' equity........................ 122,583 257,304
-------- --------
$313,139 $514,768
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
40
<PAGE> 41
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Revenues:
Net earned premiums...................................... $ 92,491 $ 98,692 $ 92,481
Net investment income.................................... 16,444 20,471 19,129
Net investment gains (losses)............................ 1,715 (1,653) 945
-------- -------- --------
110,650 117,510 112,555
-------- -------- --------
Expenses:
Net loss and loss adjustment expenses.................... 10,054 (7,451) 23,344
Net commissions, brokerage and other underwriting........ 63,204 61,312 53,904
Interest expense......................................... 1,717 4,103 4,726
Write-off of unamortized deferred loan fees.............. 700 -- 1,556
Non-recurring compensation and merger costs.............. 7,865 -- --
Amortization and impairment of goodwill and
intangibles........................................... 2,761 16,853 3,365
Other expenses, net...................................... 2,789 2,442 1,881
-------- -------- --------
89,090 77,259 88,776
-------- -------- --------
Income before income taxes................................. 21,560 40,251 23,779
Income taxes............................................... 8,181 19,721 9,401
-------- -------- --------
Net income................................................. $ 13,379 $ 20,530 $ 14,378
======== ======== ========
Weighted average shares outstanding:
Primary.................................................. 16,395 15,404 15,160
======== ======== ========
Fully diluted............................................ 16,510 15,917 15,455
======== ======== ========
Earnings per share:
Primary.................................................. $ .82 $ 1.33 $ .95
======== ======== ========
Fully diluted............................................ $ .81 $ 1.29 $ .93
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
41
<PAGE> 42
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Common Stock:
Balance, January 1....................................... $ 770 $ 770 $ 753
Common stock issued...................................... -- -- 15
Common stock issued through exercise of warrants and
options............................................... 20 -- 2
-------- -------- --------
Balance, December 31..................................... $ 790 $ 770 $ 770
======== ======== ========
Additional Paid-In Capital:
Balance, January 1....................................... $179,276 $179,250 $165,257
Common stock issued...................................... -- -- 3,985
Common stock issued through exercise of warrants and
options............................................... 2,283 26 8
Return of capital distribution on common stock........... (69,880) -- --
Change in valuation allowance for deferred tax assets.... -- -- 10,000
Stock option repricing................................... 6,734 -- --
-------- -------- --------
Balance, December 31..................................... $118,413 $179,276 $179,250
======== ======== ========
Retained Earnings:
Balance, January 1....................................... $ 75,286 $ 54,756 $ 40,378
Net income............................................... 13,379 20,530 14,378
Dividend on common stock................................. (86,368) -- --
-------- -------- --------
Balance, December 31..................................... $ 2,297 $ 75,286 $ 54,756
======== ======== ========
Unrealized Gain (Loss) on Securities, Net of Deferred
Income Taxes:
Balance, January 1....................................... $ 1,972 $ (9,830) $ 1,318
Impact of adopting SFAS No. 115.......................... -- -- 3,203
Transfer of held-to-maturity securities.................. -- 224 --
Change for the year...................................... (889) 11,578 (14,351)
-------- -------- --------
Balance, December 31..................................... $ 1,083 $ 1,972 $ (9,830)
======== ======== ========
Treasury Stock:
Balance, January 1....................................... $ -- $ (81) $ (81)
Common stock reissued through exercise of options........ -- 81 --
-------- -------- --------
Balance, December 31..................................... $ -- $ -- $ (81)
======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
COMMON STOCK
-------------------------
ISSUED IN TREASURY
---------- -----------
<S> <C> <C>
Shares:
Balance, January 1, 1994.................................. 15,055,231 (13,666)
Common stock issued through exercise of warrants and
options................................................ 45,481 --
Common stock issued in connection with Universal Surety
Holding Corp. acquisition.............................. 307,103 --
---------- -------
Balance, December 31, 1994................................ 15,407,815 (13,666)
Common stock reissued from treasury through exercise of
options................................................ -- 13,666
Common stock issued through exercise of options........... 934 --
---------- -------
Balance, December 31, 1995................................ 15,408,749 --
Common stock issued through exercise of options........... 396,000 --
---------- -------
Balance, December 31, 1996................................ 15,804,749 --
========== =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
42
<PAGE> 43
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------
1996 1995 1994
--------- --------- ---------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income............................................ $ 13,379 $ 20,530 $ 14,378
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization...................... 4,822 18,272 4,617
Accretion of bond discount, net.................... (409) (2,471) (3,933)
Net investment (gains) losses...................... (1,715) 1,653 (945)
Non-recurring compensation and merger costs........ 7,865 -- --
Changes in:
Reserves for unpaid losses and loss adjustment
expenses......................................... (2,364) (22,980) 10,477
Reserve for unearned premiums...................... 5,457 151 (1,160)
Deferred income taxes, net......................... 7,291 18,086 8,820
Other assets and liabilities....................... (3,193) (2,502) (2,970)
--------- --------- ---------
Net cash provided by operating activities............... 31,133 30,739 29,284
--------- --------- ---------
INVESTING ACTIVITIES:
Securities available-for-sale:
Purchases -- fixed maturities...................... (73,862) (108,924) (93,452)
Sales -- fixed maturities.......................... 67,380 71,889 43,762
Maturities -- fixed maturities..................... 46,935 63,315 35,020
Purchases -- equity securities..................... (190) (3,165) (28,350)
Sales -- equity securities......................... 22,451 6,225 8,091
Change in short-term investments...................... 855 (15,786) 47,881
Net proceeds from the sale of UCHC.................... 28,024 -- --
Acquisitions, net of cash acquired.................... -- -- (26,175)
Proceeds from sale of other invested assets........... 508 1,821 1,733
Capital expenditures, net............................. (2,948) (1,351) (1,679)
--------- --------- ---------
Net cash provided by (used in) investing activities..... 89,153 14,024 (13,169)
--------- --------- ---------
FINANCING ACTIVITIES:
Proceeds from long-term debt.......................... 62,000 -- 96,000
Principal payments on long-term debt.................. (27,000) (46,000) (110,214)
Dividends paid........................................ (156,248) -- --
Exercise of warrants and options, net of option
repricing payments................................. 1,186 107 10
Debt issuance costs................................... (489) -- (1,060)
--------- --------- ---------
Net cash used in financing activities................... (120,551) (45,893) (15,264)
--------- --------- ---------
Increase (decrease) in cash............................. (265) (1,130) 851
Cash at beginning of year............................... 3,001 4,131 3,280
--------- --------- ---------
Cash at end of year..................................... $ 2,736 $ 3,001 $ 4,131
========= ========= =========
Supplemental Disclosure of Cash Flow Information:
Cash paid during the year for:
Interest........................................... $ 1,426 $ 3,759 $ 4,121
Income taxes, net of refunds....................... $ 1,195 $ 658 $ 642
Supplemental Disclosure of Non-Cash Investing and
Financing Activities:
Common stock issued in connection with
acquisitions..................................... $ -- $ -- $ 4,000
</TABLE>
The accompanying notes are an integral part of these financial statements.
43
<PAGE> 44
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of Capsure
Holdings Corp. and all significant majority-owned subsidiaries ("Capsure" or the
"Company"). Capsure provides surety and fidelity bonds in all 50 states through
a combined network of 120,000 independent agents. Capsure's principal
subsidiaries are Western Surety Company ("Western Surety"), acquired in August
1992, and Universal Surety of America ("Universal Surety"), acquired in
September 1994. Western Surety writes small fidelity and noncontract surety
bonds, referred to as "miscellaneous" bonds, and errors and omissions liability
insurance, as a licensed insurer in all 50 states and the District of Columbia.
Western Surety's sister company, Surety Bonding Company of America, writes
similar business and is licensed in 17 states. Universal Surety specializes in
the underwriting of small contract and miscellaneous surety bonds. Universal
Surety is licensed in 37 states and the District of Columbia with most of its
business generated in Texas.
Basis of Presentation
The accompanying consolidated financial statements have been prepared in
accordance with generally accepted accounting principles. 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 and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates. Certain balances in the prior years' financial statements
have been reclassified to conform to current presentation.
Investments
The Company has the ability to hold all debt securities to maturity.
However, the Company may dispose of securities prior to their scheduled maturity
due to changes in interest rates, prepayments, tax and credit considerations,
liquidity or regulatory capital requirements, or other similar factors. As a
result, the Company considers substantially all of its debt (bonds and
redeemable preferred stocks) and equity securities as available-for-sale.
Certain equity securities at the parent company level that are held principally
for the purpose of selling them in the near term are considered trading
securities.
The accounting policies for each investment category are as follows:
Available-for-Sale Securities -- These securities are reported at fair
value, with unrealized gains and losses, net of deferred income taxes,
reported as a separate component of stockholders' equity until realized.
Cash flows from purchases, sales and maturities are reported gross in the
investing activities section of the cash flow statement.
Trading Securities -- These securities are reported on the balance
sheet at fair value, with any unrealized gains and losses included in
earnings. Cash flows from purchases, sales and maturities are included in
the operating activities section of the cash flow statement.
The amortized cost of debt securities is adjusted for amortization of
premiums and accretion of discounts to maturity. Such amortization is included
in investment income. For mortgage-backed and certain asset-backed securities,
Capsure recognizes income using a constant effective yield based on estimated
cash flows including anticipated prepayments. Significant variances in actual
cash flows from expected cash flows are accounted for prospectively. Any related
adjustment is reflected in investment income. Investment gains or losses are
determined using the specific identification method. Investments with an other
than temporary decline in value are written down to fair value, resulting in
losses that are included in investment gains and losses.
44
<PAGE> 45
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Short-term investments are carried at amortized cost which approximates
fair value.
Deferred Policy Acquisition Costs
Policy acquisition costs, consisting of commissions and other underwriting
expenses which vary with, and are directly related to, the production of
business, net of reinsurance commission income, are deferred and amortized to
income as the related premiums are earned. Deferred policy acquisition costs are
subject to a limitation representing the excess of anticipated net earned
premiums over anticipated losses, loss adjustment expenses and maintenance
costs. The ultimate recoverability of policy acquisition costs is determined
without regard to investment income.
Excess Cost Over Net Assets Acquired and Intangible Assets
The excess cost over the fair value of the net assets acquired is amortized
substantially over 40 years. Other intangible assets are amortized over periods
ranging from three to 20 years, a substantial portion of which is amortized over
20 years. Other intangible assets primarily relate to the estimated value of the
acquired insurance in force and the producing agency force as of the acquisition
date. Excess cost over net assets acquired is reported net of accumulated
amortization of $6.3 million and $21.1 million (includes $13.2 million
write-down in 1995) at December 31, 1996 and 1995, respectively. Intangible
assets are reported net of accumulated amortization of $27.3 million and $25.7
million at December 31, 1996 and 1995, respectively.
Management assesses the recoverability of goodwill and intangible assets
based upon estimates of undiscounted future operating cash flows whenever
significant events or changes in circumstances suggest that the carrying amount
of an asset may not be recoverable.
Unpaid Losses and Loss Adjustment Expenses
The liability for unpaid losses and loss adjustment expenses is based on
estimates of (a) the ultimate settlement value of reported claims, (b) incurred
but not reported ("IBNR") claims, (c) future expenses to be incurred in the
settlement of claims and (d) claim recoveries. These estimates are determined
based on the Company's and industry loss experience as well as consideration of
current trends and conditions. The liability for unpaid losses and loss
adjustment expenses is an accounting estimate and, similar to other accounting
estimates, there is the potential that actual future loss payments will differ
significantly from initial estimates. The methods of determining such estimates
and the resulting estimated liability are continually reviewed and updated.
Changes in the estimated liability are reflected in operating income in the year
in which such changes are determined. As described in Note 6, the Company's
incurred losses and loss adjustment expenses in 1995 were reduced by $29.1
million, net of reinsurance, as a result of favorable claim settlements and
certain changes in estimates relating to insured events of prior years.
Insurance Premiums
Insurance premiums are recognized as revenue ratably over the terms of the
related policies. Unearned premiums represent the portion of premiums written
applicable to the unexpired terms of policies in force calculated on a daily pro
rata basis. Premium revenues are reported net of amounts ceded to reinsurers.
Reinsurance
Amounts recoverable from reinsurers are estimated in a manner consistent
with the claim liability associated with the reinsured policy and are reported
as reinsurance receivable rather than netted against the liability for unpaid
losses and loss adjustment expenses. Losses and loss adjustment expenses
incurred are reported net of estimated recoveries under reinsurance contracts.
45
<PAGE> 46
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Income Taxes
The Company uses the asset and liability method of accounting for income
taxes required by SFAS No. 109, "Accounting for Income Taxes." Under the asset
and liability method, deferred income taxes are established for the future tax
effects of temporary differences between the tax and financial reporting bases
of assets and liabilities using currently enacted tax rates. Such temporary
differences primarily relate to net operating tax loss carryforwards ("NOLs"),
loss reserve discounting, deferred policy acquisition costs and intangible
assets. Under SFAS No. 109, the effect on deferred taxes of a change in tax
rates is recognized in income in the period of enactment.
In addition, deferred tax assets are valued based upon the expectation of
future realization on a "more likely than not" basis. The initial recognition of
the tax benefits of the NOLs resulted in a credit to additional paid-in capital
for the available NOLs for which future realization was expected. Tax benefits
resulting from the future utilization of such NOLs will reduce the net deferred
tax asset established in accordance with SFAS No. 109.
Reorganization Proceedings
On July 31, 1986, the Company emerged from voluntary bankruptcy proceedings
under Chapter 11 of the United States Bankruptcy Code (the "Bankruptcy Code").
After the requisite acceptances were obtained and the Bankruptcy Court
determined that the Second Amended Joint Plan of Reorganization, as amended (the
"Plan of Reorganization"), satisfied applicable requirements of the Bankruptcy
Code, the Bankruptcy Court confirmed the Plan of Reorganization on December 20,
1985, and the Plan of Reorganization was consummated on July 31, 1986 (the
"Reorganization Date"). The Company emerged from bankruptcy with approximately
$300 million of NOLs resulting from oil and gas operations prior to the
reorganization.
In accordance with accounting principles applicable to reorganizations, the
net assets of the Company were adjusted to fair value, the accumulated deficit
in retained earnings at the date of reorganization was eliminated and the excess
of the fair values of the net assets over the stated value of outstanding
capital stock was assigned to additional paid-in capital.
Earnings Per Share
Earnings per common and common equivalent shares outstanding are computed
using the treasury stock method. Weighted average shares outstanding assuming
full dilution for 1996, 1995 and 1994 were 16.5 million, 15.9 million and 15.5
million, respectively.
Pending Accounting Standards
In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share," which
is effective for both interim and annual periods ending after December 15, 1997.
SFAS No. 128 replaces APB Opinion No. 15, "Earnings Per Share." APB Opinion No.
15 required that entities with simple capital structures present a single
earnings per common share ("EPS") on the face of the income statement, whereas
those with complex capital structures had to present both primary and fully
diluted EPS. SFAS No. 128 simplifies the computation of EPS by replacing the
presentation of primary EPS with a presentation of basic EPS and requires dual
presentation of basic and diluted EPS by entities with complex capital
structures. Basic EPS includes no dilution and is computed by dividing income
available to common stockholders by the weighted average number of common shares
outstanding for the period, whereas primary EPS includes the dilutive effect of
common stock equivalents, such as stock options. Diluted EPS reflects the
potential dilution of securities that could share in the earnings of an entity,
similar to fully diluted EPS. The Company intends to present basic and diluted
EPS in financial statements issued after the effective date.
46
<PAGE> 47
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. ACQUISITION AND DISPOSITION OF SUBSIDIARIES
On September 22, 1994, Capsure, through its wholly owned subsidiary,
Capsure Financial Group, Inc. ("CFG"), acquired all of the outstanding common
stock of Universal Surety Holding Corp. ("USHC"). USHC is the holding company of
Universal Surety. Capsure paid $28 million in cash and $4 million in Capsure
common stock for USHC, pursuant to a Stock Purchase Agreement dated as of July
26, 1994. The cash portion of the purchase price was financed with borrowings
under Capsure's revolving credit facility.
The acquisition has been accounted for as a purchase and, accordingly, the
acquired assets and liabilities have been recorded at their estimated fair
values. The operating results of USHC are included in the consolidated
statements of income and cash flows from the September 22, 1994 acquisition
date. The excess of the purchase price over the fair value of net assets
acquired is recorded as excess cost over net assets acquired in the consolidated
balance sheets.
The USHC Stock Purchase Agreement provides for a contingent payment to
certain of the selling shareholders. Such payment shall be in cash or an
equivalent amount of Capsure common stock, at the Company's option, in the year
2000, equal to twenty percent of the excess of the after-tax fair market value
of Universal Surety at December 31, 1999, over an assumed fifteen percent
return, compounded annually, on Capsure's invested capital. The contingent
consideration, if any, shall be reported as compensation expense in the period
the contingency is resolved and the consideration is payable. If the contingent
consideration was determined and payable solely upon results through December
31, 1996, there would be no such payment required.
The following table of unaudited pro forma information has been prepared as
if the acquisition of USHC had been consummated on January 1, 1993, at the same
purchase price, with adjustments to the consolidated results of operations for
the effects of the acquisition in the same manner as subsequent to the
acquisition. Such adjustments include: (i) decreased net investment income and
realized investment gains at USHC; (ii) decreased operating expenses at USHC;
and (iii) increased interest and amortization expense. In management's opinion,
the pro forma financial information is not indicative of consolidated results of
operations that may have occurred had the acquisition taken place on January 1,
1993, or of future results of operations of USHC under the ownership and
operation of Capsure. In the following table, the dollars are in thousands,
except per share amounts:
<TABLE>
<CAPTION>
PRO FORMA (UNAUDITED)
FOR THE YEAR ENDED
DECEMBER 31, 1994
---------------------
<S> <C>
Revenues......................... $122,967
Net income....................... $ 15,086
Net income per common share...... $ .98
</TABLE>
On May 22, 1996, the Company consummated the sale of United Capitol Holding
Company ("UCHC") and its subsidiaries, United Capitol Insurance Company ("United
Capitol"), United Capitol Managers, Inc. and Fischer Underwriting Group,
Incorporated, to a subsidiary of Frontier Insurance Group, Inc. The operating
results of UCHC and its subsidiaries are reflected in Capsure's results through
the closing date. Net proceeds to Capsure of $77 million, which included the
purchase price for the capital stock of UCHC and the release of United Capitol's
excess statutory surplus at closing, approximated Capsure's carrying value. The
goodwill associated with the 1990 acquisition of United Capitol was previously
reduced to estimated net realizable value as of December 31, 1995, resulting in
a $13.2 million impairment of goodwill in 1995.
47
<PAGE> 48
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. INVESTMENTS
The cost and estimated fair values of investments in debt and equity
securities as of December 31, 1996 and 1995 were as follows (dollars in
thousands):
<TABLE>
<CAPTION>
AMORTIZED GROSS GROSS ESTIMATED
COST UNREALIZED UNREALIZED FAIR
OR COST GAINS LOSSES VALUE
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
AS OF DECEMBER 31, 1996:
Fixed maturities:
U.S. Treasury securities and obligations of U.S.
Government corporations and agencies:
U.S. Treasury notes........................... $ 5,030 $ 66 $ (13) $ 5,083
Collateralized mortgage obligations........... 35,565 373 (49) 35,889
Mortgage pass-through securities.............. 36,221 244 (84) 36,381
Obligations of states and political
subdivisions.................................. 2,696 8 (36) 2,668
Non-agency collateralized mortgage
obligations................................... 21,877 114 (59) 21,932
Asset-backed securities:
Second mortgages/home equity loans............ 26,961 135 (114) 26,982
Other underlying assets....................... 7,070 22 (132) 6,960
-------- ------ ------- --------
Total fixed maturities................ 135,420 962 (487) 135,895
Equity securities............................... 3,687 839 -- 4,526
-------- ------ ------- --------
Total available-for-sale securities... $139,107 $1,801 $ (487) $140,421
======== ====== ======= ========
AS OF DECEMBER 31, 1995:
Fixed maturities:
U.S. Treasury securities and obligations of U.S.
Government corporations and agencies:
U.S. Treasury notes........................... $ 15,047 $ 488 $ (1) $ 15,534
Collateralized mortgage obligations........... 64,610 430 (349) 64,691
Mortgage pass-through securities.............. 40,313 788 (3) 41,098
Debt securities of foreign governments.......... 5 -- -- 5
Obligations of states and political
subdivisions.................................. 5,748 10 (18) 5,740
Corporate bonds................................. 91 -- (16) 75
Non-agency collateralized mortgage
obligations................................... 34,574 392 (66) 34,900
Asset-backed securities:
Second mortgages/home equity loans............ 49,060 947 (102) 49,905
Automobile loans.............................. 8,229 1 (2) 8,228
Other underlying assets....................... 15,599 97 (154) 15,542
-------- ------ ------- --------
Total fixed maturities................ 233,276 3,153 (711) 235,718
Equity securities............................... 24,758 1,303 (1,245) 24,816
-------- ------ ------- --------
Total available-for-sale securities... $258,034 $4,456 $(1,956) $260,534
======== ====== ======= ========
Equity trading securities....................... $ 2,366 $ 593 $ (22) $ 2,937
======== ====== ======= ========
</TABLE>
As of December 31, 1996, virtually 100% of the Company's debt securities
were considered investment grade by The Standard & Poors Corporation or Moody's
Investor Services, Inc., and 93% were rated at least AA by those agencies. In
addition, the Company's investments in debt securities did not contain any
significant geographic or industry concentration of credit risk.
48
<PAGE> 49
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The U.S. Treasury notes and mortgage pass-through securities are backed by
the full faith and credit of the U.S. Government. The U.S. Government
collateralized mortgage obligations consist of securities collateralized by
first mortgages issued by the Federal National Mortgage Association and the
Federal Home Loan Mortgage Corporation, or guaranteed by the Government National
Mortgage Association.
The Company has reduced the prepayment variability commonly associated with
collateralized mortgage obligations by generally investing in planned
amortization class tranches which are structured largely to insulate the
investor from prepayment risk.
The Company's insurance subsidiaries, as required by state law, deposit
certain securities with state insurance regulatory authorities. At December 31,
1996, fixed maturities on deposit had an aggregate carrying value of $4.8
million.
Short-term investments are generally comprised of U.S. Treasury notes,
maturing corporate notes, money market funds, and investment grade commercial
paper equivalents.
The amortized cost and estimated fair value of debt securities at December
31, 1996, by contractual maturity, are shown below. Expected maturities will
differ from contractual maturities as borrowers may have the right to call or
prepay obligations with or without call or prepayment penalties (dollars in
thousands):
<TABLE>
<CAPTION>
ESTIMATED
AMORTIZED FAIR
COST VALUE
--------- ---------
<S> <C> <C>
AVAILABLE-FOR-SALE SECURITIES
Due within one year......................................... $ 110 $ 111
Due after one year but within five years.................... 4,911 4,951
Due after five years but within ten years................... 208 224
Due after ten years......................................... 2,496 2,466
-------- --------
7,725 7,752
Mortgage pass-through securities, collateralized mortgage
obligations and asset-backed securities................... 127,695 128,143
-------- --------
$135,420 $135,895
======== ========
</TABLE>
Major categories of net investment income and net investment gains (losses)
were as follows (dollars in thousands):
<TABLE>
<CAPTION>
1996 1995 1994
------- ------- -------
<S> <C> <C> <C>
Investment income:
Fixed maturities.......................................... $12,009 $16,964 $16,405
Equity securities......................................... 720 1,924 915
Short-term investments.................................... 3,593 1,814 1,722
Other..................................................... 519 260 532
------- ------- -------
Total investment income................................... 16,841 20,962 19,574
Investment expenses......................................... 397 491 445
------- ------- -------
Net investment income....................................... $16,444 $20,471 $19,129
======= ======= =======
Gross investment gains:
Fixed maturities.......................................... $ 1,109 $ 722 $ 88
Equity securities......................................... 4,220 2,505 3,762
Gross investment losses:
Fixed maturities.......................................... (973) (3,757) (625)
Equity securities......................................... (2,718) (2,068) (1,802)
Net unrealized gains (losses) on trading securities......... -- 945 (374)
Other....................................................... 77 -- (104)
------- ------- -------
Net investment gains (losses)............................... $ 1,715 $(1,653) $ 945
======= ======= =======
</TABLE>
49
<PAGE> 50
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Net unrealized gain (loss) on securities included in stockholders' equity
was as follows (dollars in thousands):
<TABLE>
<CAPTION>
1996 1995
------------------------ --------------------------
GAINS LOSSES NET GAINS LOSSES NET
------ ------ ------ ------ ------- -------
<S> <C> <C> <C> <C> <C> <C>
Fixed maturities..................... $ 962 $(487) $ 475 $3,153 $ (711) $ 2,442
Equity securities.................... 839 -- 839 1,303 (1,245) 58
Other................................ 352 -- 352 534 -- 534
------ ----- ------ ------ ------- -------
$2,153 $(487) 1,666 $4,990 $(1,956) 3,034
====== ===== ====== =======
Deferred income taxes................ (583) (1,062)
------ -------
Net unrealized gain on securities.... $1,083 $ 1,972
====== =======
</TABLE>
The net investment losses in 1995 reflected the $2.7 million write-down of
the carrying value for two asset-backed securities from the same issuer which
experienced an other than temporary decline in fair value.
A majority of the realized investment gains and losses on equity securities
resulted from sales of securities held at the parent company level. For 1996,
1995 and 1994, investment activity for the equity trading portfolio held at the
parent company level included gross realized investment gains of $3.4 million,
$1.9 million and $1.5 million, respectively, and gross realized investment
losses of $2.6 million, $1.8 million and $1.0 million, respectively.
4. DEFERRED POLICY ACQUISITION COSTS
Policy acquisition costs deferred and the related amortization charged to
income were as follows (dollars in thousands):
<TABLE>
<CAPTION>
1996 1995 1994
------- ------- --------
<S> <C> <C> <C>
Balance at January 1............................... $27,057 $25,150 $ 18,421
Balance at date of acquisition (disposition)....... (478) -- 4,369
Costs deferred during year......................... 39,449 37,666 31,750
Amortization during year........................... (37,505) (35,759) (29,390)
------- ------- --------
Balance at December 31............................. $28,523 $27,057 $ 25,150
======= ======= ========
</TABLE>
5. REINSURANCE
The Company's insurance subsidiaries, in the ordinary course of business,
cede reinsurance to other insurance companies to limit their exposure to loss.
Reinsurance contracts do not relieve the Company of its primary obligations to
claimants. A contingent liability exists with respect to reinsurance ceded to
the extent that any reinsurer is unable to meet the obligations assumed under
the reinsurance agreements. The Company evaluates the financial condition of its
reinsurers, establishes allowances for uncollectible amounts and monitors
concentrations of credit risk. At December 31, 1996, Capsure's largest
reinsurance receivable, including prepaid reinsurance premiums of $0.8 million,
was approximately $2.3 million with Transatlantic Reinsurance Company.
Transatlantic Reinsurance Company is rated A+ (Superior) by A.M. Best Company,
Inc.
50
<PAGE> 51
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The effect of reinsurance on premiums written and earned was as follows
(dollars in thousands):
<TABLE>
<CAPTION>
1996 1995 1994
------------------- ------------------- -------------------
WRITTEN EARNED WRITTEN EARNED WRITTEN EARNED
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Direct............................. $107,197 $105,467 $111,305 $113,538 $102,062 $103,871
Assumed............................ 72 45 93 247 294 143
Ceded.............................. (12,160) (13,021) (13,670) (15,093) (11,778) (11,533)
-------- -------- -------- -------- -------- --------
Net premiums....................... $ 95,109 $ 92,491 $ 97,728 $ 98,692 $ 90,578 $ 92,481
======== ======== ======== ======== ======== ========
</TABLE>
The effect of reinsurance on losses and loss adjustment expenses incurred
was as follows (dollars in thousands):
<TABLE>
<CAPTION>
1996 1995 1994
------- ------- -------
<S> <C> <C> <C>
Gross losses and loss adjustment expenses..... $12,769 $ (815) $31,566
Reinsurance recoveries........................ (2,715) (6,636) (8,222)
------- ------- -------
Net losses and loss adjustment expenses....... $10,054 $(7,451) $23,344
======= ======= =======
</TABLE>
6. LIABILITY FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
Activity in the liability for unpaid losses and loss adjustment expenses
was as follows (dollars in thousands):
<TABLE>
<CAPTION>
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Gross balance at January 1................................. $126,061 $149,041 $135,825
Balance at date of acquisition (disposition)............... (84,823) -- 2,738
Incurred related to:
Current year............................................... 23,685 34,073 46,206
Prior years................................................ (10,579) (34,559) (14,522)
-------- -------- --------
Total incurred............................................. 13,106 (486) 31,684
-------- -------- --------
Paid related to:
Current year............................................... 3,390 4,150 3,003
Prior years................................................ 12,080 18,344 18,203
-------- -------- --------
Total paid................................................. 15,470 22,494 21,206
-------- -------- --------
Gross balance at December 31............................... $ 38,874 $126,061 $149,041
======== ======== ========
Balance net of reinsurance at December 31.................. $ 33,378 $ 87,078 $111,164
======== ======== ========
</TABLE>
As a result of favorable claim settlements and changes in estimates of
insured events in prior years, the provision for losses and loss adjustment
expenses decreased by $10.6 million ($6.9 million, net of reinsurance) in 1996,
$34.6 million ($29.1 million, net of reinsurance) in 1995 and $14.5 million
($8.3 million, net of reinsurance) in 1994.
United Capitol's claims development through December 31, 1995, had been
favorable relative to expectations based on industry experience. Due to the
limited prior operating experience of United Capitol and the long-tail nature of
its business, management previously relied principally upon industry development
patterns and expected loss ratios in estimating IBNR. Given the availability of
nine full years of experience and the growing evidence of favorable loss trends
relative to industry indications, management concluded in the fourth quarter of
1995 that it was appropriate to place greater reliance on United Capitol's own
development patterns and emerging loss ratios in estimating IBNR. United Capitol
reduced loss and loss adjustment expenses by $23.2 million in 1995 for net
favorable development related to prior years,
51
<PAGE> 52
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
substantially all of which pertains to this change in estimate. This loss
reserve reduction increased Capsure's consolidated income before taxes by $23.2
million, and net income by $15.1 million, or $0.98 per share.
7. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table summarizes disclosure of fair value information of
financial instruments, whether or not recognized in the balance sheet, for which
it is practicable to estimate that value. In cases where quoted market prices
are not available, fair values may be based on estimates using present value or
other valuation techniques. These techniques are significantly affected by the
assumptions used, including the discount rates and estimates of future cash
flows. Accordingly, the estimates presented herein are subjective in nature and
are not necessarily indicative of the amounts that Capsure could realize in a
current market exchange. This information excludes certain financial instruments
and all nonfinancial instruments such as insurance contracts from fair value
disclosure. Thus, the following fair value amounts cannot be aggregated to
determine the underlying economic value of Capsure.
The carrying amounts and estimated fair values of financial instruments
were as follows (dollars in thousands):
<TABLE>
<CAPTION>
1996 1995
---------------------- ----------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
-------- ---------- -------- ----------
<S> <C> <C> <C> <C>
Debt securities......................... $135,895 $135,895 $235,718 $235,718
Equity securities....................... 4,526 4,526 27,753 27,753
Short-term investments.................. 19,416 19,416 37,865 37,865
Other investments....................... 2,695 2,695 3,219 3,219
Cash.................................... 2,736 2,736 3,001 3,001
Long-term debt.......................... 60,000 60,000 25,000 25,000
</TABLE>
The following methods and assumptions were used by Capsure in estimating
fair values of financial instruments:
Investment Securities -- The estimated fair values for debt securities
(including redeemable preferred stock) are based upon quoted market prices,
where available. For debt securities not actively traded, the estimated
fair values are determined using values obtained from independent pricing
services or, in the case of private placements, by discounting expected
future cash flows using a current market rate applicable to the yield,
credit quality and maturity of the investments. The estimated fair values
for equity securities are based on quoted market prices.
Cash, Short-Term Investments and Other Investments -- The carrying
amount for these instruments approximates their estimated fair values.
Long-Term Debt -- The estimated fair value of Capsure's long-term debt
is based on the quoted market prices for the same or similar issues or on
the current rates offered to the Company for debt of the same remaining
maturity.
8. LONG-TERM DEBT
On March 29, 1994, the Company formed a direct, wholly owned subsidiary,
CFG, to which Capsure contributed substantially all its assets and liabilities.
Concurrently, CFG entered into a senior reducing revolving credit agreement with
a syndicate of banks for the principal amount of $135 million (the "Credit
Facility"). The common stock of substantially all of Capsure's subsidiaries and
substantially all assets of Capsure's non-insurance operations have been pledged
under the Credit Facility.
52
<PAGE> 53
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Concurrent with the sale of UCHC and its subsidiaries, Capsure and its
lenders entered into an agreement to amend and restate the Credit Facility. The
amendment reduced the commitment to $100 million from $135 million and permitted
an initial draw of up to $70 million for a special dividend to stockholders.
Transaction costs totaled approximately $0.5 million. As of December 31, 1996
and 1995, $60 million and $25 million, respectively, were outstanding under the
Credit Facility. The remaining availability under the Credit Facility may be
used for additional dividends, stock repurchases, acquisitions and for general
corporate purposes.
On September 11, 1996, the Company declared a special cash distribution in
the amount of $10 per share of common stock, payable to all holders of record as
of September 25, 1996. The special distribution was funded from $62 million of
borrowings under the Credit Facility and approximately $94 million from
available cash and marketable securities accumulated at the parent company
level.
The interest rate on borrowings under the Credit Facility may be fixed, at
the Company's option, for a period of one to six months and is based on a margin
over either the London Interbank Offered Rate ("LIBOR") or the greatest of the
agent banks' prime rate, certificate of deposit rate plus 1.0% and the Federal
Funds Effective Rate plus 0.5%. The margin varies based on a leverage ratio and
ranges from 0.75% to 1.50% on LIBOR borrowings and 0.0% to 0.50% on non-LIBOR
borrowings. The Credit Facility provides for a commitment fee on the unused
availability which also varies based on leverage. At December 31, 1996, the
interest rate on outstanding borrowings was 6.56% and the applicable commitment
fee was 0.25%.
The Credit Facility limits the Company with respect to the incurrence of
additional indebtedness and the payment of dividends, imposes certain
restrictions on investments and requires the maintenance of certain financial
ratios and levels of Risk-Based Capital ("RBC"). As of December 31, 1996, the
Company was in compliance with all material restrictions or covenants contained
in the Credit Facility agreement. The use of the Credit Facility for acquisition
purposes is subject to certain conditions with respect to the business and
historical financial results of the target company, the maintenance of certain
financial ratios on a prospective and pro forma basis, and the structure of the
acquisition transaction.
Total borrowings available under the Credit Facility reduce semi-annually
commencing March 31, 1997 by the following amounts (dollars in thousands):
<TABLE>
<S> <C>
March 31, 1997.............................................. $ 6,250
September 30, 1997.......................................... 6,250
March 31, 1998.............................................. 7,000
September 30, 1998.......................................... 7,000
March 31, 1999.............................................. 7,500
September 30, 1999.......................................... 7,500
March 31, 2000.............................................. 8,500
September 30, 2000.......................................... 8,500
March 31, 2001.............................................. 8,500
September 30, 2001.......................................... 8,500
March 31, 2002.............................................. 8,500
September 30, 2002.......................................... 8,500
March 31, 2003.............................................. 7,500
--------
$100,000
========
</TABLE>
Principal and interest payments required under the Credit Facility are
funded principally by dividend and intercompany tax sharing payments received
from Capsure's insurance subsidiaries.
53
<PAGE> 54
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. STATUTORY FINANCIAL DATA
Capsure's insurance subsidiaries file annual financial statements prepared
in accordance with statutory accounting practices prescribed or permitted by
applicable insurance regulatory authorities. Prescribed statutory accounting
practices include state laws, regulations and general administrative rules, as
well as guidance provided in 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 may differ from state to state, may differ from company to company
within a state, and may change in the future. The permitted statutory accounting
practices of Capsure's insurance subsidiaries did not have a material effect on
reported statutory surplus. The principal differences between statutory
financial statements and financial statements prepared in accordance with
generally accepted accounting principles are that statutory financial statements
do not reflect deferred policy acquisition costs and deferred income taxes and
debt securities are generally carried at amortized cost in statutory financial
statements.
The NAIC has promulgated RBC requirements for property/casualty insurance
companies to evaluate the adequacy of statutory capital and surplus in relation
to investment and insurance risks such as asset quality, asset and liability
matching, loss reserve adequacy, and other business factors. The RBC information
will be used by state insurance regulators as an early warning tool to identify,
for the purpose of initiating regulatory action, insurance companies that
potentially are inadequately capitalized. In addition, the formula defines new
minimum capital standards that will supplement the current system of fixed
minimum capital and surplus requirements on a state-by-state basis. Regulatory
compliance is determined by a ratio (the "Ratio") of the enterprise's regulatory
total adjusted capital, as defined by the NAIC, to its authorized control level
RBC, as defined by the NAIC. Generally, a Ratio in excess of 200% of authorized
control level RBC requires no corrective actions by the company or regulators.
As of December 31, 1996, each of Capsure's insurance subsidiaries had a Ratio
that was substantially in excess of the minimum RBC requirements.
Capsure's insurance subsidiaries are subject to regulation and supervision
by the various state insurance regulatory authorities in which they conduct
business. Such regulation is generally designed to protect policyholders and
includes such matters as maintenance of minimum statutory surplus and
restrictions on the payment of dividends. Generally, statutory surplus of each
insurance subsidiary in excess of a statutorily prescribed minimum is available
for payment of dividends to the parent company. However, such distributions as
dividends may be subject to prior regulatory approval, including a review of the
impact on RBC. Without prior regulatory approval in 1997, Capsure's insurance
subsidiaries may pay stockholder dividends of $18.0 million in the aggregate. In
1996, 1995 and 1994, Capsure received $65.7 million (including $50.2 million of
dividends requiring prior approval), $40.9 million (including $21.6 million of
dividends requiring prior approval), and $21.0 million (including $5.0 million
of dividends requiring prior approval), respectively, in dividends from its
insurance subsidiaries. Capsure received $15.6 million, $21.9 million and $9.5
million in dividends from its surety and fidelity subsidiaries in 1996, 1995 and
1994, respectively.
Combined statutory surplus and net income for insurance operations,
including preacquisition results, as reported to regulatory authorities were as
follows (dollars in thousands):
<TABLE>
<CAPTION>
1996 1995 1994
------- -------- --------
<S> <C> <C> <C>
Statutory surplus........................... $48,913 $113,894 $109,750
Statutory net income........................ $22,045 $ 41,717 $ 23,796
</TABLE>
54
<PAGE> 55
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. INCOME TAXES
The components of deferred income taxes were as follows (dollars in
thousands):
<TABLE>
<CAPTION>
1996 1995
------- -------
<S> <C> <C>
Deferred tax assets:
Net operating losses................................... $50,122 $62,000
Loss and loss adjustment expense reserves.............. 793 5,534
Unearned premium reserves.............................. 4,673 4,791
Accrued expenses....................................... 3,738 3,768
Other.................................................. 3,626 839
------- -------
Total gross deferred tax assets................ 62,952 76,932
Valuation allowance.................................... 30,800 30,800
------- -------
Deferred tax asset, net of valuation allowance........... 32,152 46,132
------- -------
Deferred tax liabilities:
Intangible assets...................................... 4,894 5,477
Deferred policy acquisition costs...................... 9,983 9,470
Unrealized gain on securities.......................... 583 1,062
Other.................................................. 673 830
------- -------
Total deferred tax liabilities................. 16,133 16,839
------- -------
Net deferred tax asset................................... $16,019 $29,293
======= =======
</TABLE>
The Internal Revenue Service ("IRS") has not examined the Company's tax
returns for the years in which the Company reported net operating losses. Under
Section 382 of the Internal Revenue Code of 1986, as amended (the "Code"),
certain restrictions on the utilization of NOLs will apply if there is an
ownership change of a corporation entitled to use such carryovers. The Company
believes that there is currently no restriction on the ability of the Company to
utilize its NOLs. If the pending business combination as described in Note 16 is
consummated, an ownership change of the Company under Section 382 of the Code
will occur. This will result in significant restrictions of the Company's
ability to utilize NOLs during all taxable periods after the date of the
business combination.
Capsure and its subsidiaries file a consolidated federal income tax return.
As of December 31, 1996, based upon the Company's consolidated federal income
tax returns, approximately $143 million of consolidated NOLs were available to
offset future taxable income of the Company and its subsidiaries. Such
carryforwards expire by tax year as follows: $42.4 million in 1997, $50.7
million in 1998, $39.2 million in 1999, $7.0 million in 2000, $2.4 million in
2001, $0.9 million in 2002 and $0.4 million in 2003. Although realization is not
assured, management believes that it is more likely than not that Capsure will
generate sufficient taxable income to utilize at least $19.3 million of tax
benefits from its available NOLs at December 31, 1996. Such estimate is based
upon the earnings history of each of its insurance subsidiaries and projections
of future taxable income. The amount of the deferred tax asset considered
realizable, however, could be reduced in the near term if estimates of future
taxable income during the carryforward period are reduced, or if an ownership
change under Section 382 of the Code were to occur.
55
<PAGE> 56
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The income tax provisions consisted of the following (dollars in
thousands):
<TABLE>
<CAPTION>
1996 1995 1994
------ ------- ------
<S> <C> <C> <C>
Federal deferred................................ $7,291 $18,086 $8,820
Federal current................................. 560 1,500 305
State........................................... 330 135 276
------ ------- ------
Total income tax expense........................ $8,181 $19,721 $9,401
====== ======= ======
</TABLE>
Reconciliations from the federal statutory tax rate to the effective tax
rate are as follows:
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Federal statutory rate................................. 35.0% 35.0% 35.0%
Excess of cost over net assets acquired and other
purchase accounting adjustments...................... 2.8 13.7 3.0
State income and environmental tax, net of federal
income tax benefit................................... 1.0 .1 .8
Tax exempt interest.................................... (0.1) (.3) (.3)
Other.................................................. (0.8) .5 1.0
---- ---- ----
Effective tax rate........................... 37.9% 49.0% 39.5%
==== ==== ====
</TABLE>
Intercompany tax sharing agreements between Capsure and its subsidiaries
provide that tax sharing payments shall be determined based upon each
subsidiaries' separate return liability, as calculated in accordance with the
Code. Intercompany tax payments are remitted at such times as estimated tax
payments would be required to be made to the IRS. Capsure received tax sharing
payments from its subsidiaries of $17.3 million, $12.8 million and $12.3 million
in 1996, 1995 and 1994, respectively, of which $10.8 million, $8.3 million and
$7.3 million were from its surety and fidelity subsidiaries.
11. COMMITMENTS AND CONTINGENCIES
At December 31, 1996, the future minimum commitment under operating leases
was as follows: 1997 -- $2.5 million; 1998 -- $2.3 million; 1999 -- $1.7
million; 2000 -- $1.3 million; 2001 -- $1.1 million and 2002 and after -- $0.3
million. Total rental expense for 1996, 1995 and 1994 was $2.8 million, $2.3
million and $2.3 million, respectively.
The Company was engaged in oil and gas production, exploration and
development until mid-1993. In connection with the sale of substantially all of
the Company's oil and gas properties, the buyers assumed all material
environmental liabilities.
The Company and its subsidiaries are parties to numerous lawsuits arising
in the normal course of business, some seeking material damages. The Company
believes the resolution of these lawsuits will not have a material adverse
effect on its financial condition, results of operations and liquidity.
12. EMPLOYEE BENEFITS
The Company sponsors a tax-deferred savings plan (401(k)) covering
substantially all of its employees. The Company matches 50% of the participating
employee's contribution up to 6% of eligible compensation (3% maximum matching).
Western Surety employees may also receive a discretionary profit sharing payment
up to 3% of eligible compensation. Company contributions, including profit
sharing payments, for the years ended December 31, 1996, 1995 and 1994, were
$0.8 million, $0.7 million and $0.7 million, respectively.
The Company sponsors a noncontributory defined contribution retirement plan
covering all eligible employees other than Western Surety personnel. The Company
contributes 4.35% of eligible compensation
56
<PAGE> 57
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(8.7% on amounts exceeding the social security wage base). Company contributions
for the years ended December 31, 1996, 1995 and 1994, were $0.2 million, $0.3
million and $0.1 million, respectively.
Western Surety sponsors two postretirement benefit plans covering
substantially all of its employees. One plan provides medical benefits, and the
other plan provides sick leave termination payments. The postretirement health
care plan is contributory; the sick leave plan is noncontributory. The
actuarially determined net periodic postretirement benefit costs for these plans
were $0.4 million, $0.3 million and $0.5 million for the years ended December
31, 1996, 1995 and 1994, respectively. The unfunded accumulated postretirement
benefit obligation (for retirees and fully vested active plan participants) was
$4.4 million and $4.1 million as of December 31, 1996 and 1995, respectively.
13. STOCKHOLDERS' EQUITY
On September 11, 1996, the Company declared a special cash distribution in
the amount of $10 per share of common stock, payable to all holders of record as
of September 25, 1996. Approximately $86.4 million ($5.53 per share) of the
$156.2 million total distribution was paid out of available retained earnings,
with the excess of $69.8 million ($4.47 per share) charged to additional paid-in
capital. The special distribution was paid on October 4, 1996 and was funded
from $62 million of borrowings under Capsure's revolving credit agreement and
approximately $94 million from available cash and marketable securities
accumulated at the parent company level.
On May 24, 1995, the Board of Directors of the Company approved a stock
repurchase plan. The plan authorizes the Company to repurchase up to 500,000
shares of its common stock. These shares may be purchased from time to time in
the public market or through privately negotiated transactions. As of December
31, 1996, no shares have been repurchased under this plan.
The Company has reserved shares of its Common Stock for issuance to
directors, officers, employees and consultants of the Company through incentive
stock options, non-qualified stock options and stock appreciation rights
("SARs") to be granted under the Company's Amended and Restated 1990 Stock
Option Plan (the "Plan"). The most recent Plan amendments approved by
stockholders at the Annual Meeting held on May 23, 1996, among other matters,
increased the aggregate number of shares available for which options and SARs
may be granted under the Plan to 2,250,000 shares.
The Plan is administered by the Compensation Committee (the "Committee"),
consisting of independent members of the Board of Directors. The option prices
are determined by the Committee, but may not be less than the fair market value
of the Common Stock of the Company at the date of grant for incentive stock
options, and may not be less than the par value of the Common Stock of the
Company for non-qualified stock options.
The Plan provides for the granting of incentive stock options as defined
under the Code. All non-qualified stock options and incentive stock options
expire ten years after the date of grant. Since January 1, 1993, all stock
options were granted at an option price equal to fair market value at the date
of grant. In connection with the payment of the special distribution, the Board
of Directors also authorized a corresponding repricing of all outstanding stock
options. This resulted in a new measurement date for the stock options under
applicable accounting pronouncements and required the Company to record in the
third quarter of 1996 a non-recurring compensation charge of $4.1 million, after
applicable income taxes, or 25 cents per share of which $3.6 million, or 22
cents per share, was non-cash. All repriced stock options will be treated as
non-qualified stock options for tax purposes.
57
<PAGE> 58
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Stock option activity for the three years ended December 31, 1996 was as
follows:
<TABLE>
<CAPTION>
WEIGHTED
SHARES SUBJECT AVERAGE OPTION
TO OPTION PRICE PER SHARE
-------------- ---------------
<S> <C> <C>
Balance at January 1, 1994...................... 905,775 $ 8.97
Options granted............................... 295,250 $13.38
Options canceled.............................. (1,876) $12.25
Options exercised............................. (1,037) $ 7.74
---------
Balance at December 31, 1994.................... 1,198,112 $10.05
Options granted............................... 190,000 $13.55
Options canceled.............................. (9,063) $13.22
Options exercised............................. (14,600) $ 7.34
---------
Balance at December 31, 1995.................... 1,364,449 $10.55
Options granted............................... 45,000 $18.00
Options canceled.............................. (30,050) $ 9.00
Options exercised............................. (216,000) $10.28
---------
Balance at October 4, 1996 (date of
repricing).................................... 1,163,399 $ 2.04
Options canceled after repricing.............. (1,339) $ 3.26
Options exercised after repricing............. (180,000) $ .46
---------
Balance at December 31, 1996.................... 982,060 $ 2.32
=========
</TABLE>
As of December 31, 1996, 754,662 shares were exercisable under the Plan.
The number of shares available for granting of options under the Plan were
802,528 and 96,189 at December 31, 1996 and 1995, respectively.
The weighted average fair value of options granted in 1996 was $3.22. The
fair value of each option granted during 1996 was estimated on the date of grant
using the Black-Scholes option-pricing model with the following assumptions: (1)
dividend yield of 0%, (2) expected volatility of 25.7%, (3) risk-free interest
rate of 6.47%, and (4) expected life of 6 years.
The following table summarizes information about stock options outstanding
at December 31, 1996:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------- ------------------------
RANGE OF WGTD. AVG. WGTD. AVG. WGTD. AVG.
EXERCISE NUMBER REMAINING EXERCISE NUMBER EXERCISE
PRICES OUTSTANDING CONTR. LIFE PRICE EXERCISABLE PRICE
-------- ----------- ----------- ---------- ----------- ----------
<S> <C> <C> <C> <C> <C>
$0.05 to $8.00...................... 982,060 6.3 years $2.32 754,662 $2.10
======= ========== ===== ======= =====
</TABLE>
In October 1995, the Financial Accounting Standards Board issued SFAS No.
123, "Accounting for Stock-Based Compensation." SFAS No. 123 is effective for
fiscal years beginning after December 15, 1995. SFAS No. 123 introduces a
preferable fair value-based method of accounting for stock-based compensation.
SFAS No. 123 encourages, but does not require, companies to recognize
compensation expense for grants of stock, stock options, and other equity
instruments to employees based on the new fair value-based method of accounting.
As permitted under SFAS No. 123, the Company has continued to apply the existing
accounting rules contained in Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees,"
58
<PAGE> 59
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
and related interpretations. Required pro forma disclosures, as if the Company
had adopted the fair value-based recognition requirements under SFAS No. 123 in
1995, are presented below:
<TABLE>
<CAPTION>
1996 1995
----------------------- -----------------------
AS REPORTED PRO FORMA AS REPORTED PRO FORMA
----------- --------- ----------- ---------
<S> <C> <C> <C> <C>
Net income (in thousands)......................... $13,379 $13,256 $20,530 $20,438
======= ======= ======= =======
Net income per common share....................... $ .82 $ .81 $ 1.33 $ 1.32
======= ======= ======= =======
</TABLE>
The effects of applying SFAS No. 123 in this pro forma disclosure are not
indicative of future amounts. SFAS No. 123 does not apply to awards prior to
1995.
14. RELATED PARTY TRANSACTIONS
Equity Group Investments, Inc. ("EGI"), a company affiliated with certain
directors, officers and stockholders of the Company; other affiliated entities;
and individuals affiliated with certain directors and officers of the Company
perform or provide services to the Company and its subsidiaries. These services
relate to acquisition consulting, financial planning, legal and tax advice, and
investor relations, as well as leasing office space and providing certain
computer equipment, operations and maintenance services to the Company. Related
party agreements are generally for a term of one year and are approved by the
independent members of the Board of Directors. The Company's corporate office
space is leased pursuant to a facilities sharing agreement with EGI.
The Company paid rent, administrative services, and office facility
services to EGI or its affiliates of $0.1 million in 1996, 1995 and 1994. The
Company paid $0.2 million in 1996, 1995 and 1994 for financial planning, tax,
accounting, investor relations and computer support and maintenance to EGI or
its affiliates. The Company paid approximately $0.1 million in 1996 and 1995 and
$0.2 million in 1994 in fees for legal services to a law firm affiliated with
EGI. The Company received reimbursement from affiliates of EGI for financial
management services provided by employees of the Company amounting to
approximately $0.1 million in 1995 and 1994, and a negligible amount in 1996.
59
<PAGE> 60
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
15. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following is a summary of the unaudited results of operations for the
past two years. The Company sold United Capitol on May 22, 1996 and the
consolidated results of operations shown below include the operating results of
United Capitol through the date of disposition, which affects the comparability
of the financial information (dollars in thousands, except per share data):
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
------- ------- ------- -------
<S> <C> <C> <C> <C>
1996
Revenues.......................................... $28,906 $28,828 $26,878 $26,038
======= ======= ======= =======
Income before income taxes........................ $ 8,917 $ 8,062 $ 899 $ 3,682
Income taxes...................................... 3,397 3,057 342 1,385
------- ------- ------- -------
Net income........................................ $ 5,520 $ 5,005 $ 557 $ 2,297
======= ======= ======= =======
Earnings per common and common equivalent share... $ .35 $ .31 $ .02 $ .14
======= ======= ======= =======
1995
Revenues.......................................... $29,535 $29,485 $29,431 $29,059
======= ======= ======= =======
Income before income taxes........................ $ 6,968 $ 7,287 $ 7,235 $18,761
Income taxes...................................... 2,731 2,851 2,816 11,323
------- ------- ------- -------
Net income........................................ $ 4,237 $ 4,436 $ 4,419 $ 7,438
======= ======= ======= =======
Earnings per common and common equivalent share... $ .28 $ .28 $ .29 $ .48
======= ======= ======= =======
</TABLE>
As described in Note 6, the Company's incurred losses and loss adjustment
expenses were reduced by $29.1 million, net of reinsurance, in the fourth
quarter of 1995 as a result of favorable claim settlements and certain changes
in estimates relating to insured events of prior years. As described in Note 2,
the goodwill associated with the 1990 acquisition of United Capitol was reduced
to estimated net realizable value as of December 31, 1995, resulting in a $13.2
million impairment of goodwill in the fourth quarter of 1995.
16. PENDING BUSINESS COMBINATION
On December 19, 1996, Capsure and certain direct and indirect subsidiaries
of CNA Financial Corporation ("CNAF") entered into a definitive Reorganization
Agreement pursuant to which Capsure will merge with a wholly-owned subsidiary of
CNA Surety Corporation ("CNA Surety"). CNAF, through its subsidiaries, will be
the majority stockholder of CNA Surety, owning 61.75 percent of the shares on a
fully diluted basis. The remaining shares will be issued to the existing Capsure
stockholders (a portion of these shares will be reserved for issuance to the
existing holders of Capsure options who will receive CNA Surety options in the
merger) in a tax-free exchange for their Capsure shares on a one-for-one basis.
The CNA Surety shares are expected to be traded on the New York Stock Exchange.
Equity Capsure Limited Partnership ("Equity Capsure"), Capsure's largest
stockholder with a 25.6 percent ownership interest, and certain other directors
of the Company have agreed to vote their shares in favor of the merger. The
agreement and the transactions contemplated thereby are subject to several
conditions, including ratification by the affirmative vote of Capsure
stockholders and approval by governmental and insurance regulatory authorities.
The completion of the merger pursuant to the Reorganization Agreement will
cause an ownership change under Section 382 of the Code and significantly limit
the future utilization of Capsure's NOLs. If the Reorganization Agreement and
transactions contemplated thereby are approved, Capsure shareholders will be
asked to approve an amendment to its Certificate of Incorporation to delete a
provision designed to facilitate the Company's ability to preserve and utilize
its NOLs.
60
<PAGE> 61
SCHEDULE I
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
SUMMARY OF INVESTMENTS
OTHER THAN INVESTMENTS IN RELATED PARTIES
AS OF DECEMBER 31, 1996
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
FAIR CARRYING
COST VALUE VALUE
-------- -------- --------
<S> <C> <C> <C>
FIXED MATURITIES:
Bonds:
U.S. Government and government agencies and
authorities........................................... $ 76,816 $ 77,353 $ 77,353
States, municipalities and political subdivisions........ 2,696 2,668 2,668
All other corporate bonds................................ 55,908 55,874 55,874
-------- -------- --------
Total fixed maturities........................... 135,420 135,895 135,895
-------- -------- --------
EQUITY SECURITIES:
Real estate investment trusts.............................. 3,687 4,526 4,526
-------- -------- --------
Total equity securities.......................... 3,687 4,526 4,526
-------- -------- --------
Short-term investments..................................... 19,416 19,416
Other investments.......................................... 2,343 2,695
-------- --------
Total investments................................ $160,866 $162,532
======== ========
</TABLE>
61
<PAGE> 62
SCHEDULE II
CAPSURE HOLDINGS CORP.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY)
BALANCE SHEETS
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1996 1995
-------- --------
<S> <C> <C>
ASSETS
Investment in and advances to Capsure Financial Group,
Inc....................................................... $ 93,695 $221,552
Deferred income taxes, net of valuation allowance........... 31,647 37,275
-------- --------
$125,342 $258,827
======== ========
LIABILITIES
Other liabilities........................................... $ 2,759 $ 1,523
-------- --------
STOCKHOLDERS' EQUITY
Common stock................................................ 790 770
Additional paid-in capital.................................. 118,413 179,276
Retained earnings from August 1, 1986 (date of
reorganization)........................................... 2,297 75,286
Unrealized gain on securities, net of deferred income
taxes..................................................... 1,083 1,972
-------- --------
Total stockholders' equity.................................. 122,583 257,304
-------- --------
$125,342 $258,827
======== ========
</TABLE>
See Notes to Condensed Financial Information and Notes to Consolidated Financial
Statements
62
<PAGE> 63
SCHEDULE II
CAPSURE HOLDINGS CORP.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(PARENT COMPANY) -- (CONTINUED)
STATEMENTS OF INCOME
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------
1996 1995 1994
------- ------- -------
<S> <C> <C> <C>
Revenues:
Net investment income..................................... $ -- $ -- $ 17
Net investment gains...................................... -- -- 444
Other income.............................................. -- -- --
------- ------- -------
-- -- 461
Expenses:
Non-recurring compensation and merger costs............... 7,865 -- --
Corporate expense......................................... -- -- 355
------- ------- -------
7,865 -- 355
------- ------- -------
Income (loss) from operations before income taxes and equity
in net income of subsidiaries............................. (7,865) -- 106
Income taxes................................................ (2,632) -- 37
------- ------- -------
Income (loss) before equity in net income of subsidiaries... (5,233) -- 69
Equity in net income of subsidiaries, less cash dividends... 18,612 20,530 14,309
------- ------- -------
Net income.................................................. $13,379 $20,530 $14,378
======= ======= =======
</TABLE>
See Notes to Condensed Financial Information and Notes to Consolidated Financial
Statements
63
<PAGE> 64
SCHEDULE II
CAPSURE HOLDINGS CORP.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(PARENT COMPANY) -- (CONTINUED)
STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------
1996 1995 1994
--------- -------- --------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income.............................................. $ 13,379 $ 20,530 $ 14,378
Adjustments to reconcile net income to net cash
provided by operating activities:
Equity in net income of subsidiaries, less cash
dividends....................................... (18,612) (20,530) (14,309)
Net investment gains............................... -- -- (444)
Non-recurring compensation and merger costs........ 7,865 -- --
Changes in:
Deferred income taxes, net......................... 5,628 18,341 1,217
Other assets and liabilities....................... (279) -- 2,406
--------- -------- --------
Net cash provided by operating activities................. 7,981 18,341 3,248
--------- -------- --------
INVESTING ACTIVITIES:
Available-for-sale equity securities purchased.......... -- -- (209)
Change in short-term investments........................ -- -- 5,451
Change in investments in and advances to subsidiaries... 147,081 (18,448) (8,981)
--------- -------- --------
Net cash provided by (used in) investing activities....... 147,081 (18,448) (3,739)
--------- -------- --------
FINANCING ACTIVITIES:
Dividends paid.......................................... (156,248) -- --
Exercise of warrants and options, net of repricing
payments............................................. 1,186 107 10
--------- -------- --------
Net cash (used in) provided by financing activities....... (155,062) 107 10
--------- -------- --------
Increase (decrease) in cash............................... -- -- (481)
Cash at beginning of year................................. -- -- 481
--------- -------- --------
Cash at end of year....................................... $ -- $ -- $ --
========= ======== ========
</TABLE>
See Notes to Condensed Financial Information and Notes to Consolidated Financial
Statements
64
<PAGE> 65
SCHEDULE II
CAPSURE HOLDINGS CORP.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(PARENT COMPANY) -- (CONTINUED)
NOTES TO CONDENSED FINANCIAL INFORMATION
1. BASIS OF PRESENTATION
The condensed financial information of the parent company includes the
accounts of Capsure Holdings Corp. ("Capsure"). On March 29, 1994, Capsure
formed Capsure Financial Group, Inc., a direct wholly owned subsidiary, to which
Capsure contributed substantially all its assets and liabilities, including its
investments in SI Acquisition Corp. (parent company of Western Surety), NI
Acquisition Corp. (former parent company of United Capitol) and Pin Oak
Petroleum, Inc.
65
<PAGE> 66
SCHEDULE III
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
SUPPLEMENTARY INSURANCE INFORMATION
AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
PROPERTY AND CASUALTY INSURANCE
--------------------------------
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Deferred policy acquisition costs.......................... $ 28,523 $ 27,057 $ 25,150
======== ======== ========
Future policy benefits, losses, claims and loss expenses... $ 38,874 $126,061 $149,041
======== ======== ========
Unearned premiums.......................................... $ 69,570 $ 76,781 $ 76,630
======== ======== ========
Other policy claims and benefits payable................... $ -- $ -- $ --
======== ======== ========
Net premium revenue........................................ $ 92,491 $ 98,692 $ 92,481
======== ======== ========
Net investment income...................................... $ 14,195 $ 19,773 $ 18,597
======== ======== ========
Benefits, claims, losses and settlement expenses........... $ 10,054 $ (7,451) $ 23,344
======== ======== ========
Amortization of deferred policy acquisition costs.......... $ 37,505 $ 35,759 $ 29,390
======== ======== ========
Other operating expenses................................... $ 25,699 $ 25,553 $ 24,514
======== ======== ========
Net premiums written....................................... $ 95,109 $ 97,728 $ 90,578
======== ======== ========
</TABLE>
66
<PAGE> 67
SCHEDULE IV
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
REINSURANCE
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
PERCENTAGE
CEDED TO ASSUMED OF AMOUNT
GROSS OTHER FROM OTHER NET ASSUMED
AMOUNT COMPANIES COMPANIES AMOUNT TO NET
-------- --------- ---------- ------- ----------
<S> <C> <C> <C> <C> <C>
1996
Premiums:
Property and casualty insurance.... $105,467 $13,021 $ 45 $92,491 --
-------- ------- ---- ------- ---
Total premiums.................. $105,467 $13,021 $ 45 $92,491 --
======== ======= ==== ======= ===
1995
Premiums:
Property and casualty insurance.... $113,538 $15,093 $247 $98,692 0.3%
-------- ------- ---- ------- ---
Total premiums.................. $113,538 $15,093 $247 $98,692 0.3%
======== ======= ==== ======= ===
1994
Premiums:
Property and casualty insurance.... $103,871 $11,533 $143 $92,481 0.2%
-------- ------- ---- ------- ---
Total premiums.................. $103,871 $11,533 $143 $92,481 0.2%
======== ======= ==== ======= ===
</TABLE>
67
<PAGE> 68
SCHEDULE V
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
ADDITIONS
------------------------
BALANCE AT CHARGED TO CHARGED TO BALANCE AT
BEGINNING OF COSTS AND OTHER END OF
PERIOD EXPENSES ACCOUNTS DEDUCTIONS(1) PERIOD
------------ ---------- ---------- ------------- ----------
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1996
Allowance for possible losses on
premiums receivable........... $ 768 $423 $ -- $329 $862
====== ==== ==== ==== ====
Allowance for possible losses on
reinsurance receivable........ $ 70 $ -- $ -- $ 70 $ --
====== ==== ==== ==== ====
Year ended December 31, 1995
Allowance for possible losses on
premiums receivable........... $ 898 $245 $ -- $375 $768
====== ==== ==== ==== ====
Allowance for possible losses on
reinsurance receivable........ $ 5 $ 65 $ -- $ -- $ 70
====== ==== ==== ==== ====
Year ended December 31, 1994
Allowance for possible losses on
premiums receivable........... $1,276 $190 $ -- $568 $898
====== ==== ==== ==== ====
Allowance for possible losses on
reinsurance receivable........ $ 2 $ 3 $ -- $ -- $ 5
====== ==== ==== ==== ====
</TABLE>
- ---------------
(1) Accounts charged against allowance.
68
<PAGE> 69
SCHEDULE VI
CAPSURE HOLDINGS CORP. AND SUBSIDIARIES
SUPPLEMENTAL INFORMATION CONCERNING PROPERTY-CASUALTY
INSURANCE OPERATIONS
AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Deferred policy acquisition costs.......................... $ 28,523 $ 27,057 $ 25,150
======== ======== ========
Reserves for unpaid claims and claim adjustment expenses... $ 38,874 $126,061 $149,041
======== ======== ========
Discount (if any) deducted................................. $ -- $ -- $ --
======== ======== ========
Unearned premiums.......................................... $ 69,570 $ 76,781 $ 76,630
======== ======== ========
Net earned premiums........................................ $ 92,491 $ 98,692 $ 92,481
======== ======== ========
Net investment income...................................... $ 14,195 $ 19,773 $ 18,597
======== ======== ========
Net claims and claim adjustment expenses incurred related
to:
Current year............................................. $ 16,909 $ 21,631 $ 31,688
======== ======== ========
Prior years.............................................. $ (6,855) $(29,082) $ (8,344)
======== ======== ========
Amortization of deferred policy acquisition costs.......... $ 37,505 $ 35,759 $ 29,390
======== ======== ========
Net paid claims and claim adjustment expenses.............. $ 11,039 $ 16,636 $ 16,719
======== ======== ========
Net premiums written....................................... $ 95,109 $ 97,728 $ 90,578
======== ======== ========
</TABLE>
69
<PAGE> 70
(a)(3) EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C>
2 Reorganization Agreement dated as of December 19, 1996 among
Capsure Holdings Corp., Continental Casualty Company, CNA
Surety Corporation, Surety Acquisition Company and certain
affiliates of Continental Casualty Corporation (filed on
December 27, 1996 as Exhibit 2 to Capsure Holdings Corp.'s
Form 8-K, and incorporated herein by reference).
3(1) The Certificate of Incorporation of Nucorp, Inc. dated May
6, 1988 together with the Certificate of Merger of Nucorp
Energy, Inc. with and into Nucorp, Inc. dated August 12,
1988 (filed on August 15, 1988 as Exhibit 3.1 to Nucorp,
Inc.'s Quarterly Report on Form 10-Q for the Period March
31, 1988 through June 30, 1988, and incorporated herein by
reference).
3(2) Amendment to the Certificate of Incorporation dated July 14,
1995 (filed on March 27, 1996 as Exhibit 3.2 to Capsure
Holdings Corp.'s Form 10-K, and incorporated herein by
reference).
3(3) Bylaws of Nucorp, Inc. (filed on August 15, 1988 as Exhibit
3.2 to Nucorp, Inc.'s Quarterly Report on Form 10-Q for the
Period March 31, 1988 through June 30, 1988, and
incorporated herein by reference).
4 Specimen of Capsure Holdings Corp. Common Stock Certificate
(filed on March 30, 1995 as Exhibit 4 to Capsure Holdings
Corp.'s Form 10-K, and incorporated herein by reference).
9 Not applicable.
10(1) Employment Agreement dated as of September 30, 1995 by and
between Capsure Holdings Corp., a Delaware corporation, and
Bruce A. Esselborn, an individual (filed on March 27, 1996
as Exhibit 10.1 to Capsure Holdings Corp.'s Form 10-K, and
incorporated herein by reference).
10(2) First Amendment dated as of February 20, 1997 to the
Employment Agreement dated as of September 30, 1995 by and
between Capsure Holdings Corp., a Delaware corporation, and
Bruce A. Esselborn, an individual.
10(3) Employment Agreement dated as of September 30, 1995 by and
between Capsure Holdings Corp., a Delaware corporation, and
Mary Jane Robertson, an individual (filed on March 27, 1996
as Exhibit 10.2 to Capsure Holdings Corp.'s Form 10-K, and
incorporated herein by reference).
10(4) First Amendment dated as of February 20, 1997 to the
Employment Agreement dated as of September 30, 1995 by and
between Capsure Holdings Corp., a Delaware corporation, and
Mary Jane Robertson, an individual.
10(5) Employment Agreement dated as of September 22, 1994 by and
among Universal Surety Holdings Corp., Universal Surety of
America, Capsure Financial Group, Inc., Capsure Holdings
Corp. and John Knox, Jr.
10(6) Employment Agreement dated as of April 26, 1996 (effective
as of April 15, 1996) by and Between Western Surety Company
and Steven T. Pate.
10(7) Purchase Agreement dated as of December 21, 1989 among
Nucorp, Inc. and Bruce A. Esselborn (filed on August 2, 1990
as Exhibit 10.8 to Post-Effective Amendment No. 1 to
Nucorp's Registration Statement on Form S-1, and
incorporated herein by reference).
</TABLE>
70
<PAGE> 71
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C>
10(8) Purchase Agreement dated as of March 25, 1992 among Nucorp,
Inc., SI Acquisition Corp. and Surewest Financial Corp.
(filed on March 27, 1992, as Exhibit 2 on Form 8-K, and
incorporated herein by reference).
10(9) Stock Purchase Agreement between Nucorp, Inc.; SI
Acquisition Corp.; Surewest Financial Corp.; Joe P. Kirby;
Dan L. Kirby; Kevin T. Kirby; Steven T. Kirby; First Bank of
South Dakota, N.A., as Trustee of the Dan L. Kirby Trust;
First Bank of South Dakota, N.A., as Trustee of the Kevin T.
Kirby Trust; Norwest Bank South Dakota, N.A., as Trustee of
the Joe P. Kirby Trust; and Norwest Bank South Dakota, N.A.,
as Trustee of the Steven T. Kirby Trust, dated March 25,
1992 and schedules thereto (filed on March 25, 1992 as
Exhibit 2 on Nucorp, Inc.'s Form 8-K, and incorporated
herein by reference).
10(10) Credit Agreement dated as of March 29, 1994, as amended and
restated as of May 22, 1996, among Capsure Financial Group,
Inc., Capsure Holdings Corp., the Lenders named therein and
Chemical Bank, as Administrative Agent (filed on June 3,
1996 as Exhibit 2.2 to Capsure Holdings Corp's Form 8-K, and
incorporated herein by reference).
10(11) Stock Purchase Agreement among John Knox, Jr., Universal
Surety Holding Corp., Capsure Financial Group, Inc. and
Capsure Holdings Corp. dated July 26, 1994 (filed on October
6, 1994 as Exhibit 2 to Capsure Holdings Corp. Current
Report on Form 8-K, and incorporated herein by reference).
10(12) Amended and Restated 1990 Stock Option Plan (filed on April
16, 1996 as part of Capsure Holdings Corp.'s Proxy Statement
for the Annual Meeting of Shareholders on May 23, 1996, and
incorporated herein by reference).
10(13) Non-Competition and Non-Solicitation Agreement between
Capsure Holdings Corp. and Frontier Insurance Company, dated
as of May 22, 1996.
10(14) Contract Surety Bond Reinsurance Agreement dated as of
September 22, 1994 between Western Surety Company, a South
Dakota corporation, and Universal Surety of America, a Texas
corporation (filed on March 30, 1995 as Exhibit 10.23 to
Capsure Holdings Corp's Form 10-K, and incorporated herein
by reference).
10(15) Co-Employee Agreement dated as of September 22, 1994 between
Western Surety Company and Universal Surety of America
(filed on March 30, 1995 as Exhibit 10.24 to Capsure
Holdings Corp's Form 10-K, and incorporated herein by
reference).
10(16) Directors' and Officers' and Errors and Omissions Liability
Quota Share Reinsurance Agreement dated as of August 15,
1994 between Western Surety Company, a South Dakota
corporation, and United Capitol Insurance Company, a
Wisconsin corporation (filed on March 27, 1996 as Exhibit
10.19 to Capsure Holdings Corp.'s Form 10-K, and
incorporated herein by reference.)
10(17) Stock Purchase Agreement dated as of February 29, 1996 among
Capsure Holdings Corp., NI Acquisition Corp. and Frontier
Insurance Company (Filed on June 3, 1996 as Exhibit 2.1 to
Capsure Holdings Corp.'s Form 8-K, and incorporated herein
by reference).
11 Earnings per share computation.
12 Not applicable.
13 Not applicable.
16 Not applicable.
18 Not applicable.
21 Subsidiaries of the Registrant.
</TABLE>
71
<PAGE> 72
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C>
22 Not applicable.
23 Consent of Coopers & Lybrand dated March 12, 1997.
24(1) Power of Attorney for Herbert A. Denton dated February 26,
1997.
24(2) Power of Attorney for Bradbury Dyer, III dated February 26,
1997.
24(3) Power of Attorney for Talton R. Embry dated February 26,
1997.
24(4) Power of Attorney for Dan L. Kirby dated February 26, 1997.
24(5) Power of Attorney for Joe P. Kirby dated February 26, 1997.
24(6) Power of Attorney for L.G. Schafran dated February 27, 1997.
</TABLE>
"SAFE HARBOR" STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995:
The statements which are not historical facts contained in this Annual
Report and Form 10-K are forward-looking statements that involve risks and
uncertainties, including, but not limited to, product and policy demand and
market response risks, the effect of economic conditions, the impact of
competitive products, policies and pricing, product and policy development,
regulatory changes and conditions, rating agency policies and practices,
development of claims and the effect on loss reserves, the performance of
reinsurance companies under reinsurance contracts with the Company, investment
portfolio developments and reaction to market conditions, the results of
financing efforts, the actual closing of contemplated transactions and
agreements, the effect of the Company's accounting policies, and other risks
detailed in the Company's Securities and Exchange Commission filings. No
assurance can be given that the actual results of operations and financial
condition will conform to the forward-looking statements contained herein.
72
<PAGE> 73
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
CAPSURE HOLDINGS CORP.
/s/ BRUCE A. ESSELBORN
--------------------------------------
Bruce A. Esselborn
President
(Principal Executive Officer)
/s/ MARY JANE ROBERTSON
--------------------------------------
Mary Jane Robertson
Senior Vice President and Chief
Financial Officer
(Principal Financial Officer)
/s/ JOHN S. HENEGHAN
--------------------------------------
John S. Heneghan
Vice President and Controller
(Principal Accounting Officer)
Dated: March 21, 1997
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, 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
--------- ----- ----
<C> <C> <S>
/s/ SAMUEL ZELL Chairman of the Board and Chief March 21, 1997
- ----------------------------------------------------- Executive Officer
Samuel Zell
/s/ ROD F. DAMMEYER Director March 21, 1997
- -----------------------------------------------------
Rod F. Dammeyer
*HERBERT A. DENTON Director March 21, 1997
- -----------------------------------------------------
*Herbert A. Denton
*BRADBURY DYER, III Director March 21, 1997
- -----------------------------------------------------
*Bradbury Dyer, III
*TALTON R. EMBRY Director March 21, 1997
- -----------------------------------------------------
*Talton R. Embry
/s/ BRUCE A. ESSELBORN Director March 21, 1997
- -----------------------------------------------------
*Bruce A. Esselborn
*DAN L. KIRBY Director March 21, 1997
- -----------------------------------------------------
*Dan L. Kirby
*JOE P. KIRBY Director March 21, 1997
- -----------------------------------------------------
*Joe P. Kirby
/s/ DONALD W. PHILLIPS Director March 21, 1997
- -----------------------------------------------------
Donald W. Phillips
/s/ SHELI Z. ROSENBERG Director and March 21, 1997
- ----------------------------------------------------- *Attorney-in-Fact
Sheli Z. Rosenberg
*L. G. SCHAFRAN Director March 21, 1997
- -----------------------------------------------------
*L. G. Schafran
/s/ RICHARD I. WEINGARTEN Director March 21, 1997
- -----------------------------------------------------
Richard I. Weingarten
</TABLE>
73
